RISK FACTORS
Investing in our common stock involves a high degree of risk. You should carefully
consider the following risk factors and all other information contained in this prospectus supplement and the accompanying prospectus and incorporated by reference into the accompanying prospectus before purchasing our common stock. The risks and
uncertainties described below are not the only ones facing us. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us. If any of such risks or the risks
described below occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and you may lose some or all of your investment.
Risks Related to Our Business and Industry
Our business plan relies on certain assumptions pertaining to the market for our products that, if incorrect, may adversely affect our growth and profitability.
We allocate our design, development, manufacturing, marketing, management and financial resources based on our business plan, which includes assumptions
about various demographic trends and trends in the treatment of spine disorders and the resulting demand for our products. However, these trends are uncertain. There can be no assurance that our assumptions with respect to an aging population with
broad medical coverage and longer life expectancy, which we expect to lead to increased spinal injuries and degeneration, are accurate. In addition, an increasing awareness and use of non-invasive means for the prevention and treatment of back pain
and rehabilitation purposes may reduce demand for, or slow the growth of sales of, spine fusion products. A significant shift in technologies or methods used in the treatment of back pain or damaged or diseased bone and tissue could adversely
affect demand for some or all of our products. For example, pharmaceutical advances could result in non-surgical treatments gaining more widespread acceptance as a viable alternative to spine fusion. The emergence of new biological tissue-based or
synthetic materials to facilitate regeneration of damaged or diseased bone and to repair damaged tissue could increasingly minimize or delay the need for spine fusion surgery and provide other biological alternatives to spine fusion. New surgical
procedures could diminish demand for some of our products. The increased acceptance of emerging technologies that do not require spine fusion, such as artificial discs and nucleus replacement, for the surgical treatment of spine disorders would
reduce demand for, or slow the growth of sales of, spine fusion products. If our assumptions regarding these factors prove to be incorrect or if alternative treatments to those offered by our products gain further acceptance, then actual demand for
our products could be significantly less than the demand we anticipate for our products and we may not be able to achieve or sustain growth or profitability.
If we fail to properly manage our anticipated growth, our business could suffer.
We continue to experience rapid
growth in, and we will continue to pursue rapid growth in, the number of surgeons using our products, the types of products we offer and the number of states in which our products are sold. Such growth has placed and will continue to place
significant demands on our managerial, operational and financial resources and systems. We are currently focused on increasing the size and effectiveness of our sales force and distribution network, marketing activities, research and development
efforts, inventory management systems, management team and corporate infrastructure. If we do not manage our growth effectively, the quality of our products, our relationships with physicians, distributors and hospitals, and our reputation could
suffer, which would have a material adverse effect on our business, financial condition and results of operations. For example, in 2006, our revenues were adversely impacted by a sales force reorganization and a slower than expected revenue ramp
among newer distributors and recently hired direct sales professionals. We must attract and retain qualified personnel and third-party distributors and manage and train them effectively. Personnel qualified in the design, development, production and
marketing of our products are difficult to find and hire, and enhancements of information technology systems to support our growth are difficult to implement. We will also need to carefully monitor and manage our surgeon services, our manufacturing
capabilities, quality assurance and
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efficiency, and the quality assurance and efficiency of our suppliers and distributors. This managing, training and monitoring will require allocation of
valuable management resources and significant expense. The efficient operation of our business is dependent on our management information systems. We rely on our management information systems to effectively manage accounting and financial
functions; manage order entry, order fulfillment and inventory replenishment processes; and maintain our research and development data. Any failure of our management information systems to perform as we anticipate could disrupt our business and
product development and could result in decreased sales, increased overhead costs, excess inventory and product shortages, causing our business and results of operations to suffer.
We may not be successful in manufacturing spine fusion products at the levels required to meet future market demand.
We are seeking to rapidly grow sales of our products and if we are successful, such growth may strain our ability to manufacture an increasingly large supply of our products. We have never produced spine fusion
products in quantities significantly in excess of our current production levels. Manufacturers regularly experience difficulties in scaling up production and we may face such difficulties in increasing our production levels. Moreover, we
may not be able to manufacture our products with consistent and satisfactory quality or in sufficient quantities to meet demand. Our failure to produce products of satisfactory quality or in sufficient quantities could hurt our reputation,
cause hospitals, surgeons or distributors to cancel orders or refrain from placing new orders for our products and reduce or slow growth of sales of our products. Increases in our production volume also could make it harder for us to maintain
control over expenses, manage our relationships with our suppliers, maintain good relations with our employees or otherwise manage our business.
We
are in a highly competitive market segment, face competition from large, well-established medical device companies with significant resources, and may not be able to compete effectively.
The market for spine fusion products and procedures is intensely competitive, subject to rapid technological change and significantly affected by new
product introductions and other market activities of industry participants. In 2006, approximately 67% of U.S. spine fusion product revenues were generated by Medtronic Sofamor Danek, Inc., a subsidiary of Medtronic, Inc.,
Depuy, Inc., a subsidiary of Johnson & Johnson, and Synthes, Inc. Our competitors also include numerous other publicly traded companies and privately held companies.
Several of our competitors enjoy competitive advantages over us, including:
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more established relationships with spine surgeons;
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more established distribution networks;
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broader spine surgery product offerings;
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stronger intellectual property portfolios;
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greater financial and other resources for product research and development, sales and marketing, and patent litigation;
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greater experience in, and resources for, launching, marketing, distributing and selling products;
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significantly greater name recognition as well as more recognizable trademarks for products similar to the products that we sell;
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more established relationships with healthcare providers and payors;
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products supported by more extensive clinical data; and
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greater experience in obtaining and maintaining FDA and other regulatory clearances or approvals for products and product enhancements.
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In addition, at any time our current competitors or other companies may develop alternative
treatments, products or procedures for the treatment of spine disorders that compete directly or indirectly with our products, including ones that prove to be superior to our spine surgery products. For these reasons, we may not be able to
compete successfully against our existing or potential competitors. Any such failure could lead us to modify our strategy, lower our prices, increase the commissions we pay on sales of our products and have a material adverse effect on our business,
financial condition and results of operations.
A large percentage of our revenues are derived from the sale of our polyaxial pedicle screws.
Net sales of our Zodiac polyaxial pedicle screws represented approximately 39.9% and 36.3% of our net sales for 2005 and for 2006,
respectively. A decline in sales of these screws, due to market demand, the introduction by a third party of a competitive product, an intellectual property dispute involving these screws, or otherwise, would have a material adverse impact on our
business, financial condition and results of operations. Some of the technology related to our polyaxial pedicle screws is licensed to us. The loss of such license would prevent us from manufacturing, marketing and selling our Zodiac polyaxial
pedicle screws and other future products that may incorporate such technology, which would have a material adverse effect on our business, financial condition and results of operations.
To be commercially successful, we must convince the spine surgeon community that our products are an attractive alternative to our competitors products. If
the spine surgeon community does not use our products, our sales will decline or we will be unable to increase our sales and profits.
In order for us to sell our products, surgeons must be convinced that they are superior to competing products for use in spine fusion procedures. Acceptance of our products depends on educating the spine surgeon community as to the
distinctive characteristics, perceived benefits, safety and cost-effectiveness of our products compared to our competitors products and on training surgeons in the proper application of our products. If we are not successful in convincing the
spine surgeon community of the merit of our products, our sales will decline and we will be unable to increase our sales and will be unable to achieve and sustain growth or profitability.
There is a learning process involved for spine surgeons to become proficient in the use of our products. Although most spine surgeons may have
adequate knowledge on how to use most of our products based on their clinical training and experience, we believe that the most effective way to introduce and build market demand for our products is by directly training spine surgeons in the use of
the products. If surgeons are not properly trained, they may misuse or ineffectively use our products. This may also result in unsatisfactory patient outcomes, patient injury, negative publicity or lawsuits against us, any of which could
have a material adverse effect on our business, financial condition and results of operations.
Our sales and marketing efforts are largely dependent
upon third parties who are free to market products that compete with our products.
In the United States, we currently sell our
products primarily through a network of approximately 72 independent distributors, which we believe employ approximately 180 agents. As a result, we are dependent upon the sales and marketing efforts of our independent distributors. We also employ
38 direct sales representatives and executives, 18 of whom sell our products in the United States, 18 of whom sell our products in Japan and two of whom sell our products in Hong Kong. We pay our independent distributors a commission based on their
product placements and sales. Certain of our independent distributors also market and sell the products of our competitors, and those competitors may have the ability to influence the products that our independent distributors choose to market
and sell. Our competitors may be able, by offering higher commission payments or otherwise, to convince our independent distributors to terminate their relationships with us, carry fewer of our products or reduce their sales and marketing
efforts for our products.
As we launch new products and increase our marketing efforts with respect to existing products, we will need to
expand our sales and marketing organization. We plan to accomplish this by increasing our network of independent distributors and hiring additional direct sales representatives. The establishment and development of
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a broader sales network and dedicated sales force may be expensive and time consuming. Because of the intense competition for their services, we
may be unable to recruit or retain additional qualified independent distributors and to hire additional direct sales representatives to work with us. Often, our competitors enter into distribution agreements with independent distributors that
require such distributors to exclusively sell the products of our competitors. Further, we may not be able to enter into agreements with independent distributors on commercially reasonable terms, if at all. Even if we do enter into agreements
with additional independent distributors, it often takes 90 to 120 days for new distributors to reach full operational effectiveness and such distributors may not generate revenue as quickly as we expect them to, commit the necessary resources
to effectively market and sell our products or ultimately be successful in selling our products. Our business, financial condition and results of operations will be materially adversely affected if we do not retain our existing independent
distributors and attract new, additional independent distributors or if the marketing and sales efforts of our independent distributors and our own direct sales representatives are unsuccessful.
We depend on various third-party suppliers, and in one case a single third-party supplier, for key raw materials used in our manufacturing processes and the loss
of these third-party suppliers, or their inability to supply us with adequate raw materials, could harm our business.
We use a
number of raw materials, including titanium, titanium alloys, stainless steel, polyetheretherketone, or PEEK, and allograft, which is human tissue donated by a third party. We rely from time to time on a number of suppliers and in one case on a
single source vendor, Invibio, Inc. We have a supply agreement with Invibio, pursuant to which it supplies us with PEEK, a biocompatible plastic that we use in some of our spacers. Invibio is still currently the only company approved to
distribute PEEK in the United States for use in implantable devices. 11.3% and 15.9% of our revenues were derived from products manufactured using PEEK during 2005 and 2006, respectively.
We depend on a limited number of sources of human tissue for use in our allograft implants and a limited number of entities to process the human tissue
into allograft for our allograft implants, and any failure to obtain tissue from these sources or to have the tissue processed by these entities for us in a timely manner will interfere with our ability to effectively meet demand for our allograft
implants. The processing of human tissue into allograft is very labor intensive and it is therefore difficult to maintain a steady supply stream. In addition, due to seasonal changes in mortality rates, some scarce tissues used for our allograft are
at times in particularly short supply. We cannot be certain that our supply of human tissue from our current suppliers and our supply of allograft from our current tissue processors will be available at current levels or will be sufficient to meet
our needs.
Our dependence on a single third-party PEEK supplier and the challenges we may face in obtaining adequate supplies of
allograft involve several risks, including limited control over pricing, availability, quality and delivery schedules. In addition, any supply interruption in a limited or sole sourced component or raw material, such as PEEK or allograft, could
materially harm our ability to manufacture our products until a new source of supply, if any, could be found. We may be unable to find a sufficient alternative supply channel in a reasonable time period or on commercially reasonable terms, if
at all, which would have a material adverse effect on our business, financial condition and results of operations.
Negative publicity concerning
methods of tissue recovery and screening of donor tissue in our industry could reduce demand for allograft and impact the supply of available donor tissue.
Media reports or other negative publicity concerning both alleged improper methods of tissue recovery from donors and disease transmission from donated tissue could limit widespread acceptance of allograft.
Unfavorable reports of improper or illegal tissue recovery practices, both in the United States and internationally, as well as incidents of improperly processed tissue leading to the transmission of disease, may broadly affect the rate of
future tissue donation and market acceptance of allograft technologies. In addition, such negative publicity could cause the families of potential donors to become reluctant to agree to donate tissue to for-profit tissue processors, which could have
a negative effect on our allograft business.
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If hospitals and other healthcare providers are unable to obtain sufficient reimbursement for procedures performed
with our products, it is unlikely that our products will be widely used.
Successful sales of our products will depend on the
availability of adequate reimbursement from third-party payors, including government programs such as Medicare and Medicaid, private insurance plans and managed care programs. Hospitals and other healthcare providers that purchase medical devices
such as the ones that we manufacture for the treatment of their patients generally rely on third-party payors to pay for all or a part of the costs and fees associated with the procedures performed with these devices. The existence of adequate
reimbursement for the procedures performed with our products by government and private insurance plans are central to the acceptance of our current and future products. We may be unable to sell our products through our distribution channels on
a profitable basis if third-party payors deny coverage or reduce their current levels of payment, or if our costs of production increase faster than increases in reimbursement levels. Many private payors use coverage decisions and payment amounts
determined by the Centers for Medicare & Medicaid Services, or CMS, which administers the Medicare program, as guidelines in setting their reimbursement policies. Future action by CMS or other government agencies may diminish payments
to physicians, outpatient centers and hospitals. Those private payors that do not follow the Medicare guidelines may adopt different reimbursement policies for procedures performed with our products. For some governmental programs, such as
Medicaid, reimbursement differs from state to state, and some state Medicaid programs may not pay for the procedures performed with our products in an adequate amount, if at all. As the portion of the U.S. population over age 65 and eligible
for Medicare continues to grow, we may become more vulnerable to reimbursement limitations imposed by CMS. Furthermore, the healthcare industry in the United States has experienced a trend toward cost containment as government and private
insurers seek to control healthcare costs by imposing lower payment rates and negotiating reduced contract rates with service providers. Therefore, we cannot be certain that the procedures performed with our products will be adequately reimbursed.
Continued market acceptance in Japan will depend, in part, upon the availability of reimbursement within its healthcare payment systems.
Reimbursement and healthcare payment systems vary significantly from country to country, and include both government sponsored healthcare and private insurance. We may not continue to obtain reimbursement approvals in Japan in a timely manner,
if at all. Any failure to receive reimbursement approvals would negatively impact market acceptance of our products in Japan and any other international markets in which those approvals are sought.
We may face significant uncertainty in the industry due to government healthcare reform.
Political, economic and regulatory influences are subjecting the healthcare industry to fundamental changes. Reforms under consideration in the United
States include mandated basic healthcare benefits, controls on healthcare spending through limitations on the growth of private health insurance premiums and Medicare and Medicaid spending, the creation of large insurance purchasing groups and
significant modifications to the healthcare delivery system. We anticipate that Congress and certain state legislatures will continue to review and assess alternative healthcare delivery systems and payment methods. Public debate of these issues
will likely continue in the future. Due to uncertainties regarding the ultimate features of reform initiatives and their enactment and implementation, we cannot predict which, if any, of such reform proposals will be adopted, when they
may be adopted or what impact they may have on us.
We are subject to substantial governmental regulation that could change and thus force
us to make modifications to how we develop, manufacture and price our products.
The medical device industry is regulated
extensively by governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies. The FDA and other federal, state and foreign governmental agencies regulate, among other things, the development, manufacturing,
clinical trials, marketing clearance and approval, promotion and sale of medical devices.
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Compliance with these regulations are, and will continue to be, time consuming, burdensome and expensive.
Failure to comply with these regulations could jeopardize our ability to manufacture and sell our products and result in enforcement actions such as warning letters, fines, injunctions, civil penalties, termination of distribution, seizures of
products, total or partial suspension of production, refusal of the FDA or other regulatory agencies to grant future clearances or approvals, or withdrawals or suspensions of current clearances or approvals, all of which could result in higher than
anticipated costs or lower than anticipated revenue and have a material adverse effect on our business, financial condition and results of operations. In the most egregious cases, we could face criminal sanctions, closure of our manufacturing
facilities and prohibitions on the sales of our products.
The regulations to which we are subject are complex and have tended to become
more stringent over time. Regulatory changes could result in restrictions on our ability to carry on or expand our operations, higher than anticipated costs or lower than anticipated revenue.
Foreign governmental authorities that regulate the manufacture and sale of medical devices have become increasingly vigilant and sales of our products in
foreign countries are subject to rigorous foreign regulations. We rely on Alphatec Pacific, Inc. with respect to compliance with Japanese regulations. In Hong Kong, the only other country where we currently sell products, we have an internal sales
force that sells our products to comply with local regulations. Any failure to comply with applicable regulations could result in restrictions on the sale of our products in foreign countries.
If we fail to obtain, or experience significant delays in obtaining, FDA clearances or approvals for our future products or modifications to our products, our
ability to commercially distribute and market our products could suffer.
Our medical devices are subject to rigorous regulation by
the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory clearances or approvals to market a medical device, particularly from the FDA, can be costly and time consuming, and there can be no
assurance that such clearances or approvals will be granted on a timely basis, if at all. In particular, the FDA permits commercial distribution of most new medical devices only after the devices have received clearance under Section 510(k) of
the Federal Food, Drug and Cosmetic Act, or 510(k), or are the subject of an approved pre-market approval application, or a PMA. The 510(k) process generally takes three to nine months, but can take significantly longer. A PMA must be submitted to
the FDA if the device cannot be cleared through the 510(k) process or is not exempt from pre-marketing review by the FDA. A PMA must be supported by extensive data, including results of preclinical studies and clinical trials, manufacturing and
control data and proposed labeling, to demonstrate to the FDAs satisfaction the safety and effectiveness of the device for its intended use. The PMA process is more costly and uncertain than the 510(k) clearance process, and generally takes
between one and three years, if not longer. In addition, any modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design or manufacture,
requires a new 510(k) clearance or, possibly, a PMA.
Our commercial distribution and marketing of any products or product modifications
that we develop may be delayed since regulatory clearance or approval is required. In addition, because we cannot assure you that any new products or any product modifications we develop will be subject to the shorter 510(k) clearance process,
the regulatory approval process for our new products or product modifications may take significantly longer than anticipated. There is no assurance that the FDA will not require a new product or product modification to go through the lengthy
and expensive PMA approval process. Delays in obtaining regulatory clearances and approvals may:
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delay or prevent commercialization of products we develop;
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require us to perform costly procedures;
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diminish any competitive advantages that we may attain; and
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reduce our ability to collect revenues or royalties.
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To date, all of our medical device products have been cleared through the 510(k) process. We have no experience in obtaining approval for a device through the PMA process.
Our allograft implants and related technologies could become subject to significantly greater regulation by the FDA, which could disrupt our business.
The FDA may regulate certain allografts as medical devices, drugs or biologics if the allograft is deemed to have been more than
minimally manipulated or indicated for nonhomologous use. Homologous use is generally interpreted as the use of tissue for the same basic function in the recipient as it fulfilled in the donor. If the FDA decides that any of our current or future
allografts are more than minimally manipulated or indicated for nonhomologous use, it would require us to either obtain 510(k) clearance or a PMA approval if the allograft is viewed as a medical device or obtain approval as a drug or biologic if it
is viewed as a drug or biologic. Depending on the nature and extent of any FDA decision applicable to our allografts, further distribution of the affected products could be interrupted for a substantial period of time, which would reduce our
revenues and hurt our profitability.
The safety of our products is not yet supported by long-term clinical data and may therefore prove to be
less safe and effective than initially thought.
We obtained clearance to offer all of our current medical device products through
the FDAs 510(k) clearance process. The 510(k) clearance process is generally based on the FDAs agreement that a new product is substantially equivalent to already marketed products. Thus, the FDAs 510(k) clearance process is less
rigorous than the PMA process and requires little, if any, supporting clinical data. For these reasons, surgeons may be slow to adopt our 510(k)-cleared products, we may not have the comparative data that our competitors have or are
generating, and we may be subject to greater regulatory and product liability risks. Further, future studies or experience may indicate that treatment with our products does not improve patient outcomes. Such results would reduce demand
for our products and this could cause us to withdraw our products from the market. Moreover, if future studies or experience indicate that our products cause unexpected or serious complications or other unforeseen negative effects, we could be
subject to significant legal liability, significant negative publicity, damage to our reputation and a dramatic reduction in sales of our products, all of which would have a material adverse effect on our business, financial condition and results of
operations.
If we or our suppliers fail to comply with the FDAs quality system and good tissue practice regulations, the manufacture of our
products could be delayed.
We and our suppliers are required to comply with the FDAs quality system regulations, or QSRs,
which cover the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. In addition, suppliers and processors of allograft must comply with
the FDAs current good tissue practice regulations, or CGTPs, which govern the methods used in and the facilities and controls used for the manufacture of human cell tissue and cellular and tissue-based products, record keeping and the
establishment of a quality program. The FDA audits compliance with the QSRs and CGTPs through inspections of manufacturing and other facilities. If we or our suppliers have significant non-compliance issues or if any corrective action plan is not
sufficient, we or our suppliers could be forced to delay the manufacture of our products until such problems are corrected to the FDAs satisfaction, which could have a material adverse effect on our business, financial condition and results of
operations. Further, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective. Any recall or FDA requirement demanding that we seek additional approvals or clearances could result in
delays, costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA, all of which could have a material adverse effect on our business, financial condition and results of
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operations. As a result of our last inspection in November 2003, minor non-compliance items were cited on an FDA Form 483, which is a notice of
inspection observation that we received following the inspection. Following receipt of the Form 483, we submitted a formal response in which we indicated the steps that we had taken to correct the noted deficiencies and we have not received any
further request from the FDA with respect to the Form 483 we received.
If we choose to acquire new and complementary businesses, products or
technologies, we may be unable to complete these acquisitions or successfully integrate them in a cost effective and non-disruptive manner.
Our success depends in part on our ability to continually enhance and broaden our product offering in response to changing customer demands, competitive pressures and technologies and our ability to increase our
market share. Accordingly, we intend to pursue the acquisition of complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to successfully complete any acquisitions, or whether we
will be able to successfully integrate any acquired business, product or technology into our business or retain any key personnel, suppliers or distributors. Our ability to successfully grow through acquisitions depends upon our ability to identify,
negotiate, complete and integrate suitable acquisitions and to obtain any necessary financing. These efforts could be expensive and time consuming, disrupt our ongoing business and distract management. If we are unable to integrate any future
acquired businesses, products or technologies effectively, our business, financial condition and results of operations will be materially adversely affected. For example, an acquisition could materially impair our operating results by causing us to
incur debt or requiring us to amortize significant amounts of expenses, including non-cash acquisition costs, and acquired assets.
We may face
additional challenges in our attempts to expand in the Japanese market.
We believe that many of the primary barriers to success in
the market for spinal products in Japan are similar to those in the United States, including the challenges of increasing market penetration, expanding the direct representative sales force and obtaining regulatory approval for new products. In
addition, we may face additional difficulties and challenges in Japan, including the expansion of the scope of our spine product offering, despite our history of selling orthopedic trauma products in Japan, and the receipt by Alphatec Pacific
of Japanese regulatory approval for some of our existing products to permit Alphatec Pacifics spine fusion product line offering to become as extensive as ours is in the United States.
We may not be able to timely develop new products or product enhancements that will be accepted by the market.
We sell our products in a market that is characterized by technological change, product innovation, evolving industry standards, competing patent claims,
patent litigation and intense competition. Our success will depend in part on our ability to develop and introduce new products and enhancements or modifications to our existing products, which we will need to do before our competitors do so
and in a manner that does not infringe issued patents of third parties from which we do not have a license. We cannot assure you that we will be able to successfully develop or market new, improved or modified products, or that any of our future
products will be accepted by even the surgeons who use our current products. Our competitors product development capabilities could be more effective than our capabilities, and their new products may get to market before our products. In
addition, the products of our competitors may be more effective or less expensive than our products. The introduction of new products by our competitors may lead us to have price reductions, reduced margins or loss of market share and
may render our products obsolete or noncompetitive. The success of any of our new product offerings or enhancement or modification to our existing products will depend on several factors, including our ability to:
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properly identify and anticipate surgeon and patient needs;
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develop new products or enhancements in a timely manner;
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obtain the necessary regulatory approvals for new products or product enhancements;
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provide adequate training to potential users of new products;
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receive adequate reimbursement approval of third-party payors such as Medicaid, Medicare and private insurers; and
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develop an effective marketing and distribution network.
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Developing products in a timely manner can be difficult, in particular because product designs change rapidly to adjust to third-party patent constraints and to market preferences. As a result, we may experience
delays in our product launches which may significantly impede our ability to enter or compete in a given market and may reduce the sales that we are able to generate from these products. We may experience delays in any phase of a
product launch, including during research and development, clinical trials, manufacturing, marketing and the surgeon training process. In addition, our suppliers of products or components that we do not manufacture can suffer similar delays, which
could cause delays in our product introductions. If we do not develop new products or product enhancements in time to meet market demand or if there is insufficient demand for these new products or enhancements, it could have a material adverse
effect on our business financial condition and results of operations.
Our products and product enhancements under development may not be
commercially viable.
While we devote significant resources to research and development, our research and development may not
lead to improved or new products that are commercially successful. The research and development process is expensive, prolonged and entails considerable uncertainty. Development of medical devices, from discovery, through testing and registration,
to initial product launch, typically takes between three and seven years in the United States. Each of these periods varies considerably from product to product and country to country. Because of the complexities and uncertainties associated with
spine fusion research and development, we may elect to cease development of one or more of our product candidates if we believe that the product candidate would not be commercially viable.
We are dependent on our senior management team, sales and marketing team, engineering team and key surgeon advisors, and the loss of any of them could harm our
business.
Our continued success depends in part upon the continued availability and contributions of our senior management,
sales and marketing team and engineering team and the continued participation of our key surgeon advisors. The Chairman of our board of directors, Mortimer Berkowitz III, has obligations outside Alphatec Holdings, including those arising in his
capacity as a Managing Member of HGP, LLC, the General Partner of (with a 20% profits interest in) HealthpointCapital, a private equity fund focused on the worldwide musculoskeletal sectorspecifically orthopedics and dental, and the President,
a member of the Board of Managers and a Managing Director of HealthpointCapital, LLC, a values-driven, research-based private equity firm exclusively focused on the musculoskeletal sectorspecifically orthopedics and dental, which owns a 25%
ownership interest in HGP, LLC and is the parent company of the fund manager of HealthpointCapital. Mr. Berkowitz is also a member of the board of directors of Scientx S.A., BioHorizons Implant Systems, Inc., BioLok International Inc.,
Micro Dental Laboratories and DTI Dental Technologies Inc. In addition, we have experienced significant turnover in our senior management team in recent years. For example, Shunshiro Roy Yoshimi recently tendered his resignation as
President, Chief Executive Officer and Chairman of Alphatec Pacific, to be effective October 31, 2007. While we have succession plans in place and have entered into employment agreements with all members of our senior management team, none of these
agreements guarantees the services of the individual for a specified period of time. We would be adversely affected if we fail to adequately plan for future turnover of our senior management team. Our ability to grow or at least maintain our sales
levels depends in large part on our ability to attract and retain sales and marketing personnel and for these sales people to maintain their relationships with surgeons directly and through our distributors. We rely on our engineering team to
research, design and develop potential products for our product pipeline. We also rely on our
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surgeon advisors to advise us on our products, our product pipeline, long-term scientific planning, research and development and industry trends. We compete
for personnel and advisors with other companies and other organizations, many of which are larger and have greater name recognition and financial and other resources than we do. The loss of members of our senior management team, sales and marketing
team, engineering team and key surgeon advisors, or our inability to attract or retain other qualified personnel or advisors could have a material adverse effect on our business, financial conditions and results of operations.
We rely on our information technology systems for inventory management, distribution and other functions and to maintain our research and development data. If our
information technology systems fail to adequately perform these functions, or if we experience an interruption in their operation, our business, financial condition and results of operations could be adversely affected.
The efficient operation of our business is dependent on our information technology systems. We rely on our information technology systems to effectively
manage accounting and financial functions; manage order entry, order fulfillment and inventory replenishment processes; and maintain our research and development data. The failure of our information technology systems to perform as we
anticipate could disrupt our business and product development and could result in decreased sales, increased overhead costs, excess inventory and product shortages, all of which could have a material adverse effect on our business, financial
condition and results of operations. In addition, our information technology systems are vulnerable to damage or interruption from:
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earthquake, fire, flood and other natural disasters;
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terrorist attacks and attacks by computer viruses or hackers;
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computer systems, or Internet, telecommunications or data network failure.
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Any such interruption could have material adverse effect on our business, financial condition and results of operations.
The majority of our operations and all of our manufacturing facilities are currently conducted in locations that may be at risk of damage from fire,
earthquakes or other natural disasters. If a natural disaster strikes, we may be unable to manufacture certain products for a substantial amount of time.
We currently conduct the majority of our development, manufacturing and management activities in Carlsbad, California near known wildfire areas and earthquake fault zones. We have taken precautions to safeguard our
facilities, including obtaining property and casualty insurance, and implementing health and safety protocols. We have started to store computer date offsite and expect to have completed the Information Technology disaster recovery plan in December
2007. However, any future natural disaster, such as a fire or an earthquake, could cause substantial delays in our operations, damage or destroy our equipment or inventory and cause us to incur additional expenses. A disaster could seriously harm
our business, financial condition and results of operations. Our facilities would be difficult to replace and would require substantial lead time to repair or replace. We do not maintain insurance against earthquakes and floods and the insurance we
maintain against fires and other natural disasters would not be adequate to cover a total loss of our manufacturing facilities, may not be adequate to cover our losses in any particular case and may not continue to be available to us on
acceptable terms, or at all.
Alphatec Holdings is a holding company with no operations, and unless it receives dividends or other payments from
Alphatec Spine, Inc., it will be unable to fulfill its cash obligations.
As a holding company with no business operations, Alphatec
Holdings material assets consist only of the common stock of Alphatec Spine (and any other subsidiaries Alphatec Holdings may own in the future), dividends and other payments received from time to time from Alphatec Spine or such
subsidiaries, and the proceeds raised from the sale of debt and equity securities. Alphatec Spine is legally distinct from Alphatec Holdings and has no obligation, contingent or otherwise, to make funds available to Alphatec Holdings. Alphatec
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Holdings will have to rely upon dividends and other payments from Alphatec Spine (and any other subsidiaries Alphatec Holdings may own in the future) to
generate the funds necessary to fulfill its cash obligations. Alphatec Holdings may not be able to access cash generated by Alphatec Spine in order to fulfill cash commitments. The ability of Alphatec Spine to make dividend and other payments
to Alphatec Holdings is subject to the availability of funds after taking into account Alphatec Spines funding requirements, the terms of Alphatec Spines indebtedness and applicable state laws. Alphatec Spines current credit
facilities from Bank of the West and General Electric Capital Corporation prohibit Alphatec Spine from declaring or paying dividends, other than dividends payable in capital stock, during the term of the facility, which expire in January 2008
and December 2009, respectively.
Risks Related to Our Financial Results and Need for Financing
Our quarterly financial results could fluctuate significantly.
Our quarterly financial results are difficult to predict and may fluctuate significantly from period to period, particularly because our sales prospects are uncertain. The level of our revenues and results of
operations at any given time will be based primarily on the following factors:
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acceptance of our products by surgeons, patients, hospitals and third-party payors;
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demand and pricing of our products;
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the mix of our products sold, because profit margins differ among our products;
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timing of new product offerings, acquisitions, licenses or other significant events by us or our competitors;
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our ability to grow and maintain a productive sales and marketing organization;
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regulatory approvals and legislative changes affecting the products we may offer or those of our competitors;
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the effect of competing technological and market developments;
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levels of third-party reimbursement for our products;
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interruption in the manufacturing or distribution of our products;
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our ability to produce or obtain products of satisfactory quality or in sufficient quantities to meet demand; and
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changes in our ability to obtain FDA, state and international approval or clearance for our products.
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In addition, until we have a larger base of surgeons using our products, occasional fluctuations in the use of our products by individual surgeons or
small groups of surgeons will have a proportionately larger impact on our revenues than for companies with a larger customer base.
Many of
the products we may seek to develop and introduce in the future will require FDA, state and international approval or clearance. We cannot begin to commercialize any such products in the United States without FDA approval or clearance or
outside of the United States without appropriate regulatory approvals and import licenses. As a result, it will be difficult for us to forecast demand for these products with any degree of certainty. We cannot assure you that our revenue will
increase or be sustained in future periods or that we will be profitable in any future period. Any shortfalls in revenue or earnings from levels expected by our stockholders or by securities or industry analysts could have an immediate and
significant adverse effect on the trading price of our common stock in any given period.
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We may need to raise additional funds in the future and such funds may not be available on acceptable
terms, if at all.
We believe that our current cash and cash equivalents, revenues from our operations, and Alphatec Spines
ability to draw down on its secured credit facilities, will be sufficient to fund our projected operating requirements through January 1, 2008. In January 2006, Alphatec Spine entered into a two-year credit agreement with Bank of the West to
support the expansion of our distribution channels. The financing is collateralized by substantially all of the assets and capital stock of Alphatec Spine and is guaranteed by us. Under the terms of this credit facility, Alphatec Spine is required
to make monthly interest payments and is subject to certain covenants, which include among other things, prohibiting a certain specified net loss, requiring a specified ratio of debt to cash flow and a specified ratio of debt to tangible net worth
plus subordinated debt, requiring certain levels of profitability and restricting certain mergers and acquisitions without prior approval of the bank. In addition, this credit facility prohibits Alphatec Spine from declaring or paying cash
dividends. On December 31, 2006, there was $0.6 million outstanding borrowing under this line of credit and Alphatec Spine was in breach of certain covenants set forth in its credit agreement with the Bank of the West. In March 2007, Alphatec
Spine obtained waivers of these covenant breaches and entered into an amendment to the credit agreement which deleted the quarterly and annual net profit financial condition, modified the net loss financial condition and modified the definition of
the borrowing base covenants. Although as of June 30, 2007, there was no outstanding borrowing under this line of credit, there is no assurance that we will be able to extend our agreement or continue to have access to funds after
January 1, 2008.
We may seek additional funds from public and private stock offerings, borrowings under new debt facilities or
other sources. Our capital requirements will depend on many factors, including:
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the revenues generated by sales of our products;
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the costs associated with expanding our sales and marketing efforts;
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the expenses we incur in manufacturing and selling our products;
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the costs of developing new products or technologies;
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the cost of obtaining and maintaining FDA or other regulatory approval or clearance for our products and products in development;
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the number and timing of acquisitions and other strategic transactions;
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the costs associated with increased capital expenditures; and
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the costs associated with our employee retention programs and related benefits.
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As a result of these factors, we may need to raise additional funds and such funds may not be available on favorable terms, if at all.
Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution and the new equity or debt securities may have rights, preferences and privileges senior to those of our
existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our potential products or proprietary technologies, or to
grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our products, execute our business plan, take advantage of future opportunities, or respond to
competitive pressures or unanticipated customer requirements. Any of these events could adversely affect our ability to achieve our development and commercialization goals and have a material adverse effect on our business, financial condition and
results of operations.
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We are subject to certain risks associated with our foreign operations.
Our operations outside of the United States are primarily in Japan. Certain risks are inherent in international operations, including:
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difficulties in enforcing agreements and collecting receivables through certain foreign legal systems;
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foreign customers who may have longer payment cycles than customers in the United States;
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tax rates in foreign countries may exceed those in the United States and foreign earnings may be subject to withholding requirements or the imposition of
tariffs, exchange controls or other restrictions including transfer pricing restrictions when products produced in one country are sold to an affiliated entity in another country;
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economic and political instability in countries where we operate or where end-users of spine fusion surgery reside;
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difficulties associated with managing a large organization spread throughout various countries;
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difficulties in obtaining and enforcing intellectual property rights;
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required compliance with a variety of foreign laws and regulations;
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imposition of costly and lengthy new export licensing requirements;
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laws and business practices favoring local companies; and
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lack of availability and reduced level of reimbursement within prevailing foreign healthcare payment systems.
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If we continue to expand our business outside of the United States, our success will depend, in part, on our ability to anticipate and effectively manage
these and other risks. We cannot assure you that these and other factors will not have a material adverse effect on our international operations or our business as a whole.
Our independent registered public accounting firm brought to our attention a material weakness in our internal controls during the audit of our 2005 annual consolidated financial statements. Our failure to
maintain effective internal controls could have a material adverse effect on our business, operating results and financial condition and cause our stockholders, lenders, suppliers and others to lose confidence in the accuracy or completeness of our
financial reports.
Our independent registered public accounting firm identified and communicated to us a material weakness in our
internal control over financial reporting as of December 31, 2005. Management has evaluated this communication and has also concluded that a material weakness existed as of that date.
A material weakness, as defined by the Public Company Accounting Oversight Board, is a control deficiency, or a combination of control deficiencies, that
results in a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected. Our independent registered public accounting firm advised our board of directors and our management
that our process for our financial statement year-end close and reporting was insufficiently defined and represented a deficiency in the design and operating effectiveness of our year-end close and reporting controls. One of the primary causes of
the deficiency in the financial statement close and reporting process noted by our independent registered public accounting firm was the inadequate staffing in our financial accounting and reporting functions. Management believes that the primary
cause of many of the observed deficiencies resulted from our transition from a small, private company with immature processes and controls to one that is growing rapidly and must meet the reporting and control standards applicable to public
companies.
During 2006, we undertook a number of actions to correct this material weakness in our internal controls and enhance such
internal controls and the accuracy of our financial reporting, including the review and
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documentation of our processes and key controls, and the engagement of experienced financial personnel, including our Chief Financial Officer and Corporate
Controller.
While we have taken such actions, additional measures may be necessary to continue our maintenance of effective internal
controls. Our independent registered public accounting firm did not detect any material weaknesses in our internal controls during the most recent audit of our 2006 consolidated financial statements. However, we plan to regularly assess our internal
controls and procedures and take further action as necessary or appropriate to address any matters we identify. The process of maintaining, designing and implementing effective internal controls and procedures is a continuous effort that requires us
to anticipate and react to changes in our business and the economic and regulatory environments.
We may incur substantial expenses
relating to the refinement and maintenance of our internal controls. Our accounting and financial reporting functions may not be unable to maintain adequate resources to ensure that we will not have any future control deficiencies or material
weaknesses in our system of internal controls. The effectiveness of our internal controls may in the future be limited by a variety of factors including:
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faulty human judgment and errors, omissions or mistakes;
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inappropriate management override of policies and procedures;
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failure to properly implement our upgraded financial software system; and
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the possibility that any enhancements to our internal controls may still not be adequate to assure timely and accurate financial information.
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If we fail to maintain effective internal controls and procedures for financial reporting, we could be unable to provide
timely and accurate financial information and therefore be subject to delisting from the NASDAQ Global Market, an investigation by the SEC, and civil or criminal sanctions. Additionally, ineffective internal control over financial reporting would
place us at increased risk of fraud or misuse of corporate assets and could cause our stockholders, lenders, suppliers and others to lose confidence in the accuracy or completeness of our financial reports.
In the quarterly reports on Form 10-Q and the annual reports on Form 10-K, our management may not be able to conclude that we have effective
disclosure controls and procedures, and we or our independent registered public accounting firm may not be able to conclude that we have effective internal controls over financial reporting. We are also exposed to risks relating to evaluations
of controls required by Section 404 of the Sarbanes-Oxley Act.
We are subject to the reporting requirements of the Exchange
Act that require us to file, among other things, quarterly reports on Form 10-Q and annual reports on Form 10-K. Under Section 302 of the Sarbanes-Oxley Act, as a part of each of these reports, our Chief Executive Officer and
Chief Financial Officer are required to evaluate and report their conclusions regarding the effectiveness of our disclosure controls and procedures and to certify that they have done so. In addition, under Section 404 of the Sarbanes-Oxley Act,
we are required to include a report of management on our internal control over financial reporting in our Form 10-K and the independent registered public accounting firm auditing our financial statements will be required to attest to and report
on managements assessment of the effectiveness of our internal control over financial reporting and on the effectiveness of our internal control over financial reporting. This requirement will first apply to our Form 10-K for our fiscal
year ending December 31, 2007.
We will be evaluating our internal controls systems to allow management to report on, and our
independent auditors to attest to, our internal controls. We will be performing the system and process evaluation, testing and any necessary remediation required to comply with the management certification and auditor attestation requirements of
Section 404 of the Sarbanes-Oxley Act. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404, we cannot be certain as to the
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timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations since there is presently no precedent
available by which to measure compliance adequacy.
If we are unable to conclude in a timely manner that our disclosure controls and
procedures and internal control over financial reporting are effective, or if our independent registered public accounting firm is unable to conclude that our assessment of our internal control over financial reporting is sufficient or is unable to
conclude that our internal controls over financial reporting are effective and therefore issues an adverse opinion, we may be subject to sanctions or investigation by regulatory authorities, including the SEC or the NASDAQ Global Market. This
type of action could adversely affect our financial results or investors confidence in our company and our ability to access capital markets, and could cause our stock price to decline. In addition, the control and procedures that we will
implement may not comply with all of the relevant rules and regulations of the SEC and the NASDAQ Global Market. If we fail to develop and maintain effective controls and procedures, we may be unable to provide the required financial
information in a timely and reliable manner.
Changes in or interpretations of accounting rules and regulations, such as expensing of stock
options, could result in unfavorable accounting charges or require us to change our compensation policies.
Accounting methods and
policies, including policies regarding expensing stock options, are subject to further review, interpretation and guidance from relevant accounting authorities, including the SEC. For example, effective January 1, 2006, we adopted the Statement
of Financial Accounting Standards (SFAS) No. 123R,
Share-Based Payment
, which requires all public companies to treat the fair value of stock options granted to employees as an expense effective as of the beginning of the first fiscal
year commencing after June 15, 2005. Due to this change, we have changed our accounting policy to record expense for the fair value of stock options granted in 2006 and 2007, and as a result our operating expenses have increased. Through our
compensation plan, we rely on grants of stock options and restricted stock to compensate existing employees and attract new employees. Since we currently are required to expense stock options granted on or after January 1, 2006, we
may choose to reduce our reliance on stock options as a compensation tool. If we reduce our use of stock options, it may be more difficult for us to attract and retain qualified employees. If we do not reduce our reliance on stock options
or if we continue to issue restricted shares, our reported income would decrease. Although we believe that our accounting practices are consistent with current accounting pronouncements, changes to our interpretations of accounting methods or
policies in the future may require us to adversely revise how our financial statements are prepared.
A portion of our revenues and expenditures
is subject to exchange rate fluctuations that could adversely affect our reported results of operations.
While a majority of our
business is denominated in U.S. dollars, we maintain operations in foreign countries, primarily Japan, that require payments in the local currency. Payments received from customers for goods sold in these countries are typically in the local
currency. Consequently, fluctuations in the rate of exchange between the U.S. dollar and certain other currencies may affect our results of operations and period-to-period comparisons of our operating results. For example, if the value of the
U.S. dollar were to fall relative to the Japanese Yen, the principal foreign currency material to our business, then our reported revenues would increase when we convert the higher valued foreign currency into U.S. dollars. If the value of the U.S.
dollar were to increase in relation to the Japanese Yen, then there would be a negative effect on the value of our sales in Japan to the extent our revenues in Japanese Yen are in excess of our Japanese Yen costs at the time that we converted
amounts to U.S. dollars in connection with the preparation of our financial statements. We do not currently engage in hedging or similar transactions to reduce these risks.
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Risks Related to Our Intellectual Property and Potential Litigation
If our patents and other intellectual property rights do not adequately protect our products, we may lose market share to our competitors and be unable to
operate our business profitably.
Our success depends significantly on our ability to protect our proprietary rights to the
technologies used in our products. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology.
However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example, we cannot assure you that any of our pending patent applications will
result in the issuance of patents to us. The United States Patent and Trademark Office, or PTO, may deny or require significant narrowing of claims in our pending patent applications, and patents issued as a result of the pending patent
applications, if any, may not provide us with significant commercial protection or be issued in a form that is advantageous to us. We could also incur substantial costs in proceedings before the PTO. These proceedings could result in
adverse decisions as to the priority of our inventions and the narrowing or invalidation of claims in issued patents. Our issued patents and those that may be issued in the future could subsequently be successfully challenged by others and
invalidated or rendered unenforceable, which could limit our ability to stop competitors from marketing and selling related products. In addition, our pending patent applications include claims to aspects of our products and procedures that are not
currently protected by issued patents.
Both the patent application process and the process of managing patent disputes can be time
consuming and expensive. Competitors may be able to design around our patents or develop products that provide outcomes that are comparable to our products. Although we have entered into confidentiality agreements and intellectual property
assignment agreements with certain of our employees, consultants and advisors as one of the ways we seek to protect our intellectual property and other proprietary technology, such agreements may not be enforceable or may not provide
meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements. Furthermore, the laws of some foreign countries may not protect our intellectual
property rights to the same extent as the laws of the United States, if at all. Since most of our issued patents and pending patent applications are for the United States only, we lack a corresponding scope of patent protection in other
countries, including Japan. Thus, we may not be able to stop a competitor from marketing products in other countries that are similar to some of our products.
In the event a competitor infringes upon one of our patents or other intellectual property rights, enforcing those patents and rights may be difficult and time consuming. Even if successful, litigation to defend
our patents against challenges or to enforce our intellectual property rights could be expensive and time consuming and could divert managements attention from managing our business. Moreover, we may not have sufficient resources to
defend our patents against challenges or to enforce our intellectual property rights.
In addition, we hold licenses with third parties to
utilize certain technologies useful in the design and manufacturing of some of our products, including our Zodiac polyaxial pedicle screws, which represented approximately 39.9% and 36.3% of our net sales for 2005 and 2006, respectively. The loss of
such licenses could prevent us from manufacturing, marketing and selling these products, which would have a material adverse effect on our business, financial condition and results of operations.
Alphatec Spine licenses patents relating to features of its pedicle screw from Biomet, Inc., or Biomet, pursuant to a license agreement, or the 555
license agreement. The licensed technology is incorporated into Alphatec Spines Zodiac and Solanas pedicle screws and may be incorporated into future products. The 555 license agreement provides that the royalty shall remain in full force
and effect without modification regardless of any ruling by any court regarding the scope, validity, or enforceability of the patents covered by the 555 license agreement. The validity of the United States patents covered by the 555 license
agreement is being challenged by Medtronic in an infringement action brought by Biomet in the United States. On March 20, 2007, the United States Count of Appeals for the Federal Circuit ruled that Medtronics current multi-axial screw
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products do not infringe upon the 555 patent. The European patent covered by the 555 license agreement has been revoked by the European Patent Office after
it was successfully challenged in an opposition proceeding in Europe initiated by Stryker and Synthes. Biomet is appealing this decision. Biomet can terminate the license in the event Alphatec Spine fails to make any of the payments required under
the license agreement, materially breaches the license agreement, or becomes insolvent.
The medical device industry is characterized by patent and
other intellectual property litigation and we could become subject to litigation that could be costly, result in the diversion of managements time and efforts, require us to pay damages, and/or prevent us from marketing our existing or future
products.
The medical device industry is characterized by extensive litigation and administrative proceedings over patent and other
intellectual property rights. Determining whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that our products, the components of those
products, the methods of using those products, or the methods we employ in processing those products are covered by U.S. or foreign patents held by them. In addition, they may claim that their patents have priority over ours because their
patents were issued first. Because patent applications can take many years to issue, there may be applications now pending of which we are unaware, which may later result in issued patents that our products may infringe. There could
also be existing patents that one or more components of our products may be inadvertently infringing, of which we are unaware. As the number of participants in the market for spine disorder devices and treatments increases, the possibility of
patent infringement claims against us increases.
Any such claim against us, even those without merit, may cause us to incur
substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If the relevant patents were upheld as valid and enforceable and we were found to
infringe, we could be required to pay substantial damages, including treble, or triple, damages if an infringement is found to be willful, and/or royalties and we could be prevented from selling our products unless we could obtain a license or were
able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all, and there can be no assurance that we would be able to redesign our products in a way that would not infringe those
patents. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may have to withdraw existing products from the market or may be unable to commercialize one or more of our products,
either of which could have a material adverse effect on our business, financial condition and results of operations.
In addition, in order
to further our product development efforts, from time to time we enter into agreements with surgeons to develop new products. As consideration for product development activities rendered pursuant to these agreements, in certain instances we have
agreed to pay such surgeons royalties on products developed by cooperative involvement between us and such surgeons. There can be no assurance that surgeons with whom we have entered into such an arrangement will not claim to be entitled to a
royalty even if we do not believe that such products were developed by cooperative involvement between us and such surgeons. Any such claim against us, even those without merit, may cause us to incur substantial costs, and could place a
significant strain on our financial resources, divert the attention of management from our core business and harm our reputation.
We cannot predict
the outcome of lawsuits in which we are a defendant.
On June 26, 2006, Biedermann Motech GmbH and DePuy Spine, Inc. filed
suits for patent infringement against a number of companies selling pedicle screws, including Alphatec Spine. The complaint against Alphatec Spine was filed in the United States District Court for the District of Massachusetts and alleges
infringement of United States Patent No. 5,207,678, or the 678 Patent, owned by Biedermann Motech and exclusively licensed to DePuy Spine in the U.S. The complaint alleges that this patent covers certain pedicle screw designs and
requests monetary damages and injunctive relief. Alphatec Spine does not believe that any of its products infringe any valid claim of this patent and intends to defend itself vigorously against these claims. On July 21,
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2006, the plaintiffs filed a motion for preliminary injunction, requesting the Court to enjoin Alphatec Spine from making, using, and selling Alphatec
Spines Zodiac and Solanas products pending trial. Alphatec Spine opposed this motion, which was denied by the Court on October 26, 2006. On January 12, 2007, Alphatec Spine filed a motion for summary judgment that its products do not
infringe this patent. The plaintiffs filed a cross motion for partial summary judgment that the accused Zodiac and Solanas products include one element of the asserted patent claims. On March 29, 2007, the Court ruled against Alphatec Spine and
issued a claim construction order on one element of the asserted patent claim. It has not yet formally ruled on the motion and cross-motion. In June 2007, the U.S. Patent and Trademark office decided to reexamine the 678 Patent following a request
for reexamination that was made by a third party. In July 2007, Alphatec Spine made a motion to stay the proceeding pending the results of the reexamination. Subsequent to such filing, the Company and the plaintiffs filed a joint motion that
withdrew the Companys motion until January 2, 2008, or sooner if necessary in the Companys judgment based on the status of the reexamination. Given that our Zodiac and Solanas products constitute a significant portion of our
revenues, an adverse outcome in this suit would have a material adverse effect on our business, financial conditions and results of operations.
On April 12, 2006, Alphatec Spine and HealthpointCapital, our majority stockholder, and its affiliate, HealthpointCapital, LLC, were served with a complaint by Drs. Darryl Brodke, Alan Hilibrand, Richard Ozuna and Jeffrey Wang, or the
claimant surgeons, in the Superior Court of California in the County of Orange, claiming, among other things, that, pursuant to certain contractual arrangements Alphatec Spine allegedly entered into with the claimant surgeons in 2001, it
was required to pay the claimant surgeons quarterly royalties in an aggregate amount of 6% of the net sales of polyaxial screws, which the claimant surgeons allege were developed with their assistance prior to the cessation of such development
activities in March 2002. Alphatec Spine first began to sell polyaxial screws in 2003 and has continued to sell them through the date of this prospectus supplement. In October of 2006, the parties to this litigation initiated a mediation session in
an attempt to mediate a resolution to this matter, but were unsuccessful in doing so. Alphatec Spine brought a motion to compel arbitration of the claimant surgeons claims and is currently appealing the Courts denial of said motion.
Alphatec Spine does not believe that any of the claimant surgeons are entitled to any royalty amounts and intends to vigorously defend itself against this complaint; however, Alphatec Spine cannot predict the outcome to this matter or the impact on
the financial statements, if any.
If we become subject to product liability claims, we may be required to pay damages that exceed our insurance
coverage.
Our business exposes us to potential product liability claims that are inherent in the testing, design, manufacture and
sale of medical devices for spine surgery procedures. Spine surgery involves significant risk of serious complications, including bleeding, nerve injury, paralysis and even death. To date, our products have not been the subject of any material
product liability claims. Currently, we carry product liability insurance in the amount of $10 million per occurrence and $10 million in the aggregate. Any product liability claim brought against us, with or without merit, could result in
the increase of our product liability insurance rates or our inability to secure coverage in the future on commercially reasonable terms, if at all. In addition, if our product liability insurance proves to be inadequate to pay a damage award, we
may have to pay the excess out of our cash reserves, which could harm our financial condition. If longer-term patient results and experience indicate that our products or any component of our products cause tissue damage, motor impairment or
other adverse effects, we could be subject to significant liability. Even a meritless or unsuccessful product liability claim could harm our reputation in the industry, lead to significant legal fees and result in the diversion of managements
attention from managing our business.
Because allograft products entail a potential risk of communicable disease to human recipients, we may be
the subject of product liability claims regarding our allograft products.
Our allograft business may expose us to additional
potential product liability claims. The development of allografts and technologies for human tissue repair and treatment entails a risk of additional product liability
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claims because of the risk of transmitting disease to human recipients, and substantial product liability claims may be asserted against us. In
addition, successful product liability claims made against one of our competitors could cause claims to be made against us or expose us to a perception that we are vulnerable to similar claims. Even a meritless or unsuccessful product liability
claim could harm our reputation in the industry, lead to significant legal fees and result in the diversion of managements attention from managing our business.
We may be subject to damages resulting from claims that we, our employees or our independent distributors have wrongfully used or disclosed alleged trade secrets of our competitors or are in breach of
non-competition or non-solicitation agreements with our competitors.
Many of our employees were previously employed at other
medical device companies, including our competitors or potential competitors. Many of our independent distributors sell, or in the past have sold, products of our competitors. We may be subject to claims that we, our employees or our
independent distributors have inadvertently or otherwise used or disclosed the trade secrets or other proprietary information of our competitors. In addition, we have been and may in the future be subject to claims that we caused an employee or
independent distributor to break the terms of his or her non-competition agreement or non-solicitation agreement. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims,
litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key
personnel or their work product could hamper or prevent our ability to commercialize products, which could have an adverse effect on our business, financial condition and results of operations.
Any claims relating to our improper handling, storage or disposal of biological, hazardous and radioactive materials could be time consuming and costly.
The manufacture of certain of our products, including our allograft implants, involves the controlled use of biological, hazardous and/or
radioactive materials and waste. Our business and facilities and those of our suppliers are subject to foreign, federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials
and waste products. Although we believe that our safety procedures for handling and disposing of these materials comply with legally prescribed standards, we cannot completely eliminate the risk of accidental contamination or injury from these
materials. In the event of an accident, we could be held liable for damages or penalized with fines. This liability could exceed our resources and any applicable insurance. In addition, under some environmental laws and regulations, we could also be
held responsible for all of the costs relating to any contamination at our past or present facilities and at third-party waste disposal sites, even if such contamination was not caused by us. We may incur significant expenses in the future
relating to any failure to comply with environmental laws. Any such future expenses or liability could have a significant negative impact on our business, financial condition and results of operations.
We and our independent sales agents must comply with various state and federal anti-kickback, self-referral, false claims and similar laws, the breach of which
could cause a material adverse effect on our business, financial condition and results of operations.
Our relationship with
surgeons, hospitals and the marketers of our products are subject to scrutiny under various state and federal anti-kickback, self-referral, false claims and similar laws, often referred to collectively as healthcare fraud and abuse laws. Healthcare
fraud and abuse laws are complex, and even minor, inadvertent violations can potentially give rise to claims that the relevant law has been violated. Any violations of these laws could result in a material adverse effect on the market price of our
common stock, as well as our business, financial condition and results of operations. We cannot assure you that any of the healthcare fraud and abuse laws will not change or be interpreted in the future in a manner which restricts or adversely
affects our business activities or relationships with surgeons, hospitals and marketers of our products.
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Federal anti-kickback laws and regulations prohibit any knowing and willful offer, payment, solicitation
or receipt of any form of remuneration by an individual or entity in return for, or to induce:
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the referral of an individual for a service or product for which payment may be made by Medicare, Medicaid or other government-sponsored healthcare program; or
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purchasing, leasing, ordering or arranging for any service or product for which payment may be made by a government-sponsored healthcare program.
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Possible sanctions for violation of these anti-kickback laws include monetary fines, civil and criminal penalties,
exclusion from Medicare and Medicaid programs and forfeiture of amounts collected in violation of such prohibitions. Certain states in which we market our products have similar anti-kickback, anti-fee splitting and self-referral laws, imposing
substantial penalties for violations.
We have entered into consulting agreements and royalty agreements with surgeons, some of whom make
referrals to us. In addition, some of our referring surgeons own shares of our capital stock, which they either purchased in an arms length transaction on terms identical to those offered to non-surgeons or received from us as fair market
value consideration for consulting services performed by them. While these transactions were structured with the intention of complying with all applicable laws, including the federal ban on physician self-referrals, commonly known as the
Stark Law, state anti-referral laws and other applicable anti-kickback laws, to the extent applicable, it is possible that regulatory agencies may in the future view these transactions as prohibited arrangements that must be
restructured or for which we could be subject to other significant penalties, or prohibit us from accepting referrals from these surgeons. We would be materially impacted if regulatory agencies interpret our financial relationships with certain
surgeons who refer our products to be in violation of applicable laws and we were unable to achieve compliance with applicable laws. This could subject us to monetary penalties for non-compliance, the cost of which could be substantial, or we
may be unable to accept referrals from such surgeons.
We must comply with a variety of other laws, such as laws prohibiting false
claims for reimbursement under Medicare and Medicaid, which can also be triggered by violations of federal anti-kickback laws; Healthcare Insurance Portability and Accounting Act of 1996, which makes it a federal crime to commit healthcare fraud and
make false statements; and the Federal Trade Commission Act and similar laws regulating advertisement and consumer protection. In certain cases, federal and state authorities pursue actions for false claims on the basis that manufacturers and
distributors are promoting unapproved or off-label uses of their products. Pursuant to FDA regulations, we can only market our products for cleared or approved uses. Although surgeons are permitted to use medical devices for indications other than
those cleared or approved by the FDA based on their medical judgment, we are prohibited from promoting products for such off-label uses. We market our products and provide promotional materials and training programs to surgeons regarding the use of
our products. Although we believe our marketing, promotional materials and training programs for surgeons do not constitute promotion of unapproved uses of our products, if it is determined that our marketing, promotional materials or training
programs constitute promotion of unapproved uses, we could be subject to significant fines in addition to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure and criminal penalty.
The scope and enforcement of these laws are uncertain and subject to rapid change, especially in light of the lack of applicable precedent and
regulations. There can be no assurance that federal or state regulatory authorities will not challenge our current or future activities under these laws. Any such challenge could have a material adverse effect on our business, financial condition
and results of operations. Any state or federal regulatory review of us, regardless of the outcome, would be costly and time consuming. Additionally, we cannot predict the impact of any changes in these laws, whether or not retroactive.
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Risks Related to Our Common Stock and This Offering
We expect that the price of our common stock will fluctuate substantially and the market price of our common stock may decline in value in the future.
The market price of our common stock is likely to be highly volatile and may fluctuate substantially due to many factors, including:
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volume and timing of orders for our products;
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quarterly variations in our or our competitors results of operations;
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our announcement or our competitors announcements regarding new products, product enhancements, significant contracts, number of distributors, number of
hospitals and surgeons using products, acquisitions or strategic investments;
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announcements of technological or medical innovations for the treatment of spine pathology;
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changes in earnings estimates or recommendations by securities analysts;
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our ability to develop, obtain regulatory clearance or approval for, and market new and enhanced products on a timely basis;
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changes in healthcare policy in the United States and internationally;
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product liability claims or other litigation involving us;
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sales of large blocks of our common stock, including sales by our executive officers, directors and significant stockholders;
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changes in governmental regulations or in the status of our regulatory approvals, clearances or applications;
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disputes or other developments with respect to intellectual property rights;
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changes in the availability of third-party reimbursement in the United States or other countries;
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changes in accounting principles; and
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general market conditions and other factors, including factors unrelated to our operating performance or the operating performance of our competitors.
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We may become involved in securities class action litigation that could divert managements attention and harm our
business.
The stock market in general, and the NASDAQ Global Market and the market for medical device companies in particular, has
experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. Further, the market prices of securities of medical device companies have been particularly
volatile. Factors contributing to this volatility include FDA and international actions with respect to the government regulation of medical devices and third-party reimbursement matters, changes in U.S. or international healthcare policies, and
changes in the condition of the medical device industry generally. These broad market and industry factors may materially harm the market price of our common stock, regardless of our operating performance. In the past, following periods of
volatility in the market price of a particular companys securities, securities class action litigation has often been brought against that company. We may become involved in this type of litigation in the future. Litigation is often
expensive and diverts managements attention and resources, which could materially harm our financial condition, results of operations and business.
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Management will have broad discretion as to the use of the proceeds from this offering, and we may not use the
proceeds effectively.
We have not designated the amount of net proceeds we will use for any particular purpose. Accordingly, our
management will have broad discretion as to the application of the net proceeds and could use them for purposes other than those contemplated at the time of this offering. Our stockholders may not agree with the manner in which our management
chooses to allocate and spend the net proceeds. Moreover, our management may use the net proceeds for corporate purposes that may not yield profitable results or increase our market value.
You will experience immediate dilution in the book value per share of the common stock you purchase.
Because the price per share of our common stock being offered is substantially higher than the net tangible book value per share of our common stock, you
will suffer substantial dilution in the net tangible book value of the common stock you purchase in this offering. Based on the public offering price of $3.45 per share, if you purchase shares of common stock in this offering, you will suffer
immediate and substantial dilution of $2.74 per share in the net tangible book value of the common stock. If the underwriter exercises its overallotment option, you will experience additional dilution. See Dilution on page S-33 for a
more detailed discussion of the dilution you will incur in this offering.
Securities analysts may not continue to provide coverage of our
common stock or may issue negative reports, which may have a negative impact on the market price of our common stock.
Securities analysts may not continue to provide research coverage of our common stock. If securities analysts do not cover our common stock, the lack of research coverage may cause the market price of our common stock to decline.
The trading market for our common stock may be affected in part by the research and reports that industry or financial analysts publish about our business. If one or more of the analysts who elects to cover us downgrades our stock, our
stock price would likely decline rapidly. If one or more of these analysts ceases coverage of us, we could lose visibility in the market, which in turn could cause our stock price to decline. In addition, recently-adopted rules mandated by the
Sarbanes-Oxley Act and a global settlement reached in 2003 between the SEC, other regulatory agencies and a number of investment banks have led to a number of fundamental changes in how analysts are reviewed and compensated. In particular, many
investment banking firms are required to contract with independent financial analysts for their stock research. It may be difficult for companies such as ours, with smaller market capitalizations, to attract independent financial analysts that
will cover our common stock. This could have a negative effect on the market price of our stock.
Because of their significant stock ownership, our
executive officers, directors and principal stockholders will be able to exert control over us and our significant corporate decisions.
Based on shares outstanding at September 1, 2007, our executive officers, directors and stockholders holding more than 5% of our outstanding common stock and their affiliates will, in the aggregate, beneficially own approximately 52.7%
of our outstanding common stock. In addition, HealthpointCapital Partners II, L.P., an affiliate of our principal stockholder HealthpointCapital Partners, L.P., will purchase 2,750,000 shares in this offering. As a result, these persons will, in the
aggregate, beneficially own approximately 48.3% of our outstanding common stock after this offering and, acting together, will have the ability to determine the outcome of all matters requiring stockholder approval, including the election and
removal of directors and any merger, consolidation, or sale of all or substantially all of our assets. This concentration of ownership may harm the market price of our common stock by, among other things:
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delaying, deferring or preventing our change in control;
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impeding a merger, consolidation, takeover or other business combination involving us;
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causing us to enter into transactions or agreements that are not in the best interests of all of our stockholders; or
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reducing our public float held by non-affiliates.
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Certain members of our board of directors also serve as officers and directors of HealthpointCapital, its
affiliates and other portfolio companies.
Four members of our board of directors also serve as officers and directors of our
largest stockholder, HealthpointCapital, or its related entities and of other companies in which HealthpointCapital invests, including companies with which we compete or may in the future compete. As of September 1, 2007,
HealthpointCapital owns approximately 36.5% of our outstanding common stock. In addition, HealthpointCapital Partners II, L.P., an affiliate of our principal stockholder HealthpointCapital Partners, L.P., will purchase 2,750,000 shares in this
offering. After this offering, HealthpointCapital will own approximately 35.5% of our outstanding common stock. HealthpointCapital and its affiliates may make investments and hold interests in businesses that compete directly or indirectly with
us. For example, HealthpointCapital owns a 33% interest in Scientx S.A., a French company. The Chairman of our board of directors, Mortimer Berkowitz III, is a Managing Member of HGP, LLC, the General Partner of (with a 20% profits interest
in) HealthpointCapital and the President, a member of the Board of Managers and a Managing Director of HealthpointCapital, LLC, which owns a 25% ownership interest in HGP, LLC and is the parent company of the fund manager of HealthpointCapital.
Mr. Berkowitz is also a member of the Board of Directors of Scientx S.A., BioHorizons Implant Systems, Inc., BioLok International Inc., Micro Dental Laboratories and DTI Dental Technologies Inc. John H. Foster, a member of our board
of directors, is a Managing Member of HGP, LLC and the Chairman, Chief Executive Officer, a member of the Board of Managers and a Managing Director of HealthpointCapital, LLC. He is Chairman of BioHorizons Implant Systems, Inc., BioLok International
Inc., Micro Dental Laboratories and DTI Dental Technologies Inc. Our directors R. Ian Molson and Stephen E. ONeil also serve on the Board of Managers of HealthpointCapital, LLC. Such directors may have obligations to
HealthpointCapital, HealthpointCapital, LLC, HGP, LLC and to investors in those companies and other portfolio companies of HealthpointCapital and its affiliates, the fulfillment of which might not be in the best interests of us or our stockholders.
Our Chairman, Mortimer Berkowitz III, has a less than 1% direct capital interest in HealthpointCapital, a 24.4% direct interest in
HGP, LLC and a 30.5% direct and beneficial interest in HealthpointCapital, LLC. Our director, John H. Foster, has a 3.2% beneficial capital interest in HealthpointCapital, a 36.6% direct interest in HGP, LLC and a 42.7%
direct and beneficial interest in HealthpointCapital, LLC. Our director, R. Ian Molson, has a less than 1% direct capital interest in HealthpointCapital and a 2.1% direct interest in HealthpointCapital, LLC. Our director,
Stephen E. ONeil, has a 1.4% direct interest in HealthpointCapital, LLC.
Because of these possible conflicts of interest,
such directors may direct potential business and investment opportunities to other entities rather than to us or such directors may undertake or otherwise engage in activities or conduct on behalf of such other entities that is not in, or
which may be adverse to, our best interests. Whether a director directs an opportunity to us or to another company, our directors may face claims of breaches of fiduciary duty and other duties relating to such opportunities. Our amended
and restated certificate of incorporation requires us to indemnify our directors to the fullest extent permitted by law, which may require us to indemnify them against claims of breaches of such duties arising from their service on our board of
directors. HealthpointCapital or its affiliates may pursue acquisition opportunities that may be complementary to our business and, as a result, those acquisition opportunities may not be available to us. Furthermore,
HealthpointCapital may have an interest in us pursuing acquisitions, divestitures, financings or other transactions that, in its judgment, could enhance its equity investment, even though such transactions might involve risks to us and our
stockholders generally. In addition, if we were to seek a business combination with a target business with which one or more of our existing stockholders or directors may be affiliated, conflicts of interest could arise in connection with
negotiating the terms of and completing the business combination. Conflicts that may arise may not be resolved in our favor.
S-28
Anti-takeover provisions in our organizational documents and change of control provisions in some of our employment
agreements and agreements with distributors, and in some of our outstanding debt agreements, as well as the terms of our new redeemable preferred stock, may discourage or prevent a change of control, even if an acquisition would be beneficial
to our stockholders, which could affect our stock price adversely.
Certain provisions of our amended and restated certificate of
incorporation and restated by-laws could discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which our stockholders might otherwise receive a premium
for their shares. These provisions also could limit the price that investors might be willing to pay in the future for shares of our common stock, thereby depressing the market price of our common stock. Stockholders who wish to participate in these
transactions may not have the opportunity to do so. Furthermore, these provisions could prevent or frustrate attempts by our stockholders to replace or remove our management. These provisions:
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allow the authorized number of directors to be changed only by resolution of our board of directors;
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allow vacancies on our board of directors to be filled only by resolution of our board of directors;
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authorize our board of directors to issue, without stockholder approval, blank check preferred stock that, if issued, could operate as a poison pill to
dilute the stock ownership of a potential hostile acquirer to prevent an acquisition that is not approved by our board of directors;
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require that stockholder actions must be effected at a duly called stockholder meeting and prohibit stockholder action by written consent;
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establish advance notice requirements for stockholder nominations to our board of directors and for stockholder proposals that can be acted on at stockholder
meetings; and
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limit who may call stockholder meetings.
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Some of our employment agreements and all of our restricted stock agreements and incentive stock option agreements provide for accelerated vesting of benefits, including full vesting of restricted stock and options,
upon a change of control. A limited number of our agreements with our distributors include a provision that extends the term of the distribution agreement upon a change in control and makes it more difficult for us or our successor to terminate the
agreement. These provisions may discourage or prevent a change of control.
In addition, in the event of a change of control, we would
be required to redeem all outstanding shares of our new redeemable preferred stock for an aggregate of $30 million, at the price of $9.00 per share. Further, our amended and restated certificate of incorporation permits us to issue
additional shares of preferred stock. The terms of our new redeemable preferred stock or any new preferred stock we may issue could have the effect of delaying, deterring or preventing a change in control.
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