ITEM 1. BUSINESS
Corporate History
K2M, Inc. was incorporated in 2004 and began working with leading spine surgeons for the purpose of designing, developing and commercializing innovative and proprietary complex spine technologies and techniques. Between 2005 and 2010, we continued to develop our product portfolio while expanding our business, including through the investment of venture capital from Ferrer Freeman & Company, LLC. On August 12, 2010, K2M Group Holdings, Inc., an entity then controlled by Welsh, Carson, Andersen & Stowe, acquired K2M, Inc. Welsh, Carson, Anderson & Stowe XI, L.P. and certain of its affiliated funds are referred to herein as “WCAS,” and WCAS, together with the other owners of K2M Group Holdings, Inc. prior to our May 2014 initial public offering, are collectively referred to as our “pre-IPO owners.” Since 2010, we have continued to invest in our business by expanding our global distribution network, including through the investment of additional capital raised from our pre-IPO owners, our initial public offering in May 2014, subsequent public offerings in February and July 2015 and issuance of convertible senior notes in August 2016.
Overview
We are a global leader of complex spine and minimally invasive solutions focused on achieving three-dimensional Total Body Balance™. Our complex spine products are used by spine surgeons to treat some of the most difficult and challenging spinal pathologies, such as deformity (primarily scoliosis), trauma and tumor. We believe these procedures typically receive a higher rate of positive insurance coverage and often generate more revenue per procedure as compared to traditional degenerative spine surgery procedures. We have applied our product development expertise in innovating complex spine technologies and techniques to the design, development and commercialization of an expanding number of proprietary minimally invasive surgery (“MIS”) products. These proprietary MIS products are designed to allow for less invasive access to the spine and faster patient recovery times as compared to traditional open access surgical approaches. We have also leveraged these core competencies in the design, development and commercialization of an increasing number of products for patients suffering from degenerative spinal conditions.
Our products consist of implants, disposables and instruments which are marketed and sold primarily to hospitals for use by spine surgeons. As of
December 31, 2016
, our product portfolio contains
83
product lines that are used in complex spine, MIS and degenerative surgeries, enabling us to effectively compete in the $
10.5
billion global spinal surgery market. We believe many of our products offer simplified surgical techniques and promote improved clinical outcomes for patients, although their quality, safety and efficacy are not yet supported by long-term clinical data.
Our focus on our core competences of complex spine and MIS is highlighted by the fact that, for the year ended
December 31, 2016
,
55.6%
of our revenue in the United States was derived from the use of our products in complex spine and MIS surgeries. We believe this represents a greater proportion of total revenue devoted to these markets as compared to our competitors. We further believe the proportion of our international revenue derived from complex spine and MIS is even higher than in the United States.
We have also leveraged our core competences of complex spine and minimally invasive offerings into Balance ACS™, a platform of products, services, and research designed to help surgeons achieve three-dimensional spinal balance across the axial, coronal and sagittal planes, with the goal of supporting the entire clinical care continuum to help facilitate quality patient outcomes. The Balance ACS platform, in combination with the Company’s technologies, techniques and leadership in the 3D-printing of spinal devices, enables us to compete favorably in the global spinal surgery market.
Some of our key proprietary technologies include:
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EVEREST: a spinal screw technology that we believe, based on internal testing, provides for improved insertion speed, industry-leading pull-out strength and the versatility to accommodate a variety of titanium and cobalt chrome rods of two different diameters, which has been used to treat more than 30,000 patients;
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MESA: a low-profile spinal screw technology that is used primarily during deformity correction, features our proprietary locking mechanism that eliminates the need for a secondary locking feature and reduces rotational force on the spine during implantation, which has been used to treat more than 55,000 patients;
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Rail 4D: an innovative “beam-like” implant, used with our proprietary MESA spinal screws, that aids in the restoration of spinal balance or sagittal balance while providing enhanced rigidity and significantly greater strength as compared to existing titanium and cobalt chrome rod offerings;
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Quicket Deformity: Next generation spinal correction rod reduction instrumentation, used with our proprietary MESA spinal screws, that provides surgeons with an innovative approach to more easily capture, manipulate and align a deformed spine as compared to traditional deformity correction instrumentation;
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CASCADIA: a titanium 3D-printed implant technology based on our Lamellar 3D Titanium Technology, which exploits the material properties of titanium in conjunction with a product design that incorporates an approximately 70% porosity to mitigate the device's radiographic signature;
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CAPRI: a corpectomy cage system which provides an innovative solution for stabilization of the spine in cases of vertebral body resections resulting from trauma or tumor. Offered in various configurations, this versatile system allows for in-situ height expansion and endplate angulation;
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SERENGETI: minimally invasive retractor systems featuring one-step placement of screws and retractors, thereby reducing the number of surgical steps, while allowing for direct visualization and improved access to the spine;
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RAVINE: minimally invasive retractor systems representing an innovative design departure from standard tubular retractors, facilitating retractor placement, positioning and fixation to the patient’s anatomy to allow for endplate to endplate visualization and multi-level balance through a lateral access approach;
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tifix
: a locking technology integrated into a number of our interbody and plate implants which provides surgeons with the flexibility to insert screws at various angles and lock them to an implant with a one-step locking mechanism that eliminates the need for a secondary locking feature.
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We have grown our revenue to $
236.6
million in
2016
from $118.0 million in 2011, representing a five-year Compounded Annual Growth Rate (“CAGR”) of
15.0%
. For
2016
,
2015
and
2014
our net loss was $
41.7
million, $
39.2
million and $
59.6
million, respectively, and our Adjusted EBITDA was
$0.6
million,
$(0.1)
million and
$(8.8)
million, respectively. For information about how we calculate Adjusted EBITDA, see Non-GAAP Financial Measures below. We expect to continue to incur additional losses as we invest in the global expansion of our business. As of
December 31, 2016
, our accumulated deficit was $
211.1
million.
We continue to develop and maintain an expanding portfolio of intellectual property, which included
415
issued patents globally and
228
pending patent applications globally as of
December 31, 2016
. In addition to our current product offerings, we continue to invest in the research and development necessary to design, develop and commercialize new surgical solutions for unmet clinical needs. Our highly efficient product development process utilizes an integrated design team approach that involves collaboration among select teams of leading surgeons in their respective specialties, our product management team, our engineers and our clinical and regulatory personnel. We believe that utilizing these integrated design teams enables us to develop innovative and differentiated technologies and techniques that meet the needs of the market and allow surgeons and hospitals to better serve their patients. As of
December 31, 2016
, our product portfolio contains
83
product lines, which include our EVEREST, MESA and CASCADIA technologies, demonstrating our ability to leverage our product development process to rapidly innovate new products.
We currently market or sell our products in the United States, including the territory of Puerto Rico, and
38
other countries. In
2016
, international sales represented approximately
23.5%
of our revenue. We have made significant investments in building a global hybrid sales organization consisting of direct sales employees, independent sales agencies and distributor partners. As of
December 31, 2016
, our U.S. sales organization consisted of
140
direct sales employees and
86
independent sales agencies and our international distribution network consisted of
39
direct sales employees,
nine
independent sales agencies and
26
independent distributorships. We expect to continue to invest in the expansion of our global hybrid sales organization. We believe the continuing expansion of our global sales force will provide us with significant opportunities for future growth as we increase our penetration of existing geographic markets and enter new ones. We do not sell our products through or participate in PODs.
Industry Background
Overview of Spine Anatomy
The spine is the central core of the human skeleton and provides structural support, balance and flexibility to the body. It consists of 24 interlocking bones, called vertebrae, which are stacked on top of one another. The spine is comprised of five
regions, of which there are three primary regions: cervical, thoracic and lumbar. There are seven vertebrae in the cervical, or neck, region of the spine, 12 vertebrae in the thoracic, or central, region of the spine, and five vertebrae in the lumbar, or lower back which is the primary load-bearing region of the spine. The bottom of the spine, comprised of the sacrum and the coccyx, consists of naturally fused vertebrae connected to the hip bones to provide support for the spine. A healthy spine has a natural curvature when viewed from the side and is straight when viewed from the front or back. The cervical and lumbar regions contain forward convex curves referred to as lordosis while the thoracic region contains a backward concave curve referred to as kyphosis. Between each pair of vertebrae is an intervertebral disc that acts as a shock absorber during movement. Vertebrae are paired as motion segments, or levels, and are connected to each other by facet joints in the rear region of the spine that provide flexibility and enable the spine to bend and twist. The back, or posterior, part of each vertebra is comprised of a bony arch called the lamina and the spinous process. Soft tissues, including ligaments, tendons and muscles are attached to these structures, which provide stability to the spinal column and facilitate movement of the spine. The largest load bearing bony structure, which is in the front, or anterior, and middle part of each vertebra, is referred to as the vertebral body. These collective spinal elements serve as a protective cage for the spinal cord, which runs through the center of the spine, or spinal canal, carrying nerves that exit through openings between the vertebrae, or foramen, which run from every area of the body to the brain, delivering sensation and control to the entire body.
Overview of Spine Disorders
Complex spine pathologies and back pain related to spine disorders affect more than 31 million people in the United States and are a leading driver of healthcare costs globally. Spine disorders range in severity from mild discomfort and numbness, to curvatures of the spine, extreme pain and paralysis. Spine disorders can be categorized as either complex, which consists of deformity (primarily scoliosis), trauma and tumor, or degenerative.
Spine deformity is any variation in the natural curvature of the spine. The most common form of spine deformity is
scoliosis which is either a lateral, or side-to-side curvature of the spine, or an extreme rotation of the vertebral body. Other common types of deformity include hyperlordosis, which is an over-extension of the normal convex curvature of the cervical and lumbar spine, and hyperkyphosis, which is an over-flexion of the normal concave curvature of the thoracic spine.
Spine deformity can be further grouped into the following four categories, which are known to have different spine characteristics:
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Pediatric infantile scoliosis,
presents in children under 10 years of age as a result of conditions present at birth or congenital conditions;
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Adolescent scoliosis,
presents in patients between the ages of 10 and 18 as a result of congenital conditions, neuromuscular conditions such as cerebral palsy or muscular dystrophy, or other unknown previously existing conditions;
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Adult scoliosis,
presents in patients between the ages of 19 and 64 as a result of scoliosis, which typically starts after the age of 40 due to arthritis or other conditions of aging, or as a result of scoliosis that started when the patient was younger; and
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Aging spine,
presents in patients 65 years of age or older as a result of a pre-existing deformity that has progressed or the onset of severe degenerative spine disorders.
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Spine trauma is often the result of impact from a fall, car accident or other external forces. Spine traumas include fractures, dislocations, soft tissue damage and other musculoskeletal and nervous system injuries.
Spine tumors are relatively rare. Benign tumors are typically removed surgically while malignant tumors are more difficult to treat and often originate in other areas of the body such as the lungs, thyroid or kidneys.
Degenerative spine disorders are typically the result of repetitive stresses experienced during the normal aging process and are the most common type of spine disorders. Degenerative spine disorders occur when the intervertebral disc at a motion segment weakens and loses its normal height, thereby compressing the spinal nerves. Compression of the spinal nerves often leads to pain and/or loss of feeling in the arms, back and legs.
Treatment Alternatives for Degenerative Spine Disorders
Treatment for degenerative spine disorders usually begins with conservative therapies, including observation to determine if the spine disorder is progressing, lifestyle changes such as exercise and weight loss, anti-inflammatory and pain medication and physical therapy. If and when conservative therapies fail to provide adequate quality of life improvements, patients may ultimately require spine surgery.
The goals of spine surgery are to reduce patient pain and restore structural support and balance while maintaining natural flexibility within the spine, if possible. Surgical options for degenerative spine disorders vary greatly depending on each patient’s unique pathology and include procedures that either (1) do not use spinal implants or (2) use spinal implants. Decompression procedures are typically performed earlier in the continuum of care and may or may not include the use of spinal implants. These procedures include discectomies and laminectomies, which involve the removal of part of a damaged disc or lamina in order to relieve pressure on the spinal nerves. Decompression procedures may occasionally result in spinal instability due to the removal of these spinal elements and as a result require the utilization of spinal implants.
In the case of advanced degenerative spine disorders, treatment often turns to procedures that involve the use of spinal implants, the most common of which is a fusion procedure. The goal of fusion is to permanently decompress the spinal nerves exiting the spine by restoring the natural height of the disc and eliminating motion at the affected level. A fusion procedure involves the surgical removal of bone and/or diseased or damaged disc material that is believed to be the source of the pain and insertion of spinal implants to the spine to stabilize the affected vertebrae. Spinal implants used in fusion procedures include interbody devices that replace the disc space between the vertebrae, as well as spinal implants such as Rails, stabilization rods, screws, plates and biomaterials that provide stability and promote fusion between the vertebrae. Treatments for degenerative spine disorders may also include motion preservation technologies such as cervical and lumbar disc replacement, dynamic stabilization, annular closure, nucleus replacement and facet arthroplasty devices. In some instances, degenerative spine disorders may progress to complex spine disorders, depending on the severity and advancement of the pathology or structural deformity.
Treatment Alternatives for Complex Spine Disorders
Treatments for complex spine disorders, such as deformity, address patients with severe curves in their spine seeking to prevent curve progression and obtain curve correction. The treatment pathway for deformity cases may begin with bracing or casting which are designed to slow or correct the progression of the adverse curvature of the spine. Bracing and casting are typically used as the first course of treatment in young children who are still growing. If a child’s curve has shown progression despite bracing or casting, surgery is often considered. Surgical treatment for deformity conditions in young patients that have not stopped growing, such as pediatric infantile scoliosis, typically seek to correct the deformity while avoiding long fusions of the spine. These procedures include the use of spinal implants, such as pedicle screws and expandable rods that are periodically lengthened, to control the spine deformity while still allowing for the spine to grow until the child reaches an appropriate size or age for a more permanent solution, such as spinal fusion. When these patients mature and reach spinal maturity, spinal fusions are typically considered.
Treatment of more intricate complex spine disorders, such as traumas and tumors, may require the use of one or several procedural alternatives, such as (1) decompression, (2) fusion or (3) corpectomy techniques, where the vertebral body may be completely removed and replaced by a vertebral body replacement device.
The indications for surgical treatment of complex spine disorders such as deformity are determined by anatomical angle measurements that are established and well defined among hospitals, physicians and third-party payors. Conversely, fusion procedures for degenerative conditions are typically indicated when the source of the patient’s pain originates from the vertebral level in question and a diagnostic confirmation of degenerative disc disease is made. Current techniques to identify the source of a patient’s degenerative back pain are imprecise and it may be difficult to locate the source of pain. Third-party payors typically require a confirmed diagnosis of degenerative disc disease in order to reimburse for surgical procedures. We believe complex spine procedures typically receive a higher rate of positive insurance coverage and often generate more revenue per case, as compared to degenerative procedures.
MIS Treatment Alternatives for Complex and Degenerative Spine Disorders
Traditional approaches for complex spine and degenerative spine surgery require large incisions in order to provide surgeons with access to, and visibility of, the spine and surrounding areas. Consequently, traditional surgical procedures are considered highly invasive and are often associated with several limitations including significant blood loss, extensive soft tissue disruption, long operative times, extended hospital stays and lengthy patient recovery times.
Over time, there has been significant increase in surgeon and patient interest for less invasive surgical techniques for treating both complex and degenerative spine disorders. MIS techniques are designed to allow for less invasive access to
the spine and, as a consequence, faster patient recovery times as compared to traditional open access surgical techniques. The figures below illustrate the different incision sizes in a multi-level deformity case utilizing both traditional open and MIS surgical techniques.
Biomaterials Treatment Alternatives for Complex and Degenerative Spine Disorders
Biomaterial treatments are typically derived from human bone or synthetic sources and come in a variety of forms. These biomaterials are used by spine surgeons during the surgical treatment of certain complex spine and degenerative pathologies to augment spinal implants and to promote fusion by accelerating or substituting for the normal regenerative capacity of bone.
Market Opportunity
According to iData, the global spine surgery market was estimated at approximately $
10.5
billion in 2014:
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2014 Estimated Global Spine Market Size (dollars in millions)
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United
States
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Europe
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Asia/
Pacific
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Latin
America
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Total
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Complex Spine
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$
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1,044
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$
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198
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$
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268
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$
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75
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$
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1,585
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MIS (Degenerative)
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1,189
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61
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93
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28
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1,371
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Degenerative Spine
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4,284
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912
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998
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309
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6,503
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Spine Implants and Instrumentation
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$
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6,517
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$
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1,171
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$
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1,359
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$
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412
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$
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9,459
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Biomaterials
(1)
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759
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90
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170
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(2
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)
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1,019
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Total
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$
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7,276
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$
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1,261
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$
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1,529
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$
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412
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$
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10,478
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(1)
We report revenue related to the sale of biomaterials as part of our complex spine, MIS and degenerative spine revenue categories.
Source:iData Research, Inc.
(2)
Not included in market sizing estimates
Overviews of the global spine markets in which we compete, and their associated growth drivers, are as follows:
Complex Spine
The approximately $1.6 billion global complex spine market includes technologies used to treat cases of spine deformity, trauma and tumor, including those treated through a minimally invasive approach. While many advancements in the treatment of complex spine disorders have been made, considerable challenges and limitations associated with performing complex spine surgery remain. For example, many of the spinal implants and instruments currently used to perform complex spine surgeries are not designed to sufficiently address the variable and unpredictable nature of complex spine surgeries caused by the different sizes, shapes, densities and growth characteristics of each individual spine. It is not always possible for spine surgeons to anticipate which of these variables will be present in any given spine surgery, which may result in suboptimal patient outcomes and longer procedure times if they do not have the proper spinal implants and instruments readily available during the procedure. Further, many existing complex spine surgery implants, instruments and surgical approaches are not designed to concurrently access multiple levels of the spine through a MIS approach.
We believe the global complex spine market has been underserved and underdeveloped by major spine market competitors, which generally focus on the larger degenerative spine market. As a result, we believe the complex spine patient population has and will continue to benefit from innovative technologies and techniques that enable simplified surgical procedures, MIS approaches and surgical treatment earlier in the continuum of care.
MIS
The approximately $1.4 billion global MIS market includes technologies used in treating degenerative spine disorders through minimally invasive approaches to the spine.
These technologies and techniques include MIS pedicle screws that are affixed to the spine through either percutaneous, or puncture-like, incisions or retractors that provide direct visualization of the spine with a smaller incision than traditional open procedures. The MIS market also includes minimally invasive interbody devices, including posterior, transforaminal and lateral lumbar interbody fusion (“LLIF”) devices. LLIF devices are inserted from the side and are associated with less disruption to the soft tissues of the back. We believe the vast majority of surgeons and patients, when given the option, will utilize MIS procedures rather than traditional open procedures due to the advantages of MIS approaches, which often include less soft tissue disruption, reduced frequency of surgical morbidity, faster operating times, reduced scarring and, as a consequence of these advantages, shorter patient recovery times. Finally, we believe the overall improvement to the standard of care resulting from the introduction of new MIS products will increase global demand for MIS technologies and techniques.
Degenerative Spine
The approximately $6.5 billion global degenerative spine market includes technologies and techniques used to treat degenerative spine disorders. These technologies and techniques include products such as cervical, thoracic and lumbar spinal fusion devices, interbody devices, motion preservation technologies and vertebral compression fracture devices. We believe that several factors will continue to influence the growth in the global degenerative spine market, including aging patient demographics, increased life expectancies, the desire for maintaining and/or improving lifestyles and demand from patients and surgeons for innovative technologies and techniques that enable simplified surgical procedures, faster procedure times and improved clinical outcomes.
Our Competitive Strengths
Our executive management team is highly experienced in the spinal surgery industry. We believe this experience and the following competitive strengths have been instrumental to our success and continue to enable us to grow our revenue and market share.
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Focus in Complex Spine and MIS.
Our strategic focus and core competencies are the design, development and commercialization of innovative complex spine and MIS technologies and techniques. In addition to our innovative product portfolio, our dedication to the complex spine and MIS markets is evidenced by our strong relationships with key opinion leaders and spine societies focused on the complex spine and MIS markets, such as the Scoliosis Research Society and the Pediatric Orthopedic Society of North America.
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Furthermore, we dedicate significant global resources to educating spine surgeons on the safe and effective use of our complex spine and MIS technologies.
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Comprehensive Portfolio of Innovative Proprietary Technologies.
We continue to expand our comprehensive portfolio of products that address a broad array of spinal pathologies, anatomies and surgical approaches in the complex spine and MIS markets. We believe the benefits of our product offerings in these two markets include simplified surgical techniques, less invasive access to implant sites, enhanced capabilities to manipulate and correct the spinal column, lower-profile spinal implant technology and improved clinical outcomes as compared to traditional alternatives such as open surgical techniques utilizing higher profile screws and other implants that provide more limited manipulation of the spine and often require the use of more components, including additional locking parts and set screws. Our strength in complex spine and MIS provides us with an opportunity to cross-sell our broad portfolio of product offerings in the degenerative market. To protect our innovative technologies and techniques, we maintain and continue to grow our intellectual property portfolio.
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Highly Efficient Product Development Process.
Responding quickly and efficiently to the needs of patients, surgeons and hospitals is central to our culture and critical to our success. Our integrated teams of surgeon advisors, product managers, engineers and clinical and regulatory personnel conceptualize, design and develop potential new products through an iterative process that allows for rapid product development, which has enabled us to commercialize products since our inception. We believe that our integrated approach allows us to (1) quickly assess the market, (2) address evolving patient, surgeon and hospital needs, (3) evaluate new treatment options and (4) accelerate the development of a potential product from concept to commercialization. In 2017, we expect to continue our track record of innovation and introduce an additional five to eight new product lines or line extensions.
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Broad Global Distribution Network.
Our global distribution network continues to expand and included
179
direct sales employees and contractual relationships with
95
independent sales agencies and
26
distributor partners as of
December 31, 2016
. In addition, we continue to broaden our operational capabilities by investing in implants and surgical instrument inventories and maintaining sales offices in strategic markets worldwide, such as the United Kingdom, Italy and Germany. We believe that our significant global distribution footprint provides us with the opportunity to effectively introduce new products in the markets in which we have a sales presence.
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Demonstrated Track Record of Innovation and Execution
.
Our management team has achieved the following milestones:
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Designed and commercialized
83
product lines as of
December 31, 2016
;
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Established a global distribution network with a sales presence in
39
countries;
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Implemented and maintained a comprehensive compliance program, including educational and training components;
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Developed an efficient clinical and regulatory function; and
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Grew revenue at a CAGR of
15%
from 2011 to
2016
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We believe our management has the vision, experience and network of relationships to continue our successful growth.
Our Strategies
For 2017, our primary goals are (i) to drive sustainable growth in revenue and our customer base by servicing the needs of patients, surgeons and hospitals through product innovation and differentiation in the complex spine and MIS markets and continuing to leverage these core competencies in the degenerative spinal surgery market; and, (ii) through a combination of revenue growth and leverage and efficiencies to our sales and operations platforms, to reduce our net loss for 2017 and begin to achieve profitability during 2018.
To achieve these goals, we intend to:
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Capitalize on Our Highly Efficient Product Development Process to Innovate New Technologies and Techniques.
We have a proven history of developing and commercializing new technologies in our core competencies of complex spine and MIS, as well as degenerative spine. We plan to continue developing
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innovative new products. Our product pipeline includes a number of new product or product line extensions of which we expect to introduce five to eight to market during 2017. We believe that the strengthening of our product offerings will allow us to continue to attract highly qualified sales professionals, strengthen our relationship with existing customers, acquire new customers and, ultimately, compete more effectively in the global spine market.
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Leverage Our Investments in Infrastructure to Further Penetrate the Global Spine Market.
We plan to continue to leverage our product development process, robust intellectual property portfolio, key opinion leader expertise, compliance infrastructure, comprehensive training and education programs, investments in inventory and global sales and marketing infrastructure to effectively distribute our products and continue our expansion in the approximately $10.5 billion global spine surgery market.
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Expand Our Global Distribution Footprint.
We will continue to make significant investments in our global distribution network to increase our penetration in existing markets or expand our geographic presence into new markets. We believe there remains significant opportunity for us to expand our global presence. In 2017, we plan to hire additional direct sales employees on an opportunistic basis, while continuing to develop relationships with independent sales agencies and distributor partners in select markets. We also plan to continue our investments in inventory and specialized training to improve the productivity and efficiency of our sales force.
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Selectively Pursue Opportunities to Enhance Our Product Offerings.
We expect to selectively pursue opportunities to license or acquire complementary products and technologies to strengthen our market position. For example, we intend to pursue strategic alliances to develop next generation technologies and techniques for the treatment of complex spine pathologies through MIS approaches. We may also engage in strategic transactions such as acquisitions or joint ventures that allow us to increase our product and service offerings.
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Our Products
The tables below group our core products with the primary market in which they are typically used and provide a summary of each technology’s features and market introduction date. Revenue from products that incorporate EVEREST represented
25%
, 21% and 16% of our total revenue for the years ended
December 31, 2016
,
2015
and
2014
, respectively, and revenue from our products that incorporate MESA represented
24%
, 29% and 31% of our total revenue for the years ended
December 31, 2016
,
2015
and
2014
, respectively.
Complex Spine
We define complex spine as procedures involving the placement of eight or more pedicle screws or procedures that utilize products specific to the correction of deformity, trauma or tumor conditions such as specialized fixation devices, construct extenders or connectors and corpectomy cages. Many of our products designed for use in complex spine procedures incorporate our proprietary EVEREST and MESA technologies.
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Selected Products
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Image
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Description
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Market Introduction
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EVEREST
Deformity Spinal System
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A top-loading pedicle screw system featuring
a variety of screw types and the ability
to accommodate titanium and cobalt chrome rods
of two different diameters. The instrumentation is designed to address the most difficult correction maneuvers for complex spinal pathologies.
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2015
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MESA
Deformity Spinal System
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A low-profile spinal screw technology, used during deformity correction, featuring our proprietary locking mechanism that eliminates the need for a secondary locking feature and reduces rotational force on the spine during implantation, coupled with instrumentation to address complex spine conditions.
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2006
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Selected Products
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Image
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Description
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Market Introduction
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MESA 2
Deformity Spinal System
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Our next-generation MESA technology poised to address the most difficult correction maneuvers for complex spinal pathologies, featuring top-loading, low-profile screws and Zero-Torque Technology. The streamlined instrumentation is designed for efficiency and speed.
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2015
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NILE
Alternative Fixation System
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An alternative non-pedicle based fixation technology featuring low-profile, robust implants coupled with intuitive and light ergonomic instruments, to provide solution for the most complex deformity cases.
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2015
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MESA
Rail Deformity Spinal System
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An innovative “beam-like” design, used with our proprietary MESA Spinal Systems, that aids in the restoration of spinal balance or sagittal balance while providing enhanced rigidity and significantly greater strength as compared to existing titanium and cobalt chrome rod offerings.
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2011
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Cricket
Deformity
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Spinal correction instrumentation, used with our proprietary MESA spinal screws, that provides surgeons with an innovative approach to more easily capture, manipulate and align a deformed spine as compared to traditional deformity correction instrumentation, such as threaded rod reducers or rod forks.
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2008
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Quicket
Deformity
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Next generation spinal correction rod reduction instrumentation, used with our propreitary MESA spinal screws, that provides surgeons with an innovative approach to more easily capture, manipulate and align a deformed spine as compared to traditional deformity correction instrumentation.
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2015
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CAPRI
Corpectomy Cage System
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A corpectomy cage system which provides an innovative solution for stabilization of the spine in cases of vertebral body resections resulting from trauma or tumor. Offered in various configurations, this versatile system allows for in-situ height expansion and endplate angulation.
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2015
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DENALI
Deformity Spinal System
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A top-loading spinal screw technology featuring off-axis screw height adjustments for ease of implant insertion.
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2006
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Selected Products
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Image
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Description
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Market Introduction
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MESA
Small Stature Spinal System
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A low-profile spinal screw technology, used primarily during deformity correction, featuring our proprietary locking mechanism that eliminates the need for a secondary locking feature and reduces rotational force on the spine during implantation, coupled with instrumentation to address complex spine conditions in smaller stature patients.
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2012
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MESA
Rail Small Stature
Spinal System
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An innovative “beam-like” implant, used with our proprietary MESA spinal screws, that aids in the restoration and maintenance of spinal balance or sagittal balance in smaller stature patients, while providing enhanced rigidity and strength as compared to existing titanium and cobalt chrome rod offerings.
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2012
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MESA
Mini Spinal System
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A low-profile spinal screw technology, used during deformity correction, featuring our proprietary locking mechanism that eliminates the need for a secondary locking feature and reduces rotational force on the spine during implantation, coupled with instrumentation to address complex spine conditions in the upper regions of the spine.
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2008
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SERENGETI
Complex Spine Minimally Invasive Retractor System
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A minimally invasive retractor system featuring one- step placement of screws and retractors, thereby reducing the number of surgical steps, while allowing for direct visualization, improved access to the spine and specialized instrumentation to facilitate multi-level corrections of complex spine pathologies.
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2011
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RAVINE
Complex Spine Lateral Access System
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A minimally invasive retractor system that represents an innovative design departure from standard tubular retractors, facilitating retractor placement, positioning and fixation to the patient’s anatomy to allow for endplate to endplate visualization and multi-level balance through a lateral access approach for large construct resection procedures.
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2013
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SANTORINI Corpectomy Cage System
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An expandable vertebral body replacement device made of biocompatible polymer (polyether ether ketone, or PEEK) for radiographic visibility that allows for intra-operative height adjustment.
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2012
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Minimally Invasive Surgery
We define MIS technologies and techniques as spinal implants and instruments used to facilitate and treat spinal pathologies through minimally invasive approaches to the spine. These include patented technologies for a lateral approach, oblique approach and posterior access to the patient's spinal anatomy.
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Selected Products
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Image
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Description
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Market Introduction
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EVEREST
Minimally Invasive
Spinal System
|
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Cannulated top-loading polyaxial pedicle screw system featuring the ability to accommodate titanium and cobalt chrome rods of two different diameters. The innovative dual-lead thread pattern allows for faster insertion and demonstrates increased pullout strength. The mixed metal tulip minimizes head splay and improves mechanical performance.
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2014
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EVEREST
Minimally Invasive XT Spinal System
|
|
Cannulated top-loading polyaxial pedicle screw featuring rigid closed top break-off extension tabs for MI rod passage. Inner threads provide 25 mm of reduction while streamlined instrumentation provides a simple two step extension tab removal technique. The innovative dual-lead thread pattern allows for faster insertion and demonstrates increased pullout strength.
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2016
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SERENGETI
Minimally Invasive Retractor System
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A minimally invasive retractor system featuring one-step placement of screws and retractors, thereby reducing the number of surgical steps, while allowing for direct visualization and improved access to the spine.
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2006
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RAVINE
Lateral Access System
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|
A minimally invasive retractor system that represents an innovative design departure from standard tubular retractors, facilitating retractor placement, positioning and fixation to the patient’s anatomy to allow for endplate to endplate visualization and multi-level balance through a lateral access approach.
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2010
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CASCADIA
Lateral Interbody System
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A 3D-printed titanium interbody device utilizing our innovative Lamellar 3D Titanium Technology to allow the potential for both bony ongrowth and ingrowth while maintaining a high degree of radiolucency and an overall stiffness similar to PEEK. The system is designed to work in conjunction with the RAVINE Lateral Access System.
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2015
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ALEUTIAN
Lateral Interbody System
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An intervertebral implant made of biocompatible polymer (PEEK) for radiographic visibility, designed to be inserted with RAVINE refractor systems to provide spinal column support through lateral MIS access.
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2010
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TERRA NOVA Minimally Invasive Access System
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A distractor blade system designed to be used in conjunction with the SERENGETI retractor systems to provide the ability to simultaneously retract tissue while distracting the intervertebral disc space to allow for decompression and access for implant insertion.
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2007
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Degenerative Spine
Our degenerative spine technologies are used to treat degenerative spine disorders and include products such as cervical, thoracic and lumbar spinal fusion devices and interbody devices. Many of our products designed for use in degenerative spine procedures incorporate our proprietary EVEREST or Lamellar 3D Titanium technologies.
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Selected Products
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Image
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Description
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Market Introduction
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EVEREST
Degenerative Spinal System
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A spinal screw technology that we believe, based on internal testing, provides for improved insertion speed, industry-leading pull-out strength and the versatility to accommodate a variety of titanium and cobalt chrome rods of two different diameters.
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2011
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CASCADIA
Interbody Systems
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3D-printed titanium interbody devices in anatomically narrow (
“
AN
”
) and thoracular lumbar (
“
TL
”
) configurations utilizing our innovative Lamellar 3D Titanium Technology to allow the potential for both bony ongrowth and ingrowth while maintaining a high degree of radiolucency and an overall stiffness similar to PEEK.
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2015
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ALEUTIAN
Interbody Systems
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Full range of anatomically designed intervertebral implants made of biocompatible polymer (PEEK) for radiographic visibility and use in multiple spinal applications
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2005
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BaseCamp
Rod Reduction Technology
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Versatile rod reduction technology which allows for controlled symmetrical and asymmetrical reduction of the vertebral body for spondylolithesis.
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2014
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RHINE
Cervical Disc System
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Cervical disc system featuring a one-piece compressible polymer core design with dome-shaped, plasma-coated endplates and a central-split keel, with proprietary molding technology incorporated to minimize wear between the polymer core and metal titanium alloy endplates.
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2016
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CHESAPEAKE Interbody Systems
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Multi-screw intervertebral implants providing surgeons with the flexibility to insert screws at various angles and lock them to an implant with our
tifix
one-step locking mechanism to stabilize the spine while reducing the need for supplemental fixation.
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2010
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PYRENEES
Cervical Plate Systems
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Low-profile plates for treating the cervical spine that provide surgeons with the flexibility to insert screws at various angles and lock them to an implant with our
tifix
one-step locking mechanism.
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2005
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BLUE RIDGE
Hybrid Cervical Plate System
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A plate technology for treating the cervical spine providing surgeons with the flexibility to create constrained, semi-constrained or hybrid screw constructs.
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2011
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Product Pipeline
In addition to our comprehensive commercialized product portfolio, we plan to continue developing innovative new technologies and techniques to enhance our robust product pipeline. Our next generation product development efforts will remain focused on the complex spine and MIS markets, as well as creating three-dimensional solutions across the entire episodic care continuum to help drive quality outcomes for spine patients.
We will continue with the expansion of the MESA 2, EVEREST and NILE Alternative Fixation Spinal Systems to address complex adolescent and adult deformities.
In the MIS market, we will continue the rollout of the EVEREST MI XT Spinal System, intended to treat patients with degenerative disc disease and spondylolisthesis through a minimally invasive approach. We plan further additions to this product line in 2017, including implants and instruments to address more complicated pathologies.
Our product development efforts in the degenerative spine market includes the further expansion our CASCADIA Interbody Systems, featuring Lamellar 3D Titanium Technology, and additional implant options for TL, AN, Lateral, AN Lordotic Oblique, and Cervical designs. In 2017, we expect this expansion to continue with additional implant footprints and lordotic designs. Overall, we expect to introduce five to eight new product or product line extensions during 2017.
In addition to our product development efforts focused on spinal implants and instrumentation, we will continue to develop a variety of enabling technologies in the areas of preoperative planning, intraoperative support and postoperative patient care, with the goal of correcting the spine in all three anatomical planes and improving short- and long-term outcomes.
Research and Product Development
We have made significant investments in our product development capabilities to enhance our product lines, and believe that ongoing research and development efforts are essential to our success. Our product design teams consist of surgeon advisors, product managers, engineers and clinical and regulatory personnel who work closely together in an integrated product development process to design, enhance and validate our technologies and techniques.
These product design teams conceptualize technologies and then build and test prototypes utilizing in-house and third- party prototyping and testing facilities. As part of the development process, spine surgeons evaluate the implantation of the product in our cadaveric laboratory to ensure it meets the needs of both surgeons and patients. Prototypes are then quickly refined or redesigned as necessary based on the results of the product testing, allowing us to perform rapid iterations of the design-prototype-test development cycle.
Our regulatory and clinical affairs personnel allow us to anticipate and resolve any potential issues at early stages in the development cycle. In addition, they are able to submit regulatory filings shortly after the final development testing has been completed and are committed to timely and responsive communication with regulatory agencies. We have demonstrated an ability to gain rapid regulatory approvals of our technologies.
Our research and development expense was $
21.5
million, $
19.9
million and $
16.3
million for the years ended
December 31, 2016
,
2015
and
2014
, respectively.
Global Spine Community Involvement, Education and Training
We devote significant resources towards global surgeon education on the proper use of our technologies and techniques. This education includes approved patient indications, contra-indications and overviews of the features and clinical benefits of our products. For example, we support local, regional, national and global educational courses, intensive hands-on cadaveric training and product-based programs that include didactic sessions coupled with hands-on-lab segments to allow surgeons to learn and experience new technologies.
We believe that our success has been, and will continue to be, driven by the quality of our products and reputation within the spine surgeon community. We collaborate with spine surgeons in various aspects of our strategy and product development. These spine surgeons are compensated pursuant to written agreements with us. These agreements generally provide for compensation on an hourly-basis for time spent on our projects and may entitle such surgeons to royalties. We also work with surgeons and other healthcare professionals in the area of clinical research in order to gain a better understanding of the safety and efficacy of our products and support the necessary requirements for product clearances and registrations internationally.
As an active member of the global spine community, we support and maintain a presence in trade and industry
organizations, including the Scoliosis Research Society and the Pediatric Orthopedic Society of North America, as well as other local, regional, national and international spine societies. At these meetings, we demonstrate the clinical benefits of our products to surgeons and generate awareness among these societies as to the clinical benefits of our innovative technologies and techniques.
We provide charitable support to the medical community and the community in general. We also provide financial and product support to international medical missions in underdeveloped countries around the world and to local community charitable causes.
Sales and Marketing
We promote, market and sell our products through a global hybrid sales organization comprised of direct sales employees, including complex spine and MIS product specialists, independent agencies and distributor partners. Our hybrid U.S. sales organization consists of
140
direct sales employees and
86
independent sales agencies. Each direct sales employee and independent sales agency is assigned a defined territory.
Our international sales organization includes over
39
direct sales employees, primarily located in the United Kingdom and Germany. In addition, we directly manage nine independent agencies in Italy and Canada and sell to
26
distributors in certain other international markets. Combined, these international distribution efforts permit us to market and sell our products in
38
countries outside the United States and the territory of Puerto Rico. To support our international sales force, we deploy a number of international market managers who leverage product fluency and local market expertise to broaden and deepen our relationships with our independent agency and distributor partners as well as to provide a direct line of communication to our surgeon customers. Our hybrid global sales organization provides us with broad geographic coverage in regions where our products are sold, including the Americas, Europe, Middle East, South Africa and Asia/Pacific. We continually evaluate new market opportunities and expect to expand our international market presence.
The contractual relationships with our independent sales agencies and distributor partners generally have terms of one to five years, with automatic renewal unless otherwise terminated. Our independent sales agents are compensated based on a commission structure while our distributor partners purchase and take title to our products and resell them to their customers. These contractual arrangements may generally be terminated by us for failure to meet certain sales quotas or minimum purchase requirements or upon breach of the agreement by the counterparty. The nature of these contractual relationships vary, with certain contracts that are exclusive, some of which have limited exceptions to the exclusivity provisions, and others that are nonexclusive.
We support the efforts of both our direct sales employees and independent agency partners through the deployment of product specialists with expertise in complex spine and MIS. These specialists provide technical expertise relating to our products and engage surgeons and hospitals directly to assist them in better understanding product capabilities, value propositions and market trends.
We have also implemented certification programs designed to ensure a sophisticated proficiency within our global sales organization in the effective promotion, marketing and selling of our complex spine and MIS products, respectively. These certification programs include in-depth training on our products and promote a detailed proficiency in and understanding of the anatomical issues, clinical pathologies and diagnosis challenges associated with complex spine surgery and MIS technologies and techniques. We make decisions on whether to be direct or utilize independent agencies or distributor partners on a market-by-market basis using a number of parameters, including the availability of sales talent with the necessary level of spinal expertise, the reputation of the sales talent with surgeons and hospitals, the results of our compliance diligence and the overall potential of the market.
We continually evaluate and refine the performance of our global sales organization using a number of tools, including metric-driven scorecards and reviews of performance relative to budgets. Our direct sales force is compensated through a combination of base salaries, individual and company-based performance bonuses, commissions and stock-based compensation. Our independent agencies are compensated with commissions and individual-based performance bonuses. Our compensation programs are designed to balance rewarding performance, incentivizing the desired sales behaviors to align with our corporate strategy and maximizing sales force retention.
Suppliers and Raw Materials
We have a strong base of more than 50 third-party suppliers located primarily in the United States, with a small number located in the European Economic Area (“EEA”), that manufacture our products. We work with these suppliers in support of our supply chain strategy, which involves minimizing our capital investment, controlling costs and shortening cycle
times. We believe this allows us to compete with larger volume manufacturers of spine surgery products. We work closely with our suppliers to ensure our inventory needs are met while maintaining high quality and reliability.
We select our suppliers carefully. Our internal quality assurance and supply chain groups conduct on-site audits of our suppliers. As suppliers meet our internal quality control standards they are added to our approved supplier list. We regularly audit our suppliers to ensure they meet FDA, International Organization for Standardization (“ISO”) and other country-specific requirements as necessary. In addition, suppliers of our biomaterials products are certified by the American Association of Tissue Banks (“AATB”). Our quality assurance and supply chain groups conduct annual audits to ensure continued compliance with our standards; our suppliers provide a certificate of compliance with every shipment of inventory that we receive in conformance with our quality control standards. Our quality control group also performs incoming inspection of our products, in-process inspections and packaging and labeling inspections on-site at our headquarters facility.
We generally do not have long-term supply contracts with our suppliers and they are not required to provide us with any guaranteed minimum production levels. In most cases, we maintain redundant manufacturing capabilities for each of our products to ensure our inventory needs are met. We do, however, have single or limited source contracts with certain suppliers, who provide our biomaterials and materials for select interbody products.
We believe our supplier relationships will be able to support our potential capacity needs for the foreseeable future. To date, we have not experienced any significant difficulty locating and obtaining the suppliers or materials necessary to fulfill our production requirements.
Intellectual Property
Our success depends upon our ability to protect our intellectual property. We proactively protect our innovations by filing
U.S. and foreign patent applications, and our growing intellectual property portfolio reflects significant investment. We have also acquired intellectual property rights via the strategic purchase and license of patents from third parties to complement our internally-developed intellectual property holdings. We utilize specialist intellectual property lawyers to oversee our intellectual property assets. As of
December 31, 2016
, we owned or licensed
253
issued U.S. patents and
162
issued foreign patents. We had
113
pending U.S. patent applications and
115
pending foreign patent applications. As of
December 31, 2016
, we also had
28
U.S. trademark registrations,
80
foreign trademark registrations,
10
pending U.S. applications to register trademarks and
11
foreign applications to register trademark registrations.
We license certain technologies used in our MESA products from Spinal LLC pursuant to an exclusive license agreement, which provides us with an exclusive license to the MESA technology and related patents and patent applications to treat diseases of or injuries to the spine until the expiration of all patents licensed pursuant to the agreement, which is expected to be in February 2024 for the material patents currently licensed under this agreement. Under this license agreement, we are required to make royalty payments equal to 6.0% of the net sales of our products that incorporate the MESA technology, subject to an annual minimum royalty payment of $0.4 million.
In addition, we license our
tifix
one-step locking technology from Dr. Dietmar Wolter pursuant to a license agreement, which provides us with an exclusive license to use such technology in the field of spinal surgery in the United States and a non-exclusive license to use such technology internationally until the expiration of all patents licensed pursuant to the agreement, which is expected to be in December 2019. Under the terms of this license agreement, we are required to make payments equal to 9.0% of net sales of products that incorporate tifix technology.
In 2011, we acquired certain proprietary spinal disc implant technologies that were developed and used in our RHINE™ Cervical Disc System, pursuant to an asset purchase agreement, which could require additional payments up to $
12.0
million if certain milestones are met related to U.S. regulatory applications and approvals as of
December 31, 2016
. In addition, milestone payments of $
0.5
million, $
2.0
million and $
4.0
million are due upon the achievement of net sales from products incorporating such proprietary technologies of $
10.0
million, $
25.0
million and $
50.0
million, respectively. We are also required to make royalty payments equal to
7.0%
of net sales from patented products, up to an aggregate amount of $
20.0
million.
In 2010, we acquired all rights to certain technologies used in our EVEREST pedicle screw system from Dr. John Carbone, pursuant to an asset purchase agreement, which requires us to make payments to Dr. Carbone equal to
3.5%
of the net sales from EVEREST pedicle screws and
1.5%
of the net sales from any of our other products that incorporate certain elements of our EVEREST screw technology until the expiration of the last to expire U.S. patent related to such technologies, which is expected to be in August 2031, or, if no U.S. patent issues, for 10 years from product launch, except that we will have no obligation to make such payments on any sales of products made after February 23, 2031.
In 2007, we acquired all rights to certain technologies used in our SERENGETI retractor system from Dr. Josef Gorek, which requires us to make royalty payments equal to 3.0% of net sales from products that incorporate the SERENGETI retractor technology, subject to a minimum annual royalty of the greater of (1) $25 for each retractor sold or used in surgery or (2) $178,375. If we market a non-disposable reusable product incorporating the SERENGETI retractor technology, we will pay to Dr. Gorek a royalty of $25 for each use of such reusable product to place a screw implant in surgery, with a minimum royalty of $100 per surgery in which such reusable product is used. We are required to make such royalty payments on the net sales of any such product until the expiration of the last to expire U.S. patent used in the SERENGETI retractor, which is expected to be in May 2029. In the event we fail to pay the minimum royalties, and do not cure such non-payment after receiving notice of such non-payment, Dr. Gorek would have the right to have one partner other than us for the assigned intellectual property.
In 2004, we acquired all rights to certain technologies used in our DENALI pedicle screw system from Fastenetix LLC and certain other persons, pursuant to an assignment agreement, which requires us to make payments to the assignors equal to 6.0% of net sales of products that incorporate our DENALI screw technology that are covered by an issued patent or described in a patent application assigned to us under this agreement until the expiration of the last to expire patent related to such technologies, which is expected to be in February 2017, and 2.0% to 3.0% of such net sales thereafter. We are also obligated to make payments to the assignors on a product-by-product basis equal to 4.0% of net sales of products that incorporate our DENALI screw technology and that are covered by intellectual property assigned to us under this agreement other than patents and patent applications until either the expiration of the last to expire issued patent relating to such intellectual property or the abandonment of all patent applications relating to such intellectual property, and 2.0% to 3.0% of such net sales thereafter. The Fastenetix parties may have the right to re-purchase the contributed intellectual property in the event we cease operations (other than due to a sale or merger) or we enter into bankruptcy, insolvency or similar proceedings.
We also rely upon trade secrets and know-how to develop and maintain our competitive position. We protect our proprietary rights in trade secrets and know-how through a variety of methods, including confidentiality agreements and proprietary information agreements with suppliers, employees, consultants, and others who may have access to our proprietary information.
Although we believe our patents are valuable, we also believe that our knowledge and experience and our trade secret information with respect to development and manufacturing processes, materials and product design have been equally important in maintaining our proprietary product lines. As a condition of employment, we generally require employees to execute a confidentiality agreement relating to proprietary information and assignment of patents and other intellectual property to us.
Seasonality
Our revenue is typically higher in the late spring and summer and in the fourth quarter of our fiscal year, driven by higher sales of our complex spine products, which is influenced by the higher incidence of adolescent surgeries during these periods to coincide with the beginning of summer vacation and holiday periods. In addition, due to seasonal changes in mortality rates, some scarce tissues used in our biomaterials products may be, at times, in particularly short supply.
Competition
Our currently marketed products are, and any future products we commercialize will be, subject to intense competition. We believe that the principal competitive factors in our markets are:
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the quality of outcomes for medical conditions affecting the spine;
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acceptance by spine surgeons;
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ease of use and reliability;
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•
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technical leadership and superiority;
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effective marketing and distribution;
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•
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product price and qualification for coverage and reimbursement.
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We also compete in the marketplace to recruit and retain qualified scientific, management and sales personnel, as well as in acquiring technologies and technology licenses complementary to our products or advantageous to our business.
We are aware of several companies that compete or are developing technologies in our current and future product areas. As a result, we expect competition to remain intense. We believe that our principal competitors include Medtronic Public Limited Company, DePuy Synthes Inc., Stryker Corporation, Globus Medical, Inc., Zimmer Biomet Holdings, Inc. and NuVasive Inc., which together represent a significant portion of the spine market. We also compete with smaller spine market participants such as Alphatec Holdings, Inc., Orthofix International N.V. and SeaSpine Holdings Corporation who generally have a smaller market share than the principal competitors listed above.
Our ability to compete successfully will depend on our ability to develop proprietary products that reach the market in a timely manner, receive adequate coverage and reimbursement, are cost effective and are safe and effective.
Government Regulation
Our products are medical devices and tissues and therefore subject to extensive regulation by the FDA under the authority of the Federal Food, Drug and Cosmetics Act (“FDCA”), the Public Health Service Act (“PHSA”) and the regulations promulgated under both statutes, as well as by other domestic and international regulatory bodies. These regulations govern the following activities that we and our suppliers, licensors and partners perform and will continue to perform:
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product design and development;
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•
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premarket clearance or approval;
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advertising and promotion;
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•
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product marketing, sales and distribution;
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postmarket surveillance; and
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postmarket adverse event reporting.
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Regulatory Clearances and Approvals
Unless an exemption applies, each medical device that we wish to commercially distribute in the United States will require prior 510(k) clearance or approval of a Pre-Market Approval Application (“PMA”) from the FDA. The FDA classifies medical devices into one of three classes. Devices deemed to pose a low or moderate risk are placed in class I or II, which requires the manufacturer to submit to the FDA a 510(k) premarket notification requesting clearance for commercial distribution, unless the device type is exempt from this requirement. Devices deemed by the FDA to pose the greatest risk, such as life-sustaining, life supporting or implantable devices or devices deemed not substantially equivalent to a previously cleared 510(k) device are placed in class III, requiring submission and approval of a PMA. Both premarket clearance and approval submissions are subject to user fees, which must be paid at the time of submission for FDA review.
To obtain 510(k) clearance, we must submit a premarket notification demonstrating that the proposed device is “substantially equivalent” to a previously cleared 510(k) device or a device that was in commercial distribution before May 28, 1976 for which the FDA has not yet called for the submission of PMAs. The FDA’s 510(k) clearance pathway usually takes from three to 12 months from the date the notification is submitted, but it can take considerably longer, depending on the extent of FDA's requests for additional information and the amount of time a sponsor takes to fulfill them. FDA requests for additional information can include clinical data that the FDA determines is necessary to make a
determination regarding substantial equivalence.
All of our commercial medical device products to date have been classified as either class I or class II devices and have been cleared for marketing and distribution through the 510(k) pathway, unless exempt.
After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, will require a new 510(k) clearance or could require premarket approval. The FDA requires each manufacturer to make this decision initially, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s decision not to seek a new premarket clearance, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or premarket approval is obtained. We have made, and plan to continue to make, product enhancements that we believe do not require new 510(k) clearances. However, if the FDA requires us to seek 510(k) clearance or premarket approval for any such modifications to previously cleared products, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval, and we could be subject to significant regulatory fines or penalties.
A PMA must be submitted if a device cannot be cleared through the 510(k) clearance process. A PMA application must be supported by extensive data, including, but not limited to, technical information, preclinical data, clinical trial data, manufacturing data and labeling, to demonstrate to the FDA’s satisfaction the safety and efficacy of the device for its intended use.
Once a complete PMA application is submitted, the FDA begins an in-depth review which generally takes between one and three years, but may take significantly longer. During this review period, the FDA may request additional information or clarification of information already provided. Also during this review period, an advisory panel of experts from outside the FDA may be convened to review and evaluate the application and provide recommendations to the FDA as to the approvability of the device. In addition, the FDA will conduct a pre-approval inspection of the manufacturing facility to ensure compliance with quality system regulations. New PMA applications or supplements are required prior to marketing for product modifications that affect the safety and efficacy of the device. PMA supplements often require submission of the same type of information as a PMA application, except that the supplement is limited to information needed to support the changes to the device and may not require extensive clinical data or the convening of an advisory panel.
None of our existing products are currently approved under a PMA. In the future, we may decide to strategically commercialize products in the U.S. that would require a PMA but we have no plans to do so at the present time.
Clinical Trials
Clinical trials are almost always required to support a PMA and are sometimes required for a 510(k) premarket notification. In the United States, these trials often require submission of an application for an investigational device exemption, or IDE, if the investigation involves a significant risk device. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE must be approved in advance by the FDA for a specified number of patients, unless the product is deemed a non-significant risk device and is eligible for more abbreviated IDE requirements. Clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and appropriate institutional review boards, or IRBs, at the clinical trial sites.
Future clinical trials of certain types of products will most likely require that we obtain an IDE from the FDA prior to commencing clinical trials and that the trial be conducted under the oversight of IRBs at the clinical trial sites. Our clinical trials must be conducted in accordance with FDA regulations and similar federal and state regulations concerning human subject protection, including requirements for informed consent, healthcare privacy and financial disclosures by the clinical investigators. The receipt of personal information in connection with our clinical trial initiatives is subject to these human subject protection laws. These laws could create liability for us if one of our research collaborators were to use or disclose research subject information without proper consent or in violation of applicable laws. A clinical trial may be suspended by the FDA or the investigational review board at any time for various reasons, including a belief that the risks to the study participants outweigh the benefits of participation in the study. Even if a study is completed, the results of our clinical testing may not demonstrate the safety and efficacy of the device, or may be equivocal or otherwise not be sufficient to obtain clearance or approval of our products. Similarly, in the EEA, conduct of clinical studies in relation to investigational medical devices is governed by detailed regulatory obligations. These include the requirement for prior authorization by the competent authorities of the country in which the study takes place and the requirement to obtain a positive opinion from a competent Ethics Committee.
Pervasive and Continuing FDA Regulation
After a device is placed on the market, numerous FDA and other regulatory requirements continue to apply. These include:
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establishment registration and device listing with the FDA;
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quality system regulations, which require manufacturers to follow stringent design, testing, process control, documentation and other quality assurance procedures;
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labeling regulations, which prohibit the promotion of products for unapproved, i.e. “off-label,” uses and impose other restrictions on labeling;
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medical device reporting, “MDR” regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if it were to recur;
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corrections and removal reporting regulations, which require that manufacturers report to the FDA field corrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FDCA that may present a risk to health;
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requirements to conduct post market surveillance studies to establish continued safety data, and other post-approval conditions; and
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the FDA’s recall authority, whereby the agency can ask, or under certain conditions order, device manufacturers to recall from the market a product that is in violation of governing laws and regulations.
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We are required to, and have, registered with the FDA and ISO as medical device manufacturers and must obtain all necessary permits and licenses to operate our business. As manufacturers, we and our suppliers are subject to announced and unannounced inspections by the FDA and European notified bodies to determine our compliance with the QSR and other applicable regulations. The FDA has inspected our former Leesburg facility on several separate occasions from 2006 through 2016.
Failure to comply with the applicable regulatory requirements can result in enforcement action by the FDA, which may include, among other things, any of the following sanctions:
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warning letters, fines, injunctions, consent decrees and civil penalties;
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repair, replacement, refund or seizure of our products;
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operating restrictions, partial suspension or total shutdown of production;
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refusing our request for 510(k) clearance or premarket approval of new products or modifications to existing products;
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withdrawing or suspending clearances or approvals that are already granted; and
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International Regulations
Many foreign countries in which we market or intend to market our products have regulatory bodies and restrictions, similar to those of the FDA. International sales are subject to foreign government regulation, the requirements of which vary substantially from country to country. The time required to obtain approval in a foreign country or a CE Certificate of Conformity may be longer or shorter than that required for FDA approval and the related requirements may differ. Some third-world countries accept CE Certificates of Conformity or FDA clearance or approval as part of applications of approval for marketing of medical devices in their territory. Other countries, including Australia, Japan and Canada require separate regulatory filings.
In the EEA, companies compliant with ISO requirements such as the EN ISO 13485:
2003 Medical devices-Quality management systems-Requirements for regulatory purposes
, benefit from a presumption of conformity with the relevant quality system requirements laid down in the Annexes to the Medical Devices Directive. This certification process
requires that the Company’s quality system and facilities be inspected by a Notified Body for compliance with ISO requirements. Compliance with the ISO requirements can also facilitate market access in other jurisdictions.
We received ISO 13485 certification in November 2007, and we affix the CE Mark to our products concurrently with the 510(k) process in the U.S. We cannot assure that we or our original equipment manufacturer partners will be able to continue to obtain the necessary foreign government approvals or successfully comply with foreign regulations. Our failure to do so could hurt our business, results of operations and financial condition.
European Economic Area
In the EEA, our devices are required to comply with the Essential Requirements laid down in Annex I to the Medical Devices Directive. Compliance with these requirements entitles us to affix the CE mark to our medical devices. We cannot commercialize our medical devices in the EEA without the CE Mark. To demonstrate compliance with the Essential Requirements laid down in Annex I to the Medical Devices Directive and obtain the right to affix the CE mark to our medical devices, we must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. The Medical Devices Directive groups medical devices into four product classes. These classes and related rules are based on the potential risks associated with the technical design and manufacture of the medical devices that fall within their classification. The classification rules make a distinction between non-invasive, invasive, and active medical devices. A number of additional rules govern specific medical devices, such as those incorporating an ancillary medicinal substance. Except for low risk medical devices (Class I with no measuring function and which are not sterile), where the manufacturer can issue an EC Declaration of Conformity based on a self-assessment of the conformity of its products with the Essential Requirements laid down in the Medical Devices.
A conformity assessment procedure requires the intervention of a Notified Body, which is an organization designated by the competent authorities of a European Union (“EU”) country to conduct conformity assessments.
Depending on the relevant conformity assessment procedure, the Notified Body would typically audit and examine products’ Technical File and the quality system for the manufacture, design and final inspection of our devices before issuing a CE Certificate of Conformity demonstrating compliance with the relevant Essential Requirements laid down in Annex I to the Medical Devices Directive. The Notified Body issues a CE Certificate of Conformity following successful completion of a conformity assessment procedure conducted in relation to the medical device and its manufacturer and their conformity with the Essential Requirements. This Certificate entitles the manufacturer to affix the CE mark to its medical devices after having prepared and signed a related EC Declaration of Conformity. We have now successfully passed annual Notified Body audits since our original certification in November 2007. Following these audits, our Notified Body issued ISO certificates and CE Certificates of Conformity allowing us to draw up an EC Declaration of Conformity and affix the CE mark of conformity to certain of our devices.
In September 2012, the European Commission adopted a package of legislative proposals designed to replace the existing regulatory framework for medical devices in the EEA. Among these proposals, the Medical Devices Regulation (“MD Regulation”) will replace the Medical Devices Directive and the Active Implantable Medical Devices Directive.
On June 17, 2016, the Dutch Presidency of the Council of the European Union formally informed the Council of Ministers of the agreement that was reached, on May 25, 2016, with the European Parliament as part of the trialogue discussion concerning the text of the proposed MD Regulation. On February 22, 2017, after finalization a final linguistic review of the text and the last revisions, the final text of the MD Regulation was published on the Council of the European Union's website. The Regulation is now definitively adopted by the Council and the European Parliament would enter into force in May 2017 and will become applicable in May 2020. The MD Regulation would, among other things, impose additional reporting requirements on manufacturers of high risk medical devices, impose an obligation on manufacturers to appoint a “qualified person” responsible for regulatory compliance, and provide for stricter clinical evidence requirements, impose additional requirements on economical operators (including distributors, authorized representatives), and is expected to impose extensive changes to labeling / implant cards and other requirements. As a result of the approval of the MD Regulation certain spinal devices will be reclassified from Class IIb to Class III. Rule 8 of Annex VIII to the MD Regulation states that all implantable devices and long-term surgically invasive devices are classified as Class IIb unless they “are spinal disc replacement implants and implantable devices that come into contact with the spinal column, in which case they are in Class III with the exception of components such as screws, wedges, plates and instruments.” For us, this means rods, hooks, connectors, cervical discs, and corpectomy cages will be reclassified to Class III and will be subject to stricter requirements by the notified body.
The scrutiny imposed by notified bodies for the technical documentation related these devices will increase considerably. Some differences between requirements for Class IIb and Class III devices are summarized below:
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Class III devices undergo an additional technical documentation assessment following which the notified bodies issue a technical documentation assessment certificate.
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Increased strength of requirement for clinical investigation and evaluation.
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A summary of safety and clinical performance must be prepared by manufacturers for publication on the EUDAMED database for medical devices;
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Greater expectation of “proactive” post market surveillance, and in particular, post market clinical follow up studies.
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Review for Class III devices is not a sampling process, unlike for Class IIa and Class IIb devices which is done on a sampling basis; and
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Notified Bodies shall notify the Commission and the newly created Medical Device Coordination Group (“MDCG”) of new applications for Class III devices as part of a mandatory clinical evaluation consultation procedure.
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Further, the advertising and promotion of our products in the EEA is subject to the provisions of the Medical Devices Directive, Directive 2006/114/EC concerning misleading and comparative advertising, and Directive 2005/29/EC on unfair commercial practices, as well as other national legislation in the EEA countries governing the advertising and promotion of medical devices. These laws may limit or restrict the advertising and promotion of our products to the general public and may impose limitations on our promotional activities with healthcare professionals.
Tissue, Cellular and Tissue Based Products
Tissue-only products are regulated by the FDA as Human Cell, Tissue and Cellular and Tissue Based Products, or HCT/P. In regards to HCT/P, we are registered with FDA and subject to the regulations related only to labeling, packaging, storage and distribution.
Human cells or tissue intended for implantation, transplantation, infusion, or transfer into a human recipient is regulated as a HCT/P. In the United States the FDA Center for Biologics Evaluation and Research (“CBER”) regulates HCT/Ps under 21 CFR Part 1270 and CFR Part 1271. Parts 1270 and 1271 require tissue establishments to screen and test donors, to prepare and follow written procedures for the prevention of the spread of communicable disease, and to maintain records. FDA has published three final rules to broaden the scope of products subject to regulation and to include more comprehensive requirements to prevent the introduction, transmission and spread of communicable disease. One final rule requires firms to register and list their HCT/Ps with FDA. The second rule requires tissue establishments to evaluate donors, through screening and testing, to reduce the transmission of infectious diseases through tissue transplantation. The third rule establishes current good tissue practices for HCT/Ps. FDA’s revised regulations are contained in Part 1271 and apply to tissues recovered after May 25, 2005. The new requirements are intended to improve protection of the public health while minimizing regulatory burden.
We currently distribute VIKOS machined allograft and VESUVIUS morselized products, which are manufactured by a third-party supplier. The FDA periodically inspects tissue processors to determine compliance with these requirements. Violations of applicable regulations noted by the FDA during facility inspections could adversely affect the continued marketing of our products. We believe we comply with all aspects of the current good tissue practices, although there can be no assurance that we will comply, or will comply on a timely basis, in the future. Entities that provide us with allograft bone tissue are responsible for performing donor recovery, donor screening and donor testing and our compliance with those aspects of the current good tissue practices regulations that regulate those functions are dependent upon the actions of these independent entities.
The procurement and transplantation of allograft bone tissue is subject to U.S. federal law pursuant to the National Organ Transplant Act, or NOTA, a criminal statute which prohibits the purchase and sale of human organs used in human transplantation, including bone and related tissue, for “valuable consideration.” NOTA permits reasonable payments associated with the removal, transportation, processing, preservation, quality control, implantation and storage of human bone tissue. With the exception of removal and implantation, we provide services in all of these areas. We make payments to vendors in consideration for the services they provide in connection with the recovery and screening of donors. Failure to comply with the requirements of NOTA could result in enforcement action against us. The procurement of human tissue is also subject to state anatomical gift acts and some states have statutes similar to NOTA. In addition, some states require that tissue processors be licensed by that state. Failure to comply with state laws could also result in enforcement action against us.
Healthcare Fraud and Abuse
Healthcare fraud and abuse laws apply to our business including when a customer submits a claim for an item or service that is reimbursed under Medicare, Medicaid or most other federally-funded healthcare programs. Companies operating in the health industry must comply with state and federal health care fraud and abuse regulations that have criminal, civil and administrative penalties for potential violations.
The federal Anti-Kickback Statute prohibits, among other things, persons from knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in cash or in kind, to induce or reward either the referral of an individual for, or the purchase, order or recommendation of, items or services for which payment may be made, in whole or in part, under federal health care programs, such as by Medicare or Medicaid. The federal Anti-Kickback Statute is subject to evolving interpretations and has been applied by government enforcement officials to a number of common business arrangements in the medical device industry. For example, the federal government has enforced the Anti-Kickback Statute to reach large settlements with device manufacturers based on allegedly sham consultant arrangements with physicians. A number of states also have anti-kickback laws that establish similar prohibitions that may apply to items or services reimbursed by government programs as well as any third-party payors, including commercial insurers. Further, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, or, collectively, the “PPACA”, among other things, clarified the intent requirements of the federal Anti-Kickback Statute and the federal criminal statute governing healthcare fraud. Specifically, a person or entity can be found to have violated the statutes without actual knowledge of these statutes or specific intent to violate them. In addition, the PPACA amended the Social Security Act to provide that the government may assert that a claim for reimbursement for items or services from federal healthcare programs resulting from a violation of the federal Anti-Kickback Statute may constitute a false or fraudulent claim for purposes of the federal False Claims Act or federal civil money penalties statute potentially subjecting a company to treble damages and mandatory penalties for each false claim.
The civil False Claims Act prohibits, among other things, knowingly presenting or causing the presentation of a false, fictitious or fraudulent claim for payment of federal funds, or knowingly making, or causing to be made, a false record or statement material to a false or fraudulent claim to avoid, decrease or conceal an obligation to pay money to the federal government. Actions under the federal False Claims Act may be brought by the Attorney General or as a private citizen action (known as qui tams) brought by a private individual in the name of the government. Violations of the federal False Claims Act can result in very significant monetary penalties and treble damages. The federal government is using the False Claims Act, and the accompanying threat of significant liability, in its investigations of healthcare companies throughout the country for a wide variety of Medicare billing practices, as well as federal Anti-Kickback Statute violations and certain marketing practices, including off-label promotion, and has obtained multi-million and multi-billion dollar settlements under the federal False Claims Act in addition to individual criminal convictions under applicable criminal statutes. Given the significant size of actual and potential settlements, it is expected that the government will continue to devote substantial resources to investigating healthcare providers’ and suppliers’ compliance with the healthcare reimbursement rules and fraud and abuse laws.
The federal False Claims Act amendments in 2009 and 2010 expanded the scope of the liability for health care entities generally to potentially reach violations of regulatory duties, such as good manufacturing practices. There have been large settlements in the life sciences arena related to FDA regulatory violations related to promotional activities and the failure to maintain good manufacturing practices.
Even in instances where a company may have no actual liability, the federal False Claims Act private citizen provisions (qui tam) allow the filing of federal False Claims Act actions under seal and impose a mandatory duty on the U.S. Department of Justice to investigate such allegations. Most private citizen actions are declined by the Department of Justice or dismissed by federal courts. However, the investigation costs for a company can be significant and material even if the allegations are without merit.
Federal False Claims Act liability is potentially significant in the health industry because the statute provides for treble damages and mandatory minimum penalties of $5,500 to $11,000 per false claim or statement. Because of the potential for large monetary exposure, health care companies resolve allegations without admissions of liability for significant and material amounts to avoid the uncertainty of treble damages that may awarded in litigation proceedings. Many state jurisdictions have implemented state false claims act statutes that mirror the federal statute.
In addition to civil False Claims Act liability and anti-kickback liability, there are several criminal and administrative health care fraud statutes that provide for criminal and civil monetary penalties and the potential for exclusion from federal health care programs.
If a governmental authority were to conclude that we are not in compliance with applicable laws and regulations, we and our officers and employees could be subject to severe criminal and civil penalties, including, for example, exclusion from
participation as a supplier of product to beneficiaries covered by Medicare, Medicaid and other federal health care programs.
Reimbursement Overview
Healthcare providers in the United States generally rely on third-party payors, principally private insurers and governmental payors such as Medicare and Medicaid, to cover and reimburse all or part of the cost of a spine surgery in which our products are used. We expect that sales volumes and prices of our products will continue to depend in large part on the availability of coverage and reimbursement from such third-party payors. Third-party payors perform analyses on new technologies to determine if they are medically necessary before providing coverage for them. These third-party payors may still deny reimbursement on covered technologies if they determine that a device used in a procedure was not used in accordance with the payor’s coverage policy. Particularly in the United States, third-party payors continue to carefully review, and increasingly challenge, the prices charged for surgical procedures and medical products.
Medicare coverage and reimbursement policies are developed by the Centers for Medicare and Medicaid Services (“CMS”) and its contractors. CMS establishes Medicare coverage and reimbursement policies for medical products and procedures and such policies are periodically reviewed and updated. In 2017, we believe CMS will continue to pilot “bundled payments” as will the private payers. The payers are committed to the transfer from quantity reimbursement to reimbursing and incentivizing based on quality and improved outcomes. The private payers are responding the needs of their customers and are jumping ahead of CMS bundled payment program with their own, more predicable medical costs and better quality of care for their employees. While private payors vary in their coverage and payment policies, most look upon the coverage and payment by Medicare as a benchmark by which to make their own coverage decisions. Medicare reimbursement rates for the same or similar procedures vary due to geographic location, nature of the facility in which the procedure is performed (i.e., teaching or community hospital) and other factors.
In the United States, a large percentage of insured individuals receive their medical care through managed care programs, which monitor and often require pre-approval of the services that a member will receive. Some managed care programs pay their providers on a per capita basis, which puts the providers at financial risk for the services provided to their patients by paying these providers a predetermined payment per member per month and, consequently, may limit the willingness of these providers to use our products.
The indications for surgical treatment of complex spine disorders such as deformity are defined by anatomical angle measurements that are established and well defined among hospitals, physicians and third-party payors. Conversely, fusion procedures for degenerative conditions are typically indicated when the source of the patient’s pain originates from the vertebral level in question and a diagnostic confirmation of degenerative disc disease is made. Current techniques to identify the source of a patient’s degenerative back pain are imprecise and it may be difficult to locate the source of pain. Third-party payors typically require a confirmed diagnosis of degenerative disc disease in order to reimburse for surgical procedures. We believe complex spine procedures typically receive a higher rate of positive insurance coverage as compared to degenerative procedures.
We believe that the overall escalating cost of medical products and services has led to, and will continue to lead to, increased pressures on the healthcare industry to reduce the costs of products and services. We cannot assure you that government or private third-party payors will cover and reimburse the procedures using our products in whole or in part in the future or that payment rates will be adequate. In addition, it is possible that future legislation, regulation or coverage and reimbursement policies of third-party payors will adversely affect the demand for our products or our ability to sell them on a profitable basis.
Internationally, reimbursement and healthcare payment systems vary substantially from country to country and include single-payor, government-managed systems as well as systems in which private payors and government managed systems exist side-by-side. Our ability to achieve market acceptance or significant sales volume in international markets we enter will be dependent in large part on the availability of reimbursement for procedures performed using our products under the healthcare payment systems in such markets. A number of countries may require us to gather additional clinical data before recognizing coverage and reimbursement for our products. It is our intent to complete the requisite clinical studies and obtain coverage and reimbursement approval in countries where it makes economic sense to do so.
Employees
As of
December 31, 2016
, we had 457 employees in the United States, including the territory of Puerto Rico. Internationally, we had 66 employees based in nine countries, with international offices located in the United Kingdom,
Germany and Italy.
Our employees are not unionized and we consider our relationship with our employees to be good.
ITEM 1A. RISK FACTORS
Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below and the other information contained in this report, including our consolidated financial statements and the related notes.
Risks Related to Our Business and Our Industry
We have incurred losses in the past and may not be able to achieve or sustain profitability in the future.
We have incurred losses in most fiscal years since inception. We incurred net losses of $
41.7
million, $39.2 million and $59.6 million in
2016
,
2015
and
2014
, respectively. As a result of ongoing losses, we had an accumulated deficit of $
211.1
million at
December 31, 2016
. We expect to continue to incur significant product development, clinical and regulatory, sales and marketing and other expenses. We will need to generate significant additional revenue to achieve and maintain profitability and, even if we achieve profitability, we cannot be sure that we will remain profitable for any substantial period of time. Our failure to achieve or maintain profitability could negatively impact the value of our common stock.
Spine surgeons must continue to recognize the merits of our technologies and techniques and use of our products compared to those of our competitors.
Spine surgeons play a significant role in determining the course of treatment and, ultimately, the type of product that will be used to treat a patient. As a result, our success depends, in large part, on effectively marketing to them. In order for us to sell our products, we must continue to successfully demonstrate to spine surgeons the merits of our technologies and techniques compared to those of our competitors for use in treating patients with spinal pathologies. Acceptance of our products depends on educating spine surgeons as to the distinctive characteristics, perceived benefits, safety, ease of use and cost-effectiveness of our products as compared to our competitors’ products, and on educating spine surgeons in the proper application of our products. If we are not successful in convincing spine surgeons of the merits of our products or educating them on the use of our products, they may not use our products and we may be unable to increase our sales, sustain our growth or achieve profitability.
Furthermore, we believe many spine surgeons may be hesitant to adopt certain products unless they determine, based on experience, clinical data and published peer-reviewed journal articles, that our complex spine products, MIS technologies and techniques and degenerative products provide benefits or are an attractive alternative to existing treatments of spine disorders. Spine surgeons may be hesitant to change their medical treatment practices for the following reasons, among others:
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lack of experience with our technologies;
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existing relationships with competitors and sales representatives that sell competitive products;
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lack or perceived lack of evidence supporting additional patient benefits;
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perceived liability risks generally associated with the use of new products and procedures;
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less attractive availability of coverage and reimbursement within healthcare payment systems, compared to other products and techniques;
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costs associated with the purchase of new products and equipment; and
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the time commitment that may be required for training.
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In addition, we believe recommendations and support of our products by influential spine surgeons are essential for market acceptance and adoption. If we do not receive support from such surgeons or long-term data does not show the benefits of using our products, surgeons may not use our products. In such circumstances, we may not achieve expected sales or profitability.
Pricing pressure from our competitors, hospitals and changes in third-party coverage and reimbursement may impact our
ability to sell our products at prices necessary to support our current business strategies.
Competition in the spinal surgery industry has increased as a result of new market entrants, new technologies and as more established companies have intensified competitive pricing pressure. As a result of these competitive forces, we believe there will be increased pricing pressure in the future. Because our products are generally purchased by hospitals that typically bill various third-party payors, changes in the purchasing behavior of such hospitals or the amount such payors are willing to reimburse our customers for procedures using our products, including as a result of healthcare reform initiatives, could create additional pricing pressure on us. In addition to these competitive forces, we continue to see pricing pressure as hospitals introduce new pricing structures into their contracts and agreements, including fixed price formulas, capitated pricing and construct pricing intended to contain healthcare costs. If such trends continue to drive down the prices we are able to charge for our products, our profit margins will shrink, which may adversely affect our ability to invest in and grow our business.
Our currently marketed products are, and any future products we develop and commercialize will be, subject to intense competition. The spinal surgery industry is intensely competitive, subject to rapid change and highly sensitive to the introduction of new products or other market activities of industry participants. Our ability to compete successfully will depend on our ability to develop products that reach the market in a timely manner, receive adequate coverage and reimbursement from third-party payors, and are safer, less invasive and more effective than competing products and treatments. Because of the size of the potential market, we anticipate that companies will dedicate significant resources to developing competing products.
We are aware of several companies that compete or are developing technologies in our current and future product areas. As a result, we expect competition to remain intense. We believe that our principal competitors include Medtronic Public Limited Company, DePuy Synthes Inc., Stryker Corporation, Globus Medical, Inc., Zimmer Biomet Holdings, Inc. and NuVasive Inc., which together represent a significant portion of the spine market. We also compete with smaller spine market participants such as Alphatec Holdings, Inc., Orthofix International N.V. and SeaSpine Holdings Corporation who generally have a smaller market share than the principal competitors listed above. At any time, these and other potential market entrants may develop new devices or treatment alternatives that may render our products obsolete or uncompetitive. In addition, they may gain a market advantage by developing and patenting competitive products or processes earlier than we can or by obtaining regulatory clearances or market registrations more rapidly than we can. Many of our current and potential competitors have substantially greater sales and financial resources than we do. In addition, these companies may have more established distribution networks, entrenched relationships with surgeons and greater experience in launching, marketing, distributing and selling products.
In addition, new market participants continue to enter the spinal surgery industry. Many of these new competitors specialize in a specific product or focus on a particular market sector, making it more difficult for us to increase our overall market position. The frequent introduction by competitors of products that are or claim to be superior to our products or that are alternatives to our existing or planned products may also create market confusion that may make it difficult to differentiate the benefits of our products over competing products. In addition, the entry of multiple new products and competitors may lead some of our competitors to employ pricing strategies that could adversely affect the pricing of our products and pricing in the spinal surgery market generally.
Spine surgeons often contribute to the decisions as to whether hospitals purchase our products, and we believe that many spine surgeons are highly sensitive to technological change and to the commercial reputation of spinal product companies. Accordingly, we believe that many spine surgeons actively seek new technologies and devote special attention to companies they perceive to have novel and innovative solutions to surgical challenges. As a result, we believe that we must continue to develop and commercialize innovative new products or our existing customers may decrease their purchases from us and instead purchase products from companies perceived by them to be more innovative. In order to develop innovative products, we must attract and retain talented and experienced engineers and management personnel, have productive dialogues with practicing spine surgeons and hospital purchasing administrations and have adequate capital to fund research and development efforts. If we fail to deliver innovative products to the market, our future revenue may be reduced and our stock price may decline.
In addition, we face a particular challenge overcoming the long-standing practices by some spine surgeons of using the products of our larger, more established competitors. Spine surgeons who have completed many successful, complex surgeries using the products made by these competitors may be disinclined to try new products from a source with which they are less familiar. If these spine surgeons do not try our products, then our revenue growth may slow or decline and our stock price may decline.
Our competitors may also develop and patent processes or products earlier than we can or obtain regulatory clearance, approval or CE Certificates of Conformity for competing products more rapidly than we can, which could impair our ability to develop and commercialize similar processes or products. We also compete with our competitors in establishing clinical trial sites and patient enrollment in clinical trials, as well as in acquiring technologies and technology licenses complementary to our products or advantageous to our business. In addition, we compete with our competitors to engage the services of sales agencies and independent distributors, both those presently working with us and those with whom we hope to work as we expand.
Many of our competitors have greater resources than we have.
Many of our current and potential competitors are major medical device companies that have substantially greater financial, technical and marketing resources than we do. Many of these current and potential competitors are publicly traded or are divisions of publicly-traded companies, which enjoy several competitive advantages, including:
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greater financial and human resources for product development, sales and marketing and patent litigation;
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significantly greater name recognition;
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established relationships with spine surgeons, hospitals and third-party payors;
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more expansive portfolios of intellectual property rights;
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broader product range and ability to cross-sell their products or offer rebates or bundle products to incentivize hospitals or surgeons to use their products;
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products supported by long-term clinical data;
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large and established sales and marketing and distribution networks; and
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greater experience in conducting research and development, manufacturing, clinical trials, preparing regulatory submissions and obtaining regulatory clearance, approval or CE Certificates of Conformity for products and marketing approved products.
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Aggregation of hospital purchasing from collaboration and consolidation may lead to demands for price concessions or to the exclusion of some suppliers from certain market opportunities, which could have an adverse effect on our business, results of operations or financial condition.
Because healthcare costs have risen significantly over the past decade, numerous initiatives and reforms initiated by legislators, regulators and third-party payors to curb these costs have resulted in a consolidation trend in the healthcare industry to aggregate purchasing power. As the healthcare industry consolidates, competition to provide products and services to industry participants has become more intense and may intensify. This in turn has resulted and will likely continue to result in greater pricing pressures or the exclusion of certain suppliers from certain market opportunities as group purchasing organizations, independent delivery networks and large single accounts continue to use their market power to consolidate purchasing decisions. In addition, such consolidation may lead these organizations to limit their number of suppliers. We expect that market demand, government regulation, third-party coverage and reimbursement policies and societal pressures will continue to impact the healthcare industry, resulting in further business consolidations and alliances among our customers, which may exert further downward pressure on the prices of our products and may adversely impact our business, results of operations or financial condition.
If hospitals and other healthcare providers are unable to obtain adequate coverage and reimbursement for procedures performed using our products, it is unlikely that our products will gain widespread acceptance.
Maintaining and growing sales of our products depends on the availability of adequate coverage and 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 products, such as the ones that we manufacture, generally rely on third-party payors to pay for all or part of the costs and fees associated with the procedures performed with these products. The existence of adequate coverage and reimbursement for the procedures performed with our products by government and private insurance plans is central to the acceptance of our current and future products. We
may be unable to sell our products on a profitable basis if third-party payors deny coverage or reduce their current levels of payment, or if our costs increase faster than increases in reimbursement levels. In the United States, many private payors use coverage decisions and payment amounts determined by the Centers for Medicare and Medicaid Services, or CMS, which administers the Medicare program, as guidelines in setting their coverage and reimbursement policies. Future action by CMS or other government agencies may diminish payments to physicians, outpatient centers and/or hospitals. Those private payors that do not follow the Medicare guidelines may adopt different coverage and reimbursement policies for procedures performed with our products. For some governmental programs, such as Medicaid, coverage and reimbursement differ from state to state, and some state Medicaid programs may not pay an adequate amount for the procedures performed with our products, if any payment is made at all. As the portion of the U.S. population over the age of 65 and eligible for Medicare continues to grow, we may be more vulnerable to coverage and 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 reimbursed at a cost-effective level. Accordingly, even if our products and procedures using our products are currently covered and reimbursed by third-party payors, adverse changes in payors’ coverage and reimbursement policies that affect our products would harm our ability to market and sell our products and adversely impact our business, results of operations or financial condition.
Moreover, we are unable to predict what changes will be made to the reimbursement methodologies used by third-party payors. We cannot be certain that under current and future payment systems, in which healthcare providers may be reimbursed a set amount based on the type of procedure performed, such as those used by Medicare and in many privately managed care systems, the cost of our products will be properly reflected and incorporated into the overall cost of the procedure.
In addition, as we continue to expand into international markets, market acceptance may depend, in part, upon the availability of coverage and reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets such as in the EEA, which is comprised of the 28 Member States of the EU, Iceland, Liechtenstein and Norway, vary significantly by country, and include both government-sponsored healthcare and private insurance. We may not obtain international coverage and reimbursement approvals in a timely manner, if at all. Our failure to receive such approvals, and any adverse changes in coverage and the reimbursement policies of foreign third-party payors, would negatively impact market acceptance of our products in such international markets.
The safety and efficacy of our products is not yet supported by long-term clinical data, which could limit sales, and our products might therefore prove to be less safe and effective than initially thought.
We have obtained 510(k) clearances to manufacture, market and sell the products we market in the United States, unless exempt from premarket review by the FDA, and the right to affix the CE mark to the products we market in the EEA. In the 510(k) clearance process, the FDA must determine that a proposed device is “substantially equivalent” to a legally marketed device, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, which sometimes requires the submission of clinical data. In the EEA, as a general rule, compliance with the Essential Requirements laid down in Annex I to the Council Directive 93/42/EEC of 14 June 1993 concerning medical devices, or the Medical Devices Directive, must be based on clinical data, though such clinical data can originate from the literature if equivalence to the device to which the literature relates can be demonstrated. For implantable devices and devices classified as Class III in the EEA, the provisions of Annex I to the Medical Devices Directive require manufacturers to conduct clinical investigations to generate the required clinical data, unless it is justifiable to rely on the existing clinical data related to similar devices. While clinical data generated during a clinical investigation is sometimes required to support a 510(k) clearance, CE mark or product registration in other countries, we have not yet generated our own clinical data in support of our currently marketed products. As a result, we currently lack the breadth of published long-term clinical data supporting the quality, safety and efficacy of our products that might have been generated in connection with more costly and rigorous premarket approval, or PMA, processes, and that some of our competitors who have been in business longer may have collected.
To address this issue, we are currently collecting and plan to continue collecting long-term clinical data regarding the quality, safety and effectiveness of our marketed products. For example, we have recently launched voluntary postmarket studies in relation to our EVEREST, MESA, and RAVINE medical devices. The clinical data collected and generated as part of these studies will enable us to further strengthen our clinical evaluation concerning safety and performance of these important products. We believe that this additional data will help with the marketing of our EVEREST, MESA, and RAVINE medical devices by providing our customers with additional confidence in the long-term safety and efficacy of these products. However, as we conduct clinical trials designed to generate long-term data on our products, the data we
generate may not be consistent with our existing data and may demonstrate less favorable safety or efficacy. These results could reduce demand for our products and significantly reduce our ability to achieve expected revenue. We do not expect to undertake such studies for all of our products and will only do so in the future where we anticipate the benefits will outweigh the costs. In addition, in the degenerative disease market, we may determine from postmarket experience that certain patient characteristics, such as age or preexisting medical conditions, may affect fusion rates, which could lead to misleading or contradictory data on the efficacy of our degenerative disease products. For these reasons, spine surgeons may be less likely to purchase our products than competing products with longer-term clinical data. Also, we may not choose or be able to generate the comparative data that some of our competitors have or are generating and we may be subject to greater regulatory and product liability risks. Moreover, if future results and experience indicate that our products cause unexpected or serious complications or other unforeseen negative effects, we could be subject to mandatory product recalls or withdrawals, suspension or withdrawal of FDA or other government clearances or approvals or CE Certificates of Conformity, significant legal and regulatory liability and harm to our business reputation.
We are dependent on a limited number of third-party suppliers for most of our products and components, and the loss of any of these suppliers, or their ability to provide us with an adequate supply of quality materials, could harm our business.
We rely on third-party suppliers to supply substantially all of our products as well as the raw materials for the limited number of products we manufacture in-house. For us to be successful, our suppliers must be able to provide us with products and components in substantial quantities, in compliance with regulatory requirements, in accordance with agreed upon specifications, at acceptable costs and on a timely basis. Our anticipated growth could strain the ability of our suppliers to deliver an increasingly large supply of products, materials and components. Suppliers often experience difficulties in scaling up production, including problems with production yields and quality control and assurance, especially with biomaterials products such as allograft, which is processed human tissue. If we are unable to obtain sufficient quantities of high quality components to meet demand on a timely basis, we may not be able to produce sufficient quantities of our products to meet market demand and, as a result, could lose customers, our reputation may be harmed and our business could suffer.
Our dependence on a limited number of suppliers exposes us to risks, including limited control over pricing, availability and delivery schedules. If any one or more of our suppliers cease to provide us with sufficient quantities of manufactured products or raw materials in a timely manner or on terms acceptable to us, or cease to manufacture components of acceptable quality, we would have to seek alternative sources of supply. Because of the nature of our internal quality control requirements, regulatory requirements and the proprietary nature of the parts, we cannot quickly engage additional or replacement suppliers for many of our critical components. Failure of any of our third-party suppliers to deliver products or raw materials at the level our business requires would limit our ability to meet our sales commitments to our customers and could have a material adverse effect on our business. We may also have difficulty obtaining similar components from other suppliers that are acceptable to the FDA, the competent authorities or notified bodies of the countries of the EEA, each a Notified Body, or other foreign regulatory authorities, and the failure of our suppliers to comply with strictly enforced regulatory requirements could expose us to regulatory action including warning letters, product recalls and withdrawals, suspension or withdrawal of our regulatory clearances or CE Certificates of Conformity, termination of distribution, product seizures or civil, administrative or criminal penalties. We could incur delays while we locate and engage qualified alternative suppliers, and we may be unable to engage alternative suppliers on favorable terms or at all. Any such disruption or increased expenses could harm our business, results of operations or financial condition.
If we are unable to maintain and expand our network of direct sales employees, independent sales agencies and international distributors, we may not be able to generate anticipated sales.
In the United States we maintain a hybrid sales organization consisting of
140
direct sales employees and
86
independent agency partners. Our products are marketed in
38
countries internationally, in addition to the United States. Our international sales organization includes
39
direct sales employees, primarily located in the United Kingdom and Germany. In addition, we directly manage
nine
independent sales agencies across Italy and Canada. We sell to
26
distributors in certain other international markets. Our results of operations are directly dependent upon the sales and marketing efforts of not only our employees, but also our independent sales agencies and distributors. We expect our direct sales employees, independent sales agencies and distributors to develop long-lasting relationships with the surgeons and hospitals they serve. If our direct sales employees, independent sales agencies or distributors fail to adequately promote, market and sell our products, our sales could significantly decrease. If revenue generated by our newly hired employees and independent sales agencies fails to increase over time in line with our expectations, our business, results of operations and financial condition could be materially adversely affected.
We face significant challenges and risks in managing our geographically dispersed distribution network and retaining the individuals who make up that network. If any of our direct sales employees, independent sales agencies or distributors
were to reduce their efforts to promote our products or cease to do business with us, our sales could be adversely affected. In such a situation, we may need to seek alternative direct sales employees, independent sales agencies or distributors or increase our reliance on our existing direct sales employees, which we may be unable to do in a timely and efficient manner, if at all. In addition, our competitors may require that members of our sales force cease doing business with us. We may not be able to rely on our sales force to distribute new products that we introduce that compete with products of our competitors that they also represent. If a direct sales employee, independent sales agency or distributor were to depart and be retained exclusively by one of our competitors, we may be unable to prevent them from helping competitors solicit business from our existing customers, which could further adversely affect our sales. Because of the intense competition for their services, we may be unable to recruit or retain additional qualified independent sales agencies or distributors or to hire additional direct sales employees. We also may not be able to enter into agreements with them on favorable or commercially reasonable terms, if at all. Failure to hire or retain qualified direct sales employees or independent sales agencies or distributors would adversely impact our ability to generate sales and expand our business.
As we launch new products and increase our marketing efforts with respect to existing products, we will need to expand the reach of our marketing and sales networks. Our future success will depend largely on our ability to continue to hire or contract with, train, retain and motivate skilled sales managers, direct sales employees, independent sales agencies and distributors with significant technical knowledge in various areas, such as spinal care practices, spine injuries and disease and spinal health. New hires and new independent sales agencies and distributors require training and take time to achieve full productivity. If we fail to hire quality personnel, fail to provide adequate training or experience high turnover in our sales force, the new members of our sales force may not be as productive as is necessary to maintain or increase our sales.
The proliferation of PODs could result in increased pricing pressure on our products or harm our ability to sell our products to physicians who own or are affiliated with those distributorships.
Physician-owned distributorships, or PODs, are product distributors that are owned, directly or indirectly, by physicians. These physicians derive a proportion of their revenue from selling or arranging for the sale of products for use in procedures they perform on their own patients at hospitals that agree to purchase from or through the POD, or that otherwise furnish ordering physicians with income that is based directly or indirectly on those orders of products.
We do not sell or distribute any of our products through PODs. The number of PODs in the spinal surgery industry may continue to grow as economic pressures increase throughout the industry, hospitals, insurers and physicians search for ways to reduce costs and, in the case of the physicians, search for ways to increase their incomes. PODs and the physicians who own, or partially own, them have significant market knowledge and access to the surgeons who use our products and the hospitals that purchase our products and thus the growth of PODs may reduce our ability to compete effectively for business from surgeons who own such distributorships.
A large percentage of our revenue is derived from the sale of our EVEREST, MESA and DENALI spinal systems or products that incorporate these technologies, and therefore, a decline in the sales of these products could have a material impact on our business, results of operations and financial condition.
Revenue from our EVEREST spinal systems and other products that incorporate our EVEREST technology represented approximately
25%
, 21% and 16% of our revenue for the years ended
December 31, 2016
,
2015
and
2014
, respectively. Revenue from our MESA spinal systems and other products that incorporate our MESA technology represented approximately
24%
, 29% and 31% of our revenue, for the years ended
December 31, 2016
,
2015
and
2014
, respectively, revenue from our DENALI spinal systems and other products that incorporate our DENALI technology represented approximately
10%
, 12% and 15% of our revenue for the years ended
December 31, 2016
,
2015
and
2014
, respectively. Competition is intense among companies selling devices for spinal surgery, and sales of EVEREST, MESA, or DENALI could decline as a result of a number of factors, such as the introduction by a competitor of products which our customers prefer. Sales of EVEREST, MESA or DENALI could also be disrupted by allegations of intellectual property infringement which, even if meritless, could result in temporary injunctions against sales of these products and damage to relationships with agencies, distributors and customers. A decline in sales of EVEREST, MESA or DENALI for any reason could have a material adverse impact on our business, results of operations and financial condition.
Our business could suffer if we lose the services of key members of our senior management, consultants or personnel.
We are dependent upon the continued services of key members of our senior management and a limited number of consultants and personnel. In particular, we are highly dependent on the skills and leadership of our Chief Executive Officer, Eric D. Major, and our Chief Medical Officer, John P. Kostuik, M.D. The loss of either of these individuals could disrupt our operations or our strategic plans. In addition, our future success will depend on, among other things, our ability to continue to hire or contract with, and retain, the necessary qualified scientific, technical and managerial personnel, for
whom we compete with numerous other companies, academic institutions and organizations. The loss of members of our management team, consultants or personnel, or our ability to attract or retain other qualified personnel or consultants could have a material adverse effect on our business, results of operations and financial condition.
If we do not enhance our product offerings through our research and development efforts, we may be unable to effectively compete.
In order to increase our market share in the spinal surgery industry, we must enhance and broaden our product offerings in response to changing customer demands and competitive pressures and technologies. We might not be able to successfully develop, obtain regulatory clearances, approvals, or CE Certificates of Conformity for or market new products, and our future products might not be accepted by the surgeons or the third-party payors who reimburse for many of the procedures performed with our products. The success of any new product offering or enhancement to an existing product will depend on numerous factors, including our ability to:
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properly identify and anticipate surgeon and patient needs;
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develop and introduce new products or product enhancements in a timely manner;
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adequately protect our intellectual property and avoid infringing upon the intellectual property rights of third parties;
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demonstrate the quality, safety and efficacy of new products; and
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obtain the necessary regulatory clearances, approvals or CE Certificates of Conformity for new products or product enhancements.
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If we do not develop and obtain regulatory clearance, approval or CE Certificate of Conformity for new products or product enhancements in time to meet market demand, or if there is insufficient demand for these products or enhancements, our results of operations will suffer. Our research and development efforts may require a substantial investment of time and resources before we are adequately able to determine the commercial viability of a new product, technology, material or other innovation. Such efforts may not result in the development of a viable product. In addition, even if we are able to successfully develop enhancements or new generations of our products, these enhancements or new generations of products may not produce sales in excess of the costs of development and they may be quickly rendered obsolete by changing customer preferences or the introduction by our competitors of products embodying new technologies or features.
If we fail to properly manage our anticipated growth, our business could suffer.
Our rapid growth has placed, and will continue to place, a significant strain on our operational and financial resources and systems. Failure to manage our growth effectively could cause us to over-invest or under- invest in infrastructure and result in losses or weaknesses in our infrastructure, which could materially adversely affect our business. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our development and commercialization goals.
We may seek to grow our business through acquisitions of or investments in new or complementary businesses, products or technologies, through the licensing of products or technologies from third parties or other strategic alliances, and the failure to manage acquisitions, investments, licenses or other strategic alliances, or the failure to integrate them with our existing business, could have a material adverse effect on us.
Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures, technologies and market pressures. Accordingly, from time to time we may consider opportunities to acquire, make investments in or license other technologies, products and businesses that may enhance our capabilities, complement our current products or expand the breadth of our markets or customer base. Potential and completed acquisitions, strategic investments, licenses and other alliances involve numerous risks, including:
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problems assimilating the purchased or licensed technologies, products or business operations;
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issues maintaining uniform standards, procedures, controls and policies;
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unanticipated costs associated with acquisitions or strategic alliances;
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diversion of management’s attention from our core business;
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adverse effects on existing business relationships with suppliers and customers;
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risks associated with entering new markets in which we have limited or no experience;
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potential loss of key employees of acquired businesses; and
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increased legal and accounting compliance costs.
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We do not know if we will be able to identify acquisitions or strategic relationships we deem suitable, whether we will be able to successfully complete any such transactions on favorable terms or at all 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 strategic transactions depends upon our ability to identify, negotiate, complete and integrate suitable target businesses, technologies or products and to obtain any necessary financing. These efforts could be expensive and time-consuming and may disrupt our ongoing business and prevent management from focusing on our operations. If we are unable to integrate any acquired businesses, products or technologies effectively, our business, results of operations and financial condition could be materially adversely affected.
If we are unable to educate spine surgeons on the safe and appropriate use of our products, we may be unable to achieve our expected growth.
An important part of our sales process includes the ability to educate surgeons on the safe and appropriate use of our products. If we become unable to attract potential new surgeon customers to our training programs, or if we are unable to attract existing customers to training programs for future products, we may be unable to achieve our expected growth.
There is a learning process involved for spine surgeons to become proficient in the use of our products. This training process may take longer than expected and may therefore affect our ability to increase sales. Following completion of training, we rely on the educated surgeons to advocate the clinical benefits of our products in the broader marketplace. Convincing surgeons to dedicate the time and energy necessary for adequate education is challenging, and we cannot assure you we will be successful in these efforts. If surgeons are not properly educated, 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 an adverse effect on our business.
Although we believe our education methods for surgeons are conducted in compliance with applicable FDA and foreign regulatory requirements, if the FDA or any other regulatory authority determines that our training constitutes promotion of an unapproved use, they could request that we modify our training or subject us to regulatory enforcement actions, including the issuance of a warning letter, injunction, seizure, civil fine and criminal penalty.
We are required to maintain high levels of inventory, which could consume a significant amount of our resources, reduce our cash flows and lead to inventory impairment charges.
As a result of the need to maintain substantial levels of inventory, we are subject to the risk of inventory obsolescence. Many of our products come in sets, which feature components in a variety of sizes so that the appropriate spinal implant may be selected by the surgeon based on the patient’s needs. In order to market our products effectively, we often must maintain and provide hospitals with consigned sets which typically consist of spinal implants and instruments, including products to ensure redundancy and products of different sizes. In a typical surgery, fewer than all of the components of the set are used, and therefore certain portions of the set may become obsolete before they can be used. In the event that a substantial portion of our inventory becomes obsolete, it could have a material adverse effect on our earnings and cash flows due to the resulting costs associated with the inventory impairment charges and costs required to replace such inventory.
Our total assets include substantial amounts of goodwill and intangible assets and an impairment of our goodwill or intangible assets could adversely affect our results of operations.
Goodwill and intangible assets represented approximately
37.7%
of our total assets as of
December 31, 2016
. We evaluate our goodwill for impairment on an annual basis or at other times during the year if events or circumstances indicate that it is more likely than not that the fair value is below the carrying value. We evaluate intangible assets for impairment when facts
or circumstances suggest that the carrying value of these assets may not be recoverable. Our evaluation of impairment may require us to make certain estimates and assumptions including projections of future results. Such estimates and assumptions may not prove to be accurate in the future. After performing our evaluation for impairment, including an analysis to determine the recoverability of intangible assets, we will record a noncash impairment loss when the carrying value of the underlying asset, asset group or reporting unit exceeds its fair value. If these impairment losses are significant, our results of operations could be adversely affected.
If we experience significant disruptions in our information technology systems, our business, results of operations and financial condition could be adversely affected.
The efficient operation of our business depends on our information technology systems. We rely on our information technology systems to effectively manage:
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sales and marketing, accounting and financial, and legal and compliance functions;
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engineering and product development tasks; and
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our research and development data.
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Our information technology systems are vulnerable to damage or interruption from:
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earthquakes, fires, floods 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 failures.
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The failure of our information technology systems to perform as we anticipate or our failure to effectively implement new systems could disrupt our entire operation and could result in decreased sales, increased overhead costs, excess inventory and product shortages and a loss of important information, all of which could have a material adverse effect on our reputation, business, results of operations and financial condition.
Most of our operations are at a single location. Any disruption in this facility or any ability to ship a sufficient number of our products to meet demand could adversely affect our business and results of operations.
Most of our operations are currently at a single location in Leesburg, Virginia. Our operations may be affected by man-made or natural disasters, such as a tornado or hurricane. While we currently rely on third parties to manufacture, assemble, package, label and sterilize most of our products and components, we might also be forced to rely on third parties to inspect, warehouse or ship our products and components in the event our facilities are affected by a disaster. Our Leesburg facility, if damaged or destroyed, could be difficult to replace and any efforts to repair or replace could require substantial lead-time. In addition, if we obtain an FDA PMA for any of our future devices, we might be required to obtain prior FDA approval of an alternate facility, which could delay or prevent our marketing of the affected products until this supplemental approval is obtained. Our Notified Body in the EEA or other international regulatory authorities may also need to audit our alternate facility to ensure that we continue to comply with applicable quality systems requirements. In addition, our products are expensive to make and are valuable to hospitals and surgeons worldwide. If a theft of our inventory occurred at our Leesburg facility or elsewhere, it could be a significant loss to us. Although we believe we possess adequate insurance for damage to our property and the disruption of our business from casualties, this insurance may not be sufficient to cover all of our potential losses and may not continue to be available to us on acceptable terms, or at all.
We may not be able to strengthen our brand.
We believe that establishing and strengthening the K2M brand and the brands associated with our individual product lines is critical to achieving widespread acceptance of our products, particularly because of the rapidly developing nature of the market for our products. Promoting and positioning our brand will depend largely on the success of our marketing efforts
and our ability to provide surgeons with a reliable product for successful treatment of spine diseases and disorders. Historically, our efforts to build our brand have involved significant expense, and it is likely that our future marketing efforts will require us to incur significant additional expenses. These brand promotion activities may not yield increased sales and, even if they do, any sales increases may not offset the expenses we incur to promote our brand. If we fail to successfully promote and maintain our brand, or if we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, our products may not be accepted by spine surgeons, which would cause our sales to decrease and would adversely affect our business, results of operations and financial condition.
Fluctuations in insurance cost and availability could adversely affect our profitability or our risk management profile.
We hold a number of insurance policies, including product liability insurance, directors’ and officers’ liability insurance, general liability insurance, property insurance and workers’ compensation insurance. If the costs of maintaining adequate insurance coverage increase significantly in the future, our results of operations could be materially adversely affected. Likewise, if any of our current insurance coverage should become unavailable to us or become economically impractical, we would be required to operate our business without indemnity from commercial insurance providers. If we operate our business without insurance, we could be responsible for paying claims or judgments against us that would have otherwise been covered by insurance, which could materially adversely affect our business, results of operations and financial condition. In addition, the financial health of our insurers may deteriorate and they may not be able to respond if we should have claims reaching their policies.
Risks Related to our Legal and Regulatory Environment
Our products and operations are subject to extensive governmental regulation in the United States, and our failure to comply with applicable requirements could cause our business to suffer.
The medical device industry is regulated extensively by governmental authorities, principally the FDA and corresponding state and foreign regulatory agencies and authorities. The FDA and other U.S. and foreign governmental agencies and authorities regulate and oversee, among other things, with respect to medical devices:
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design, development and manufacturing;
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testing, labeling, content and language of instructions for use and storage;
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marketing, sales and distribution;
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pre-market clearance and approval;
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conformity assessment procedures;
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record-keeping procedures;
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advertising and promotion;
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recalls and other field safety corrective actions;
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post-market surveillance, including reporting of deaths or serious injuries and malfunctions that, if they were to recur, could lead to death or serious injury;
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post-market studies; and
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product import and export.
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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 sales.
Our failure to comply with U.S. federal and state regulations could lead to the issuance of warning letters or untitled letters, the imposition of injunctions, suspensions or loss of regulatory clearance or approvals, product recalls, termination of distribution, product seizures or civil penalties. In the most extreme cases, criminal sanctions or closure of our manufacturing facilities are possible.
Our products and operations also are subject to extensive governmental regulation in foreign jurisdictions, such as Europe, and our failure to comply with applicable requirements could cause our business to suffer.
In the EEA, our medical devices must comply with the Essential Requirements laid down in Annex I to the Medical Devices Directive. Compliance with these requirements is a prerequisite to be able to affix the CE mark to our medical devices, without which they cannot be marketed or sold in the EEA. To demonstrate compliance with the Essential Requirements and obtain the right to affix the CE mark to our medical devices, we must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. Except for low risk medical devices (Class I with no measuring function and which are not sterile), where the manufacturer can issue an EC Declaration of Conformity based on a self-assessment of the conformity of its products with the Essential Requirements, a conformity assessment procedure requires the intervention of a Notified Body, which is an organization designated by a competent authority of an EEA country to conduct conformity assessments. Depending on the relevant conformity assessment procedure, the Notified Body would audit and examine the Technical File and the quality system for the manufacture, design and final inspection of our devices. The Notified Body issues a CE Certificate of Conformity following successful completion of a conformity assessment procedure conducted in relation to the medical device and its manufacturer and their conformity with the Essential Requirements. This Certificate entitles the manufacturer to affix the CE mark to its medical devices after having prepared and signed a related EC Declaration of Conformity.
As a general rule, demonstration of conformity of medical devices and their manufacturers with the Essential Requirements must be based, among other things, on the evaluation of clinical data supporting the safety and performance of the products during normal conditions of use. Specifically, a manufacturer must demonstrate the device achieves its intended performance during normal conditions of use and that the known and foreseeable risks, and that any adverse events, are minimized and acceptable when weighed against the benefits of its intended performance, and that any claims made about the performance and safety of the device (e.g., product labeling and instructions for use) are supported by suitable evidence. This assessment must be based on clinical data, which can be obtained from (1) clinical studies conducted on the devices being assessed, (2) scientific literature from similar devices whose equivalence with the assessed device can be demonstrated or (3) both clinical studies and scientific literature. With respect to implantable medical devices or Class III devices, the manufacturer must conduct clinical studies to obtain the required clinical data, unless reliance on existing clinical data from equivalent devices can be justified. The conduct of clinical studies in the EEA is governed by detailed regulatory obligations. These may include the requirement of prior authorization by the competent authorities of the country in which the study takes place and the requirement to obtain a positive opinion from a competent Ethics Committee. This process can be expensive and time-consuming.
Our failure to comply with applicable foreign regulatory requirements, including those administered by the competent authorities of the EEA countries, could result in enforcement actions against us, including refusal, suspension or withdrawal of our CE Certificates of Conformity by our Notified Body, which could hurt our ability to market products in the EEA in the future.
If we fail to maintain, or are unable to obtain, or experience significant delays in obtaining, regulatory clearances or approvals for our future products or product enhancements, our ability to commercially distribute and market these products could suffer.
Before we can commercially distribute a new medical device product or a significant modification to an existing product in the United States, we must obtain either clearance under Section 510(k) of the Federal Food, Drug and Cosmetics Act, or the FDCA, or approval of a PMA application from the FDA, unless an exemption from premarket review applies. In the 510(k) clearance process, the FDA must determine that a proposed device is “substantially equivalent” to a legally marketed device, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence. The PMA pathway requires an applicant to demonstrate the safety and effectiveness of the device based, in part, on extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing and labeling data. The PMA process is typically required for devices that are deemed to pose the greatest risk, such as life-sustaining, life- supporting or implantable devices. Products that are approved through a PMA application generally need FDA approval before they can be modified. Similarly, some modifications made to products cleared through a 510(k) may require a new 510(k). Both the 510(k) and PMA processes can be expensive and lengthy and require the payment of significant fees, unless exempt. The FDA’s 510(k)
clearance process usually takes from three to 12 months, but may last longer. The process of obtaining a PMA is much more costly and uncertain than the 510(k) clearance process and generally takes from one to three years, or even longer, from the time the application is submitted to the FDA until an approval is obtained. The process of obtaining regulatory clearances or approvals to market a medical device can be costly and time-consuming, and we may not be able to obtain these clearances or approvals on a timely basis, if at all.
Our currently commercialized products have either received premarket clearance under Section 510(k) of the FDCA or are exempt from premarket review. If the FDA requires us to go through a lengthier, more rigorous examination for future products or modifications to existing products than we had expected, our product introductions or modifications could be delayed or canceled, which could cause our sales to decline. Should the FDA disagree with our position that certain of our products are appropriately considered exempt from premarket review and require us to submit a 510(k) or PMA in order to market our devices, it could limit our ability to market these products. In addition, the FDA may determine that future products will require the more costly, lengthy and uncertain PMA process. Although we do not currently market any devices under a PMA, the FDA may demand that we obtain a PMA prior to marketing certain of our future products or modifications to existing products. In addition, if the FDA disagrees with our determination that a product we currently market is subject to an exemption from premarket review, the FDA may require us to submit a 510(k) or PMA in order to continue marketing the product. Further, even with respect to those future products where a PMA is not required, we cannot assure you that we will be able to obtain 510(k) clearance with respect to those products.
The FDA can delay, limit or deny clearance or approval of a device for many reasons, including:
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we may not be able to demonstrate to the FDA’s satisfaction that our products are safe and effective for their intended users;
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the data from pre-clinical studies and clinical trials may be insufficient to support clearance or approval, where required; and
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the manufacturing process or facilities we use may not meet applicable requirements.
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Obtaining clearances and approvals can be a time consuming process, and delays in obtaining required future clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our future growth.
Modifications to our products may require new 510(k) clearances, premarket approvals or new or amended CE Certificates of Conformity, and may require us to cease marketing or recall the modified products until clearances, approvals or the relevant CE Certificates of Conformity are obtained.
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. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review such determinations. The FDA may not agree with our decisions regarding whether new clearances or approvals are necessary. We have modified some of our 510(k) cleared products, and have determined based on our review of the applicable FDA guidance that in certain instances new 510(k) clearances or PMAs are not required. If the FDA disagrees with our determination and requires us to submit new 510(k)s or PMAs for modifications to our previously cleared products for which we have concluded that new clearances or approvals are unnecessary, we may be required to cease marketing or to recall the modified products until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties.
Furthermore, the FDA’s ongoing review of the 510(k) program may make it more difficult for us to make modifications to our previously cleared products, either by imposing more strict requirements on when a new 510(k) for a modification to a previously cleared product must be submitted, or applying more onerous review criteria to such submissions. In July and December 2011, respectively, the FDA issued draft guidance documents addressing when to submit a new 510(k) due to modifications to 510(k)-cleared products and the criteria for evaluating substantial equivalence.
The July 2011 draft guidance document was ultimately withdrawn as the result of the FDASIA, and as a result, the FDA’s original guidance document regarding 510(k) modifications, which dates back to 1997, remains in place. It is uncertain when the FDA will seek to issue new guidance on product modifications. Any efforts to do so could result in a more rigorous review process and make it more difficult to obtain clearance for device modifications.
In the EEA, we must inform the Notified Body that carried out the conformity assessment of the medical devices we market or sell in the EEA of any planned substantial changes to our quality system or changes to our medical devices which could affect compliance with the Essential Requirements laid down in Annex I to the Medical Devices Directive or the devices’ intended use. The Notified Body will then assess the planned changes and verify whether they affect the products’ conformity with the Medical Devices Directive. If the assessment is favorable, the Notified Body will issue a new CE Certificate of Conformity or an addendum to the existing certificate attesting compliance with the Essential Requirements and quality system requirements laid down in the Annexes to the Medical Devices Directive.
We may fail to obtain or maintain foreign regulatory approvals to market our products in other countries.
We currently market our products internationally and intend to expand our international marketing. International jurisdictions require separate regulatory approvals and compliance with numerous and varying regulatory requirements. For example, we intend to seek regulatory clearance to market our primary products in Brazil, China and other key markets. The approval procedures vary among countries and may involve requirements for additional testing, and the time required to obtain approval may differ from country to country and from that required to obtain FDA clearance or approval, or a CE Certificate of Conformity in the EEA.
In certain of our international markets, our product registrations are in the name of our distributors and if we end our relationships with such distributors, we may experience difficulties in getting such product registrations back in our name or obtaining new registrations from the appropriate regulatory authorities.
Clearance or approval by the FDA, or the CE marking of our products in the EEA, does not ensure approval or certification by regulatory authorities in other countries or jurisdictions, and approval or certification by one foreign regulatory authority does not ensure approval or certification by regulatory authorities in other foreign countries, the EEA or by the FDA. The foreign regulatory approval or certification process may include all of the risks associated with obtaining FDA clearance or approval, or a CE Certificate of Conformity. We may not obtain foreign regulatory approvals on a timely basis, if at all. We may not be able to file for regulatory approvals or certifications and may not receive necessary approvals to commercialize our products in any market. If we fail to receive necessary approvals or certifications to commercialize our products in foreign jurisdictions on a timely basis, or at all, our business, results of operations and financial condition could be adversely affected.
Even after clearance or approval for our products is obtained, we are subject to extensive post-market regulation by the FDA. Our failure to meet strict regulatory requirements could require us to pay fines, incur other costs or even close our facilities.
Even after we have obtained the proper regulatory clearance or approval to market a product, the FDA has the power to require us to conduct post-market studies. These studies can be very expensive and time-consuming to conduct. Failure to complete such studies in a timely manner could result in the revocation of clearance or approval and the recall or withdrawal of the product, which could prevent us from generating sales from that product in the United States. The FDA has broad enforcement powers, and any regulatory enforcement actions or inquiries, or other increased scrutiny on us, could dissuade some surgeons from using our products and adversely affect our reputation and the perceived safety and efficacy of our products.
We are also required to comply with the FDA’s Quality System Regulation, or QSR, which covers the methods used in, and the facilities and controls used for, the design, manufacture, quality assurance, labeling, packaging, sterilization, storage, shipping, installation and servicing of our marketed products. The FDA enforces the QSR through periodic announced and unannounced inspections of manufacturing facilities. In addition, in the future, regulatory authorities and/or customers may require specific packaging of sterile products, which could increase our costs and the price of our products.
Later discovery of previously unknown problems with our products, including unanticipated adverse events or adverse events of unanticipated severity or frequency, manufacturing problems, or failure to comply with regulatory requirements such as QSR, may result in changes to labeling, restrictions on such products or manufacturing processes, withdrawal of the products from the market, voluntary or mandatory recalls, a requirement to repair, replace or refund the cost of any medical device we manufacture or distribute, fines, suspension of regulatory approvals, product seizures, injunctions or the imposition of civil or criminal penalties which would adversely affect our business, operating results and prospects.
If our products, or malfunction of our products, cause or contribute to a death or a serious injury, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or agency enforcement actions.
Under the FDA’s medical device reporting, or MDR, regulations, we are required to report to the FDA any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. Repeated product malfunctions may result in a voluntary or involuntary product recall, which could divert managerial and financial resources, impair our ability to manufacture our products in a cost-effective and timely manner, and have an adverse effect on our reputation, results of operations and financial condition. We are also required to follow detailed recordkeeping requirements for all firm-initiated medical device corrections and removals, and to report such corrective and removal actions to the FDA if they are carried out in response to a risk to health and have not otherwise been reported under the MDR regulations. According to FDA guidance, if any change or group of changes to a device addresses a violation of the FDCA, the change or changes would generally constitute a medical device recall and require submission of a recall report to the FDA.
All manufacturers bringing medical devices to market in the EEA are legally bound to report any incident that led or might have led to the death or serious deterioration in the state of health of a patient, user or other person, and which the manufacturer’s device is suspected to have caused, to the competent authority in whose jurisdiction the incident occurred. In such case, the manufacturer must file an initial report with the relevant competent authority, which would be followed by further evaluation or investigation of the incident and a final report indicating whether further action is required.
Any adverse event involving our products could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action. Adverse events involving our products have been reported to us in the past, and we cannot guarantee that they will not occur in the future. Any corrective action, whether voluntary or involuntary, will require the dedication of our time and capital, distract management from operating our business and may harm our reputation and financial results.
A recall of our products, either voluntarily or at the direction of the FDA or another governmental authority, or the discovery of serious safety issues with our products, could have a significant adverse impact on us.
The FDA and similar foreign governmental authorities such as the competent authorities of the EEA countries have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture or in the event that a product poses an unacceptable risk to health. Manufacturers may, under their own initiative, recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us or one of our distributors could occur as a result of an unacceptable risk to health, component failures, manufacturing errors, design or labeling defects or other deficiencies and issues.
Any recalls of any of our products would divert managerial and financial resources and could have an adverse effect on our reputation, results of operations and financial condition, which could impair our ability to produce our products in a cost-effective and timely manner in order to meet our customers’ demands. We may also be required to bear other costs or take other actions that may have a negative impact on our future sales and our ability to generate profits.
Further, under the FDA’s MDR regulations, we are required to report to the FDA any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury.
In the EEA we must comply with the EU Medical Device Vigilance System. Under this system, incidents must be reported to the relevant authorities of the EEA countries, and manufacturers are required to take Field Safety Corrective Actions, or FSCAs, to reduce a risk of death or serious deterioration in the state of health associated with the use of a medical device that is already placed on the market. An incident is defined as any malfunction or deterioration in the characteristics and/or performance of a device, as well as any inadequacy in the labeling or instructions for use or an unanticipated adverse reaction or side effect which, directly or indirectly, might lead to or might have led to the death of a patient, user or other person or to a serious deterioration in their state of health. An FSCA may include the recall, modification, exchange, destruction or retrofitting of the device. FSCAs must be communicated by the manufacturer or its legal representative to its customers and/or to the end users of the device through Field Safety Notices.
Repeated product malfunctions may result in a voluntary or involuntary product recall, which could divert managerial and financial resources, impair our ability to manufacture our products in a cost-effective and timely manner and have an adverse effect on our reputation, results of operations and financial condition.
If we or our suppliers fail to comply with ongoing regulatory requirements, or if we experience unanticipated problems with our products, our products could be subject to restrictions or withdrawal from the market.
Any product for which we obtain clearance or approval, and the manufacturing processes, reporting requirements, post- approval clinical data and promotional activities for such product, will be subject to continued regulatory review, oversight and periodic inspection by the FDA and other domestic and foreign regulatory bodies. In particular, we and our third-party suppliers are required to comply with the QSR. In the EEA countries, compliance with harmonized standards is also recommended as this is interpreted as a presumption of conformity with the relevant Essential Requirements laid down in Annex I to the Medical Devices Directive. These FDA regulations and EU standards cover the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. Compliance with the QSR is subject to continual review and is monitored rigorously through periodic inspections by the FDA. Compliance with harmonized standards in the EEA is also subject to regular review through audits by Notified Bodies or other certification bodies. If we, or our manufacturers, fail to adhere to QSR requirements in the United States or other harmonized standards in the EEA, this could delay production of our products and lead to fines, difficulties in obtaining regulatory clearances and CE Certificate of Conformity, recalls, enforcement actions, including injunctive relief or consent decrees, or other consequences, which could, in turn, have a material adverse effect on our financial condition or results of operations.
In May 2016 our headquarters moved from 751 Miller Drive SE, Leesburg, VA to 600 Hope Parkway SE, Leesburg, VA. Prior to the move, the FDA inspected our Miller Drive facility on three separate occasions: August 2006, October 2007 and January 2011. We received a Form FDA-483 list of inspectional observations on each occasion, all of which have been closed by the FDA. We have not received any warning letters associated with any of these inspections. The FDA subsequently re-inspected our 751 Miller Drive facility in July 2015, and we did not receive a Form FDA-483 or a warning letter associated with the inspection. Our 600 Hope Parkway SE facility has not been inspected by FDA to date.
Any future failure by us or one of our suppliers to comply with applicable statutes and regulations administered by the FDA, or the failure to timely and adequately respond to any adverse inspectional observations or product safety issues, could result in any of the following enforcement actions:
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untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties;
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unanticipated expenditures to address or defend such actions;
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customer notifications or repair, replacement, refund, recall, detention or seizure of our products;
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operating restrictions or partial suspension or total shutdown of production;
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refusing or delaying our requests for 510(k) clearance or PMA approval of new products or modified products;
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withdrawing 510(k) clearances that have already been granted;
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refusal to grant export approval for our products; or
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Any of these sanctions could have a material adverse effect on our reputation, business, results of operations and financial condition. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with all applicable regulatory requirements, which could result in our failure to produce our products on a timely basis and in the required quantities, if at all.
Outside the EEA and the United States, our products and operations are also often required to comply with standards set by foreign regulatory bodies, and those standards, types of evaluation and scope of review differ among foreign regulatory bodies. We intend to comply with the standards enforced by such foreign regulatory bodies as needed to commercialize our products. If we fail to comply with any of these standards adequately, a foreign regulatory body may take adverse actions similar to those within the power of an EEA Notified Body or competent authority or the FDA. Any such action may harm our reputation and business, and could have an adverse effect on our business, results of operations and financial condition.
We may be subject to enforcement action if we engage in improper marketing or promotion of our products.
Our promotional materials and training methods must comply with FDA and other applicable laws and regulations, including the prohibition of the promotion of unapproved, or off-label, use. Surgeons may use our products off-label, as the
FDA does not restrict or regulate a surgeon’s choice of treatment within the practice of medicine. However, if the FDA determines that our promotional materials or training constitutes promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine or criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an off-label use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged and adoption of the products could be impaired. Although our policy is to refrain from statements that could be considered off- label promotion of our products, the FDA or another regulatory agency could disagree and conclude that we have engaged in off-label promotion. In addition, the off-label use of our products may increase the risk of injury to patients and, in turn, the risk of product liability claims. Product liability claims are expensive to defend and could divert our management’s attention, result in substantial damage awards against us, and harm our reputation.
Further, the advertising and promotion of our products is subject to the Medical Devices Directive, Directive 2006/114/EC concerning misleading and comparative advertising, Directive 2005/29/EC on unfair commercial practices, and other EEA countries’ legislation governing the advertising and promotion of medical devices. In addition, we are subject to EU and national Codes of Conduct. These laws and Codes of Conduct may limit or restrict the advertising and promotion of our products to the general public and may impose limitations on our promotional activities with healthcare professionals.
The misuse or off-label use of our products may harm our image in the marketplace or result in injuries that lead to product liability suits, which could be costly to our business.
The FDA and the competent authorities of the EEA countries do not prevent a physician from using our products off-label, as the FDA and the laws of the EEA countries generally do not restrict or regulate a physician’s choice of treatment within the practice of medicine. The use of our products for indications other than those indications for which our products have been cleared by the FDA, or CE marked in the EEA, may not effectively treat such conditions or may increase the risk of injury to patients, which could harm our reputation in the marketplace among physicians and patients. Physicians may also misuse our products or use improper techniques if they are not adequately educated, potentially leading to injury and an increased risk of product liability. If our products are misused or used with improper technique, we may become subject to costly litigation by our customers or their patients. Product liability claims could divert management’s attention from our core business, be expensive to defend and result in sizable damage awards against us that may not be covered by insurance. Any of these events could harm our business and results of operations and cause our stock price to decline.
Clinical trials necessary to support a PMA application are expensive and require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Delays or failures in any future clinical trials will prevent us from commercializing any modified or new products associated with such trials and could adversely affect our business, results of operations and financial condition.
Certain of our future products may require the approval of a PMA. Initiating and completing clinical trials necessary to support a PMA application, and additional safety and efficacy data beyond that typically required for a 510(k) clearance, can be time consuming and expensive and the outcome uncertain. Moreover, the results of early clinical trials are not necessarily predictive of future results, and any product we advance into clinical trials may not have favorable results in later clinical trials.
Conducting successful clinical studies requires the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Patient enrollment in clinical trials and completion of patient participation and follow-up depends on many factors, including the size of the patient population, the nature of the trial protocol, the attractiveness of, or the discomforts and risks associated with, the treatments received by enrolled subjects, the availability of appropriate clinical trial investigators and support staff, proximity of patients to clinical sites, patient ability to meet the eligibility and exclusion criteria for participation in the clinical trial and patient compliance. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures or follow-up to assess the safety and effectiveness of our products or if they determine that the treatments received under the trial protocols are not attractive or involve unacceptable risks or discomforts. Patients may also not participate in our clinical trials if they choose to participate in contemporaneous clinical trials of competitive products. In addition, patients participating in clinical trials may die before completion of the trial or suffer adverse medical events unrelated to investigational products.
Sufficient and appropriate clinical protocols to demonstrate safety and efficacy are required and we may not adequately develop such protocols to support clearance and approval. Further, the FDA may require us to submit data on a greater
number of patients than we originally anticipated and/or for a longer follow-up period or change the data collection requirements or data analysis applicable to our clinical trials. Delays in patient enrollment or failure of patients to continue to participate in a clinical trial may cause an increase in costs and delays in the approval and attempted commercialization of our products or result in the failure of the clinical trial. In addition, despite considerable time and expense invested in our clinical trials, the FDA may not consider our data adequate to demonstrate safety and efficacy. Such increased costs and delays or failures could adversely affect our business, results of operations and prospects.
If the third parties on which we rely to conduct our clinical trials and to assist us with pre-clinical development do not perform as contractually required or expected, we may not be able to obtain regulatory approval for or commercialize our products.
We do not have the ability to independently conduct pre-clinical or clinical trials for our products and, if we need to conduct such trials in the future, we would need to rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories to conduct such trials. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if these third parties need to be replaced, or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our pre-clinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for, or successfully commercialize, our products on a timely basis, if at all, and our business, results of operations and prospects may be adversely affected. Furthermore, our third-party clinical trial investigators may be delayed in conducting our clinical trials for reasons outside of their control.
The results of clinical trials may not support future product candidates or claims or may result in the discovery of adverse side effects.
In the future, we may need to conduct clinical trials to support approval of new products, and any future clinical trial activities that we undertake will be subject to extensive regulation and review by numerous governmental authorities both in the United States and abroad. Clinical studies intended to support a 510(k) or PMA must be conducted in compliance with the FDA’s Good Clinical Practice regulations and similar requirements in foreign jurisdictions. Even if our clinical trials are completed as planned, we cannot be certain that their results will support our product candidate claims or that the FDA or foreign authorities and Notified Bodies will agree with our conclusions regarding them. Success in pre-clinical studies and early clinical trials does not ensure that later clinical trials will be successful, and we cannot be sure that the later trials will replicate the results of prior trials and pre-clinical studies. The clinical trial process may fail to demonstrate that our product candidates are safe and effective for the proposed indicated uses, which could cause us to abandon a product candidate and may delay development of others. Any delay or termination of our clinical trials will delay the filing of associated product submissions and, ultimately, our ability to commercialize products requiring submission of clinical data. It is also possible that patients enrolled in a clinical trial will experience adverse side effects that are not currently part of the product candidate’s safety profile, which could cause us to delay or abandon development of such product.
Governmental regulation and limited sources and suppliers could restrict our procurement and use of allograft bone tissue.
In the United States, the procurement and transplantation of allograft bone tissue is subject to federal law pursuant to the National Organ Transplant Act, or NOTA, a criminal statute which prohibits the purchase and sale of human organs used in human transplantation, including bone and related tissue, for “valuable consideration.” NOTA permits reasonable payments associated with the removal, transportation, processing, preservation, quality control, implantation and storage of human bone tissue. We provide processing fees to certain of our suppliers, which are registered tissue banks, for their services related to recovering allograft bone tissue. If NOTA is interpreted or enforced in a manner that prevents us from making these processing fees to our tissue bank suppliers for the services they render for us, our business could be materially adversely affected. The FDA periodically inspects tissue processors to determine compliance with these requirements. Violations of applicable regulations noted by the FDA during facility inspections could adversely affect the continued marketing of our products. We believe we comply with all aspects of the FDA’s Current Good Tissue Practice regulations, although there can be no assurance that we will comply, or will comply on a timely basis, in the future. The entity that provides us with allograft bone tissue is responsible for performing donor recovery, donor screening and donor testing and our compliance with those aspects of the Current Good Tissue Practice regulations that regulate those functions are dependent upon the actions of this independent entity.
Three third-party suppliers currently provide all of our needs for biomaterials products, which incorporate allograft bone tissue. The processing of allograft bone tissue into our biomaterials products 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 in our biomaterials products may be, at times, in particularly short supply. We cannot be certain that our current supply of biomaterials products from our suppliers, plus any additional sources that we identify in the future, will be sufficient to meet our needs. Our dependence on a limited number of third-party suppliers and the challenges we may face in obtaining adequate supplies of allograft bone tissue involve several risks, including limited control over pricing, availability, and quality and delivery schedules. In addition, any supply interruption in a sole-sourced human tissue component, could materially harm our and our third-party suppliers’ ability to manufacture our biomaterials 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, results of operations and financial condition.
Negative publicity concerning methods of tissue recovery and screening of donor tissue in our industry could reduce demand for our biomaterials products 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 some of our biomaterials products. 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 technologies incorporating human tissue. 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. For example, the media has reported examples of alleged illegal harvesting of body parts from cadavers and resulting recalls conducted by certain companies selling human tissue based products affected by the alleged illegal harvesting. These reports and others could have a negative effect on our biomaterials business.
We are subject to environmental laws and regulations that can impose significant costs and expose us to potential financial liabilities.
The manufacture of certain of our products, including our biomaterials products, and the handling of materials used in the product testing process, including in our cadaveric laboratory, involve the controlled use of biological and/or hazardous materials and wastes. Our business and facilities and those of our suppliers are subject to foreign, federal, state and local laws and regulations relating to the protection of human health and the environment, including those governing the use, manufacture, storage, handling and disposal of, and exposure to, such materials and wastes. In addition, under some environmental laws and regulations, we could be held responsible for costs relating to any contamination at our present facilities and at third-party waste disposal sites even if such contamination was not caused by us. A failure to comply with current or future environmental laws and regulations could result in severe fines or penalties. Any such expenses or liability could have a significant negative impact on our business, results of operations and financial condition.
We or our suppliers may be the subject of claims for non-compliance with FDA regulations in connection with the processing, manufacturing or distribution of our proposed allograft bone tissue or other biomaterials products.
Allegations may be made against us or against donor recovery groups or tissue banks, including those with which we have a contractual supplier relationship, claiming that the acquisition or processing of biomaterials products does not comply with applicable FDA regulations or other relevant statutes and regulations. Allegations like these could cause regulators or other authorities to take investigative or other action against us or our suppliers, or could cause negative publicity for us or our industry generally. These actions or any negative publicity could cause us to incur substantial costs, divert the attention of our management from our business and harm our reputation.
If we or our sales representatives fail to comply with fraud and abuse laws, we could be subject to civil and criminal penalties, which could adversely impact our reputation and business operations.
There are numerous U.S. federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Our relationships with surgeons, hospitals, group purchasing organizations and our international distributors are subject to scrutiny under these laws. Violations of these laws are punishable by criminal and civil sanctions, including significant monetary penalties and, in some instances, imprisonment and exclusion from participation in federal and state healthcare programs, including the Medicare, Medicaid and Veterans Administration health programs.
Healthcare fraud and abuse regulations are complex, and even minor irregularities can potentially give rise to claims that a statute or prohibition has been violated. The laws that may affect our ability to operate include:
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the federal Anti-Kickback Statute, which prohibits, among other things, persons from knowingly and
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willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal healthcare programs such as Medicare and Medicaid;
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the federal False Claims Act, which prohibits, among other things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid or other third-party payors that are false or fraudulent;
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the federal Health Insurance Portability and Accountability Act of 1996, as amended, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program and making false statements relating to healthcare matters;
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the Federal Trade Commission Act and similar laws regulating advertisement and consumer protections;
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The FCPA prohibits corrupt payments, gifts or transfers of value to foreign officials; and
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foreign and/or U.S. state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers.
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Further, the PPACA, among other things, amends the intent requirements of the federal Anti-Kickback Statute and the criminal statute governing healthcare fraud. A person or entity can now be found guilty of violating the federal Anti-Kickback Statute and the federal criminal healthcare fraud statute without actual knowledge of the statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal False Claims Act or federal civil money penalties statute. Possible sanctions for violation of laws include monetary fines, civil and criminal penalties, exclusion from Medicare and Medicaid programs and forfeiture of amounts collected in violation of such prohibitions. Moreover, while we do not submit claims and our customers make the ultimate decision on how to submit claims, from time-to-time, we may provide reimbursement guidance to our customers. If a government authority were to conclude that we provided improper advice to our customers and/or encouraged the submission of false claims for reimbursement, we could face action against us by government authorities. Any violations of these laws, or any action against us for violation of these laws, even if we successfully defend against it, could result in a material adverse effect on our reputation, business, results of operations and financial condition.
Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available under the federal Anti-Kickback Statute, it is possible that some of our business activities, including our relationship with surgeons, hospitals, group purchasing organizations and our independent sales agencies and distributors, could be subject to challenge under one or more of such laws.
We have entered into certain agreements, including consulting agreements and royalty agreements, with surgeons, including some who order and use our products in procedures they perform. While these transactions were structured to comply with all applicable laws, including state and federal anti-kickback laws, to the extent applicable, regulatory agencies may view these transactions as prohibited arrangements that must be restructured, or discontinued, or for which we could be subject to other significant penalties, including debarment. Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. We could also be adversely affected if regulatory agencies interpret our financial relationships with spine surgeons who order our products to be in violation of applicable laws. This could subject us to civil and criminal penalties for non-compliance, the cost of which could be substantial.
To enforce compliance with the federal laws, the U.S. Department of Justice has recently increased its scrutiny of interactions between healthcare companies and healthcare providers, which has led to a number of investigations, prosecutions, convictions and settlements in the healthcare industry. Dealing with investigations can be time and resource consuming and can divert management’s attention from the business. In addition, settlements with the Department of Justice or other law enforcement agencies have forced healthcare providers to agree to additional compliance and reporting requirements as part of a consent decree or corporate integrity agreement. Any such investigation or settlement could increase our costs or otherwise have an adverse effect on our business.
In addition, there has been a recent trend of increased federal and state regulation of payments made to physicians. The PPACA imposed new reporting requirements on device manufacturers for payments made by them and in some cases, their distributors, to physicians and teaching hospitals, as well as ownership and investment interests held by physicians (commonly known as the Physician Payment Sunshine Act). Failure to submit required information may result in civil monetary penalties of up to an aggregate of $150,000 per year (or up to an aggregate of $1 million per year for “knowing failures”), for all payments, transfers of value or ownership or investment interests that are not timely, accurately and completely reported in an annual submission. Manufacturers must submit reports by the 90th day of each subsequent calendar year. Due to the difficulty in complying with the Physician Payment Sunshine Act and the use of independent sales agencies as part of our U.S. sales force, we cannot assure you that we will successfully report all transfers of value by us and our independent sales agencies, and any failure to comply could result in significant fines and penalties.
Certain states mandate implementation of commercial compliance programs, impose restrictions on device manufacturer marketing practices and tracking and/or require the reporting of gifts, compensation and other remuneration to physicians. A similar trend is observed in foreign jurisdictions such as France. In France, a recently adopted law and a decree require companies working in the health sector to publicly disclose direct or indirect benefits granted to, and agreements entered into with, physicians and other healthcare professionals. The shifting commercial compliance environment and the need to build and maintain robust and expandable systems to comply with different compliance and/or reporting requirements in multiple jurisdictions increase the possibility that a healthcare company may violate one or more of the requirements.
Most of these laws apply to not only the actions taken by us, but also actions taken by our independent sales agencies and distributors. We have limited knowledge and control over the business practices of our independent sales agencies and distributors, and we may face regulatory action against us as a result of their actions which could have a material adverse effect on our reputation, business, results of operations and financial condition.
In addition, the scope and enforcement of these laws is uncertain and subject to rapid change in the current environment of healthcare reform, especially in light of the lack of applicable precedent and regulations. Federal or state regulatory authorities might challenge our current or future activities under these laws. Any such challenge could have a material adverse effect on our reputation, business, results of operations and financial condition. Any state or federal regulatory review of us, regardless of the outcome, would be costly and time-consuming. In addition, we cannot predict the impact of any changes in these laws, whether or not retroactive.
U.S. legislative or FDA regulatory reforms may make it more difficult and costly for us to obtain regulatory approval of our product candidates and to manufacture, market and distribute our products after approval is obtained.
From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the regulatory approval, manufacture and marketing of regulated products or the reimbursement thereof. In addition, FDA regulations and guidance are often revised or reinterpreted by the FDA in ways that may significantly affect our business and our products. Any new regulations or revisions or reinterpretations of existing regulations may impose additional costs or lengthen review times of future products. In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be.
For example, in December 2016, the 21
st
Century Cures Act (the “Cures Act”) was enacted into law. The Cures Act includes many provisions that impact the regulation of medical devices. Among other things, the Cures Act includes provisions regarding, among other things:
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Expediting the development and prioritizing FDA review of “breakthrough” technologies;
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expanding the scope of diseases/conditions eligible for a humanitarian device exemption;
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encouraging the FDA to rely more on real-world evidence to demonstrate device safety and effectiveness;
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requiring additional validation data prior to marketing certain reusable medical devices;
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streamlining the review process for combination products;
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making certain types of low-risk software functions not generally subject to regulation as medical devices; and
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emphasizing the least burdensome standard for device reviews.
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Because the Cures Act has only recently been enacted, it is difficult to know whether it will directly affect our business. Furthermore, because these provisions allow the FDA to spend several years developing policies, any potential impact on our business could be delayed.
Moreover, a new President of the United States, as well as many members of the U.S. Congress, were elected on November 8, 2016. The policies of the new administration and their impact on the regulation of our products in the United States are uncertain. The outcome of this election could result in significant legislative and regulatory reforms impacting the FDA’s regulation of our products. Any change in the laws or regulations that govern the clearance and approval processes relating to our current and future products could make it more difficult and costly to obtain clearance or approval for new products, or to produce, market and distribute existing products. Significant delays in receiving clearance or approval, or the failure to receive clearance or approval for our new products would have an adverse effect on our ability to expand our business.
U.S. legislative or regulatory healthcare reforms may make it more difficult and costly for us to market and distribute our products after clearance or approval is obtained.
Recent political, economic and regulatory influences are expected to subject the healthcare industry in the United States to fundamental changes. The sales of our products depend in part on the availability of coverage and reimbursement from third-party payors such as government health programs, private health insurers, health maintenance organizations and other healthcare-related organizations. Both the federal and state governments in the United States and foreign governments continue to propose and pass new legislation and regulations designed to contain or reduce the cost of healthcare. Such legislation and regulations may result in decreased reimbursement for medical devices and/or the procedures in which they are used, which may further exacerbate industry-wide pressure to reduce the prices charged for medical devices. This could harm our ability to market our products and generate sales.
Significant healthcare reform was enacted in 2010 when the PPACA was signed into law. State laws also were enacted to implement the PPACA. While the goal of these healthcare reform efforts was to expand coverage to more individuals, it also involved increased government price controls, additional regulatory mandates and other measures designed to constrain medical costs. The PPACA significantly impacts the medical device industry. Among other things, the PPACA:
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imposes an annual excise tax of 2.3% on any entity that manufactures or imports medical devices offered for sale in the United States, which began on January 1, 2013 (described in more detail below), but was suspended during 2016 and 2017;
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establishes a new Patient-Centered Outcomes Research Institute to oversee and identify priorities in comparative clinical effectiveness research in an effort to coordinate and develop such research;
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implements payment system reforms including a national pilot program on payment bundling to encourage hospitals, physicians and other providers to improve the coordination, quality and efficiency of certain healthcare services through bundled payment models; and
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creates an independent payment advisory board that will submit recommendations to reduce Medicare spending if projected Medicare spending exceeds a specified growth rate.
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In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. For example, on January 2, 2013, former President Obama signed into law the American Taxpayer Relief Act of 2012, or the ATRA, which, among other things, further reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.
In light of the results of the November 8, 2016, U.S. presidential election, the future of the PPACA is uncertain, with President Trump and many Republicans calling for its repeal. Even if the PPACA is repealed, we expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state
governments will pay for healthcare products and services, which could result in reduced demand for our products or additional pricing pressure.
Our financial performance may be adversely affected by medical device tax provisions in the healthcare reform laws.
The PPACA imposes, among other things, an excise tax of 2.3% on any entity that manufactures or imports medical devices offered for sale in the United States, which began on January 1, 2013, but was suspended during 2016 and 2017. The Internal Revenue Service issued final regulations implementing the tax in December of 2012 which require, among other things, bi-monthly payments and quarterly reporting. President Trump has promised to repeal the PPACA and its medical device tax. If, however, the PPACA and/or the associated device tax is not repealed, we anticipate that primarily all of our sales of medical devices in the United States will be subject to this 2.3% excise tax.
Current economic and political conditions make tax rules in any jurisdiction subject to significant change.
Proposals for broad reform of the existing United States corporate tax system are under evaluation by various legislative and administrative bodies. We cannot predict the overall impact that such proposals may have on our business. In addition, further changes in the tax laws of foreign jurisdictions could arise, including as a result of the base erosion and profit shifting (“BEPS”) project undertaken by the Organization for Economic Cooperation and Development (“OECD”). The OECD, which represents a coalition of member countries, has issued recommendations that, in some cases, would make substantial changes to numerous long-standing tax positions and principles. These contemplated changes, to the extent adopted by OECD members and/or other countries, could increase tax uncertainty and may adversely affect our provision for income taxes.
Risks Related to our Financial Results and Future Capital Needs
We will need to generate significant sales to become profitable.
We intend to increase our operating expenses and purchases of inventory as we expand our global distribution network to increase our geographic sales coverage, increase our marketing capabilities, conduct clinical trials and increase our general and administrative functions to support our growing operations. We will need to generate significant sales to achieve profitability and we might not be able to do so. Even if we do generate significant sales, we might not be able to achieve profitability on a quarterly or annual basis in the future. If our sales grow more slowly than we anticipate or if our operating expenses exceed our expectations, our financial performance will likely be adversely affected.
Our sales volumes and our results of operations may fluctuate over the course of the year.
We have experienced and continue to experience meaningful variability in our sales and gross profit among quarters, as well as within each quarter, as a result of a number of factors, including, among other things:
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the number of products sold in the quarter;
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the unpredictability of sales of full sets of spinal implants and instruments to our international distributors;
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the demand for, and pricing of, our products and the products of our competitors;
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the timing of or failure to obtain regulatory clearances or approvals for products;
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costs, benefits and timing of new product introductions;
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the availability and cost of components and materials;
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the number of selling days in the quarter;
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fluctuation and foreign currency exchange rates; and
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impairment and other special charges.
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In addition, our sales may be influenced by summer vacation and winter holiday periods, as we have experienced a higher incidence of adolescent surgeries during these periods which may lead to higher sales of our products in the late spring and summer and in the fourth quarter of our fiscal year.
Our future capital needs are uncertain and we may need to raise additional funds in the future, and such funds may not be available on acceptable terms or at all.
We believe that our current cash and cash equivalents, in combination with the borrowing availability under our senior secured credit facility and our expected cash from operations, will be sufficient to meet our projected operating requirements for the foreseeable future. However, the continued expansion of our business will be expensive and we may seek additional funds from public and private stock offerings, borrowings under our existing or new credit facilities or other sources which we may not be able to maintain or obtain on acceptable or commercially reasonable terms, if at all. Our capital requirements will depend on many factors, including:
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market acceptance of our products;
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the revenue 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 and commercializing new products or technologies;
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the scope, rate of progress and cost of our clinical trials;
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the cost of obtaining and maintaining regulatory approval or clearance of our products and products in development;
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the costs associated with complying with state, federal and international transparency laws;
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the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;
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the cost of defending, in litigation or otherwise, any claims that we infringe third-party patent or other intellectual property rights;
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the cost of enforcing or defending against non-competition claims;
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the number and timing of acquisitions and other strategic transactions;
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the costs associated with our international expansion efforts;
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the costs associated with increased capital expenditures, including fixed asset purchases of instrument sets which we loan to hospitals to support surgeries; and
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unanticipated general and administrative expenses.
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As a result of these factors, we may seek to raise additional capital to:
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maintain appropriate product inventory levels;
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fund our operations and clinical trials;
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continue our research and development;
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defend, in litigation or otherwise, any claims that we infringe third-party patents or other intellectual property rights;
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address FDA or other governmental, legal/enforcement actions and remediate underlying problems;
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commercialize our new products, if any such products receive regulatory clearance or approval for sale; and
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acquire companies and license products or intellectual property.
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Furthermore, if we issue equity or debt securities to raise additional capital, 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 capital through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our products, potential products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise capital 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, changes in our supplier relationships, or unanticipated customer requirements. Any of these events could adversely affect our ability to achieve our development and commercialization goals, which could have a material adverse effect on our business, results of operations and financial condition.
Our revolving credit facility contains restrictive covenants that may limit our operating flexibility.
Our revolving credit facility contains certain restrictive covenants that limit, among other things, our ability to dispose of assets, merge with other companies or consummate certain changes of control, pay dividends, incur additional indebtedness and liens, make investments, enter into transactions with affiliates, enter new businesses or prepay subordinated indebtedness. We therefore may not be able to engage in any of the foregoing transactions unless we obtain the consent of the lenders or terminate the revolving credit facility. There is no guarantee that we will be able to generate sufficient cash flow or sales to meet the financial covenants or pay the principal and interest on such debt. Furthermore, there is no guarantee that future working capital, borrowings or equity financing will be available to repay or refinance any such debt.
Our indebtedness and liabilities could limit the cash flow available for our operations and expose us to risks that could adversely affect our business, financial condition and results of operations.
As of December 31, 2016, we had $72.8 million of outstanding indebtedness. We may also incur additional indebtedness to meet future financing needs. Our indebtedness could have significant negative consequences for our security holders and our business, results of operations and financial condition by, among other things:
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increasing our vulnerability to adverse economic and industry conditions;
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limiting our ability to obtain additional funding;
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requiring the dedication of a substantial portion of our cash flow from operations to service our indebtedness, which will reduce the amount of cash available for other purposes;
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limiting our flexibility to plan for, or react to, changes in our business;
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diluting the interest of our existing stockholders as a result of issuing shares of our common stock upon conversion of our convertible senior notes; and
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placing us at a possible competitive disadvantage with competitors that are less leveraged than us or have better access to capital.
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Our business may not generate sufficient funds, and we may otherwise be unable to maintain sufficient cash reserves, to pay amounts due under our indebtedness, and our cash needs may increase in the future.
We may be unable to raise the funds necessary to repurchase our convertible
senior
notes for cash following a fundamental change or on the option repurchase dates, or to pay any cash amounts due upon conversion, and our other indebtedness limits our ability to repurchase our convertible notes or pay cash upon their conversion.
Under the indenture governing our convertible senior notes that we issued in August 2016, noteholders may require us to repurchase their notes following a fundamental change (as defined in the indenture) or on each of August 15, 2021, August 15, 2026 and August 15, 2031 at a cash repurchase price generally equal to the principal amount of the convertible senior notes to be repurchased, plus accrued and unpaid interest, if any. In addition, upon conversion, we must satisfy part or all of our conversion obligation in cash unless we elect to settle conversions solely in shares of our common stock. We may not have enough available cash or be able to obtain financing at the time we are required to repurchase the convertible senior notes or pay the cash amounts due upon conversion. In addition, applicable law, regulatory authorities and the agreements governing
our other indebtedness may restrict our ability to repurchase the convertible senior notes or pay the cash amounts due upon conversion. Under our revolving credit facility, our operating subsidiaries are limited in the amount of cash that they can distribute to us. Until the maturity of the revolving credit facility in April 2018, our operating subsidiaries will be permitted to distribute only up to $1.5 million in aggregate to permit us to make cash payments in connection with any conversions of our convertible senior notes. If noteholders elect to convert their convertible senior notes prior to the maturity of the revolving credit facility, we may be required to elect physical settlement rather than combination settlement or cash settlement or seek a waiver or amendment from the lenders under the revolving credit facility. Furthermore, following a fundamental change, under our revolving credit facility, our subsidiaries would not be permitted to distribute any cash to us to repurchase any convertible senior notes. Our failure to repurchase convertible senior notes or to pay the cash amounts due upon conversion when required will constitute a default under the indenture governing the convertible senior notes. A default under the indenture or the fundamental change itself could also lead to a default under agreements governing our other indebtedness, which may result in that other indebtedness becoming immediately payable in full. We may not have sufficient funds to satisfy all amounts due under the other indebtedness and the convertible senior notes.
Provisions in the indenture governing our convertible senior notes could delay or prevent an otherwise beneficial takeover of us
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Certain provisions in the convertible senior notes and the indenture governing our convertible senior notes could make a third party attempt to acquire us more difficult or expensive. For example, if a takeover constitutes a fundamental change under the indenture, then noteholders will have the right to require us to repurchase their convertible senior notes for cash. In addition, if a takeover constitutes a make whole fundamental change (as defined in the indenture), then we may be required to temporarily increase the conversion rate on our convertible senior notes. In either case, and in other cases, our obligations under the convertible senior notes and the indenture could increase the cost of acquiring us or otherwise discourage a third party from acquiring us or removing incumbent management, including in a transaction that holders of our common shares may view as favorable.
The accounting method for our convertible senior notes could adversely affect our reported financial condition and results.
The accounting method for reflecting the convertible senior notes on our balance sheet, accruing interest expense for the convertible notes and reflecting the underlying shares of our common stock in our reported diluted earnings per share may adversely affect our reported earnings and financial condition.
Under applicable accounting principles, the liability carrying amount of the convertible senior notes is the fair value of a similar debt instrument that does not have a conversion feature, valued using our cost of capital for straight, unconvertible debt. We have reflected the difference between the net proceeds from the offering of the convertible senior notes and the initial carrying amount as a debt discount for accounting purposes, which will be amortized into interest expense over the term of the convertible senior notes. As a result of this amortization, the interest expense that we recognize for the convertible senior notes for accounting purposes is greater than the cash interest payments we pay on the convertible senior notes, which results in lower reported net income. The lower reported income resulting from this accounting treatment could depress the trading price of our common stock.
In addition, because we intend to settle conversions by paying the conversion value in cash up to the principal amount of the convertible senior notes being converted and any excess in shares, we are eligible to use the treasury stock method to reflect the shares underlying the convertible senior notes in our diluted earnings per share. Under this method, if the conversion value of the convertible senior notes exceeds their principal amount for a reporting period, then we will calculate our diluted earnings per share assuming that all the convertible senior notes were converted and that we issued shares of our common stock to settle the excess. However, if reflecting the convertible senior notes in diluted earnings per share in this manner is anti-dilutive, or if the conversion value of the convertible senior notes does not exceed their principal amount for a reporting period, then the shares underlying the convertible senior notes will not be reflected in our diluted earnings per share. However, if accounting standards change in the future and we are not permitted to use the treasury stock method, then our diluted earnings per share may decline.
Furthermore, if any of the conditions to the convertibility of the convertible senior notes is satisfied, then we may be required under applicable accounting standards to reclassify the liability carrying value of the convertible senior notes as a current, rather than a long-term, liability. This reclassification could be required even if no noteholders convert their convertible senior notes and could materially reduce our reported working capital.
Continuing worldwide economic instability could adversely affect our revenue, collectability of our accounts receivable, financial condition or results of operations and those of our suppliers, counterparties and consumers, which could harm our financial position.
Since fiscal year 2008, the global economy has been impacted by the sequential effects of an ongoing global financial crisis. This global financial crisis has caused extreme disruption in the financial markets, including severely diminished liquidity and credit availability. There can be no assurance that there will not be further deterioration in the global economy. Our customers and suppliers may experience financial difficulties or be unable to borrow money to fund their operations, which may adversely impact their ability to purchase our products, pay for our products on a timely basis, if at all, or supply us with our products. As with our customers and suppliers, these economic conditions make it more difficult for us to accurately forecast and plan our future business activities. In light of the current economic state of many countries in which we do business, we continue to monitor their creditworthiness. Failure to receive payment of all or a significant portion of these receivables could adversely affect our results of operations.
Risks Related to our Intellectual Property and Potential Litigation
If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur significant expenses to enforce our rights.
Our success depends significantly on our ability to protect our proprietary rights to the technologies and inventions used in, or embodied by, 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.
Patent Rights
As of
December 31, 2016
, we owned or licensed
253
issued U.S. patents and
162
issued foreign patents. We had
113
pending U.S. patent applications and
115
pending foreign patent applications. It is our practice to file continuation and divisional applications as warranted which may provide additional intellectual property protection if those continuation and divisional applications issue as U.S. patents. Our patents will expire between 2017 and 2035, subject to payment of required maintenance fees, annuities and other charges.
We have applied for patent protection relating to certain existing and proposed products and processes. While we generally apply for patents in those countries that represent major markets where we intend to make, have made, use or sell key patented products, we may not accurately predict all of the countries where patent protection will ultimately be desirable. If we fail to timely file a patent application in any such country, we may be precluded from doing so at a later date.
Furthermore, the process of applying for patent protection itself is time consuming and expensive and we cannot assure you that any of our patent applications will issue as patents. The rights granted to us under our patents, including prospective rights sought in our pending patent applications, may not be meaningful or provide us with any commercial advantage and they could be opposed, contested or circumvented by our competitors or be declared invalid or unenforceable in judicial or administrative proceedings. In addition, our pending patent applications include claims to material aspects of our products and procedures that are not currently protected by issued patents. In addition, the patents we own may not be of sufficient scope or strength to provide us with any meaningful protection or commercial advantage, and competitors may be able to design around our patents or develop products that provide outcomes comparable to ours without infringing on our intellectual property rights.
Moreover, the United States Patent and Trademark Office, or USPTO, and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. In addition, periodic maintenance fees on issued patents often must be paid to the USPTO and foreign patent agencies over the lifetime of the patent. While an unintentional lapse can in many cases be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. Non-compliance events that could result in abandonment or lapse of a patent or patent application include, but are not limited to, failure to respond to official actions within prescribed time limits, non-payment of fees and failure to properly legalize and submit formal documents. If we fail to maintain the patents and patent applications covering our products or procedures, we may not be able to stop a competitor from marketing products that are the same as or similar to our products, which would have a material adverse effect on our business.
Due to differences between foreign and U.S. patent laws, our patented intellectual property rights may not receive the same degree of protection in foreign countries as they would in the United States. Even if patents are granted outside the United States, effective enforcement in those countries may not be available, and the scope of protection may vary
significantly from country to country. In some cases, we have filed patent applications outside the United States in the EEA, Canada, Australia and Japan and we therefore lack any patent protection in all other countries. In countries where we do not have significant patent protection, we may not be able to stop a competitor from marketing products in such countries that are the same as or similar to our products.
Trademarks
We rely on our trademarks as one means to distinguish our products from the products of our competitors, and have registered or applied to register many of these trademarks. As of
December 31, 2016
, we had
28
U.S. trademark registrations,
80
foreign trademark registrations,
10
pending U.S. applications to register trademarks and
11
foreign applications to register trademarks. However, our trademark applications may not be approved. Third parties may oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing new brands. Our competitors may infringe our trademarks and we may not have adequate resources to enforce our trademarks.
Confidentiality Agreements and Intellectual Property Assignments
Furthermore, although we have taken steps to protect our intellectual property and proprietary technology, including entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants and scientific advisors, such agreements may not be enforceable or may not provide meaningful protection for our proprietary information or technology in the event of unauthorized use or disclosure or other breaches of such agreements.
Intellectual Property Litigation
In the event a competitor infringes upon our patents, trademarks or other intellectual property rights, enforcing those patents, trademarks and other rights may be costly, difficult, time consuming or unsuccessful. Even if successful, litigation to enforce our intellectual property rights or to defend our patents against challenge could be expensive and time consuming and could divert our management’s attention from managing our business. Litigation to defend our patents and trademarks against challenges or enforce our intellectual property rights could provoke significant retaliatory litigation, which could be costly, result in the diversion of management’s time and efforts, require us to pay damages and other amounts or prevent us from marketing our existing or future products. Moreover, we may not have sufficient resources or desire to enforce our intellectual property rights or to defend our patents or trademarks against a challenge.
We rely heavily on patent rights that we either license from others or have obtained through assignments which may be subject to assignment back to the original assignor. In both cases, if we fail to make payments, or under certain other circumstances, the other party may terminate the license or require re-assignment of the patent rights, as applicable. If we are unable to maintain our licenses to or ownership of such patent rights, as applicable, or obtain additional licenses and assignments that we may need, our ability to compete will be harmed.
We rely heavily on intellectual property that we license from others, including patented technology that is integral to our devices. We are particularly dependent on our licensing arrangements relating to our MESA technology. We also rely on our licensing arrangement relating to our angle-stable fixation systems and our licensing arrangement relating to our interbody fusion implants. Any of these licensors or other third-party licensors may terminate our license or, in some cases, terminate the limited exclusivity we enjoy under a license, in the event that we fail to make required payments or for other causes. In addition, we may not have the right to enforce licensed patents against third-party infringers, and we thus may be unable to derive full competitive advantage from the licensed patents. Approximately
46%
, 47% and 50% of our revenue were derived from sales of products that incorporate licensed technologies for the years ended December 31, 2016, 2015 and 2014, respectively. Furthermore, a number of the patents and patent applications we own were acquired pursuant to assignments which are subject to assignment back to the original licensor if we fail to make required payments or for other causes. If we are unable to maintain our licenses to or ownership of certain patent rights, our ability to compete in the market for spinal surgery devices will be harmed.
In addition, as we enhance our current product offerings and develop new ones, we may find it advisable or necessary to seek additional licenses or assignments from third parties that hold patents covering technology or methods used in our products. If we cannot obtain these additional licenses or assignments, we could be forced to design around those patents at additional cost or abandon the product altogether. As a result, our ability to grow our business and compete in the market for spinal surgery devices may be harmed.
The medical device industry is characterized by patent litigation and we could become subject to litigation that could be
costly, result in the diversion of management’s time and efforts and require us to pay damages or prevent us from marketing our existing or future products.
Our commercial success will depend in part on not infringing the patents or violating the other proprietary rights of others. Significant litigation regarding patent rights occurs in our industry. Our competitors in both the United States and abroad, many of which have substantially greater resources and have made substantial investments in patent portfolios and competing technologies, may have applied for or obtained or may in the future apply for and obtain, patents that will prevent, limit or otherwise interfere with our ability to make, use and sell our products. Generally, we do not conduct independent reviews of patents issued to third parties. In addition, patent applications in the United States and elsewhere can be pending for many years before issuance, so there may be applications of others now pending of which we are unaware that may later result in issued patents that will prevent, limit or otherwise interfere with our ability to make, use or sell our products. The large number of patents, the rapid rate of new patent applications and issuances, the complexities of the technology involved and the uncertainty of litigation increase the risk of business assets and management’s attention being diverted to patent litigation. In the future, we may receive communications from various industry participants alleging our infringement of their patents, trade secrets or other intellectual property rights and/or offering licenses to such intellectual property. Any lawsuits resulting from such allegations could subject us to significant liability for damages and invalidate our proprietary rights. Any potential intellectual property litigation also could force us to do one or more of the following:
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stop making, selling or using products or technologies that allegedly infringe the asserted intellectual property rights;
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lose the opportunity to license our technology to others or to collect royalty payments based upon successful protection and assertion of our intellectual property rights against others;
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incur significant legal expenses;
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pay substantial damages or royalties to the party whose intellectual property rights we may be found to be infringing;
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pay the attorney fees and costs of litigation to the party whose intellectual property rights we may be found to be infringing;
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redesign those products that contain the allegedly infringing intellectual property, which could be costly, disruptive and/or infeasible; or
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attempt to obtain a license to the relevant intellectual property from third parties, which may not be available on reasonable terms or at all.
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Any litigation or 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. Further, as the number of participants in the spinal surgery industry grows, the possibility of intellectual property infringement claims against us increases. If we are found to infringe the intellectual property rights of third parties, we could be required to pay substantial damages (which may be increased up to three times of awarded damages if we are found to have willfully infringed such intellectual property rights) and/or substantial royalties and could be prevented from selling our products unless we obtain a license or are 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 the intellectual property rights of others. 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, all of which could have a material adverse effect on our business, results of operations and financial condition.
In addition, we generally indemnify our customers, independent sales agencies and international distributors with respect to infringement by our products of the proprietary rights of third parties. Third parties may assert infringement claims against our customers, independent sales agencies or distributors. These claims may require us to initiate or defend protracted and costly litigation on behalf of our customers, independent sales agencies or distributors, regardless of the merits of these claims. If any of these claims succeed, we may be forced to pay damages on behalf of our customers, independent sales agencies or distributors or may be required to obtain licenses for the products they use. If we cannot obtain all necessary licenses on commercially reasonable terms, our customers may be forced to stop using our products.
We may be subject to damages resulting from claims that we, our employees, our independent sales agencies or our 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, in some cases until recently. Many of our independent sales agencies and 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 sales agencies and distributors have inadvertently or otherwise used or disclosed alleged trade secrets or other proprietary information of these former employers or competitors. In addition, we have been and may in the future be subject to claims that we caused an employee to breach the terms of his or her non-competition 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 could be a distraction to management. If our defense to those claims fails, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. Any litigation or the threat thereof may adversely affect our ability to hire employees or contract with independent sales agencies and distributors and their representatives. A loss of key personnel or their work product could have an adverse effect on our business, results of operations and financial condition.
If product liability lawsuits are brought against us, our business may be harmed, and 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, 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. Furthermore, if spine surgeons are not sufficiently educated in the use of our products, they may misuse or ineffectively use our products, which may result in unsatisfactory patient outcomes or patient injury. We could become the subject of product liability lawsuits alleging that component failures, malfunctions, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information resulted in an unsafe condition or injury to patients.
As of
December 31, 2016
, we have had, and continue to have, a small number of product liability claims relating to our products, none of which either individually, or in the aggregate, have resulted, or we believe will result, in a material negative impact on our business. In the future, we may be subject to additional product liability claims, some of which may have a negative impact on our business.
Regardless of the merit or eventual outcome, product liability claims may result in:
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decreased demand for our products;
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injury to our reputation;
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significant litigation costs;
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substantial monetary awards to or costly settlements with patients;
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the inability to commercialize new products or product candidates; and
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diversion of management attention from pursuing our business strategy and may be costly to defend.
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Although we have product and other liability insurance that we believe is appropriate for our current level of operations, this insurance is subject to deductibles and coverage limitations. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if it is available, the coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at acceptable cost or on acceptable terms with adequate coverage or otherwise protect against potential product liability claims, we could be exposed to significant financial and other liabilities, which may harm our business. If a product liability claim or series of claims is brought against us for uninsured liabilities or for amounts in excess of insured liabilities, it could have a material adverse effect on our business, results of operations and prospects. Any product liability claim brought against us, with or without merit,
could result in the increase of our product liability insurance rates or the inability to secure coverage in the future. In addition, a recall of some of our products, whether or not the result of a product liability claim, could result in significant costs and loss of customers.
In addition, medical malpractice carriers are withdrawing coverage in certain regions or substantially increasing premiums. In the event we become a defendant in a product liability suit in which the treating surgeon or hospital does not have adequate malpractice insurance, the likelihood of liability being imposed on us could increase.
Defending a suit, regardless of merit, could be costly, could divert management’s attention from our business and might result in adverse publicity, which could result in the withdrawal of, or inability to recruit, clinical trial patient participants or result in reduced acceptance of our products in the market. As a result, any product liability claims against us, regardless of their merit, could severely harm our financial condition, strain our management and other resources and adversely affect or eliminate the prospects for commercialization or sales of a product or product candidate that is the subject of any such claim.
Because allograft bone tissue used in our biomaterials program may entail a risk of communicable diseases to human recipients, we may be the subject of product liability claims regarding our allograft bone tissue.
The development and use of allograft bone tissue and biomaterials products may entail particular risk of transmitting diseases to human recipients. Any such transmission could result in the assertion of substantial product liability claims 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. Claims against us arising out of our biomaterials program, regardless of their merit or potential outcome, may also hurt our reputation and ability to sell our products.
Risks Related to Our International Operations
Our international operations subject us to certain operating risks, which could adversely impact our net sales, results of operations and financial condition.
International sales of our products represented
24%
, 28% and 29% of our revenue for the years ended
December 31, 2016
,
2015
and
2014
, respectively. The sale and shipment of our products across international borders, as well as any purchase of components and products from international sources, subject us to extensive U.S. and foreign governmental trade, import and export and customs regulations and laws. Compliance with these regulations is costly and exposes us to penalties for non-compliance. Other laws and regulations that can significantly impact us include various anti-bribery laws, including the FCPA and anti-boycott laws. Any failure to comply with applicable legal and regulatory obligations could impact us in a variety of ways that include, but are not limited to, suspension or withdrawal of our CE Certificates of Conformity, significant criminal, civil and administrative penalties, including imprisonment of individuals, fines and penalties, denial of export privileges, seizure of shipments, product recalls and withdrawals, restrictions on certain business activities, and exclusion or debarment from government contracting. Also, the failure to comply with applicable legal and regulatory obligations could result in the disruption of our shipping and sales activities.
In addition, many of the countries in which we sell our products are, to some degree, subject to political, economic or social instability. Our international operations expose us and our distributors to risks inherent in operating in foreign jurisdictions. These risks include, but are not limited to:
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differing existing or future regulatory and certification requirements;
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the imposition of additional U.S. and foreign governmental controls or regulations;
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the imposition of costly and lengthy new export licensing requirements;
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pricing pressure that we may experience internationally, which could result from, among other causes, the fact that many foreign governments subject their constituent surgical device companies to a materially less costly regulatory regime than that imposed upon U.S. surgical device companies by the United States government;
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difficulties and costs of staffing and managing foreign operations;
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changes in third-party reimbursement policies that may require some of the patients who receive our
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products to directly absorb medical costs or that may necessitate the reduction of the selling prices of our products;
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changes in duties and tariffs, license obligations and other non-tariff barriers to trade;
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the imposition of new trade restrictions;
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the imposition of restrictions on the activities of foreign agents, representatives and distributors;
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scrutiny of foreign tax authorities which could result in significant fines, penalties and additional taxes being imposed on us;
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potentially adverse U.S. tax consequences, including regulatory requirements regarding our ability to repatriate profits to the United States;
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the imposition of U.S. or international sanctions against a country, company, person or entity with whom we do business that would restrict or prohibit continued business with the sanctioned country, company, person or entity;
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laws and business practices favoring local companies;
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greater difficulty in collecting accounts receivable and longer collection periods;
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management communication and integration problems related to entering new markets with different languages, cultures and political systems;
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difficulties in maintaining consistency with our internal guidelines in new markets;
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difficulties in enforcing agreements through certain foreign legal systems;
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the uncertainty of protection for intellectual property rights in some countries and difficulties in enforcing or defending intellectual property rights internationally;
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political and economic instability and terrorism; and
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adverse effects due to changes in the EU or Eurozone membership, including risks associated with the potential exit of the United Kingdom from the EU.
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In addition, we may encounter difficulties in converting our earnings from international operations to U.S. dollars for use in the United States. These obstacles may include problems moving funds out of the countries in which the funds were earned and difficulties in collecting accounts receivable in foreign countries where the usual accounts receivable payment cycle is longer.
Any of these factors may adversely impact our operations. All of our international sales with independent distributor partners to date have been denominated in U.S. dollars. In the EEA, healthcare regulation and reimbursement for medical devices varies significantly from country-to-country. This changing environment could adversely affect our ability to sell our products in some EEA countries, which could negatively affect our results of operations.
Our international operations expose us to risks of fluctuations in foreign currency exchange rates between the US dollar and the currencies in which our foreign operations receive revenues and pay expenses
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Because our consolidated financial statements are presented in U.S. dollars, during times of a strengthening US dollar, our reported international revenues and earnings will be reduced because the local currency will translate into fewer US dollars. In addition, the assets and liabilities of our non-US subsidiaries are translated into US dollars at the exchange rates in effect at the balance sheet date. Revenues and expenses are translated into US dollars at the average exchange rate for the period. Translation adjustments arising from the use of differing exchange rates from period to period are recorded in shareholders’ equity as accumulated other comprehensive income (loss). Translation adjustments arising from intercompany receivables with our foreign subsidiaries are generally recorded as a component of other expense (income). To date, we have not used risk
management techniques to hedge the risks associated with these fluctuations. Even if we were to implement hedging strategies, not every exposure can be hedged and, where hedges are put in place based on expected foreign currency exchange exposure, they are based on forecasts that may vary or that may later prove to have been inaccurate. As a result, changes in currency exchange rates and our failure to effectively hedge these risks will cause our revenues, operating costs, net loss and stockholders’ equity to fluctuate, as they have in the past, which could have a material adverse effect on our results of operations and financial condition.
Failure to comply with the FCPA and similar laws associated with our activities outside the United States could subject us to penalties and other adverse consequences.
We are subject to the FCPA and other anti-bribery legislation around the world. The FCPA generally prohibits covered entities and their intermediaries from engaging in bribery or making other prohibited payments, offers or promises to foreign officials for the purpose of obtaining or retaining business or other advantages. In addition, the FCPA imposes recordkeeping and internal controls requirements on publicly traded corporations and their foreign affiliates, which are intended to, among other things, prevent the diversion of corporate funds to the payment of bribes and other improper payments, and to prevent the establishment of “off books” slush funds from which such improper payments can be made. As a substantial portion of our revenue is, and we expect will continue to be, from jurisdictions outside of the United States, we face significant risks if we fail to comply with the FCPA and other laws that prohibit improper payments, offers or promises of payment to foreign governments and their officials and political parties by us and other business entities for the purpose of obtaining or retaining business or other advantages. In many foreign countries, particularly in countries with developing economies, some of which represent significant markets for us, it may be a local custom that businesses operating in such countries engage in business practices that are prohibited by the FCPA or other laws and regulations. Although we have implemented a company policy requiring our employees and consultants to comply with the FCPA and similar laws, such policy may not be effective at preventing all potential FCPA or other violations. Although our agreements with our international distributors clearly state our expectations for our distributors’ compliance with U.S. laws, including the FCPA, and provide us with various remedies upon any non-compliance, including the ability to terminate the agreement, we also cannot guarantee our distributors’ compliance with U.S. laws, including the FCPA. Therefore there can be no assurance that none of our employees and agents, or those companies to which we outsource certain of our business operations, have not and will not take actions that violate our policies or applicable laws, for which we may be ultimately held responsible. Any violation of the FCPA and related policies could result in severe criminal or civil sanctions, which could have a material and adverse effect on our reputation, business, results of operations and financial condition.
Furthermore, we are subject to the export controls and economic embargo rules and regulations of the United States, including, but not limited to, the Export Administration Regulations and trade sanctions against embargoed countries, which are administered by the Office of Foreign Assets Control within the Department of the Treasury, as well as the laws and regulations administered by the Department of Commerce. These regulations limit our ability to market, sell, distribute or otherwise transfer our products or technology to prohibited countries or persons. A determination that we have failed to comply, whether knowingly or inadvertently, may result in substantial penalties, including fines and enforcement actions and civil and/or criminal sanctions, the disgorgement of profits and the imposition of a court- appointed monitor, as well as the denial of export privileges, and may have an adverse effect on our reputation.
Risks Related Ownership of Our Common Stock
We are incurring increased costs and are subject to additional regulations and requirements as a result of being a public company, which could lower our profits or make it more difficult to run our business.
As a public company, we are incurring significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will continue to incur costs associated with the Sarbanes-Oxley Act and related rules implemented by the SEC and NASDAQ. The expenses incurred by public companies generally for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations also could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our Board of Directors, our board committees or as our executive officers. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory action and potentially civil litigation.
We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to “emerging growth companies” will make our common stock less attractive to investors.
We are an emerging growth company (“EGC”) as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) and we may continue to take advantage of certain exemptions and relief from various reporting requirements that are applicable to other public companies that are not EGCs. In particular, while we remain an EGC (1) we are not required to comply with the auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act, (2) we are exempt from any rules that may be adopted by the PCAOB requiring mandatory audit firm rotations or a supplement to the auditor’s report on financial statements, (3) we are subject to reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and (4) we are not required to hold nonbinding advisory votes on executive compensation or stockholder approval of any golden parachute payments not previously approved.
In addition, we have elected to delay the adoption of new or revised accounting standards applicable to public companies until those standards apply to private companies, and as a result, we may not comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. As a result of this election, our financial statements may not be comparable to the financial statements of other public companies.
We also currently take advantage of the reduced disclosure requirements regarding executive compensation. We may take advantage of other exemptions, including the exemptions from the advisory vote requirements and executive compensation disclosures under the Dodd-Frank Wall Street Reform and Customer Protection Act, or the Dodd-Frank Act, and the exemption from the provisions of Section 404(b) of the Sarbanes-Oxley Act. We may remain an “emerging growth company” until as late as December 31, 2019 (the fiscal year-end following the fifth anniversary of the completion of our IPO), though we may cease to be an EGC earlier under certain circumstances, including (1) if the market value of our common stock that is held by nonaffiliates is $700.0 million or more as of the last business day of our second fiscal quarter, in which case we would cease to be an “emerging growth company” as of the following December 31, (2) if our gross revenue exceeds $1.0 billion in any fiscal year or if we issue more than $1.0 billion in non-convertible notes in any three year period. Once we cease to be an emerging growth company, we will no longer be able to take advantage of these exemptions and relief from various reporting requirements. As of February 28, 2017, we believe the market value of our common stock that is held by non-affiliates exceeds $700.0 million or more. In the event the market value of our common stock continues to be $700.0 million or more on June 30, 2017, the last business day of our 2017 second fiscal quarter, we would cease to be an EGC as of December 31, 2017.
If we are unable to implement and maintain effective internal control over financial reporting in the future, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock may be negatively affected.
As a public company, we are required to maintain internal controls over financial reporting and to report any material weaknesses in such internal controls. Included in this annual report on Form 10-K, is our management's report on the effectiveness of our internal control over financial reporting, pursuant to Section 404 of the Sarbanes-Oxley Act. However, as an EGC, our independent registered public accounting firm is not be required to express an opinion as to the effectiveness of our internal control over financial reporting pursuant to Section 404 until we file our annual report for the first fiscal year in which we are no longer an emerging growth company. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed or operating. The process of designing, implementing, and testing the internal control over financial reporting required to comply with this obligation is time consuming, costly, and complicated. If we identify material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner or assert that our internal control over financial reporting is effective or if our independent registered public accounting firm, when required, is unable to express an opinion as to the effectiveness of our internal control over financial reporting, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected, and we could become subject to investigations by the stock exchange on which our securities are listed, the SEC or other regulatory authorities, which could require additional financial and management resources.
The market price of shares of our common stock may be volatile, which could cause the value of your investment to decline.
The market price of our common stock may be highly volatile and could be subject to wide fluctuations. Securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as general economic, market or political conditions, could reduce the market price of shares of our common stock in spite of our
operating performance. In addition, our results of operations could be below the expectations of public market analysts and investors due to a number of potential factors, including variations in our quarterly results of operations, additions or departures of key management personnel, failure to meet analysts’ earnings estimates, publication of research reports about our industry, litigation and government investigations, changes or proposed changes in laws or regulations or differing interpretations or enforcement thereof affecting our business, adverse market reaction to any indebtedness we may incur or securities we may issue in the future, changes in market valuations of similar companies or speculation in the press or investment community, announcements by our competitors of significant contracts, acquisitions, dispositions, strategic partnerships, joint ventures or capital commitments, adverse publicity about the industries we participate in or individual scandals, and in response the market price of shares of our common stock could decrease significantly. You may be unable to resell your shares of common stock at or above the price at which you purchased them.
In the past few years, stock markets have experienced extreme price and volume fluctuations. In the past, following periods of volatility in the overall market and the market price of a company’s securities, securities class action litigation has often been instituted against these companies. This litigation, if instituted against us, could result in substantial costs and a diversion of our management’s attention and resources.
Because we have no current plans to pay cash dividends on our common stock, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.
We have no current plans to pay dividends on our common stock. The declaration, amount and payment of any future dividends on shares of common stock will be at the sole discretion of our Board of Directors. Our Board of Directors may take into account general and economic conditions, our financial condition and results of operations, our available cash and current and anticipated cash needs, capital requirements, contractual, legal, tax and regulatory restrictions and implications on the payment of dividends by us to our stockholders or by our subsidiaries to us and such other factors as our Board of Directors may deem relevant. In addition, our ability to pay dividends will be limited by our revolving credit facility and may be limited by covenants of other indebtedness we or our subsidiaries incur in the future. As a result, you may not receive any return on an investment in our common stock unless you sell our common stock for a price greater than that which you paid for it.
You may be diluted by the future issuance of additional common stock in connection with our incentive plans, acquisitions, conversion of our convertible senior notes or otherwise.
We have approximately 707.7 million shares of common stock authorized but unissued. Our amended and restated certificate of incorporation authorizes us to issue these shares of common stock and options, rights, warrants and appreciation rights relating to common stock for the consideration and on the terms and conditions established by our Board of Directors in its sole discretion, whether in connection with acquisitions or otherwise. We have reserved an aggregate of
1,705,417
shares for future issuance under our 2016 and 2014 Omnibus Incentive Plans. In addition, as of
December 31, 2016
, we have reserved
255,262
shares of common stock for future issuance under our Employee Stock Purchase Plan (“ESPP”). In addition, we have also reserved up to 2,974,415 shares of our authorized common stock to permit the conversion of all of our outstanding convertible senior notes. Any common stock that we issue, including under our Omnibus Incentive Plans, our ESPP or other equity incentive plans that we may adopt in the future, or from the conversion of our convertible senior notes, would dilute the percentage ownership held by the investors who currently own our common stock.
If we or our pre-IPO owners sell additional shares of our common stock, the market price of our common stock could decline.
The sale of substantial amounts of shares of our common stock in the public market, or the perception that such sales could occur, could harm the prevailing market price of shares of our common stock. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
Pursuant to a registration rights agreement entered into in connection with our purchase by WCAS, we granted WCAS the right, subject to certain conditions, to require us to register the sale of their shares of our common stock under the Securities Act. By exercising their registration rights and selling a large number of shares, WCAS could cause the prevailing market price of our common stock to decline. As of February 28, 2017, the shares covered by registration rights would represent approximately 13% of our outstanding common stock. Registration of any of these outstanding shares of common stock would result in such shares becoming freely tradable without compliance with Rule 144 upon effectiveness of the registration statement.
As restrictions on resale end or if WCAS exercises its registration rights, the market price of our shares of common stock could drop significantly if the holders of these restricted shares sell them or are perceived by the market as intending to sell them. These factors could also make it more difficult for us to raise additional funds through future offerings of our shares of common stock or other securities.
Anti-takeover provisions in our organizational documents and Delaware law might discourage or delay acquisition attempts for us that you might consider favorable.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that may make the merger or acquisition of our company more difficult without the approval of our Board of Directors. Among other things:
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although we do not have a stockholder rights plan, these provisions would allow us to authorize the issuance of undesignated preferred stock in connection with a stockholder rights plan or otherwise, the terms of which may be established and the shares of which may be issued without stockholder approval, and which may include super voting, special approval, dividend, or other rights or preferences superior to the rights of the holders of common stock;
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these provisions provide for a classified Board of Directors with staggered three-year terms;
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these provisions prohibit stockholder action by written consent unless such action is recommended by all directors then in office;
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these provisions provide that the Board of Directors is expressly authorized to make, alter, or repeal our bylaws and any amendment, alteration, rescission or repeal of our bylaws by our stockholders requires the affirmative vote of the holders of at least 66 2/3% in voting power of all the then-outstanding shares of stock of the Company entitled to vote thereon, voting together as a single class; and
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these provisions establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.
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Further, as a Delaware corporation, we are also subject to provisions of Delaware law, which may impair a takeover attempt that our stockholders may find beneficial. These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, including actions that our stockholders may deem advantageous, or negatively affect the trading price of our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing and to cause us to take other corporate actions you desire.
Our Board of Directors is authorized to issue and designate shares of our preferred stock in additional series without stockholder approval.
Our amended and restated certificate of incorporation authorizes our Board of Directors, without the approval of our stockholders, to issue 100 million shares of our preferred stock, subject to limitations prescribed by applicable law, rules and regulations and the provisions of our amended and restated certificate of incorporation, as shares of preferred stock in series, and to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. The powers, preferences and rights of these additional series of preferred stock may be senior to or on parity with our common stock, which may reduce its value.
Our ability to use our net operating loss carryforwards may be subject to limitation.
As of
December 31, 2016
, we had federal net operating loss carryforwards (“NOLs”), to offset future taxable income. A lack of future taxable income would adversely affect our ability to use these NOLs and, as a result of this and other factors, we have taken a valuation allowance against the NOLs. In addition, under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), a corporation that undergoes an “ownership change” is subject to limitations on its ability to use its NOLs to offset future taxable income. In general, a corporation that undergoes an ownership change may use its NOLs for a given year in an amount not greater than the product of the applicable federal long-term tax-exempt rate multiplied by the value of its capital stock immediately before the ownership change, and potentially increased for certain gains recognized by the corporation within five years after the ownership change if it has a net built-in gain in its assets at the time of the ownership change. We underwent such an ownership change in 2010 and 2015, and, as a result, we are limited in our ability
to use the portion of our NOLs that existed as of the time of such ownership changes. Because of this limitation and other factors, we have taken a valuation allowance against all of our NOLs. If we experience another ownership change, we would also become limited in our ability to use the portion of any NOLs that did not exist as of the time of the ownership changes that occurred in 2010 or 2015.