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EX-32.1 - EX-32.1 - BAXANO SURGICAL, INC.g22448exv32w1.htm
EX-31.2 - EX-31.2 - BAXANO SURGICAL, INC.g22448exv31w2.htm
EX-32.2 - EX-32.2 - BAXANO SURGICAL, INC.g22448exv32w2.htm
EX-10.7.1 - EX-10.7.1 - BAXANO SURGICAL, INC.g22448exv10w7w1.htm
Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
 
     
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the fiscal year ended December 31, 2009
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period          to          
 
Commission File Number 001-33744
 
TRANS1 INC.
(Exact name of Registrant as specified in its charter)
 
     
DELAWARE
(State or other jurisdiction of
incorporation or organization)
  33-0909022
(I.R.S. employer
identification no.)
 
301 GOVERNMENT CENTER DRIVE, WILMINGTON, NC 28403
(Address of principal executive office) (Zip code)
 
(910) 332-1700
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act
 
     
Title of Each Class:
 
Name of Each Exchange on Which Registered:
 
Common Stock, par value $0.0001 per share   The NASDAQ Stock Market LLC
 
Securities registered pursuant to Section 12(g) of the Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  YES o     NO þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  YES o     NO þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  YES þ     NO o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulations S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  YES o     NO o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer o
  Accelerated filer þ   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller Reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES o     NO þ
 
As of June 30, 2009, the last business day of our most recently completed second fiscal quarter, the aggregate market value of the voting stock held by non-affiliates was approximately $107.6 million, based on the number of shares held by non-affiliates of the registrant and based on the reported last sale price of common stock on June 30, 2009. This calculation does not reflect a determination that persons are affiliates for any other purposes.
 
The number of shares of the registrant’s common stock outstanding as of March 8, 2010 was 20,656,293 shares.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Portions of the Registrant’s Definitive Proxy Statement to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year covered by this annual report, relating to the Registrant’s annual meeting of stockholders, are incorporated by reference into Part III of this Form 10-K. With the exception of the portions of the Proxy Statement specifically incorporated herein by reference, the Proxy Statement is not deemed to be filed as part of this Form 10-K.
 


 

 
TRANS1 INC.
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2009

TABLE OF CONTENTS
 
             
PART I
  Business     4  
  Risk Factors     17  
  Unresolved Staff Comments     36  
  Properties     36  
  Legal Proceedings     36  
  Submission of Matters to a Vote of Security Holders     36  
 
PART II
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     37  
  Selected Financial Data     40  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     41  
  Quantitative and Qualitative Disclosures About Market Risk     47  
  Consolidated Financial Statements and Supplementary Data     48  
  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure     48  
  Controls and Procedures     48  
  Other Information     48  
 
PART III
  Directors, Executive Officers and Corporate Governance     48  
  Executive Compensation     48  
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     49  
  Certain Relationships and Related Transactions, and Director Independence     49  
  Principal Accountant Fees and Services     49  
 
PART IV
  Exhibits, Financial Statement Schedules     49  
    50  
    51  
 EX-10.7.1
 EX-23.1
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2


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Cautionary Note Regarding Forward-Looking Statements
 
In addition to historical financial information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 that concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. All statements other than statements of historical fact contained in this report, including statements regarding future events, our future financial performance, business strategy and plans and objectives of management for future operations, are forward-looking statements. We have attempted to identify forward-looking statements by terminology including “anticipates,” “believes,” “can,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “should” or “will” or the negative of these terms or other comparable terminology. Although we do not make forward-looking statements unless we believe we have a reasonable basis for doing so, we cannot guarantee their accuracy. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements. Readers are urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, operating results, financial condition and stock price, including without limitation the disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this report and in the consolidated financial statements and notes thereto included elsewhere in this report. Furthermore, such forward-looking statements speak only as of the date of this report. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations.
 
References in this report to “TranS1”, “we”, “our”, “us”, or the “Company” refer to TranS1 Inc.


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Item 1.   Business
 
Overview
 
We are a medical device company focused on designing, developing and marketing products that implement our proprietary minimally invasive surgical approach to treat degenerative disc disease and instability affecting the lower lumbar region of the spine. Using this TranS1 pre-sacral approach, a surgeon can access discs in the lower lumbar region of the spine through a 1.5 cm incision adjacent to the tailbone and can perform an entire fusion procedure through a small tube that provides direct access to the intervertebral space. We developed our TranS1 pre-sacral approach to allow spine surgeons to access and treat intervertebral spaces without compromising important surrounding soft tissue. We believe this approach enables fusion procedures to be performed with low complication rates, low blood loss, short hospital stays, fast recovery times and reduced pain. We have developed and currently market two single-level fusion products, the AxiaLIF® and the AxiaLIF 360°tm and a two-level fusion product, the AxiaLIF 2Ltm, which include the Vectre and Avatartm posterior fixation systems for lumbar fixation supplemental to AxiaLIF fusion.
 
Our AxiaLIF product received 510(k) clearance from the U.S. Food and Drug Administration, or FDA, in December 2004 and a CE mark in March 2005 and was commercially launched in the United States in January 2005. Our AxiaLIF 360° product received FDA 510(k) clearance in September 2005 and a CE mark in March 2006 and was commercially launched in the United States in July 2006. We received a CE mark for our AxiaLIF 2L product in the third quarter of 2005 and began commercialization in the European market in the fourth quarter of 2006. We received 510(k) clearance for our AxiaLIF 2L from the FDA and began marketing this product in the United States in April 2008. In November 2009, we commenced the limited market release of our next generation Vectre facet screw system. Our AxiaLIF 2L+ product received FDA 510(k) clearance, and we began marketing the product, in January 2010. In January 2010, we entered into a partnership agreement with Life Spine, Inc. to distribute Avatar, a minimally invasive pedicle screw system. As of December 31, 2009, over 8,600 fusion procedures have been performed globally using our AxiaLIF products. At December 31, 2009, we sold our AxiaLIF products through 55 direct sales personnel and 19 independent sales agents in the United States and 4 direct sales personnel and 14 independent distributors internationally. For the year ended December 31, 2009, our revenues were $29.8 million and our net loss was $23.2 million.
 
Lower back pain affects over six million people annually in the United States and is a leading cause of healthcare expenditures globally. Our currently marketed products address the lower lumbar spine fusion market. We believe the introduction of minimally invasive spine procedures, such as ours, will attract more back pain patients, and attract them earlier, to a definitive surgical solution, thereby increasing the rate at which the market grows.
 
Spine Anatomy
 
The human spine is the core of the human skeleton and provides important structural support while remaining flexible to allow movement. It consists of 33 separate interlocking bones called vertebrae that are connected by soft tissue and provide stability while facilitating motion. Vertebrae are paired into motion segments that move by means of two facet joints and one disc. The facet joints provide stability and enable the spine to bend and twist while the discs absorb pressures and shocks to the vertebrae. Nerves are contained in the spinal column and run through the foramen openings to the rest of the body.
 
The vertebrae are categorized into five regions: cervical, thoracic, lumbar, sacral and coccyx. The lumbar region, which is at the bottom of the spine and consists of five vertebrae, is capable of limited movement, and primarily functions as support for the body’s weight. The sacrum consists of five fused vertebrae labeled S1 through S5 directly below the lumbar region and that provide attachment for the hipbones as well as protection to organs in the pelvic area. The coccyx, also known as the tailbone, is at the end of the spine.


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Medical Conditions Affecting the Lower Lumbar Spine and Traditional Treatment Alternatives
 
Degenerative disc disease is a common medical condition affecting the lower lumbar spine and refers to the degeneration of the disc from aging and repetitive stresses resulting in a loss of flexibility, elasticity and shock-absorbing properties. As degenerative disc disease progresses, the space between the vertebrae narrows, which can pinch the nerves exiting the spine and result in back pain, leg pain, numbness and loss of motor function. This lower back pain can be overwhelming for patients as the resulting pain can have significant physical, psychological and financial implications.
 
Treatment alternatives for lower lumbar spine conditions range from non-operative conservative therapies to highly invasive surgical interventions. Conservative therapies are typically the initial treatments selected by patients and physicians and they include rest, bracing, physical therapy, chiropractics, electrical stimulation and drugs. When conservative therapies fail to provide adequate pain relief, surgical interventions, including fusion procedures, may be used to address the pain. If a patient’s disc degeneration has not progressed to a stage requiring fusion, but has progressed beyond the stage where conservative therapies provide pain relief, physicians may use non-fusion surgical procedures. Non-fusion surgical procedures utilize implants that are designed to restore disc height and allow limited movement of the vertebrae similar to a healthy spine in order to avoid increased pressures on adjacent vertebrae. These procedures and implants include dynamic stabilization devices, artificial discs and prosthetic disc nucleuses.
 
Fusion procedures attempt to alleviate lower back pain by removing problematic disc material and permanently joining together two or more opposing vertebrae. This is done in a manner that restores the appropriate space between the vertebrae surrounding the degenerative disc and eliminates mobility of the affected vertebrae. By restoring disc height and eliminating motion, fusion attempts to prevent the pinching of the nerves exiting the spine and thereby reducing pain.
 
Traditional fusion procedures typically involve an incision in the skin, and cutting muscle or moving organs to gain access to the spine. The degenerated disc is then removed, referred to as a discectomy, and a rigid implant is inserted, such as a bone graft or cage, to stabilize the diseased vertebrae. This process is referred to as fixation. The bone graft or cage promotes the growth of bone between the vertebrae. Surgeons often also affix supplementary rods and screws along the spine to provide additional stabilization while the vertebrae fuse together during the six to eighteen months following surgery. The primary surgical fusion procedures performed in the lower lumbar region include: ALIF, PLIF, TLIF and XLIF.
 
Anterior Lumbar Interbody Fusion, or ALIF.  To perform an ALIF procedure, surgeons access the spine through an incision on the patient’s abdomen which provides them with optimal access to the vertebral space for performing a discectomy and inserting bone grafts for fusion. Supporting soft tissue and nerves are manipulated or removed to accommodate the anterior access required by the ALIF procedure. Surgeons commonly perform ALIF procedures in conjunction with a general or vascular surgeon because critical vasculature and organs must be retracted to gain access to the spine. The assistance of a second surgeon can reduce the economics for the spine surgeon and increase the difficulty in scheduling the surgery. Complications associated with ALIF procedures include vascular damage to the vena cava and aorta.
 
Posterior Lumbar Interbody Fusion, or PLIF.  To perform a PLIF procedure, surgeons access the spine through an incision on the center of the patient’s back. The surgeon then navigates through muscles and nerves to gain access to the spine. Once at the spine, the surgeon removes bone from the lamina to gain access to the affected disc space where a discectomy is performed and a bone graft is placed. When compared to ALIF procedures, PLIF procedures are generally considered easier to perform and can achieve better nerve root decompression in certain cases. However, the anatomy of the spine prevents surgeons from removing the entire degenerated disc and obtaining optimal access for insertion of an implant or bone graft. Complications associated with PLIF procedures include nerve damage, soft tissue damage and implant migration.
 
Transforaminal Lumbar Interbody Fusion, or TLIF.  TLIF procedures are performed in a similar manner to PLIF procedures, except the surgeon accesses the spine through a small incision slightly to the left or right of the center of the patient’s back. After reaching the spine, the surgeon removes a portion of the facet joint and navigates through the foramen which provides better visualization and disc removal capabilities than PLIF.


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Complications associated with TLIF procedures are similar to those found in PLIF procedures including nerve damage, soft tissue damage and implant migration.
 
Extreme Lateral Interbody Fusion, or XLIF.  To perform an XLIF procedure, the surgeon accesses the spine from the patient’s side through one or two small incisions. The XLIF procedure is not appropriate for fusions in the L5/S1 segment because the pelvis interferes with access. While the XLIF procedure damages less patient tissue than other fusion procedures, we believe that there is a significant physician learning curve.
 
360° Lumbar Fusion Procedure.  Currently, the most common and structurally rigid lumbar fusion surgery is referred to as a 360° fusion and requires a second surgical procedure immediately following an ALIF, PLIF, TLIF or XLIF procedure. The additional procedure involves the permanent placement of screws and rods in the back to provide additional support while the vertebrae fuse together during the six to eighteen months following surgery.
 
Limitations of Traditional Lower Lumbar Spine Procedures
 
While traditional and minimally invasive fusion procedures can be effective at treating lower back pain, common drawbacks of these procedures include:
 
  •  Disruption to Soft Tissue and Support Structures.  Current lumbar fusion procedures require creating a pathway from the skin to the degenerative disc that is large enough to allow direct visualization and work by the surgeon. It is common to cut through healthy muscle or move critical organs, arteries, nerves and soft tissue, which can lead to bleeding, scarring, nerve damage and bowel disruption.
 
  •  Significant Blood Loss.  As a result of undergoing current lumbar fusion procedures, patients typically experience significant blood loss of between 100 and 1,400 cc of blood. As a result, it is common for patients to use the hospital’s blood supply or donate units of their own blood before a lumbar fusion procedure to replenish any significant blood loss.
 
  •  Lengthy Operative Procedure Times.  We believe it is common for current lumbar fusion procedures to take between 90 minutes and 4 hours to complete. With some procedures a second surgeon may be required. Long procedure times increase the risks of complications and blood loss. Also, hospital and physician resources are consumed for lengthy periods of time, which can reduce productivity and increase costs.
 
  •  Lengthy Patient Hospital Stays.  Patients remain in the hospital for an average of three days following a lumbar fusion procedure which consumes hospital and physician resources.
 
  •  Significant Patient Recovery Time.  Patients require three to six months to recover and rehabilitate after undergoing a lumbar fusion procedure before resuming normal activities.
 
  •  Unresolved Patient Pain.  Patients may continue to experience lower back pain after undergoing lumbar fusion procedures even though x-rays show successful fusion has been achieved through the growth of new bone. We believe this may be caused by muscle dissection, implant irritation and scar tissue that develops around the site of the surgery.
 
Our Solution
 
We believe we have developed the least invasive approach for surgeons to perform fusion and motion preserving surgeries in the L4/L5/S1 region without the drawbacks associated with current lumbar fusion procedures. We refer to this unique proprietary approach as our pre-sacral approach. We have developed and are marketing three fusion products that are delivered using our pre-sacral approach: AxiaLIF, AxiaLIF 360 and AxiaLIF 2L.
 
To access the spine using our pre-sacral approach, the surgeon creates a 1.5 cm incision adjacent to the tailbone while the patient is lying on their stomach. The surgeon then navigates a blunt dissecting tool a short distance along the sacrum using imaging technologies to a spine access point near the junction of the S1/S2 vertebral bodies. As the dissecting tool is advanced it moves soft tissue structures, including the bowel, to the


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side. From this access point, a guide pin is inserted through the bone into the disc of the lowest lumbar motion segment known as the L5/S1 disc. A tubular dissector is inserted over the guide pin to create a tissue-protecting working channel between the surgical access site and the L5/S1 disc where the entire fusion operation is then performed. This protected working channel provides access to the interior of the disc for removal of disc material with rotating cutters and brushes, introduction of bone graft material with special instrumentation and insertion of our AxiaLIF implant. The implant immediately provides fixation and restores disc height. The AxiaLIF 2L procedure uses the same approach to provide access for our procedure to both the L5/S1 and L4/L5 discs. The AxiaLIF 360° procedure supplements the AxiaLIF implant with fixation for the back of the spine. In our AxiaLIF 360° procedure, a second incision is made approximately eight inches above the first incision, and two facet screws are implanted.
 
We believe our pre-sacral approach and its associated products provide the following benefits for patients, providers and payors:
 
  •  Least Invasive Approach Minimizes Complications.  Our AxiaLIF products are delivered using our unique pre-sacral approach, which we believe is the least invasive solution for delivering fusion and motion-preserving products to the L4/L5/S1 region. Procedures performed utilizing our pre-sacral approach have been documented to have favorable clinical safety profiles with complication rates of approximately 1%.
 
  •  Spinal Stability.  We believe our approach is the only spinal fusion that does not violate or cut through any muscles or ligaments that control the stability of the spine.
 
  •  Short Learning Curve.  We believe that the ease of use of our pre-sacral approach enables reduced physician training as compared to alternative lower lumbar spine procedures.
 
  •  Low Blood Loss.  We believe the least invasive nature of our pre-sacral approach results in the average patient losing approximately 25 to 125 cc of blood during an AxiaLIF, AxiaLIF 2L or AxiaLIF 360° procedure, which is much lower than current techniques and correlates to reduced pain and faster recoveries. Given the associated low blood loss, patients generally do not need to donate blood prior to undergoing procedures that utilize our pre-sacral approach.
 
  •  Short Patient Hospital Stays.  Patients typically stay only one night in the hospital after receiving a procedure performed using our pre-sacral approach. In a small percentage of cases, patients are able to return home the same day.
 
  •  Reduction in Patient Pain.  We believe our pre-sacral approach is effective at reducing lower back pain because surrounding soft tissue is not violated which prevents the creation of scar tissue, a leading cause of pain.
 
Our Strategy
 
Our goal is to become a global leader in the treatment of conditions affecting the L4/L5/S1 region of the lumbar spine utilizing our pre-sacral approach and associated instrumentation. To achieve this goal, we are pursuing the following strategies:
 
  •  Establish our Pre-Sacral Approach as a Standard of Care for Lower Lumbar Spine Surgery.  We believe patients commonly avoid back surgery due to its invasive nature and other drawbacks associated with current surgical treatment options. We expend significant resources promoting our pre-sacral approach as the least invasive approach to lower back surgery and we believe the advantages of our technique will enable our AxiaLIF products to become a standard of care for the lower lumbar region of the spine.
 
  •  Focus our Sales and Marketing Infrastructure to Drive Surgeon Adoption.  We intend to continue expending significant resources targeting spine surgeons through our sales and marketing efforts in the United States and internationally in order to drive the adoption of our pre-sacral approach. We believe the ease of use, short hospital stays and reduction in patient pain will be compelling reasons for surgeon adoption of our technologies.


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  •  Opportunistically Pursue Acquisitions of Complementary Businesses and Technologies.  In addition to building our internal product development efforts, we intend to selectively license or acquire complementary products and technologies that we believe will enable us to leverage our growing distribution platform.
 
Products
 
Our products include surgical instruments for creating a safe and reproducible access route to the L4/L5/S1 vertebrae, fusion implants, as well as supplemental stabilization products. We believe our AxiaLIF implants and instruments, combined with facet screws, provide surgeons with the tools necessary to perform a 360° lumbar fusion in the least invasive manner available. We sell these products to our customers in procedure kits that include all the instruments and implants needed to complete a lumbar fusion.
 
AxiaLIF Lumbar Fusion Implants.  Our AxiaLIF implant is a threaded titanium rod, called our 3D Axial Rod, that comes in varying lengths to enable one-level L5/S1 fusions and two-level L4/L5/S1 fusions. As it is implanted, its proprietary thread design separates the vertebrae to restore disc height. The increased disc height relieves pressure on the nerve, while our 3D Axial Rod provides immediate rigid fixation.
 
AxiaLIF 360° Implants.  Our proprietary AxiaLIF 360° implants consist of our 3D Axial Rod plus our titanium facet screws for supplemental posterior fixation. The two AxiaLIF 360° facet screws are implanted through a single 1.5 cm incision in the patient’s back using our proprietary delivery system.
 
TranS1 Access and Disc Preparation Instruments.  Our pre-sacral approach requires the use of a sterile set of surgical instruments that are used to create a safe and reproducible working channel and to prepare the disc and vertebrae for our implant. The instrumentation contained in the set includes stainless steel navigation tools and tubular dissectors to create the working channel, as well as nitinol cutters and brushes to cut and remove the degenerated disc material and prepare the disc space for our implant and the bone graft material.
 
AVATAR Pedicle Screw System.  In January 2010, we entered into a partnership agreement with Life Spine, Inc. to distribute Avatar, a minimally invasive pedicle screw system. Avatar can be used with our implants to provide supplemental posterior fixation. Avatar offers cannulated pedicle screws inserted over a guidewire to reduce muscle and tissue trauma. Extended tabs integrated to the screws combined with a variety of rod insertion mechanisms provide secure implantation of the rod while minimizing tissue dissection. In-situ reduction, compression, and distraction are achieved simply and effectively with intuitive instrumentation.
 
Product Pipeline
 
We have re-prioritized our product development efforts and are pursuing products that enhance our existing product line and those that that have a shorter pathway to regulatory clearance and commercialization. Due to an uncertain regulatory pathway, we have decided to put our Percutaneous Nucleus Replacement, or PNR, project on hold in the U.S., which also impacts our Partial Disc Replacement project, which was an enhancement of the PNR.
 
In the future, we believe our product offerings will be expanded to address additional clinical applications in the surgical treatment of conditions affecting the lower lumbar spine. Such applications would require FDA 510(k) clearance or PMA approval, most likely supported by safety and efficacy data from clinical trials. We also have an active program aimed at developing tools that will lower complications for our procedures.
 
Sales and Marketing
 
Our sales and marketing effort primarily targets industry leaders and high volume spine surgeons. We also market our products at various industry conferences and through industry organized surgical training courses. In addition, we intend to develop and implement marketing programs targeted at potential patients, which we believe will accelerate the demand for our products.
 
In 2009, no customer accounted for 10% or more of revenues.


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In the United States, we market and sell our products through a combination of direct sales representatives and independent sales agents that have allocated representatives to solicit our products. At December 31, 2009, our U.S. sales team included territory managers, direct sales representatives, case coverage specialists and independent sales agents covering specific geographic regions. We select our sales representatives and independent sales agents based on their expertise in spine surgery medical device sales, reputation within the surgeon community and sales coverage. Our sales representatives receive a base salary and a percentage of the net sales that they generate. In January 2010, as part of our on-going effort to best address current market opportunities, we reduced our direct sales representatives from 55 to 45. We have taken our most successful reps and given them more territory to grow while ensuring that all territories are appropriately covered. Our overriding goal is to make each of our sales reps profitable as quickly as possible. The sales management structure remains unchanged. The independent sales agents are compensated based on a percentage of the net sales that they generate. We have agreements with our independent sales agents that provide them with an exclusive right to sell our products in their territories, which are generally terminable upon 90 days’ written notice.
 
Outside of the United States, we utilize third-party distributors and our own direct sales representatives and agents, with support from our vice president of international sales and our U.S. and international sales and marketing staff, to support the commercialization of our products. Through December 31, 2009, the majority of our international sales have been in Europe. In 2008, we hired direct sales representatives in Germany, and in 2009 we began direct sales through our own sales representatives and agents in Germany, Switzerland, Netherlands and Belgium. In 2009, 69% of our international revenues were through third-party distributors and 31% were through our direct sales efforts.
 
We intend to continue to hire sales and marketing personnel as appropriate to enable us to support the commercialization of our products.
 
Surgeon Training
 
We devote significant resources to training and educating surgeons on the specialized skills involved in the proper use of our instruments and implants. We believe that the most effective way to introduce and build market demand for our products is by training spine surgeons in the use of our products. We accomplish our training objectives primarily through cadaver and surrogate models and live case observations with surgeons experienced in our pre-sacral approach. We supplement this training with online didactic tutorials. After this training, surgeons are generally able to perform unsupervised surgeries using our pre-sacral approach. As of December 31, 2009, we had trained over 1,150 U.S. spine surgeons and 200 surgeons outside of the U.S. in the use of our single-level product. Of the U.S. surgeons trained on our pre-sacral approach, approximately 380 have performed a procedure in the 12 months ended December 31, 2009 using our pre-sacral approach. In addition, we have trained over 250 U.S. surgeons in the use of our AxiaLIF 2L product. We believe we have the necessary capacity to train a sufficient number of surgeons to meet our current goals.
 
Third-Party Reimbursement
 
In the United States, healthcare providers 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 fusion surgery in which our medical device is used. Surgeons are reimbursed for performing the surgical procedure, while hospitals are reimbursed for the cost of the device, all patient care related to the fusion procedure and the overhead associated with maintaining the facility.
 
Most payors follow Medicare’s Diagnosis-Related Group, or DRG, based payment system for reimbursing facilities. Under this model, hospitals are paid a set amount to cover the costs associated with a fusion patient, including the cost of the device used in the procedure. The most commonly associated DRGs for spinal fusion are 453/454/455 (“Combined Anterior/Posterior Spinal Fusion with major complications and comorbidities (MCC), with complications and comorbidities (CC) or without MCC/CC”) and 459/460 (“Spinal Fusion Except Cervical with or without MCC”). Private payors typically use Medicare DRGs as a benchmark when setting their own reimbursement rates for facilities.


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Surgeons use the American Medical Association’s Current Procedural Terminology, or CPT, system to bill payors for the AxiaLIF procedure. CPT codes describe the services and procedures provided for patients to third-party payors so that physicians may be reimbursed. Effective January 1, 2009, the AMA implemented a Category III code which may describe the work involved in treating some AxiaLIF patients. Unlike Category I CPT codes, Category III codes do not have a set value which physicians use as a benchmark for setting their fee. Additionally, some payors view Category III codes as “investigational” or “experimental” and may not reimburse them. However, AxiaLIF adoption continues to grow and unlike many new or novel procedures, AxiaLIF is an access variation on the current standard of care (spinal fusion) and surgeons should code appropriately for the work they perform based on the unique clinical decision making, time, risk, and diagnosis of each patient.
 
As the breadth and depth of peer-reviewed clinical research regarding AxiaLIF continues to grow, we will continue to diligently work to ensure that patients have continued access to AxiaLIF should their doctors determine this is best clinical solution for their condition.
 
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 small 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 and strategic sense to do so.
 
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 reimbursement policies of third-party payors will adversely affect the demand for our procedures and products or our ability to sell them on a profitable basis. The unavailability or inadequacy of third-party payor coverage or reimbursement could have a material adverse effect on our business, operating results and financial condition.
 
Competition
 
The medical device industry is highly competitive, subject to rapid technological change and significantly affected by new product introductions and market activities of other participants. Our currently marketed products are, and any future products we commercialize will be, subject to intense competition. Our competitors include providers of conservative, non-operative therapies for lower lumbar spine conditions, as well as a number of major medical device companies that have developed or plan to develop products for minimally invasive spine surgery in each of our current and future product categories. We believe that the principal competitive factors in our markets include:
 
  •  improved outcomes for medical conditions affecting the lower lumbar spine;
 
  •  acceptance by spine surgeons;
 
  •  ease of use and reliability;
 
  •  product price and qualification for reimbursement;
 
  •  technical leadership and superiority;
 
  •  effective marketing and distribution; and
 
  •  speed to market.
 
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 most significant


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competitors are Medtronic Sofamor Danek, Johnson & Johnson DePuy Spine, Stryker Spine, NuVasive, Zimmer Spine, Synthes, Orthofix International, Globus Medical, Alphatec Spine and others, many of which have substantially greater sales and financial resources than we do. In addition, these companies may have more established distribution networks, entrenched relationships with physicians, and greater experience in launching, marketing, distributing and selling products.
 
Our ability to compete successfully will depend on our ability to develop proprietary products that reach the market in a timely manner, receive adequate reimbursement and are safer, less invasive and less expensive than alternatives available for the same purpose. Because of the size of the potential market, we anticipate that companies will dedicate significant resources to developing competing products.
 
Research and Development
 
As of December 31, 2009, our research and development team was comprised of 11 employees who have extensive experience in developing products to treat medical conditions affecting the lower lumbar spine. These employees work closely with our clinical advisors and spine surgeon customers to design and enhance our products and approach. Our R&D spending was $6.4 million, $4.1 million and $3.9 million for the years ending December 31, 2009, 2008 and 2007, respectively. Since inception, we have devoted significant resources to develop and enhance our AxiaLIF product kits utilizing the pre-sacral approach.
 
Manufacturing and Supply
 
We rely on third parties to manufacture all of our products and their components, except for our nitinol nucleus cutter blades and nucleus cutter sheaths, which we manufacture at our facilities in Wilmington, North Carolina. Our outsourcing partners are manufacturers that meet FDA, International Organization for Standardization, or ISO, and other internal quality standards. We believe these manufacturing relationships allow us to work with suppliers who have the best specific competencies while we minimize our capital investment, control costs and shorten cycle times, all of which we believe allows us to compete with larger-volume manufacturers of spine surgery products.
 
All of our products and components are assembled, packaged, labeled and sterilized at third-party facilities in the United States under our existing contracts requiring compliance with Good Manufacturing Processes, or GMPs. Following receipt of products or components from our third-party manufacturers, we inspect, warehouse and ship the products and components at our facilities in Wilmington or at a third-party distribution facility in Memphis, Tennessee. We reserve the exclusive right to inspect and assure conformance of each product and component to our specifications. In addition, FDA or other regulatory authorities may inspect our facilities and those of our suppliers to ensure compliance with quality system regulations.
 
The majority of our instruments and implants are produced by third-party manufacturers on precision, high-speed machine shop equipment. However, certain of our products, components, materials used to manufacture such products and components, and manufacturing operations are produced, performed or supplied by third-party specialty vendors due to their proprietary or non-conventional nature. For example, the blades for our nucleus cutter are made from a metal called nitinol, which is converted into strip form by three manufacturers in the United States known to us. We have sourced nitinol strip from two of these vendors. The nitinol strip is then further converted for us into cutter blanks by a scalpel blade specialty vendor. Other vendors are available to manufacture the cutter blanks, as we may deem desirable or necessary. We convert the cutter blanks into cutter blades at our facilities. Our tissue extractor product is produced for us by a supplier that specializes in wire forming and coiling specifically for the medical device industry. A limited number of similar vendors exist that could be used to produce the tissue extractor product, and we believe we could replace this supplier on reasonable terms without substantial delay, if necessary.
 
We are currently working with our third-party manufacturers to plan for our manufacturing requirements as we increase our commercialization efforts. In most cases, we have redundant manufacturing capability with multiple vendors and enjoy the significant capacity this arrangement provides to us. We may consider manufacturing certain products or product components internally, if and when demand or quality requirements


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make it appropriate to do so. We believe the manufacturing capacity available to us is sufficient to meet our demands into the foreseeable future.
 
Patents and Proprietary Technology
 
We rely on a combination of patent, trademark, copyright, trade secret and other intellectual property laws, nondisclosure agreements and other measures to protect our intellectual property rights. We believe that in order to have a competitive advantage, we must develop and maintain the proprietary aspects of our technologies. We require our employees, consultants and advisors to execute confidentiality agreements in connection with their employment, consulting or advisory relationships with us. We also require our employees, consultants and advisors who we expect to work on our products to agree to disclose and assign to us all inventions conceived during the work day, using our property or which relate to our business. We cannot provide any assurance that employees and consultants will abide by the confidentiality or assignment terms of these agreements. Despite any measures taken to protect our intellectual property, unauthorized parties may attempt to copy aspects of our products or to obtain and use information that we regard as proprietary.
 
Patents
 
As of December 31, 2009, we had 22 issued United States patents, 46 pending patent applications in the United States, 2 issued European patents and 96 foreign patent applications as counterparts of U.S. cases. The issued and pending patents cover, among other things:
 
  •  our method for performing trans-sacral procedures in the spine, including diagnostic or therapeutic procedures, and trans-sacral introduction of instrumentation or implants;
 
  •  apparatus for conducting these procedures including access, disc preparation and implantation including the current TranS1 instruments individually and in kit form; and
 
  •  implants for fusion and motion preservation in the spine.
 
Our issued patents begin to expire in 2021 assuming timely payment of all maintenance fees. We have multiple patents covering unique aspects and improvements for many of our methods and products. We do not believe that the expiration of any single patent is likely to significantly affect our business, operating results or prospects.
 
Trademarks
 
We own four trademark registrations in the United States and seven trademark registrations in the European Union. We also own eight pending trademark applications in the United States, two pending trademark applications in the European Union and eight pending trademark applications in Canada.
 
Government Regulation
 
Our products are medical devices subject to extensive regulation by the FDA and other U.S. federal and state regulatory bodies and comparable authorities in other countries. To ensure that medical products distributed domestically and internationally are safe and effective for their intended use, FDA and comparable authorities in other countries have imposed regulations that govern, among other things, the following activities that we or our partners perform and will continue to perform:
 
  •  product design and development;
 
  •  registration and listing;
 
  •  product testing (preclinical and clinical);
 
  •  product manufacturing;
 
  •  product labeling;
 
  •  product storage;


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  •  premarket clearance or approval;
 
  •  advertising and promotion;
 
  •  product marketing, sales and distribution; and
 
  •  post-market surveillance, including reporting deaths or serious injuries related to products and certain product malfunctions.
 
FDA’s Premarket Clearance and Approval Requirements
 
Unless an exemption applies, each medical device we wish to commercially distribute in the United States will require either prior 510(k) clearance or prior premarket approval from the FDA. The FDA classifies medical devices into one of three classes. Devices deemed to pose lower risk are placed in either class I or II, which in many cases requires the manufacturer to submit to the FDA a premarket notification or 510(k) submission requesting permission for commercial distribution. This process is known as requesting 510(k) clearance. Some low risk devices are exempt from this requirement. Devices deemed by the FDA to pose the greatest risk, such as many life-sustaining, life-supporting or implantable devices, or devices deemed not substantially equivalent to a legally marketable device, are placed in class III, requiring a PMA. Our current commercial products are class II devices marketed under FDA 510(k) premarket clearance. Both premarket clearance and PMA applications are subject to the payment of user fees, paid at the time of submission for FDA review.
 
510(k) Clearance Pathway
 
To obtain 510(k) clearance, we must submit a premarket notification demonstrating that the proposed device is substantially equivalent to a legally marketable device not requiring a PMA. Although statutorily mandated to clear or deny a 510(k) premarket notification within 90 days of submission of the application, FDA’s 510(k) clearance pathway usually takes from three to twelve months, based on requests for additional information by FDA, but it can take significantly longer. Additional information can include clinical data to make a determination regarding substantial equivalence.
 
After a device receives 510(k) clearance, any modification that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, will require a new 510(k) clearance or, depending on the modification, require a PMA. The FDA requires each manufacturer to determine whether the proposed change requires submission of a 510(k), or a PMA, but the FDA can review any such decision and can disagree with a manufacturer’s determination. If the FDA disagrees with a manufacturer’s determination, the FDA can require the manufacturer to cease marketing and/or recall the modified device until 510(k) clearance or a PMA is obtained. If the FDA requires us to seek 510(k) clearance or a PMA for any modifications to a previously cleared product, we may be required to cease marketing or recall the modified device until we obtain this clearance or approval. Also, in these circumstances, we may be subject to significant regulatory fines or penalties. We have made and plan to continue to make additional product enhancements to our AxiaLIF, AxiaLIF 2L (including AxiaLIF 2L+) and AxiaLIF 360° (including Vectre) products that we believe do not require new 510(k) clearances.
 
Premarket Approval Pathway
 
A PMA application must be submitted if the device is not exempt and cannot be cleared through the 510(k) process. The PMA application process is generally more costly and time consuming than the 510(k) process. A PMA application must be supported by extensive data including, but not limited to, technical, preclinical, clinical trials, manufacturing and labeling to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use.
 
After a PMA application is sufficiently complete, the FDA will accept the application and begin an in-depth review of the submitted information. By statute, the FDA has 180 days to review the “accepted application”, although, generally, review of the application can take between one and three years, but it may take significantly longer. During this review period, the FDA may request additional information or


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clarification of information already provided. Also during the 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 preapproval inspection of the manufacturing facility to ensure compliance with quality system regulations. New PMA applications or PMA application 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 any changes from the device covered by the original PMA application, and may not require as extensive clinical data or the convening of an advisory panel. None of our products are currently approved under a PMA but devices in development may require it.
 
Clinical Trials
 
Clinical trials are almost always required to support a PMA application and are sometimes required for a 510(k) premarket notification. In the U.S., these trials require submission of an application for an investigational device exemption, or IDE. 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 application 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 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 the appropriate institutional review boards at the clinical trial sites. Future clinical trials of our motion preservation designs will require that we obtain an IDE from the FDA prior to commencing clinical trials and that the trial be conducted under the oversight of an institutional review board at the clinical trial site. Our clinical trials must be conducted in accordance with FDA regulations and federal and state regulations concerning human subject protection, including informed consent and healthcare privacy and financial disclosure by clinical investigators. A clinical trial may be suspended by 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 one of our products. Similarly, in Europe the clinical study must be approved by the local ethics committee and in some cases, including studies of high-risk devices, by the Competent Authority in the applicable country.
 
Pervasive and Continuing FDA Regulation
 
After a device is placed on the market, numerous FDA and other regulatory requirements continue to apply. These include:
 
  •  quality system regulation, which requires manufacturers, including third-party contract manufacturers, to follow stringent design, testing, control, documentation, and other quality assurance controls, during all aspects of the manufacturing process;
 
  •  establishment registration and listing;
 
  •  labeling regulations, and FDA prohibitions against the promotion of products for uncleared or unapproved “off-label” uses;
 
  •  medical device reporting obligations, which require that manufacturers submit reports to the FDA if information reasonably suggests their device (i) may have caused or contributed to a death or serious injury, or (ii) malfunctioned and the device or a similar company device would likely cause or contribute to a death or serious injury if the malfunction were to recur; and
 
  •  other post-market surveillance requirements, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device.


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We must register and list with FDA as medical device manufacturers and must obtain all necessary state permits or licenses to operate our business. As manufacturers, we are subject to announced and unannounced inspections by FDA to determine our compliance with quality system regulation and other regulations. We have not yet been inspected by the FDA. We believe that we are in substantial compliance with quality system regulation and other regulations.
 
Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA, which may include, among other things, any of the following sanctions:
 
  •  warning letters, fines, injunctions, consent decrees and civil penalties;
 
  •  repair, replacement, refunds, recall or seizure of our products;
 
  •  operating restrictions, partial suspension or total shutdown of production;
 
  •  refusing our request for 510(k) clearance or premarket approval of new products, new intended uses or other modifications to existing products;
 
  •  withdrawing or suspending premarket approvals that are already granted; and
 
  •  criminal prosecution.
 
We are subject to announced and unannounced inspections by the FDA and these inspections may include the manufacturing facilities of our subcontractors.
 
Fraud and Abuse
 
We may directly or indirectly be subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws. In particular, the federal healthcare program anti-kickback statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing, arranging for or recommending a good or service, for which payment may be made in whole or part under federal healthcare programs, such as the Medicare and Medicaid programs. The anti-kickback statute is broad and prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. In implementing the statute, the Office of Inspector General, or OIG, has issued a series of regulations, known as the “safe harbors,” which began in July 1991. These safe harbors set forth provisions that, if all their applicable requirements are met, will assure healthcare providers and other parties that they will not be prosecuted under the anti-kickback statute. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy all requirements of an applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG. Penalties for violations of the federal anti-kickback statute include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs.
 
The federal False Claims Act prohibits persons from knowingly filing or causing to be filed a false claim to, or the knowing use of false statements to obtain payment from, the federal government. Suits filed under the False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government. These individuals, sometimes known as “relators” or, more commonly, as “whistleblowers”, may share in any amounts paid by the entity to the government in fines or settlement. The number of filings of qui tam actions has increased significantly in recent years, causing more healthcare companies to have to defend a False Claim action. If an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties of between $5,500 and $11,000 for each separate false claim. Various states have also enacted similar laws modeled after the federal False Claims Act which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor.
 
The Health Insurance Portability and Accountability Act of 1996, or HIPAA, created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute


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prohibits knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private payors. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items, or services. A violation of this statute is a felony and may result in fines or imprisonment.
 
We are also subject to certain state laws that are analogous to each of the federal laws summarized above, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of certain health information, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.
 
While we have adopted comprehensive compliance programs to attempt to comply with these laws and regulations, if any of our operations are found to have violated or be in violation of any of the laws described above and other applicable state and federal fraud and abuse laws, we may be subject to penalties, among them being civil and criminal penalties, damages, fines, exclusion from government healthcare programs, and the curtailment or restructuring of our operations.
 
International
 
International sales of medical devices are subject to foreign government regulations, which vary substantially from country to country. The time required to obtain approval by a foreign country may be longer or shorter than that required for FDA clearance or approval, and the requirements may differ.
 
The European Union, which consists of 27 of the major countries in Europe, has adopted numerous directives and standards regulating the design, manufacture, clinical trials, labeling, and adverse event reporting for medical devices. Other countries, such as Switzerland, have voluntarily adopted laws and regulations that mirror those of the European Union with respect to medical devices. Devices that comply with the requirements of a relevant directive will be entitled to bear CE conformity marking and, accordingly, can be commercially distributed throughout the member states of the European Union, and other countries that comply with or mirror these directives. The method of assessing conformity varies depending on the type and class of the product, but normally involves a combination of self-assessment by the manufacturer and a third-party assessment by a “Notified Body,” an independent and neutral institution appointed to conduct conformity assessments. This third-party assessment consists of audits of the manufacturer’s quality system. An assessment by a Notified Body in one country within the European Union is required for each product in order for a manufacturer to commercially distribute the product throughout the European Union. Compliance with voluntary harmonizing standards ISO 9001 and ISO 13845 issued by the ISO establishes the presumption of conformity with the essential requirements for a CE mark. In August 2004, our quality system was initially certified by Intertek ETL-Semko, a Notified Body, under the European Union Medical Device Directive to be in compliance with ISO standards 9001:2000 and ISO 13485:2003. The system was recertified in September 2007 and is due for further recertification in September of 2010.
 
Employees
 
As of December 31, 2009, we had 148 employees, most of whom were full-time employees, with 95 employees in U.S. sales, marketing, customer service and training, 8 employees in international sales, marketing and training, 9 employees in manufacturing, 11 employees in research and development, 15 employees in general and administrative and 10 employees in clinical, regulatory and quality assurance. We believe that our future success will depend in part on our continued ability to attract, hire and retain qualified personnel. None of our employees are represented by a labor union, and we believe our employee relations are good.


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General Information
 
We were incorporated in Delaware in May 2000 under the name “aXiaMed, Inc.” and changed our name to “TranS1 Inc.” in February 2003. Our principal executive office is located at 301 Government Center Drive, Wilmington, North Carolina 28403 and our telephone number is (910) 332-1700. Our website is located at www.trans1.com. The information on, or that can be accessed through, our website is not incorporated by reference into this report and should not be considered to be a part of this report.
 
We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports available on our website, at www.trans1.com, free of charge as soon as practicable after filing with the U.S. Securities and Exchange Commission, or SEC.
 
All such reports are also available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by us with the SEC at the SEC’s public reference room located at 100 F St., NE, Washington, D.C., 20549. Information regarding operation of the SEC’s public reference room can be obtained by calling the SEC at 1-800-SEC-0330.
 
Item 1A.   Risk Factors
 
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors, as well as the other information contained in this report, before deciding whether to invest in shares of our common stock. If any of the following risks actually occur, our business, financial condition, operating results and prospects would suffer. In that case, the trading price of our common stock would likely decline and you might lose all or part of your investment in our common stock. The risks described below are not the only ones we face. Additional risks that we currently do not know about or that we currently believe to be immaterial may also impair our operations and business results.
 
Risks Related to Our Business
 
To be commercially successful, spine surgeons must accept that our products are a safe and effective alternative to existing surgical treatments of certain spine disorders.
 
Our revenue is derived entirely from sales of our AxiaLIF products and related surgical instruments. We expect that sales of our AxiaLIF products will continue to account for a substantial portion of our revenues for the foreseeable future. We believe spine surgeons may not widely adopt our products unless they determine, based on experience, long-term clinical data and published peer reviewed journal articles, that our products provide a safe and effective alternative to conventional procedures used to treat certain spine disorders. Spine surgeons may be slow to adopt our technology for the following reasons, among others:
 
  •  lack of long-term clinical data supporting additional patient benefits;
 
  •  lack of experience with our products;
 
  •  lack of evidence supporting cost savings of our procedure over existing surgical alternatives;
 
  •  perceived liability risks generally associated with the use of new products and procedures;
 
  •  training time required to use a new product; and
 
  •  availability of adequate coverage and reimbursement for hospitals and surgeons.
 
If we are unable to effectively demonstrate to spine surgeons the benefits of our products as compared to existing surgical treatments of spine disorders and our products fail to achieve market acceptance, our future revenues will be adversely impacted. 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 these spine surgeons or do not have favorable long-term clinical data, spine surgeons may not use our products and our future revenues will be harmed and our stock price would likely decline.


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The efficacy of our products is not yet supported by long-term clinical data and may therefore prove to be less effective than initially thought.
 
We obtained 510(k) clearance to manufacture, market and sell all of our currently U.S. marketed products from the FDA. The FDA’s 510(k) clearance process is less costly and rigorous than the PMA process and requires less supporting clinical data. As a result, we currently lack the breadth of published long-term clinical data supporting the efficacy of our AxiaLIF and AxiaLIF 360° products and the benefits they offer that might have been generated in connection with the PMA process. In addition, we may determine from post-market experience that certain patient characteristics, such as age or preexisting medical conditions, could affect fusion rates, which could lead to misleading or contradictory data on the efficacy of our products. For these reasons, spine surgeons may be slow to adopt our products. Also, we may not be able to generate the comparative data that our competitors have or are generating and we may be subject to greater regulatory and product liability risks. Further, any long-term safety or efficacy 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, significantly reduce our ability to achieve expected revenues and could prevent us from becoming profitable. 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 significant legal and regulatory liability and harm to our business reputation.
 
The demand for our products and the prices which customers and patients are willing to pay for our products depend upon the ability of our customers to obtain adequate third-party coverage and reimbursement for their purchases of our products.
 
Sales of our products depend in part on the availability of adequate coverage and reimbursement from governmental and private payors. In the United States, healthcare providers that purchase our products generally rely on third-party payors, principally Medicare, Medicaid and private health insurance plans, to pay for all or a portion of the costs and fees associated with the AxiaLIF procedure. Medicare coverage and reimbursement policies are developed by the Centers for Medicare and Medicaid Services, or CMS, the federal agency responsible for administering the Medicare program, and its contractors. In carrying out its responsibilities, the Agency must adhere to relevant terms of the Social Security Act, and federal regulations to ensure that it is complying with applicable Medicare law, regulations and guidance. For a wide variety of reasons, including the fact that the law permits coverage and reimbursement for “medically necessary” procedures approved by the Food and Drug Administration, AxiaLIF has strong justification for coverage under the Medicare Program. However, even when a product meets some of the criteria typically relied upon to receive reimbursement under the Medicare Program, it still must be “described adequately” under an American Medical Association Current Procedural Terminology, or CPT code, (typically used to describe services performed by physicians) or included within a Diagnosis-Related Group payment (broad payment categories used to reimburse hospitals).
 
As a result of some uncertainty regarding the CPT descriptions used to describe the AxiaLIF surgery, some physicians have found it more difficult to get reimbursed for the procedure. Moreover, since many commercial payors rely upon Medicare policies as a framework to establish commercial payment, some of the uncertainty experienced by providers in receiving reimbursement may not only negatively impact Medicare, and Medicaid utilization, but commercial purchases as well. Accordingly, any delays in obtaining, or an inability to clarify the reimbursement policies for procedures using our products could significantly affect the acceptance of our products and have a material adverse effect on our business. If uncertainty remains, or the reimbursement amount for a procedure declines, physicians may revert to other fusion surgeries where reimbursement is higher or more certain. Additionally, third-party payors continue to review their coverage policies carefully for existing and new therapies and can, without notice, deny coverage for treatments that include the use of our products. Our business would be negatively impacted to the extent any such changes reduce reimbursement for our products.
 
With respect to coverage and reimbursement outside of the United States, reimbursement systems in international markets vary significantly by country, and by region within some countries, and reimbursement approvals must be obtained on a country-by-country basis and can take up to 18 months, or longer. Many


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international markets have government-managed healthcare systems that govern reimbursement for new devices and procedures. In most markets, there are private insurance systems as well as government-managed systems. Additionally, some foreign reimbursement systems provide for limited payments in a given period and therefore result in extended payment periods. Reimbursement in international markets may require us to undertake country-specific reimbursement activities, including additional clinical studies, which could be time consuming, expensive and may not yield acceptable reimbursement rates.
 
Furthermore, healthcare costs have risen significantly over the past decade. There have been and may continue to be proposals by legislators, regulators and third-party payors to contain these costs. These cost-control methods include managed care models, prospective payment systems, capitated rates, group purchasing, redesign of benefits, pre-authorizations or second opinions prior to major surgery, encouragement of healthier lifestyles and exploration of more cost-effective methods of delivering healthcare. Healthcare providers may also attempt to control costs by authorizing fewer elective surgical procedures or by requiring the use of the least expensive devices possible. These cost-control methods also potentially limit the amount which healthcare providers may be willing to pay for medical devices. In addition, in the United States, no uniform policy of coverage and reimbursement for medical technology exists among all payors. Therefore, coverage of and reimbursement for medical technology can differ significantly from payor to payor. The continuing efforts of third-party payors, whether governmental or commercial, whether inside the United States or outside, to contain or reduce these costs, combined with closer scrutiny of such costs, could restrict our customers’ ability to obtain adequate coverage and reimbursement from these third-party payors. The cost containment measures that healthcare providers are instituting both in the United States and internationally could harm our business by adversely affecting the demand for our products or the price at which we can sell our products.
 
Our future growth depends on increasing physician awareness of our pre-sacral approach and our related products for appropriate treatment, intervention and referral.
 
We target our sales and education efforts to spine surgeons. However, the initial point of contact for many patients may be primary care physicians who commonly treat patients experiencing lower lumbar spine pain. We believe that we must educate physicians to change their screening and referral practices. If we do not educate referring physicians about lower lumbar spine conditions in general, and the existence of the pre-sacral approach and our related products in particular, they may not refer patients who are candidates for the procedures utilizing our pre-sacral approach to spine surgeons, and those patients may go untreated or receive conservative, non-operative therapies. If we are not successful in educating physicians about screening for lower lumbar spine conditions or about referral opportunities, our ability to increase our revenue may be impaired.
 
We have incurred losses since inception and we expect to incur increasing losses for the foreseeable future. We may never achieve or sustain profitability.
 
We were incorporated in May 2000 and began commercial sales of our products in early 2005. We have incurred net losses since our inception and through December 31, 2009, we had an accumulated deficit of $71.1 million. To date, we have financed our operations primarily through sales of our equity securities and have devoted substantially all of our resources to research and development of our products and the commercial launch of our AxiaLIF products. We expect our expenses to increase significantly in connection with our additional clinical trials and research and development activities, as well as to support the expansion of our sales and marketing efforts. As a result, we expect to continue to incur significant operating losses for the foreseeable future. These losses will continue to have an adverse effect on our stockholders’ equity and we may never achieve or sustain profitability.


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We are in a highly competitive market segment, which is subject to rapid technological change. If our competitors are better able to develop and market products that are safer, more effective, less costly or otherwise more attractive than any products that we may develop, our ability to generate revenue will be reduced or eliminated.
 
The market for treatment of spine disorders is highly competitive and subject to rapid and profound technological change. Our success depends, in part, upon our ability to maintain a competitive position in the development of technologies and products for use in the treatment of spine disorders. We face competition from both established and development stage companies. Many of the companies developing or marketing competing products are publicly traded or are divisions of publicly-traded companies, and these companies enjoy several competitive advantages, including:
 
  •  greater financial and human resources for product development, sales and marketing and patent litigation;
 
  •  significantly greater name recognition;
 
  •  established relationships with spine surgeons, customers and third-party payors;
 
  •  additional lines of products, and the ability to offer rebates or bundle products to offer greater discounts or incentives to gain a competitive advantage;
 
  •  established sales and marketing, and distribution networks; and
 
  •  greater experience in conducting research and development, manufacturing, clinical trials, preparing regulatory submissions and obtaining regulatory clearance or approval for products and marketing approved products.
 
Our competitors may develop and patent processes or products earlier than us, obtain regulatory clearance or approvals for competing products more rapidly than us, and develop more effective or less expensive products or technologies that render our technology or products obsolete or non-competitive. We also compete with our competitors in recruiting and retaining qualified scientific and management personnel, 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. If our competitors are more successful than us in these matters, our business may be harmed.
 
Our failure to continue building effective sales and marketing capabilities for our products could significantly impair our ability to increase sales of our products.
 
We commercially launched our AxiaLIF single-level product in 2005, our AxiaLIF 360° product in 2006, our AxiaLIF 2L product in 2008 and our AxiaLIF 2L+ product in 2010, and we have limited experience marketing and selling our products. We utilize a hybrid model of independent sales agents and direct sales representatives for product sales in the United States and rely on third-party distributors, direct sales representatives and agents for international sales. As of December 31, 2009, we employed 55 direct sales representatives in the United States and 4 direct sales representatives in Europe. In January 2010, we reduced our U.S. force to 45 representatives to better address current market opportunities. We have limited experience managing a direct sales force, which can be an expensive and time consuming process. If we are unable to efficiently manage those individuals, our sales will suffer. We also rely on marketing arrangements with independent sales agents in the United States and independent distributors in Europe, in particular their sales and service expertise and relationships with the customers in the marketplace. We do not control, nor monitor the marketing practices of our independent sales agents or distributors and they may not be successful in implementing our marketing plans or complying with applicable laws regarding marketing practices. Independent distributors and sales agents may terminate their relationship with us, or devote insufficient sales efforts to our products. Our failure to maintain our existing relationships with our independent sales agents or distributors, or our failure to recruit and retain additional skilled independent sales distributors and sales agents or directly-employed sales professionals, could have an adverse effect on our operations.


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Our future success depends on our ability to develop, receive regulatory clearance or approval, and introduce new products or product enhancements that will be accepted by the market in a timely manner.
 
It is important to our business that we continue to build a more complete product offering for treatment of spine disorders. As such, our success will depend in part on our ability to develop and introduce new products and enhancements to our existing products to keep pace with the rapidly changing spine market. However, we may not be able to successfully develop and obtain regulatory clearance or approval for product enhancements, or new products or our future products, or these products may not be accepted by spine surgeons or the payors who financially support many of the procedures performed with our products.
 
The success of any new product offering or enhancement to an existing product will depend on several factors, including our ability to:
 
  •  properly identify and anticipate spine surgeon and patient needs;
 
  •  develop and introduce new products or product enhancements in a timely manner;
 
  •  avoid infringing upon the intellectual property rights of third parties;
 
  •  demonstrate, if required, the safety and efficacy of new products with data from preclinical studies and clinical trials;
 
  •  obtain the necessary regulatory clearances or approvals for new products or product enhancements;
 
  •  be fully FDA-compliant with marketing of new devices or modified products;
 
  •  provide adequate training to potential users of our products;
 
  •  receive adequate coverage and reimbursement for procedures performed with our products; and
 
  •  develop an effective and FDA-compliant, dedicated marketing and distribution network.
 
If we do not develop 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.
 
If clinical trials of our current or future product candidates do not produce results necessary to support regulatory clearance or approval in the United States or elsewhere, we will be unable to commercialize these products.
 
We have several product candidates in our development pipeline which might require a PMA from the FDA. A PMA application must be supported by extensive information including, technical data, preclinical and clinical trial data, and manufacturing and labeling information to demonstrate to the FDA’s satisfaction the safety and effectiveness of the device for its intended use. As a result, to receive regulatory approval for our products requiring PMA approval, we must conduct, at our own expense, adequate and well controlled clinical trials to demonstrate efficacy and safety in humans for their intended uses. Clinical testing is expensive, typically takes many years and has an uncertain outcome. The initiation and completion of any of these studies may be prevented, delayed or halted for numerous reasons, including, but not limited to, the following:
 
  •  the FDA, institutional review boards or other regulatory authorities do not approve a clinical study protocol, force us to modify a previously approved protocol, or place a clinical study on hold;
 
  •  patients do not enroll in, or enroll at the expected rate, or complete a clinical study;
 
  •  patients or investigators do not comply with study protocols;
 
  •  patients do not return for post-treatment follow-up at the expected rate;
 
  •  patients experience serious or unexpected adverse side effects for a variety of reasons that may or may not be related to our products such as the advanced stage of co-morbidities that may exist at the time of treatment, causing a clinical study to be put on hold;
 
  •  sites participating in an ongoing clinical study may withdraw, requiring us to engage new sites;


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  •  difficulties or delays associated with bringing additional clinical sites on-line;
 
  •  third-party clinical investigators decline to participate in our clinical studies, do not perform the clinical studies on the anticipated schedule or consistent with the investigator agreement, clinical study protocol, good clinical practices, and other FDA and Institutional Review Board requirements;
 
  •  third-party organizations do not perform data collection and analysis in a timely or accurate manner;
 
  •  regulatory inspections of our clinical studies require us to undertake corrective action or suspend or terminate our clinical studies;
 
  •  changes in U.S. federal, state, or foreign governmental statutes, regulations or policies;
 
  •  interim results are inconclusive or unfavorable as to immediate and long-term safety or efficacy; or
 
  •  the study design is inadequate to demonstrate safety and efficacy.
 
Clinical failure can occur at any stage of the testing. Our clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical and/or non-clinical testing in addition to those we have planned. Our failure to adequately demonstrate the efficacy and safety of any of our devices would prevent receipt of regulatory clearance or approval and, ultimately, the commercialization of that device.
 
Our international operations subject us to certain operating risks, which could adversely impact our net revenues, results of operations and financial condition.
 
Sales of our products outside the United States represented 5.9% of our revenue in 2009. Through December 31, 2009, we have sold our products in the following countries outside of the United States: United Kingdom, Italy, Austria, Australia, Germany, Switzerland, Turkey, the Netherlands, Belgium, Israel, Denmark, Spain, Greece, Hong Kong, Czech Republic, Slovenia, Japan and Singapore. The sale and shipment of our products across international borders, as well as the purchase of components and products from international sources, subject us to extensive U.S. and foreign governmental trade, import and export, and custom 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 U.S. Foreign Corrupt Practices Act 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, significant criminal, civil and administrative penalties, including imprisonment of individuals, fines and penalties, denial of export privileges, seizure of shipments, 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:
 
  •  the imposition of additional U.S. and foreign governmental controls or regulations;
 
  •  the imposition of costly and lengthy new export licensing requirements;
 
  •  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;
 
  •  economic instability;
 
  •  a shortage of high-quality sales people and distributors;
 
  •  changes in third-party reimbursement policies that may require some of the patients who receive our 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;
 
  •  the imposition of new trade restrictions;
 
  •  the imposition of restrictions on the activities of foreign agents, representatives and distributors;
 
  •  scrutiny of foreign tax authorities which could result in significant fines, penalties and additional taxes being imposed on us;
 
  •  pricing pressure that we may experience internationally;
 
  •  laws and business practices favoring local companies;
 
  •  longer payment cycles;
 
  •  difficulties in maintaining consistency with our internal guidelines;
 
  •  difficulties in enforcing agreements and collecting receivables through certain foreign legal systems; and
 
  •  difficulties in enforcing or defending intellectual property rights.
 
Any of these factors may adversely impact our operations. Our international sales are predominately in Europe. In Europe, healthcare regulation and reimbursement for medical devices vary significantly from country to country. This changing environment could adversely affect our ability to sell our products in some European countries, which could negatively affect our results of operations.
 
The use, 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 or result in FDA sanctions if we are deemed to have engaged in such promotion.
 
Our currently marketed products have been cleared by the FDA’s 510(k) clearance process for use under specific circumstances for the treatment of certain lower lumbar spine conditions. We cannot, however, prevent a physician from using our products or procedure outside of those indications cleared for use, known as off-label use. There may be increased risk of injury if physicians attempt to use our products off-label. We train our sales force not to promote our products for off-label uses. Furthermore, the use of our products for indications other than those indications for which our products have been cleared by the FDA may not effectively treat such conditions, 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 trained, 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. If we are deemed by FDA to have engaged in the promotion of any our products for off-label use, we could be subject to FDA prohibitions on the sale or marketing of our products or significant fines and penalties, and the imposition of these sanctions could also affect our reputation and position within the industry. Any of these events could harm our business and results of operations and cause our stock to decline.
 
We purchase some of the key components of our products from single suppliers. The loss of these suppliers could prevent or delay shipments of our products or delay our clinical trials or otherwise adversely affect our business.
 
Some of the key components of our products and related services are currently purchased from only single suppliers. We do not have long-term contracts with the third-party suppliers of our product components. If necessary or desirable, we could source our product components and related services from other suppliers. However, establishing additional or replacement suppliers for these components, and obtaining any additional regulatory clearances or approvals, if necessary, that may result from adding or replacing suppliers, will take a substantial amount of time and could result in increased costs and impair our ability to produce our products, which would adversely impact our business, operating results and prospects. In addition, some of our products,


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which we acquire from third parties, are highly technical and are required to meet exacting specifications, and any quality control problems that we experience with respect to the products supplied by third-party vendors could adversely and materially affect our reputation, our attempts to complete our clinical trials or commercialization of our products. We may also have difficulty obtaining similar components from other suppliers that are acceptable to the FDA or 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, termination of distribution, product seizures or civil penalties, among others. Furthermore, since some of these suppliers may be located outside of the United States, we are subject to foreign export laws and U.S. import and customs statutes and regulations, which complicate and could delay shipments of components to us.
 
If we experience any delay or deficiency in the quality of products supplied to us by third-party suppliers, or if we have to switch to replacement suppliers, we may face additional regulatory delays and the manufacture and delivery of our products would be interrupted for an extended period of time, which would adversely affect our business, operating results and prospects. In addition, we may be required to obtain prior regulatory clearance or approval from the FDA or foreign regulatory authorities to use different suppliers or components. As a result, regulatory clearance or approval of our products may not be received on a timely basis, or at all, and our business, operating results and prospects would be harmed.
 
We depend on our officers and other key employees, and if we are not able to retain and motivate them or recruit additional qualified personnel, our business will suffer.
 
We are highly dependent on our officers and other key employees. Due to the specialized knowledge each of our officers and other key employees possesses with respect to the treatment of spine disorders and our operations, the loss of service of any of our officers and other key employees could delay or prevent the successful completion of our clinical trials, the growth of revenue from existing products and the commercialization of our new products. Each of our officers and key employees may terminate his or her employment without notice and without cause or good reason.
 
If we fail to properly manage our anticipated growth, our business could suffer.
 
The anticipated growth of our business could place a significant strain on our managerial, operational and financial resources and systems. To execute our anticipated growth successfully, we must attract and retain qualified personnel and manage and train them effectively. We must also review our internal business processes and capabilities and internal controls to create the scalability that a growing business demands. We will be dependent on our personnel and third parties to accomplish this, as well as to effectively market our products to an increasing number of spine surgeons. We will also depend on our personnel to develop next generation technologies.
 
Further, our anticipated growth will place additional strain on our suppliers and manufacturers, resulting in increased need for us to carefully monitor quality assurance. 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 expect to expand our operations and grow our research and development, product development, clinical, regulatory, operations, sales and marketing and administrative functions. Our growth will require hiring a significant number of qualified clinical, scientific, regulatory, quality, commercial and administrative personnel. Recruiting, motivating and retaining such personnel will be critical to our success. There is intense competition from other companies and research and academic institutions for qualified personnel in the areas of our activities. In addition, our operations are located in a geographic region which historically does not have a large number of medical device companies and it may be difficult to convince qualified personnel to relocate to our area. If we fail to identify, attract, retain and motivate these highly skilled personnel, we may be unable to continue our development and commercialization activities.


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If we need additional funding, we may be unable to raise capital when needed, which would force us to delay, reduce, eliminate or abandon our commercialization efforts or product development programs.
 
We may need to raise substantial additional capital to:
 
  •  expand the commercialization of our products;
 
  •  fund our operations and clinical trials;
 
  •  continue our research and development;
 
  •  defend, in litigation or otherwise, any claims that we infringe third-party patents or other intellectual property rights;
 
  •  address FDA or other governmental, legal/enforcement actions and remediate underlying problems;
 
  •  commercialize our new products, if any such products receive regulatory clearance or approval for commercial sale; and
 
  •  acquire companies and in-license products or intellectual property.
 
We believe that our existing cash and cash equivalent balances and cash receipts generated from sales of our products, will be sufficient to meet our anticipated cash requirements for at least the next two years. However, our future funding requirements will depend on many factors, including:
 
  •  market acceptance of our products;
 
  •  availability of adequate coverage and reimbursement for hospitals and surgeons;
 
  •  the scope, rate of progress and cost of our clinical trials;
 
  •  the cost of our research and development activities;
 
  •  the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights;
 
  •  the cost of defending, in litigation or otherwise, any claims that we infringe third-party patent or other intellectual property rights;
 
  •  the cost and timing of additional regulatory clearances or approvals;
 
  •  the cost and timing of establishing additional sales, marketing and distribution capabilities;
 
  •  the effect of competing technological and market developments; and
 
  •  the extent to which we acquire or invest in businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.
 
If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Debt financing, if available, may involve covenants restricting our operations or our ability to incur additional debt. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or our products, or grant licenses on terms that are not favorable to us. As a result of the recent and continuing economic uncertainty, it has been difficult for companies, particularly small cap medical device companies, to obtain equity or debt financing. If we are unable to raise adequate funds, we may have to liquidate some or all of our assets, or delay, reduce the scope of or eliminate some or all of our development programs.
 
If we do not have, or are not able to obtain, sufficient funds, we may have to delay development or commercialization of our products or license to third parties the rights to commercialize products or technologies that we would otherwise seek to commercialize. We also may have to reduce marketing, customer support or other resources devoted to our products or cease operations. Any of these factors could harm our operating results.


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If we choose to acquire new businesses, products or technologies, we may experience difficulty in the identification or integration of any such acquisition, and our business may suffer.
 
Our success depends on our ability to continually enhance and broaden our product offerings in response to changing customer demands, competitive pressures and technologies. Accordingly, we may in the future pursue the acquisition of complementary businesses, products or technologies instead of developing them ourselves. We do not know if we will be able to identify or complete any acquisitions, or whether we will be able to successfully integrate any acquired business, product or technology or retain key employees. Integrating any business, product or technology we acquire could be expensive and time consuming, The diversion of our management’s attention, and any delays or difficulties encountered in connection with any of our acquisitions, could result in the disruption of our ongoing business or inconsistencies in standards, controls, procedures and policies that could negatively affect our ability to maintain relationships with customers, suppliers, employees and others with whom we have business dealings. If we are unable to integrate any acquired businesses, products or technologies effectively, our business will suffer. In addition, any amortization or charges resulting from acquisitions could harm our operating results.
 
In addition, other companies, including those with substantially greater resources than ours, may compete with us for the acquisition of complementary businesses, products or technologies, resulting in the possibility that we devote resources to potential acquisitions or arrangements that are never completed. If we do engage in any such acquisition, we will incur a variety of costs, and we may never realize the anticipated benefits of the acquisition in light of those costs. If we fail to realize the expected benefits from acquisitions we may consummate in the future, whether as a result of unidentified risks, integration difficulties, regulatory setbacks or other events, our business, consolidated results of operations and financial condition could be adversely affected.
 
Furthermore, any strategic acquisition may require us to obtain additional debt or equity financing, resulting in increased debt obligations or dilution of ownership to our existing stockholders, as applicable. Therefore, we may not be able to finance acquisitions on terms satisfactory to us, if at all.
 
Consolidation in the healthcare industry could lead to demands for price concessions or to the exclusion of some suppliers from certain of our markets, which could have an adverse effect on our business, financial condition or results of operations.
 
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 create new companies with greater market power, including hospitals. As the healthcare industry consolidates, competition to provide products and services to industry participants has become and will continue to become more intense. This in turn has resulted and will likely continue to result in greater pricing pressures and the exclusion of certain suppliers from important market segments as group purchasing organizations, independent delivery networks and large single accounts continue to use their market power to consolidate purchasing decisions for some of our customers. We expect that market demand, government regulation, third-party reimbursement policies and societal pressures will continue to change the worldwide healthcare industry, resulting in further business consolidations and alliances among our customers, which may reduce competition, exert further downward pressure on the prices of our products and may adversely impact our business, financial condition or results of operations.
 
We face the risk of product liability or other claims and may not be able to obtain sufficient insurance coverage, if at all.
 
Our business exposes us to the risk of product liability claims that is inherent in the testing, manufacturing and marketing of implantable medical devices. We may be subject to product liability claims if our products cause, or merely appear to have caused, an injury or death. Claims may be made by patients, consumers or healthcare providers. Although we have product liability and clinical trial 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


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acceptable terms, if at all, and, if available, the coverages 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. A product liability claim, product recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could have a material adverse effect on our business, operating results and prospects.
 
We may be subject to claims against us even if the apparent injury is due to the actions of others. For example, we rely on the expertise of spine surgeons, nurses and other associated medical personnel to perform the medical procedure and related processes for our products. If these medical personnel are not properly trained or are negligent in their provision of care, the therapeutic effect of our products may be diminished or the patient may suffer critical injury, which may subject us to liability. In addition, an injury that is caused by the activities of our suppliers may be the basis for a claim against us.
 
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.
 
These liabilities could prevent, delay or otherwise adversely interfere with our product commercialization efforts, and result in judgments, fines, damages and other financial liabilities which have adverse effects on our business, operating results and prospects. 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. In addition to adversely impacting our business and prospects, such adverse publicity could materially adversely affect our stock price.
 
If our independent contract manufacturers fail to timely deliver to us sufficient quantities of some of our products and components in a timely manner, our operations may be harmed.
 
Our reliance on independent contract manufacturers to manufacture most of our products and components involves several risks, including:
 
  •  inadequate capacity of the manufacturer’s facilities;
 
  •  financial difficulties experienced by manufacturers due to the current economic recession;
 
  •  interruptions in access to certain process technologies; and
 
  •  reduced control over product availability, quality, delivery schedules, manufacturing yields and costs.
 
Shortages of raw materials, production capacity or financial constraints, or delays by our contract manufacturers could negatively affect our ability to meet our production obligations and result in increased prices for affected parts. Any such reduction, constraint or delay may result in delays in shipments of our products or increases in the prices of components, either of which could have a material adverse effect on our business.
 
We do not have supply agreements with all of our current contract manufacturers and we often utilize purchase orders, which are subject to acceptance by the supplier. Failure to accept purchase orders could result in an inability to obtain adequate supply of our product or components in a timely manner or on commercially reasonable terms.
 
An unanticipated loss of any of our contract manufacturers could cause delays in our ability to deliver our products while we identify and qualify a replacement manufacturer, which delays could negatively impact our revenues.
 
The liquidity of our customers and suppliers may also be affected by the current economic and financial downturn. Our suppliers may experience credit or liquidity problems which could negatively affect sources of our products and components.


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We operate at a single location. Any disruption in this facility or any inability to ship a sufficient number of our products to meet demand could adversely affect our business and results of operations.
 
We operate at a single location in Wilmington, North Carolina. Our facility may be affected by man-made or natural disasters, such as a hurricane. While we currently rely on third parties to manufacture, assemble, package, label and sterilize our products and components, and to warehouse and ship a portion of our products, we might also be forced to rely on third parties to inspect, warehouse or ship all our products and components in the event our facilities were affected by a disaster. Our facility, if damaged or destroyed, could be difficult to replace and could require substantial lead-time to repair or replace. In the case of a device with a PMA approval, we might be required to obtain prior FDA, or notified body, approval of an alternate facility, which could delay or prevent our marketing of the affected product until this supplemental approval is obtained. 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.
 
Current challenges in the commercial and credit environment may adversely affect our business and financial condition.
 
Unpredictable changes in economic conditions, including recession, inflation, increased government intervention, or other changes, may adversely affect our general business strategy. Our ability to generate cash flows from operations or enter into financing arrangements on acceptable terms could be adversely affected if there is a material decline in the demand for our products or in the solvency of our customers, deterioration in our key financial ratios or credit ratings, or other significantly unfavorable changes in conditions. While these conditions and the current economic uncertainty have not meaningfully impaired our ability to access credit markets or meaningfully adversely affected our operations to date, continuing volatility in the global financial markets could increase borrowing costs or affect our ability to access the capital markets. Current or worsening economic conditions may also adversely affect the business of our customers, including their ability to pay for our products and services, and the amount spent on healthcare generally. This could result in a decrease in the demand for our products and services, longer sales cycles, slower adoption of new technologies and increased price competition.
 
Our future operating results are difficult to predict and may vary significantly from quarter to quarter, which may negatively impact our stock price in the future.
 
We have only commercially distributed our products since 2005. Given this limited history, it is difficult to predict future revenues derived from sales of our products. Because of this and the uncertain effects of the following factors, our quarterly revenues and results of operations may fluctuate in the future due to, among others, the following reasons:
 
  •  market acceptance of our products;
 
  •  availability of adequate coverage and reimbursement for hospitals and surgeons;
 
  •  the conduct and results of clinical trials;
 
  •  the timing and expense of obtaining future regulatory approvals;
 
  •  fluctuations in our expenses associated with expanding our operations;
 
  •  the introduction of new products by our competitors; and
 
  •  changes in our pricing policies or in the pricing policies of our competitors or suppliers.
 
Because of these and possibly other factors, it is possible that in some future period our operating results will not meet investor expectations or those of public market analysts.
 
Any unanticipated change in revenues or operating results is likely to cause our stock price to fluctuate since such changes reflect new information available to investors and analysts. New information may cause investors and analysts to re-evaluate our stock, which could cause a decline in the trading price of our stock.


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Risks Related to Regulatory Environment
 
If we fail to maintain regulatory approvals and clearances, or are unable to obtain, or experience significant delays in obtaining, FDA clearances or approvals for our future products or product modifications, our ability to commercially distribute and market these products could suffer.
 
Our products are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory clearances or approvals to market a medical device 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. In particular, the FDA permits commercial distribution of most new medical devices only after the device has received clearance under Section 510(k) of the Federal Food, Drug and Cosmetic Act, or is the subject of an approved PMA. The FDA will clear marketing of a non-exempt lower risk medical device through the 510(k) process if the manufacturer demonstrates that the new product is substantially equivalent to other legally marketed products not requiring PMA approval. High risk devices deemed to pose the greatest risk, such as life-sustaining, life-supporting, or implantable devices, or devices not deemed substantially equivalent to a legally marketed device, require a PMA. The PMA process is more costly, lengthy and uncertain than the 510(k) clearance process. A PMA application must be supported by extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing and labeling data, to demonstrate to the FDA’s satisfaction the safety and efficacy of the device for its intended use. Our currently commercialized products have been cleared through the 510(k) process. However, we may need to submit a PMA for future products we develop.
 
Certain of the FDA’s policies and procedures are under review by new leadership and it is uncertain whether any changes arising from such review could adversely affect our products and business.
 
Our failure to comply with U.S. federal, state and foreign governmental regulations could lead to the imposition of injunctions, suspensions or loss of regulatory clearance or approvals, product recalls, termination of distribution, product seizures or civil penalties, among other things. In the most extreme cases, criminal sanctions or closure of our manufacturing facility are possible.
 
Foreign governmental authorities that regulate the manufacture and sale of medical devices have become increasingly stringent and, to the extent we market and sell our products internationally, we may be subject to rigorous international regulation in the future. In these circumstances, we would rely significantly on our foreign independent distributors to comply with the varying regulations, and any failures on their part could result in restrictions on the sale of our products in foreign countries.
 
Modifications to our marketed products may require new 510(k) clearances or PMA approvals, or may require us to cease marketing or recall the modified products until clearances or approvals are obtained.
 
Any modification to our currently marketed 510(k)-cleared devices that could significantly affect its safety or efficacy, or that would constitute a change in its intended use, 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 the manufacturer’s decision. The FDA may not agree with our decisions regarding whether new clearances or approvals are necessary. If the FDA requires us to seek 510(k) clearance or a PMA for any modification to a previously cleared product, we may be required to cease marketing and distributing, or to recall the modified product until we obtain such clearance or approval, and we may be subject to significant regulatory fines or penalties. Further, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective because they are in violation of the FDCA. Any recall or FDA requirement that we seek additional approvals or clearances could result in significant delays, fines, increased costs associated with modification of a product, loss of revenue and potential operating restrictions imposed by the FDA.


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Clinical trials necessary to support a PMA application will be expensive and will require the enrollment of large numbers of patients, and suitable patients may be difficult to identify and recruit. Delays or failures in our clinical trials will prevent us from commercializing any modified or new products and will adversely affect our business, operating results and prospects.
 
Initiating and completing clinical trials necessary to support a PMA application and additional safety and efficacy data beyond that typically required for 510(k) clearances for possible future product candidates, will be time consuming and expensive and the outcomes 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 may require 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, support staff, and proximity of patients to clinical sites. 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.
 
Development of sufficient and appropriate clinical protocols and data 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 clearance or 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, FDA may not consider our data adequate to demonstrate safety and efficacy. Such increased costs and delays or failures could adversely affect our business, operating results 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 clearance or approval for or commercialize our products.
 
We do not have the ability to independently conduct our pre-clinical and clinical trials for our products and we must 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 perform 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 clearance or approval for, or successfully commercialize, our products on a timely basis, if at all, and our business, operating results 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.
 
Even if our products are approved by regulatory authorities, if we or our suppliers fail to comply with ongoing FDA or other foreign regulatory authority requirements, or if we experience unanticipated problems with our products, these 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 labeling and promotional activities for such product, will be subject


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to continued regulatory review, oversight and periodic inspections by the FDA and other domestic and foreign regulatory bodies. In particular, we and our suppliers are required to comply with the Quality System Regulations, or QSR, and MDD regulations, which may include ISO standards, for the manufacture of our products and other regulations which cover the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of any product for which we obtain clearance or approval. Regulatory bodies enforce the QSR and ISO regulations through inspections. The failure by us or one of our suppliers to comply with applicable statutes and regulations administered by the FDA and other regulatory bodies, or the failure to timely and adequately respond to any adverse inspectional observations or product safety issues, could result in, among other things, any of the following enforcement actions:
 
  •  warning letters or untitled letters;
 
  •  fines and civil penalties;
 
  •  unanticipated expenditures to address or defend such actions;
 
  •  delays in clearing or approving, or refusal to clear or approve, our products;
 
  •  withdrawal or suspension of approval of our products or those of our third-party suppliers by the FDA or other regulatory bodies;
 
  •  product recall or seizure;
 
  •  orders for physician notification or device repair, replacement or refund;
 
  •  interruption of production;
 
  •  operating restrictions;
 
  •  injunctions; and
 
  •  criminal prosecution.
 
If any of these actions were to occur it would harm our reputation and cause our product sales to suffer and may prevent us from generating revenue. 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.
 
Even if regulatory clearance or approval of a product is granted, such clearance or approval may be subject to limitations on the intended uses for which the product may be marketed and reduce our potential to successfully commercialize the product and generate revenue from the product. If the FDA determines that our promotional materials, labeling, training or other marketing or educational activities constitute promotion of an unapproved use, it could request that we cease or modify our training educational, labeling or promotional materials or subject us to regulatory enforcement actions. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our training educational, labeling or other promotional materials to constitute promotion of an unapproved use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement.
 
In addition, we may be required to conduct costly post-market testing and surveillance to monitor the safety or effectiveness of our products, and we must comply with medical device reporting requirements, including the reporting of adverse events and certain malfunctions related to 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 the QSR or GMP, 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.


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We may be subject to or otherwise affected by federal and state healthcare laws, including fraud and abuse and health information privacy and security laws, and could face substantial penalties if we are unable to fully comply with such laws.
 
Although we do not provide healthcare services, submit claims for third-party reimbursement, or receive payments directly from Medicare, Medicaid, or other third-party payors for our products or the procedures in which our products are used, healthcare regulation by federal and state governments could significantly impact our business. Healthcare fraud and abuse and health information privacy and security laws potentially applicable to our operations include:
 
  •  the federal Anti-Kickback Law, which constrains our marketing practices and those of our independent sales agents and distributors, educational programs, pricing policies, and relationships with healthcare providers, by prohibiting, among other things, soliciting, receiving, offering or providing remuneration, intended to induce the purchase or recommendation of an item or service reimbursable under a federal healthcare program (such as the Medicare or Medicaid programs);
 
  •  federal false claims laws which prohibit, among other things, knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false or fraudulent;
 
  •  the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, and its implementing regulations, which created federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters and which also imposes certain regulatory and contractual requirements regarding the privacy, security and transmission of individually identifiable health information; and
 
  •  state laws analogous to each of the above federal laws, such as anti-kickback and false claims laws that may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy of certain health information, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.
 
We have adopted comprehensive compliance programs to attempt to comply with these regulations. However, because of the breadth of these laws and regulations and the sometimes subjective nature of their application, it is possible that some of our business activities could be subject to challenge under one or more of such laws. If our past or present operations, or those of our independent sales agents and distributors, are found to be in violation of any of such laws or any other governmental regulations that may apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from federal healthcare programs and/or the curtailment or restructuring of our operations. Similarly, if the healthcare providers or entities with whom we do business are found to be non-compliant with applicable laws, they may be subject to sanctions, which could also have a negative impact on us. Any penalties, damages, fines, curtailment or restructuring of our operations could adversely affect our ability to operate our business and our financial results. The risk of our being found in violation of these laws is increased by the fact that many of them have not been fully interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. Any action against us for violation of these laws, even if we successfully defend against them, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business.
 
Risks Related to Our Intellectual Property
 
Our ability to protect our intellectual property and proprietary technology through patents and other means is uncertain.
 
Our success depends significantly on our ability to protect our proprietary rights to the procedures created with, and the technologies used in, our products. We rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, and nondisclosure, confidentiality and other contractual restrictions to protect our proprietary technology. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. For example, our


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pending United States and foreign patent applications may not be approved, may not issue as patents in a form that will be advantageous to us, or may issue and be subsequently successfully challenged by others and invalidated. In addition, our pending patent applications include claims to material aspects of our products and procedures that are not currently protected by issued patents. Both the patent application process and the process of managing patent disputes can be time consuming and expensive. 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 which provide outcomes which are comparable to ours. 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 officers, employees, consultants and advisors, such agreements may not be enforceable or may not provide meaningful protection for our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of such agreements. Furthermore, the laws of some foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States.
 
We rely on our trademarks, trade names, and brand names to distinguish our products from the products of our competitors, and have registered or applied to register many of these trademarks. However, our trademark applications may not be approved. Third parties may also 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. Further, our competitors may infringe our trademarks, or we may not have adequate resources to enforce our trademarks.
 
In the event a competitor infringes upon our patent or other intellectual property rights, enforcing those rights may be costly, difficult and time consuming. 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. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents or other intellectual property rights against a challenge.
 
Any lawsuit, whether initiated by us to enforce our intellectual property rights or by a third party against us alleging infringement, may cause us to expend significant financial and other resources, and may divert our attention from our business and adversely affect our business, operating results and prospects.
 
The medical device industry is characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. Patent litigation can involve complex factual and legal questions and its outcome is uncertain. Any claim relating to infringement of patents that is successfully asserted against us may require us to pay substantial damages. Even if we were to prevail, any litigation could be costly and time-consuming and would divert the attention of our management and key personnel from our business operations. Our success will also depend in part on our not infringing patents issued to others, including our competitors and potential competitors. If our products are found to infringe the patents of others, our development, manufacture and sale of such products could be severely restricted or prohibited. In addition, our competitors may independently develop similar technologies. Because of the importance of our patent portfolio and unpatented proprietary technology to our business, we may lose market share to our competitors if we fail to protect our patent rights.
 
As the number of entrants into our market increases, the possibility of a patent infringement claim against us grows. Our products and methods may be covered by patents held by our competitors. Some of our competitors have considerable resources available to them to engage in this type of litigation. We, on the other hand, are an early stage company with comparatively few resources available to us to engage in costly and protracted litigation. Because some patent applications are maintained in secrecy for a period of time after they are filed, there is a risk that we could adopt a technology without knowledge of a pending patent application, which technology would infringe a third-party patent once that patent is issued. In addition, our competitors may assert that future products we may market infringe their patents.
 
A patent infringement suit or other infringement or misappropriation claim brought against us or any of our strategic partners or licensees may force us or any of our strategic partners or licensees to stop or delay


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developing, manufacturing or selling potential products that are claimed to infringe a third party’s intellectual property, unless that party grants us or any strategic partners or licensees rights to use its intellectual property. In such cases, we may be required to obtain licenses to patents or proprietary rights of others in order to continue to commercialize our products. However, we may not be able to obtain any licenses required under any patents or proprietary rights of third parties on acceptable terms, or at all. Even if our strategic partners or licensees or we were able to obtain rights to the third party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately, we may be unable to commercialize some of our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business.
 
In any infringement lawsuit, a third party could seek to enjoin, or prevent, us from commercializing our existing or future products, and/or may seek damages from us, and any such lawsuit would likely be expensive for us to defend against. A court may determine that patents held by third parties are valid and infringed by us and we may be required to:
 
  •  pay damages, including, but not limited to, treble damages and attorneys’ fees, which may be substantial;
 
  •  cease the development, manufacture, use and sale of products that infringe the patent rights of others, through a court-imposed sanction called an injunction;
 
  •  expend significant resources to redesign our technology so that it does not infringe others’ patent rights, or develop or acquire non-infringing intellectual property, which may not be possible;
 
  •  discontinue manufacturing or other processes incorporating infringing technology; or
 
  •  obtain licenses to the infringed intellectual property, which may not be available to us on acceptable terms, or at all.
 
Any development or acquisition of non-infringing products or technology or licenses could require the expenditure of substantial time and other resources and could have a material adverse effect on our business and financial results. If we are required to, but cannot, obtain a license to valid patent rights held by a third party, we would likely be prevented from commercializing the relevant product. We believe that it is unlikely that we would be able to obtain a license to any necessary patent rights controlled by companies against which we would, directly or indirectly, compete. If we need to redesign products to avoid third-party patents, we may suffer significant regulatory delays associated with conducting additional studies or submitting technical, manufacturing or other information related to the redesigned product and, ultimately, in obtaining regulatory approval.
 
Risks Related to our Common Stock
 
A sale of a substantial number of shares of our common stock may cause the price of our common stock to decline.
 
If our stockholders sell substantial amounts of our common stock in the public market, including shares issued upon the exercise of options, the market price of our common stock could decline. At December 31, 2009, we had 20,648,447 shares of common stock outstanding. All of these shares are freely tradable, without restriction, in the public market, of which 7,484,856 shares are held by directors, executive officers and other affiliates and are subject to volume limitations under Rule 144 under the Securities Act. In addition, the 2,216,026 shares of our common stock that are subject to outstanding options as of December 31, 2009 will be eligible for sale in the public market to the extent permitted by the provisions of the various vesting agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or it is perceived they will be sold, the trading price of our common stock could decline. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate.


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Our directors, officers and principal stockholders have significant voting power and may take actions that may not be in the best interests of our other stockholders.
 
At December 31, 2009, our officers, directors and principal stockholders, each holding more than 5% of our common stock, collectively controlled approximately 56% of our outstanding common stock. As a result, these stockholders, if they act together, are able to control the management and affairs of our company and most matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of our other stockholders.
 
If securities or industry analysts do not publish research or reports about our business, if they change their recommendations regarding our stock adversely or if our operating results do not meet their expectations, our stock price and trading volume could decline.
 
The trading market for our stock may be influenced by the research and reports that industry or securities analysts publish about us or our business. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, if one or more of the analysts who cover us downgrade our stock or if our operating results do not meet their expectations, our stock price could decline.
 
Trading in our stock over the last twelve months has been limited, so investors may not be able to sell as much stock as they want at prevailing prices.
 
The average daily trading volume in our common stock for the year ended December 31, 2009 was approximately 76,000 shares. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices. Moreover, the market price for shares of our common stock may be made more volatile because of the relatively low volume of trading in our common stock. When trading volume is low, significant price movement can be caused by the trading in a relatively small number of shares. Volatility in our common stock could cause stockholders to incur substantial losses.
 
Volatility in the stock price of other companies may contribute to volatility in our stock price.
 
The Nasdaq Global Market, particularly in recent years, has experienced significant volatility with respect to medical technology, pharmaceutical, biotechnology and other life science company stocks. The volatility of medical technology, pharmaceutical, biotechnology and other life science company stocks often does not relate to the operating performance of the companies represented by the stock. Further, there has been particular volatility in the market price of securities of early stage life science companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in substantial costs, potential liabilities and the diversion of management’s attention and resources.
 
Our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law contain provisions that could discourage a takeover.
 
Anti-takeover provisions of our amended and restated certificate of incorporation, amended and restated bylaws and Delaware law may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. The provisions of our charter documents include:
 
  •  a classified board so that only one of the three classes of directors on our board of directors is elected each year;
 
  •  procedures for advance notification of stockholder director nominations and proposals;


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  •  the ability of our board of directors to amend our bylaws without stockholder approval;
 
  •  a supermajority stockholder vote requirement for amending certain provisions of our amended and restated certificate of incorporation and our amended and restated bylaws; and
 
  •  the ability of our board of directors to issue up to 5,000,000 shares of preferred stock without stockholder approval upon the terms and conditions and with the rights, privileges and preferences as our board of directors may determine.
 
In addition, as a Delaware corporation, we are subject to Delaware law, including Section 203 of the Delaware General Corporation Law, or DGCL. In general, Section 203 prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years following the date that the stockholder became an interested stockholder unless certain specific requirements are met as set forth in Section 203. These provisions, alone or together, could have the effect of deterring or delaying changes in incumbent management, proxy contests or changes in control.
 
We do not anticipate declaring any cash dividends on our common stock.
 
We have never declared or paid cash dividends on our common stock and do not plan to pay any cash dividends in the near future. Our current policy is to retain all funds and any earnings for use in the operation and expansion of our business. If we do not pay dividends, our stock may be less valuable to you because a return on your investment will only occur if our stock price appreciates.
 
Item 1B.   Unresolved Staff Comments.
 
None.
 
Item 2.   Properties.
 
At December 31, 2009, we leased approximately 30,000 square feet of space in a single-user building located in an industrial park in Wilmington, North Carolina. Of that amount, approximately 19,800 square feet were used for manufacturing and warehousing, approximately 8,400 square feet were used for office space and approximately 1,800 square feet were used for research and development activities. This lease was terminated in February 2010. In February 2010, we moved into a new facility of approximately 30,000 square feet, also located in Wilmington, North Carolina. Of that amount, approximately 5,000 square feet are used for manufacturing and warehousing, approximately 18,000 square feet are used for office space and approximately 7,000 square feet are used for research and development activities. This lease expires in December 2019. We believe that our current facility will be sufficient to meet our needs through that time.
 
Item 3.   Legal Proceedings.
 
We are not currently party to any material legal proceedings. We may be subject to various claims and legal actions arising in the ordinary course of business from time to time.
 
Item 4.   Submission of Matters to a Vote of Security Holders.
 
No matter was submitted to a vote of our security holders during the quarter ended December 31, 2009.
 


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PART II
 
Item 5.   Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
Price of Common Stock
 
Our common stock is traded on the NASDAQ Global Market under the symbol “TSON.” The following table sets forth the high and low sales prices of our common stock as quoted on the NASDAQ Global Market for the periods indicated.
 
                 
    Price Range
    High   Low
 
Fiscal 2009:
               
Fourth quarter
  $ 5.00     $ 3.26  
Third quarter
    6.83       4.08  
Second quarter
    8.74       5.65  
First quarter
    7.66       4.55  
Fiscal 2008:
               
Fourth quarter
  $ 9.54     $ 5.82  
Third quarter
    14.25       7.45  
Second quarter
    15.74       9.93  
First quarter
    17.24       8.96  
 
The closing price for our common stock as reported by the NASDAQ Global Market on March 8, 2010 was $3.93 per share.
 
As of March 8, 2010, we had approximately 40 stockholders of record based upon the records of our transfer agent, which does not include beneficial owners of our common stock whose shares are held in the names of various securities brokers, dealers and registered clearing agencies.
 
Uses of Proceeds from Sale of Registered Securities
 
On October 22, 2007, we completed our initial public offering of 6,325,000 shares of common stock (inclusive of 825,000 shares sold to the underwriters upon exercise of their over-allotment option) at the initial public offering price of $15.00 per share. We effected the offering through a Registration Statement on Form S-1 (Registration No. 333-144802), which was declared effective by the SEC on October 16, 2007, and through a Registration Statement on Form S-1 filed pursuant to Rule 462(b) under the Securities Act (Registration No. 333-146753), which became effective upon filing on October 17, 2007 pursuant to Rule 462(b) (collectively, the “Registration Statement”). The offering commenced on October 17, 2007 and terminated on October 22, 2007 after all of the 6,325,000 shares of common stock registered under the Registration Statement were sold. Our initial public offering resulted in aggregate proceeds to us of approximately $86.7 million, net of underwriting discounts and commissions of approximately $6.6 million and offering expenses of approximately $1.6 million. Lehman Brothers Inc. and Piper Jaffray & Co. acted as joint book-running managers for the offering with Cowen and Company, LLC and Wachovia Capital Markets, LLC acting as co-managers.
 
No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or person owning ten percent or more of any class of our equity securities or to any other affiliates. All offering expenses were paid directly to others.
 
As of December 31, 2009, we had used all of the net proceeds for sales, marketing, general administrative and research and development activities.


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Dividend Policy
 
We have never declared or paid any cash dividends on our capital stock. We currently intend to retain future earnings, if any, for development of our business and do not anticipate that we will declare or pay cash dividends on our capital stock in the foreseeable future.
 
Securities Authorized For Issuance Under Equity Compensation Plans
 
                         
                (c)
 
                Number of Securities
 
    (a)
          Remaining Available
 
    Number of
    (b)
    for Future Issuance
 
    Securities to be
    Weighted-Average
    Under Equity
 
    Issued Upon Exercise
    Exercise Price of
    Compensation Plans
 
    of Outstanding
    Outstanding
    (Excluding Securities
 
    Options, Warrants
    Options, Warrants
    Reflected in Column
 
Plan Category
  and Rights     and Rights     (a)  
 
Equity compensation plans approved by security holders
    2,216,026     $ 6.96       1,032,914  
Equity compensation plans not approved by security holders
                 
                         
Total
    2,216,026     $ 6.96       1,032,914  
                         


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Stock Price Performance Graph
 
The following graph compares the cumulative total stockholder return on our common stock from October 17, 2007 (the date our common stock began trading on the NASDAQ Global Market) through December 31, 2009 to that of the cumulative return over such period for (i) The NASDAQ Stock Market Composite Index, and (ii) NASDAQ Medical Equipment Index. Total stockholder return assumes $100.00 invested at the beginning of the period in our common stock and in each of the comparative indices. The graph further assumes that such amount was initially invested in our common stock at the closing market price on the first day of trading, and that any dividends have been reinvested. We have not paid any dividends on our common stock. The stock price performance on the following graph is not necessarily indicative of future stock price performance.
 
(PERFORMANCE GRAPH)
 
The material in the above performance graph does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing, whether under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made on, before or after the date of this report and irrespective of any general incorporation language in such filing, except to the extent we specifically incorporate this performance graph by reference therein.


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Item 6.   Selected Financial Data.
 
The selected financial data has been derived from our audited consolidated financial statements. You should read the following financial information together with the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the notes included elsewhere in this report.
 
                                         
    Years Ended December 31,  
    2009     2008     2007     2006     2005  
    (In thousands, except share data)  
 
Consolidated Statements of Operations Data:
                                       
Revenue
  $ 29,807     $ 25,304     $ 16,473     $ 5,812     $ 1,469  
Cost of revenue
    5,687       4,315       3,042       1,580       386  
                                         
Gross profit
    24,120       20,989       13,431       4,232       1,083  
                                         
Operating expenses
                                       
Research and development
    6,439       4,081       3,885       3,816       2,100  
Sales and marketing
    34,098       29,375       15,706       9,288       2,635  
General and administrative
    7,184       7,116       3,801       1,596       1,637  
                                         
Total operating expenses
    47,721       40,572       23,392       14,700       6,372  
                                         
Operating loss
    (23,601 )     (19,583 )     (9,961 )     (10,468 )     (5,289 )
Interest income
    405       2,548       1,384       858       264  
Other income (expense)
                      131       (17 )
                                         
Net loss
  $ (23,196 )   $ (17,035 )   $ (8,577 )   $ (9,479 )   $ (5,042 )
                                         
Net loss per common share - basic and diluted
  $ (1.13 )   $ (0.84 )   $ (1.46 )   $ (3.91 )   $ (2.25 )
Weighted average common shares outstanding — basic and diluted
    20,603,600       20,288,711       5,872,008       2,423,223       2,243,018  
 
                                         
    December 31,
    2009   2008   2007   2006   2005
 
Consolidated Balance Sheet Data:
                                       
Cash, cash equivalents and short-term investments
  $ 55,251     $ 77,266     $ 93,921     $ 14,962     $ 25,994  
Working capital
    63,467       84,174       98,351       17,448       26,696  
Total assets
    68,991       90,491       102,856       20,004       28,013  
Preferred stock
                      40,089       40,089  
Common stock
    2       2       2              
Additional paid in capital
    136,402       133,507       130,325       820       219  
Total stockholders’ equity/(deficit)
    65,280       85,586       99,439       (21,529 )     (12,654 )


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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes to our consolidated financial statements included in this report. The following discussion contains forward-looking statements. See “Cautionary Note Regarding Forward-Looking Statements” on page 1 of this report.
 
Overview
 
We are a medical device company focused on designing, developing and marketing products that implement our proprietary minimally invasive surgical approach to treat degenerative disc disease and instability affecting the lower lumbar region of the spine. Using this pre-sacral approach, a surgeon can access discs in the lower lumbar region of the spine through a 1.5 cm incision adjacent to the tailbone and can perform an entire fusion procedure through a small tube that provides direct access to the intervertebral space. We developed our pre-sacral approach to allow spine surgeons to access and treat intervertebral spaces without compromising important surrounding soft tissue. We believe this approach enables fusion procedures to be performed with low complication rates, low blood loss, short hospital stays, fast recovery times and reduced pain. We have developed and currently market in the United States and Europe two single-level fusion products, AxiaLIF and AxiaLIF 360°, and a two-level fusion product, the AxiaLIF 2L, which include the Vectre and Avatar posterior fixation systems for lumbar fixation supplemental to AxiaLIF fusion. All of our AxiaLIF products are delivered using our pre-sacral approach.
 
From our incorporation in 2000 through 2004, we devoted substantially all of our resources to research and development and start-up activities, consisting primarily of product design and development, clinical trials, manufacturing, recruiting qualified personnel and raising capital. We received FDA 510(k) clearance for our AxiaLIF product in the fourth quarter of 2004, and commercially introduced our AxiaLIF product in the United States in the first quarter of 2005. We received FDA 510(k) clearance for our AxiaLIF 360° product in the United States in the third quarter of 2005 and began commercialization in the United States in the third quarter of 2006. We received a CE mark to market AxiaLIF in the European market in the first quarter of 2005 and began commercialization in the first quarter of 2006. For AxiaLIF 360°, we received a CE mark in the first quarter of 2006. We received a CE mark for our AxiaLIF 2L product in the third quarter of 2006 and began commercialization in the European market in the fourth quarter of 2006. We received 510(k) clearance for the AxiaLIF 2L from the FDA and began marketing this product in the United States in the second quarter of 2008. In November 2009, we commenced the limited market release of our next generation Vectre facet screw system. Our AxiaLIF 2L+ product received FDA 510 (k) clearance, and we began marketing the product, in January 2010. In January 2010, we also entered into a partnership agreement with Life Spine, Inc to distribute Avatar, a minimally invasive pedicle screw system. We currently sell our products through a direct sales force, independent sales agents and international distributors.
 
We rely on third parties to manufacture most of our products and their components. We believe these manufacturing relationships allow us to work with suppliers who have the best specific competencies while we minimize our capital investment, control costs and shorten cycle times, all of which allows us to compete with larger volume manufacturers of spine surgery products.
 
Since inception, we have been unprofitable. As of December 31, 2009, we had an accumulated deficit of $71.1 million.
 
We expect to continue to invest in maintaining our sales and marketing infrastructure for our products in order to gain wider acceptance for them. We also expect to continue to invest in research and development and related clinical trials, and increase general and administrative expenses as we grow. As a result, we will need to generate significant revenue in order to achieve profitability.


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Financial Operations
 
Revenue
 
We generate revenue from the sales of our procedure kits and implants used in our AxiaLIF fusion procedure for the treatment of degenerative disc disease and instability. Our revenue is generated by our direct sales force, independent sales agents and independent distributors. Our sales representatives or independent sales agents hand deliver the procedure kit to the customer on the day of the surgery or several days prior to the surgery. The sales representative or independent agent is then responsible for reporting the delivery of the procedure kit, and the date of the operation to the corporate office for proper revenue recognition. We recognize revenue upon the confirmation that the procedure kit has been used in a surgical procedure. The other sales method is for sales to distributors outside the United States. These distributors order multiple procedure kits at one time to have on hand. These transactions require the customer to send in a purchase order before shipment will be made to the customer. We determine revenue recognition on a case by case basis dependent upon the terms and conditions of each individual distributor agreement. Under the distributor agreements currently in place, a distributor only has the right of return for defective products and, accordingly, revenue is recognized upon shipment of our products to our independent distributors. Although we intend to continue to expand our international sales and marketing efforts, we expect that a substantial amount of our revenues will be generated in the United States in future periods.
 
Cost of Revenue
 
Cost of revenue consists primarily of material and overhead costs related to our products. Cost of revenue also includes facilities-related costs, such as rent, utilities and depreciation.
 
Research and Development
 
Research and development expenses consist primarily of personnel costs, including stock-based compensation expense, within our product development, regulatory and clinical functions and the costs of clinical studies and product development projects. In future periods, we expect research and development expenses to grow as we continue to invest in basic research, clinical trials, product development and in our intellectual property.
 
Sales and Marketing
 
Sales and marketing expenses consist of personnel costs, including stock-based compensation expense, sales commissions paid to our direct sales representatives and independent sales agents, and costs associated with physician training programs, promotional activities, and participation in medical conferences. In future periods, we expect sales and marketing expenses to increase as we expand our sales and marketing efforts.
 
General and Administrative
 
General and administrative expenses consist of personnel costs, including stock-based compensation, related to the executive, finance, business development and information technology and human resource functions, as well as professional service fees, legal fees, accounting fees, insurance costs and general corporate expenses. We expect general and administrative expenses to increase as we grow our business.
 
Interest Income
 
Interest income is primarily composed of interest earned on our cash, cash equivalents and available-for-sale securities.


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Results of Operations
 
Comparison of the Years Ended December 31, 2009, 2008 and 2007
 
Revenue.  Revenue increased to $29.8 million in 2009 from $25.3 million in 2008 and $16.5 million in 2007. The $4.5 million increase in revenue from 2008 to 2009, and the $8.8 million increase in revenue from 2007 to 2008, was primarily attributable to an increase in the number of products sold, which we believe resulted from the continued market acceptance of our AxiaLIF, AxiaLIF 360°, and AxiaLIF 2L products. None of this increase was attributable to price increases. Beginning in the second quarter of 2009, our revenue was negatively impacted by lower than expected case volume as a result of concerns and uncertainty in the marketplace surrounding physician reimbursement for our AxiaLIF procedure. We are addressing these issues with increased education and support resources for our current and prospective surgeon users. These issues have more of an impact on our AxiaLIF 360° procedure where ours is the only procedure being performed. In cases where our procedure is being performed in conjunction with other techniques or in complex cases, we have seen a less-pronounced impact on cases. Domestically, sales of our AxiaLIF 360° product decreased to $7.8 million in 2009 from $8.5 million in 2008, which was an increase from $6.8 million in 2007. Sales of our AxiaLIF 2L product, which began commercialization in the United States in the second quarter of 2008 and which has a higher selling price than our other products, increased to $8.0 million in 2009 from $3.3 million in 2008. As a result, average selling prices in the United States increased to approximately $10,500 in 2009 from approximately $9,850 in 2008 and $9,250 in 2007. In 2009, 2008 and 2007, we recorded 2,578, 2,280 and 1,591 domestic AxiaLIF cases, respectively. This included 780, 852 and 677 AxiaLIF 360° cases in 2009, 2008 and 2007, respectively, and 596 and 229 AxiaLIF 2L cases in 2009 and 2008, respectively. Additionally, in 2009, 2008 and 2007, we generated $953,000, $868,000 and $359,000, respectively, in revenues from stand alone sales of our facet screw system. Revenue generated outside the United States decreased to $1.8 million in 2009 from $2.0 million in 2008, which was an increase from $1.4 million in 2007. In 2009, 2008 and 2007, initial stocking shipments to new distributors were $122,000, $382,000 and $438,000, respectively. In 2009, we began direct sales through our own sales representatives and agents in Europe and generated revenue of $543,000. In 2009, 2008 and 2007, 94%, 92% and 92%, respectively, of our revenues were generated in the United States.
 
Cost of Revenue.  Cost of revenue increased to $5.7 million in 2009 from $4.3 million in 2008 and $3.0 million in 2007. The $1.4 million increase from 2008 to 2009 and the $1.3 million increase from 2007 to 2008 were primarily the result of higher material and overhead costs associated with increased sales volumes of our AxiaLIF, AxiaLIF 360° and AxiaLIF 2L products. As a percentage of revenue, cost of revenue was 19.1% in 2009, 17.1% in 2008 and 18.5% in 2007. The increase in cost of revenue as a percentage of revenue from 2008 to 2009 was primarily related to specific inventory reserves of $0.4 million taken in 2009 for excess inventory and the under-absorption of manufacturing overhead of $0.2 million as we reduced inventory purchases in response to lower than anticipated business volume. The decrease in cost of revenue as a percentage of revenue from 2007 to 2008 was primarily attributable to increased efficiencies associated with higher production and sales volumes.
 
Research and Development.  Research and development expenses increased to $6.4 million in 2009 from $4.1 million in 2008 and $3.9 million in 2007. The $2.3 million increase in expense from 2008 to 2009 was primarily the result of increased research and development and clinical project-related spending. The $0.2 million increase in expense in 2008 compared to 2007 was primarily the result of increases in personnel related costs, including stock-based compensation expense, of $0.4 million, partially offset by reductions in project related research and development and clinical trial costs of $0.2 million.
 
Sales and Marketing.  Sales and marketing expenses increased to $34.1 million in 2009 from $29.4 million in 2008 and $15.7 million in 2007. The increase in expense from 2008 to 2009 of $4.7 million was primarily attributable to increased personnel related costs, including commissions and stock-based compensation expense, of $3.6 million, as we continued to build out our sales and marketing organization in order to continue to drive global market acceptance of our AxiaLIF products, increased training costs of $0.6 million and increased promotional activities of $0.5 million. The increase in expenses from 2007 to 2008 of $13.7 million was primarily attributable to increased personnel related costs, including commissions and stock-


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based compensation expense, of $7.2 million, increased travel costs of $2.7 million related to our expanded sales force, increased training costs of $1.7 million and increased tradeshow and promotional activities of $1.2 million. In January 2010, we reduced our U.S. sales force to better address current market opportunities.
 
General and Administrative.  General and administrative expenses increased to $7.2 million in 2009 from $7.1 million in 2008 and $3.8 million in 2007. The increase in expenses from 2008 to 2009 of $0.1 million was primarily attributable to increased personnel related costs, including stock-based compensation expenses, of $0.5 million, partially offset by a decrease in consulting expenses, of $0.4 million. The increase in expenses from 2007 to 2008 of $3.3 million was primarily attributable to increased personnel related costs, including stock-based compensation expenses, of $1.0 million, increased professional fees of $1.5 million related to our operating as a public company, including accounting, legal and board of director expenses, increased directors and officers insurance expense of $0.3 million and higher franchise taxes of $0.2 million.
 
Other and Interest Income (Expense).  Other and interest income decreased to $0.4 million in 2009 from $2.5 million in 2008 and $1.4 million in 2007. The decrease of $2.1 million in other and interest income from 2008 to 2009 was primarily the result of historically low interest rates, the conservative and liquid nature of the investment portfolio and lower investment balances. The increase $1.1 million from 2007 to 2008 was primarily due to interest income on higher average cash and investment balances from the net proceeds to the Company of $86.7 million from our October 2007 IPO.
 
Liquidity and Capital Resources
 
Sources of Liquidity
 
Since our inception in 2000, we have incurred significant losses and, as of December 31, 2009, we had an accumulated deficit of $71.1 million. We have not yet achieved profitability, and anticipate that we will continue to incur losses in the near term. We expect that research and development, sales and marketing and general and administrative expenses will continue to grow and, as a result, we will need to generate significant revenues to achieve profitability. To date, our operations have been funded primarily with proceeds from the sale of preferred stock and, most recently, the net proceeds from our October 2007 initial public offering. Gross proceeds from our preferred stock sales totaled $40.5 million to date, and the net proceeds from our October 2007 initial public offering were approximately $86.7 million.
 
As of December 31, 2009, we did not have any outstanding debt financing arrangements, we had working capital of $63.5 million and our primary source of liquidity was $55.3 million in cash, cash equivalents and short-term investments. We currently invest our cash and cash equivalents primarily in money market treasury funds and our short-term investments primarily in U.S. agency backed debt instruments.
 
Cash, cash equivalents and short-term investments decreased from $77.3 million at December 31, 2008 to $55.3 million at December 31, 2009. The decrease of $22.0 million was primarily the result of net cash used in operating activities of $20.8 million and purchases of property and equipment of $1.3 million.
 
Cash, cash equivalents and short-term investments decreased from $93.9 million at December 31, 2007 to $77.3 million at December 31, 2008. The decrease of $16.6 million was primarily the result of net cash used in operating activities of $15.7 million and purchases of property and equipment of $1.1 million.
 
Cash Flows
 
Net Cash Used in Operating Activities.  Net cash used in operating activities was $20.8 million in 2009, $15.7 million in 2008 and $7.3 million in 2007. For each of these periods, net cash used in operating activities was attributable primarily to net losses after adjustment for non-cash items, such as depreciation, stock-based compensation expense, inventory reserves and increases in working capital requirements to support the increased market acceptance of our AxiaLIF products. The increase in working capital requirements for 2009 was driven by the growth in inventories, and for 2008 and 2007 by the growth in inventories and related payables, along with smaller changes in all years in prepaid assets and accrued liabilities due to the timing of activities in those accounts.


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Net Cash Provided by (Used In) Investing Activities.  Net cash provided by investing activities was $8.0 million in 2009. Net cash used in investing activities was $7.1 million in 2008 and $19.8 million in 2007. For each of these periods, this amount reflected purchases or sales and maturities of investments and purchases of property and equipment, primarily for research and development, information technology, manufacturing operations and capital improvements to our facilities.
 
Net Cash Provided by Financing Activities.  Net cash provided by financing activities in 2009 and 2008 was $0.1 million and $0.2 million, respectively, representing proceeds from the issuance of shares of our common stock upon the exercise of stock options. Net cash provided by financing activities in 2007 was $86.8 million, which represented the net proceeds to the Company of our October 2007 initial public offering of 6,325,000 shares of our common stock, resulting in net proceeds to us, after deducting underwriting discounts, commissions and offering expenses, of approximately $86.7 million and $0.1 million in proceeds from the issuance of shares of our common stock upon the exercise of stock option.
 
Operating Capital and Capital Expenditure Requirements
 
We believe that our existing cash and cash equivalents, together with cash received from sales of our products, will be sufficient to meet our cash needs for at least the next two years. We intend to spend substantial sums on sales and marketing initiatives to support the ongoing commercialization of our products and on research and development activities, including product development, regulatory and compliance, clinical studies in support of our currently marketed products and future product offerings, and the enhancement and protection of our intellectual property. We may need to obtain additional financing to pursue our business strategy, to respond to new competitive pressures or to take advantage of opportunities that may arise. The sale of additional equity or convertible debt securities could result in dilution to our stockholders. If additional funds are raised through the issuance of debt securities, these securities could have rights senior to those associated with our common stock and could contain covenants that would restrict our operations. Any additional financing may not be available in amounts or on terms acceptable to us, if at all. If we are unable to obtain this additional financing, we may be required to reduce the scope of our planned product development and marketing efforts.
 
Contractual Obligations
 
The following table discloses information about our contractual obligations by the year in which payments are due as of December 31, 2009:
 
                                         
    Payments Due by Year
        Less Than
          After 5
Contractual Obligations
  Total   1 Year   1-3 Years   3-5 Years   Years
    ( In thousands)
 
Operating leases(1)
  $ 4,128     $ 374     $ 695     $ 735     $ 2,324  
 
 
(1) We rent office space under an operating lease which expires in 2019.
 
Off-Balance Sheet Arrangements
 
As of December 31, 2009, we did not have any outstanding debt or available debt financing arrangements or off-balance sheet liabilities.
 
Critical Accounting Policies and Estimates
 
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenue and expenses, and disclosures of contingent assets and liabilities at the date of the financial statements. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, accounts receivable, inventories, income taxes and stock-based compensation. We use authoritative pronouncements, historical experience and other


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assumptions as the basis for making estimates. Actual results could differ from those estimates under different assumptions or conditions.
 
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.
 
Revenue Recognition.  We recognize revenue based on the following criteria: (i) persuasive evidence that an arrangement exists with the customer; (ii) the delivery of the products and/or services has occurred (title has transferred); (iii) the selling price has been fixed for the products or services delivered; and (iv) the collection is reasonably assured. Revenue is generated from the sale of our implants and procedure kits, which consist of disposable instruments. We have two distinct sale methods. The first method is when procedure kits are sold directly to hospitals or surgical centers. Our sales representatives or independent sales agents hand deliver the procedure kit to the customer on the day of the surgery or several days prior to the surgery. The sales representative or independent agent is then responsible for reporting the delivery of the procedure kit, and the date of the operation to our corporate office for proper revenue recognition. We recognize revenue upon the confirmation that the procedure kit has been used in a surgical procedure. The other sales method is for sales to distributors outside the United States. These distributors order multiple procedure kits at one time to have on hand. These transactions require the customer to send in a purchase order before shipment will be made to the customer. We determine revenue recognition on a case by case basis dependent upon the terms and conditions of each individual distributor agreement. Under the distributor agreements currently in place, a distributor only has the right of return for defective products and, accordingly, revenue is recognized upon shipment.
 
Accounts Receivable and Allowances.  We monitor collections and payments from our customers and maintain an allowance for doubtful accounts based upon our historical experience and any specific customer collection issues that we have identified. While our credit losses have historically been within our expectations and the allowance established, we may not continue to experience the same credit loss rates that we have in the past. We make estimates on the collectability of customer accounts based primarily on analysis of historical trends and experience and changes in customers’ financial condition. Management uses its best judgment, based on the best available facts and circumstances, and records a reserve against the amounts due to reduce the receivable to the amount that is expected to be collected.
 
These reserves are reevaluated and adjusted as additional information is received that impacts the amount reserved.
 
Inventory.  We state our inventories at the lower of cost or market, computed on a standard cost basis, which approximates actual cost on a first-in, first-out basis and market being determined as the lower of replacement cost or net realizable value. Costs are monitored on an annual basis and updated as necessary to reflect changes in supplier costs and the rate of our overhead absorption is adjusted based on projections of our manufacturing department costs and production plan. Inventory reserves are established when conditions indicate that the selling price could be less than cost due to obsolescence, usage, or we deem we hold excessive levels of inventory based on market demand.
 
Accounting for Income Taxes.  Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance on our net deferred tax assets as of December 31, 2009 due to uncertainties related to our ability to utilize our deferred tax assets in the foreseeable future.
 
Stock-Based Compensation.  Effective January 1, 2006, we adopted Accounting Standards Codification, (“ASC”) 718 (formerly Statement of Financial Accounting Standards No. 123R (“SFAS 123R”), Share-Based Payment) using the prospective transition method, which requires the measurement and recognition of compensation expense for all share-based payment awards granted, modified and settled to our employees and directors after January 1, 2006. The fair value of stock options was estimated using a Black-Scholes option pricing model. This model requires the input of subjective assumptions, including expected stock price volatility, expected life and estimated forfeitures of each award. The fair value of equity-based awards is


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amortized over the vesting period of the award, and we have elected to use the straight-line method of amortization. Due to the limited amount of historical data available to us, particularly with respect to stock-price volatility, employee exercise patterns and forfeitures, actual results could differ materially from our expectations.
 
Recent Accounting Pronouncements
 
New Accounting Standards
 
In February 2008, the Financial Accounting Standards Board (“FASB”) issued ASC 820 (formerly Staff Position No. FAS 157-2, “Fair Value Measurements”), which delayed the effective date of ASC 820 for non-financial assets and liabilities to fiscal years beginning after November 15, 2008. We adopted ASC 820 for our non-financial assets and non-financial liabilities on January 1, 2009, and it did not have a material impact on our consolidated financial statements.
 
In June 2009, the FASB issued the FASB Accounting Standards Codification (“ASC”). The Codification has become the single source for all authoritative GAAP recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. We applied the Codification to our Annual Report on Form 10-K for the period ending December 31, 2009. The Codification does not change GAAP and did not have an effect on our consolidated financial position or results of operations.
 
In May 2009, the FASB issued ASC 855 (formerly SFAS No. 165, “Subsequent Events”), which establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. ASC 855 provides guidance on the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. We adopted ASC 855 during the second quarter of 2009, and its application did not have a material impact on our consolidated financial statements.
 
No other recently issued, but not yet effective, accounting standards are believed to have a material impact on us.
 
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk
 
Our exposure to interest rate risk at December 31, 2009 is related to our investment portfolio. We invest our excess cash primarily in money market funds and debt instruments of the U.S. government and its agencies. Due to the short-term nature of these investments, we have assessed that there is no material exposure to interest rate risk arising from our investments. Thus, a hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of our interest-sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense. Historically, and as of December 31, 2009, we have not used derivative instruments or engaged in hedging activities.
 
Although substantially all of our sales and purchases are denominated in U.S. dollars, future fluctuations in the value of the U.S. dollar may affect the competitiveness of our products outside the United States. We do not believe, however, that we currently have significant direct foreign currency exchange rate risk and have not hedged exposures denominated in foreign currencies.


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Item 8.   Consolidated Financial Statements and Supplementary Data.
 
The consolidated financial statements and supplementary data required by this item are set forth under Item 15.
 
Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
 
None.
 
Item 9A.   Controls and Procedures
 
Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of December 31, 2009. We maintain disclosure controls and procedures that are designed to provide a reasonable assurance level that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow for timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of December 31, 2009, our principal executive officer and principal financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.
 
Internal Control Over Financial Reporting
 
Management’s annual report on internal control over financial reporting.  Management’s report on our internal control over financial reporting is included on page 64 hereof. The report of our independent registered public accounting firm related to their assessment of the effectiveness of internal control over financial reporting is included on page 65 hereof.
 
Changes in Internal Control over Financial Reporting.  There has been no change in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
 
Item 9B.   Other Information.
 
None.
 
PART III
 
Item 10.   Directors, Executive Officers and Corporate Governance.
 
The information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of December 31, 2009, and delivered to stockholders in connection with our annual meeting of stockholders.
 
Item 11.   Executive Compensation.
 
The information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of December 31, 2009, and delivered to stockholders in connection with our annual meeting of stockholders.


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The material incorporated herein by reference to the material under the caption “Compensation Committee Report” in the Proxy Statement shall be deemed furnished, and not filed, in this report and shall not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, as a result of this furnishing, except to the extent that we specifically incorporate it by reference.
 
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
 
With the exception of the information regarding securities authorized for issuance under our equity compensation plans, which is set forth in Item 5 of this report under the heading “Securities Authorized For Issuance under Equity Compensation Plans” and incorporated herein by reference, the information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of December 31, 2009, and delivered to stockholders in connection with our annual meeting of stockholders.
 
Item 13.   Certain Relationships and Related Transactions, and Director Independence.
 
The information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of December 31, 2009, and delivered to stockholders in connection with our annual meeting of stockholders.
 
Item 14.   Principal Accounting Fees and Services.
 
The information required by this Item is incorporated herein by reference to our definitive Proxy Statement, which will be filed within 120 days of December 31, 2009, and delivered to stockholders in connection with our annual meeting of stockholders.
 
PART IV
 
Item 15.   Exhibits, Financial Statement Schedules.
 
(a) Financial Statements
 
(1) Index to Financial Statements
 
         
    Page
 
Management Report on Internal Control Over Financial Reporting
    52  
Report of Independent Registered Public Accounting Firm
    53  
Consolidated Balance Sheets
    54  
Consolidated Statements of Operations
    55  
Consolidated Statements of Stockholders’ Equity (Deficit)
    56  
Consolidated Statements of Cash Flows
    57  
Notes to Consolidated Financial Statements
    58  
       
(2) Financial Statement Schedule: Schedule II — Valuation Accounts
    71  
 
All other financial statement schedules have been omitted because they are not applicable, not required or the information required is shown in the financial statements or the notes thereto.
 
         
(3) Exhibits
    72   
 
The exhibits filed with this Annual Report on Form 10-K are listed in the Exhibit Index immediately following the financial statement schedules, which Exhibit Index is incorporated herein by reference.


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SIGNATURES
 
Pursuant to the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
TranS1 Inc.
 
  By: 
/s/  Richard Randall
Richard Randall
President and Chief Executive Officer
 
Date: March 12, 2010
 
POWER OF ATTORNEY
 
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Richard Randall and Michael Luetkemeyer, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes may do or cause to be done by virtue hereof.
 
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
             
Signature
 
Title
 
Date
 
         
/s/  Richard Randall

Richard Randall
  President and Chief Executive Officer (Principal Executive Officer)   March 12, 2010
         
/s/  Michael Luetkemeyer

Michael Luetkemeyer
  Chief Financial Officer
(Principal Financial and Accounting Officer)
  March 12, 2010
         
/s/  Michael Carusi

Michael Carusi
  Director   March 12, 2010
         
/s/  Mitchell Dann

Mitchell Dann
  Director   March 12, 2010
         
/s/  Paul LaViolette

Paul LaViolette
  Director   March 12, 2010
         
/s/  Jonathan Osgood

Jonathan Osgood
  Director   March 12, 2010
         
/s/  James Shapiro

James Shapiro
  Director   March 12, 2010
         
/s/  Joseph Slattery

Joseph Slattery
  Director   March 12, 2010


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Management Report on Internal Control Over Financial Reporting
 
The management of TranS1 is responsible for establishing and maintaining adequate internal control over financial reporting. TranS1’s internal control system was designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
TranS1’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2009. In making this assessment, it used the criteria set forth in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on management’s assessment, we concluded that, as of December 31, 2009, our internal control over financial reporting was effective based on those criteria.
 
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2009 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.


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Report of Independent Registered Public Accounting Firm
 
To the Board of Directors and Stockholders of TranS1 Inc.
 
In our opinion, the accompanying consolidated financial statements for 2009 and the financial statements for 2008 listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of TranS1 Inc. and its subsidiaries at December 31, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule and on the Company’s internal control over financial reporting based on our integrated audits which were integrated audits in 2009 and 2008. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
 
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
 
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
 
/s/  PricewaterhouseCoopers LLP
 
Raleigh, NC
March 12, 2010


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    December 31,  
    2009     2008  
    (In thousands, except share amounts)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 29,298     $ 42,051  
Short-term investments
    25,953       35,215  
Accounts receivable, net
    3,926       4,812  
Inventory
    7,325       6,369  
Prepaid expenses and other assets
    676       632  
                 
Total current assets
    67,178       89,079  
Property and equipment, net
    1,813       1,412  
                 
Total assets
  $ 68,991     $ 90,491  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
Accounts payable
  $ 2,442     $ 2,896  
Accrued expenses
    1,269       2,009  
                 
Total current liabilities
    3,711       4,905  
                 
Commitments (Note 5)
               
Stockholders’ equity:
               
Common stock, $0.0001 par value; 75,000,000 shares authorized, 20,648,447 and 20,538,333 shares issued and outstanding at December 31, 2009 and 2008,respectively
    2       2  
Preferred stock, $0.0001 par value; 5,000,000 shares authorized, none issued and outstanding at December 31, 2009 and 2008. 
           
Additional paid-in capital
    136,402       133,507  
Accumulated other comprehensive income
    (5 )      
Accumulated deficit
    (71,119 )     (47,923 )
                 
Total stockholders’ equity
    65,280       85,586  
                 
Total liabilities and stockholders’ equity
  $ 68,991     $ 90,491  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.


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TranS1 Inc.
 
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (In thousands, except per share amounts)  
 
Revenue
  $ 29,807     $ 25,304     $ 16,473  
Cost of revenue
    5,687       4,315       3,042  
                         
Gross profit
    24,120       20,989       13,431  
                         
Operating expenses:
                       
Research and development
    6,439       4,081       3,885  
Sales and marketing
    34,098       29,375       15,706  
General and administrative
    7,184       7,116       3,801  
                         
Total operating expenses
    47,721       40,572       23,392  
                         
Operating loss
    (23,601 )     (19,583 )     (9,961 )
Interest income
    405       2,548       1,384  
                         
Net loss
  $ (23,196 )   $ (17,035 )   $ (8,577 )
                         
Net loss per common share — basic and diluted
  $ (1.13 )   $ (0.84 )   $ (1.46 )
                         
Weighted average common shares outstanding — basic and diluted
    20,604       20,289       5,872  
                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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TranS1 Inc.
 
 
                                                         
                            Accumulated
          Total
 
                Additional
          Other
          Stockholders’
 
    Common Stock     Paid-In
    Notes
    Comprehensive
    Accumulated
    Equity
 
    Number     Amount     Capital     Receivable     Income     Deficit     (Deficit)  
    (In thousands, except share data)  
 
Balance at December 31, 2006
    2,435,484     $     $ 820     $ (38 )   $     $ (22,311 )   $ (21,529 )
Issuance of common stock from exercised options
    290,292               123                               123  
Issuance of common stock from initial public offering
    6,325,000       1       86,658                               86,659  
Conversion of preferred stock to common stock
    10,793,165       1       40,088                               40,089  
Stock based compensation
                    2,636                               2,636  
Repayment of note receivable
                            38                       38  
Net loss
                                            (8,577 )     (8,577 )
                                                         
Balance at December 31, 2007
    19,843,941       2       130,325                   (30,888 )     99,439  
Issuance of common stock from exercised options
    694,392               203                               203  
Stock based compensation
                    2,979                               2,979  
Net loss
                                            (17,035 )     (17,035 )
                                                         
Balance at December 31, 2008
    20,538,333       2       133,507                   (47,923 )     85,586  
Issuance of common stock from exercised options
    110,114               96                               96  
Stock based compensation
                    2,799                               2,799  
Other comprehensive income
                                    (5 )             (5 )
Net loss
                                            (23,196 )     (23,196 )
                                                         
Balance at December 31, 2009
    20,648,447     $ 2     $ 136,402     $     $ (5 )   $ (71,119 )   $ 65,280  
                                                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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TranS1 Inc.
 
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (In thousands)  
 
Cash flows from operating activities:
                       
Net loss
  $ (23,196 )   $ (17,035 )   $ (8,577 )
Adjustments to reconcile net loss to net cash used in operating activities:
                       
Depreciation
    909       804       540  
Stock-based compensation
    2,799       2,979       2,636  
Allowance for excess and obsolete inventory
    505       400       306  
Provision for bad debts
    80       101       95  
Changes in operating assets and liabilities:
                       
(Increase) decrease in accounts receivable
    806       (1,688 )     (1,700 )
Increase in inventory
    (1,461 )     (2,744 )     (2,251 )
Increase in prepaid expenses
    (44 )     (35 )     (367 )
Increase (decrease) in accounts payable
    (454 )     1,265       788  
Increase (decrease) in accrued liabilities
    (745 )     223       1,185  
                         
Net cash used in operating activities
    (20,801 )     (15,730 )     (7,345 )
                         
Cash flows from investing activities:
                       
Purchase of property and equipment
    (1,310 )     (1,128 )     (516 )
Purchases of investments
    (50,872 )     (55,761 )     (30,687 )
Sales of investments
    60,134       49,791       11,370  
                         
Net cash provided by (used in) investing activities
    7,952       (7,098 )     (19,833 )
                         
Cash flows from financing activities:
                       
Proceeds from issuance of common stock
    96       203       86,820  
                         
Net cash provided by financing activities
    96       203       86,820  
                         
Net increase (decrease) in cash and cash equivalents
    (12,753 )     (22,625 )     59,642  
Cash and cash equivalents, beginning of period
    42,051       64,676       5,034  
                         
Cash and cash equivalents, end of period
  $ 29,298     $ 42,051     $ 64,676  
                         
Supplemental disclosure of noncash financing activities:
                       
Conversion of preferred stock to common stock
  $     $     $ 40,089  
                         
 
The accompanying notes are an integral part of these consolidated financial statements.


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TranS1 Inc.
 
 
1.   Organization
 
TranS1 Inc., a Delaware corporation (the “Company”), was incorporated in May 2000 and is headquartered in Wilmington, North Carolina. The Company is a medical device company focused on designing, developing and marketing products that implement its minimally invasive surgical approach to treat degenerative disc disease and instability affecting the lower lumbar region of the spine and operates in one business segment. The Company has developed and currently markets two single-level fusion products, the AxiaLIF® and the AxiaLIF 360°tm and a two-level fusion product, the AxiaLIF 2Ltm. All of the Company’s products are delivered using its pre-sacral approach. The AxiaLIF product was commercially released in January 2005, the AxiaLIF 360° product was commercially released in July 2006 and the AxiaLIF 2L product was commercially released in Europe in the fourth quarter of 2006. The Company received 510(k) clearance for the AxiaLIF 2L from the FDA and began marketing this product in the United States in the second quarter of 2008. The Company generates revenue from the sale of implants and procedure kits. The Company sells its products directly to hospitals and surgical centers in the United States and in certain European countries and to independent distributors outside the United States.
 
The Company is subject to a number of risks similar to other companies in the medical device industry. These risks include rapid technological change, uncertainty of market acceptance of our products, uncertainty of regulatory approval, competition from substitute products and larger companies, the need to obtain additional financing, compliance with government regulation, protection of proprietary technology, product liability, and the dependence on key individuals.
 
2.   Summary of Significant Accounting Policies
 
Basis of Presentation
 
The Company has prepared the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The Company’s fiscal year ends on December 31. On October 5, 2007, the Company’s Board of Directors approved an amendment to the Company’s existing certificate of incorporation effecting a 0.9-for-1 reverse stock split. All share and per share information in the accompanying consolidated financial statements and notes to the consolidated financial statements has been retroactively restated to reflect the effect of the stock split.
 
On October 22, 2007, all of the outstanding preferred shares were converted into 10,793,165 common shares and the Company completed its initial public offering of 6,325,000 shares of common stock, at an offering price of $15.00 per share. The net proceeds of this offering, after deducting the underwriting discounts, commissions and offering expenses, were approximately $86.7 million.
 
In the second quarter of 2009, the Company revised the classification of patent-related legal costs from research and development expense to general and administrative expense as such costs typically would be excluded from research and development costs as defined by Accounting Standards Codification 730 (formerly Statement of Financial Accounting Standards No. 2, “Accounting for Research and Development Costs”). Amounts related to prior periods are not considered material to the financial statements taken as a whole, but were revised for purposes of comparability. Such amounts for the years ended December 31, 2008 and 2007 were $940,000 and $900,000, respectively. The revision did not affect previously reported total operating expenses, net loss, loss per share, assets, liabilities, stockholders’ equity or cash flows.
 
Principles of Consolidation:
 
These consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany transactions and accounts have been eliminated in consolidation.


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Use of Estimates
 
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The principal estimates relate specifically to accounts receivable reserves, inventory reserves, stock-based compensation, accrued expenses and income tax valuations.
 
Cash and Cash Equivalents
 
The Company considers all highly liquid investments with an original maturity of three months or less at the date of purchase to be cash equivalents. Cash and cash equivalents include money market funds and commercial paper. Cash equivalents are carried at fair market value. Related unrealized gains and losses were insignificant as of December 31, 2009 and 2008.
 
Investments
 
All marketable investments are classified as available-for-sale and therefore are carried at fair market value. Related unrealized gains and losses were insignificant as of December 31, 2009 and 2008. Realized gains and losses on the sale of all such investments are reported in earnings and computed using the specific identification cost method and were insignificant for the years ended December 31, 2009 and 2008. All of the Company’s investments as of December 31, 2009 have maturities of one year or less. The following table presents the components of the Company’s available-for-sale investments:
 
                 
    December 31,  
    2009     2008  
    (In thousands)  
 
Short-term investments:
               
U.S. government securities
  $ 25,953     $ 9,035  
Commercial paper
          4,978  
Corporate debt securities
          18,972  
Certificate of deposit
          2,230  
                 
Total short-term investments
  $ 25,953     $ 35,215  
                 
 
Fair Value of Financial Instruments
 
The carrying values of cash equivalents, short-term investments, accounts receivable, and accounts payable at December 31, 2009 and 2008 approximated their fair values due to the short-term nature of these items.
 
At December 31, 2009, the Company holds certain assets that are required to be measured at fair value on a recurring basis. These assets include available for sale securities classified as cash equivalents and short-term investments. Accounting Standards Codification (“ASC”) 820-10 (formerly Statement of Financial Accounting Standards No. 157 (SFAS 157), “Fair Value Measurements”), requires the valuation of investments using a three tiered approach, which requires that fair value measurements be classified and disclosed in one of three tiers. These tiers are: Level 1, defined as quoted prices in active markets for identical assets or liabilities; Level 2, defined as valuations based on observable inputs other than those included in Level 1, such as quoted prices for similar assets and liabilities in active markets, or other inputs that are observable or can be corroborated by observable input data; and Level 3, defined as valuations based on unobservable inputs


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
reflecting the Company’s own assumptions, consistent with reasonably available assumptions made by other market participants.
 
At December 31, 2009, all available for sale securities are classified as Level 1 assets with a fair value of $54.9 million, which included money market funds of $28.9 million and short-term investments of $26.0 million. At December 31, 2008, all available for sale securities are classified as Level 1 assets with a fair value of $76.8 million, which included money market funds of $41.6 million and short-term investments of $35.2 million. The Company had no Level 2 or Level 3 assets or liabilities at December 31, 2009 or 2008.
 
Accounts Receivable
 
Accounts receivable are presented net of an allowance for uncollectible accounts. Estimates on the collectability of customer accounts are based primarily on an analysis of historical trends and experience and changes in customers’ financial condition. The following table presents the components of accounts receivable:
 
                 
    December 31,  
    2009     2008  
    (In thousands)  
 
Gross accounts receivable
  $ 4,119     $ 5,005  
Allowance for uncollectible accounts
    (193 )     (193 )
                 
Total accounts receivable, net
  $ 3,926     $ 4,812  
                 
 
Concentration of Credit Risk and Significant Customers
 
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash and cash equivalents.
 
The Company places cash deposits with a federally insured financial institution, in amounts which at times exceed the federally insured limit, which was $250,000 at December 31, 2009 and 2008. The total amount of deposits in excess of federally insured limits was $71,000 and $1,914,000 at December 31, 2009 and 2008, respectively.
 
In 2009, 2008 and 2007 no customer accounted for 10% or more of revenues. As of December 31, 2009 and 2008, no single customer accounted for 10% or more of the accounts receivable balance.
 
Inventories
 
Inventories consist of the following:
 
                 
    December 31,  
    2009     2008  
    (In thousands)  
 
Raw materials
  $ 220     $ 437  
Work-in-process
    3,993       3,334  
Finished goods
    3,112       2,598  
                 
Total inventories
  $ 7,325     $ 6,369  
                 
 
Inventories are stated at the lower of cost or market, computed on a standard cost basis, which approximates actual cost on a first-in, first-out basis and market being determined as the lower of replacement cost or net realizable value. Inventory reserves are established when conditions indicate that the selling price could be less than cost due to obsolescence or the Company determines that it holds excessive levels of inventory based on market demand.


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Property and Equipment
 
Property and equipment are recorded at cost and depreciated over their estimated useful lives using the straight-line method. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the related asset. Maintenance and repairs are charged to expense as incurred. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation and amortization are removed from the accounts and any resulting gain or loss is credited or charged to income.
 
The estimated useful lives are:
 
     
Furniture and fixtures
  5-10 years
Equipment
  3-5 years
Other depreciable assets
  2-10 years
Leasehold improvements
  Lesser of estimated useful life or lease term
 
Revenue Recognition
 
Revenue is recognized based on the following criteria: (i) persuasive evidence that an arrangement exists with the customer; (ii) the delivery of the products and/or services has occurred (title has transferred); (iii) the selling price has been fixed for the products or services delivered; and (iv) the collection is reasonably assured. Revenue is generated from the sale of implants and procedure kits, which consist of disposable instruments. The Company has two distinct sale methods. The first method is when procedure kits are sold directly to hospitals or surgical centers. The Company’s sales representatives or independent sales agents hand deliver the procedure kit to the customer on the day of the surgery or several days prior to the surgery. The sales representative or independent agent is then responsible for reporting the delivery of the procedure kit, and the date of the operation to the corporate office for proper revenue recognition. The Company recognizes revenue upon the confirmation that the procedure kit has been used in a surgical procedure. The other sales method is for sales to distributors outside the United States. These distributors order multiple procedure kits at one time to have on hand. These transactions require the customer to send in a purchase order before shipment will be made to the customer. The Company determines revenue recognition on a case by case basis dependent upon the terms and conditions of each individual distributor agreement. Under the distributor agreements currently in place, a distributor only has the right of return for defective products and, accordingly, revenue is recognized upon shipment.
 
Shipping and Handling Costs
 
Shipping and handling costs in the United States are expensed as incurred and are included in the cost of revenue. These costs are not reimbursed by the Company’s customers. Shipping costs to distributors outside the United States are either paid directly by the distributor to the freight carrier or charged to the distributor and reimbursed to the Company.
 
Sales and Marketing Expenses
 
Sales and marketing expenses consist of personnel costs, including stock-based compensation expense, sales commissions paid to the Company’s direct sales representatives and independent sales agents, and costs associated with physician training programs, promotional activities, and participation in medical conferences. All costs of advertising and promotional activities are expensed as incurred. Advertising expenses were $1.8 million, $1.7 million and $0.7 million for the years ending December 31, 2009, 2008 and 2007, respectively.


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
Research and Development Expenses
 
Research and development expenses consist primarily of personnel costs, including stock-based compensation expense, within the Company’s product development, regulatory and clinical functions and the costs of clinical studies and product development projects. Research and development expenses are expensed as incurred.
 
Patent Costs
 
Costs associated with the submission of a patent application are expensed as incurred given the uncertainty of the patents resulting in probable future economic benefits to the Company.
 
Income Taxes
 
The Company accounts for income taxes using the liability method which requires the recognition of deferred tax assets or liabilities for the temporary differences between financial reporting and tax bases of the Company’s assets and liabilities and for tax carryforwards at enacted statutory tax rates in effect for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in the period that includes the enactment date. In addition, valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.
 
Stock-Based Compensation
 
The Company accounts for stock-based compensation under the fair value provisions of ASC 718, (formerly SFAS 123R, Share-Based Payment). ASC 718 requires the recognition of compensation expense, using a fair-value-based method, for costs related to all share-based payments including stock options. ASC 718 requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The Company adopted ASC 718 using the prospective transition method, which requires that for nonpublic entities that used the minimum value method for either pro forma or financial statements recognition purposes, ASC 718 shall be applied to option grants or modifications to existing options after the required effective date. For options granted prior to the new ASC 718 effective date and for which the requisite service period has not been performed as of January 1, 2006, the Company has continued to apply the intrinsic value provisions of Accounting Principles Board Opinion No. 25 (APB 25), Accounting for Stock Issued to Employees, on the remaining unvested awards. All options granted after January 1, 2006 are expensed on a straight-line basis over the vesting period.
 
The Company accounts for stock-based compensation arrangements with nonemployees in accordance with ASC 505-50 (formerly the Emerging Issues Task Force Abstract No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services). The Company records the expense of such services based on the estimated fair value of the equity instrument using the Black-Scholes pricing model. The value of the equity instruments is charged to earnings over the term of the service agreement.
 
Net Loss Per Common Share
 
Basic net loss per common share (“Basic EPS”) is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding. Diluted net loss available to common stockholders per common share (“Diluted EPS”) is computed by dividing net loss available to common stockholders by the weighted average number of common shares and dilutive potential common share equivalents then outstanding. The Company’s potential dilutive common shares, which consist of shares issuable upon the exercise of stock options and conversion of convertible preferred stock, have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive.


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
The following table sets forth the potential shares of common stock that are not included in the calculation of diluted net loss per share as the result would be anti-dilutive as of the end of each period presented:
 
                         
    Year Ended December 31,
    2009   2008   2007
 
Weighted average stock options outstanding
    2,110,689       1,915,687       1,928,495  
                         
 
Segment and Geographic Reporting
 
The Company applies ASC 280 (formerly SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”). ASC 280 establishes standards for the reporting by business enterprises of information about operating segments, products and services, geographic areas, and major customers. The Company has determined that it did not have any separately reportable segments as of December 31, 2009, 2008 or 2007.
 
Revenue by geographic area was:
 
                         
    Year Ended December 31,  
    2009     2008     2007  
    (In thousands)  
 
United States
  $ 28,045     $ 23,322     $ 15,085  
Europe
    1,602       1,854       1,183  
Other
    160       128       205  
                         
    $ 29,807     $ 25,304     $ 16,473  
                         
 
Long-lived assets are primarily located in the United States.
 
Recently Issued Accounting Standards
 
In February 2008, the FASB issued ASC 820 (formerly Staff Position No. FAS 157-2, “Fair Value Measurements”), which delayed the effective date of ASC 820 for non-financial assets and liabilities to fiscal years beginning after November 15, 2008. The company adopted ASC 820 for its non-financial assets and non-financial liabilities on January 1, 2009, and it did not have a material impact on the Company’s consolidated financial statements.
 
In June 2009, the FASB issued the FASB Accounting Standards Codification (“ASC”). The Codification has become the single source for all authoritative GAAP recognized by the FASB to be applied for financial statements issued for periods ending after September 15, 2009. The Company applied the Codification to its Annual Report on Form 10-K for the period ending December 31, 2009. The Codification does not change GAAP and did not have an effect on the Company’s consolidated financial position or results of operations.
 
In May 2009, the FASB issued ASC 855 (formerly SFAS No. 165, “Subsequent Events”), which establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. ASC 855 provides guidance on the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The Company adopted ASC 855 during the second quarter of 2009, and its application did not have a material impact on its consolidated financial statements.


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
No other recently issued, but not yet effective, accounting standards are believed to have a material impact on the Company.
 
3.   Property and Equipment
 
Property and equipment consist of the following:
 
                 
    December 31,  
    2009     2008  
    (In thousands)  
 
Furniture and fixtures
  $ 210     $ 186  
Equipment
    2,620       2,061  
Computer software
    410       415  
Leasehold improvements
    380       380  
Tools
    73       73  
Construction in process
    588       14  
                 
      4,281       3,129  
Less: accumulated depreciation and amortization
    (2,468 )     (1,717 )
                 
    $ 1,813     $ 1,412  
                 
 
Depreciation and amortization expense for the years ended December 31, 2009, 2008 and 2007 was $909,000, $804,000, and $540,000, respectively.
 
4.   Accrued Expenses
 
Accrued expenses consist of the following:
 
                 
    December 31,  
    2009     2008  
    (In thousands)  
 
Commissions
  $ 597     $ 1,178  
Vacation
    186       163  
Franchise taxes
    122       121  
Consulting
    120       66  
Legal and professional fees
    90       69  
Travel & entertainment
    50       50  
Bonus
    10       270  
Clinical
    10       20  
Other
    84       72  
                 
Total accrued expenses
  $ 1,269     $ 2,009  
                 


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
5.   Lease Obligations
 
The Company rents office space under the terms of an operating lease, which expires in 2019.
 
Future minimum lease payments under operating lease obligations at December 31, 2009 are as follows (in thousands):
 
         
Year ending December 31,
       
2010
  $ 374  
2011
    332  
2012
    363  
2013
    363  
2014 and after
    2,696  
         
    $ 4,128  
         
 
Rent expense related to operating leases for the years ended December 31, 2009, 2008 and 2007 was $204,000, $157,000 and $152,000, respectively.
 
6.   Stockholders’ Equity
 
At December 31, 2009 and 2008, the Company’s Amended and Restated Certificate of Incorporation, which was adopted in connection with the Company’s initial public offering, authorized up to 80,000,000 shares of capital stock, of which 75,000,000 shares were designated as common stock with a par value of $0.0001 and up to 5,000,000 shares were designated as preferred stock with a par value of $0.0001. At December 31, 2009 and 2008, there were 20,648,447 and 20,538,333 shares of common stock issued and outstanding, respectively, and there were no shares of preferred stock issued and outstanding.
 
In 2009, the Company issued 110,114 shares of the common stock to employees and consultants for $96,000 upon the exercise of stock options. In 2008, the Company issued 694,392 shares of common stock to employees and consultants for $203,000 upon the exercise of stock options. In 2007, the Company issued 290,292 shares of common stock to employees and consultants for $123,000 upon the exercise of stock options.
 
7.   Stock Incentive Plans and Stock-Based Compensation
 
2007 Employee Stock Purchase Plan
 
The Company’s board of directors adopted the 2007 Employee Stock Purchase Plan (the “ESPP”) in July 2007. The ESPP became effective upon the completion of the Company’s initial public offering. A total of 250,000 shares of common stock are available for sale. In addition, the ESPP provides for annual increases in the number of shares available for issuance under the ESPP on the first day of each fiscal year beginning in 2008, equal to the lesser of (i) 2.0% of the outstanding shares of common stock on the first day of such fiscal year or (ii) an amount determined by the administrator of the ESPP. The Company’s Compensation Committee administers the ESPP.
 
Shares shall be offered pursuant to the ESPP in six-month periods commencing on the first trading day on or after June 1 and December 1 of each year, or on such other date as the administrator may determine.
 
Our ESPP permits participants to purchase common stock through payroll deductions of up to 10% of their eligible compensation, which includes a participant’s base straight time gross earnings, certain commissions, overtime and shift premium, but exclusive of payments for incentive compensation, bonuses and other compensation. A participant may purchase a maximum of 2,500 shares during a six-month purchase period. Amounts deducted and accumulated by the participant are used to purchase shares of the Company’s common


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
stock at the end of each six-month purchase period. The purchase price of the shares will be 95% of the fair market value of Company common stock on the exercise date. Participants may end their participation at any time during an offering period, and will be paid their accrued payroll deductions that have not yet been used to purchase shares of common stock. Participation ends automatically upon termination of employment with the Company. Pursuant to ASC 718, the Company is not required to recognize compensation expense in connection with purchases under the ESPP.
 
During fiscal years ended December 31, 2009, 2008 and 2007, no shares were issued to participants under the ESPP.
 
2000 and 2007 Stock Incentive Plans
 
The Company established the TranS1 Inc. Stock Incentive Plan in 2000, (as amended, the “2000 Plan”) and the 2007 Stock Incentive Plan (the “2007 Plan”) in October 2007 (collectively, the “Plans”) . Under the 2000 Plan and the 2007 Plan, the Company may grant options to employees, directors or service providers and contractors for a maximum of 3,159,108 and 1,400,000 shares, respectively, of the Company’s common stock. Options granted under the Plans may be incentive stock options or non-qualified stock options. Non-qualified stock options may be granted to service providers and incentive stock options may be granted only to employees. The exercise periods may not exceed ten years for options. However, in the case of an incentive stock option granted to an optionee who, at the time of the option grant owns stock representing more than 10% of the outstanding shares, the term of the option shall be five years from the date of the grant. The exercise price of incentive stock options cannot be less than 100% of the fair market value per share of the Company’s common stock on the grant date. The exercise price of a nonqualified option under the 2000 Plan and the 2007 Plan shall not be less than 85% and 100%, respectively, of the fair market value per share on the date the option is granted. If an optionee owns more than 10% of the outstanding shares, the exercise price cannot be less than 110% of the fair market value of the stock on the date of the grant. Options granted under the Plans generally vest over periods ranging from three to four years.
 
The following table summarizes the activity of the Company’s 2000 Plan and 2007 Plan, including the number of shares under options (“Number”) and the weighted average exercise price (“Price”):
 
                 
    Number     Price  
 
Outstanding as of December 31, 2008
    2,247,733     $ 7.12  
Options granted
    495,500       6.53  
Options exercised
    (110,114 )     0.91  
Options forfeited
    (417,093 )     8.88  
                 
Outstanding as of December 31, 2009
    2,216,026     $ 6.96  
                 
 
The following table summarizes information about the Company’s stock options at December 31, 2009:
 
                                 
          Weighted
    Weighted
       
          Average
    Average
    Number of
 
    Number
    Contractual
    Exercise
    Options
 
Range of Exercise Prices
  Outstanding     Life (Years)     Price     Exercisable  
 
$ 0.11 - $ 2.00
    569,756       5.5     $ 0.81       539,862  
$ 2.01 - $ 6.00
    689,770       8.1       5.69       255,923  
$ 6.01 - $10.00
    385,375       8.4       8.78       174,175  
$12.00 - $13.00
    380,084       7.9       12.39       186,875  
$14.00 - $20.00
    191,041       7.7       15.36       129,241  
                                 
      2,216,026       7.4       6.96       1,286,076  
                                 


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
The aggregate intrinsic value of outstanding stock options at December 31, 2009 was $1.8 million. At December 31, 2009, exercisable stock options had an aggregate intrinsic value of $1.7 million, a weighted average contractual life of 6.8 years and a weighted average exercise price of $5.88.
 
Stock-Based Compensation for Non-employees
 
During 2009, the Company issued options to purchase 2,500 shares of common stock with an exercise price of $6.00 per share to consultants. These options vest over 3 years and expire 10 years from the date of issuance. During 2008, the Company issued options to purchase 35,000 shares of common stock with an average exercise price of $12.43 per share to consultants. These options vest over a range of 1 to 3 years and expire 10 years from the date of issuance. During 2007, the Company issued options to purchase 50,207 shares of common stock with an average exercise price of $7.52 per share to consultants. These options vest over a range of zero to three years and expire 10 years from the date of issuance. The Company determined the estimated fair value of the options issued to the consultants using the Black-Scholes pricing model. The Company used the following assumptions in the Black-Scholes pricing model for 2009 grants: 60% volatility, 0% dividend yield, 2.65% risk-free rate and a 6 year expected legal life. The Company used the following assumptions in the Black-Scholes pricing model for 2008 grants: 54% volatility, 0% dividend yield, 1.54% risk-free rate and 6 year expected life. The Company used the following assumptions in the Black-Scholes pricing model for 2007 grants: 45% volatility, 0% dividend yield, 4.92% risk-free rate and 6 year expected life.
 
Stock-based compensation expense charged to operations on options granted to non-employees for years ended December 31, 2009, 2008 and 2007 was $8,000, $118,000 and $1.1 million, respectively. As of December 31, 2009, there was $3,000 of total unrecognized compensation costs related to non-vested stock option awards which is expected to be recognized over a weighted-average period of 0.5 years.
 
Employee Stock-Based Compensation
 
Under ASC 718, compensation cost for employee stock-based awards is based on the estimated grant-date fair value and is recognized over the vesting period of the applicable award on a straight-line basis. For the period from January 1, 2006 to December 31, 2009, the Company issued employee stock-based awards in the form of stock options. The Company recorded stock-based compensation expense of $2.8 million, $2.9 million and $1.5 million for the years ended December 31, 2009, 2008 and 2007, respectively. The weighted average estimated fair value of the employee stock options granted for the years ended December 31, 2009, 2008 and 2007 was $6.53, $11.77 and $10.34 per share, respectively. The aggregate intrinsic value of stock options (the amount by which the market price of the stock on the date of exercise exceeded the exercise price of the option) exercised for the years ended December 31, 2009, 2008 and 2007, was $0.6 million, $5.4 million, and $3.8 million, respectively.
 
The Company uses the Black-Scholes pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include our expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates and expected dividends. Prior to the Company’s initial public offering, the Board of Directors, with the assistance of management, performed contemporaneous fair value analyses to determine the fair value of the common stock at the time of the stock option grants. The estimated grant-date fair values of the employee stock options were calculated using the Black-Scholes valuation model, based on the following assumptions for the years ended December 31, 2009, 2008 and 2007:
 
Expected Life.  The expected life of six years is based on the “simplified” method described in the SEC Staff Accounting Bulletin No. 110, which provides guidance regarding the application of ASC 718.
 
Volatility.  Through October 17, 2007, the Company was a private entity with no historical data regarding the volatility of its common stock. Accordingly, the expected volatility used for 2007 was based


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
on volatility of similar entities, referred to as “guideline” companies. In 2009 and 2008, the expected volatility was based on a weighted average of the actual volatility of the Company for the current year and the guideline companies for prior periods. In evaluating similarity, the Company considered factors such as industry, stage of life cycle and size. The Company utilized an expected volatility range of 54% to 58% for 2009, 45% to 54% for 2008 and 45% for 2007.
 
Risk-Free Interest Rate.  The risk-free rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options. The risk-free rates were:
 
     
Option Grant Year
  Risk-Free Rate Range
 
2009
  1.79% to 2.52%
2008
  2.68% to 3.21%
2007
  4.58% to 4.92%
 
Dividend Yield.  The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
 
Forfeitures.  ASC 718 also requires the Company to estimate forfeitures at the time of grant, and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. The Company uses historical data to estimate pre-vesting option forfeitures and record stock-based compensation expense only for those awards that are expected to vest. All stock-based payment awards are amortized on a straight-line basis over the requisite service periods of the awards, which are generally the vesting periods.
 
As of December 31, 2009, there was $4.4 million of total unrecognized compensation costs related to non-vested employee stock option awards granted after January 1, 2006, which is expected to be recognized over a weighted-average period of 2.8 years.
 
8.   Income Taxes
 
No provision for federal or state income taxes has been recorded as the Company has incurred net operating losses since inception.
 
Significant components of the Company’s deferred tax assets and liabilities consist of the following:
 
                 
    2009     2008  
    (In thousands)  
 
Deferred tax assets
               
Domestic net operating loss carryforwards
  $ 20,707     $ 14,350  
Inventory
    272       200  
Fixed assets
    532       242  
Other
    638       485  
Research and development credit
    1,031       716  
                 
Total deferred tax assets
    23,180       15,993  
Valuation allowance for deferred assets
    (23,180 )     (15,993 )
                 
Deferred tax assets
           
                 
Deferred tax liabilities
               
Fixed assets
           
                 
Total deferred tax liabilities
           
                 
Net deferred tax assets (liabilities)
  $     $  
                 


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
The Company provided a full valuation allowance against its net deferred tax assets since realization of these benefits could not be reasonably assured. The increase in valuation allowance resulted primarily from the additional net operating loss carryforward generated.
 
As of December 31, 2009, the Company had federal and state net operating loss carryforwards of approximately $54.7 million and $51.7 million, respectively. These net operating loss carryforwards begin to expire in 2021 and 2016 for federal and state tax purposes, respectively. Additionally, as of December 31, 2009, the Company had research credit carryforwards of $1.1 million for federal tax purposes. These credit carryforwards begin to expire in 2021. The utilization of the federal net operating loss carryforwards may be subject to limitations under the rules regarding a change in stock ownership as determined by the Internal Revenue Code.
 
A reconciliation of differences between the U.S. federal income tax rate and the Company’s effective tax rate for the years ended December 31 is as follows:
 
                                                 
    2009     2008     2007  
          % of
          % of
          % of
 
    Amount     Net Loss     Amount     Net Loss     Amount     Net Loss  
    (In thousands)  
 
Tax at statutory rate
  $ (8,119 )     35.0 %   $ (5,962 )     35.0 %   $ (3,002 )     35.0 %
State taxes
    (59 )     0.3 %     (447 )     2.6 %     (394 )     4.6 %
Non deductible items
    1,129       (4.9 )%     1,168       (6.9 )%     998       (11.6 )%
Other
    215       (0.9 )%     (470 )     2.8 %     53       (0.6 )%
R&D credits
    (486 )     2.1 %     (148 )     0.9 %     (115 )     1.3 %
Change in valuation allowance
    7,320       (31.6 )%     5,859       (34.4 )%     2,460       (28.7 )%
                                                 
Total
  $       0.0 %   $       0.0 %   $       0.0 %
                                                 
 
As of January 1, 2007, the Company adopted the provisions of ASC 740 (formerly FASB Interpretation No. 48 or FIN 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”), which clarifies the accounting for uncertainty in tax positions. As of that date, the Company had $1.1 million of unrecognized tax benefits related to the adoption of ASC 740. This would be recorded as a component of income tax expense once the valuation allowance is released. For the year ended December 31, 2009, the Company increased its unrecognized tax benefits by $13,000. The change was recorded as a reduction to the respective deferred tax asset which was reflected as an increase in the valuation allowance. As of December 31, 2009, the Company had $0.9 million of unrecognized tax benefits which, if recognized, would be recorded as a component of income tax expense. The Company’s policy is to record estimated interest and penalties related to the underpayment of income taxes as a component of its income tax provision. As of December 31, 2007, 2008 and 2009, the Company had no accrued interest or tax penalties recorded. A reconciliation of the beginning and ending uncertain tax positions is as follows (in thousands):
 
         
Balance at December 31, 2007
  $ 1,114  
Gross decreases related to current period tax positions
    (227 )
         
Balance at December 31, 2008
    887  
Gross increases related to current period tax positions
    13  
         
Balance at December 31, 2009
  $ 900  
         
 
In many cases, uncertain tax positions are related to tax years that remain subject to examination by the relevant tax authorities. Given the losses accumulated to date, periods open for examination are 2002 to 2009 for the primary taxing jurisdictions of the United States and North Carolina. The Company currently does not expect a significant change in the FIN 48 liability in the next 12 months.


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TranS1 Inc.
 
Notes to Consolidated Financial Statements — (Continued)
 
 
9.   Comprehensive Loss
 
The following table presents the components of other comprehensive loss:
 
                         
    Year Ended December 31,  
    2009     2008     2007  
 
Net loss
  $ (23,196 )   $ (17,035 )   $ (8,577 )
Other comprehensive income (loss):
                       
Translation adjustments
    (5 )            
                         
Total comprehensive loss
  $ (23,201 )   $ (17,035 )   $ (8,577 )
                         
 
10.   Quarterly Data (Unaudited)
 
The following unaudited quarterly financial data, in the opinion of management, reflects all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of results for the periods presented (in thousands, except per share data):
 
                                 
    Year Ended December 31, 2009
    First
  Second
  Third
  Fourth
    Quarter   Quarter   Quarter   Quarter
 
Total revenues
  $ 8,678     $ 7,938     $ 6,912     $ 6,279  
Gross profit
    7,136       6,423       5,546       5,015  
Total operating expenses
    12,517       13,293       11,171       10,740  
Net loss
  $ (5,164 )   $ (6,759 )   $ (5,571 )   $ (5,702 )
Basic and diluted net loss per common share
  $ (0.25 )   $ (0.33 )   $ (0.27 )   $ (0.28 )
 
                                 
    Year Ended December 31, 2008
    First
  Second
  Third
  Fourth
    Quarter   Quarter   Quarter   Quarter
 
Total revenues
  $ 5,978     $ 5,951     $ 6,021     $ 7,354  
Gross profit
    4,940       4,814       5,010       6,225  
Total operating expenses
    8,319       10,801       10,363       11,089  
Net loss
  $ (2,439 )   $ (5,299 )   $ (4,764 )   $ (4,533 )
Basic and diluted net loss per common share
  $ (0.12 )   $ (0.26 )   $ (0.23 )   $ (0.22 )


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TRANS1 INC.
 
SCHEDULE II
 
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007
 
                                 
    Balance at
          Balance at
    Beginning of
          End of
    Period   Additions(1)   Deductions(2)   Period
    (In thousands)
 
Accounts Receivable Reserve:
                               
Year ended December 31, 2009
  $ 193     $ 80     $ 80     $ 193  
Year ended December 31, 2008
    110       101       18       193  
Year ended December 31, 2007
    29       95       14       110  
 
                                 
    Balance at
          Balance at
    Beginning of
          End of
    Period   Additions(3)   Deductions(4)   Period
    (In thousands)
 
Inventory Reserve:
                               
Year ended December 31, 2009
  $ 397     $ 505     $ 321     $ 581  
Year ended December 31, 2008
    295       400       298       397  
Year ended December 31, 2007
    57       306       68       295  
 
                                 
    Balance at
          Balance at
    Beginning of
          End of
    Period   Additions   Deductions   Period
    (In thousands)
 
Valuation Allowance for Deferred Tax Assets:
                               
Year ended December 31, 2009
  $ 15,993     $ 7,559     $ 372     $ 23,180  
Year ended December 31, 2008
    9,524       6,469             15,993  
Year ended December 31, 2007
    8,121       2,460       1,057       9,524  
 
 
(1) Amount represents customer balances deemed uncollectible.
 
(2) Uncollectible accounts written-off.
 
(3) Amount represents excess and obsolete reserve recorded to cost of sales.
 
(4) Excess and obsolete inventory written-off against reserve.


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EXHIBIT INDEX
 
         
Exhibit
   
No.
 
Description
 
  3 .1   Amended and Restated Certificate of Incorporation of TranS1 Inc. (incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
  3 .2   Amended and Restated Bylaws of TranS1 Inc. (incorporated by reference to Exhibit 3.4 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
  4 .1   Specimen common stock certificate (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
  10 .1   Amended and Restated 2000 Stock Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).*
  10 .2   Form of Stock Option Agreement under Amended and Restated 2000 Stock Incentive Plan (incorporated by reference to Exhibit 10.2 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).*
  10 .3   2007 Stock Incentive Plan, as amended (incorporated by reference to Appendix A to the Definitive Proxy Statement on Schedule 14A, as filed with the Commission on April 30, 2009.*
  10 .4   Form of Stock Option Agreement under 2007 Stock Incentive Plan (incorporated by reference to Exhibit 10.4 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).*
  10 .5   2007 Employee Stock Purchase Plan (incorporated by reference to Exhibit 10.5 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).*
  10 .6   Lease, dated July 30, 2009, between TranS1 Inc. and Market Place Group, LLC (incorporated by reference to Exhibit 10.1 of TranS1’s Current Report on Form 8-K filed with the Commission on March 11, 2010).
  10 .7   Form of Indemnification Agreement (incorporated by reference to Exhibit 10.7 to the Registration Statement on Form S-1, as amended (File No. 333-144802), and as declared effective on October 16, 2007).
  10 .7.1   Schedule of Parties to Indemnification Agreement.**
  10 .8   Offer Letter, dated December 11, 2009, between TranS1 Inc. and Kenneth Reali (incorporated by reference to Exhibit 10.1 of TranS1’s Current Report on Form 8-K filed with the Commission on January 12, 2010).*
  10 .9   Separation Agreement, dated February 23, 2010, between TranS1 Inc. and Michael Luetkemeyer (incorporated by reference to Exhibit 10.1 of TranS1’s Current Report on Form 8-K filed with the Commission on February 25, 2010).*
  23 .1   Consent of Independent Registered Public Accounting Firm.**
  24 .1   Power of Attorney (included in the signature page).
  31 .1   Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934.**
  31 .2   Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934.**
  32 .1   Certification of Chief Executive Officer Pursuant to Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.**
  32 .2   Certification of Chief Financial Officer Pursuant to Rule 13a-14(b) / 15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.**
 
 
* These exhibits are identified as management contracts or compensatory plans or arrangements of the Registrant pursuant to Item 15(a)(3) of Form 10-K.
 
** Filed herewith.


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