Surgalign Holdings, Inc.

Wendy Crites Wacker – IR Brian Hutchison – President and CEO Rob Jordheim – EVP and CFO Tom Rose - EVP, Administration and Corporate Secretary Carrie Hartill – EVP and CSO

David Turkaly - JMP Securities Matt Hewitt - Craig-Hallum William Plovanic - Canaccord Genuity

Good morning and thank you for joining RTI Surgical for our third quarter 2014 conference call. Today, we will hear from Brian Hutchison, President and Chief Executive Officer; and Rob Jordheim, Executive Vice President and Chief Financial Officer.

Also joining us this morning for Q&A are Tom Rose, Executive Vice President, Administration and Corporate Secretary; and Carrie Hartill, Executive Vice President and Chief Scientific Officer. Before we start, let me make the following disclosure about forward-looking statements.

The earnings and other matters, we will be discussing on this conference call will involve statements that are forward-looking. These statements are based on our management's current expectations, but they are subject to various risks and uncertainties associated with our lines of business and with the economic environment in general.

Our actual results may vary from any statements concerning our expectations about future events that are made during the course of this meeting, and we make no guarantees as to the accuracy of these statements. Accordingly, we urge you to consider all information about the company and not to place undue reliance on these forward-looking statements.

Now, I'll turn the call over to Brian Hutchison.

Good morning, everyone. And thank you for joining us.

I will start with an overview of the third quarter, and then Rob will review our financial results. I'll then follow-up with brief update on the untitled letter we received from the FDA regarding our map3 cellular allogeneic bone graft, followed by guidance for the fourth quarter and full year 2014.

As detailed in our press release issued this morning, we reported third quarter revenues of $65 million, a 19% increase over the third quarter of 2013. We met the upper end of our third quarter guidance of $64 million to $65 million.

If Pioneer revenues had been included for the full third quarter both 2013 and 2014, worldwide revenues would have increased by 13%. Reviewing each of our lines of business.

Third quarter spine revenues increased 16% compared to third quarter of 2013. The increase was due strong growth in the US direct business.

Our direct spine team continues to do an excellent job of converting distributors and surgeons to our broad spine portfolio, achieving record average daily sales during the third quarter. Product launches from the first half of the year such as streamline OCT continue to do well and shows steady growth.

Recently, we held our third spine surgeon symposium for the year. It was very well received and surgeons had hands on opportunities with our various final systems and biologic products.

Looking ahead, we will host our second annual biologic winter symposium in the fourth quarter featuring distinguishing faculty and an agenda focused on our extensive biologics portfolio. Continued traction from product launches, surgeon engagement efforts and investments in instrument sets will drive growth in spine as we close out the year.

At this time, we are anticipating spine will grow in the low teens for the full year of 2014 based of the fourth quarter of 2013 annualized run rate. Our sports medicine business increased 19% compared to third quarter of 2013.

The US direct sports business continues to perform well, the account recapture and new account development we've experienced in the first half have resulted in steady growth that we expect to continue. We anticipate growth in the high single digits for this line of business for the full year.

Third quarter surgical specialties revenues were comparable with the third quarter of 2013. This is due primarily to increases in the direct business in US, offset by decreases in revenue from some of our commercial customers.

At this time, we anticipate the surgical specialties business will grow in the low single digits for the full year 2014, with most of the growth coming from our direct distribution globally. Third quarter BGS general orthopedic revenues increased 20% compared to third quarter 2013, the increase in revenue for the quarter was due to growth in our direct business, offset by lower orders from our commercial customers.

We anticipate that the BGS GO revenue will grow in the mid single digits for the full year of 2014 based of the fourth quarter 2013 annualized run rate. Third quarter dental revenues increased 1% compared to third quarter 2013.

This is in line with our exclusive distributors, contracted minimums which we met our expectation. At this time, we anticipate that dental revenues will grow mid single digits for the full year of 2014 for our contract with our exclusive distributor.

Third quarter revenues for orthofixation were $9.5 million, this is an increase of 41% over third quarter 2013. We continue to be pleased with the growth in our direct cardiothoracic business, particularly around Tritium Sternal Cable Plating system.

At this time, we anticipate the orthofixation will grow in the mid teen based of fourth quarter 2013 annualize run rate. At this time, Rob will discuss more details for our financial results.

Thank you, Brian. Worldwide revenue of $65.2 million in the third quarter increased 19% compared to the third quarter of 2013.

Our prior revenues include Pioneer related revenues for the stub period of July 16, 2013 to September 30 of 2013. Whereas our current year period includes a full quarter of Pioneer related revenue.

If Pioneer revenues had been included to the third quarter for both 2013 and 2014, worldwide revenues would have been increased to 13%. Domestic revenues of $59.7 million for the third quarter increased 21% compared to the third quarter of 2013.

Pioneer revenues had been included for the entire third quarter for both 2013 and 2014, domestic revenues would have been increased to 14%. International revenues which include export and distribution from our German and Dutch facilities were $5.5 million for the third quarter of 2014 and were comparable to the third quarter of 2013.

Net income applicable to common shares for the third quarter of 2014 was $1.2 million or $0.02 per fully diluted common share based on $57.5 million fully diluted shares outstanding. This compares to net loss applicable to common shares of $9.1 million or $0.16 per fully diluted common share for the third quarter of 2013, based on $56.4 million fully diluted share outstanding.

Included net income applicable to common shares for the third quarter 2014 is a $457,000 pretax charge related to severance cost. Excluding the severance cost adjusted net income per fully diluted common share for the third quarter 2014 was $0.03.

Gross margin for the third quarter of 2014 was 53% as compared to 37% for the third quarter of 2013. On an adjusted basis excluding an inventory purchase accounting adjustment of $6.9 million taken in the third quarter of 2013, gross margin improved 300 basis points versus the prior year period as a result of an improvement in product mix.

During the quarter marketing, general and administrative expenses totaled $26.9 million, an increase of $2 million or 8% higher than the third quarter of 2013. The increase in expenses was primarily due to increases in variable compensation and distributor commission expense of $2 million and the $457,000 in severance cost.

Research and development expenses totaled $4.2 million for the third quarter of 2014, a decrease of $514,000, or 11% lower than the third quarter of 2013. The decrease was primarily due to cost reduction arising from the prior year restructure and a facility closure.

Lastly our tax rate for the third quarter of 2014 reflects the tax expense of 40% compared to a tax benefit of 37% in the third quarter of 2013. Our comparative income tax rate was negatively impacted due to the inclusion of non-deductible expenses in the prior year period which reduced the benefit in that period.

Turning to the balance sheet, our cash position at the end of the third quarter was $13.9 million compared to $18.7 million at the end of 2013. The decrease was primarily due to the construction of our new logistics and technology building and investments in spine instruments sets to drive growth.

For 2014, we anticipate being cash flow positive from operations. We are confident that with our current cash balances and available debt, we have adequate liquidity to support our future operations and meet our financing obligations.

Excluding an inventory purchase accounting adjustment of $5.7 million included in the inventory balance at the end of 2013, inventories of a $110.6 million increased $10.2 million as compared to the end of 2013. The increase in the inventories is due to set bills to support the growing spine business as well as inventory bills to support Map3 demand.

Working capital at the end of the third quarter totaled a $134.1 million, an increase of $5.5 million excluding the previously mentioned inventory purchase accounting adjustment of $5.7 million. At the end of the third quarter, we had $74.4 million of debt and approximately $7.2 million available under our revolving credit facility.

With that, I'll turn the call back over to Brian.

Thanks, Rob. Let me start by reviewing our recent interactions with FDA regarding our map3 allograft.

As most of you know, the map3 allograft is a natural and safe alternative to autograft that supports the process of bone healing and provides osteoinductive, osteoconductive and osteogenic characteristics necessary to facilitate bone growth. On September 26, we received a letter from FDA addressing some language included on the map3 website as well as some technical aspects of the processing of our map3 allograft.

On October 9, The Center for Biologics Evaluation and Research within the FDA, published the letter as an untitled letter on their website. We submitted an initial response to FDA on October 2nd.

We followed that response with the submission of a very comprehensive package of data that we believe addresses the agency's comments and provides clarification of the technical components of the implant processing. We believe we understand the basis for the FDA's questions, and we feel confident that in developing and the processing of the implant, we properly considered the relevant regulatory questions.

We expect next steps to include ongoing productive discussion with the FDA including a face to face meeting after they have time to review our comprehensive response. We continue to be confident that the map3 allograft provides clinical value and our expectations for the potential of this product have not changed.

We will update you as we have more news to share regarding the map3 allograft. Turning to guidance.

This morning, we outlined the expectations for revenue and EPS for the third quarter and full year 2014. For the first three quarters of the year, we made solid progress towards our goal.

We have maintained momentum throughout the year in our direct business and steady growth is expected in our commercial business. Our focuses on expense control and developing a strong cash position have also been successful, and we will continue as we finish up the year.

For the fourth quarter 2014, we expect revenues to be between $68 million and $69 million. This would result in 13% increase in revenues compared to Q4 of last year at the midpoint of our guidance.

We expect net income per fully diluted common share for the fourth quarter of 2014 to be approximately $0.04. Based on the results from the first three quarters of the year, we are narrowing our full year revenue guidance.

We now expect full year revenues to be between $260 million and $261 million, as compared to prior guidance of between $258 million and $261 million. This represents an increase of 32% year-over-year at the midpoint of our new guidance range.

On a non-GAAP basis, full year net income per fully diluted common share is expected to be approximately $0.11 based on $57 million fully diluted common shares outstanding as compared to prior guidance of $0.09 to $0.11. As we near completion of our first full year following the acquisition of Pioneer, we remain confident in the value RTI delivers to our stakeholders.

We believe that RTI has best in class products, that we are focused on delivering to surgeons and patients around the world. We hope to see some of you this quarter as we will be presenting at our Analyst Reception on November 10 in New York and at the Stephens Fall Investment Conference on November 11 in New York.

A recording of the Analyst Day will be available on the Investor section of our website within a few hours following the event. At this time, let's open up to questions.

Michelle?

Thanks. If I can --Brian, did you say Carrie was there?

Yes. Carrie is here.

So I'd like to take the opportunity to just get your opinion sort of post this letter, obviously, it seems like minimal manipulation was kind of in the FDA's mind sort of if you can just give us your take on why map3 meets that threshold?

Carrie will answer that.

Well, I'll do my best without getting overly technical. We understand the FDA regulations.

It is very clear relative the degree of manipulation across the threshold of minimal manipulations specifically for products that contain viable cell. And the trigger of cell expansion as well as changing the function and integrity of the cells, and we believe that through all of our development work as well as the validation and indeed lot release testing that we do, we are able to demonstrate that we do not change any of the characteristics of the cell.

And we provided that information now to FDA. We also have provided information to FDA to demonstrate that we do not conduct the cell expansion process.

And I take it with the -- you said at some point you get face to face meeting, you guys will go and sort of make that case in front of the agency post the -- I guess after they receive your initial response.

Yes. They are reviewing the response and we would be actively working actually even ahead of submitting the comprehensive response and trying to find the date for meeting, everyone's schedules are pretty crazy at the moment.

So we are actively working for date and FDA is very much looking forward to meeting with us as well.

And I guess just last one for me then on the bone growth side. Obviously a good performance across a lot of your divisions this quarter.

With a new sort of biologics and Pioneer, nanOss and then map3 as well. Just any color on sort of what do you expect from that going forward?

I mean should that be one of your higher growing divisions as we look 2015 and 2016? Thanks a lot.

I'll take that one. The answer is yes.

And as we have been talking about our longer-term growth strategies, we talk about contributions coming from both the nanOss category of product as well as map3, and combining those with our base allograft products in the bone void filler area for spine and orthopedics, both in our domestic -- our direct businesses globally as well as commercial and we absolutely do believe that they will all be contributors and we expect this category to continue to grow and expand for us as we move forward.

Good morning. Thanks for the update and taking our questions.

First off, we picked up you recently that you have expanded to a third shift in your Milwaukee facility, that the old Pioneer manufacturing facility. I am curious, is that due to demand that you are currently seeing or is that in front of what you expect to be stronger demand going forward?

Matt, this is Brian. That facility is in Marquette, Michigan not Milwaukee and it is absolutely tie to both current demand and expected growth for 2015 and beyond.

And it has been extremely well received. I will just say that when we acquire the company, a lot of folks thought that we couldn't recruit and build the business in Marquette, and I think we had little over 200 employees when we started up there, and we are as you right, we are in the process of hiring about 50 right now and we expect that will continue to grow and we had zero problem recruiting really, really talented people to that area.

It is over confidence.

Great, thanks. And sorry about that I think it was Milwaukee newspaper that we picked up in arm.

Secondly on map3, couple of questions relating the untitled letter. First and foremost, could you give us a sense for the revenue contribution here in the third quarter for map3?

Maybe what's your expectation for Q4? Just so we can get a sense of magnitude barring any changes, but how is that product ramping currently?

Well, as you guys all know, we've not given any specific numbers from map3 this year. We've said that we had a control launch going on and what I can tell you and an update is that is gone extremely well, it continues to go extremely well.

We've had upfront conversation with everyone of our customer regarding the untitled letter. It is not had any impact like you might have read from prior warning letter or anything else.

Everyone understands what these are all about. We are taking a very methodical approach to deal with our current customers and new customers on the topic.

But basically the products now have been implanted for more than a year, patients are doing really well, doctors that are using the products are very excited about what they see, and want to continue and at this point in time momentum continues to build just as we expected that it would. We will continue with not giving specific numbers around that product as we move forward.

We will be talking about the category that it is in which also includes nanOss and other allograft product as well.

I guess I think what investors and we are just trying to understand is how big of an impact, if worse case scenario, I know our job sometime is figuring out best and worse case scenario, but in a worse case scenario, let say the FDA were to say you need to pull until you receive a biologic licenses, how much of an impact would that have on maybe your near-term growth opportunities or is it such small component today that you are more than able to overwhelm that with so many other products like nanOss?

Well, I'll start with having Carrie answer your technical question of about FDA asking us to stop distributing the product. And then Rob or I could tell you that this is not a significant product for us today.

It is not budgeted to be a significant product for us next year. It is just not.

So that is not -- that is not even -- it is not part of our -- it is not-- I mean it's not that it is not an important product, it is and we certainly want to protect the investments that we made to get at this far as we have and continue to grow it. But it is not our whole business for next year.

It is not even a big driver in whole growth plan. So Carrie you want to address the technical part.

Yes. So, Matt, the worse case scenario you described, our experience is that we are looking at the way FDA is approaching these cellular type products.

Clearly, scenario of interest for FDA that this is now I think number five or six in the series of untitled letters. With the exception of one where there was a voluntary removed from the market.

All of these products remained on the market as they work through their issues with FDA. Different outcomes have come out depending upon what the outcome of this negotiation; some companies simply just alter their processing a little to adjust the FDA's need.

Others are filing a BLA. None of them have been required that we remove from the market.

And we would not expect unless there were significant safety concerns declared by FDA that any of these products would be removed from the market. And map3 certainly does not raise any questions of safety.

Okay. Maybe one last one then I'll hop back in a queue.

And this is might just be a terminology but in the untitled letter, the letter from the FDA itself, they refer to map3 bone chips. In your press release and in your prior communications that you put out, you refer to it as a bone graft.

Is there a difference between those two? Are the bone chips are some product of map3 or is it simply just terminology?

They talk about the map3 chip allograft; it is a bone graft, so it is a terminology issue. The letter was focused on where they speak about the map3 chips product on the website where we would describing aspects and characteristics of chips product which is why they cited this chip.

So that's the way we actually mark the product as a map3 chips product. But it is a bone graft in function

Great, thanks, good morning. Can you hear me, okay?

So just couple of questions. One, Carrie mentioned that you are actively working toward a date with the FDA on the untitled letter.

Can you just give us a timeline, when do you think you will get that meeting on the book? When would you think-- how long do you think it will take your resolution of the whole map3 issue?

All right. Well, all of this is now speculation.

Obviously, the sooner the better from our perspective. FDA is looking for-- we are looking for date in November, December.

We are screening through a battery of date. The first set didn't work.

Second set is now our hands. So -- and we are actively seeking an opportunity to meet.

And we actually receive confirmation from some senior people at FDA this week that they are actively seeking to try to pull people together as well. So we think relatively shortly.

When it comes to ultimate resolution, very difficult to predict. It could be week, maybe into the first quarter of next year before we have a completely resolved outcome.

And that, Bill, could just be a pathway, so we have to wait until we have our meeting to give you any kind of definitive prediction. And even than some of these letters, if you looked at them, they have been out there since 2011, so sometimes these -- they stay out there for quite long time.

So we are just preparing for our first discussion with them and then we will see where it goes.

Okay. And then as we think about just the map3 product, I think you just kind of characterize that's not a big significant product in 2014 or 2015.

But how should we think about your marketing of the product with the untitled letter outstanding? I mean just kind of have you frozen it to the existing accounts and you won't expanded until this is resolved or really how should we think about that?

No differently than you were before, our strategy hasn't changed. This will not be launched broadly for quite some time that was not our plan.

Our plan is always been to control this launch and it will be through at least the first half of next year. And so that continues, so we continue to show it to selected new customers.

And that has gone very, very well. We expect that it will continue and we continue to work on expanding our ability to process the graft and so they are going in parallel right now, the operation side and the distribution side.

And there has been nothing yet that changes our mind that, that's going to change. So our plan right now is going to be to continue that same process.

I will say that we've always said this and I'll say it again. We've always try to market this as an allograft.

So it [ACTP], you can't make claims, you can't do all these other things. What triggers this letter frankly was an unintended issue on our website and it has been corrected and we'll continue on the pathway that we have been on.

The company's position is always been that is an allograft, and that's what we intend to market it as which means your claims are limited and always will be.

Okay and then just last question on the severance. You called it out as a one time.

Just what is it specifically related to?

Bill, this is Rob. It's just from time to time we look at the organization and we look at what we can do right size the cost base and things like that.

So in Q3, this is the continued process and Q3 the numbers got a little bit bigger than they historically have been. So we thought it was appropriate to call that out in our result.

Because it is close to $0.5 million which equates to penny.

So this is some like you have ongoing severance, so just this quarter was little larger than any other quarter?

Yes.

Thank you for joining us today. And we look forward to speaking with many of you later today and as we go for the next week.

Thanks.