Surgalign Holdings, Inc.

Wendy Crites Wacker - VP, Global Communications Brian Hutchison - President & CEO Rob Jordheim - EVP & CFO

Matt Hewitt - Craig-Hallum David Turkaly - JMP Securities William Plovanic - Canaccord Genuity Michael Rich - Raymond James

Good morning everyone and thank you for joining RTI Surgical for our first quarter 2015 conference call. Today, we will hear from Brian Hutchison, President and Chief Executive Officer; and Rob Jordheim, Executive Vice President and Chief Financial 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. Thank you for joining us.

I will start the call with an overview of the first quarter then Rob will review our financial results. I will follow-up with some financial guidance for the second quarter and full-year 2015.

As detailed on our press release issued this morning, we reported first quarter revenues of $68 million, a 12% increase over the first quarter of 2014. When reviewing each of our lines of business, first quarter spine revenues increased 2% compared to first quarter of 2014.

Our direct spine business had strong growth of 20% year-over-year offset by lower orders from our commercial distributors. Our direct spine team continues to do an excellent job of converting surgeons and gaining market share.

The team has been very successful in following our strategy to lead with our best in class biologics and pull through our high quality hardware. At this time, we anticipate the spine will grow the mid to high single digits for the full-year 2015.

Our sports medicine business increased 7% compared to first quarter of 2014. The direct sports team is executing well and is on track for the year.

We anticipate growth in the mid to high single digits for this line of business for the full-year 2015. First quarter surgical specialties revenues decreased 17% compared to first quarter 2014.

This was due primarily to the decrease in revenue from our commercial distributor in the hernia market. The decrease was partially offset by our direct surgical specialties business, which have a record quarter, driven by strong growth in one of our focused products, Fortiva porcine dermis.

In the beginning of the first quarter our distributor in the breast reconstruction market relinquished their exclusive distribution right. As a result, our direct surgical specialties team now has access to our full line of biological surgical specialties implant for both hernia and breast reconstruction market.

At this time, we anticipate that the surgical specialties business will grow in the mid-single-digit for the full-year 2015 due to growth from our direct distribution globally offset by declines in the commercial business. First quarter BGS general orthopedic revenues increased 34% compared to first quarter of 2014.

The increase in revenues for the quarter was due to growth in our direct and commercial businesses, offset by declines in our international business. As we have mentioned on our last quarterly conference call we had strong momentum leaving fourth quarter across our BGS/GO portfolio specifically with our focused products of Map3, Bone Grafts, and nanOss Advanced Bone Graft Substitute.

The momentum continued through the first quarter with solid growth across our BGS/GO portfolio. We anticipate that BGS/GO revenues will grow in the low 20% range for the full-year in 2015 due to growth in our direct BGS/GO business.

First quarter dental revenues increased 2% compared to first quarter 2014. This is in line with our exclusive distributors contracted minimum which met our expectation.

At this time we anticipate that dental revenues will grow mid-single-digits for the full-year 2015 per our contract with our exclusive distributor. First quarter revenues for Orthofixation increased 42% compared to first quarter 2014.

We continue to be pleased with the growth in both commercial business and our direct cardiothoracic business. At this time, we anticipate that Orthofixation will grow in the mid -- in the low teens for 2015.

At this point, Rob will provide some more detail on the financial results.

Thank you, Brian. Worldwide revenues of $68 million in the first quarter increased 12% compared to the first of 2014.

Domestic revenues were $67.2 million for the first quarter compared to $54.8 million in the first quarter of 2014. International revenues, which include exports and distribution from our German and Dutch facilities, were $5.3 million for the first quarter of 2015, a decrease of 10% over the first quarter of 2014.

On a constant currency basis, international revenues increased 1% over the first quarter of 2014. During the first quarter of 2015, the company benefited from accelerated deferred revenue recognition of $1.5 million due to the relinquishing of exclusivity by our commercial partner in the breast reconstruction market.

Gross margin for the first quarter of 2015 was 54% as compared to 43% for the first quarter of 2014. On a non-GAAP basis, excluding a pre-tax inventory purchase accounting adjustment of $5.7 million taken in the first quarter of 2014, gross margin improved 190 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 $27.3 million, an increase of $1.4 million or 5% higher than the first quarter of 2014. The increase in expenses was primarily due to increases in variable compensation and distributor commission expense.

Research and development expenses totaled $3.6 million, a decrease of $252,000 or 7% lower than the first quarter of 2014. The decrease in expenses was primarily due to lower research study related expenses.

Our tax rate for the first quarter of 2015 reflects a tax expense of 36% compared to a tax benefit of 40% in the first quarter of 2014. Our first quarter 2015 tax rate was positively impacted due to the increased profitability in lower tax rate jurisdictions.

Net income applicable to common shares for the first quarter 2015 was $2.9 million or $0.05 per fully diluted common share based on 57.9 million fully diluted shares outstanding. This compares to net loss applicable to common shares of $3.1 million or $0.05 per fully diluted common share for the first quarter of 2014 based on 56.5 million fully diluted shares outstanding.

As mentioned above, during the first quarter of 2015, the company benefited from accelerated deferred revenue recognition of $1.5 million due to the relinquishing of exclusivity by its commercial partner in the breast reconstruction market. As a result, the company benefited from $900,000 in net income applicable to common shares or $0.02 per fully diluted common share.

The company's first quarter adjusted earnings before interest, taxes, depreciation and amortization, or EBITDA, was $10.7 million or 16% of revenues for the first quarter of 2015, compared to $6.4 million or 10% of revenues for the first quarter of 2014. Turning to the balance sheet, our cash position at the end of the first quarter was $11.9 million, compared to $15.7 million at the end of 2014.

The decrease was primarily due to a decrease in accrued expenses and principal payments on long-term obligations. For 2015, we anticipate being cash flow positive from operations.

We are confident that with current cash balances and available debt, we have adequate liquidity to support our future operations and meet our financing obligations. Working capital at the end of the first quarter totaled $136.3 million, an increase of $2.8 million.

During the first comp quarter, the company made the first quarterly principal payment of $1.5 million on the $60 million term loan. At the end of the first quarter, we had $74.7 million of debt and approximately $5 million available under our revolving credit facilities.

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

Thanks, Rob. Last quarter we laid our multiyear plan path to become a $500 million revenue company with gross margins approaching 60% and operating margins approaching 20%.

To reach this goal, we have three major areas of focus. Our base biologics business, which includes allograft and xenograft graft implants; our hardware business, which includes metals and synthetic-based implants; and our focused products, which includes nanOss, Advanced Bone Graft Substitute, Fortiva porcine dermis, and the Map3 allograft.

I'm pleased to report that our growth during the first quarter was in line with our expectations for each of these areas. Our base biologics business was comparable to the prior-year quarter.

Our hardware business grew 30% and most notably our focused products grew 100%. Turning to guidance.

In our press release issued this morning we outlined expectations for revenue, EPS for the second quarter and full-year of 2015. For the second quarter 2015, we expect revenues to be between $70 million and $71 million.

This would result in a 7% increase in revenues compared to Q2 last year at the midpoint of our guidance. We expect net income per fully diluted common share for the second quarter 2015 to be approximately $0.04.

Based on results from the first quarter, we are raising full-year guidance for 2015. We now expect full-year revenues to be between $281 million and $286 million, an increase of 8% year-over-year at the midpoint of our guidance compared to 2014.

Full-year net income per fully diluted common share is expected to be in the range of $0.19 to $0.23 based on 58.2 million fully diluted common shares outstanding. Moving forward, as we concentrate on the three key areas, we'll continue to gain momentum on the path of $500 million.

The key value drivers in this process will be driving growth in our focused products, capturing market share in spine hardware through targeted customer conversions, building additional spine instrument sets to support more surgeries and by leveraging our broad biologics portfolio. Growing international revenues, specifically in Europe and Asia Pacific, and finally, controlling spending and implementing additional lean manufacturing processes in order to continue improve margins.

Based on our solid start to the year, our goals are within reach and the team is committed to success in 2015 and beyond. We hope to see some of you this quarter as we'll be presenting at the Deutsche Bank Securities Healthcare Conference on May 6 in Boston; UBS Global Healthcare Conference on May 18 in New York; and the JMP Securities Life Sciences Conference on June 23 and 24 in New York.

At this time, let's open up for questions. Bridget?

Good morning, gentleman, congratulations on the good quarter, good start and thank you for taking our questions.

Thank you. Good morning.

Good morning.

First one, obviously, there were some tough weather situations in the first quarter. I'm curious if you guys saw any impact from that and would the results have been even better?

I would say very, very minor impact to us.

Okay. So a bit surgeries were able to get rescheduled for those weather events?

In my knowledge, yes.

Okay. And then secondly on the deferred revenue breakout how does that flow through the income statement?

Is there -- was there any impact on gross margin? It looks like that would be a cost of goods type situation but it didn't, I'm not seeing that was reflected in the results?

Yes, Matt, this is Rob. The acceleration of deferred revenue affects obviously revenue, it affects gross margin because it's 100% pure profit, right, there is no costs of sales associated with it.

So it drops straight through to gross margin and it drops straight through to operating income. Of course it is tax affected and then on the EPS side or the net income side it would benefit of $900,000 as I mentioned.

Okay. So and I'm going to do this on the player but if we back that $1.5 million out in the quarter gross margin improvement wouldn't quite have been as good for last year but how should we be thinking about that for the second quarter then will you be able to recover?

Yes, I think if you back out the $1.5 million our gross margin will go from $54.4 million down to $53.4 million so it cost us 1 percentage point. But if you look at the last several quarter as we've communicated in the past we expect sequential improvement just from our base operating result.

So I still believe that as you look out over the remainder of this year that we're going to see sequential improvement in gross margin on a quarterly basis.

Okay, great. May be one more for me and then I will jump back into queue obviously.

Map3, it sounds like you're seeing some traction there but how does the FDA's current stands guidelines and the proposed guidelines, how is that impacting your ability to take that product to market if at all?

At this stage it is really not at all. As I've said these guidance that are out there, it will take quite a longtime to cycle entirely through the process.

But at this stage it's really non-event in terms of us in the market.

Okay. Great.

Thank you for taking the questions.

Thanks. The breast rate on the exclusivity, the way that we heard that is that your partner will still be able to shop it, now you will as well, is that correct?

That is correct.

And is that just curious, was that contractual or did something change or I guess was that your call, their call, how did that come about?

It was a mutual decision means there was a very long negotiation that ended that way.

So now you're reps, will you add reps that will focus specifically on that indication or your hernia guys can do that as well?

We've not really added reps when we're leveraging more reps in the biologic area that we're not -- that could not see these products before, now they can. And we're seeing the -- we're seeing already and, we -- as Rob said, we had a record quarter in our direct business with our -- with those implants and I think that's going to continue.

And just to be clear the breast recon is the larger component of that sub-segment in terms of what you are doing hernia, historically, correct?

Yes, Dave, this Rob. That is correct.

This is the largest sub-segment.

Great. And I know last quarter we talked a little about system shifted to Washington and the FDA and imagine nothing is changed but I was just curious if -- if you've had further dialogue or if any -- if there is any news on sort of any update from where they stand?

There really isn't any news, and yes, we have continued the dialogue and I assume that we will continue that dialogue for quite some time. I don't see this ending any time soon.

Great. Thanks a lot.

Great, thank you. Good morning.

Can you hear me okay?

Good morning, Bill.

Good morning.

Good morning. So questions are going to first center around the surgical specialties the breast recon.

So as we think about this that partner is the largest component of surgical specialties. Can you quantify that as ballpark of percentage of surgical specialty revenues?

And then, what do you expect that business to do now that there I gave up exclusivity are they replacing it with another product, are they defocusing on it?

Yes, Bill, this is Rob. In terms of percentage, the breast construction through our commercial partner is roughly 40% of revenue in that revenue category.

Right now, as Brian mentioned, we've been along just we were in the negotiation with them in terms of whether to keep exclusively or not. Obviously, we chose mutually to -- for them not to keep exclusivity.

So we have access to full product line of our biologics. But we're not seeing any downturn in orders quite honestly.

The business is still coming along as if it did when they had exclusivity. So we're still bullish on the product, we're excited to have it in our direct sales bag, and our commercial partner is still placing orders at the levels they were in the prior year.

Okay. So when did you make that change?

Q1 change.

Early Q1, late Q1.

Early.

Early.

Okay. And then on spine contracts just there first, in the last and surgical specialties, when you say 40% was 40% is surgical specialties?

Correct.

Okay. Thank you for that.

And then on spine, just a point of clarification, on the press release it says 30% in your opening comments and I -- may be I caught this wrong. I think you said direct spine was up 20% year-over-year in that spine division is that correct?

That's correct, yes.

Okay. So in the press release you're including nanOss in that 30% year-over-year basically?

No, we're not actually. That product falls in the BGS/GO revenue category.

So what's in the spine is that is obviously U.S. hardware, international hardware, and then the commercial allograft constructs.

Got you. So the way, but should I think about it tough, if I think of the business as the old pioneer business that was up -- the U.S.

hardware and no U.S. hardware, that's probably trending in-line with your nanOss biologics which is like 30% year-over-year, is that fair?

Yes, may be a little -- may be a little bit lower than the biologics that came from Pioneer, but obviously still 20% growth in the hardware piece.

Okay. And then my last question and I asked this on the last conference call.

I mean there is a ton of moving parts in the surgical specialties business and I guess the question I ask every quarter is when would you expect that to hit to stabilize, when to hit the bottom, when does that stabilize, do you think in your projections? And that's all I have.

Thank you.

It's going to stabilize on the commercial side in the second half of this year is what we're expecting.

Great. Thank you very much.

Hi, this is Michael. I'm in for Jason.

Can you hear me okay?

Yes.

Great. Thanks for taking the questions.

First on orthofixation, a very strong quarter again above what we're expecting. Can you give us an idea what's driving the growth in that business.

I know it’s relatively new for the company. So can you give us a little background there?

Yes, what's driving the growth is really both our direct business, our CT business, as well as the business through our commercial partners. Q1 is really continuation of the Q4, if you remember in Q4 we had really strong growth and that's continuing into Q1.

We do expect that to moderate a little bit over the next three quarters as the comps get a little bit tougher. But it's just -- it's -- the orders from our partners' just keep coming in.

Okay, great. You mentioned focused products up 100% year-over-year.

Can you quantify I guess a combined contribution from the three products? I think you said it was 5% to 6% of 2014 revenue but can you give us an idea in the first quarter?

Yes, in the first quarter our focused products, which is the Map3, the nanOss and Fortiva is roughly 12%, 10% to 12% of our overall revenues.

Okay, great.

And obviously we expect that to increase throughout the year.

Got it. And then the $1.5 million of deferred revenue, what segment did that get booked in?

That shows up in our other revenue line.

Okay. And then lastly the $1.5 million, can you give us an idea over what timeframe you originally expected that revenue to be booked?

Yes, it would go over a period through 2019 so that's I guess about four years.

Four long years.

So it's really, we still have some deferral related to this relationship that we're going to be amortizing but based on the analysis that we performed $1.5 million of it was accelerated due to the loss of exclusivity.

Got it. Okay, that's it from me.

Thank you.

Thank you for joining us. We look forward to speaking with some of you later on today and as the days go by and later on the quarter.

Take care.