Surgalign Holdings, Inc.

Roxane Wergin - Director, Corporate Communication and Investor Relation Camille Farhat - Chief Executive Officer Rob Jordheim - Chief Financial Officer

Matthew Hewitt - Craig-Hallum Capital Group LLC Dominic Prioli - Raymond James John Gillings - JMP Securities

Good morning and thank you for joining RTI Surgical for our first quarter 2017 conference call. Today, we will hear from Camille Farhat, RTI's Chief Executive Officer and Rob Jordheim, our 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 that 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 call 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. During the call, we will also present certain financial information on a non-GAAP basis.

Management believes that non-GAAP financial measures, taken in conjunction with US GAAP financial matters, provide useful informational for both management and investors by excluding certain non-cash and other expenses that are not indicative of our core operating results. Management uses non-GAAP measures to compare our performance relative to forecasts and strategic plans to benchmark our performance externally against competitors and for certain compensation decisions.

Reconciliations between US GAAP and non-GAAP results are presented in tables that accompany our earnings release which can be found in the investor relations section of our website. Now I will turn the call over to Camille.

Thank you Roxane and good morning everyone. Thank you for joining us on my first earnings call as RTI's CEO.

I'm very excited to be here and to report on the progress we are making. As you will hear from Rob shortly we have had another good quarter.

But before we get into those details I would like to take a moment to talk about RTI and what I have learned during my first six weeks with the Company. One of the biggest reasons I chose to join RTI is the considerable untapped potential of the business.

RTI is a Company with a solid foundation and substantial opportunities for growth. We certainly have challenges ahead of us, but I'm confident that we have the key ingredients we need to meaningfully improve our results, grow our business and generate sustainable attractive returns for our shareholders.

RTI is a Company with solid fundamental, we produce high quality in demand products that improve people's lives. We serve growing markets that offer multiple channels for expansion.

We also have customers, shareholders and employees who are committed to our Company and our growth plan. As Rob and others shared last quarter, we have started taking costs out of our system.

We also are thoroughly evaluating all of our businesses. Our plan is to pull back on resources for those areas that we identify as less profitable and allocate more resources to those areas of the business that we believe offer the greatest potential for growth.

Our efforts are beginning to deliver real results with improving performance on the top-line. The initiatives we have put in place and continue to implement are also positioning RTI's operating platform to better capitalize on future growth opportunities.

The initial phase of our restructuring program remains on target to yield annualized savings of approximately $8 million beginning primarily in the second quarter. We will be strategic in our capital allocation and will continue to make the necessary organic investment in our business, product and people that will best set up RTI to deliver on our growth goals.

And we will do this and be laser focused on execution. Our initiatives are beginning to take home, our first quarter generated solid results relative to our expectations.

Our revenue came in at 69.9 million, adjusted EBITDA was 6.5 million and adjusted net income applicable per common share and adjusted net income per common share were a 139,000 and breakeven respectively. Importantly, these results do not include any one-time puts or takes demonstrating the underlying strength of the business.

The fact that we have achieved two consecutive quarters of solid top-line performance is encouraging and demonstrates that we are starting to turn the corner. That said we are still turning that proverbial corner and two quarters do not make a trend.

We are in the very early stages of what will be a long-term transformation of RTI. During my first six weeks as CEO, I have been meeting with customers employees and shareholders.

I also have been evaluating our business segments with our leadership team to determine what changes we need to make to get our entire employee base moving in the right direction as one tightly integrated laser focused and cohesive team. There remain a number of variables and contingencies that we have to manage to ensure that we are as free mind and cohesive as we can be.

Well what we do know is how we will judge our success. And here our goals are clear, profitable growth, improved cash flow generation and predictability.

All three will be driven by highly motivated talented and focused employee base. The first two goals our self exploratory particularly for the people listening in on this call and are interestedly tied to the three central themes that are circulating in my mind as I evaluate the business.

One, continues to invest in our spine business and build scale. Two, the increase investments in our commercial business to drive innovation and create new growth opportunities and three, improve margins in our tissue based implants.

Now regarding predictability, let me provide a brief explanation because it is integral to our ability to execute profitable growth and generate cash. In short, predictability means that we are going to do what we say we are going to do.

To accomplishments we are committed to doing a better job communicating internally and externally regarding what makes our business thick, what the main growth drivers are and the levers that we are able to pull to propel us ahead. We are going to reduce the complexity of our business and hone in on the areas that offers the biggest opportunities for growth.

We are also going to be very clear about what we expect of everyone and our staff. Internally this should lead to more effective alignment, improved collaboration and greater motivation to make our innovation more relevant and growing the most promising areas of our business.

Externally, this will make it easier for you to better understand our strategy and how we are progressing against it. We hope this will in turn yield and market valuation for RTI that is more in line with our growth prospectus and overall potential.

Now as I have said, we are still in the early stages of our transformation, but these objectives of one, profitable growth, two, improved cash flow and three, predictability are what will guide us as we finalize our strategy and move forward. Our customers value our product and our relationships with them.

However, it's clear that there is more that we could be doing for them and their patients, and this present a tremendous opportunity for us to invest in key areas, expand our business and treat even more patients with our product than we do today. As for our shareholders they have been patient and supportive.

They share my personal and the entire management teams’ desire for improved performance and stock price depreciation. I believe we are on the right track towards both of these aspiration.

Our employees will be critical to our success and on that front I couldn’t be more enthusiastic. To say that I have been impressed with our employees during my first few weeks would be an understatement.

They are extremely dedicated to their jobs and deeply passionate about our products and the positive impact they have on people's lives. They are also highly experienced, whether in their chosen field or through there tenure at RTI.

And they are hungry, they are hungry to continuously improve, hungry to get behind doing any strategy and hungry to put RTI back on back on a path towards profitable growth. And the management team and I are committed to guiding them and providing them with the tools they need to succeed.

Our plan is to provide our employees with clear direction and prioritization and better communication across the Company, so that they can execute, enhance and make our innovation more relevant. By doing this right, we will help our people grow our business not matter the specific function they serve.

We are going to tear down walls, drive clear accountability and provide people with incentives to move in a common direction for the good of our patients in our entire Company. All of this will take time, but I'm confident we will get there.

A big part of helping our employees and by expansion in our business will be integration. Currently we are organized functionally in what I refer to as function first organization.

Simplistically this is employees that are incented and focus totally on their particular corner of the world, whether be it R&D, regulatory affairs, product quality or another function. And what I would like to see more is a customer or product first organization.

This means ensuring that our various functions are focused on developing and delivering the very best products and working collaboratively with each other in the process. This will come through the greater focus and clear accountability I referenced earlier.

It will also come through better and more open lines of communication among all of our functions. Our goal will be to create more cross functional themes for a wealthy organization.

While our direct business performed well across all of our operating segments in the first quarter, we are continuing to take a hard work at each of our segment to determine, which ones will remain part of RTI and which we will look to divert or pair back. We should be in a position to provide further details on this front within the next few months, but I envision pure business lines in the future.

And the ones that remain will be those that we can manage well and fund appropriately, so that they can contribute to our overall profitable growth. One of the outputs of stream lining and reducing cost will be a great focused investment in R&D.

Our R&D investment historically speaking has not been as concentrated or relevant as it should be, something the management team and I know that we can improve upon. We will do this as part of the larger efforts to right size our spending that is accelerating it in certain high growth areas and paring it back in other areas where the potential for profitable growth is isn’t at the level we would like it to be.

And with that, I'll turn the call over to Rob Jordheim to provide an overview of our first quarter financial performance as well as highlights of our business segments. Rob.

Thank you Camille. I would like to focus my remarks on the three areas we see as key drivers of our first quarter results.

These are for the fifth quarter in a row we delivered double-digit growth in our direct business. As we expected our commercial business declined in the first quarter, however, we continue to see signs of stabilization on a sequential basis.

Our results include the financial impact of the previously announced severance charges. Now, I'll go through the detailed results.

Our first quarter revenue of $69.9 million represents a 4% increase from the first quarter of 2016. It includes domestic revenue of $63.3 million an increase of 3% from the prior year period.

This increase was primarily due to strong performance from our domestic direct business. International revenue was $6.6 million an increase of 8% compared to the first quarter of 2016 primarily due to growth in the international direct spine business.

On a constant currency basis, international revenue for the first quarter of 2017 was $6.8 million an increase of 10% compared to the first quarter of 2016. We saw continued strong performance from our direct business in the first quarter of this year with revenue of $43.8 million, an increase of 13% compared to last year's first quarter.

We experienced double-digit growth in the spine, surgical specialties and cardiothoracic direct business segment. However, this growth was offset by declines in our [convertial] (Ph) business which delivered $23.6 million in revenue in the first quarter of 2017, a decrease of 7% compared to the first quarter of 2016.

This decline was partly due to lower orders in our OEM trauma business versus last year's first quarter. However, our commercial business is stabilizing on a sequential basis and we intend to solidify and grow it.

Our net loss applicable to common shares for the first quarter of 2017 of $2.8 million or $0.05 per fully diluted common share compares to net income applicable to common shares of $1.5 million or $0.03 per fully diluted common share reported in the first quarter of 2016. The loss in this year's first quarter was primarily driven by our previously disclosed pre-tax severance charge totaling $4.4 million.

Excluding the $4.4 million in pre-tax severance charges, we reported adjusted net income applicable to common shares of a $139,000. Let me now review the revenue performance of each of our business lines.

First quarter direct U.S. spine revenue increased 19% compared to the first quarter of 2016.

During the first quarter revenue for the spine business biologics increased 56% compared to the first quarter of 2016, additionally hardware revenue increased 12% over the same period. We continue to add new surgeon users and had a record number of surgeon users for both Map3 and hardware during the quarter.

Our U.S. direct sports and orthopedics business increased 3% compared to the first quarter of 2016 largely due to strong net growth and Map3 Allograft distributions in the foot and ankle market.

First quarter surgical specialties revenue for our U.S. direct business increased 75% compared to the first quarter of 2016.

Growth was driven primarily by our Cortiva Allograft surgical mash used in breast reconstruction procedures. Revenue for our U.S.

direct cardiothoracic business in the first quarter increased 24%, compared to the first quarter of 2016, primarily due to balanced growth and sternal closure hardware and biologics. First quarter revenues for our direct international business increased 3%.

On a constant currency basis our direct international business increased 5% compared to the first quarter of 2016. This growth was led by strong performance in the European market primarily in biologics and in Asia Pacific primarily in spine.

Our commercial other business decreased 9%, partly due to the lower orders in our OEM business that I mentioned previously. First quarter adjusted EBITDA of $6.5 million was 9% from our revenues for the same period.

This compares to adjusted EBITDA of $9.1 million or 14% of revenues for the first quarter of 2016. Gross margin for the first quarter of 2017 was 51% compared to 53% for the first quarter of 2016.

The decrease in gross margin was primarily due to lower production levels in the first quarter of 2017 as compared to the first quarter of 2016 and the impact of the deferred unfavorable manufacturing branches capitalized at the end of the 2016 being amortized into cost of sales in the first quarter of 2017. We expect the headwinds from amortization of this deferral into cost of sales to diminish in the second half of the year.

During the first quarter of 2017 marketing general and administrative expenses totaled $29.7 million an increase of $2.1 million or 8% compared to the first quarter of 2016. The increase was primarily due to higher variable compensation and distributor commission expenses on direct revenue, mostly in our spine business.

Research and development expenses totaled $3.7 million an increase of $473,000 due to lower project spend. Operating loss for the first quarter of 2017 was $2 million compared to operating income of $4 million for the first quarter of 2016.

Excluding the $4.4 million of severance charges adjusted operating income in the first quarter of 2017 was $2.4 million. Our tax rate for the first quarter of 2017 was a 33% benefit compared to the 35% provision in the first quarter of 2016.

Turning to the balance sheet, our cash position at the end of the first quarter was $17.6 million an increase of $3.7 million compared to our cash position at the end of 2016. Working capital at the end of the first quarter of 2017 totaled to $116.2 million, a decrease of $5.2 million, compared to working capital at the end of 2016.

At the end of the first quarter this year, we had $81.1 million of debt and approximately $9.5 million available under our revolving credit facility. Based on the results from the first quarter we affirming our full-year 2017 revenue guidance of between $274 million and $285 million and our full-year 2017 adjusted net income per fully diluted share guidance of between $0.05 and $0.10.

As we continue to execute on our cost savings plans and focus the business on profitable growth, we may incur additional severance/restructuring charges. We will update you accordingly on these activities on our next call.

With that, Camille and I would be happy to take your questions.

Good morning gentlemen, welcome Camille.

Thank you.

A couple of questions first, as you look at the Company today and obviously you have only been on board for six weeks, but one of the things that I think as alluded RTI has been the double-digit growth, a total double-digit reported number. Do you think that’s achievable and what is it going to take to get the Company there?

So I think this theme has demonstrated where we have made the investments on the direct side that it is achievable, then when you look at that and you say to what extent and how far out, when we see the size of our business compared to the markets that we are competing in where we have invested, I think it is with us for the foreseeable future. So if you take the cardiothoracic exposure, if you take the spine business, if you take the specialty therapies business, I think all these where we have gone direct there is opportunity to continue in that double-digit.

I also feel that there is more opportunity to resume growth and potentially be in solid may be single-digit, but definitely reversing the trend we are in on the OEM side. The market is there, we have very good products, we have great engineers, we have very good relationship with our customers, it's just that the growth on the direct channels came at the expense of less focus in this area.

And as you heard in my comments, we are going to be refocusing as well in the arena.

Thank you, on the flip side, in your prepared remarks you mentioned that there are some challenges as you see the Company today, what are they may be the one or two areas in particular that you would like to either stabilize or are may be looking to divest if that becomes the route.

The big lever is when we talk about that that we need to focus our R&D and our talent and resource allocation in line with the areas that presents the biggest opportunities for growth, profitability and cash generation. That adjustment is not and it's an easy one on paper, but you need to kind put the systems, reallocate the theme that may take time to finish certain things that are half way through in order to do that, so that’s one part.

The second part is we are moving from a function first organization that I have alluded to, to more across functional collaboration, where passing of the baton matters a lot and that’s a very different team effort that it's all about practicing together, that is going to make difference and that will take some time. So I'm confident in that there is nothing fundamentally broken that is going to prevent us from getting there, but thinking about focusing innovation, flawless execution, reallocation and readjustment of resources would be the top three challenges that I see having to focus our energy on.

Okay, and then Rob this might be for you. Gross margins, as you mentioned that we should see an uptick in the second half of the year, I'm assuming that kind of gets you back into that 53% maybe a little bit higher range and is there opportunity for that to continue to expand as we look maybe a little bit further, whether its 2018 or 2019.

Thank you.

Yes Matt, I think to your point if you look at our gross margin at 51% as I said in the prepared remarks, we did have a headwind from the, or we do have a headwind from the amortization of deferred manufacturing variances from last year. And if you recall we did say that we intentionally had slowed down the plants to limit inventory growth.

We are seeing part of that flow through the P&L the first half of this year, but the good news is when you look at the second half that will burn off and with the natural mix that we have towards our direct products, we should see sequential improvement in our margin this year and even going into next year.

Great, alright, thank you.

Thank you.

Hi guys, this is Dominic in for Jason, thank you for taking the questions and welcome Camille.

Thank you.

I just want to start with restructuring. On the last call you guys announced Phase I and then mentioned as Camille comes on board, there would be Phase II and you would look at further restructuring or different things you could do.

So I was wondering if Phase II could also include the further cost cutting initiatives or whether that was, you know divesting the business, just wondering what else could we see in the next coming months from you guys in that respect?

So, this is Camille, let me comment. One of the things that we are focused on right now is finishing what we started and that is the Phase I.

In terms of Phase II, I would like to finish my deep dive into the business and finishing the strategic assessment and refocus on that business, so we will come back in a few months and talk about that like I said in my opening remarks. But what I can share with you so that would be helpful and in line with what we said, we communicate externally differently so you can see what we are doing.

We believe that our gross margin has some room for improvement but the bigger opportunity for us is in freeing up organizational capacity below that. And so how we are going to work together, how we are going to structure the business, how we are going to get things done, is going to lead us to believe where is the opportunity for the restructuring and how deep would that be.

It's premature at this point, we think that there is a lot of opportunity when we benchmark ourselves a hybrid Company if we want to be in the top docile which is our aspiration overtime, then what are the choices we have to make in making us free up that organizational capacity. And we will articulate that more, I just need time to finish my deep dive on the strategic assessment of the business.

Okay, that makes sense, thanks for that color there. In terms of the quarter direct international in terms of both specialties really strong quarter-over-quarter and year-over-year.

I was just wondering if that momentum can be sustained going forward in the year.

My answer is yes, and again your starting from a relatively smaller base on the surgical specialty so yes we can anticipate that, the products are doing well, some are also introducing on the international side and we expect going to pick-up some momentum. So it kind of goes hand-in-hand, you may end up seeing both happening where surgical specialty internationally also helps in that growth as well.

And then on the international side, I think yes we do have as you can imagine it's a larger basket of different country and businesses, but we can sustain solid growth in that area as well.

Okay, and I think you guys have mentioned in the past there was an opportunity with distributor coming in more than China in the direct distributor I think the direct international business. I was wondering if you could frame that opportunity for us and maybe what we could see from that.

Yes, I mean for strategically I think we are starting to look at our international markets and actually I have my deeper dive visiting going internationally starting next week. There will be delineation how we are going to run the international business more focused and more services in the countries where there is more demand for our products where we think that we are going to get the profitability and we can focused the resources to go deeper and broader in these countries.

China is one of them for us, we will continue that focus and we expect that to pay dividends in line with our expectation.

Okay, and I just had two quick ones focused products, it sound that it really gets from the prepared comments. I was wondering if there was a percent of revenue we could start label them with.

Yes, this is Rob. Focused products in the first quarter represented about 14% of our total revenue and as you recall focused products included our Map3 bone growth substitute our mass synthetic from bone growth substitute and our direct surgical specialties business.

Okay, and then just the last one. The other revenue, it looked which is down a bit year-over-year I was just wondering if that's something we should see stable about at that range going forward.

Yes, I think that this quarter is a good proxy for the following three quarters included in other revenue is really differed amortization from exclusivity payments and things like that and also we do some third-party recoveries and things of that nature for other tissue banks and that business can be a little bit lumpy. It's pretty small, but it can be a little lumpy, so I would say Q1 again is probably good proxy for the remainder of the year.

Okay. Thank you guys.

Okay, great. So Camille, I'm sure you have kicked the tires a little before accepting the job, so I'm sure you haven’t been entirely surprised, but and you have given us some high level color on what you have seen so far.

But I'm wondering if you could let us know is there anything in the last six weeks that’s been a surprise either on the good side or the bad side.

Yes I mean I can tell you mostly on the good side, when I look at the people side that was a big positive for me and I went out in my way to articulate that in my prepared remarks. There is a lot of experience and there is a lot of desire to win the culture in this Company.

We just need to guide it and channel it in the right direction. The products, the margin on these products, the quality of the products are good well received.

The channel is strong and getting stronger, the market there is demand for our products. So the fundamentals are there and in a way there is nothing that’s really fundamentally broken.

We just need to evolve as we have had two or three acquisition, how do we get ourselves ready to start building scale in our businesses. That said, some of the work we had ahead of us as we continue to grow organically or may be potentially inorganically, some of our processes are going to be challenged and because they came from individual smaller businesses and our job is to make sure as we are revalidation towards more cross collaboration to have processes that can scale with us as we go into the future.

So that basically what I would say the big ones for me.

Okay great that’s helpful and then I just wanted to ask quickly about the commercial business, [AL] (Ph) was down a lot last year, we are expecting it to be flat to down a little bit this year and historically at least it's one to tended to be a little bit more challenging to predict based on potentially big orders in a certain quarter from one of the OEM customers, one or the other of them. So in the time that you had, what is that makes you comfortable enough about that business to not just sort of keep it as a maintenance business, but to actually increase investment there.

Yes. I like it; I think that there is a lot of tailwind with us in terms of our customer want to outsource more.

We have the knowhow and the R&D to be able to help them with that, either make their products and services better or even make improvements to the procedure, where we are more relevant and we have demonstrated that where we have differentiation we get stickiness and we get price and I like that because of that. So this is not just a straight contract manufacturing, not to mention that this because when you look at the net EBITDA and EBIT is pretty good and if we are going to continue to grow in the other parts of the business this one's means to resume growth, but that its throw off the cash that we also need to make the other investments.

So we are good at it, the market trends are there, it has attractive margin and cash for us, why wouldn’t we invest in it.

Alright, that make sense, next I just want to turn really quickly to the surgical specialty business, I had less than $2 million this quarter that certainly qualifies as one of those businesses you alluded to the small versus the opportunity that’s there and RTI has some great products, can you just give us some color on how things are going both in terms of the surgeon symposium and in terms of sort of ramping up productivity of sales force that’s there. Just can you help us to get little bit more color about how that's going and what the potential is for that business.

Looks like I said, the growth and the number are speaking for themselves in that we are off and we are doing well and you can see the growth rates with it. Well received, doing well, we expect more, we want more, the challenge in these areas and I don't have the view.

But if you were me you would ask yourself the question how do you treat the most number of patients in the shortest time possible, and do we continue down the direct channel and what is it going to take for us to be of relevant size and make that be a beachhead for us and what are the affirmatives to that. These are things I'm considering, I don't have the juries out yet, and with time we will hone in on it, but for now it's really growing well and it's doing what we expect it to do.

Okay, alright. That's all we have got for today.

Thanks a lot guys.

Well thank you.

Thank you.

So, I want to thank you again for joining us this morning and for your interest in RTI. As you could tell, we are off to a good start in our path to returning RTI to long-term sustainable profitable growth.

We are optimistic about our progress thus far, and we remain comfortable with the 2017 outlook we announced last quarter. We have a great deal more to do, we get that.

We will continue to seek profitable growth and be guided by ensuring that our resources spending and other costs are calibrated to our revenue expectations across our business. And while I know we have more specifics to provide you about our path forward.

I hope you know have the better sense of how we are rethinking our business and approaching our business. We are looking forward to staying in touch with you and continuing to update you about the progress we are making against our turnaround plan.

Again, thanks for joining and have a great day.