Surgalign Holdings, Inc.

Roxane Wergin - Director, Corporate Communication and Investor Relations Camille Farhat - President and Chief Executive Officer Jonathon Singer - Chief Financial and Administrative Officer

Matthew Hewitt - Craig-Hallum Capital Jayson Bedford - Raymond James

Good morning, and thank you for joining the RTI Surgical's third quarter 2017 conference call. My name is Roxane Wergin, Director of Corporate Communications.

Today, we will hear from Camille Farhat, RTI's Chief Executive Officer; and Jonathon Singer our Chief Financial and Administrative Officer. Before we start, let me make the following disclosure.

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 this call. We make no guarantees as to the accuracy of these statements.

Accordingly, we urge you to consider all information about the company and do not 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 U.S. GAAP financial measures, 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 U.S.

GAAP and non-GAAP results are presented in tables accompanying 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. I am pleased to report on RTI's continued progress towards our three strategic goals focused on reducing complexity, driving operational excellence and accelerating growth.

We managed through a challenging quarter to deliver financial results in line with our guidance. For the quarter RTI's revenue was $66.7 million driven by growth in RTI Spine, Commercial and International businesses.

Adjusted EBITDA was $8.1 million, adjusted net income applicable to common shares was $400,000 and adjusted net income per diluted common share was one penny. I am particularly pleased that we delivered on our financial commitments while mobilizing across our organization to mitigate the impact of the recent hurricanes which disrupted end user demand across many of our markets and necessitated the closure of our Florida operations for several days.

Our strategic focus on driving operational excellence was evident through our organizations response to hurricane Irma. To ensure the safety of our employees and to protect the assets of the company RTI enacted a zero occupancy state prior to and during the hurricane.

All nonessential equipment was shutdown and moved internally to safe locations. Operations were suspended for two full days during the crux of the storm.

Two days after the storm hit the local area, the Alachua plant was back up to full production and shipping by Wednesday. I could not be proud of our organization's response to the storm which ensured the safety of our employees and physical assets, prioritized the needs of our customers and minimized the financial impact for the organization.

I would like to personally recognize the dedication of our employee base who all found a way to return to work despite facing damage to their personal property, blocked roads, and other storm related challenges. Our decision to close our facilities and suspend operations in line with our emergency response plan, as well as reduced procedures by customers affected by the storm, resulted in an estimated $1.2 million in permanently lost revenue and impacted net income by approximately $500,000 or one penny per fully diluted shares.

While responding to the hurricane was an expected event, we continued to drive forward our long term initiatives focused on driving operational excellence with a laser focus on reducing the cost of our tissue based products. We are pleased by the engagements we've had with our organ procurement organization partners to work together to lower donor acquisition fees.

We believe we have developed a solution that will benefit the market and help us move into 2018 with a better cost position. Our response to hurricane Irma and efforts to reduce donor acquisition costs are great examples of the organizational performance we are striving to achieve with our strategic focus to reduce complexity, drive operational excellence and accelerate growth.

To support these objectives, we added three highly experienced executives to our leadership team this quarter. I am pleased to welcome Jonathon Singer, Olivier Visa and Julius Aviza to the RTI leadership team.

Jon maybe new to his role as Chief Financial and Administrative Officer, but he is not new to RTI. He has served on the Board since May 2016 as a member of the Audit and Compensation Committees.

Jon has more than 30 years of leadership experience in publicly traded healthcare and pharmaceutical organizations. He has a long track record of success in high growth environments.

In addition to more than 10 years of public company CFO experience Jon has both strategy and business development in multiple settings. Olivier, who was appointed our new President of OEM, Donor Services and Sports has extensive leadership experience in both direct and commercial businesses in the global healthcare industry with a focus on transforming businesses and building sustainable value.

With over 25 years of global commercial leadership experience he brings the knowledge and leadership to significantly transform our tissue based businesses to drive improved profitability with sustainable cash generation. Finally, Julius who is our new Vice President of Quality Assurance is a recognized leader with quality expertise across the medical device industry, including healthcare IT, radiological imaging, diagnostic assays, drug delivery systems, disposable and implantable devices.

His knowledge spreads across new product development sustaining engineering in operations with a proven track record of resolving quality and compliance issues. Julius has experience and extensive interaction with both domestic and international regulatory agencies.

I am excited about the team we have successfully recruited and are in process of building. We have come together quickly and are fully aligned around driving our strategic initiatives towards those areas that we believe will have the greatest impact on earnings growth and cash generation over the next 12 to 18 months.

I am cognizant that the investment community would like greater specificity and direction on the financial goals and targets we are working to achieve. We are deep into the 2018 planning process and believe we will be able to provide our expectations for the impact of our strategic initiatives in early January.

Concurrent with the 2018 planning process, we have begun to expand our efforts on finding new and better ways to serve our customers by enhancing our product portfolio and evaluating and pursuing strategic growth opportunities that capitalize on our strengths and will enable us to take market leadership positions. I am very proud of the progress we have made to date in building the foundation for continued long term profitable growth.

Our organization is resilient with a laser focus on our customers and a strong winning spirit. Our employees have embraced a sea of change and we are all eager to demonstrate the new RTI in the near future.

With that, I am pleased to now turn the call over to Jonathon Singer for his inaugural review of our financial performance. Jonathon?

Thank you, Camille. Our total revenue of $66.7 million for the three months ended September 30, 2017 were comparable to the three months ended September 30, 2016.

Our direct revenues increased by $791,000 or 2.1% to $37.3 million and our global commercial revenues increased by $1.5 million or 6% to $26.8 million. The decrease in direct revenue is the result of the loss of $1.6 million of revenue from the sale of the Cardiothoracic closure business offset by growth in Spine and International.

In addition, RTI estimates that the impact of the domestic hurricanes during the quarter reduced revenue by approximately $1.2 million due to the cancellation of procedures in the affected areas. The increase in global commercial revenues is driven by higher orders from certain commercial distributors primarily in the trauma markets.

Gross profit for the third quarter of 2017 was $33.5 million or 50.3% of revenue compared to $34.3 million or 51.5% of revenue in the third quarter of 2016. Gross margin was impacted adversely by approximately $900,000 in the third quarter of 2017 due to the lost revenue in the closure of RTI's Florida facilities related to the hurricanes and by $1.3 million due to sale of the Cardiothoracic closure business.

Marketing, general and administrative expenses decreased $1 million or 3.6% to $27.7 million for the three months ended September 30, 2017 from $28.7 million for the three months ended September 30, 2016. The decrease was primarily due to lower variable compensation and distributor commissions on direct revenue.

Marketing, general and administrative expenses decreased as a percentage of revenue from 43.2% for the three months ended September 30, 2016 to 41.5% for the quarter just ended. Research and development expenses decreased by $1 million, or 26.1% to $2.8 million for the three months ended September 30, 2017 from $3.8 million for the three months ended September 30, 2016.

The decrease was primarily due to lower compensation in research study related expenses. R&D spending decreased a percentage of revenue from 5.7% for the three months ended September 30, 2016 to 4.2% for the three months ended September 30, 2017.

Severance charges related to reduction in head count and improvement in operational efficiencies resulted in $2.8 million of expenses for the three months ended September 30, 2017 related largely by the departure of certain former executives. The company completed the sale of substantially all the assets of the Cardiothoracic closure business which resulted in a $34.1 million or $18.2 million after tax gain for the three months ended September 30, 2017.

Adjusted earnings before interest, taxes, depreciation and amortization also known as adjusted EBITDA of $8.1 million was comparable to the third quarter of 2016. Net income was $16.5 million or $0.23 for both fully diluted common share in the third quarter of 2017 compared to a net loss of $4.5 million or $0.08 per fully diluted common share in the third quarter of 2016.

Excluding the impact of the gain from the Cardiothoracic closure sale and severance charges in the third quarter of 2017 adjusted net income applicable to common shares was $400,000 dollars or $0.01 per fully diluted common share. Briefly, looking at liquidity, our cash position at the end of the third quarter was $17.7 million and working capital totaled a $126.1 million.

We utilized $32 million of the proceeds from the sale of the Cardiothoracic closure business to retire outstanding borrowings. At the end of the third quarter we had approximately $50 million of debt with $17.5 million available under our revolving credit facility.

Finally, turning to guidance, based upon our year-to-date results, RTI continues to expect full year revenues for 2017 to be between $274 million and $280 million, due primarily to the third quarter impact of the hurricanes we narrowed the guidance range for adjusted full year net income per fully diluted common share when adjusted for non-recurring activity to be between $0.05 and $0.07 based upon an estimate of $61 million fully diluted shares outstanding. Camille and I would relish the opportunity to answer your questions.

Operator, please open the call for questions.

Good morning, gentlemen and congratulations on navigating what was a pretty tricky quarter.

Thank you.

Thank you.

I was hoping to talk a little bit about some of the new products and your plans in R&D segment, so starting with that it was down to 4.2% of sales in the quarter, obviously below what you have historically been at least the last few years. Camille, what are you thinking or how should we think about R&D going forward?

I know you are just still kind of figuring out strategies and working on some things, but as far as the percentage of sales and more importantly what types of areas, what types of products are you thinking about as we go forward?

Thanks Matt. One of the elements we continue to discuss internally is we need to make sure that our R&D organization is not only productive but we get on what we call it disciplined and relevant innovation.

We start talking about platforms, followed by derivative products that there is a continued cadence of new products coming out. Part of that is challenged right now by as you know we have the top three R&D jobs that are open and we are in the process of revamping that.

We are shifting and accelerating in that direction and now that we have a clear line of sight on the operational excellence initiatives that we have and we are driving, that's the next thing and we are shifting the focus to be on that direction. I think a great example of that is the TETRAfuse platform on 3D printed material work we just come out with and announce at NASS.

If you think today as an example of what is relevant innovation, and the discipline in terms of a platform of derivative product, if you think today doctors have to compromise everything on the market whether it is peak or it is titanium, it does end up showing in the x-ray. This is the only product that is translucent.

This is the only platform that participates in fusion and bone growth and it does have antimicrobial characteristics. We are very bullish on this product.

It will continue to phase into the market over the next few months. By the end of next year we would be fully launched across all the segments on the spine side.

I think that there is also on the OEM side an opportunity by us getting closer and more intermittent with our customers to understand their needs better and to help them with what I would say more focused innovation in that part of the business, whether it is in the product derivative family or may be even in helping on the delivery side of our product. I think the opportunities are there.

What you have seen us scale back is we just want to make sure that our teams are very well grounded in the new processes and procedures as we practice working together in a new way that would accelerate us moving faster in the market. We do understand at the same time that we do have other gaps in our portfolio where we may opportunistically fill these inorganically and we are ready to do both.

Our guys, we're going slow to go fast making sure they understand the new way of doing things and working together, onboarding new leadership to coach with that, make sure that we have the engine to continue to deliver a disciplined and relevant innovation while inorganically augmenting and showing up the portfolio with the gaps that we need. And Jon, go ahead.

Yes, and just you know briefly adding to that from a purely tactical modeling perspective is we have gone into the operating plan this year. What we have done is we benchmark what the spending rates of our peers within the different segments of the business.

And if you think about it, you know the general spine company is well positioned in the marketplace. They are spending somewhere between 5% to 7% of revenue on R&D, wherein the OEM and sports franchises which are less innovation driven and more mature, you see the spending in the 2% to 3%.

And so, that’s kind of what we are thinking about training and as we provide the guidance early next year you know that’s where you can be thinking that we will be guiding you from that perspective.

Great, thank you, and then may be just a follow up, and Camille you touched on this briefly, but the TETRAfuse 3D, may be if you could provide a little bit more color there, where will these products be made, or you be housing the 3D printing capabilities in your facilities and then shipping out the product or – and then does this, is there opportunities to go beyond spine, you know market size or market opportunity any feedback that you got at NASS or anything along those lines will be helpful? Thank you.

The feedback from NASS has been very positive around this product. I talk to distributors.

I talk to surgeons. We've had a lot of discussions and the idea and the feedback we got is this is the only product where you don’t have to compromise on patient care.

And it is the only one that is radiolucent with the characteristics of helping in the growth and antimicrobial. The 3D printing for this material is very unique and actually we have to go to aerospace actually to get some of that technology and license that.

So, it is a combination of I guess shared possibility on the operational side between us and our partners to get that platform on market. So, that’s the feedback on NASS and more around the product and the technology with TETRAfuse.

Okay, thank you very much.

Thank you.

Hi, good morning. Thanks for taking the questions.

Just a couple, on the impact of the hurricane was it entirely on your direct business or did it have an impact on the global commercial as well?

What we were able to identify is predominately on the direct. We may have seen ancillary slowdown and but the dollars that we indicated are direct dollars.

Okay and then can you just flush out a little bit as to where that the impact was felt meaning, you saw a bit of a deceleration in Spine off of admittedly some pretty tough comp and some pretty growthy numbers over the last year, sports and ortho was also down so I’m just wondering is there a way to I guess, 1, kind of described some of those end markets and 2, allocate the impact by segment if possible?

Well, you’ve identified where we felt the impact, it’s really sports and spine and obviously in the areas that were impacted by the storms discretionary procedures were not being performed and generally people choose when they have orthopedic procedures. So that's what where you're seeing the impact.

The allocation of dollars is probably somewhere in the vicinity of two-thirds sports, one- third spine directionally.

Okay, that's helpful and your assumption is that these are permanently lost?

Well the procedures that just aren’t going to be done in 2017, correct. Or put it differently the hospital only has so much capacity to do surgery and they lost surgery days, so these procedures will be done, but others won't.

Got it. Okay, on the potential reduction in cost, I think you called out your desire to kind of lower donor acquisition costs.

I'm just curious are these contractual changes when does this kick in, can you give us a little bit more detail on the reduction in donor acquisition cost?

So as Jayson, we've talked on last call and then through the discussions we've had is in general we feel that there is a big opportunity for us on the tissue based products around not only acquisition but also processing and the processing piece is within our control. We have initiatives that already started will continue into ’18.

And then the donor acquisition was an initiative that we undertook to explain the market dynamics and the interdependencies and the partnerships that we had with the organ procurement organizations in where they fit in our competitiveness. And we're very pleased that all of our partners have understood the dynamics we're in, the competitiveness of the market and then were happy to be with us facing the same problem and in agree in our solution for ’18.

The guidance on the - what that benefit would look like, as I said we're in the middle of that and will give you a combined number around both of these we're saying early January as we finalize our ’18 planning.

Okay, that's fair and helpful, but are you benefiting from this now or do these changes kick in on say Jan 01/18?

Yes, so given that there are raw material inputs you're generally we are seeing the acquisition cost benefit, but much of the benefit is actually being capitalized and so will roll out as you would typically see inventory rollout.

Okay, that's it for me. I'll let someone else jump in.

Thank you.

Hey guys.

Hi.

Thanks for taking the questions this morning. I just, I wanted to get a little clarification on the sale of the cardiothoracic business.

Could you help us break out what were the transaction costs that you incurred during the 3Q and could you maybe break out what the income related to the cardiothoracic business was, the contribution to income was in the 3Q?

Yes, I can. So the lost revenue we estimate to be about a $1.6 million from a comparable perspective and that was 75% to 80% margin contribution.

And then the transaction related costs are not sitting in the body of the income statement. They're embedded out in the gain, but they were somewhere in the vicinity of $3.5 million to $4 million.

And then I just want to get an idea in terms of the treatment in the operating expenses versus being broken out below could you kind of walk us through why chose to go that route? And that's it from me.

I guess can you clarify the question? I'm not sure I understand.

Sure. We were - I was just curious as to it looks like, I mean you guys broke it out as an operating expense so to speak in terms of the gain and we were just wondering it seems like something that would often be broken out below the line and so I wasn't sure what the treatment was there?

I guess our interpretation of GAAP was that that’s the appropriate place for it. I mean I think it's pretty clear what the amounts are and you've got the gross to net amount so at the end of the day it's pretty easy for everybody just for it, but as we went through the reporting guidance, our crack accounting team told me that's where we put it.

Sounds good. Thank you guys for taking the questions.

Given there are no questions, I just want to thank everybody for joining us this morning and your interest and support for RTI. We're very confident that our three strategic goals focused on reducing complexity, driving operational excellence and accelerating growth have us on a very solid path toward achieving profitable long term growth.

Thank you and have a great day.