Mark Quick - Director of Business Development & IR Brad Mason - President & CEO Doug Rice - CFO Mike Finegan - Chief Strategy Officer.

Raj Denhoy - Jefferies Jim Sidoti - Sidoti & Company Ryan Zimmerman - BTIG.

Good day, everyone and welcome to the Orthofix International NV First Quarter 2017 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mark Quick, Director of Business Development and Investor Relations. Please go ahead..

Good afternoon, everyone. Welcome to the Orthofix first quarter 2017 earnings call. Joining me on the call today are President and Chief Executive Officer, Brad Mason, Chief Financial Officer, Doug Rice, and Chief Strategy Officer, Mike Finegan. I'll start with our safe harbor statements and then pass over to Brad.

During this call, we'll be making forward-looking statements that involve risks and uncertainties. All statements other than those of historical fact are forward looking statements including any earnings guidance we provide and any statements about our plans, beliefs, strategies, expectations, goals or objectives.

Investors are cautioned not to place undue reliance on such forward-looking statements as there's no assurance that the matters contained in such statements will occur. The forward-looking statements made by us on today's call are based on our beliefs and expectations as of today May 04, 2017.

We do not undertake any obligation to revise or update such forward-looking statements.

Some factors that could cause actual results to be materially different from the forward-looking statements made by us on the call include the risk disclosed under the heading Risk Factors in our 410-K for the year ended December 31, 2016 as well as additional SEC filings we make in the future.

If you need copies of these documents, please contact my office at Orthofix in Lewisville, Texas. In addition, on today’s call we'll refer to various non-GAAP financial measures.

We believe that in order to properly understand our short-term and long-term financial trends, investors may wish to review these measures as a supplement to financial measures determined in accordance with U.S. GAAP.

Please refer to today’s press release announcing our first quarter 2017 results for reconciliations of these non-GAAP financial measures to our U.S. GAAP financial results. I'll turn the call over to Brad..

Thanks, Mark and good afternoon, everyone. Since it hasn’t been long since our last call, I'll be able to more abbreviated with my prepared remarks today. As usual, I'll start by giving you a summary of our first quarter 2017 performance after which Doug will walk you through the financial results that we reported today.

I'll then follow-up with our updated guidance for 2017 before opening it up for Q&A. Starting with the top line, our first-quarter performance exceeded our expectations in all four of our strategic business units or SBUs with net sales coming in at $102.7 million, which was an increase of 4.6% over prior year in constant currency.

Looking at each of our SBU's, BioStim grew 8.5% over the prior year quarter. This business continues to grow significantly faster in the spinal fusion procedure volume growth rates, primarily driven in the quarter by a growing prescribing physician base.

Our recent performance clearly demonstrates the sustainability and consistency of growth in this business.

Given the momentum from the NASS positive coverage recommendation in the launch of our next generation of spinal fusion therapy devices, we believe that we are well positioned to grow both our market share and the overall market for bone growth stimulators. Moving on to Biologics, net sales increased 6.3% for the period.

These results were primarily driven by strong Trinity elite volume growth from distributors added in the last year. We had previously indicated that we expected to return to growth in this SBU in the next several quarters.

We are very pleased to have not only returned to growth earlier than expected, but encouraged by our momentum and the response we've seen in the last few quarters to our initiatives to drive the top line in this business.

In Extremity Fixation, net sales decreased 1% in constant currency for the period but grew 4.8% on a constant currency trailing 12-month basis. As we pointed out in previous quarters, calculating the growth over this extended time, minimizes the variability of cash collections.

This growth was primarily driven by continued adoption of the TrueLok Hex system, particularly in the U.S. offset in the quarter by the divestiture of non-core business in the U.K., which impacted this SBU's growth rate. This non-core business generated approximately $500,000 in net sales in each quarter of 2016.

As a reminder, at the year progresses, we also expect additional currency headwinds and a reduction in sales in Brazil and Puerto Rico as we convert from direct sales to stocking distributors as a part of our restructuring initiatives.

Net sales for our spine fixation SBU increased 2.3% year-over-year in the first quarter, exceeding our expectations and returning to growth earlier than anticipated. This increase was primarily driven by strong year-over-year growth in the U.S.

due to improved distributor engagement, the addition of new distributor partners and the uptake of the recent product introductions. This was offset by reduced collections over prior year in our international cash-based spine business. We're obviously very pleased with this strong performance and momentum shift in this SBU.

Moving on, adjusted EBITDA as a percent of net sales for the quarter was 15.3% compared to 15.7% in Q1 of 2016 and adjusted earnings per share was $0.27, which was down $0.01 versus the prior year. Our modest decrease in adjusted EBITDA margin year-over-year was primarily driven by an increase in commission expenses.

Doug will give you more details on this in a few minutes and as a reminder, first quarter margins are not reflective of the full year due primarily to frontloaded sales and marketing assets in the first quarter of each year. As of the end of the first quarter, we had a trailing 12-month adjusted ROIC of 10.4% versus the prior year of 9.3%.

Free cash flow for the quarter increased $1.3 million over the prior year to $400,000 outflow. Just as with our EBITDA margin in Q1 of each year, cash flow is not linear throughout the year due to seasonality and the timing of certain payments, such as employee bonuses and annual sales meetings.

Our cash balance as of March 31, 2017 of $41.7 million was up slightly from $39.6 at the end of 2016. I'll now spend a few minutes reviewing our key R&D and marketing initiatives in each of SBUs. In our BioStim business, the first quarter marked the initiation of the U.S.

launch of our next generation of spinal stem and cervical stem bone growth therapy devices. As a reminder, these products will be phased in during the year and ultimately will replace our existing products.

In addition to having many new patient comfort and convenience features, these devices are Bluetooth enabled and accompanied by a mobile app called Stim on Track.

The new features and apps are centered on the goal of redefining the patient recovery experience by providing first to market Bluetooth connectivity and real-time compliance tracking, we feel these enhancements combined with our proven EMS technologies can assist in improving clinical outcomes.

For our Biologics SBU, as a reminder, we intend to introduce a differentiated disposable delivery system for our Trinity tissues in the second quarter. One of the challenges that surgeons often face is introducing Biologics into confined spaces.

We expect this system could be particularly beneficial to physicians for use in minimally invasive surgeries and provide more precise delivery in open and small bone procedures. Additionally, we note the recent publication of two level cervical fusion data from a prospective Trinity evolution study.

The results of this 40-patient study, demonstrated very high fusion rates and most notably, showed that patients with risk factors for synarthrosis including current or former smokers, diabetic and obese patients, compared to those without risk factors, demonstrated similar fusion rates.

We intend to continue investing in clinical research to show the benefits of our tissue forms in its efficacy in various spine and orthopedic procedures.

Moving on to our Extremity Fixation business, this week we announced the launch of JuniOrtho, our new pediatric brand focused on solutions for children and young adults with orthopedic and congenital deformities.

Orthofix has a long history of providing a broad portfolio of pediatric extremity product worldwide in this new brand and we'll highlight our position as a leader in this important market. In addition to our development of new products for the pediatric market, we're also focused on the U.S.

foot and ankle market and targeted international trauma markets. In 2016, we added nine new products and line extensions and expect to add an additional 14 in 2017. Lastly, our spine fixation SBU continues to broaden its portfolio of products that incorporate our proprietary, porous titanium endplates and PEEK composite technology.

We are in the process of rolling out our PTC pillar SA anterior lumbar standalone interbody implant, which follows the introduction of our FORZA interbody line last year. In the first quarter, we also initiated our launch of the Cetra Anterior Cervical Plate, which significantly strengthens our overall cervical offering.

As with our Extremity Fixation business, we're planning to launch more than a dozen additional products as line extensions this year as we did in 2016. In summary, we feel very good about our Q1 results and believe we're well-positioned for the remainder of the year.

After Doug’s more detailed comments on Q1 financial results, I'll discuss our updated guidance.

Doug?.

Thanks Brad and good afternoon, everyone. I'll start by providing details into our net sales and earnings results and then discuss some or other financial measures. Total net sales in the quarter were $102.7 million up 4.1% on a reported basis and 4.6% on a constant currency basis when compared to the first quarter 2016.

As Brad, mentioned, the increase was primarily driven by our BioStim SBU and the return to growth in our Biologics and spine fixation SBU's. Gross margin in the first quarter 2017 was 78% up 40 basis points over the prior year period.

These results were in line with our first quarter expectations and we continue to expect gross margins for the full-year 2017 to be consistent with 2016. Sales and marketing expenses were $48.5 million or 47.2% of net sales in the first quarter 2017, compared to $44.8 million or 45.4% of net sales in the first quarter of 2016.

This year-over-year increase was largely due to the higher mix of sales from new distributors in Biologics and spine fixation and typically start with higher commission rates for the first year. Additionally, we had various frontloaded sales and marketing expenses in BioStim during the quarter.

As a reminder, first quarter sales and marketing expenses as a percentage of net sales have historically been higher in subsequent quarters due to lower revenue and the conferences in annual sales meetings that occurred during the period.

For the full year of 2017, we expect sales and marketing expenses as a percentage of sales to decline slightly as the year progresses from what we saw in the first quarter.

Net margin which we define as gross profit, minus sales and marketing expenses was $31.6 million or 30.8% of net sales in the first quarter of 2017, a slight decrease from $31.7 million or 32.1% of net sales in the first quarter of 2016. This decrease was primarily due to higher sales and marketing spending.

General and administrative expenses were $18.3 million or 17.8% of net sales in the first quarter of 2017, which were up from $17 million or 17.2% in the prior-year period.

This year-over-year increase was due primarily to higher professional fees related to our strategic initiatives, depreciation related to previous Bluecore investments and share-based compensation, driven by the ratable expense recognition of the relative TSR performance awards granted in Q3 2016.

Research and development expenses were $7.4 million or 7.2% of net sales in the first quarter, which were down from $7.6 million or 7.7% of net sales in the prior-year period. The decrease was due primarily to the variability and the timing of R&D investments in Biologics.

We expect full year 2017 R&D expenses as a percent of sales to be consistent with 2016. Adjusted EBITDA during the first quarter increased to $15.7 million or 15.3% of net sales from $15.5 million or 15.7% of net sales in the prior year.

The slight decrease in adjusted EBITDA margin was primarily due to the expected increase spending in sales and marketing during the quarter. Other expenses during the quarter were $4.3 million, due primarily to further impairment of our net receivable from eNeura.

Based on our review of current financial information from eNeura and other assumptions, we updated our mark-to-market estimate of fair value to $9 million. This estimate resulted in a pretax impairment charge of $5.6 million.

Now turning to tax, we had income tax expenses for the quarter of $3.9 million a 243% effective tax rate, compared to income tax expenses of $4.3 million or 48% effective tax rate in the same period of 2016.

The high effective tax rate this quarter was due in large part to the low pretax income as a result of the eNeura impairment and current period losses in jurisdictions where we do not currently receive a tax benefit.

2017, we reported net loss from continuing operations of $2.3 million or $0.13 per share as compared to net income of $4.6 million or $0.24 per share for the first quarter 2016.

After adjusting for certain expenses and when normalizing for tax, using a rate of 38% adjusted net income from continuing operations was $4.9 million or $0.27 per share compared to $5.2 million or $0.28 per share in the first quarter of 2016.

These bottom line results were due to revenue growth, partially offset by higher sales and marketing and certain non-cash expenses. Moving on to the balance sheet highlights, day sales outstanding or DSOs were 52 days at the end of the first quarter of 2017, up from 51 days at the end of the first quarter 2016.

Our inventory turns at the end of the first quarter 2017 were 1.3 times, which while slower than the prior year and 1.5 times reflect the acceleration of our new product introductions and resulting increases in inventories.

Cash and cash equivalents at the end of the first quarter increased to $41.7 million compared to $39.6 million at the end of 2016. Cash for the quarter was $3.5 million compared to $4.6 million in the first quarter of 2016.

Full expenditures during the quarter were $3.9 million versus $6.4 million in the prior-year, due primarily to the company's 2016 completion of project Bluecore, offset slightly by increased demand of instrument sets required for recent product introductions.

Free cash flow defined as cash flow from operations minus capital expenditures was an outflow of $400,000 during the quarter, compared to a cash outflow of $1.8 million in the prior year. As Brad noted, free cash flow generation in the first quarter is seasonally low due to the timing of certain payments.

We continue to expect a significant increase in free cash flow generation in 2017 versus the prior year. I will now turn it back to Brad..

Thanks Doug. Now looking ahead to the rest of 2017, we are updating our topline guidance due to the stronger than expected performance in the first quarter. Starting with net sales, we now expect to finish 2017 between $411 million to $450 million based on current foreign exchange rates.

This expectation includes headwinds in our extremity fixation SBU specifically and anticipated negative foreign currency impact, a loss of revenue due to a restructuring in Brazil and Puerto Rico and the wind down of a non-core business in the U.K.

Looking at the growth contribution from each SBU, we expect BioStim to continue to grow above market growth rates in the mid-single digit range for the full-year. As for Biologics, while we are pleased with our earlier than expected return to growth, we currently expect this SBU to grow in the low single digits for the full year.

Extremity fixation net sales as I just mentioned, will be impacted by a number of headwinds that will result in a low to mid-single digit topline decrease for the year. When excluding these items, we expect a trailing 12-month growth rate in this SBU to be in the mid-single digit range as we've seen in the past.

Finally, for spine fixation, we are encouraged by our momentum and the impact of the strategies that we began to implement over a year ago. We remain optimistic about achieving low single-digit growth for the year.

Moving on to the rest of the P&L, we believe that as we are currently structured and considering the increase commissions paid to recently added distributors in our Biologics and spine fixation businesses to drive sales growth, we continue to expect adjusted EBITDA for the full-year 2017 to be in the range of $76 million to $79 million.

Full-year 2017 adjusted earnings per share is expected to be in the range of $1.48 to $1.58 using weighted average shares of 18.4 million and a long-term tax rate of 38%. That concludes my prepared remarks.

I'll now as the operator to open up the lines for questions, operator?.

Thank you. [Operator instructions] And we'll go first to Raj Denhoy with Jefferies..

Hi. Good afternoon..

Hey Raj..

Wonder if I could start with a clarification on the guidance, looking at the reconciliation you gave you on the 2017 outlook on adjusted EBITDA, the biggest change that strikes me between what you previously gave us now is that you've reclassified a lot of the expenses or a fair number of the expenses into the strategic investments bucket.

But that went up by about $7 million to $8 million, but the underlying spending also seemed to go up and so you reclassified it here and I'm just curious what the thinking is behind that?.

This is Doug. Thank you for the question. The $7.1 million that you see in strategic investments this quarter is made up of a couple of components that are one is new in terms of our $1.5 million investment in our strategic initiatives primarily around professional fees and consulting.

The other component is the impairment, the further impairment that we saw around in our security..

Okay. I guess the question was partially about the guidance here for '17 because previously you had -- you hadn’t classified those as strategic investments.

So, I don't know if it was that now because there are consultants and not internal ongoing expense you're looking at them as kind of adjustable out in a sense when you get your adjusted EBITDA, is that's the way to think about it..

Yeah, hey Raj this is Brad. I think the confusion here is these are not the same consultants and professionals that we had in prior years. These are new people that we've indicated in the past that we were going to look at our strategic alternatives and that's what -- that's what that spending is for.

It's not anything that we would classified previously similarly, does that make sense..

Okay. Maybe I'll follow-up with you guys offline about it.

The other question I guess is just on the extremity fixation business, just trying to understand the various moving parts there in terms of the weaker outlook for '17, it sounds like the challenges you're seeing are mostly in international markets, but perhaps the TrueLok Hex and the adoption of that in the United States has been a significant driver.

So maybe you could help us understand those, those two geographic markets and how they're performing differently and then also the new pediatric initiative you have there, maybe you could outline some of the expectation around what that could do for that business over time?.

Yeah, sure. So, when you think about Hex it's going to be -- the impact this year is going to be, we do expect further currency impact as part of the guidance that we're giving on that with the low to mid-single-digit decline for the year.

The second thing is a loss -- we shut down a non-core business next year -- last year rather than contributed about $500,000 per quarter and then the third thing is the restructuring that we've done and are in the process of doing in Brazil and Puerto Rico.

The difference there is that we are going to be converting what are currently some of our sales -- a good portion of our sales are through our direct to hospitals in those countries. We're converting that business to stocking distributors.

So, when you do that of course you give a pretty significant discount to the stocking distributors over what we would charge the hospital because they take all the sales and marketing expenses etcetera.

So, there will be a reduction in our -- the volume will be the same, but there will be reduction in what we recognize the sales because of that -- because of those discounts. So those are the things that are driving the business this year. Just to back up a little bit on that, the restructuring is very purposeful.

So, we knew it would hurt this year on the top line, but it will help us we think very well in the bottom line next year both in what we report, but also in the money that we can spend on R&D in that business to support our marketing initiatives such as our JuniOrtho that I'll talk about now. So those are the main drivers.

I'll spend a little bit of time on JuniOrtho because we're really excited about that and we're very proud of the business that we have pediatrics. So, this is an initiative that highlights earlier leadership position in that market and just to give you an idea of the size of the market, track indicates that market is about $300 million in the U.S.

and we think it's probably at least that size if not larger outside the U.S., hard to get some data from China and India and those things.

Currently over a third of our extremity fixation business is pediatric and is made up of pediatric products, but if you think about the market, most of the products that are used for pediatric care are adaptations of adult products where most of our products and we'll have even more focus going forward are really conceived, designed, engineered and manufactured all for pediatric care, which is different.

But I think the initiative does more than that, it's more than just a branding because we're going to be providing links between the surgeon's parents and children with our products and then tools like websites and games and activities to promote education.

So, I don't have a number that I give to you in terms of how that's going to expand our business, but it really will help drive our focus in the business and give us a great story to tell and deliver to the surgeons around the world..

Can we just put a final point on you mentioned a third of your -- that business now is pediatric, do you have a goal that it becomes majority over time or it sounds like this is going to be an area where you focus that business now, is that at the expense of focusing on other areas or how to really think about it as -- or is yet another whole business unit for you potentially going forward?.

No, that's a really good question. So, as we think about our extremity fixation business, we're focused on three markets. We're focused on the U.S. market and a primary focus there is obviously external fixation, but also foot and ankle as we're expanding that product line. So that's one key focus. The second key focus is on OUS trauma.

So, it's elected countries and geographies, we have the trauma products like our hip fracture system, our galaxy system that worked very well in concert with our external fixation. And then the third leg of that stool is the pediatric market.

So, we give equal weight to each of those and equal focus and investment in each of those three businesses, that's a really good question.

And just as a reminder that the trailing 12-month performance, when you look at businesses is mid-single digits and we do expect that to continue in the once we get past these headwinds that we talk about this today..

Great. Thank you very much..

Thanks Raj..

We'll go next to Jim Sidoti with Sidoti & Company..

Hi, can you hear me?.

Hey Jim..

Great, couple questions, the turnaround you saw in the biologic and spinal in the quarter, can you just throw more color what you think, added products or a little of everything?.

Sure. So, looking at the biologic business first, Biologics business that's all about new distribution and engaging the legacy distributors we have. So, we've added in the last -- in 2016, we added 66 distributors as a company which is a 28% increase just to give you an idea.

Over half of those were in our Biologics business well over half and we've also added a significant number in our spine fixation business. Now the way we do those deals are typical commission structure is a percentage on the base of business. In other words, what they did the previous year and then a higher percentage on new business.

So, if we bring on a new distributor, they get paid at that higher rate for the first year because they had no base business to start from. As they exit that first year, then that rate starts to come down because then have a base of business they're working from. So, it really incentivizes their growth, early on the uptake of our product early on.

So that's was driven up our commission cost this year, but it's also which I'm okay with because what was really important to me was the top line in getting those businesses back to growth, which is what is has happened. So, Biologics is new distributors.

In the spine fixation, it's new distributors, it's really about engagement of our legacy distributors, just through personal contact through suppling new products through better customer service, better delivery, all of those things and then it's also adding new distributors in underserved markets.

So, it's a combination of all the things, but we're just now seeing the benefit of the things that we're started really 18 months ago, 18 months ago to a year ago that we're still now seeing the benefit of those things..

And then can you just the change in making Puerto Rico and Brazil, is that going from distributor to glass or the other way around?.

Other way around. So, a portion of our business is we sell through in-house sales reps, we sell directly to hospitals and healthcare systems.

In the future, we will be bringing on -- now the majority of our business is still done through independent distributors, but the portion that was done directly, we will be converting to independent distributors that typically get a significant discount off the price that we would sell to the hospital so that they have their margin and costs -- they can other costs as well.

So, we're going from direct to distributor model..

And when do you think that will really start with impact numbers..

Marginally in Q2 and accelerating through the year Q3 and Q4..

And then for Puerto Rico there was some funding that Medicaid paid in Puerto Rico and the budget expenses, any of that impact in your business?.

Jim, I am sorry, I struggled to hear that, could you repeat that?.

In the latest budget compromise for the rest of this fiscal year for this year on the federal government fiscal year, they allocated some funding for Puerto Rico I think it some Medicaid programs.

Does that impact you guys at all?.

No, no..

Okay.

And then last question, any update on situation which the classification for the stimulation project, has there been any changes since the last time you guys talked?.

Not at all..

Thank you..

You bet Jim..

[Operator instructions] And we'll go next to Ryan Zimmerman with BTIG..

Hey guys, can you hear me okay?.

Hey Ryan, yes absolutely..

All right. Great. So BioStim came in pretty good in the quarter on a tough comp.

Just opened to parse that out a little bit in terms of what you may attribute to pass the momentum on that, additional education of new larger base of surgeons and then also potentially the new project system on track, if any color there would be helpful?.

Yes, yes and yes. Those were exactly the three contributors. We really don't have a way to quantify how much it's contributing, whether the excitement of the new products, if the new product are rolled out over the next six months, it will be probably pretty much fully, they will be fully rolled out and the old products will be gone.

So probably the most important thing is when you -- when you look at those things as how does the sales force respond to them and when I talk about this a lot is we're so dependent on our sales force that if they're engaged, they're excited about the new products, they're excited about the other things that are -- that we have going in that business, then that really -- that really helps to drive it.

So, it's a combination of all those things. We don't really have, the net guidelines are certainly helping us, but we don't really have any metrics around what percentage each is helping..

Okay. That's fair and then given the updated guidance, I certainly appreciate the color you gave on each of those segments, but to come in even at the top end given where you've been performing now this quarter and BioStim and the turnaround Biologics, that would imply the business moderates a little bit through the rest of the year.

Is that a fair assumption or should we -- I don't see what reason it wouldn't continue on this track given where you've shown in the trailing 12 months and just any thoughts there and where you came on guidance and whether you're comfortable with that level?.

Yes, we're very comfortable with the level, if I take you through the business then it makes a little bit more sense, it's better way to break it down. So, our BioStim business, we've got tough comps in Q2 and Q4 of this year.

We expect it -- we're still outgrowing the procedure growth rate for spinal fusions and so we do expect it to moderate a bit and come back to mid-single digits. We're very, very pleased with Q1. Biologics it's early, Biologics and spine it's early in the turnaround.

We would like to see another quarter or two under our belts before we get too excited about it. So, we need a little bit of time there. And then the headwinds that we talked about, it could bring it down to even in the mid-single-digit decrease and we're struggling backing up a little bit to spine. We're going to struggle this year in OUS. The U.S.

is going to do fine. We've got good energy and momentum there, but OUS is tough. As you know it's a cash collection issue that's what we book. The orders were declining last year because of the strong dollar. We've got some little prop -- it's problematic in Brazil right now. We have some of those things are offset.

We've got very strong business in Australia and some things going on but that's going to be -- that's going to challenge the business this year. OUS spine business will be down this year no doubt and it will be offset by the U.S..

Got it. Understood. Thank you and then lastly for me, the CapEx is the quarter, this is I guess more directed to Doug, took a little bit out of the brief cash flow for the quarter.

What are you thinking your expectations are around CapEx through for the cadence for the rest of the year given that your free cash flow should pick up pretty materially through the rest of the year..

You're right. So, we saw CapEx decline during the quarter largely because of the completion in 2016 of our project Bluecore. We continue to guide $13 million to $16 million for CapEx and with regards to free cash flow, that decreased level of spending versus 2016 will certainly have uplift on free cash flow..

All right. Thank you so much for taking the question..

Thanks Ryan, I appreciate it..

And with no further questions in the queue, I would like to turn the conference back over to Brad Mason for any additional or closing remarks..

Thank you, operator and thanks everybody for joining us today. We appreciate the questions and we look forward to speaking to you again soon. Have a nice evening..

Again, that does conclude today's presentation. We thank you for your participation..