Mark Quick - Director of Business Development & IR Brad Mason - President & CEO Doug Rice - CFO.

Bruce Nudell - SunTrust Raj Denhoy - Jefferies Craig Bijou - Cantor Fitzgerald Jeffrey Cohen - Ladenburg Thalmann Jim Sidoti - Sidoti & Company.

Good day, ladies and gentlemen, and welcome to the Orthofix Second Quarter 2018 Earnings Results Conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference to your host, Mr. Mark Quick, Director of Business Development and Investor Relations. Sir, the floor is yours..

Thank you, operator and good afternoon, everyone. Welcome to the Orthofix second quarter 2018 earnings call. Joining me on the call today are President and Chief Executive Officer, Brad Mason; and Chief Financial Officer, Doug Rice. I’ll start with our Safe Harbor statements, and then pass it 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 we make on today’s call are based on our beliefs and expectations as of today, August 06, 2018.

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 risks disclosed under the heading Risk Factors in our Form 10-K for the year-ended December 31, 2017, 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 matters as a supplement to financial measures determined in accordance with U.S. GAAP.

Please refer to today's press release announcing our second quarter 2018 results for reconciliations of these non-GAAP financial measures to our U.S. GAAP financial results. At this point, I'll turn the call over to Brad..

Thanks, Mark, and good afternoon, everyone. As usual, I'll start by giving you a summary of our second quarter 2018 performance, after which Doug will discuss the financial results that we reported today. I will then follow up with our outlook for the remainder of 2018 before taking questions.

Starting with the big wins in the quarter, operationally, we completed the acquisition and integration of Spinal Kinetics; realigned our business unit structure to accelerate future growth and realize synergy opportunities across all four of our spine businesses; position the company for the move of our corporate domicile from Curacao to Delaware, which was finalized on July 31; and excluding the addition of the Spinal Kinetics inventory, reduced the inventories by $7.5 million or almost 10% over prior year.

We expect to see the benefit of these positive developments for many years to come. I will give you a little more color on each of these in a few minutes. Another highlight of the quarter was our bottom line performance. Adjusted EBITDA margin came in strong at 19.7%, compared to 18.8% in Q2 of 2017, a 90 basis point increase.

When excluding the impact of Spinal Kinetics, we had a 20.8% adjusted EBITDA margin in the quarter. We are pleased to show continuing progress in reducing our operating expenses to achieve our stated goal of increasing our organic adjusted EBITDA margin by at least 100 basis points this year and in each of the next two years.

Moving on to top line performance, there were a few temporary drivers of the sales shortfall to our guidance in the quarter that I will now discuss in more detail. For the period, including Spinal Kinetics, we reported net sales of $111.5 million, representing a year-over-year increase of 2.4% as reported and 1.3% in constant currency.

The core organic growth rate, normalized for the MTF fee change and excluding Spinal Kinetics, was 1.3% as reported and 0.3% in constant currency. Starting with BioStim, reported net sales grew 2.2% over prior year.

This performance was approximately $1 million short of our plan due to the unusually late receipt of a large quantity of documentation necessary to convert orders to sales at the end of the quarter. While it is normal to get some documentation too late in the period to be processed, in Q2, we far exceeded our typical period ending open orders.

However, as we would expect, this documentation was processed in early July, and the orders were then converted to revenue. More importantly, we continue to see an upward trend in the demand for Orthofix bone growth therapy portfolio of products, demonstrated by the expansion of our customer base by 4.2% in the second quarter versus prior year.

When adjusting for the increase in period ending open orders, the sales growth rate for BioStim was 4.3% for the period. We remain very confident about the future performance of this business. In our Spine Fixation SBU, excluding Spinal Kinetics, reported sales increased 0.8%. U.S.

sales have remained solid, with 4.4% year-over-year growth in the second quarter and 6.9% growth year-to-date, driven primarily by new products such as CETRA Anterior Cervical Plate and FORZA Expandable Interbody. Three months ago, we began a reorganization of international spine sales management in anticipation of the Spinal Kinetics acquisition.

As a part of the integration plan, Spinal Kinetics management now have the responsibility for all OUS spinal implant sales, in addition to the Spinal Kinetics M6 disc. Long term, we believe this change will be very beneficial. However, this disruption did have an impact in the period that is expected to continue for the next quarter or two.

Between the close of the transaction on April 30 and the end of the quarter, Spinal Kinetics contributed net sales of $2.3 million which was in line with our expectations. We reported a sales decrease in our biologics business compared to prior year of 6.3%.

As previously mentioned, the sales in this business are being negatively impacted this year by the contractual reduction in the marketing service fee percentage Orthofix receives from MTF Biologics. When normalized for this change which occurred in March, sales increased 1% in the period with volumes increasing 3% offset by a 2% ASP decline.

As in the first quarter, we are still underperforming in one of our three regions where we have a sales management change late last year.

In a few minutes, I will speak more about the realignment of our spine businesses; but for our biologics business in particular, we believe this realignment will create additional opportunities to accelerate sales growth in the future.

Orthofix Spine in total, including bone growth therapies, spinal implants, biologics and Spinal Kinetics produced $86.8 million in sales in the second quarter, which was a reported 3% increase over prior year. Lastly, in our Extremity Fixation business, reported net sales increased 0.2% and constant currency net sales decreased 4%.

The factors impacting the period included an increase in unshipped orders at the end of June of approximately $1.5 million, compared to a typical quarter-end due to the late timing of several large orders that were expected earlier in the quarter.

Also, an impact of $800,000 from the change in foreign currency rate since we last gave guidance; and lastly, a miss of $500,000 in the quarter versus our plan due to a delay in the rollout of the RIVAL foot and ankle plating system. We expect this delay to continue for the remainder of this year.

However, we do expect the period ending open orders to normalize in the second half of the year and we'll strive to mitigate the RIVAL sales shortfall with overachievement in other products and geographies. Overall, the core extremities business remains healthy and we feel very good about the long-term outlook.

Moving on to non-sales metrics, we are very pleased with our bottom line performance, cash flow improvement and inventory reduction in the quarter. Adjusted earnings per share were flat at $0.42 compared to Q2 2017. Excluding the dilution of Spinal Kinetics, adjusted EPS was $0.45 per share for a 7.1% increase over prior year.

Free cash flow was $13.4 million for the second quarter, which was an $11.8 million improvement over prior year. Adjusted trailing 12-month ROIC showed a modest improvement to 10.4% compared to 10.1% in 2017. However, excluding Spinal Kinetics, our adjusted ROIC was 13.5%. And lastly, we had a cash balance of $45.7 million as of June 30, 2018.

I will now touch on a few of the execution highlights in the quarter, starting with our top priority for the period, finalizing the Spinal Kinetics acquisition and executing our integration plan. Following the close of the deal, the combined with Orthofix and Spinal Kinetics teams completed the integration plan on schedule.

Spinal Kinetic team members have already proven to be a great addition to Orthofix with experience and relationships that will help us across all of our spine businesses.

Additionally, we remain on track with the Food and Drug Administration approval process and continue to target final approval in 2019 with midyear still being the most likely timing. In the meantime, the Spinal Kinetics business is performing as planned.

As announced in June, we are realigning our four spine businesses, bone growth therapies, spinal implants, biologics, and Spinal Kinetics under one leader into a single global spine organization.

We believe that there are many opportunities to leverage our core spine competencies and differentiated products across all of our spine businesses to further accelerate long-term growth. This is particularly relevant with the addition of the Spinal Kinetics M6 disc which is generating significant interest from both surgeons and sales agents.

In the initial phases of this realignment, we've already consolidated our R&D, operations, international sales management, and marketing. Although the primary objective of this change is to leverage sales opportunities to accelerate growth, we also anticipate there will be cost saving synergies that can be achieved in the longer term.

Another highlight since our last call was our success in preparing for and getting shareholder approval to change our corporate domicile from Curacao to Delaware. For a number of years, we have been working to evolve our corporate legal and tax structure.

It has been a well-planned and executed effort by our legal, finance and tax teams, and the last major step in this process was to move our domicile to the U.S.

We did this to align our incorporation with our primary business operations, improve our operational structure and financial flexibility including better cash management capabilities, benefit from the predictability and flexibility of Delaware Law, and to position the company to better respond to global tax developments which had an immediate beneficial change to our non-GAAP long-term tax rate, reducing it from 35% to 29%.

We are very pleased to have completed this work and officially became a Delaware-domiciled company on July 31. We will still be traded under the same Nasdaq ticker symbol, OFIX, but now renamed Orthofix Medical, Inc. Lastly, I want to talk about the progress we are making on improving our inventory management.

As I mentioned in the past, this is a high priority for us this year and beyond. It is a key element of our plan to achieve the margin expansion that we've committed to.

Despite the increasing need for inventory due to our pace of new product launches and growth trajectory, we have made great progress in better managing both field consignment and in-house inventories. We have taken a holistic approach looking at all opportunities for improvement from initial product design to end of life and everything in between.

This has already yielded the very positive progress that I noted a few minutes ago of an almost 10% reduction in inventory over prior year excluding the inventory acquired in the Spinal Kinetics acquisition.

In summary, although the top line faced some unexpected headwinds, we had a very strong quarter in our bottom line performance in many areas that will benefit the company for years to come. Overall, we remain confident in our ability to continue to increase shareholder value in the future through disciplined execution of our strategies.

I’ll now turn the call over to Doug for the financial details.

Doug?.

Thanks, Brad, and good afternoon, everyone. Our financial results had many highlights this quarter that validate our margin expansion opportunities, especially given the challenges faced on the topline the brad mentioned.

I'll start by providing some additional details into our net sales and earnings results and then discuss some of our other financial measures. As Brad noted, total net sales in the quarter were $111.5 million, up 2.4% on a reported basis and 1.3% on a constant currency basis when compared to the second quarter of 2017.

When adjusting for Spinal Kinetics sales and the MTF fee change, we were up slightly over prior year in constant currency. The shortfall to our expectations primarily reflects the unexpected delay in certain revenues in BioStim and Extremity Fixation as we exited the quarter.

As Brad mentioned, we expect to see most of this recover in the second half of the year. Gross margin in the second quarter 2018 was 79.5% compared to 78.7% in the prior year period.

The 80 basis point increase was driven by continued improvement related to inventory management initiatives, partially offset by the addition of Spinal Kinetics acquisition-related inventory fair value adjustments. For the full year 2018, we continue to expect gross margins to be between 78% and 79%.

Sales and marketing expenses were 46.2% of net sales in the second quarter of 2018, roughly flat with 46.3% of net sales in the second quarter of 2017 and in line with our expectations. We continue to expect sales and marketing expense as a percent of sales to approximately track the 2017’s results.

Non-GAAP net margin in the quarter was 33.3% of net sales, which was up 90 basis points from 32.4% of net sales in the second quarter of 2017. This improvement was primarily due to the improvement in gross margin over prior year.

GAAP general and administrative expenses were 20% of net sales in the second quarter of 2018, which were up from 18.7% in the prior-year period. This increase is due primarily to higher share-based compensation and strategic investments.

The accounting treatment of the relative total shareholder return-based performance shares and earlier grant date in 2018 were the primary drivers of the higher share-based comp. The strategic investments increased spending reflects costs primarily related to the Spinal Kinetics acquisition and integration and our corporate re-domicile.

These increases were mostly offset by cost savings from core compensation and professional fee expense reductions and the benefits of our 2017 U.S. restructuring.

Research and development expenses were 7.1% of net sales in the second quarter, which were up from 6.3% in the prior year, primarily due to costs pertaining to the addition of the Spinal Kinetics regulatory efforts associated with the FDA premarket approval of the M6 cervical disk.

With these ongoing expenses, we expect R&D spending to step up to approximately 8% in the back half of the year and be between 7% and 8% for the full year. Adjusted EBITDA during the second quarter increased to 19.7% of net sales from 18.8% of net sales in the prior year.

The primary driver of this 90-basis-point margin improvement in the quarter came from our gross margin improvement. We have also created fairly significant operating leverage in cost savings since our 2017 U.S. restructuring in core G&A spending. U.S. restructuring in core G&A spending. Offsetting these improvements was the increase in R&D expenses.

As Brad mentioned, excluding Spinal Kinetics, margin expansion during the quarter was 200 basis points. Now, turning to tax, we had income tax expense for the quarter of $1.1 million or 53.8% of income before income taxes, as compared to income tax expense of $3.9 million or 45.3% of income before income taxes in the same period of 2017.

This year-over-year increase in our quarter tax rate was driven by lower GAAP earnings and higher nondeductible expenses offset by the lower U.S. tax rate enacted in December. We will continue to see quarterly volatility in the GAAP tax rate as a result of the Spinal Kinetics acquisition as well as the timing of potential tax audit settlements.

As Brad noted earlier, on July 31, subsequent to shareholder approval, the company's corporate domicile was moved from Curacao to Delaware. As part of this transition, the corporate structure has been simplified to improve our financial flexibility and reduce costs.

These changes are expected to provide benefits including a reduction in our non-GAAP long-term effective tax rate from 35% to 29% beginning in the third quarter.

This six-point reduction in the long term-rate reflects our ability to more fully benefit certain corporate costs historically incurred by our peers out there as well as current expectations regarding mix of earnings and interpretations of current tax law. We are excited about our future as a U.S.-based company.

The domicile change was completed under budget and earlier than expected. We are undertaking a few remaining activities to maximize efficiencies, most of which should be substantially complete by the end of this year.

For the second quarter 2018, we reported GAAP net income from continuing operations of $0.05 per share as compared to $0.26 per share for the second quarter of 2017.

After adjusting for certain items and when normalizing for tax using a non-GAAP long-term rate of 35%, adjusted net income from continuing operations was $0.42 per share, same as the $0.42 per share in the second quarter of 2017.

As Brad mentioned, when excluding the operating losses associated with Spinal Kinetics, adjusted net income from continuing operations was $0.45 per share for the period. As I also just noted, another contributor to the flat growth in adjusted EPS was higher stock-based compensation expense versus last year.

As a reminder, we expect stock-based compensation to increase for the full-year 2018 over prior year by approximately $6 million or $0.20 per share. During this quarter, this was approximately $2.5 million or $0.09. Moving onto the balance sheet highlights.

Days sales outstanding or DSOs were 61 days at the end of the second quarter 2018, up from 51 days at the end of the second quarter 2017. As noted on the last call, this increase was due primarily to the increased receivables from the adoption of the new revenue recognition standard.

Our inventory turns at the end of the second quarter 2018 were 1.2 times flat to the second quarter 2017 as the impact of our inventory management improvements were offset by an $8 million increase in inventory related to the acquisition of Spinal Kinetics.

Cash and cash equivalents at the end of the second quarter were $45.7 million compared to $81.2 million at the end of 2017. The decrease in cash was primarily related to the upfront consideration for the acquisition of Spinal Kinetics.

Cash flow from operations for the quarter was an inflow of $16.6 million compared to $6.3 million in the second quarter of 2017. This improvement was due to lower investments and product launches when compared to the prior-year period and the resulting impact of our inventory management initiatives.

Capital expenditures during the quarter were $3.2 million versus $4.7 million in the prior year. The decreased spending during the quarter primarily reflected lower investments in instrument sets for new products.

Free cash flow defined as cash flow from operations minus capital expenditures was $13.4 million during the quarter compared to $1.6 million in the prior year. This improvement primarily reflects the operating cash flow items that I just noted. With that, I will now turn it back to Brad..

Thanks, Doug. Looking ahead to the remainder of the year, the company now expects to report net sales of $450 million to $456 million based on current foreign exchange rates. For the third quarter, we now expect net sales to be in the range of $110 million to $113 million.

Regarding the full year growth contribution from each SBU, we continue to expect the BioStim business to grow in the 4% to 5% range. We now expect spinal implants growth including Spinal Kinetics to be in the range of 12% to 14%, which reflects our lower expectations for international spine implant sales.

Biologics sales are now expected to decrease mid-single digits for the full year, primarily due to the MTF fee reduction and the under-performance in one region. And lastly, due to currency headwinds and the delays in the RIVAL launch, we expect Extremity Fixation sales to grow in the low-single digits.

Including Spinal Kinetics, we now expect to achieve adjusted EBITDA in the range of $85 million to $87 million for the full year 2018, and adjusted earnings per share to increase to $1.66 to $1.72 using weighted average shares of 18.9 million and a non-GAAP long-term tax rate of 35% for the first half of the year and 29% for the second half.

For the third quarter, we expect adjusted EPS to be in the range of $0.35 to $0.37. As a reminder, we are giving quarterly guidance for the last three quarters of 2018 to help our investors navigate the numerous changes this year. However, in 2019 and beyond, we will only be giving full year guidance as we have in the past.

With that, operator, we are now ready to open up the lines for questions..

Thank you. [Operator Instructions] Our first question comes from the line of Bruce Nudell from SunTrust. Your line is open..

Hi. Good afternoon and congratulations on the redomicile and the margin improvement. Brad, now that you've kind of got Spinal Kinetics in place, you kind of have their team in Europe, you’ve reorganized the selling effort there and you kind of got a sense for the rebranding efforts and the long-term implication -- the long-term potential of RIVAL.

Could you just kind of like paint a picture beyond this year for kind of the expectations for the trajectory of a biosimilar, which I'm sure is unchanged, Spinal including Biologics as well as Ex Fix?.

Absolutely, Bruce. Nice to hear from you. So biosimilar, you're exactly right. No change to our outlook there. It’s a solid business, continues to be solid. The down blip we saw in Q2 has already recovered in Q3. So, no problem there. We expect same expectations as we've had in the past, very solid. Regarding spinal implants, the U.S.

business is doing really well. I mean, we're up 6.9% year-to-date, and that's on some pretty tough comps when you look at last year. So, we're happy with the U.S. business. There’s some things that we can still improve there and we're working on them and always will be, of course.

Spinal Kinetics is exactly on track with where we expected it to be at this point. The feedback that we're getting from surgeons from the interest, inbound interest from sales force, distributors and things out there is terrific. So, all is looking very good there, and we're also still on track with the FDA in terms of the timing.

Still expecting the middle of next year. To your point, on the international spine sales, I think with Tom Afzal now heading that up, who has a lot of experience in international spine sales, great relationships around the world. He's going to be a big help to us. He's going to be the leader of that, and I think he'll bring a lot to the table.

It's going to take a little while for him to get up to speed and to get his arms around what we have and how we can integrate that with what he has and who he knows. But we expect to see really good things out of – to come out of that. Although back half of this year, we will still be challenged in that regard.

And then that -- generally in spinal implants, we're in a good spot, and particularly more excited than ever about Spinal Kinetics, particularly since we have now accomplished the integration which has gone as flawlessly as you can expect. So, we’re very, very pleased with that.

Biologics, obviously we're still impacted by the MTF fee split change, and that's going to continue here for until March of next year. But in volume, we grew 3%. We got a little bit of hit from ASP pressure of a couple of percent, and that's while still underperforming and one of the reasons pretty significantly.

If you recall -- you may recall, Bruce, a couple of years ago, we had the same issue in a different region. That region not only rebounded, it's now our strongest region by far, and hopefully we can have the same sort of impact here going forward.

It’s just going to take a little bit of time, so we don't expect great things before the end of the year, but our outlook for next year and beyond is still unchanged. We still have solid expectations for that business going forward.

The other thing I would say is with the realignment of our spine businesses, I think I believe that the Biologics business can benefit the most from that. The relationships that come on the BioStim side could be very, very beneficial to that business, and so -- as well as the spinal implant side.

So, we think that business can do very well in the new structure. And then finally, Extremities, obviously, we're hit by some order timing. It's a lumpy business, whether it's cash collections or whether it's large orders. That's pretty normal. So, we saw that in the second quarter; nothing to worry about there.

We will have some currency headwinds for the rest of the year versus what our last guidance was of a couple million dollars. Again, that's not a problem either. RIVAL is a little bit of a different issue. We launched RIVAL and had some issues that have caused us to pull back.

And it's only on a couple of components, but that's all it takes to have the distributors and the physicians hesitate. So we're going to get that right and then re-launch in the future. I think we will be suffering from -- through that for the rest of this year and then move on from there.

But we did have quite a bit of sales in our plan for the remainder of the year, about $3 million that we are now taken out of our guidance. When you see the drop in the guidance, that's one of the primary drivers of it. But overall for the business, the core business is fine. I mean, our order volume year-over-year increased in Q2 by 6.8%.

We're having -- getting great feedback on our G-Beam, which we think we’ll -- which we just recently launched and gives us another great product to add to our Charcot foot portfolio. So, that's kind of the overview of all of the businesses and what the drivers are and our expectations..

Thanks. And for just my follow-up, I'm going to put words in your mouth and correct me. So just thinking about this beyond the turbulence of this year, I should be thinking BioStim at 3% to 5%, spine with Biologics but also with Spinal Kinetics around you know 5% to 7% and then maybe Ex Fix, 2% to 4%.

Are those kind of reasonable ranges to be thinking about for midterm trajectories?.

I think you're spot on in the BioStim, I think that's right. I would be hopeful of better in spine with Spinal Kinetics. With Spinal Kinetics, it should be higher than that. And then Extremity Fixation, that’s probably a reasonable estimate, maybe some opportunity. I would say, more upside potential on that than downside.

Probably, a couple of points higher there, I would hope..

Thanks so much. Have a great day..

Okay. You bet, Bruce. Thank you..

Thank you. Our next question comes from the line of Raj Denhoy from Jefferies. Your line is open..

Hi. Good afternoon..

Hey, Raj..

So, you gave us a lot of information the last question from Bruce. But I guess the question though is that it's the slowest growth you guys have posted in quite a bit of time, 0.3% kind of underlying growth excluding everything. That sounds like there was a lot of one-time issues in moving parts in the quarter.

As we think about the third quarter into the fourth, how do we get the confidence that these issues have been sort of contained in that there isn't anything more going on perhaps with the timing of orders through distributors or anything else that might -- might be behind some of the softness we've seen in this quarter?.

Sure, Raj. So, I think probably the most important piece here is in our BioStim and our Extremity Fixation business, we had open orders that exceeded our normal open order totals at the end of the period of $2.5 million. So you add that, we also had a currency headwind versus our guidance of $800,000.

You put those two together and we're at the top end of our range in Q2. So, there -- while the BioStim has already recovered, we expected that to recover in our Extremities business as well.

Although I'm going to be a little more cautious about forecasting the Extremities business for a period because those large orders can hit, it can be make it a little more choppy. I would not use this quarter as any sort of a benchmark for our underlying business or our sales going forward. It's an anomaly for a few reasons.

I will tell you, we have some -- we have the RIVAL issue that we talked about, we have some softness in international spine and other than that, our core business is in a biologics reason that’s underperforming a little bit. Other than that, our businesses are very, very solid. And nothing that's happened in Q2 changes our view of 2019 and beyond..

Okay. Maybe just a couple of follow ups, so the RIVAL product launch – I’m sorry if I missed it, if you gave us the explanation.

But what's behind the delay or the decision not to be more aggressive with that product?.

Yeah. We had a -- we had a couple of components of the system that had some failures in the field that we pulled back. And when you do that, people hesitate about using the overall system. These were two components – I mean, a few components out of almost a 1,000 SKUs in that system.

But it gets – it hasn’t has a disproportionate impact on the physicians who had an issue and also the distributors. So we're going to fix it. And then, while we’re we still selling a significant portion of the number of SKUs that we have in that line, the sales -- we're not pushing it, the sales are low.

We're not estimating anything to speak of between now and the end of the year. But by year-end, we hope to have those components fixed and relaunched with a new attitude and a new confidence in the system..

Okay. Maybe just I can ask one additional question.

There were some questions about the recognition of this ASC 606 accounting standard last quarter and whether it resulted in perhaps some revenue recognition last quarter that might have been delayed in the sense or that you recognize in a sense maybe sooner than you would have normally? Is there anything you want to comment around that front, whether there was actually some perhaps revenue in the first quarter that maybe would have fallen in the second quarter if not for that revenue recognition standard?.

Yeah. Raj, that’s a good question. This is Doug. Yeah. I would say generally that we would expect the new revenue recognition under ASC 606 to match up over time with the previous revenue recognition standard. As Brad just mentioned, our extremities business does tend to be lumpy or choppy. And so there was some Q1 volatility, as you noted.

I think, over time, that that will even out. In fact, we saw it worked the other way in Q2 in terms of going the other direction..

Okay. So perhaps again that is explaining some of the volatility we're seeing.

And when do you expect it will take the entire full year before we get to perhaps a more normalized reporting where we won't see these spikes quarter in and quarter out?.

Yeah. I think every quarter that we get more behind us, it will start to normalize on an accumulated basis..

Okay. Fair enough. I'll leave it there. Thanks..

Yeah. Thanks, Raj..

Thank you. Our next question comes from Craig Bijou from Cantor Fitzgerald. Your line is open..

Good afternoon, guys. Thanks for taking the questions..

Sure, Craig..

So I wanted to start with EPS guidance. I obviously recognize you guys raised it by $0.06 at the midpoint. You’ve beaten Q2 by $0.06. I think there was – if I'm correct, I believe you talked about maybe increased R&D spending in the back half of the year, or at least relative to what we were expecting.

So, but – and you also were going to get a tax, the tax benefit from moving down from 35 to 29. So maybe if you guys could just talk about the puts and takes since you only raised it by $0.06 but you’ve beaten Q2 by $0.06. So maybe the puts and takes on the EPS line for the back half..

Yeah, sure, Craig. So, as we're going to have a pickup on the tax line of probably most likely around $0.08. And so, we have put into our guidance about half of that, essentially maybe a little bit more. The shortfall in sales is where we're – where we’ll struggle a little bit.

That's our current thinking about it to make sure that we're well-covered in our guidance. I think that with that $8 million reduction in sales, we're going to feel that in the EPS offset by the tax benefit..

Okay. That's helpful. And if I could ask on the U.S. spine business. Obviously, you guys said you're strong in the first half, 6.9% year-to-date. I think the number was 4.8% in the second quarter so. And I know comps play into this, but what are you expecting or what's kind of baked in your guidance for the U.S.

spine business in the back half of the year?.

Yeah. We're expecting – we’ve got some challenges in the new products in getting enough inventory into the field, which is holding us back a little bit. It would actually be even a little bit better. Hopefully we're going to work our way through that in the next 90 days or so. But we're still going to be challenged on the international spine.

That's probably about $1.5 million or so that we're expecting headwind in the second half of the year. So if you will factor that all in, we’re still looking at the 12% to 14% growth rate with Spinal Kinetics included in there. And I think we’ve talked about Spinal Kinetics being in the $8 million to $9 million, of which $2.3 million of it was in Q2.

So then, with then, it's just arithmetic from there..

Yes..

We can help you with that after the call. I’m happy to do that..

Got it. Perfect. One last one if I can squeeze it in, is there any operating mark [ph] from the re-domiciling and could you could you quantify that? Sorry, if I missed that from the script..

Yeah. We haven’t quantified any savings there. I think they will come over time, maybe a little bit more on the soft side, but probably we'll save some money on the legal and tax side and those sorts of things over time. And – but there's nothing that we’ve quantified there. We’re just happy to be in the U.S..

Okay, great. Thanks for taking the questions, guys..

Great. Thank you..

Thank you. Our next question comes from Jeffrey Cohen from Ladenburg Thalmann. Your line is open..

Thanks for taking the questions..

Hey, Jeff..

So could you talk a little bit about Stim and the spillover on some of the ordering patterns into the third quarter, something that you expect to see a bit of bullish in the third quarter or it’s going to be more normalized in the back half of the year?.

We’ve already seen it. We thought July. So whatever carried over that was unusually – the open orders that were unusually high, we saw that returned in July already. So we’re back in good shape. We’ve also put into process that helps – a method that we believe will help to minimize that in the future.

But we just had a – it was just some late documentation that came in for a lot of orders. The part of it was holiday-related, believe it or not, coming into the 4th of July holiday.

But the sales agents out in the field have to -- once the order is approved and we've got insurance authorization, that's an open order, then they have to go apply that device. They have to get the signatures on the medical – letters of medical necessity, assignment of benefits, prescriptions things like that, and get all that in.

And I think some people left on holiday a little bit early and – but we have – again, we have a team now that will be making calls toward the end of each period. But one more important thing to note Jeff is we don't, I don't – culturally, I don't push at period ends for sales. I think it's a bad habit to get into.

It can create conflict for employees that I don't want to have happen. So, we try to close each period with some sense of urgency, but we don't push beyond that because it's not a good practice from a compliance standpoint..

Got it.

And are your comments also correlated on the Extremity side, some of your comments about ordering patterns as well?.

Ordering patterns for Extremities are a little bit different. We have such a large percentage of that business or a significant percentage, I’ll say, of that business is stocking distributors around the world. We had a couple of very large orders that we are expecting earlier in June.

It didn't come in the last few days of the quarter that we couldn't ship. So, those will go out in July. But I want to be cautious about that business and predicting it, because that's something that could happen in any quarter. It's just a little bit choppier business.

So, we're really kind of have to look at that business on a longer term basis just to remove some of the choppiness. But if that could happen -- again, if it happens in Q3, it would just be coincidence rather than a pattern, and I don't expect that it will but you never know.

So we're probably a little bit on the conservative side in our estimates for that business between now and the end of the year..

Okay. Got it.

Could you give us a little further clarity on the Biologics business as far as the reduction in ASPs, and can you give us a little read into how you feel what's going on there and how that looks for the balance of the year as well?.

Sure. Biologics, we’re still struggling in one of the territories that I talked about. We’ll rebound there. I don't think – I don't expect a lot of rebound this year. I think it will be more beginning of next year. But I've – in the past, I've erred and things have come in quicker than I expect. I hope that will be the case this time.

We did grow 3% in volume in our Trinity franchise and then with 2% ASP pressure which -- so our net volume increase was 1% if you take out MTF. Our net increase was 1% if you take out the MTF split change. That ASP is actually – ASP change is a little bit better than typical. We're usually around the 3% range. So we're happy to see that.

And long term, as I mentioned before, we should benefit from the realignment with the rest of the spine units. And I think by next year, we should be back on the trajectory that we have seen in the last few years..

Okay. Perfect. And then lastly, if I may.

Doug, could you comment a little bit about the contents of the $4.8 million, the other income expense line? Is that all related to Spinal Kinetics?.

No. Some of it. Some of it is related to non-cash re-measurement of certain intercompany notes from a foreign currency perspective. That's the majority of it..

Is that broken out within the press release?.

It is not..

Okay. Okay. Perfect. Guys, thanks for taking the questions..

Thanks, Jeff..

Thank you. Our last question comes from the line of Jim Sidoti with Sidoti & Company. Your line is open..

Good afternoon.

Can you hear me?.

Yeah, Jim..

Hi, Jim..

Hey. Good afternoon. So you took top line down about $8 million and you talked about the change in distribution and some of the timing issues.

Can you just kind of put it in buckets? Of that $8 million, how much is in each bucket?.

Absolutely. So if you think about the change in guidance from Q2 to Q3, you can put a currency headwind of about $2 million in there, the RIVAL shortfall of about $3 million estimated for the rest of the year, Biologics we're now seeing about $1.5 million short of what we were thinking at the end of Q2 because the region that we talked about.

And International Spine, about the same about $1.5 million shortfall to what our expectation was when we last gave guidance. So that'll total about that's where the buckets for $8 million are..

Okay. I got it. And you said you've been through this with the Biologics in the past with another territory.

What do you think is the key to getting that business back up? Is it new distributors? Is it just the new direct sales force and getting familiar with territory? How the teams were down their business?.

Yeah, it's sales management. We had a very good regional sales manager in that area. He left us for opportunity, not in our space, in a different place. And so, we've been reorganizing it since then. We've had two people covering three territories and we have not yet found the right leadership for that territory.

When we do, as we saw in the Northeast, that can make a huge, huge difference, and we expect it will. So that, coupled with the reorganization of or realignment of our spine businesses, getting more breadth of marketing and just the sales management team across all of the spine business – businesses now can help that as well.

So we haven't got our arms around that completely and all the opportunities that exist there, but there's a lot.

And as I said earlier, at the risk of repeating myself again, I think biologics is one that probably is in the best position to benefit from that, particularly with the relationships we have in our BioStim business both with physicians as well as with distributors..

Okay.

And then were there any changes to the timeline for the Spinal Kinetics approval? You still think that's a late 2019 event?.

We’re still -- 2019 still looks good. Our best guess is still middle of 2019. It could be plus or minus. It could be six months before that. It could be three months before that – six months after or three months before. But I think I think that's still a good target, is that middle of the year, July sort of time frame..

Okay.

And then the last one for me, that – just a follow-up to the last person, that $4.8 million charge in other income, is that included in your pro forma EPS, or is that breaking out – broken out?.

No. That's adjusted out, Jim..

Okay.

And again, what was that? What was that for?.

It's mostly re-measurement of intercompany notes that are in different currencies. So it's just that re-measurement.

There's a little bit of Spinal Kinetics, some of the purchase accounting that we've done around the contingent consideration that we have around the contingent consideration that we have as marked to fair value through other income and that's broken out in a separate line item on the adjustment table..

Okay. All right. Thank you..

Thanks, Jim. Take care..

Thank you. I'm showing no further questions. I would like to turn the conference back to Mr. Brad Mason for closing remarks..

Thank you, operator, and thanks, everyone, for joining us today and the very good questions. I appreciate it. And I look forward to talking to you in the near future. Have a good evening..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everybody have a great day..