Hello and welcome to the Orthofix Third Quarter 2016 Earnings Conference Call. Today’s call is being recorded. I would now like to turn the call over to Mr. Mark Quick, Director of Business Development and Investor Relations. Please go ahead, sir.

Thanks, operator, and good afternoon, everyone. Welcome to the Orthofix third quarter 2016 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 or 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 is 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, October 31, 2016. 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 we make on the call include the risks disclosed under the heading Risk Factors and our Form 10-K for the fiscal year 2015, 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 will 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 third quarter 2016 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. I will start by giving you a summary of our third quarter 2016 performance after which Doug will walk you through the financial results that we reported today. I will then follow-up with a few questions about our expectations for the rest of the year before opening it up for Q&A. Our third quarter results were mixed. While we fell short of our expectations for net sales, we significantly exceeded our adjusted EBITDA EPS targets. A number of factors affected both our top and bottom lines in the quarter, which I will now discuss at a high-level starting with the top line. Our third quarter consolidated net sales of $98.5 million decreased over prior year by 2.3% at constant currency. This shortfall to our expectations was led by a decrease in sales in our Spine Fixation strategic business unit or SBU over prior year. Now, looking at each business. Our BioStim SBU grew net sales 3.4% over the prior year. As I mentioned on the Q2 call, we expected the BioStim business to return to this more sustainable growth rate in the last-half of this year. This business is the mainstay of our consolidated Orthofix business for both the top and bottom line perspective. It continues to grow faster than its markets and is producing nearly 45% of our net sales and approximately 53% of our net margin dollars. The growth in this SBU continues to be driven by strong commercial execution. While net sales in our Biologics SBU declined 2.1% for the period. Both net sales and volumes for our Trinity allograft tissue were up year-over-year in the U.S. despite pricing pressures. Our Structural Allografts and other biologics business, which makes up approximately 5% of our total biologic sales decreased significantly in the…

Thanks, Brad, and good afternoon, everyone. Our revenue was down slightly this quarter. We were able to realize certain operating efficiencies, which increased our bottom line and adjusted EBITDA above our expectations. I’ll start with providing details into our net sales and earnings results and then discuss some of our other financial measures. Total net sales in the quarter were $98.5 million, down 2.6% on a reported basis and down 2.3% on a constant currency basis from the third quarter 2015. As Brad mentioned, the decrease during the quarter was primarily driven by challenges in our Spine Fixation SBU. Going through each of SBU’s briefly, BioStim third quarter 2016 net sales were $43 million, up 3.4% versus the same period in the prior year. Biologics third quarter 2016 net sales were $14.3 million, a decrease of 2.1% versus the same period in the prior year. Extremity Fixation third quarter 2016 net sales were $24.3 million, a decrease of 1.5% on a reported basis and flat on a constant currency basis in comparison to the same period in the prior year. On a constant currency basis, this SBU increased net sales 5.4% for the trailing 12 months. And lastly, Spine Fixation third quarter 2016 net sales were $16.9 million, a decrease of 16.6% in comparison to the same period in the prior year. Now, I’ll move on to the rest of the P&L. Gross margin in the third quarter 2016 was 79.8%, an increase of 340 basis points when compared with the prior-year period, primarily due to an increase in the mix of net sales from our BioStim products, which have higher margins than our Fixation products and also due to lower fixed manufacturing costs. We continue to expect that our gross margin for the full-year will be approximately 78% to…

Thanks, Doug. Before we turn to our outlook for our business, I’d like to comment on why I believe Orthofix is well-positioned to succeed in the market. We have four focused bone healing businesses serving over 75 countries. We’re the market leader in bone growth stimulation and growing faster than the market. We offer a highly differentiated stem cell allograft in our Trinity franchise to our long-term partnership with a Musculoskeletal Transplant Foundation. Our Extremity Fixation SBU is highly regarded worldwide for its best-in-class products, and as with our Spine Fixation business has an impressive pipeline of new products. In the last few years, we have successfully transformed our culture, management, processes, systems, controls, and strategies. From all of these perspectives, we are now a better company with a stronger foundation, and we have a very strong balance sheet, moderate growth, excellent gross margins, double-digit ROIC, and generate exceptional free cash flow. Now looking at the remainder of the year. In our BioStim SBU, we expect net sales growth to remain generally consistent with our Q3 growth rate. The introduction of our next-generation lumbar and cervical spine products early next year and the recent North American Spine Society policy coverage and usage recommendation for stimulation should give us good momentum heading into 2017. Considering our result over the last few quarters in our Biologics business, we’re now anticipating a low to mid single-digit decrease in year-over-year net sales for the fourth quarter and full-year 2016. We also expect that the progress we’re making in our underperforming region, the launch of our MIF delivery system in Q1, and the acceleration of net sales from our strategic distribution partner will overcome the market headwinds and enable us to resume revenue growth within the next several quarters. On our Extremity Fixation business, we…

Thank you. [Operator Instructions] And we’ll take our first question from Anthony Petrone with Jefferies.

Hi, gentlemen, thanks and good afternoon. Thanks for taking our call today. Maybe just to start a bit with some of the moving parts on revenue, specifically within Biologics first, and then we’ll move on to BioStim. Within Biologics, you did call out the, I guess, return to a hospital formulary that is effective this month. I’m just wondering, what impact you’re expecting to that business unit into the fourth quarter? And it certainly seems that it’s helping that unit get back to low single-digit growth. So maybe more specifically on that hospital system bringing Biologic spec into formulary?

Sure, Anthony this is Brad. Thanks for calling in today and being with us on Halloween, we appreciate it.

No problem.

Yes, from the – in terms of the hospital, it’s just coming back online in November, so we’re not anticipating a huge uptick in the fourth quarter. But over time, it will make a difference. It was one of the factors this year that negatively impacted our top line. But as it comes back on, that will be one of the factors that then subsequently helps it. So not a huge impact, but in Q4, as we just have a couple of months left, but it will help us particularly going into next year.

Yes. And then maybe the shift over to BioStim, the performance has – there was a guide for an improvement into the second-half and we were trending exiting last year in a high single-digit range. It looks like for all of the units return to low single digits across the board as expected. I guess a little bit more on ultimately where should we – we should be normalizing for BioStim growth? And in particular, what expectation are you expecting from the NASS coverage recommendation for electro bone growth stimulator? I mean, how much of that do you see in 2017, as that settles into coverage?

Yes, Anthony, today actually we have Brad Niemann’s with us. He is the President of BioStim, and I’ll flip it over to him, he can answer the question directly.

Hi, Anthony, it’s Brad Niemann.

Hey, Brad.

First to talk a little about the NASS coverage recommendations, it’s probably best summed up, it’s too early to tell. Obviously, we’re excited that, there’s another reference point in the market that further supports the use of cervicaly in lumbar and specifically for pulsed electromagnetic fields. But again, it’s probably little bit too early to tell and what impact that will have in the market and the use of our products. And really from your – the first part of your question on the comparables of high single-digit to mid single-digit growth rates, I think that’s just more reflective of really where the market is at and how we continue to take incremental share up against difficult comparables over the last couple of years.

Okay. Maybe shift to margins overall and zoning on gross margin, and then I’ll wrap it up with a question on use of cash. So on the gross margin, the guide, I guess, for the full-year actually factors in a sequential deceleration. And you did reference some cost savings, as well as some manufacturing efficiency gains, I know mix is part of this as well. So I’m just wondering why the step down sequentially in the margin guidance, given where it exited in 3Q? And then in uses of cash, if we could just get an update, it sounds like if I’m hearing you correctly, Brad, that there’s a little bit of a shift here and priorities away from the buyback toward strategic initiatives. But if you can just give us an update on capital deployment that would be helpful? Thanks again.

Sure.

Doug you want to.

Yes, Anthony, this is Doug Rice. With regards to the gross margin guidance of 78% to 79%, we had 79.8%, I’m sorry, we had a higher number this quarter largely because of the mix of our BioStim top line and also the manufacturing efficiencies that I mentioned earlier, which included some pickups in E&O and just as better managing our inventory. So those are the items that we expect to taper off some in the fourth quarter is why you saw the lowered range.

Okay.

And then in terms of the capital deployment and use of cash, Anthony, yes, it is a bit of a shift. We – we’ve been focused on our bottom line for quite some time now and getting our foundation rebuilt, so that we could put more weight on it. And going forward, it is a priority of us to grow our top line and we will look at opportunities that – to do that. And we’re going to look at all different sizes. We continue to, we have been looking, and we will continue to look at opportunities that that will have a good shareholder return and at a reasonable risk is where we are. And if – in the absence of that, we’ll figure out it another way, whether it’s a start buyback or some other way to get our cash back to our shareholders. But our top priority is really to grow our top line and that’s what we’re going to look to do.

And maybe just to sneak one in there. Just been looking at the business units, is there anyone in particular that jumps at you as being a preference for acquisition? And should we be thinking more on the Stim side and Biologics, as opposed to the ortho side?

I think, they all have opportunities and I don’t want to sound like a political answer here. But it’s really about what’s available in the market as much as anything else. Certainly, if we have the opportunity in our highest margin businesses, that’s where we would look first. But if – in the absence of that, we have really good opportunities to grow all of our businesses and there’s not going to be a lot of things out there that fit our criteria. So as they come along, they could be in any one of our businesses and we’ll still be actively looking for it.

Thank you.

We’ll take our next question from Jim Sidoti with Sidoti & Company.

Good afternoon. Can you hear me?

Hey, Jim.

Yes, Jim, how are you?

Good, good. Can you just repeat what you said about gross margin in the quarter and why it was so strong?

We saw a couple of things happened in the quarter, Jim, this is Doug. And the first one is, with regards to mix, as you know, our BioStim business generally carries higher margins for us. And so as that picked up for us, we saw an increase in our gross margin. And then we also had some favorable variances in some of our manufacturing costs specifically around E&O reserves and why manage inventory and some other manufacturing efficiencies.

Okay. How about geographic mix? Is that an issue in the quarter?

Geographically in what way, Jim?

Low growth, or do you have more sales in the U.S. than normal, do that help you?

No. Yes, I got you now. Sorry, the international U.S. business was basically the same – the same percentage.

Okay.

No big shift.

All right. And…

And just to be clear some – that’s roughly 23% of our top line is outside the United States and that’s pretty consistent with past quarters.

Okay. The charge – the SEC charge you took in the quarter, I assume that I just went over the queue real quickly, you were speaking that’s related to the issue in Brazil, it’s not a new issue, it’s something you think you are almost passed at this point, is that correct?

Yes, that’s basically right, Jim. I mean, we’re continuing to work with the SEC and we’re proceeding on track and looking forward to a final resolution most likely in Q1 of 2017. But they have their process. They have to go through as well and we’re just waiting to finish it up and hopeful to finish it up.

All right. And then can you just repeat why the tax credit in the quarter was that, because some of the options compensation or the obsolete charges was deductible or…?

The – you’re referring to the indirect tax favorable variance that we had in sales and marketing. We discussed before that we’ve invested a lot in managing our overall tax past year for the company, including any – potential liabilities for indirect taxes like sales and use tax, like property taxes, and other business taxes, and in large part due to some of the visibility provided by some of the systems that we’ve implemented under our Bluecore project. During the year, we were able to favorably reduce a portion of our indirect tax liability during the third quarter. So going forward, we’re going to continue to evaluate the remaining balances and expect that we could see some further reduction in these tax liabilities, but probably not to the extent that we saw in the third quarter.

So basically over-reserved in the first-half of the year and now you’re just chewing that up?

I wouldn’t say it like that, Jim. I would say that we thought our reserves were certainly adequate and that due to the management of those liabilities in the visibility that we were able to get that we’ve been able to manage them down.

Okay. And what do you think in normalized tax rate should be for the fourth quarter and for 2017 and beyond?

Yes, that’s a good question. So from an income tax perspective, so these are all just indirect tax liabilities that hit above the line. But just from an overall effective tax rate position, we expect our long-term tax rate to be in the upper 30s specifically at 38%. And so we’ve got variability from quarter-to-quarter on income taxes just because of the way our our taxes are complex, or in many jurisdictions, we don’t always get full tax credit in some of those jurisdictions. So it’s volatile for quarter-to-quarter, but we feel like 38% is the appropriate adjusted rate to use. The gap tax rate for the quarter was 44%.

Okay. But what you’re saying, is that may change going forward just because some of the issues you had in this quarter, or if some of those issues change – it might change your reported tax rate?

The other things might impact our sales and marketing line, the sales and use tax…

Oh, okay.

And other indirect tax items that I mentioned.

Okay. But in this quarter and the September 2016 quarter, those indirect items affected your income tax expense, is that correct?

No, maybe I’m not being clear. But that $2.4 million impacted sales and marketing and that was….

Okay.

because it was an indirect kind of a business tax, if you will, with sales and use property, all the different types of taxes that don’t get counted as income taxes.

Okay. So and is that why you reported the $1.2 million credit on the income tax expense line, or was that in your SG&A line?

That was a different time. So the income tax line was largely driven – so we had a – we’re in a good position this quarter for the first time and a long time to be able to do record a favorable variance on tax. So we had pre-tax book income when you would normally expect a tax provision, we actually booked a tax benefit. So it was primarily driven by a favorable change in our allocation estimates, certain compensation expenses across subsidiaries in different jurisdictions that was offset by the additional $1.5 million of SEC estimated penalty for which we get limited deductibility. So that the large favorable variance was driven by the compensation allocation.

Okay. So – all right. That’s the question I was going to do. So because you change some of your compensation assumptions that income tax expense assumption now changes, and so that’s why you reserve the – you had the credit in the quarter?

You got it.

All right, good. All right. And then as far as – as getting the top line back on track, you think you had a sales – you had reorganized your sales force in the second quarter and that impacted sales in the third quarter, so should we assume that it probably impact sales in the fourth quarter in the first-half of 2017, as well?

Definitely in Q4, as I said Jim, I think, we’re looking for Biologic. We’re looking mid single-digit decrease in Q4 in 2016 for both our Biologics and Spine Fix business – Spine Fixation businesses. So – but we do expect them to be both into the low to mid single digits growth next year. So the ramp up time of that is still not determined. We’ll give you a lot more color around that on our Q4 call when – as we get into next year. But we do expect a good recovery in those businesses next year.

All right. All right, thank you.

Thanks, Jim.

Thank you, Jim.

That does conclude today’s question-and-answer session. At this time, I’ll turn the conference back to Mr. Brad Mason for any concluding remarks.

Thank you, operator. I appreciate the help today, and thanks, everyone, for joining us on the call. Look forward again to – look forward to speaking you again after the close of the year and have a happy Halloween.

This does conclude today’s conference. Thank you for your participation. You may now disconnect.