Orthofix Medical Inc.
Q2 2017 Earnings Call Transcript

Published: 8 Aug 2017

[Operator:]

Good day, and welcome to the Orthofix International N.V. Second Quarter 2017 Earnings Conference Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mark Quick, Director of Business Development and Investor Relations. Please go ahead, sir.

[Mark Quick:]

Thanks operator, and good afternoon, everyone. Welcome to the Orthofix second 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 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 facts 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 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, August 7, 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 risks disclosed under the heading Risk Factors in our Form 10-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 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 second quarter 2017 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.

[Brad Mason:]

Thanks, Mark, and good afternoon, everyone. As usual, I’ll start by giving you a summary of our second quarter 2017 performance, after which Doug will walk you through the financial results that we reported today. I will then follow-up with our updated guidance for 2017, as well as our longer-term outlook for the business before opening it up for Q&A. We had another strong top line performance in the second quarter, with net sales coming in at $108.9 million. This represents an increase of 5.1% over prior year in constant currency. As was the case in Q1, all four strategic business units or SBUs, were ahead of plan for the quarter, most notably Biologics and Spine Fixation. The overall sales performance improvement we are seeing is result of strong SBU leadership teams, executing business fundamentals well. We’re accelerating the pace of new product introductions, supporting the use of our products and expanding indications through strong clinical research, adding new sales partners in unreserved areas, and strengthening the relationship and improving the engagement of our legacy sales people. We believe that the strong execution of these commercial initiatives will ensure the sustainability of our top line growth in the future. Now looking at each of our SBUs and staring with BioStim. Net sales grew 5.4% over the second quarter of 2016 [Audio Dip] engagement of our expansive sales force, the NASS positive coverage recommendation and new spinal fusion therapy products to achieve this top line growth. In our Biologics SBU, our momentum continued with the top line increasing 9.9% for the period, which follow the strong first quarter performance. The results in Q2 were primarily driven by strong Trinity Elite volume growth from distributors added in the last year; also benefited from improving performance from our national distribution partner and the reacquisition of the national hospital contract. Now moving on to Extremity Fixation. Net sales decreased 6% in constant currency for the period that was up 1.6 % on a constant currency trailing 12-month basis. To give a better understanding of the underlying strength of this business, I would like to point out that when normalized for the negative year-over-year impact of the divestiture of a non-core business in the UK, 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, the trailing 12-month constant currency growth rate of this business was 3.5%. Last but certainly not least, net sales for our Spine Fixation SBU increased 17.1% year-over-year in the second quarter. This increase was primarily driven by strong growth in the U.S. Historically, sales in this SBU have tended to be volatile. Our belief is that with the changes we’ve made over the last two years to the leadership team, strategy and culture of this business, we are now positioned to demonstrate elevated performance and sustainable growth. With the bulk of the improvement initiatives now behind us, we are optimistic about the remainder of this year and the future performance of this business. Moving on, adjusted EBITDA margin for the quarter was 18.8%, compared to 18.5% in Q2 of 2016; and adjusted earnings per share was $0.42, which was up $0.02 compared to the prior year. As I mentioned on our Q1 call, our expectation this year is to be relatively flat year-over-year in adjusted EBITDA margin. I will give more color on this following Doug’s prepared remarks. As of the end of the second quarter, we had a trailing 12-month adjusted ROIC of 10.1% versus the prior year of 10.5%. This decrease was primarily due to growth in inventory balances, driven by the numerous new product introductions over the last several quarters. As the sales of these new products ramp up, we expect adjusted ROIC to modestly increase as well. Free cash flow for the quarter was $1.6 million, compared to free cash flow of $12.8 million for Q2 2016. The majority of the change year-over-year is related to the changes in the balance sheet as Doug will discuss further in just a moment [Audio Dip] June 30, 2017 a $44.3 million was up $4.8 million from the year end 2016, and up $2.7million since the end of the last quarter. I’ll now review a few of our operational highlights for the quarter and year-to-date, starting with recent and upcoming product launches. The launch of our next generation Spinal-Stim and Cervical-Stim bone growth therapy devices earlier this year has gone extremely well. We have now trained and transitioned all of our sales force to these new devices. The feedback has been very positive from the sales reps, physicians and patients alike. One of the features of these products is the ability of patients to connect to the device through a mobile app to receive feedback on their treatment. Even though it’s only been a short time since its release, already more than 20% of current patients are downloading and using the Stim onTrack app. This has exceeded our expected pace of adoption for this new functionality. In our Extremity Fixation business, as a reminder, earlier this year we introduced a new brand for our orthopedic products, JuniOrtho, which highlights our dedication to producing products that are specifically designed for children and young adults. This branding represents much more than just a name for a group of products. It is a commitment to be a resource for surgeons, parents, and caregivers or pediatric patients before during and after surgery. JuniOrtho products currently account for over one-third of our Extremity Fixation sales. It is a priority for us to expand both this line of products and foot and ankle portfolio. In the second quarter we launched four new pediatric and two new foot and ankle products of significant or significant line extensions. We’re also very excited about the limited U.S. commercial launch last week of our first full line internal fixation system for the foot and ankle, which is called RIVAL. The RIVAL system is a osteopath indication specific plate and screw implant system. Additionally, RIVAL has a unique universal instrumental set designed to address over 50 indications in the foot and ankle all in one tray. We believe these dual benefits will provide significant supply chain efficiencies for our distributors and hospitals. The RIVAL system expands our reach deeper into the foot and ankle space in the U.S., which leverages our reputation as a leader in external fixation solutions. For Spine Fixation, the market acceptance of our CETRA Anterior Cervical Plate released earlier this year has been tremendous, with sales of over $1 million in the first five months. The CETRA plate filled a significant gap in our portfolio, which now allows us to get additional pull through of cervical interbody products and biologics. At fourth quarter, we expect to conduct a limited market release of our new FORZA XP line of expandable interbody products. This is also been a gap in our Spine Fixation portfolio. Both of these product lines, as well as our RIVAL foot and ankle products were developed from technologies that we have acquired in the last 18 months. Additionally, for Spine Fixation, we continue to see very strong adoption of our proprietary PTC interbody porous titanium and PEEK composite technology. The 3D printed titanium end plates have structures that were shown in a recent study to create an osteogenic environment that may enhance bone production during fusion. Just the addition of FORZA PTC and PILLAR SA PTC, revenue in our PTC product line is up 174% over 2016. Moving on to clinical studies. I am pleased to report that our 540 patients pivotal human clinical IDEs for the adjunct treatment of rotator cuff surgery to the use of our pulsed electromagnetic field technology or PEMF has been approved by the Food and Drug Administration. As background, studies show that as many as 40% of full thickness rotator cuff surgical repairs fail within two years. As a result of our basic science and laboratory testing, we believe there is a reasonable probability that the use of PEMF technology following surgery can improve patient outcomes. Now that we have the IDE approval, we will begin the site selection process and work towards initial patient enrollment later this year. Our ongoing clinical study of the effectiveness of PEMF or treatment of osteoarthritis of the knee has now enrolled approximately 50 patients in this 150 patients study. Our expectation is to be fully enrolled in early 2018. Lastly, a word on our Extremity Fixation restructuring activities. By the end of the third quarter we will have substantially completed this project, which included closing a non-core business in the UK; moving a manufacturing business from UK to our facility in Verona, Italy; the transition of direct sales business in Puerto Rico and Brazil to stocking distributors and associated significant reduction in force. While these activities have impacted our sales this year, we expect to be back to historical growth rates in this business next year as a leaner, more focused organization with lower cost. Overall, we feel very good about our second quarter and year-to-date performance in all areas of our business. As you will see when I speak about our updated guidance after Doug’s comments on our Q2 financial results, we expect to sustain our good momentum in the second half of the year and into 2018. Doug?

[Doug Rice:]

Thanks Brad, and good afternoon, everyone. I’ll start by 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 $108.9 million, up 4.7% on a reported basis and 5.1% on a constant currency basis when compared to the second quarter 2016. As Brad mentioned, the increase was primarily driven by our Spine Fixation and Biologics SBUs. Gross margin in the second quarter was 78.7% or 30 basis point improvement over the prior year period. We expect gross margins for the full year 2017 to be consistent with or modestly better than 2016. Sales and marketing expenses were $50.5 million or 46.3% of net sales in the second quarter of 2017, compared to $46 million or 44.2% of net sales in the second quarter of 2016. This year-over-year increase was primarily due to a higher mix of sales from new distributors in Biologics and higher spending in Extremity Fixation related to our sales growth in the U.S. We’re certainly pleased to see the 90 basis point decrease in sales and marketing expenses sequentially from the first quarter and we expect continued improvement in the back half of the year. Moving on the non-GAAP net margin. As of now we’ve updated this term, effect of this quarter to clarify that this is a non-GAAP measure. Even with this modification it’s important to note that this update in terms still reflects the exact same calculation we’ve been using for the last four years and then we continue to define as gross profit minus sales and marketing expenses. Non-GAAP net margin in the quarter was $35.3 million or 32.4% of net sales, which represents a slight decrease from $35.5 million or 34.1% of net sales in the second quarter of 2016. This decrease was primarily due to the increase in sales and marketing spending. General and administrative expenses were $20.4 million or 18.7% of net sales in the second quarter of 2017, which were up from $18.5 million or 17.8% of net sales compared to the prior year period. This year-over-year increase was due primarily to higher expenses related to the strategic initiatives that Brad mentioned, legal settlements and stock-based compensation during the quarter, which are all expenses that we exclude from our adjusted EBITDA calculation. These increased expenses were partially offset by Bluecore related expenses that did not occur this year, as well as significant year-over-year cost reductions in finance and legal professional fees. Research and development expenses were $6.9 million or 6.4% of net sales in the second quarter, which were up slightly from $6.8 million or 6.6% of net sales in 2016. We expect full year 2017 R&D expenses as a percent of sales to be consistent with 2016. For the second 2017, we reported net income from continuing operations of $4.7 million or $0.26 per share as compared to a net loss of $6.3 million or $0.35 per share for the second quarter 2016. After adjusting for certain expenses and when normalizing for tax using a long-term rate of 38%, adjusted net income from continuing operations was $7.8 million or $0.42 per share, compared to $7.5 million or $0.40 per share in the second quarter of 2016. This bottom line improvement primarily request revenue growth and stable margins during the quarter. Adjusted EBITDA during the second quarter increased to $20.5 million or 18.8% of net sales from $19.2 million or 18.5% of net sales in 2016. The improvement in adjusted EBITDA margin was primarily driven by higher gross profit and lower finance in legal professional fees and G&A, partially offset by higher sales and marketing spending during the quarter. We had income tax expenses for the quarter of $3.9 million or 45.3% of income before income taxes, as compared to income tax expenses of $3.7 million or negative 138.5% of income before income taxes in the same period of 2016. This year-over-year improvement in our rate was driven by a one-time $12.9 million SEC non-deductible charge in Q2 of 2016 that did not occur this year. Moving on to the balance sheet highlights. Days sales outstanding or DSOs were 51 days at the end of the second quarter 2017, up from 49 days at the end of the second quarter 2016. Our inventory turns at the end of the second quarter 2017 were 1.2 times, which were slower than the prior year at 1.5 times, reflect the new product introductions and Spine Fixation and Extremity Fixation. Cash and cash equivalents at the end of the first quarter increased to $44.3 million, compared to $39.6 million at the end of 2016. Cash flow from operations for the quarter was $6.3 million, compared to $16.7 million in the second quarter 2016. This decrease was primarily due to higher working capital investments in inventory to drive revenue growth. Capital expenditures during the quarter were $4.7 million versus $4 million in the prior year, due primarily to the instruments required for these new product introductions during the quarter. Free cash flow, defined as cash flow from operations minus capital expenditures, was $1.6 million during the quarter, compared to $12.8 million in the prior year. The decrease was primarily due to the lower cash flow from operations that I just mentioned. Free cash flow generation historically has accelerated in the back half of the year and we expect the same in 2017. However, given the work capital investments we’re making this year to drive top line growth. We now only expect modest improvement and free cash flow for the full year over last year. I will now turn it back to Brad.

[Brad Mason:]

Thanks Doug. Now looking ahead to the rest of 2017, we are updating our guidance due to our strong top line performance in the first half of the year. Starting with net sales, we now expect to finish 2017 between $422 million to $425 million, compared to our previous guidance range of $411 million to $415 million. This updated range represents a 3.0% to 3.7% year-over-year growth rate based on current foreign currency exchange rates. Looking at the growth contribution from each SBU, we continue to expect BioStim to grow in the mid-single-digit range for the full year and beyond, driven by solid execution of our commercial strategies. As for Biologics, based on our performance year-to-date and the momentum we have with our sales force, we now expect this SBU to have sustainable growth in the mid-single-digit range. We’re now projecting Extremity Fixation net sales to have a low-single-digit top line decrease for the year, a return to constant currency mid-single-digit growth in 2018, driven in large part by our U.S. foot and ankle and pediatric focus. This expectation includes some continuing headwinds for the remainder of this year that we spoke about previously, but the impact of this is expected to be less than we previously anticipated. Most notably, we are now planning for a modest positive foreign currency impact for the remainder of the year rather than our previous expectation of a negative impact. Finally, for Spine Fixation, we continue to be encouraged by our momentum and now believe we can achieve mid- to high-single-digit growth for the full year 2017. This performance will be driven primarily by our new product launches and sales force engagement, which we expect will give us good momentum heading into next year. Moving on to adjusted EBITDA. As we previously stated, our primary focus this year is investing in the areas necessary to increase our top line growth rates, which has kept our adjusted EBITDA margins relatively flat in 2017 versus prior year. The investments are evident in our spending in new product instrumentation and inventory, as well as increased sales and marketing expenses. While, this is going on, however, we have not ignored opportunities to reduce spending in other areas. As an example, our G&A spending as a percent of sales other than one-time expenses was down to 120 basis points over prior year and the lowest it’s been in many years. This in mind, we are increasing our adjusted EBTIDA expectations to a range of $79 million to $81 million for the full year. That is increased over our previous guidance of $76 million to $79 million. For the full year, we now expect adjusted earnings per share to be in the range of $1.54 to $1.60 using weighted average shares of 18.4 million and a long-term tax rate of 38%. Our previous guidance range for adjusted EPS was $1.48 to $1.58 per share. As in prior years, we expect seasonal weakness in Q3 powered by a strong fourth quarter. Changing gears now; you can see by our strategic initiatives spending year-to-date that we have been active in this area. As our first step, we took an in-depth look at the strategic fit and importance of each of our four SBUs to our overall strategy. And based on recent performance and our future expectations for each, at this point in time we are pleased with the makeup of our existing portfolio. We have also been active in looking at numerous inorganic growth opportunities. But as we’ve said in the past, we’ll be very selective about the strategic fit, ROIC, EPS accretion and risk profile in any deal. We will continue to look for transactions remaining these criteria and expect our strategic initiative spending going forward to be variable based on the number of deal opportunities that we explore. And lastly, as another outcome of this process, we identified margin expansion opportunities across the P&L. We will execute on only those opportunities that will not put our mid-single-digit top line growth expectations at risk. As a result, we have set a target of improving adjusted EBITDA margins by a minimum of 100 basis points in each of the next three years. This will be driven by a continued leveraging of our cost structure as we sustainably grow revenue. And specifically on the cost side, we expect gross margin improvement in our fixation businesses through a shift in product mix; as well as better inventory in fixed asset management; decrease sales and marketing expenses as a percentage of sales, primarily due to higher introductory commissions for new distributors normalizing over time; and finally reduced G&A expenses as a percentage of sales resulting from Extremity Fixation, restructuring decrease of professional fees and shared service optimization initiatives. We believe this combination of the mid-single-digit revenue growth and expanding EBITDA margins will drive a significant increase in adjusted EPS over the next few years. With that operator, we are now ready to open up the lines for questions.

[Operator:]

[Operator Instructions] And there are no questions at this time.

[Brad Mason:]

Well, we must have done a good enough job on the script that we have no questions. I guess we covered them all. I’ll give it another minute or so. If we have no questions, we’ll call it a day.

[Bruce Nudell:]

Hello?

[Brad Mason:]

Hello. How’s on the line?

[Bruce Nudell:]

Two questions go through.

[Mark Quick:]

Bruce, you’re on.

[Bruce Nudell:]

Thank you. Yes. Hello. Yes.

[Brad Mason:]

I think we have a few people on the line now. I think we might have some technical difficulties. Operator, can you help us out?

[Operator:]

Bruce, your line is open.

[Bruce Nudell:]

Hi.

[Brad Mason:]

Hi, Bruce.

[Bruce Nudell:]

Bruce Nudell from SunTrust. How are you guys?

[Brad Mason:]

Good, thank you.

[Bruce Nudell:]

Listen, Brad – yes, could you hear me?

[Brad Mason:]

I can. Yes. Now we’re in good shape.

[Bruce Nudell:]

Okay, great. This call is like kind of a landmark call in a way, because you basically kind of recommitted to the base business. So could you just – the Spine market has issues, the Biologics market has new competitors, there’s always that hypothetical overhang for Spinal-Stim, and Extremity is just that in tranche business other than the pediatric segments where you guys have a unique branding. So could you just like go through those businesses and really say why starting in with spine and then biologics, and the broader extent of foot and ankle, as well as Stim, as to why you come to the decision that these are sustainable mid-single-digit franchises.

[Brad Mason:]

Sure. Sure, we’d be happy to, Bruce. So starting with Spine, we started a couple years ago to really revamp that business from a leadership standpoint, culture, management, sales leadership, new product development pretty much every aspect of that business, and it took us a couple years to have that really kick in. But it’s not a surprise to us that we’re doing okay. It’s a surprise that we’re doing as well as we are now, a bit of a surprise, but we’re very pleased with that. And it is really – is a testament to the things that we’re doing, it’s all about execution, but executing the basics well, engaging the sales force, new products that we put out there, all of those things, and also adding new distribution. So as we look forward, we expect to continue to expand our sales force. We’ve gotten really good engagement of our legacy distributors and expect that to continue. We’re adding stocking distributors and targeted international markets, although our international business has been a little tougher. And we’re going to continue our base of new product launches. So the moment we’re seeing – we’re a little more cautious, after Q1 we’ve seen a couple quarters heading definitely the right direction. And now we’ve had three solid quarters with that business and it’s moving well. So we’re very satisfied with the direction it is and we think it is sustainable. I’ll join that up for a second with our talk about our Biologics business because as much as we’ve separated them for focus and for clarity with our shareholders, they’re still very much interlinked. And you see both of them a little over a year ago, Bruce, Q2 and Q3 when they suffered a little bit, they suffered together; as they were coming back, they’re coming back together. And if you look at those two businesses together, as our competitors look at their spine businesses, we essentially have $175 million – apples-to-apples $175 million Spine business growing almost double digits over the last three periods with an adjusted EBITDA margin of over 17%. So I’ll put that up against any of our spine competitors out there in the Spine business. We’re not seeing a particular softness in the business, we see it moving along well for us, and we think it will continue to. So that’s how I kind of look at those two businesses a little bit in combination, but also individually. Biologics, it’s really been – in addition to the synergies with our spine company, it’s also been adding the new distributors, we expect to continue to do that and move forward. We also think that with some of the projects that we are developing with MTS that we have a future stream that could be very attractive for us. So I can move on to Extremity Fixation now if that answers your question…

[Bruce Nudell:]

That’s great. Yes.

[Brad Mason:]

Okay. So Extremity Fixation, we have a reputation outside the U.S. as if not the best very near the best products service reputation for external fixation. What we really need to do is leverage that, not only outside the U.S., but leverage our external fixation inside the U.S., which we really have not done particularly well in the past. We feel we have a tremendous opportunity in foot and ankle. We have – to be a foot and ankle player you have to have good external fixation products which we do. What we’ve been missing is the internal fixation. With the launch of our RIVAL internal plates and screws and the way that that product line is differentiated, we feel very, very good about the U.S. market. Our U.S. business had not grown in eight years. We grew at 15% last year. And that’s really good momentum heading into this year and into next year as we now release our RIVAL products and we will have more products in foot and ankle as well. Outside the U.S. and even to extend inside the U.S., a third of our products – third of our business is in pediatric sales. And we’re branding the JuniOrtho brand to really bring together, not just our products, but also the service and commitment to everything – we have coloring books for patients that we have education for parents, we have things for surgeons or everybody involved when it comes to pediatric care and really differentiate ourselves. We’ve always had a very good pediatric portfolio, now we’re going talk about it more and we’re going to expand that. And lastly in Extremity Fixation we also have some excellent trauma products that we can sell in certain geographies in the world. We don’t sell them particularly well – we don’t sell them in the U.S. because we don’t have a distribution force in U.S. but between Galaxy and our hip fracture system, we have some excellent products there as well. So I feel that each of these businesses has the strong potential to grow, they – and Extremity Fixation business is a core of our business that we’ve always had. So there’s no reason to be to get out of any of these businesses because they’re all performing well and we expect them to continue to perform well in the future.

[Bruce Nudell:]

And I could see other thing and it probably ties in with bone Stim. In your press release you referenced the development of an augmented distributor network in kind of underserved territories or areas. Could you just – what do you mean by underserved? And if you could explain that that would be great.

[Brad Mason:]

Sure. So that was kind of a general comment around our distribution, it’s not only in the U.S. but worldwide. So as an example, Bruce – so let’s take an example. Let’s say we have two or three distributors in a large metropolitan area, let’s say it’s in Houston, Texas. And there’s – in any given business let’s say there’s 100 surgeons that could be customers, and we have three strong distributors, but they’re really only calling on 25 or 35 of those customers. There’s still a lot of – when I talk about underserved, if we really want to pin it down, we should be talking about surgeon customers that are now that we currently don’t have a representative to walk in their door and create a relationship and sell them our products. So whether it’s in geographies around the world where we need stocking distributors to gain a foothold, weather in our BioStim or Biologics or any of our businesses, there’s always room to add distribution because we never have full coverage. In some of our businesses we’re significantly better than others. Our BioStim business in the U.S. we have very, very good coverage, that’s not to say there’s not opportunity there is. Biologics, we have significant opportunities; Spine Fixation, significant opportunity; Extremity Fixation, significant opportunity. So when we talk – and if we roll this back to Biologics specifically as an example, most of the growth that you’re seeing is coming from distributors we’ve added in the last 18 months – 18 months to 24 months. So when I talk about underserved market that’s exactly what I’m talking about.

[Bruce Nudell:]

Thanks. That’s great color.

[Brad Mason:]

You bet, Bruce.

[Operator:]

Our next question comes from Ryan Zimmerman with BTIG Investments. Your line is open.

[Ryan Zimmerman:]

Great, thanks for taking the questions. I was trying to dial in there and I just – well, I couldn’t connect there. So just want to start with – in terms of your expectations for your 100 bps improvement over the next three years. You talked about gross margin improvements, you talked about decrease sales and marketing. Can you just give us a little bit more color on the puts and takes within that? And what you see within some of the opportunities that’s allowing you to put that target out there?

[Brad Mason:]

Yes, absolutely, Ryan, it’s nice to talk to you today. So I kind of think of them as about one-third each. So if I think about our gross margins, I think we have opportunity in mix a bit, as well as – if we grow in the U.S. as an example in our Biologics business faster than we do in OUS, the margins are a little bit better. Sales and marketing costs are correspondingly a little bit higher however. So that’s one area mix of – with our BioStim business growing 5% on a much larger base that improves our mix on our margins because their margins are better in that business, they’re better in Biologics than they are in our metals business as well. We also have opportunity to better manage our inventory and fixed assets and the depreciation on our fixed asset meaning instrument. Frankly, we’ve done a lot of really good things in this business over the last four years – four and a half years. That’s an area where we still have significant room for improvement and a focus for us. So coupling those two things together we think we have gross margin expansion opportunity. When I look at sales and marketing, we have bulk opportunity in marketing. We’ve spent a lot this year in marketing in some of our national sales meetings, in some specific – the branding effort in JuniOrtho, in BioStim launching our new products focusing on the NASS recommendations those sorts of things. But more importantly, we have opportunity in our – more on the commission side of things in that a significant portion of our growth is coming from sales partners who have a plan in place if they’re new with us where essentially – most of our distributors have plans where they get a higher percentage of commissions on growth. If they’re a new distributor they started with zero, so virtually all of their sales gets to the higher commission rate because it’s all growth. For our legacy distributors it’s a little different. But I’ll also tell you this year, we are – we have exceeded our expectations on the top line that can contribute to higher commissions and bonuses and those sorts of things that impact it. So we expect those to normalize and come down. So if we figure that being a third of the total adjusted EBITDA 300 basis point improvement that pretty much covers that. And then as we get into the G&A, we have – we already are seeing significant improvement there, as well as I talked about we are improving on our core G&A, we still have some outliers, but we have an opportunity to still leverage the systems, processes and controls that we put in over the last couple of years to do a nice job there. As well as the restructuring that we did in our Extremity Fixation business, that business has a very high G&A rate because they have subsidiaries around the world. We have reduced the cost significantly or in the process of reducing the cost significantly there. So if I think about across all three of those areas, think of it as a third to third to third and that’s how we get there.

[Ryan Zimmerman:]

Understood. Thank you for that color on there.

[Brad Mason:]

Yes.

[Ryan Zimmerman:]

And then you brought on a lot of distributors I think over the past 18 months or so. I mean, how should we think about the cadence of distributor growth going forward at least maybe the 12 months to 24 months just in light of the context around the lower commissions have new distributors come on and then subsequently sell out? Do you think though that your pace will continue at the rate you’ve done historically or does that settle out as well?

[Brad Mason:]

It will settle out to a degree as we fill in territories. I expect we’ve seen the highest percentage of growth in the number of distributors that we bring on. We will still always actively be looking for new distributors to replace those that aren’t performing as well as to fill in territories. But the pay should drop Ryan back to a more normalized level over the next 12 months or so, would be my best guess at this point.

[Ryan Zimmerman:]

Understood. And then just lastly from me and I will hope back in queue. You called that Stim onTrack utilization exceeding your expectation at this level. I think about 20% of patients were using the app. Just wondering what if any impact has that done for the prescribing physician base or color they can preserve – provide in terms of any quantifiable impact that has also led to the bone Stim – the BioStim outperformance from that would be helpful. Thank you.

[Brad Mason:]

Yes, the only thing quantifiable at this point as it makes us feel really good about it. We don’t have anything that would – that’s specific really in numbers as to indicate how that’s impacting the subscription or prescription rate I should say. But something we’ll keep an eye on as time goes on I think you’ll see the overall impact of those new products and how they connect with the patient and the doctor will significantly help us in our sales in that business. But we don’t have anything yet Ryan and specifically how that happened, how that’s helping us I should say.

[Ryan Zimmerman:]

Understood. All right. Well, thank you guys for taking the question.

[Brad Mason:]

You bet, Ryan. Thank you.

[Operator:]

Our next question comes from Raj Denhoy with Jefferies. Your line is open.

[Raj Denhoy:]

Hi, good afternoon.

[Brad Mason:]

Hi, Raj.

[Raj Denhoy:]

What if I could ask maybe just about bit of a longer-term question? The business is doing quite well, you’ve guided to kind of a little under 5% I guess the high-end for the top line for the year. You guys have outlined I think in some of the recent presentations though there’s desire to kind of pull that growth rate up into the mid-single digits if not even a little higher. And so if you think about next several quarters beyond where we are now, and you’ve talked a bit about how Extremity Fixation at least outside the United States can do a bit better. But where do you see the other opportunities for accelerating growth? And I’m talking specifically organically now; we can talk about inorganic in a minute, but just in terms of organic opportunities for the company.

[Brad Mason:]

Sure, Raj. And when I talk about these things, I’m talking organically as well, so that that’s perfect. If I go through the businesses, I’ll do it pretty quickly here just to kind of give you a view of where I see. In the BioStim, we think we can still leverage our new products. We have another – our Physio-Stim next generation product coming out at the beginning of next year. The investment we’re making in research for to show that the benefit of our products is going to be important, actually across all of our lines that will help drive sales and it has. We are still in the process of using the North American Spine Society’s coverage policy recommendation of course in our marketing efforts and sales efforts. And we also have an opportunity, although I wouldn’t say it’s near-term, but we have an opportunity to expand in the international markets with BioStim where there’s an established reimbursement pathway for bone growth stimulators. So that in just – the energy and momentum we have in that business – remember, the other thing about that business only a third of the – our estimates, only a third of the patients who are indicated for an on-label for use of these products get them today. So we have to do a better job of educating the public, educating the physicians about the use and benefit of bone growth stimulators, and we’re going to do that. So still that gives us a plenty of runway in that business even though we’ve done well and we have a high market share in the Spine side, it still gives us plenty of runway with that much of the market that much under penetrated. In terms of Biologics, it really is about adding new distribution both into spine as Well as into other areas, whether it’d be maxillofacial or other areas where stem cell allografts can be used. And then leveraging the Trinity lead benefit, that tissue form has such a unique advantage in its handling characteristics that it has proven out and weathered the storm of some of these competitors coming in. And you couple that with the momentum we have in our spine metal business which goes hand in hand, I think we’re going to do very well in Biologics. Our Spine Fixation strategy really is about continuing to expand in U.S. but as importantly or more importantly is engaging our legacy sales force. We’ve done a nice job of that, but we can do more, and we can also add more stocking distributors in international markets. One of the best ways we can engage our sales force is by putting out new products. It does a lot of things for us. They want to work with the company that provides them door openers, provides new products, new opportunities for income for them. So as we put out new products that’s a significant piece of the puzzle to engage our distribution and we’re doing that as well as anybody and we’re doing an extraordinary job in putting out new products and filling any gaps in our portfolio and upgrading some of our existing products. So that drives that business as well. And then Extremity Fixation strategy is really about, a lot of it has to do with the U.S. We have a great opportunity in the U.S. to grow that business particularly in foot and ankle, but also other places. With our new RIVAL line coming out to become more of a player in the foot and ankle business. Remember, a lot of our sales force is already focused on podiatrist and we have very, very good relationships there. And many of our distributors are already carrying lines of products that they can move over to us as long as we provide them the right products. So in the U.S. we have – we think we have a very, very – we have very good potential in the U.S. Additionally, when we think about pediatrics and our opportunity there, we have – we think we have that opportunity worldwide. And that’s one of the reasons that we talk about that with JuniOrtho and branding that. And we’re not talking about products that we – that are small adult products, we’re talking about products that we design specifically for the pediatric marketplace, and so we have opportunity there. We think about – and also we’re going to continue with TrueLok HEX in our deformity correction platform, which we think is second to none. So overall when we think about all of these business combined, the kind of the core, the basis for all of them is – the global idea is accelerating the product growth, expand the indications which is longer-term for our BioStim in particular, adding these sales partners and strengthening our relationships with the ones we have. So we’re very bullish about where we are and where we’re going.

[Raj Denhoy:]

Let me ask this question, I mean, there’s been a lot of – you focused a bit upon the distribution angle, right. There’s clearly been a heavy investment in expanding distribution Spine, Biologic, Extremity pretty much across the board, it sounds like you’ve been adding to the sales effort. So one of the concerns there was that that if that is what has been supporting growth recently how sustainable is that, right. And you have to start to see some of the new products and things contribute. How much of extern should that be, is maybe the way to phrase the question. I mean, do you feel like a lot of the strong growth you’ve seen the last couple of quarters north of 5% on a constant currency basis this quarter, has been driven by the sales force additions?

[Brad Mason:]

Sure, absolutely, and that only gets better from here. So the sales distributors who we’ve added are still not up to full speed, and their business isn’t going to go away, it’s still going to grow. So I think that’s the key. They’re still coming up to speed in all of these businesses, where we’ve added distribution, it takes time. It takes – whether it’s getting a hospital approval or convincing a physician to try it or going through a trial with physicians all sort of things. So we expect that to continue and then support. As I said on the BioStim side by expanding the market acceptance and then each one of our business has a different strategy. But I don’t expect that to drop off Raj, because all of these distributors have the opportunity to sell more than they’re selling today, whether they’re new or whether they’re legacy, there’s still a lot of upside potential with our sales reps.

[Raj Denhoy:]

Great, that’s helpful. Thank you.

[Brad Mason:]

Thanks Raj.

[Operator:]

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

[Jeffrey Cohen:]

Hello. Hi, there, Brad, Doug, Mike and Mark. Can you hear me okay?

[Brad Mason:]

I can, Jeff. How are you?

[Doug Rice:]

Good afternoon.

[Jeffrey Cohen:]

Great. So wanted to expand a little bit upon a couple of previous questions and what you’re just stating as for as some of the distribution channels. So specific to Spine as well as Biologics, did you feel like you’re picking up share. And if you’re picking up share in competitor channels, you’re picking up that share through the efforts of the distribution partners or you’re picking up because of your product mix or what’s your take on that and how should we think about it?

[Brad Mason:]

Yes, think we’re picking – if we’re growing more than 2% or 3% that we’re picking up share and we are. And most of that here is coming – it’s coming through – hard to separate the two, Jeff, because if you think about it, it’s definitely coming through our distributors, they have the relationship with the surgeons. So just on the relationships we’re getting – we’re picking up share. But we’re also picking up share because we’re putting out new products that meet their needs and that they can plug into their existing relationships. So it’s really a combination of both.

[Jeffrey Cohen:]

Okay, got it. Could you talk just a little bit about RIVAL offering and what’s coming? How many products you’re expecting? And how are you working generally speaking as far as some of your new launches? Are you soft launching some of these products? And talking about them you’re prepared for or in the process of fully launching them?

[Brad Mason:]

Good question. So we are soft launching them. Although the soft launch of RIVAL is a pretty, I would call it like medium rare, medium rather than – it’s a pretty significant launch. We’ve got 15 sets out, we expect to have 60 sets out for the limited market release, where in Spine we usually do a limited market release of about 15 or 20 sets. So this one we have a lot of confidence in. The unique thing about RIVAL is it has – we can treat over 50 indications with one set of instruments which is which is really unique and different. So we have plate screws, most of the time, we don’t have staples, there’s a few things we still need to add to the line, but it should give us a significant opportunity next year as it really kind of ramps up. But we do expect to have 60 sets of instruments out there and be doing – we have already – have a quarter of that out there and we expect to have the rest of them out here in the next 60 days or so within the next 60 days. So and that is typically how we do these sorts of launches. We do a soft launch because there’s going to be things that the physicians what change. As many validation labs that we do and everything else, there’s always things that aren’t quite right. So it can get expensive if we put out a lot of instrument sets and you have to replace certain instruments those sorts of things. So we do them on a limited market release, we talk about them when we do a limited market release. And then like CETRA which we talked about in early in the year, I mentioned on this call that about the great start we had with that product with over $1 million of sales in the first month – first five months. So we will continue to talk about that. If you have questions about them and we don’t cover them, feel free to ask, no problem.

[Jeffrey Cohen:]

Got it, okay. And then lastly, could you explain upon talking about some of the ex-U.S. channels out there in some of the newer territories? Are you picking up the pace there as far as upgrading or swapping out existing distributors or to add such distributors?

[Brad Mason:]

So in most cases it’s chaining out. There hasn’t been a lot of – lot of movement, most of it’s going to be in the Pacific area, where we have the most opportunity and where we’re working the hardest when we’re talking about our Extremity Fixation business. If we’re talking about Spine we are – we’ve had some very, very good luck in Australia and some other places that we’re looking, but it really depends on which business. If we’re talking about Extremity Fixation in Europe, we’re pretty well settled there, we’re not changing out a lot of distribution. If we’re talking as, I said to the Far East, we’ve got tremendous opportunity there that we are working on taking the advantage of going forward, if that answers to your question.

[Jeffrey Cohen:]

Perfect, that’s it from me. Thanks for taking the questions.

[Brad Mason:]

Thanks Jeff, I appreciate it.

[Operator:]

Our next question comes from John Gillings with JMP Securities. Your line is open.

[John Gillings:]

Hey guys. Can you hear me, okay?

[Brad Mason:]

I can, John. How are you today?

[John Gillings:]

Doing well. Congrats on the quarter.

[Brad Mason:]

Thank you.

[John Gillings:]

So I know it’s kind of been done to debt, but I want to just follow-up on a couple things on Spine just to make sure I understand. So first off, I just want to ask was there anything sort of one-time in the quarter or was it really just three engagement of the sales partners in the new distribution, because it really did perform our estimates quite significantly?

[Brad Mason:]

Right, right. There with no one-time, there was nothing one-time, that was just solid core base business in the quarter.

[John Gillings:]

Okay. And then in terms of the new products, I mean, you guys have been working on refreshing a lot of things including both the leadership and the portfolio there for quite some time. Maybe you can just remind us what are the standouts in the quarter and also what are you excited about the most going forward?

[Brad Mason:]

I think the standout for us is really more about the engagement of the distributors than anything else. Remembering – and I know I kind of harp on this, but the rubber meets the road out on the streets, out with the surgeons and the reps – and the relationships they have with the reps. So as we engage those reps, we’re just going to – we’re going to get more traction, we’re going to get more sales. Remember, most of our, not all, but most of our distributors in our Spine business, distributors meaning sales agents in the U.S., also carry other lines. Now we may be their primary line, we may be second or third on their list, but the more we can engage them, the more they’re confident in us as a significant part of their future, the more they can move that business and they have the ability to do that. It’s really what we saw probably three years ago when they moved it the other direction and we declined. We lost the engagement, we lost our hearts and minds, and getting that back is really, really critical. One of the key things to doing that is new products. So the new products excite sales reps, it gives them a reason to go talk to their doctor again and open the door and they use out of the coattail effect to pull business through. So CETRA or our expandable interbody that’s coming out, those are big deals for the reps, they’re really, really big deals and important. A good example is CETRA Anterior Cervical Plate, where you would think we would have a good offering, we did not. And when you lose the Anterior Cervical Plate, you’ll lose the interbody to go along with them, you lose the Biologics that would go into those interbodies into those cases. So it really is about engaging them, it’s about giving them new products. And in some cases it’s about incentivizing and more with incentive programs that reward significant growth in those sorts of things. That’s why you’re seeing higher – a little bit higher sales, cost and sales and marketing. But that’s really what’s driving it.

[John Gillings:]

Okay, that makes sense, I appreciate that. And then I also wanted to follow-up on the Stim onTrack app. That seems to be going better than you guys expected, better than we did as well. Maybe help us understand what’s driving that. Is this some kind of like a direct to consumer type of communication or physicians reaching out and saying you guys need to use this, it’s going to make it better for both of us?

[Brad Mason:]

No, it’s more the latter, John. So this helps engage, it’s almost like what we’re doing with JuniOrtho where we’re want to engage the whole – all the people involved in the care. So it’s not only the physician it’s also the patient, we want to be more involved with the patient. We already – people don’t think about this often, but we touch every patient with our sales force. We service these patients, we in person we fit them these sorts of things. But more we can involve them in their own care, the better the results, the better the utilization of the technology which we know if it’s – if they use it as prescribed, they’re going to have the best outcomes they can have. So I think from a patient perspective, people are becoming more and more educated about their care and recovery and the treatments they’re receiving. And the more educated they are really the better, they can then become involved, they understand why and the importance. And for them to now be able to look at their iPad or iPhone and say, oh, it reminds them that they have only achieved two of their three hours of treatment that they do that day, those sorts of things. And that’s get the doctor’s attention, because it really felt them that we’re involved with the patient, we’re trying to help them with their outcomes and that’s really what’s important to the physician. So that’s how the whole Stim OnTrack helps us with that, just engaging the patient in their own treatment protocol, and then communicating that with the doctors if they’re not doing what they’re supposed to do, the doctor can make a call or step in and remind them what they need to be doing.

[John Gillings:]

Okay. That’s makes sense as well. And then just to turn quickly for just a second to the clinical trials, give us a quick update on the rotator cuff trial and the approval there. Do you have any more specific color on when you expect to potentially enroll the first patient and any color around what the rate might be just to give us a sense of how long you’re thinking that trial might take to enroll?

[Mike Finegan:]

Hey, John, it’s Mike Finegan. We are going to comment on that a little bit later in the year. We’re busy with having gotten the approval for the rotator cuff. We’re busy now with site selection and engaging clinical investigators. So when we get toward the latter part of the year I think we’re going to expand on our commentary around that, but suffice to say that it’s a very significant unmet clinical need, and given that I think it’ll be a very popular application for physicians. So I would expect that once we get up and going, we enrolled pretty quickly.

[John Gillings:]

Okay, that’s helpful. And then just one more quick one on the DOA [ph] side. So I appreciate the color looking for enrolment in early 2018. Can use just remind us quickly what the primary endpoint is and when we might see the first data there?

[Mike Finegan:]

Sure. So it’s 12-month endpoint and it’s really pain scores that are evaluated at 6 months and 12 months in a variety of – in addition to some other endpoints. In terms of when we could expect clinical data from that, we commented that we think we’ll finish enrolling sometime early 2018, and it wouldn’t be too long after that that we’d be through the evaluation of data and so I should be able to have had some reports on that.

[John Gillings:]

Okay. So enroll early 2018, have the 12-month follow-up in early 2019 and then shortly after that, is that correct?

[Mike Finegan:]

That’s exactly right.

[John Gillings:]

Okay, perfect. Thanks a lot guys and congrats again

[Brad Mason:]

Thanks John, I appreciate it.

[Operator:]

Our next question comes from Jim Sidoti with Sidoti & Company.

[Brad Mason:]

Hey, Jim.

[Doug Rice:]

Jim, are you there?

[Operator:]

Jim, please check your mute function. Your line is open.

[Brad Mason:]

We’ll give you another couple seconds, Jim, or we can catch up with you afterwards if we don’t get you. Well, looks like you dropped off. Well, looks like you dropped off at this point. Anything else? I think that’s it. Operator, I think we’re good. I appreciate the help today, and appreciate everybody joining us on the call. And we look forward to seeing you at our upcoming meeting or on our call next quarter. Thanks very much. Have a nice evening.