MiMedx Group Inc (MDXG) 2016 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the MiMedx Group, Inc. Q4 2016 Earnings Conference Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference call, Mr. Thornton Kuntz. You may begin, sir.

Thank you, Tim. Good morning, everyone. This presentation contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements are based upon the current beliefs and expectations of our management, and are subject to risks and uncertainties. Actual results may differ materially from those set forth in, contemplated by, or underlying the forward-looking statements based on factors described in this conference call and in our reports filed with the Securities and Exchange Commission, including our Form 10-K for the year ended December 31, 2015, and our most recent 10-Q. We do not undertake to update or revise any forward-looking statement except as may be required by the company's disclosure obligations in filings it makes with the Securities and Exchange Commission under federal securities laws.

With that, I'll turn the call over to Pete Petit, MiMedx's Chairman and CEO.

Good morning, and thank you for joining us for our 2016 yearend conference call. I have with me Bill Taylor, our President and Chief Operating Officer; Mike Senken, our Chief Financial Officer; Chris Cashman, one of our executive vice presidents; and the other executive VPs; and some other executives also in the room with us. I'll make some comments about our 2016 results, our fourth quarter results and our outlook for 2017. Also, I will give some updates on our wrongful discharge lawsuits.

I'm going to start by giving you some additional information on the small revenue reduction for Q4 that we've just announced. First, in my 35 years of being a Chairman and/or CEO of healthcare public companies, this is a first reduction of a preliminary revenue release that we can recall. Even though it's a minor amount of revenue, about 0.6%, we do not like issues of this nature to ever develop.

This issue came up late in our detailed review process of AvKare's inventory. This resulted from a February 2016 contract amendment to our long-standing AvKare agreement, clarifying the wind-down details. As you may recall, AvKare has been our distributor for Veteran's Administration and Department of Defense Hospitals for over four years. Approximately two years ago, we decided we should have our own Federal Supply Schedule number. And once it was issued, we notified AvKare that we'd begin to phase over to our own FSS number. That transition began slowly, but our AvKare contract would expire on June 30, 2017, with a three-month wind-down period through September 30, 2017. At that point, we're required to repurchase any inventory of AvKare's that may be remaining, which we expect to be minimal.

Because the end of the contract is nearing, we felt it was prudent to increase our sales returns and allowances reserves specifically for AvKare, which has the effect of reducing our Q4 revenue by $1.8 million. Over the last year, we've continued to rapidly reduce the inventory that AvKare's purchased, which is located at approximately 100 VA facilities around the country. If we assist AvKare in doing an effective job of reducing this inventory, some of our reserves will flow back into our revenue.

We consider 2016 as an excellent performance year for MiMedx, particularly related to our revenue growth. As we informed shareholders early in the year, our profit growth would not be as robust because we've made conscious decisions to speed up the introduction of three new product lines and the associated expenses with those. That was accomplished, and we believe it'll pay rewards for us beginning in 2017.

Also, be aware that we've made major investments in our sales management systems in early 2016. I would highlight that those new systems played a major role in our revenue growth during the remainder of the year. Our systems now give us very adequate insight into each of our sales territories and assist management with the planning process immensely.

We've had some changes in sales management as the year progressed because some individuals are more astute relative to their management skills than others, and we've made those adjustments as the availability of our new system has helped highlight the skill sets of our numerous sales personnel. As always, some individuals might aspire to management but find out they would rather be responsible just for themselves only and go back into their very effective roles as a territory manager of themselves. These are the normal adjustments of a fast growth organization.

Now we've made some other adjustments in our overall management structure as we're attempting to integrate the accountability and responsibilities for Wound Care as well as our various surgical procedures. Bill Taylor, Chris Cashman will discuss those issues in more detail.

Looking back into 2016, you recall that our first quarter was the first time we missed our revenue estimates in what now is 21 consecutive quarters. However, as we told you we would, we immediately made the corrections. And during the next two quarters, we exceeded our revenue guidance.

As we previously discussed, we have maniacally focused on our gross profit margin. In 2016, we maintained those margins at 87%. They came down somewhat because Stability Biologics has lower gross margins on some of their products, namely the cadaveric tissue products. They have high gross profit margins on their physio products, but their shipments were delayed on physio during the latter part of the year due to production constraints. We had to make some changes in management at their production facility and also some changes in their quality systems, which delayed production of some product lines. We feel those conditions have been corrected, and they're now back in a full production status.

Even with the reduced profitability in 2016, we had a strong year in terms of cash buildup. As you're well aware, we often utilize our excess cash to repurchase MiMedx stock in the market. This has proven to be an excellent investment for our shareholders, and we anticipate continuing to do so. As 2017 unfolds, we continue -- we will continue to build cash at a stronger rate due to our increased profitability. We certainly view our stock as currently very undervalued. Therefore, we'll continue to make those purchases. Note that our board has just authorized another $10 million of purchases for this program.

As you look at our 2017 forecast, I'll call your attention again to the significant increase in operating profit margins, EBITDA, and earnings per share. As I mentioned, 2016 profitability was reduced somewhat as we sped up the introduction of these three new product lines. At the end of 2017, those accelerated expenses are behind us, and you should begin to see our profits accelerate as the year progresses. Overall, we should see a 90% increase in operating profit as 2017 unfolds. That metric will certainly gain some attention.

As we previously disclosed, we expect adjusted EBITDA for 2017 to be in the range of 22% to 24% (Sic-see press release "21% to 23%") of revenues, which will, as I've said, be reflected in significant cash buildup during the year. As I've mentioned numerous times, MiMedx should be able to produce high operating profit and EBITDA margins as a percent of revenue certainly above 30% in the years ahead. That will become quite evident as we begin to slow down our infrastructure and project investments in the future.

You've seen the press release that was published on December 27, 2016, relative to the Audit Committee and the board's preliminary findings relative to allegations made in the filing of the countersuits against MiMedx related to the two terminated employees. As we told you some time ago, it's management's position that the allegations are not factual. The Audit Committee has been busy with numerous entities and data gathering supported by outside counsel and our auditors. They will publish their final report after we issue our 10-K filing, which will occur shortly.

As a public company, we have to endure the media reporting of the allegations even if they're false and not substantiated. However, I believe MiMedx's reputation and that of its executives and board is such that this nonsense will soon dissipate. If you simply ask a question, what are the risks of these allegations to MiMedx, I believe it's really just the public relations aspect. However, we will deal with our damages and legal aspects of these false allegations in due time. MiMedx has dealt with these lawsuits in a very professional and straightforward manner, and we'll move forward having had all of our process and procedures and actions reviewed in a proper and effective manner.

We should also note that most recently, a federal court, in one of the former employee's lawsuits, entered a consent order adjuring that former employee from engaging in certain behavior deemed to be a violation of his respective covenant agreements with the company. We consider this an important victory in pursuing our claims in this case. We expect other victories to fall in, in quick succession.

Strong performance and leadership attracts attention, both good and bad. As I've said before, bull markets climb a wall of worry, so do bull stocks. We have resolved each problem as they've shown up, and we'll continue to do so. Management is very optimistic about our prospects in 2017.

So let's hear from Bill, Chris, and Mike now. Bill?

Thanks, Pete. Well, first of all, I want to thank all of the MiMedx associates for all of their hard work over the past few years. I also thank all the healthcare providers that use our products, and for your dedication and passion to help people heal. Lastly, I'd like to thank our shareholders for believing in our products and our team.

We've had a great run over the past several years and the best is yet to come. We've had a number of distractions over the last year, and I think our team has done a very good job of ignoring those distractions and maintaining their focus on ensuring people in need of our product have access to it.

The last year was a solid year in many respects. First, over 30% revenue growth is a challenge, not only from a sales standpoint but also from an organizational standpoint. We invested in the business at a higher rate than we originally anticipated as we had discussed in our earlier quarterly calls. These investments include expansion of our sales force as well as investment related to the acceleration of certain new product initiatives. By solidifying these early 2016 investments, we have a solid base to continue our strong growth, with this year projecting to be in excess of 20% revenue growth.

At this time last year, we were around 240 sales professionals in the field. And today, we have approximately 325. That's an 85-person increase. These additions were both in our Wound Care and our SSO groups. We utilized our informatics team to analyze various public data sets to understand the trends and underlying disease states in a given geographic area. And we use this data to plan our future growth and our overall territory management as we continue to grow. Our quarter-by-quarter plan suggests that we're going to need to hire another 40 to 50 sales professionals before the end of this year, and the territories can easily handle that expansion and more.

Turning now to intellectual property. We have 40 issued and allowed placental tissue patents. We also have an additional 75-or-so that are patent applications which are pending. Everyone on this call knows that MiMedx has asserted several of our patents against various infringers across the country. Those lawsuits are going well, and we have several positive things to report.

In two of our primary lawsuits, we successfully obtained favorable claim construction decisions. The claim construction phase of litigation sets the boundaries regarding the way the claims in the patent are to be construed. This then becomes the basis for determining how an entity infringes a patent. In both of the cases I just mentioned, the judge essentially adopted MiMedx claim construction arguments, which were significant wins on our part and should help in our eventual trials later this year.

Additionally, one of the parties in one of our four patent lawsuits was, in essence, forced to change their processes as a result of our suit by employing a procedure that does not appear to violate our patents. We believe this change is a direct result of our suit, and we view this competitor's actions as a significant business win since the resulting allografts are not as clinically and therapeutically effective as those offered and protected by MiMedx.

To that end, I expect we will start to see companies attempt to avoid our IP and try to make grafts that look more like undisturbed placental tissue. The challenge with this approach is that in order to properly clean it in this configuration for safety, you have to process it with harsh chemicals. This then significantly reduces the ability of the tissue to retain any growth factors and the key elements that enable wound healing. We've already analyzed grafts made by processes like this, and the test results indicate that they have significantly reduced the growth factors, leaving essentially just the tissue behind. I expect that over time, we will be hearing of companies marketing these intact grafts as "second generation" or "new generation." But regardless of the marketing moniker, these so-called second-generation grafts are a step-back in processing and are significantly inferior to MiMedx allografts.

Now I think this is a good lead in to discussing the new USP, U.S. Pharmacopeia monograph for dHACM, dehydrated Human Amnion/Chorion Membrane, that MiMedx recently received. It took us about five years in working with the USP to develop this monograph. Now understand that this is a specific monograph to dHACM, the MiMedx product. And the grafts I just mentioned from competitors who do not take the layers apart to process, cannot meet the specifications in this monograph. This monograph outlines the specific configuration of the product, the specification, the packaging, the storage, and the labeling requirements for such a product. There are also very complicated validation tests, procedures for the tests and acceptance criteria that together make up the specification. The issuance of a monograph is historically for pharmaceuticals, food ingredients, or dietary supplements. There are only a small number of monographs that describe human tissue products.

So what ultimately does having the USP monograph mean? Well, the bottom line is that our PURION Process tissue is the only amniotic-based tissue membrane that meets these stringent USP requirements of strength, quality, and purity. MiMedx continues to set the standard in our industry, as articulated recently by a Medicare Administrative Contractor, Medical Director in acknowledging our USP monograph.

Now I also want to follow up on the press release we sent out regarding the FDA's guidance document agenda for 2017. Every year, they publish a calendar year guidance agenda -- a calendar for the guidance agenda. This is a schedule that projects the release dates of guidance documents, both draft guidance as well as final guidance documents. The 2017 agenda did not include any reference to the minimum manipulation or homologous use of HCT/Ps. This was not a surprise to us as we've been told that the FDA received many thousands of comments; the vast majority of them taking issue with the draft guidance as proposed. So we're very encouraged that the FDA is taking the time to carefully review the input. And based on the calendar it has published, we don't expect any significant updates in this area for about a year or possibly more.

Another consideration that we think is very positive is that the people that are in the current consideration for the position of FDA Commissioner generally believe that new technology should be made available to the public once safety is assured, much like what was stated in the 21st Century Cures Act. So that gives us comfort that we are not likely to see something coming out of left field like the untitled letter or the draft guidance that's coming -- in the coming years.

That said, we're still continuing our progress on our injectable BLA, and we've recently completed our efforts to be fully GMP-compliant, which is a prerequisite for producing BLA products. We view this as a tremendous competitive advantage and one that very few tissue companies can match.

With that, I'll turn the call over to Chris.

Thanks, Bill, and good morning. We're pleased with the progress that we've made in the fourth quarter and for the full year 2016. We grew 31% year-over-year and grew revenues meaningfully in both of our market focuses of Wound Care and SSO. Wound Care grew 32% fourth quarter over prior year's quarter and 30% year-over-year, while SSO grew 44% fourth quarter over prior year's quarter and 32% year-over-year.

Fourth quarter is most often the strongest revenue quarter of the year. First quarter is normally the slowest revenue quarter of the year. This is due to multiple headwind factors, such as deductibles are reset, many surgeons take off in parts of January after a heavy caseload during the holidays and yearend. The weather can be an issue, of course. And this year, specific to MiMedx, a few centers associated with individuals we had to let go for selling competing or other medical products are going through some transitions, as we are actively rehiring at each. We have strong momentum in our business and feel good about the ability to continue to deliver on revenue growth, as we have communicated.

We continue to make significant investments in the sales organization, adding more Wound Care account executives and new representatives, supporting our focus into surgery and the expansion of the orthopedic, sports med, and spine agency network. We are now at approximately 325 personnel in the sales organization.

We've continued the rationalization of our sales management organization. We've integrated the management of our sales teams under the leadership of an area vice president while maintaining the specialization of the groups for our Wound and SSO initiatives. This will maximize our coordination within the hospital and the local area. Previously, we at times lacked coordination, and then we missed out on additional or expansion area opportunities. This will empower the field sales leaders to communicate better and to make decisions at the local level, while the area vice president orchestrates the process and we capture those opportunities that we previously might have missed.

We conducted our national team meeting at the end of January. We all continue to be very impressed with the quality of our sales organization. We know the profile that we hire for. However, to have everyone together really amplified the success we've had in attracting the best of the best. We see the culture, energy and integrity of our representatives as a special profile. They are professional, well rounded, broadly experienced, energized to be successful and passionate about making a difference. The meeting emphasized the planning process, and we have long sessions on regional business planning and account executive strategic account plans.

The key to maintaining our continued growth is focusing on our target accounts and following the plan process. We also have expanded our sales management team in the last six months through both internal promotions and external hires, and we feel we have raised a level of management IQ and experience that we will benefit from.

Now focusing on Wound. We continue to make significant investments in our sales force supporting clinical studies and in our support teams in the contracting and field reimbursement specialist teams. We continued the expansion of our revenues, showed robust growth in all focuses, including hospital, wound care centers and physician office. I'd also like to add that we made good progress in the burn area last year. You may have seen our press release approximately 10 days ago regarding the publishing of a burn supplement in the Annals of Plastic Surgery. This was a culmination of five-peer-reviewed articles by renowned key opinion leaders on various burn and plastic reconstructive uses of our amnion/chorion membrane technology platform. It also included a history of the evolution of burn treatments to the current use of amniotic allografts today and concluded with novel select cases.

The EpiBurn line is becoming more widely known and adopted. We participated last week in the John A. Boswick Burn and Wound Symposium in Maui. There were seven presentations that shared experience with and discussed the benefits of MiMedx enhanced sealing products.

We're pleased with the progress we're making with burn and plastic reconstructive surgeons alike. The burn market will be a good contributor to revenues this year. Additionally, you may have seen that we announced positive payment policy from Aetna on EpiFix at the end of 2016, and this brings covered lives for EpiFix approaching 300 million.

We made a significant investment in hiring surgical representatives in 2016 to focus on abdominal and pelvic procedures. Many of these territories are built from scratch. So we've made the required investment ahead of the revenue and are truly taking the appropriate steps in these greenfield areas to engage, train, educate, go through [VA] committees and conduct evaluations that will lay the basis for accelerating revenues in the years to come. 2016 was an investment year, and now we expect to see improved traction in 2017 from the education and hospital approvals achieved by our surgical group. Additionally, many case examples and clinical studies will be completed and results published in the first half of 2017 that will help with our growth and support of our strategic plans.

Now I'd like to take a few minutes and highlight the initiatives that will be our growth drivers in 2017. We launched three new products in 2016 as part of the key investments we made: umbilical cord in Q2 under the brands of EpiCord for wound care and AmnioCord for surgical uses; and in late Q3, amniotic fluid in a lyophilized five-year shelf stable terminally sterilized version. OrthoFlo Sport will be focused in the physician office and pain management market. And finally, also at the end of Q3, we introduced our human collagen placental tissue extracellular matrix platform, brand named AmnioFill for deep chronic wounds and acute dehisced surgical type wounds. AmnioFill is intended for the use to replace or supplement damaged or inadequate integumental tissue. These products will be very important in strengthening our product portfolio, specialty procedural focuses, and adding to our continued revenue growth trajectory in '17.

We will continue to utilize our informatics and analytics teams to plan for continued sales organization expansion. Directionally, we could add up to 40 to 50 more representatives this year. We are purposefully realigning our Wound Care territories, creating new territories with fewer hospital accounts that we can go deeper into with more attention. Surgically, we will continue to carve out additional territories as back approvals occur and hospital usage expands. We expect the hiring split to be 2/3 Wound, and 1/3 SSO.

There will be many clinical trials that will complete enrollment and publish results in 2017. Specifically, our large multicenter studies in diabetic foot ulcers and venous leg ulcers; our Phase 2b plantar fasciitis study; OrthoFlo studies in knee, osteoarthritis; AmnioFix studies in joint replacement, colorectal uses, nerve sparing prostatectomy and many, many more. We anticipate that each of these clinicals will strengthen the bodies of evidence to help educate providers and drive adoption in our three focuses of wound, operating room, and physician office and pain management.

On the insurance front, with the addition of Aetna to the covered lives for EpiFix, MiMedx now has only United, Humana, and Kaiser left of the larger groups, and that approximately makes up 53 million lives left. These incremental covered patients will be a driver for more patients in 2017.

We are laying the groundwork for international expansion. Revenues are not material; however, our footprint in amniotic allograft platform recognition is expanding. We are working in Italy and Switzerland specifically within Europe to be the first country adopters. We're also making progress in smaller Westpac countries and conducting planning meetings and preparing for regulatory filings with larger countries like Australia and Japan. We will be attending local conferences, working with our distribution partners to ensure they have the support and training to be successful in the local markets.

And finally, we will continue to leverage GPO/IDN contracts, which have 5,400 members. These are tiered or sole-source contracts with five GPOs and fully integrated delivery networks. These contracts have proven to be very valuable and create barriers to entry for competitors, who don't have the compendium of clinical and scientific data, terminal sterilization, the distribution channel reach of MiMedx nor the education tools and programs. We believe 2017 will be the year when we really start to reap the benefits from investments made in 2016.

Now I'll turn it over to Mike Senken.

Thanks, Chris. Good morning. The company recorded revenue for the fourth quarter of approximately $69.9 million, an increase of 35% or $18 million over prior year fourth quarter revenue of $51.8 million. Wound Care revenue was $52.8 million, which represents an increase of 32% over prior year and 5.9% sequentially, with growth driven by additions to our commercial Wound Care sales team. SSO revenue was $17.1 million, which represents growth of 44% over prior year and an increase of 17% sequentially. Growth in SSO revenue was driven by increased penetration into surgical applications and new products such as OrthoFlo lyophilized.

Sales of Stability Biologics products were below expectations at $1.9 million for the quarter. For the 12 months ended December 31, 2016, reported revenues were $245 million, which represents an increase of $57.7 million or 31% as compared to prior year. Year-to-date Wound Care revenue grew 30% to $184 million as compared to $141 million in the prior year, and SSO revenue grew 32% to $61 million as compared to $46.2 million in the prior year.

As discussed in prior earnings conference calls, due to the impact to the results of the acquisition of Stability Biologics that closed on January 13, 2016, and the release of the valuation allowance on the deferred tax assets and its effect on net income in 2015, the company has decided to include additional adjusted non-GAAP measures in our press release and earnings call to provide a means of comparing normal ongoing operating results on a year-over-year basis. The additional measures include adjusted gross margin, adjusted EBITDA, adjusted net income and adjusted EPS to normalize results for comparison purposes in addition to reporting GAAP results. Tables are provided in our press release, which reconciles non-GAAP to GAAP reported results.

GAAP gross margins for the quarter were 87% as compared to 90.4% in the fourth quarter of 2015. 2016's fourth quarter gross margins were impacted by product mix and overhead absorption issues related to the Stability Biologics production activity. Management has already taken certain actions to improve these two areas in 2017. On a year-to-date basis, GAAP gross margin was 86.8%, which includes $1.6 million in onetime costs related to the Stability Biologics acquisition. Gross margins after adjusting for these onetime costs were 87.4% as compared to gross margins of 89.2% in the prior year. The year-over-year decline of 1.8% is due to product mix and the impact of new product launches. Included in the press release is a reconciliation of GAAP gross margin to adjusted gross margin.

R&D expense for the quarter was approximately $3.5 million or 4.9% of quarterly revenue as compared to $2.3 million in the fourth quarter of 2015. On a year-to-date basis, R&D spending is up $3.6 million or 43.1% over prior year. The year-over-year increase in R&D spending is driven primarily by increased investments in animal studies and clinical trials.

Selling, general, and administrative expense was approximately $48.4 million for the quarter or 69.3% of quarterly revenue as compared to $36.5 million or 70.5% of quarterly revenue in 2015. During the quarter, we added 14 direct sales reps, bringing the total direct sales headcount to 304 at December 31, 2016. The year-over-year increase in SG&A spending was due to the continued build-out of our direct sales force in both Wound Care and surgical markets, new product launch costs, international sales development, government affairs and other support areas as well as the addition of Stability Biologics' personnel and associated costs. On a year-to-date basis, SG&A expense was 73.5% as compared to 71.2% in 2015. Included in 2016 SG&A were approximately $1.1 million in onetime cost related to the acquisition of Stability Biologics.

The company reported positive adjusted EBITDA of $13.9 million for the quarter ended December 31, 2016, as compared to $12.9 million in the fourth quarter of 2015. It is the 20th consecutive quarter reporting positive adjusted EBITDA. The increase in adjusted EBITDA is the result of increased sales volume. For the 12 months ended December 31, 2016, adjusted EBITDA was $44.4 million as compared to $44 million in 2015. The increase was driven by increased sales volume, somewhat offset by investments in our sales force, new product launches and increased investments in clinical trials.

GAAP operating income in the fourth quarter was approximately $8.7 million or 12.5% of quarterly revenue as compared to $7.7 million or 15% of Q4 2015 revenue. On a year-to-date basis, GAAP operating income was $18.4 million or 7.5% of total revenue as compared to $24.4 million or 13% of revenue in 2015. The decline in operating income was driven by the affirmation -- aforementioned increased investment as well as onetime charges of approximately $2.7 million related to the acquisition of Stability Biologics.

The company reported GAAP net income for the fourth quarter of approximately $5.5 million or $0.05 per basic and diluted common share as compared to net income of $13.4 million or $0.13 per basic and $0.11 per diluted common share in the fourth quarter of 2015. Fourth quarter 2015 net income included a net credit to income taxes of approximately $5.7 million due to the release of a substantial portion of the valuation allowance on our deferred tax asset.

On a non-GAAP basis, after adjusting for onetime items, including the release of the valuation allowance, fourth quarter adjusted net income was $8.1 million or $0.07 per diluted common share as compared to $7.1 million or $0.06 per diluted common share in the fourth quarter 2015. On a year-to-date basis, adjusted net income was $24.4 million or $0.22 per diluted common share as compared to $24.4 million or $0.21 per diluted common share in 2015. Please refer to the table in our press release for a reconciliation of GAAP net income to adjusted net income.

Turning now to our balance sheet. The company reported approximately $126.5 million in current assets, including $34.4 million in cash, $67.2 million in accounts receivable, $17.8 million in inventory and $7.2 million in prepaid expenses and other assets. Days sales outstanding were 86 days as compared to 89 days at the end of the prior quarter. We continue to add collections and field reimbursement staff to improve collection performance as we work to keep pace with the rapid growth of our customer base. We expect to see a continued positive trend in DSOs in subsequent quarters.

Inventory turns were 2.0 for the quarter as compared to 1.7 in the prior quarter. 2016 inventory levels were impacted by the significant number of new products added to our portfolio due to the Stability Biologics acquisition as well as the previously announced new product launches such as OrthoFlo Lyophilized, EpiCord, AmnioCord, and AmnioFill. We expect inventory turns to improve in subsequent quarters.

Goodwill and intangible assets were $20.2 million and $23 million -- $23.3 million, respectively, as compared to $4 million and $10.8 million at December 31, 2015. The increase was due to the Stability Biologics acquisition. Please note that during the fourth quarter, the company adjusted the fair value of the acquired assets and liabilities after determining that certain Stability Biologics products had not reached certain marketability milestones. This adjustment was recorded as a measurement period adjustment.

Also, at the time of the acquisition, management believes that certain manufacturing processes were at a standard -- at standards aligned with our overall company standard. Management subsequently concluded that the standards required improvement. These factors have resulted in a lower revenue trajectory in the periods that apply to the earn-out, thus reducing the fair value of the earn-out and a reduction in the value of goodwill and intangible assets. As of December 31, 2016, the earn-out based upon 2016 results is estimated at $8.7 million payable in April 2017 as a 60-40 split in cash and company stock, respectively. The present value of the 2017 estimated earn-out is approximately $8.7 million.

Current liabilities were $50.7 million as compared to $26.8 million at December 31, 2015, with the increase driven by normal growth in the business as well as the aforementioned earn-out liability and income taxes payable now that the majority of their net operating loss carryforwards have been utilized.

Turning now to the statement of cash flow. The company reported a positive cash flow from operating activities of approximately $16.7 million for the quarter as compared to $4.4 million in the fourth quarter 2015. Contributing to the improved year-over-year performance was better collections of accounts receivable as reflected in the 86-day DSO as of year-end 2016 versus 93 days as of December 31, 2015. Cash flows used for investing activities for the quarter were $1.3 million, driven primarily by $1 million in capital expenditures.

Turning to our guidance. MiMedx reiterates first quarter revenue to be in the range of $69.5 million to $72.5 million and full year revenue to be in the range of $302 million to $307 million. The company is reiterating our previously announced full year 2016 fully diluted GAAP EPS estimated at between $0.18 to $0.20 and adjusted EPS estimated to be in the range of $0.31 to $0.33. Please see the tables included in our press release for a reconciliation of GAAP EPS to adjusted EPS.

With that, I'll turn the call back over to Pete.

Thank you, Bill, Chris, Mike. Let's just open the call to questions and answers please.

(Operator Instructions) Our first question comes from Mike Matson with Needham & Company.

I guess I just wanted to start with the $1.8 million revenue reduction. So just curious, does that -- is that related at all to this channel stuffing allegation and the subsequent investigation?

Well, the answer to that is no. It's related to, as we stated, the termination date of the AvKare contract and the legal agreement associated with that.

Okay. But I guess why take the revenue back now versus in '17 when the distribution agreement actually ends, I guess?

Well, Mike, this is Mike Senken. According to GAAP, we have to estimate what the liability will be at the end of the contract. And because we basically shipped the product in 2016, because you're shipping it with a right to return, you basically have to reserve for whatever you think is going to be returned.

Now speaking to the timing of this, we attempted to estimate as best as possible what we thought was in the AvKare inventory prior to that prerelease of revenue. But as Pete mentioned earlier, our inventory is in 100 different facilities and a number of different departments within those facilities. And so, we undertook a process over the course of January in terms of somewhat validating what we could figure out in terms of what was sitting in stock, looking at it in terms of what the demand was and what the usage was in each one of those facilities and then came to this conclusion that, conservatively speaking, we wanted to make sure that we had everything covered.

And so it was really from a GAAP perspective that we had to go through that process. Quite frankly, our thoughts internally are that there's enough demand out there that most, if not all, of that product can be utilized. But again, you have to be somewhat conservative, and that's where we were. We just got caught up in a desire to give a feel to The Street in terms of where we were leading into JPMorgan. Because of this unique singular contract and event which shouldn't occur again, we shouldn't have that repeat itself.

So, I guess, you didn't know that you were going to have to go through this exercise when you preannounced. Or if you did know, you just didn't realize it was going to be this material, I guess, the amount that you had to increase the reserves by?

Well, again, when you talk about the complexity of trying to go out and determine what's in that inventory across the country, you do the best estimates you can leading up to that point. But quite frankly, we wanted to be -- and part of this is, you also have to look at what's happening with the rate of implants at all these different facilities, and these things can change dramatically one way or the other. And so it's not as easy to estimate as you might think.

Mike, this is Pete. This contract has gone on for some years. It's been very smooth, generally speaking; strong relationship between both the distributor, ourselves and the VA facilities, but it's coming to an end, okay? It's coming to an end June 30. And with that particular closure to the contract, that required some extra analysis and scrutiny.

So the process, there's no issue here in terms of demand falling off or some other set of issues. It's the fact the contract's coming to closure, and in so doing, the accounting regs, GAAP, et cetera, required us to do certain things. And in our desire to try to keep shareholders always very informed, we have traditionally given some insight into quarterly revenues within the shortest period of time as we could at the end of a quarter. And like I said at the start, I've never had, in my 35 years of running public companies, something like this come up. It's a small amount, 0.6%, but the fact is it's a change, and no one likes change. But facts are this is a contract coming to closure, coming to an end, and as such, we had to do some extra work here.

I think one other thing to point out just logistically as we're effecting this transition, Mike, you have numerous facilities, and you put schedules together in terms of which facilities are basically going to be 100% shifted over to the MiMedx FSS schedule versus those that are on the AvKare FSS schedule. And part of the issue is you're dealing with multiple parties here. We're dealing with AvKare. We're also dealing with each individual facility. And again, there's complexity in trying to predict which way or the timing exactly of which facility is going to move when. And that was partially the reason for the revised estimate.

Okay, I understand. Just as a related question then, I guess, just looking at the fourth quarter, you saw a pretty healthy acceleration. I know part of that was probably comps, but I guess just what growth rate should we use sort of to evaluate your true underlying organic growth in the fourth quarter? I mean, should we really take out this $1.8 million or -- because it sounds like that wasn't necessarily revenue that had originally been booked in the fourth quarter. Maybe it was spread throughout the year or prior years or something like that. I mean, was your growth really more like the 38%, I think, was what you originally reported?

I guess, the growth -- if we look at commercial versus federal, what we have been saying in our calls is that what's really driving the growth, especially as we're going through this transition with the VA accounts, is on the commercial side. And to a certain degree, you almost have to push to the side in the short term the sales to these government facilities.

Our guidance for '17 remains where it is on the Wound Care side. And so this adjust does nothing to that guidance. We felt that in our guidance we had Wound Care growth in the 25% to 30% range, and we're not backing off of that.

Okay, that's helpful. And then just with regard to the reps that -- it sounds like maybe some of the fallout from this investigation, you discovered some of -- you had additional reps that were selling competing products. So can you quantify how many of those reps or what portion of your sales force had to be replaced because of those issues, aside from the couple that were involved in this lawsuit?

Well, this is Pete. Well, we think it's well known we terminated for and filed lawsuits against them. We've terminated some others and didn't file lawsuits because we felt that they hadn't reached the point of being as problematic. And then we've had some others that came clean with us. We sat people down and said just tell us the truth, and we'll go from there. Most of these others -- all of them didn't tell us the truth. It appeared they were -- continued to dig deeper with their lies, and the few that came clean with us, they're still here. They were disciplined and very thankful to have a -- still be involved with the company.

But we terminated approximately 10, 10 individuals in total and filed lawsuits against four and then a fifth lawsuit against a person that had been with us two years ago that we let go that was also involved in the process.

So anyway, out of 300-and-some-odd sales people, to me, I'd just view this as a pruning process. It's very unfortunate it happened, extremely unfortunate. Mostly disappointing to me is the lack of integrity that we uncovered in the process. But anyway, that's behind us, and we're moving ahead.

Our next question comes from Matt Hewitt with Craig-Hallum Capital.

A couple for me. Regarding the conversion from AvKare to your own Federal Supply Schedule number, where are you in that process? How much is left to go, as from a customer standpoint? I mean, has the majority of that been done, where you are -- your schedule is now being used for the bulk of that? Or is there still a little bit of heavy lifting to go here in the first quarter maybe?

This is Bill. Thanks, Matt. We've got, I think, more than half of it's converted now. So I think we're in pretty good shape between now and June to finish that. And as Mike said, I think our -- also we've recently received a BPA, blanket purchase agreement, I think it was in December, on our FSS that will -- it's actually going to make things, in our view, run a little more smoothly and make it easier for a lot of the accounts to order through us. But if we do our jobs well operationally, we should be able to be at a point where, in June, there's virtually zero of that AvKare inventory remaining, and it's completely -- it will be completely converted over to ours. And I think we might be able to get a little bit of an upside. Plus we have a little bit better margins, obviously, when we're selling direct as opposed to through a distributor. So that will be beneficial for us as well.

Okay, great. And then just out of curiosity, so you guys updated your sales system. I think that was early last year. And I'm curious if that upgrade enabled you to find some of these issues that you've had with a few select individuals.

Yes, I would say so. One thing I think people forget is we're a manufacturer, as such, we produce products. But in our IT department, which all reports into Debbie Dean, there were individuals there that came from our prior company. Prior company had one of the largest health care informatics groups in the country, and we were one of the largest producers of that kind of information. So we have a tremendous amount of IT expertise and systems here and data which we can translate into information in our back office, and it's quite an asset for us, and we use it in many different ways.

So yes, it finally, once we got a little insight into some of this going on, it allowed us to really turn up an amazing amount of information which was, of course, generally disappointing.

Okay. One last one for me. One of your two major partners had some significant disruptions in the fourth quarter, a facility being shut down, that impacted their ability to supply surgeons and all of that. I'm curious if that had any impact on your sales through that partnership.

Hey, Matt, it's Chris. In general, I'd say we haven't seen a lot of disruption in our activities with them. It's very specific to the office space, the sales force that they have on the AmnioFlo product and then, of course, they have the sheet as well. So minimal disruption from our standpoint.

Our next question comes from Bruce Jackson with Lake Street Capital Markets.

If we could just take a look at the Wound Care business real fast, it's been a tremendous growth driver for the past couple of years. Can you just give us your thoughts on how much runway is left for this business? I know there are a couple of insurance contracts you have not obtained yet. There's some secondary markets you can expand into. But just tell us how much business do you think is left to go out there and obtain?

Well, we get that question a lot, Bruce. This is Chris. As we continue to talk about and Mike rightfully stated, our Wound Care growth truly is coming in that commercial aspect. With the contracts that we have, we have much greater leverage within the hospitals to work with them being sole-source or tiered contracts. The reason that we continue to expand on our sales force is because there is so much patient opportunity there that need healing products like EpiFix. I'm going to give you just a couple of quick numbers, and then you'll see what I mean.

There's, every year, approximately 3 million chronic non-healing wounds, okay? Of that, 1.4 million of them are diabetic foot ulcers and venous leg ulcers, again, chronic non-healing. We estimate looking at the data and the procedural data that there's somewhere between 100,000 to 150,000 patients that ever get any skin substitute, okay, any. So if you put those numbers down, let's just use the high. 150,000 patients a year get treated with something. There's 3 million chronic out there. So this is why there's a huge opportunity, and this is why we continue to expand at a rapid pace.

Now --

If I could just add the [shorter] is -- last year in '15, and we'll get the numbers for '16 here shortly, the underlying condition of those non-healing wounds only grew in the neighborhood of 2% to 3%. But the market for advanced skin substitutes grew in the neighborhood of 12% to 13%. So what that means is what we're doing, we're leading the charge of expanding the market and getting more people access to this technology. So that just kind of further goes onto Chris's point there.

Sorry to interrupt, Chris --

No, that's a great point. I'll just give you the hard number. In 2015, I think $587 million was spent on skin substitutes. We expect this year, this past year 2016, it'll probably be somewhere around $640 million, $650 million. And it's being estimated that within four years, 2020, there will be $1.1 billion spent.

Now that's not just MiMedx and EpiFix taking market share away, although we're doing that at a fairly quick clip. We're over 30% market share now. But it is also estimated that amniotic tissue in general will make up over half of that spend by 2020, okay?

Today, we are about two-thirds to 70% of all amniotic expenditure in the marketplace. So it gives you an example of the position that we have and the rate of change that's happening. It's not just taking share away, but it's truly expansionary. So the other factors that go into this are education, its coverage. And again, because of the contracts and the people that we're hiring, we're able to go into these secondary, tertiary markets. And I stated in my earlier comments about having smaller territories and being able to go deeper within those territories.

And really, our informatics, too, has really shown us that in terms of the penetration across the country, there's still a large number of pockets in the country where our products aren't being used at all. We don't have good sales coverage. We have a number of -- even smaller cities where we may have -- the analytics tell us we should have four people in that area, and we only have one person in that area. And that's even in like a secondary city type area. There's just -- there's so many opportunities out there that as we get deeper in our analytics, we find that the opportunities are just so broad that we've got a number of years of runway to go before we're going to kind of level out.

And we view those analytics to really inform us over the next four to five quarters, where we know where we're placing people and how many we're putting quarter by quarter.

Okay, that's helpful. And a follow-up to that, so roughly 70% of your incremental growth has been coming out of the Wound Care side. How do you see that playing out over the next couple of years? Is Wound Care still going to be the primary driver of this business? Or will the SSO business start to step up a little bit in terms of the revenue contribution? And then if you could also comment on the international potential, that would be helpful.

Well, I'll make some statements and then Mike can jump in if I get some numbers wrong. First of all, as we said earlier, we expect to grow in that 25% to 30% range this year on Wound Care. We think over the next four years, we can keep it, certainly, in the double-digit range and hopefully -- over 20%, I think, is what we're estimating where we end up somewhere around $300 million, $330 million by 2020. So we're going to continue on this track.

But additionally, as you've seen, we've expanded now to a third leg of our focuses. Operating room has certainly been one through SSO, and we're going to continue to hire both direct representatives for that operating room as well as managing orthopedic agents. But another piece of -- and that group will continue to grow meaningfully.

The third piece is in the physician office and pain management area. With the advent of OrthoFlo, our amniotic fluid product coming to market, as well as the clinical trials that we have running both on our AmnioFix Sports Medicine as well as OrthoFlo, we've got a lot of good data that'll be coming out throughout 2017. And actually, we'll probably be looking at the plantar fasciitis data sometime in the second quarter of this year, most likely. And then OrthoFlo data on the knee we'll also be, again, unblinding somewhere around the same time.

So this year is an investment year for OrthoFlo and for that office-based focus. We'll be utilizing agents initially as well as some direct representatives, and we're going to build that out, but we do see that being a significant driver for us as we go through our five-year plan into 2020.

Okay, and then the international piece of it?

Sure. Internationally, we're going to continue to focus in the EU. As I said, both Switzerland and Italy are earlier -- historically, are always earlier adopters of new generation type products and especially in this Biologics space. So we're going to focus there. We're going to go through a process with NICE in the U.K. We have evaluations going there in the planning and kicking-off phase. So the U.K. may move a little slower on the wound side, but we still can sell AmnioFix there. And we're also looking at the urology market in the U.K. So those will be the three drivers in the EU.

Outside of that in the Westpac, we're in countries like New Zealand now and Korea, and we're just starting to develop those relationships and go to market. And as I said earlier, we're working on other regulatory filings both in the smaller countries but then also in the bigger ones like Australia, which we're excited about. We have a great partner there, and we're looking for -- to do something as well in Japan eventually.

Okay. Just one more, if you don't mind. What was the amount of international revenue in the quarter [if that's] a percent of the total?

Very small.

Yes, it's not material at all, yes.

Our next question comes from Jason Wittes with Aegis Capital.

Are you on mute, Jason?

Did you want me to go ahead and move onto the next questioner?

Yes, please. Hopefully, he can dial back in. But yes, please move on.

Our next question comes from Joe Munda with First Analysis.

Real quick on AvKare. You broke out how much they contributed to revenue in '15 and receivables, it was roughly 25%. I was wondering if you had a number for '16 as well as how much inventory they have left as a result of the transition.

Well, I can tell you, Joe, that AvKare will not be -- you have a requirement to report any customer that represents 10% or more of your revenue, and AvKare will not be reported separately for '16. That much I can tell you.

As far as their inventory goes, that's really a matter, I think, between us and the customer, and we'd like to keep that confidential.

Okay. Mike, maybe you could walk us through, in a little bit of a better detail, the mechanics from an accounting standpoint, the relationship with AvKare. From my understanding, if you ship, there's no returns on your end, but if, let's say, a VA facility were to return, would AvKare assume possession of that product?

So in our relationship with AvKare, AvKare issues us a purchase order, and we ship products. So AvKare takes possession of it at the time we ship it.

They don't actually take physical possession.

Well, yes, it's drop-shipped to a facility. So AvKare has inventory locations. They don't have a warehouse. This is inventory that, again, is spread amongst 100-plus different -- it was 100-plus, but we have been converting facilities. And so physically, the inventory is at these different facilities and, again, not only in one department but in multiple departments. So the tracking of inventory can be somewhat of a challenge, as we're learning now that we're picking up direct shipments to these different VAs. And what was there another part of that question that I missed?

And if -- so if one of those facilities were to return the product, right, who would assume responsibility? AvKare?

That is AvKare's responsibility.

Okay.

Now, Joe, I mean, what all of this relates to is, in our contract with AvKare, at the termination of the contract, we have the obligation to buy back any remaining inventory that basically is out at these VA facilities. And so as we get closer to the termination of the contract, and quite frankly, over the course of the year, and we've extended this contract with AvKare several times, we make decisions as to whether or not we retain a customer, or not retain a customer. And so it's not as predictable as you would think. We probably would've said earlier in 2016 what's the likelihood of us renewing that contract and probably the answer would've been very high.

But as time goes on and different things change and we get more comfortable with shipping direct and the like, so then that changes. But at the end of the day, we're getting within -- the contract terminates at the end of June and then there's a 90-day run out period. You have to start paying attention to what is out there and will you have a responsibility for it, and that's what we did, and that's not an easy process, and you've got multiple facilities. You've got a sales force that's out there doing other things. And then you have to dedicate a lot of resources to make sure that we are working in conjunction with AvKare on figuring out what is in their stock. And that's when you come up with, okay, it looks like to be conservative, we're going to have to book some more returns and allowances.

And Joe, there's some administrative process here. Taking what Mike's, I think, saying, you take a salesperson's sales efforts and have to direct it a little more specifically towards a particular account and reducing inventory -- AvKare inventory there, et cetera. That's something we have to plan and execute on very carefully, which we're good at, but at the same time, it just takes some extra effort, so -- on the federal side.

As far as the terminated personnel, just taking a quick look on LinkedIn, I mean, all of four of them seem to be from the Midwestern region. And I was just wondering, A, how much the Midwest was a contributor to overall revenue; and B, I mean, if we could get to a more granular level, how much revenue did these four reps contribute to the overall '16 number?

Well, this is Pete. First of all, not being a LinkedIn guy, but you're correct. And three of those of four individuals had worked together previously and so on. And so there was old friendships there that kind of seemed to stimulate this kind of activity. So that's that. I don't know that we -- anybody sitting in this room at the moment can --

No, we don't typically break down those kind of things.

Yes, competitively, we wouldn't break that down, but they're different sized customers. And as I said, we're actively working. We have a plan and some people have been hired and others -- we'll get the right resources in there.

And again, I would just encourage everybody to realize and remember, we've been pretty effective when we have these pebbles show up in the past of working through them and kicking them aside and moving on, and that's happening here. I don't think we'll be coming back to you with some kind of big excuses of, "Oh, well, this happened and that happened." We plan well and we execute well. And every now and then, we're going to have a hiccup, but I think this will be behind us pretty quickly here. And the litigation piece will also get behind us pretty quickly. We're litigating these. We already had a success right here in Atlanta federal court and expect those kind of successes to continue.

Okay. And my last question. Pete, I want to get your takes on the push out of the Draft Guidance based on the calendar that Bill had talked about. In my view, if they were to finalize guidance, it would be more of a moat or a protective barrier for you guys -- a competitive a barrier for you guys. And I was just wondering, I mean, do you look at it that way in the sense that based on your compendium of data that you'd probably be better served if the guidance were to come and start undergoing that process rather than having it being pushed out perhaps, a year or two years, if you will. Just would love to get your thoughts on that.

Okay, Joe, you're correct. We've tried to signal clearly that MiMedx is well positioned either way that these guidance documents might change. We're way ahead of everybody by years in terms of a BLA plant. In a matter of the next few weeks, we'll be GMP rather than --

Already there, actually.

Yes. Well, Bill just gave me an update. We're well ahead there. So we're positioned either way. On the other hand, it still pains us, thinking back three and a half years ago, we were singled out with this first initiative by the agency and we've got enough Freedom of Information Act materials to know that Organogenesis had a great deal to do with that. So we feel like for the first year and a half there almost, we were standing alone. And then they put out a guidance document which allowed the whole industry to get focused on it. And since then, there's been a lot of progress made in terms of the whole industry saying, what are you doing.

Now remember, President Trump has said to these federal agencies, well, if you change one regulation, you have to knock off two. So I think some of this zealousness that, frankly, as business executives, we'd tell you it's been overly zealous, is perhaps going to temper a little bit.

So we'll see what happens. But the key is, we're planning both pathways, and we're ready to go either way and are well positioned to go either way. So it's becoming less of a focus for us, as it was three and a half years ago, two and a half years ago and so on.

And I'd just like to add one thing, Joe, too. As we mentioned before, we would actually like to see the FDA add a category of products kind of in between an HCT/P and a BLA and have a new regulation that would not be quite as onerous as a BLA but would certainly be more onerous than HCT/P. We think there are a lot of these products that the FDA, and we agree, should be more highly regulated, and I think that's going to benefit us.

Our preference is to do it that way, because that's new regulation going through the right process as opposed to try to influence regulations with guidance documents. That's never really good to do that. So we're actually talking with various folks on the user fee legislation to see if there's something in there that they could utilize to help insert some of these -- some new regulations in the line of what we're talking about right now.

And that's where that 21st century bill is headed. And that's setting some intermediate approval processes between the two extremes. And that would be something we would certainly and did support.

Okay. Mike, if I can, just one more. Do you have a full year [revenue] number for Stability? And I was wondering, based on the 2017 guidance, can you give us some ballpark either percentage of revenue or actual range, expected contribution for Stability in 2017?

Okay. So in '16, the total revenue was $11 million and we had, in our nominal forecast, had them at $15 million. And so we've taken a conservative approach for '17. And I think in our earn-out projections, we have them at, I believe, it's $14 million.

Our next question comes from Jason Wittes with Aegis Capital.

So just -- I know there's been a lot of questions about AvKare. I got on a little late, but I know what the impact is for the stocking right now. But can you give us a sense of what the annual revenue contribution was in 2016 from AvKare?

Well, we were just asked that question.

Okay, I apologize.

That's okay. How I answered it was to say that in '15, AvKare was a "10% customer". So we broke that out in our filings. In '16, they are not. So you can take from that, that they're less than 10% of $245 million.

Okay. And then if I think about '17 guidance, how much of that AvKare business do you expect to regain or is imputed into that number?

Well, in our guidance, we had contemplated the transition to our FSS schedule, and so it has no impact on our guidance.

We expect -- we expect to transition all the business over at our FSS number.

It's bit of an art and a science here. We came into 2016, like I said before, we had a certain plan in terms of transitioning facilities, but there are a lot of players that are involved in that process. We alone can't dictate what goes on there, and so there's a lot of puts and takes. But that just rolls us into '17. And again, we kind of take an overall view of what we think the federal facilities are going to generate in terms of revenue. And whether it flows through us or it flows through AvKare, we still think we can hit the guidance.

But I assume AvKare will find another supplier, and you'll be completing against AvKare in those accounts.

Yes.

But your assumption still sounds like you're pretty confident that you can retain -- maintain and grow that business, it sounds like from Pete's comments.

Just like we've done with all other competitors showing up.

That doesn't concern us at all.

That doesn't concern us.

We're very, very sure, Joe. Sorry, [first of all], Jason. Sorry.

(Operator Instructions)

Well, we don't see any more in the queue, so we'll just thank you again. It's been a, hopefully, a very informative call. We can apologize for some of the new distractions, but these too will pass just like the others have. And I'll say it again. A bull market climbs a wall of worry, and MiMedx has certainly had its walls of worry that keep coming from time to time, but that's what happens with leadership. And we'll move past this pretty quickly, and again, to show you how optimistic -- our optimistic view of '17 is playing out. Thank you very much. Appreciate it.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.