Earnings Call Transcript - GMED Q1 2022

Operator, Operator

Welcome to the Globus Medical's First Quarter 2022 Earnings Call. At this time, all lines will be on mute and a Q&A session will be held after the prepared remarks. I will now turn the call over to Brian Kearns, Senior Vice President of Business Development and Investor Relations. Mr. Kearns, you may begin.

Brian Kearns, SVP of Business Development and Investor Relations

Thank you, Richard, and thank you everyone for being with us today. Joining today's call from Globus Medical will be Dan Scavilla, President and Chief Executive Officer; and Keith Pfeil, Senior Vice President and Chief Financial Officer. This review is being made available via webcast accessible through the Investor Relations section of the Globus Medical website. Before we begin, let me remind you that some of the statements made during this review are or may be considered forward-looking statements. Our Form 10-K for the 2021 fiscal year and our subsequent filings with the Securities and Exchange Commission identify certain factors that could cause our actual results to differ materially from those projected in any forward-looking statements made today. Our SEC filings including the 10-K are available on our website. We do not undertake to update any forward-looking statements as a result of new information or future events or developments. Our discussion today will also include certain financial measures that are not calculated in accordance with Generally Accepted Accounting Principles or GAAP. We believe these non-GAAP financial measures provide additional information pertinent to our business performance. These non-GAAP financial measures should not be considered replacements for and should be read together with the most directly comparable GAAP financial measures. Reconciliations to the most directly comparable GAAP measures are available on the schedules accompanying the press release and on the Investor Relations section of the Globus Medical website. With that, I'll now turn the call over to Dan Scavilla, our President and CEO.

Dan Scavilla, CEO

Thanks, Brian, and good afternoon everyone. Q1 sales were $231 million or 1.4% growth with non-GAAP EPS of $0.42 a share and an adjusted EBITDA of 32%. These results reflect modest revenue growth against a difficult prior year comparison coupled with COVID-related revenue impacts in key countries and a slower capital purchasing quarter. While these revenue headwinds impacted EPS and adjusted EBITDA results, it is important to point out that we remain committed to investing in our strategy for above-market growth by increasing investments in R&D resources, competitive rep recruiting, and surgeon education, focusing on the goal of sustained long-term growth. US Spine grew 3% for the quarter against headwinds of a challenging Q1 prior year comparison of 20% growth coupled with additional COVID impacts. January was slow as noted in our Q4 earnings call. February showed sequential improvement and March became our highest sales month on record. The strong performance continued in April where we achieved our highest average daily sales. In addition, our competitive recruiting pipeline is strengthening, which is a leading indicator of future growth. Enabling Technology sales were $13 million, down $2 million from the prior year due to lower placements in the quarter. After a record Q4, we experienced a slowdown in hospital purchasing as administration focused more on COVID and staffing shortages in Q1. Robotic procedures and implant pull-through continued to accelerate, growing 27% versus the prior year and surpassing approximately 31,000 robotic procedures performed since launch. Entering Q2, our pipeline is stronger and we're focusing on driving robotic sales throughout the rest of the year. In May, we began shipments of our Excelsius 3D imaging system and successfully completed the first surgeries in several sites. Surgeons have said this is a game changer. Excelsius3D is a 3-in-1 imaging platform offering three image modalities in a single cart with high maneuverability, a large field of view, and seamless integration with our ExcelsiusGPS Robotic Navigation System. It is a key component in realizing the Globus ecosystem in the operating room. Market interest is high on this state-of-the-art technology and customer orders continue to grow. Excelsius3D is positioned to be a major growth driver for us as we continue to penetrate the market. On the international front, our spinal implant business was flat in Q1. Strong mid-teens growth, driven by the UK, Italy, Belgium, and Brazil was offset by declines in Japan, a trend we identified last year and expect to continue through the third quarter. We remain positive about the potential of our international business for long-term growth, as we continue to reset the Japanese market. Our Trauma business delivered its strongest quarter to date with 61% annual and 28% sequential growth, driven by sales force expansion, strong uptake of our ANTHEM Mini Frag Plating System, and double-digit growth in every product family. We're on track to launch meaningful products throughout the rest of 2022, while investing in future product lines and sales force expansion. In Q1, we launched HEDRON P, a 3D printed articulating lumbar interbody spacer, adding to our HEDRON portfolio, one of our fastest-growing product lines, as well as increasing the articulating spacer offering along with Signature and Altera. As we move into the rest of 2022, we remain focused on three core elements for long-term growth: innovative new product introductions, robot and imaging placements, and competitive rep recruiting. I'm pleased with the record US sales in March, April's highest average daily sales record, the Excelsius3D imaging system launch, and the strengthening competitive rep pipeline. Globus Medical is well positioned to achieve our mission of becoming the preeminent musculoskeletal company in the world. I will now turn the call over to Keith.

Keith Pfeil, CFO

Thank you, Dan, and good afternoon everyone. Our Q1 results reflect continued growth coming off strong prior year comparisons, while also facing COVID impacts throughout much of the quarter. Our business remained resilient and our core approach and fundamentals remained intact. Q1 revenue was $230.5 million, growing 1.4% as reported and 1.9% on a constant currency basis. Ongoing COVID impacts affected procedural volumes in the early part of the quarter, which began to improve in February; however, we did not see consistent momentum building until March. Our capital business also experienced softness in Q1, reflective of slow development of our robotics pipeline in the early part of the quarter, with many hospitals limiting access and shifting their focus to managing the uptick in COVID cases while also managing staffing shortages. As we approached the middle of March and entered the second quarter, our pipeline showed improvement, as deal activity and discussions ramped up. We remain confident in driving this business forward as we progress through 2022. Moving further into sales, our Q1 musculoskeletal revenue was $217.4 million, growing 2.3% compared to the prior year quarter, driven primarily by growth in our US Spine business, which was partially offset by lower Japan sales. The declines in Japan are primarily related to our continued transition to a direct sales force. Q1 Enabling Technology revenue was $13.1 million or 11.9% lower compared to the prior year quarter and reflects my earlier comments about our robotics pipeline. First quarter US revenue was $196.4 million, growing 1.6% compared to the first quarter of 2021, driven by growth within US Spine, partially offset by lower INR revenue related to robotic sales. International revenue for the quarter was $34.1 million, essentially flat to the first quarter of 2021, driven by the earlier comments around our Japan sales transition and in line with our expectations. Excluding Japan, our international business grew in the mid-teens, as we continue to drive deeper penetration of Spine within our focus countries, mainly within Western Europe and Latin America. First quarter gross profit was 74.3% compared to 75.8% in Q1 of 2021. The lower gross profit was primarily the result of manufacturing inefficiencies related to our new plant, higher inventory write-offs, increased freight costs, and product mix. The higher inventory write-offs are primarily related to increased scrap costs within our biologics business and implant manufacturing, while the increased freight expense was driven by fuel surcharges and freight mix changes. We estimate a roughly 30 to 40 basis point impact to gross profit as a result of inflation, which is primarily driven by the increased freight costs, as well as some slightly higher raw material costs. Looking ahead, we expect gross profit to remain in the mid-70s as we progress through 2022. Our research and development expenses for the quarter were $17.4 million or 7.6% of sales compared to $14.9 million or 6.6% of sales in the first quarter of the prior year. The increase in spending both in dollars and as a percentage of sales is consistent with comments made in 2021 regarding our plans to increase investment across our business, primarily within Spine and Enabling Technologies, which will further position us to drive our class-leading capabilities. SG&A expenses for the first quarter were $100.7 million, or 43.7% of sales compared to $97.9 million or 43.1% of sales in Q1 of 2021. The increased spending is primarily due to a return to pre-COVID levels of spending around travel and entertainment, meeting expenses and training events. This increase in spending is partially offset by lower compensation and benefit costs as well as lower bad debt expenses. Overall, this increased level of spending is consistent and in line with our expectations. The effective income tax rate for the first quarter was 22.1% compared to 20.7% in the first quarter of 2021. The increased rate was driven by lower tax benefits associated with stock option exercises. GAAP net income for the quarter was $38.1 million, and non-GAAP net income was $43.9 million which delivered $0.42 of fully diluted non-GAAP earnings per share. Adjusted EBITDA was 32.2%, as reflective of my earlier comments on sales gross profit, R&D, and SG&A impacts. We ended our first quarter with $1.02 billion of cash, cash equivalents and marketable securities. Our Q1 net cash provided by operating activities was $44.7 million and free cash flow was $24.7 million. Our Q1 free cash flow is reflective of working capital investments and inventory mainly within our INR business as well as higher CapEx focused primarily on machinery and equipment. The company remains debt-free. Our full year 2022 guidance remains unchanged at $1.025 billion in net sales and $2.10 in fully diluted non-GAAP EPS. Looking ahead, we remain extremely positive about our expectations for the remainder of the year and we will remain well positioned to execute and drive growth against our objectives. Our team is committed to driving value over the long term for our patients, our customers, and our employees. We will now open the call for questions.

Operator, Operator

Thank you. We will now begin the question-and-answer session. And our first question on line comes from Shagun Singh from RBC Capital Markets.

Shagun Singh, Analyst

Great. Thank you so much for taking the question. I'm going to start with one on capital. It does seem that Q1 was soft and we've heard it from several other companies. Can you just put a finer point on it? How much of it was pulled through to Q4 due to remaining COVID dollars? How much of it was typical seasonality versus the COVID related delays that you talked about due to staffing shortages? And what trends are you seeing in Q2? You did mention that the pipeline is strengthening. But will Q1 and Q2 kind of net out to where you expect it to be? And any comments you can provide on your outlook for 2022? It does appear that hospitals are facing more margin pressure. So do you expect it to impact spending on medical devices in any way? And then I have a follow-up.

Keith Pfeil, CFO

Okay. Thanks again. This is Keith. I'll take the first part of that. The capital business did not develop as expected in Q1. While some competitors commented on the capital environment, we did not see the pipeline mature. As we moved through the quarter, we anticipated seeing progress in deals, which didn’t materialize. Feedback indicates that hospitals are focused on responding to COVID concerns and staffing shortages, which they prioritized. We noticed improvements towards the end of the quarter. As I look at the second quarter, we are observing maturation in the pipeline that was absent in Q1, giving us more confidence regarding robotics and capital entering Q2. Additionally, we are beginning to ship our imaging systems, which is fostering discussions about the global ecosystem and enabling technologies. There may have been a couple of other points I missed, but that’s my general overview.

Dan Scavilla, CEO

I'll add to that, Shagun. As I would think back to your latter half of that question, very difficult for us to predict what hospitals could or would do. We don't know what the environment is. We'll keep our eyes on that. But as we're signaling today by keeping our guidance consistent, we believe we have enough muscle to actually deliver these results albeit we may throw levers differently to get there, but to-date with capital we're not seeing any reason why we'd want to back away.

Shagun Singh, Analyst

Got it. That's really helpful. And just as a follow-up, can you just talk about the cadence of growth through the balance of the year for sales and EPS? I think consensus is looking for $262 million in sales and $0.53 in EPS in Q2, and it implies a pretty rapid sequential increase of 14% and 27% higher than what it has been pre-pandemic. Obviously, Q1 was soft as well, but any color on cadence would be helpful? Thank you for taking my questions.

Keith Pfeil, CFO

Thanks, Shagun. This is Keith again. We haven't really given quarterly guidance and we don't really plan to start. I think where we're at today is we're reaffirming guidance for the full year. We remain positive about where the business is and really look forward to getting further into the year.

Matthew O'Brien, Analyst

Hi, thanks for taking my questions. Either Dan or Keith, the total spine figure you're projecting for the year seems to be less than what you recorded in 2019, based on the guidance. I don't have exact numbers, but in 2019, you had a year-over-year increase of about $68 million. This year, the spine growth appears to be closer to $41 million. I understand that international markets are a challenge, but you also have the benefit of 3D technology. Can you explain why the Spine business is expected to grow slower than in 2019? Additionally, is there any specific pressure on the expandable side, which I believe is a couple of hundred million dollars for your company?

Keith Pfeil, CFO

Thank you for the question. We haven't projected what our US Spine business will look like for the year. However, if we take a step back, we've seen significant growth from 2019 to 2020 and then from 2020 to 2021 was a particularly strong year for us. The key factors driving our growth include new product launches, competitive recruitment of representatives, and the impact of robotics. We expect this trend to continue as we remain committed to expanding our business.

Dan Scavilla, CEO

Yeah. Matt, I would just say maybe we could have a conversation later. I'm probably not aligning with your calculations on that, because we see very strong growth, continued growth of our sales in Spine, including new product launches, which are going to be fairly strong this year. So, I don't think I would come to that same conclusion.

Matthew O'Brien, Analyst

Okay. And Dan, you're still doing well in expandables?

Dan Scavilla, CEO

Absolutely. Keep in mind that we've got so many generations of that. That's one of the main drivers for us to date.

Matthew O'Brien, Analyst

Okay. And then, a quick follow-up is on 3D. Feedback on that one that we get is unbelievably strong. Should we expect that to be a $15 million, $20 million product for you guys this year? Thanks.

Keith Pfeil, CFO

As we look out to the year we haven't given specific guidance on what we felt the sales will be this year. I will say that we still have more than double-digit orders. The enthusiasm is great. Every time someone sees this product, they want to buy one and we remain excited to achieve our year in our guidance.

David Saxon, Analyst

Good afternoon, and thanks for taking the questions. Maybe I'll start with the Spine business in Japan. I think if memory serves, last quarter you were expecting that business to return to growth in the second half. It sounds like that might be pushed to maybe the third quarter or fourth quarter. So, just wondering if anything has changed there, or I guess, what's the plan to kind of get that business back on track?

Dan Scavilla, CEO

Thanks, David, for the question. So, obviously, the fourth quarter is the second half of the year. And so we're going to continue on that path. Nothing has really shifted with that other than I've gotten a little more precise as to the quarter since the last time we spoke. That said, I will tell you, I'm bullish on Japan. When I look at the leadership team we're putting in place, the sales team we have in place, the surgeon interest from recent events that we've had, I do see this as a very large area for us over the next coming years. And so, we're going to do what's right by cleaning up and going direct. And with that, we'll continue to contract to that point. And then once we stabilize, I expect significant growth going forward.

David Saxon, Analyst

Okay. That's helpful. And then, maybe I'll just ask my follow-up on the Recon robot. Any update there in terms of timeline? And then, how should we think about the robot launch? Do you feel like you have enough in the StelKast portfolio today to support that launch? And then, any plans for hiring ahead of that expected launch? Thanks so much.

Dan Scavilla, CEO

Okay. So I would tell you that we're progressing well with the robot. We have yet to file and get approval. I would always be difficult to call out where that is at this point in the acceptance rate. But I will tell you that with the features and the feedback as we develop it with surgeons, it's very promising and it will be a major part of our portfolio, likely this year. At the same time we have been reinvigorating the StelKast or now Globus Ortho portfolio to match with that. And that is paired to be filed and launched in unison with the robot to give us that way. And yes, you are correct. We have plans to expand our commercial team and that's something that we'll most likely get more active with in the latter part of this year as we get more product status and decide when to pull that trigger.

Kyle Rose, Analyst

Great. Thank you for taking the questions. I just wanted to ask one about capital allocation. I mean we've seen some big dislocations of valuations in the public markets. You've got $1 billion in cash on the balance sheet no leverage. You've talked in the past about being acquisitive strategically. I just wanted to see if the weakness we're seeing in the public markets is creating a buying opportunity and if you think that we should expect an increased period of M&A on the part of Globus moving forward?

Keith Pfeil, CFO

Thank you for the question. This is Keith. Your observation regarding M&A is accurate. We are continually exploring M&A opportunities. Initially, it was believed that COVID would present significant buying opportunities, but the market unexpectedly surged. Now, with rising rates and discussion of inflation and potential recession, we see that smaller companies burdened with debt may become potential targets for acquisition. Regarding specific areas of interest, we are focusing on our Ortho portfolio and exploring opportunities with small spine companies, particularly those with underdeveloped R&D. Additionally, we're interested in complementary technologies that could enhance our enabling technologies business. Overall, your assertion reflects the direction we are considering.

Kyle Rose, Analyst

Thank you. And then when we think about the leads and the pipeline you have for the 3D product, can you maybe just talk to us about what that looks like? Is it current robotic Globus users? Is it current robotic competitive users? Is it people that haven't used robots in the past? Just trying to really understand where the demand is coming from? Thank you.

Dan Scavilla, CEO

Thanks, Kyle. It's really a mix of all of the above that you just called out. It's not particular to just the people who have our robot. We've seen interest all around with this. And as you know it's applicable throughout. It's not tied just to our Excelsius robots. So the good news is it's really coming from multiple directions.

Kyle Rose, Analyst

Thank you for taking the question.

Keith Pfeil, CFO

Thank you.

Jason Wittes, Analyst

Hi, thanks. If I could just start with a follow-up. On acquisitions, in terms of adjacent orthopedic technologies, could that potentially be hip and knee type technologies like that implant type company, or is that something that you look to build internally like as you've done so far in Trauma?

Dan Scavilla, CEO

Jason, I guess it depends really on what the opportunity would be. It needs to be something innovative, something that would actually shift our timeline meaningfully, and we would take a look at that. So it's possible. But as we pursue today, most of what we're using and what we're planning on is internally built. But again, it really just depends on if the opportunity is the right one and it makes a meaningful difference we would consider it.

Jason Wittes, Analyst

Fair enough. Appreciate that. And then in terms of the visibility on the capital equipment from order to install. Has that changed at all, or generally speaking what kind of visibility do you have? Is it a full-quarter visibility? Is it a six-month visibility? Just trying to get a sense of you mentioned you have double-digit booking orders, how good the visibility is in terms of when you can actually install them?

Keith Pfeil, CFO

Sorry. This is Keith. We're trying to follow your question there for a second. In terms of visibility really there's a rollout plan. So we've done our soft launch sites, we're getting those installed, they're doing cases, and there'll be a cadence from there that we start to roll out the robots. We know what our double-digit orders are. We know how they're going to ship. The key thing is since it's a new product getting it out there and I've said before this is a really important launch for us. So, we want to make sure that we don't miss anything. So we want to make sure that the training is there for the hospital staff. So our staff will be there to get them on board. But we have basically a launch timeline. As we continue to get new orders, once we work through the backlog, we'll begin to sell those or ship those as well. But to me, by the time we work through the backlog into the third quarter and probably a little bit into the fourth quarter.

Dan Scavilla, CEO

And I'll just build on that, Jason too, is to-date because these are sensitive pieces of equipment but they have shipped well. They've been received well and they've been installed with minimal efforts so far. So we're pleased with the ability to get them up and running. I would second what Keith said; it's more about the training and getting used to it as opposed to actually getting the piece of capital functioning.

Richard Newitter, Analyst

Hi, thanks for taking the question. To start with margins, Dan, you've suggested that during investment periods your EBITDA margin could go as low as the low 30s or 32%, and in flex or payoff periods, it might trend in the 37% to 38% range. I'm trying to understand the 32% EBITDA margin. Would you say this is more aligned with the discretionary investment period? Now that we have one of your key products launching, can we expect to see a payoff and move towards the mid or even upper 30s in the upcoming quarters?

Dan Scavilla, CEO

Rich, I do. Again, I think what I was signaling when I opened up with my script is even with the lighter sales that we had against tougher headwinds, we did not step back and are spending our investment in R&D people, recruiting, etc. And so to your point, what we've called out through the years this is the right example of that where we continue to invest for the long term and are willing to take these lower EBITDA. I think as the volumes pick up, it will naturally lift. And so, I feel comfortable with what Keith has been saying, that we will remain focused in the mid-30s.

Keith Pfeil, CFO

Yes. And just to add on to what Dan said, 33% to 37% is the range that's been talked about in the past. Sitting here today coming in with 32.2%, this will obviously be at the lower end of that. But as I sit here and look out at the rest of the year, I'm still confident that we're in mid-30s EBITDA business. This quarter was a little bit light from an EBITDA perspective. But again, we talked about increasing our investment in R&D, and we did that. I called out some things in gross profit that we saw. But the thing that I wanted to raise there is that, I did make a comment on inflation on raw material inflation and it is really immaterial to the bigger picture. So that to me is an important message to get out there because as I look up and down our P&L that mid-70s gross profit is very important to us because that's going to help drive profitability for the rest of the business.

Richard Newitter, Analyst

Thanks for the color there. And just one on the environment the spine market in the US. So, you guys were pretty outsized share gainers in the spine market throughout most of last year. It appears that you guys got impacted along with the rest of the spine market. But even relative to some other players that also had tough comps smaller than you granted, you grew a little bit slower than maybe even some of them. So, I guess I just want to get a feel for what you're seeing that drove your performance back up to a record March. Do you feel like that's just some delayed recapture of procedures for the underlying market, or is that something that's specific to your business, where you're back into the share gain mode that maybe you had been in previously, or is it some combination? I'd love to just hear some commentary on March and April trends. Thanks.

Dan Scavilla, CEO

Yeah. Thanks, Rich. I would think for sure there's some recapture of a slower January and February that's come into March and April. I think that would be logical, very difficult for us to quantify, but it's an assumption I would go with. I would also tell you that competitive rep recruiting, which was decent in the first quarter, bared fruit in both those March and April months as well and we'll continue to do so. And I think as well we've seen through the news a drop in concerns or cases of COVID, which I think opened up some of those surgeries. So I think it's a combination of those things mainly in the March and April timeframe.

Vik Chopra, Analyst

Hey. Good afternoon, and thanks for taking the questions. I guess one, Dan, you had touched on new product launches. I'm just kind of wondering which ones beside the imaging system will be most impactful to growth this year. And just remind us what the growth contribution of new products is to total growth. And I have one follow-up after that. Thank you.

Dan Scavilla, CEO

Okay. So Vik, we don't actually break out obviously product contribution. Certainly, 3D imaging is a major plan that we had to get out there and I think that will be one of the main drivers. I would tell you that we do have plans for upward of 10-plus Spine launches just for this year. And as I said, Trauma quite frankly has got a great portfolio that they plan to roll out through the second half of the year. All of those have been factored in as main drivers for us to not only meet, but possibly exceed, as we get through the rest of this year.

Vik Chopra, Analyst

Okay. Great. And then my follow-up is on your international business. We just love to gauge your confidence on your international business, how should we think about the contribution from Japan this year? And do you still see a pathway to recovery in the back half of the year and return to that mid-teens growth in your international business? Thank you.

Dan Scavilla, CEO

Thanks. So I would tell you that with Japan, and I had gone deep with this. Again, I feel very confident as to the plan we have in place, who we're recruiting, the surgeon interest, and actually the sales force replenishment, all of those things are very strong. I think we still have to work through account access and that's why I'm saying that, it would possibly go out and begin neutralizing in the fourth quarter. I don't anticipate Japan being a contributor, when it comes into the rest of this year so much as a reset and stronger growth, as we get into next year. That's really it. On the rest of the world, again we had some really good results and some fairly significant COVID headwinds. People will tell you that in Australia, the government paid hospitals not to do surgeries. There's different areas like that that once I look at our internal estimates of those impacts and what it could have been without, I feel very bullish that rest of the world will be a decent contributor for us in the second half of the year without any significant COVID resurgence.

Operator, Operator

And we have no further questions at this time. And with that, thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.