Earnings Call Transcript - GMED Q3 2022

Operator, Operator

Welcome to Globus Medical’s Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I will now turn the call over to Brian Kearns, Senior Vice President of Business Development and Investor Relations. Mr. Kearns, please go ahead.

Brian Kearns, Senior Vice President of Business Development and Investor Relations

Thank you, Stacey, and thank you, everyone, for being with us today. Joining today’s call from Globus Medical will be Dan Scavilla, President and CEO; 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 at www.globusmedical.com. 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 will now turn the call over to Dan Scavilla, our President and CEO.

Dan Scavilla, President and CEO

Thanks, Brian, and good afternoon, everyone. We achieved a strong third quarter with growth throughout our business delivering sales of $254 million, an 11% increase as reported or 13% in constant currency growth, with non-GAAP EPS of $0.50, including significant non-operational headwinds for currency and tax rate that Keith will discuss later in the call. US Spine had a great quarter with 9% growth and notable gains across our product portfolio in expandables, 3D printed implants, cervical and lateral offerings, biologics, and pedicle screws. The gains are driven by competitive representative conversions and robotic pull-through. Our competitive representative recruiting is tracking ahead of the prior year and as we enter Q4, the strong recruiting pipeline should lead to a record recruiting year, setting the stage for meaningful growth in 2023. I’m pleased with the growth acceleration delivered by the US team. Enabling technology sales are $24 million, up 20% on a constant currency basis versus the prior year, driven by robotic and imaging system sales. We’re seeing increased interest in placements, both domestically and internationally. This was our highest Q3 since launching Enabling Tech, surpassing last year’s Q3 sales that delivered 124% growth post-COVID. Robotic procedures continue to accelerate, growing 48% versus the prior year and exceeding approximately 40,000 robotic procedures performed to date. The Excelsius3D Imaging System rollout is going well as we continue to penetrate the market and increase orders for future deliveries. Entering Q4, our pipeline is strong for both robots and imaging systems. ExcelsiusGPS and Excelsius3D are two foundational pieces of the digital ecosystem we have been talking about, designed and built from the ground up to communicate seamlessly between each component and surgeon in the operating room. The system provides an unmatched clinical experience for the surgeons. The successful rollout and market acceptance of ExcelsiusGPS and Excelsius3D validate our direction and strategy. We’re making significant progress developing other components of the ecosystem with plans to enhance our offering over the next several quarters to fulfill our goal of changing the way musculoskeletal surgery is performed. On the international front, our spinal implant business delivered record sales in Q3, growing 25% on a constant currency basis compared to the prior year. We deliver double-digit growth in most markets, including the UK, Australia, Brazil, India, and Poland, where growth rates continue to exceed 40% for each market. I remain impressed with our international team’s performance and the potential of our international business to contribute to our long-term growth. Our trauma business delivered another record sales quarter, growing 83% versus the prior year, and 20% sequentially versus Q2 ‘22. Trauma performance is driven by sales force expansion and strong uptake in all 14 product lines, delivering high double-digit growth in each product offering. In Q4, we have two meaningful launches planned to further strengthen our offerings that will fuel continued growth. Our recruiting pipeline is strong entering into Q4. As I mentioned last quarter, despite facing supply chain challenges, we’ve been able to offset vendor delivery delays and supply shortages without significant impact to sales. To remediate the extended vendor lead times, we’ve altered our ordering pattern to increase inventory levels. The electronic component market remains difficult but has been offset so far by our nimble procurement team. In addition to these disruptions, freight surcharges continue to impact our cost of goods. We will continue to seek offsets to mitigate these challenges. Our product development engine continues to make progress, focusing on procedural solutions, designing implants, instrumentation, and procedures that will function together with our Globus Ecosystem for a seamless and comprehensive approach in spine, trauma, and joints. At the same time, we are expanding our solutions to cover the comprehensive continuum of care, supporting surgeons in preoperative planning, intraoperative execution, and postoperative patient care, capturing outcome data that can be used to enhance future surgical planning. While this complex approach has extended development timelines beyond our historical rapid pace, I believe the upcoming launches will have greater significance in shaping procedures of the future. In addition, we have increased our investment in supply chain to boost output, streamline manufacturing, and enhance production capacity, supporting our continued growth. As we move into the final quarter of 2022, we remain focused on three core elements for long-term growth: innovative new product introductions, robot and imaging system sales, and competitive representative recruiting. I’m pleased with the Q3 results throughout the business with high single-digit growth in US Spine, strong performance from Enabling Tech, record international and trauma sales, and meaningful progress in bringing the ecosystem and procedural solutions closer to reality. Q4 is all about focus and execution to deliver value to our customers and drive growth. I know we are 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, Senior Vice President and Chief Financial Officer

Thanks, Dan, and good afternoon, everyone. Globus delivered a strong third quarter with significant sales growth across its portfolio, reflecting our continued ability to take share in our markets. It remains a testament to our drive, focus, and continued investment in our people and products. Third quarter revenue was $254.1 million, growing 10.6% as reported and 12.6% on a constant currency basis compared to Q3 of 2021. Q3 net income was $47.4 million, essentially flat to the prior year quarter. Non-GAAP net income was $50.3 million compared to $52.7 million in the prior year quarter, delivering $0.50 of fully diluted non-GAAP earnings per share flat to the prior year. Our Q3 results include $0.07 of non-operating headwinds driven by a higher tax rate and currency, partially offset by higher investment income and a lower share count. Adjusted EBITDA was 32.6% and includes a 1.7% unfavorable currency impact in the quarter. During the quarter, we generated $20.9 million of free cash flow. Moving into sales, our third quarter US revenue was $217 million, growing 9.5% versus the third quarter of 2021, led mainly by US Spine. Dan’s earlier comments provided insights into the drivers of growth. To help further put that into context, our US Spine business has grown 26.1% over the trailing four quarters compared to the full year 2019. This longer-term growth figure is an important call out given the quarterly COVID impacts we’ve seen over the past few years and underscores our continued confidence in our US Spine business. International revenue for the third quarter was $37.1 million, growing 17.7% as reported or 31.8% on a constant currency basis. Strong growth was seen across our Spinal Implant portfolio, as Dan mentioned earlier, in addition to this implant growth, we’ve continued to see solid gains with ExcelsiusGPS sales growing internationally, mainly in Western Europe. Gross profit in the third quarter was 74.2% compared to 74.5% in Q3 of 2021. The slight decline in gross profit was driven by product mix, continued freight inflation, as well as non-operational currency impacts, partially offset by lower inventory reserves and improved operational spending efficiencies. We estimate inflation had a roughly 50 basis point impact on the quarter between freight surcharges and higher material costs. Q3 research and development expenses were $18.7 million or 7.4% of sales versus $15.9 million or 6.9% of sales in Q3 of 2021. The increased spending is predominantly focused on our US Spine and Enabling Technologies businesses and is in line with expectations. These increases are driven by overall headcount growth as we realign and further invest in our product development engine to focus on procedural solutions and expand the Globus Ecosystem. SG&A expenses for the third quarter are $106.6 million or 41.9% of sales compared to $96.4 million or 42% of sales in the third quarter of 2021. The increased spending is reflective of higher sales and marketing expenses driven by higher sales volumes as well as increased travel and meeting expenses offset by fixed cost leverage. We continue to take a focused approach to managing our SG&A cost structure in a way that delivers against our needs while working to minimize negative inflationary impacts. The effective income tax rate for the third quarter was 22.8% compared to 13.3% in the prior year quarter. The increased tax rate was primarily the result of lower tax benefits associated with stock option exercises. Given this lower tax benefit, we are now projecting a full year tax rate ranging between 22.5% and 23%. Our cash, cash equivalents, and marketable securities were $909.3 million at the conclusion of Q3. Net cash provided by operating activities was $32.9 million, and free cash flow was $20.9 million as noted earlier. Year-to-date, free cash flow was $58.8 million, reflecting our continued investments in inventory, as well as machinery and equipment to further facilitate our ability to drive growth into the future. At this time, the company is reaffirming its 2022 net sales guidance of $1.025 billion, however, as a result of continued non-operating headwinds, we’re revising our non-GAAP EPS guidance to $2.03 per fully diluted share versus the previous $2.10. This reflects an additional $0.05 currency headwind and a $0.02 tax headwind versus our previous non-GAAP EPS guidance. Our third quarter results delivered strong top line performance across the business. Spine realized strong growth in the US and international, trauma continued on its path of above-market growth, and our Enabling Technologies business demonstrated resilience in delivering its new and exciting technologies to the market. Though we did experience more non-operating headwinds than previously expected, the business continues to deliver on its strong earnings quality, as evidenced in our profitability, while maintaining discipline in our approach to costs and expenses, all while investing aggressively in R&D to drive continued future growth. We look to continue to drive execution as we seek to close a strong fourth quarter and build momentum going into 2023. As always, thank you to the Globus team for their continued pursuit of excellence. The best is yet to come. We’ll now open the call for questions.

Operator, Operator

Thank you. At this time, we will conduct a question-and-answer session. Our first question is coming from Matt Miksic of Barclays. Matt, please go ahead with your question.

Matt Miksic, Analyst

Hey, good evening. Thanks so much for taking our questions. Congrats on a really strong top line quarter here. So one follow-up if I could. Just some of the drivers you mentioned, Dan, in the quarter, particularly expandables and 3D printed and competitive rep recruiting. Just if you could maybe update us on sort of how the mix of expandables and 3D printed has been driving the business? What’s been driving that in terms of demand? And what does that do to margin mix? And then just the obvious question, given the sort of merger and acquisition activity in the space, how, if at all, do you expect that to create new opportunities in recruiting?

Dan Scavilla, President and CEO

Thanks, Matt. I appreciate the question. A couple of things. I’m signaling that the growth is really throughout the portfolio. You’re right, I mentioned expandables and 3D printed implants, but also the cervical lateral offerings, the biologics, and the pedicle screws are showing healthy growth. It’s not just one product outgrowing the others. With that, though, I would tell you that the uptake of 3D printed has been great and stable itself; the expandables are really doing well. So I’m pleased with it; those drivers go beyond just existing and dedicated surgeons using us, which again, is facilitated by competitive rep recruiting, helping us penetrate the market. And as we’ve always stated, once we deploy robots, the pull-through from those robots significantly increases our volume. So it’s really a healthy portfolio, and I’m pleased with the growth mix among the products. With recent changes that are occurring in the market, certainly anytime there’s a market of uncertainty, it may make some folks jittery. However, if anything, Globus is viewed as a stable growth, high-investment place, where representatives would want to be. We’ll look at that opportunity. I’m not sure we’ve seen anything significant right now, but we’ll keep our eyes open. Regardless of the source, our goal is to continue penetrating the market, converting surgeons and representatives, regardless of where they currently are.

Matt Miksic, Analyst

And one for Keith, if I could just on margins. You’re not as global as some of the larger MedTech companies in the space that have all been impacted by some of the factors you mentioned, FX in particular. Can you talk a little bit about how we should expect that to carry over into next year? Maybe what some of the math is dropping through the P&L, on FX, given that that was part of the reason for the slight missed expectations and the guide down on the bottom line?

Keith Pfeil, Senior Vice President and Chief Financial Officer

Sure. Thanks for the question. As we go into next year, I think it’s fair to assume that our international business will continue to grow faster than our US business. We are primarily US, but over time, our international business is going to continue to grow. When I look at this year regarding currency impacts, I talked last quarter about having about a $0.09 currency impact, but we were able to offset that with the share buyback and some higher interest income. In Q3 alone, our currency impact was greater than what we experienced in the first two quarters. The guidance change from $2.10 to $2.03, with $0.05 of that being due to higher currency impacts versus what we previously expected.

Matt Miksic, Analyst

That’s helpful. Thanks a lot, Keith.

Operator, Operator

Our next question is coming from Vik Chopra of Wells Fargo. Vic, you can go ahead with your question.

Vik Chopra, Analyst

Hey, good afternoon and thanks so much for taking the question. Two for me. First one on capital equipment. Just wondering what you guys are hearing on how hospitals are thinking about their capital budgets for Q4? And any sort of color you can provide and expectations for next year? And then my follow-up question is on 2023, not asking for guidance, but any sort of potential headwinds and tailwinds we should sort of be cognizant of as we head into next year? Thanks so much.

Dan Scavilla, President and CEO

Thanks. I think hospitals are still under some level of pressure, whether it be staffing or paying for traveling, the thought of recession, and different factors. So I would just tell you that the selling cycle is probably returning to what it was pre-COVID, taking about 9 to 12 months. We haven’t seen any meaningful stops or hesitations yet. It’s hard to predict Q4; we are sitting at election night, and things could always change in one way or another. So there’s some uncertainty out there, but nothing concerning for us. I don’t think it will reflect in our guidance as we round out the year. I’ll let Keith respond regarding 2023, but I think we’ll be in a better position to discuss that in January during the guidance call. Right now, I don’t see anything significant that I would want to highlight for investors.

Keith Pfeil, Senior Vice President and Chief Financial Officer

Just a couple of comments I’d add are from my earlier prepared remarks. I discussed the third quarter delivering a strong top line performance across our portfolio. Looking ahead, we feel good about our business. That’s what that statement was intended to imply. We feel confident in our trajectory, whether it’s musculoskeletal or Enabling Tech. As I think about possible headwinds or tailwinds going down the P&L, we will keep monitoring currency impacts – which are non-operating – as well as the impact of inflation, which is a real concern. As time passes, the fuel surcharges may change, but I don’t have further comments specific to 2023 at this time.

Operator, Operator

Our next question is from Shagun Singh with RBC. Please go ahead.

Shagun Singh, Analyst

Thank you so much for taking the question. Dan, I was just wondering if you could elaborate on the Recon robotic launch, especially about timing; you know, soft versus a full launch in ‘23? What will be unique about it, the value proposition? How should we think about the economics? And really, what I'm trying to get at is, you know, you talked about the best is yet to come. And I’m wondering how significant this launch could be in helping you drive an inflection in sales in ‘23.

Dan Scavilla, President and CEO

Thanks again. I appreciate the question. The timeline for 2023 is difficult to confirm without the FDA filing and approval. Our goal is to have that later in the year, but I lack a clear timeline whether that’s Q3 or Q4. I’m excited about what we bring forward, and I think there’s meaningful differentiation that will help us penetrate this market with a viable solution. But I’ll stop there; we’ll have deeper conversations later in 2023.

Shagun Singh, Analyst

Got it. That’s helpful. And then I was just wondering if you could elaborate on the enhancements or additional components that you expect to add to the Excelsius platform to maintain and probably enhance your competitiveness. Any timing you can share there? Thank you for taking the questions.

Dan Scavilla, President and CEO

We continue to evolve and add to the Excelsius platform. The closest addition to differentiate will likely be our XR headset or Augmented Reality. This is going to change how procedures are performed and add significant value for surgeons. That is the most significant addition we are looking toward right now.

Operator, Operator

Our next question is from Richard Newitter with Truist. Richard, please go ahead with your question.

Richard Newitter, Analyst

Hi, thanks for taking the questions. Just a couple from me, maybe on your US Spine growth rate; we accelerated nicely back towards 9%. You’ve been in double digits for years leading into COVID and through COVID. Obviously, there’s some distortions. That 20% growth rate you mentioned, thank you for that. But how should we think of the go forward? What is the normalized kind of for US Spine growth rate for Globus? Are we expecting any acceleration?

Keith Pfeil, Senior Vice President and Chief Financial Officer

Thanks for the question. Looking ahead, from a US Spine perspective, we still have a lot of growth potential. We know that our number overall is getting larger. Dan mentioned competitive rep recruiting, the pull-through from robotics, and the building of the ecosystem. From my perspective, we should anticipate a high single-digit growth rate as we move forward in the US Spine market. We feel confident about where the business is and where it’s heading.

Dan Scavilla, President and CEO

I’d add to that, Richard, that we’re approximately a 9% share in the US, giving us a lot of room to grow. This growth hinges on meaningful solutions addressing unmet clinical needs. So our focus remains on developing the right products that facilitate this growth. In the near future, I would suggest aiming for a mid-to-high single-digit growth in the US.

Richard Newitter, Analyst

Okay, thanks. What about the split between imaging and robots? Is there any way you can give us a sense of whether your robotic component grew year-over-year in the third quarter? Just trying to get a sense of what’s driving that. Thanks.

Dan Scavilla, President and CEO

For competitive reasons, I can’t go into specific splits at this time. I’m very pleased with our Enabling Technology growth, both in robots and imaging, but splitting that out is something I have to refrain from doing.

Richard Newitter, Analyst

Okay, thanks. If I could do one more, how do you view operating leverage going forward, and where is your target EBITDA margin, especially with some of the non-operating items affecting the P&L? Thanks.

Keith Pfeil, Senior Vice President and Chief Financial Officer

From an SG&A perspective, we anticipate 1 to 2 points of fixed costs leverage as we go forward. The efficiency improvements should help drive the business without incurring significant additional costs. We expect leverage to land between 1 to 1.5 points.

Operator, Operator

Our next question comes from Matt O’Brien with Piper Sandler. Matt, you have the floor.

Matt O’Brien, Analyst

Okay, thanks for the question. If I look at Globus pre-pandemic, you were kind of high single-digit, low double-digit top-line growers; we are guiding this year to 7%. You've got all this robotic tailwind, cross-pull-through, trauma, and the quickening international business. So as I look at the straight numbers for next year at 9%, it’s back to that pre-pandemic level. Should we expect Globus to perform at that pre-pandemic growth level over the next several years, high singles to low doubles?

Keith Pfeil, Senior Vice President and Chief Financial Officer

Yes, as we approach the business, I lean on what Dan and I have discussed. We are performing well across our portfolio, and we feel we have strong products on the way. Short answer is yes; we feel optimistic about our portfolio. While it’s unlikely everything will align perfectly at the same time, looking ahead, I believe we have strong prospects without going into guidance for next year.

Dan Scavilla, President and CEO

I second that sentiment. Comparing 2021 to 2022 is imperfect due to the post-COVID effects. We expect a return to normal, assuming no new pandemic disruptions, and we hope for 2023 to reflect that.

Matt O’Brien, Analyst

I appreciate that. Then, over the past seven quarters, if I figure together the Enabling Tech revenue versus the previous 13 quarters, there seems to be a similar amount. Are there approximately 300 Excelsius systems out in the field? You’ve mentioned a lot of pull-through revenue; shouldn't we anticipate substantial pull-through revenue in ‘23 and ‘24 from what we've seen the last two years?

Dan Scavilla, President and CEO

We won’t disclose the exact number of placements; I’ll leave that for your estimates. The pull-through we’ve experienced with robots is a significant factor in our growth outpacing the market. Pricing the Spine market at roughly 3% growth and for us to outpace that 2 to 2.5 times is dependent on the pull-through effect as well as competitive convergence.

Operator, Operator

Our next question comes from David Saxon with Needham and Company. David, go ahead with your question.

David Saxon, Analyst

Yeah. Good afternoon, and thanks for taking the questions. I wanted to ask about the cellcast portfolio. If you could just give an update on how that product line is going? Is it competitive when the robot launches? Or is there still more work to do to get products to market?

Dan Scavilla, President and CEO

There’s more work to do to get the cellcast products to market. While we have a strong primary cemented knee, we still need to move into cementless knees, update vision systems, and other aspects. These updates are in progress but need to be completed. We anticipate next year will be more about filing and getting FDA approval for the robot, starting placements that will allow pull-through.

David Saxon, Analyst

Got it. Thanks. And then on the international business, I didn’t hear you mention anything about the commercial team in Japan, which has been an issue for a while. Can you provide an update on that market and whether the team is on the right track now? Thanks so much.

Dan Scavilla, President and CEO

I appreciate you pointing that out. The team is stabilizing in Japan, as we anticipated exiting Q3. I plan to keep an eye on that. I believe their performance will be fairly neutral in Q4. The real story will be in 2023 as we better assess the performance. However, the change wasn't significant enough in Q3 compared to the prior year for me to call it out.

Operator, Operator

This question comes from Caitlin Cronin of Canaccord Genuity. Caitlin, go ahead with your question.

Kyle Rose, Analyst

Hi, this is actually Kyle on for Caitlin. Can you hear me all right?

Dan Scavilla, President and CEO

We can hear you, Kyle.

Kyle Rose, Analyst

Hi, everybody. Just wanted to get an updated thought on, you know, I appreciate the pipeline commentary about going back to a pre-COVID type pipeline on the capital side. Can you understand what you’re seeing from ordering demand when considering new customers from a multisystem placement perspective? And I’ll also throw in another one regarding capital allocation updates. How do you see the market currently, and how should we think about capital deployment moving forward?

Dan Scavilla, President and CEO

We have had several deals where both the ExcelsiusGPS and Excelsius3D have been placed in hospitals or hospital systems, and we’re pleased with that. They’re designed to work seamlessly together. While it’s hard to give specifics, we’re focused on placements, and I can confirm multiple units have been placed along with robots. On capital allocation, are you referring to hospitals or us as Globus?

Kyle Rose, Analyst

Just speaking on Globus regarding capital deployment concerning the balance sheet strength and any potential M&A buybacks, or similar initiatives.

Keith Pfeil, Senior Vice President and Chief Financial Officer

I can address that. Capital allocation remains focused on acquisitions, whether small tuck-ins or larger purchases to complement our portfolio. That remains our first priority. Secondarily, we will continue to invest in our business through R&D or expanding our supply chain. As we grow our business, we drive vertical integration, so expect to see spending in those areas. We have roughly $150 million left on our share repurchase authorization. We did not repurchase any shares during the quarter, but that remains our order of priority.

Kyle Rose, Analyst

Thank you very much.

Keith Pfeil, Senior Vice President and Chief Financial Officer

Thank you.

Operator, Operator

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