Globus Medical, Inc. — Q2 2017 Form 10-Q
Business context and period. Globus Medical designs and commercializes musculoskeletal, primarily spine, medical devices. This unaudited report covers the quarter and six months ended June 30, 2017, compared with the corresponding 2016 periods. Globus reported one operating segment.
Financial performance
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Sales | $152.4 million | $137.5 million | $308.2 million | $276.8 million |
| Gross profit | $115.2 million | $104.8 million | $235.4 million | $212.5 million |
| Gross margin | 75.6% | 76.2% | 76.4% | 76.8% |
| Operating income | $37.4 million | $37.9 million | $77.7 million | $80.8 million |
| Net income | $28.7 million | $25.8 million | $57.4 million | $53.8 million |
| Diluted EPS | $0.29 | $0.27 | $0.59 | $0.56 |
| Operating cash flow | — | — | $79.4 million | $78.8 million |
Q2 operating margin was 24.5% versus 27.6% a year earlier; six-month operating margin was 25.2% versus 29.2%. Net margin was 18.8% in Q2 (18.8% prior year) and 18.6% for the six months (19.4% prior year). Six-month capital expenditures were $25.1 million; company-defined free cash flow was $54.4 million versus $43.8 million. Adjusted EBITDA was $53.4 million for Q2 and $111.3 million for the six months; these are non-GAAP measures.
At June 30, cash and cash equivalents were $149.7 million and marketable securities totaled $223.5 million, for combined cash, equivalents and securities of $373.1 million. Working capital was $466.1 million. There were no borrowings on the $50 million revolving facility, which was fully available; Globus said it was in compliance with its covenants. The company also held a $30 million secured note receivable from Alphatec borrowers. Total liabilities were $89.7 million; equity was $905.3 million.
Material changes and management commentary
- Sales increased 10.8% in Q2 and 11.4% for the six months. International sales rose 104.5% in Q2 and 113.5% year to date, largely reflecting the Alphatec International acquisition; U.S. sales grew 1.2% and 1.4%, respectively. Company-reported constant-currency worldwide growth was 11.0% for Q2 and 11.6% year to date.
- Innovative Fusion sales grew 15.0% in Q2 and 16.0% year to date; Disruptive Technology sales grew 6.6% and 6.7%. Management cited Alphatec-related international sales, market penetration, and sales of newer expandable interbody, minimally invasive, and regenerative biologics products. Pricing pressure partly offset growth.
- SG&A increased 20.9% in Q2 and 22.8% year to date, principally from supporting Alphatec International, expanding the Emerging Technologies and U.S. sales forces, and higher compensation and other costs. Cost of goods sold grew faster than sales, and gross margin declined.
- Globus acquired Swiss robotic developer KB Medical on June 13 for approximately $31.5 million cash, plus potential milestone consideration. The acquisition added approximately $5.4 million of goodwill; purchase accounting remained preliminary. Management expected to begin selling robotic and orthopedic trauma products later in 2017. These products were still in development and had not been cleared by the FDA for sale.
- The company said existing liquidity should meet foreseeable needs, while noting possible future funding needs for working capital, R&D, capital spending, sales-force expansion, international growth, and acquisitions. No formal financial guidance was provided in the filing.
Risks, contingencies and unusual items
- Management identified risks including pricing and competitive pressure, reimbursement changes, product-development and regulatory challenges, integration and benefit realization from Alphatec, and litigation outcomes.
- The Bianco matter includes a court-awarded 5% ongoing royalty on specified products and products not colorably different, for 15 years on sales beginning January 18, 2014. Globus said it did not expect the judgment to materially affect future revenues or its ability to operate. Other proceedings include the L5 damages litigation, a Flexuspine appeal after a defense verdict, and an appeal in the dismissed Silverstein securities action. The filing cautions that litigation costs could materially affect earnings, financial position, or cash flows.
- Disclosure controls and procedures were deemed ineffective as of June 30, 2017, due to an unremediated material weakness involving calculation of non-cash depreciation and scrap expense for instruments and cases. Management expected remediation before year-end 2017, subject to testing.
- The Q2 effective tax rate fell to 27.5% from 32.7%; the six-month rate fell to 30.0% from 34.3%. Management attributed the change mainly to historical foreign tax credits and adoption of stock-compensation accounting guidance; the prior-year six-month rate also reflected a one-time domestic legal-structure reorganization charge.
Important facts for investors to verify
- How much reported international growth reflects Alphatec acquisition contributions versus underlying growth, and whether integration and customer transitions meet management expectations.
- Whether sales growth can offset rising SG&A and pressure on gross and operating margins; assess U.S. growth separately from international performance.
- Timing, regulatory clearance, commercialization, and investment needs for robotic navigation and orthopedic trauma products.
- Final KB Medical purchase-price allocation and potential milestone payments; also monitor the $30 million Alphatec note’s repayment and credit status.
- Developments in material litigation, the Bianco royalty obligation, and remediation and validation of the internal-control material weakness.