Business context and reporting period
Globus Medical, Inc. designs and sells medical devices focused primarily on spine disorders. This Form 10-K covers the fiscal year ended December 31, 2016; it also reports fourth-quarter results. The company had launched more than 170 products and sold in the U.S. and 49 countries internationally. In September 2016, it acquired Alphatec’s international operations and distribution channels, expanding international reach.
Financial performance and liquidity
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Sales | $564.0 million | $544.8 million |
| Gross profit / margin | $429.3 million / 76.1% | $412.4 million / 75.7% |
| Operating income / margin | $154.1 million / 27.3% | $172.2 million / 31.6% |
| Net income / diluted EPS | $104.3 million / $1.08 | $112.8 million / $1.17 |
| Operating cash flow | $171.9 million | $122.0 million |
| Free cash flow (non-GAAP) | $105.3 million | $73.9 million |
Sales grew 3.5% reported and 3.8% at constant currency. Disruptive Technology sales rose 7.7% to $276.4 million, while Innovative Fusion sales were nearly flat at $287.6 million. U.S. sales grew 0.4% to $500.2 million; international sales rose 37.0% to $63.8 million, largely reflecting the Alphatec acquisition. The acquired business contributed $18.6 million of sales from acquisition through year-end and reported break-even earnings.
Cost of goods sold was 23.9% of sales versus 24.3%; operating expenses increased 14.6% to $275.1 million, including R&D of $44.5 million, up 22.6%. Cash, cash equivalents and marketable securities totaled $350.8 million; working capital was $433.9 million. There were no borrowings under the $50 million revolving facility at year-end. The facility was scheduled to expire in May 2017. The company also had a $30 million senior secured note receivable from Alphatec borrowers, with a five-year scheduled maturity.
Fourth-quarter 2016 sales were $151.6 million versus $142.6 million a year earlier; net income was $24.3 million versus $37.6 million. The filing attributes a one-time net income benefit of approximately $7.6 million to the DePuy Synthes settlement in fourth-quarter 2015.
Material changes versus prior period
- Annual sales growth slowed to 3.5% from 14.8% in 2015. Disruptive Technology remained the principal growth category; U.S. sales were nearly unchanged, while international growth was substantially acquisition-driven.
- Operating income declined 10.5% and net income declined 7.5%, despite higher sales and gross margin. Higher R&D, SG&A, amortization and litigation costs contributed; 2015 also included a litigation benefit associated with the DePuy Synthes settlement.
- Operating cash flow rose to $171.9 million, partly reflecting recovery of restricted cash related to the DePuy Synthes settlement and lower working-capital and tax cash outflows. Investing cash outflow included the $80.1 million Alphatec transaction and a $30 million loan to Alphatec.
- The company recorded a $1.8 million net cumulative prior-period cost-of-goods-sold adjustment in 2016, including a $5.5 million pre-tax increase in depreciation and a $3.7 million decrease in scrap and inventory provisions. Management said it was not material to prior years or 2016.
Outlook, risks and unusual items
Management expected to launch approximately five to ten new products annually over the next three years and cited more than 30 products in development. It was building U.S. and international sales teams for robotics and orthopedic trauma offerings. Excelsius GPS received a European CE mark in January 2017 but was not cleared for U.S. sale; trauma products were also not yet FDA-cleared or CE-marked. No specific revenue or earnings guidance was provided.
Key risks include intense competition and pricing pressure, reimbursement restrictions, dependence on surgeons and sales representatives for adoption, reliance on third-party suppliers, product-development and regulatory delays, international expansion and foreign-exchange exposure, and litigation and product-liability claims. The company reported an ongoing Bianco judgment requiring a 5% royalty on specified product sales for 15 years beginning in 2014. Other patent matters included a favorable jury verdict in the Flexuspine case that was under appeal, and a Stern patent suit with outcome and potential loss not estimable. The company recorded $3.2 million of litigation provision in 2016.
Management and the auditor identified a material weakness in controls over depreciation and scrap expense for instruments and cases. Management concluded internal controls over financial reporting and disclosure controls were ineffective at year-end; the auditor issued an adverse opinion on internal controls but an unqualified opinion on the financial statements. Management planned remediation during 2017 and stated that additional procedures found no material financial-statement errors requiring restatement. The company also noted the medical device excise tax suspension was scheduled to end after 2017 absent further legislative action.
Important facts for investors to verify
- Whether the internal-control material weakness was remediated and independently tested as planned.
- How much future growth is organic versus attributable to Alphatec, and the acquired operation’s ongoing profitability and integration costs.
- Regulatory clearance, launch timing, adoption and investment requirements for Excelsius GPS and orthopedic trauma products.
- Developments in the Bianco royalty obligation and other legal proceedings, including potential cash or earnings effects.
- Renewal or replacement of the revolving credit facility, and the collectability and terms of the $30 million Alphatec note receivable.
- The effect of the scheduled 2018 medical device excise tax reinstatement, reimbursement changes and pricing pressure on margins.