Globus Medical, Inc. — Q3 2014 Form 10-Q
Business and period: Globus Medical designs, develops and sells musculoskeletal implants, primarily for spine procedures. This unaudited filing covers the three and nine months ended September 30, 2014, compared with the corresponding 2013 periods. Unless indicated otherwise, dollar amounts below are in millions.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Sales | $117.8 | $107.2 | $345.6 | $319.2 |
| Gross profit | $90.1 | $81.9 | $266.0 | $245.6 |
| Gross margin | 76.5% | 76.4% | 77.0% | 77.0% |
| Operating income | $34.9 | $29.5 | $98.7 | $69.9 |
| Operating margin | 29.6% | 27.5% | 28.6% | 21.9% |
| Net income | $23.1 | $20.3 | $64.8 | $47.6 |
| Diluted EPS | $0.24 | $0.22 | $0.68 | $0.51 |
- Sales growth: Sales increased 9.9% in Q3 and 8.3% for the nine-month period. U.S. sales rose 8.7% and 6.0%, respectively; international sales rose 23.2% and 33.3%. Management attributed growth to new and existing territory expansion, penetration gains, and product launches. Both Innovative Fusion and Disruptive Technology sales increased.
- Costs and margins: Q3 cost of goods sold was 23.5% of sales versus 23.6% a year earlier. Nine-month R&D rose 13.8% to $23.3 million, while SG&A rose 2.4% to $140.1 million; SG&A declined as a share of sales to 40.5% from 42.9%.
- Cash flow: Nine-month operating cash flow was $77.2 million, compared with $60.8 million. Capital expenditures were $15.7 million, yielding company-defined free cash flow of $61.6 million versus $42.3 million.
- Liquidity and debt: At September 30, cash and cash equivalents were $169.4 million and marketable securities totaled $176.3 million, for combined liquidity of $345.8 million. Working capital was $412.1 million. No borrowings were outstanding under the $50 million revolving credit facility; the full amount was available, and the company reported compliance with its covenants. Total liabilities were $92.6 million, including acquisition-related liabilities.
- Other measures: Company-defined Adjusted EBITDA was $42.0 million in Q3 and $124.2 million for nine months, compared with $35.8 million and $107.6 million. These are non-GAAP measures and exclude, among other items, litigation provisions.
Material changes and unusual items
- Nine-month GAAP operating income and net income rose substantially, while litigation expense fell: the 2013 comparison included an $18.2 million DePuy Synthes litigation charge; 2014 included $3.9 million of litigation provision. Nine-month diluted EPS excluding litigation provisions, a company-defined non-GAAP measure, was $0.71 versus $0.64.
- On October 23, 2014, after quarter-end, Globus acquired Transplant Technologies of Texas for $35 million cash, with possible working-capital adjustments and milestone payments up to $15 million. The acquisition expands its biologics and allograft tissue business.
- Cash and marketable securities increased $70.3 million from year-end, primarily reflecting operating cash generation and investment activity. Nine-month investing cash flow was a net outflow of $8.6 million, versus $181.2 million in 2013, when securities purchases substantially exceeded maturities and sales.
Outlook, risks, and contingencies
- The filing provides no specific revenue or earnings guidance. Management said available liquidity and operating cash flow should meet foreseeable requirements, while noting possible need for additional liquidity to execute its strategy.
- Management expects continued investment in surgical sets, product launches, sales-force expansion, international growth, R&D and clinical trials. Risks cited include reimbursement and demand changes, pricing pressure and competition, regulatory changes, product-development execution, and adverse litigation outcomes.
- Litigation remains significant. In the Bianco matter, the court imposed an ongoing royalty of 5% of net sales of CALIBER, CALIBER-L and RISE (and products not colorably different) for 15 years on sales beginning January 18, 2014. The company said it would appeal; post-trial motions were denied October 27, 2014. The filing states the company does not expect the verdict to materially affect future revenues.
- In the DePuy Synthes matter, a jury previously awarded $16.0 million for infringement by prior versions of certain products; Globus had accrued $19.5 million in damages and related costs at December 31, 2013, and accrued an additional $0.5 million in interest during the first nine months of 2014. Several other matters remain unresolved, and the company says outcomes or potential losses cannot be determined or estimated for certain cases.
- The company reported no material change in risk factors from its 2013 Form 10-K. It is evaluating the impact of the new revenue-recognition standard, effective for public-company annual periods beginning after December 15, 2016.
Investor verification priorities
- Track sales growth by geography and product category, and whether new-product launches and territory expansion continue to support growth.
- Assess the sustainability of margins and earnings, separating recurring operating performance from litigation charges and other non-GAAP adjustments.
- Monitor the Bianco royalty and appeal, DePuy Synthes appeal, and other unresolved litigation for possible effects on costs, cash flow, or product sales.
- Review the TTOT acquisition’s integration, cash use, and potential milestone payments, alongside planned investment and liquidity needs.
- Check the composition, liquidity, and credit exposure of marketable securities, and the status of the revolving credit facility and covenants.