Business context and reporting period
Globus Medical, Inc. designs, develops and sells musculoskeletal implants, primarily for spine procedures. This unaudited Form 10-Q covers the three and six months ended June 30, 2016; comparisons are with the corresponding 2015 periods. Dollar amounts below are in millions unless otherwise noted. The company reported one operating segment. Robotic navigation and orthopedic trauma products remained in development and were not cleared by the FDA for sale.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Sales | $137.5 | $133.6 | $276.8 | $265.2 |
| Gross profit | $104.6 | $101.0 | $212.3 | $200.5 |
| Gross margin | 76.1% | 75.6% | 76.7% | 75.6% |
| Operating income | $37.9 | $37.0 | $80.8 | $75.6 |
| Operating margin | 27.6% | 27.7% | 29.2% | 28.5% |
| Net income | $25.8 | $24.1 | $53.8 | $48.7 |
| Net margin | 18.8% | 18.0% | 19.4% | 18.4% |
| Diluted EPS | $0.27 | $0.25 | $0.56 | $0.51 |
- Sales increased 2.9% in Q2 and 4.4% in the first half. Disruptive Technology sales grew 9.8% and 11.4%, respectively, while Innovative Fusion sales declined 3.0% and 1.7%.
- U.S. sales rose 2.7% in Q2 and 4.5% year to date. International sales rose 5.7% and 3.3% as reported; management cited currency headwinds and reported constant-currency growth of 8.1% and 6.7%.
- Q2 operating income grew less than sales, with operating margin slightly lower year over year. First-half operating income and margin improved.
- R&D expense rose 23.9% in Q2 and 20.9% in the first half, mainly reflecting higher headcount and product-development costs. Litigation provision was $3.1 million in both 2016 periods, compared with $0.4 million in Q2 2015 and $0.4 million in first-half 2015.
Cash flow, liquidity and debt
- First-half cash from operations was $78.1 million, versus $47.8 million in 2015. The company attributed the increase chiefly to recovery of restricted cash following the DePuy Synthes settlement, lower inventory purchases and the prior-year BMG acquisition-related payment.
- Capital expenditures were $20.1 million. Company-defined free cash flow, a non-GAAP measure adjusted for restricted cash, was $43.0 million, versus $24.0 million.
- Cash and cash equivalents were $95.3 million at June 30; marketable securities totaled $294.8 million. Combined cash, cash equivalents and marketable securities were $390.1 million, up from $329.8 million at year-end 2015. Working capital was $465.1 million.
- No revolving-credit borrowings were outstanding; $50.0 million was available under the facility, which expires in May 2017. The company reported compliance with its covenants. Total liabilities were $89.9 million, including $28.1 million of current and long-term business-acquisition liabilities; the filing reports no outstanding funded debt.
Material changes, outlook and risks
- Acquisition: On July 25, 2016, after quarter-end, Globus agreed to acquire Alphatec Holdings’ international operations and distribution channel for $80.0 million in cash, subject to adjustments and closing conditions. The parties expected closing by October 2016. Management said existing liquidity sources should meet foreseeable needs, while noting that additional liquidity could be required to execute its strategy.
- One-time and policy items: The U.S. medical-device excise tax was suspended for two years beginning January 1, 2016; management estimated a $4.0 million first-half cost-of-goods-sold benefit and said it planned to direct approximately 40% of the benefit to R&D and manufacturing job creation. The company recorded $3.1 million of litigation provision in 2016, principally related to settlements. It also reported a $1.9 million credit from a non-cash settlement of certain acquisition liabilities, included in SG&A and acquisition-related adjustments.
- Legal matters: Globus paid $7.9 million to settle four DePuy Synthes patent cases in January and recovered approximately $8.4 million from restricted cash. The Bianco trade-secret judgment includes a 5% royalty on specified product sales for 15 years; the Supreme Court denied Globus’s petition for review in June 2016. Bonutti Skeletal litigation was settled in June. Other disclosed matters include Flexuspine, L5 and a securities class action; the company said outcomes or loss ranges could not be determined for certain cases and had not accrued them. Management cautioned that litigation costs could materially affect earnings, financial position or cash flows.
- Operating and market risks: Management identified competition and pricing pressure, surgeon adoption and sales-force retention, reimbursement and coverage, product-development and regulatory changes, intellectual-property protection, litigation outcomes, and the integration and expected benefits of the Alphatec transaction as risks. The filing provides no specific revenue or earnings guidance. Management noted sales may be affected by summer and winter holidays, though the business is generally not seasonal.
Important facts for investors to verify
- Whether underlying sales growth and margin trends persist, particularly the continued growth in Disruptive Technology products and the weakness in Innovative Fusion sales.
- The final purchase price, closing conditions, integration costs and performance of the Alphatec international-channel acquisition.
- The cash and earnings effects of litigation, including the continuing Bianco royalty and unresolved cases; the $3.1 million litigation provision is a reported period expense, not a complete estimate of future exposure.
- How much of first-half operating cash flow and free cash flow is recurring, given the restricted-cash recovery and working-capital movements.
- The future impact of the medical-device excise tax if it resumes in 2018, and the company’s investment needs for surgical sets, R&D and sales-force expansion.