ArthroCare Reports Third Quarter 2011 Financial Results

ArthroCare Corp. (NASDAQ: ARTC), a leader in developing state-of-the-art, minimally invasive surgical products, announced its financial results for the third quarter ended September 30, 2011.

REVENUE

Total revenue from continuing operations for the third quarter of 2011 was $83.3 million, compared to $86.5 million for the third quarter of 2010, a decrease of 3.7 percent.

Proprietary product sales were $74.7 million in the third quarter of 2011 compared to $72.6 million for the third quarter of 2010, an increase of $2.1 million or 2.9 percent. Worldwide sales of the Company’s proprietary Sports Medicine products increased $0.8 million or 1.6 percent, as a decline in the Americas products sales was offset by higher International reported product sales. ENT product sales increased $1.9 million, or 8.2 percent, from increased product volume across all geographies as well as higher average sales prices in the Americas. Other product sales declined $0.5 million in the third quarter of 2011 compared to the same period of 2010.

Contract manufactured product sales were $4.7 million in the third quarter of 2011 compared to $10.3 million for the third quarter of 2010, a decrease of $5.6 million.

Had the same foreign currency rates been in effect in the quarter ended September 30, 2011 as were in effect in the same quarter in 2010, the U.S. dollar reported value of product sales would have been lower by $2.1 million for the quarter ended September 30, 2011.

GROSS PRODUCT MARGIN

Gross product margin was 67.9 percent for the third quarter of 2011 compared to 65.5 percent for the third quarter of 2010. The increase in gross product margin in the third quarter of 2011 was due to lower inventory obsolescence charges, lower controller amortization charges and lower contract manufactured product sales which generally realize lower product margins in the third quarter of 2011 compared to the same period in 2010.

INCOME FROM OPERATIONS

Income from operations for the third quarter of 2011 was $4.4 million compared to $11.5 million for the same period in 2010. Income from operations for the third quarter of 2011 included approximately $11.2 million of higher operating expenses than in the third quarter of 2010 associated with the investigation and restatement related costs, as well as exit and other costs associated with the relocation of the Company’s Sunnyvale operations to Austin, Texas.

In the third quarter of 2011, the Company reported investigation and restatement related costs of $6.0 million as a result of higher legal costs in connection with the ongoing shareholder class action, Department of Justice investigation, and legal fees associated with indemnification agreements for certain former executives of the Company. In the third quarter of 2010, the Company reported a net recovery of $0.1 million as insurance recoveries in the third quarter of 2010 exceeded investigation and restatement costs incurred in that period.

In the third quarter of 2011, the Company incurred exit costs related to the closure and relocation of its Sunnyvale, California facilities and operations of approximately $2.8 million. The Company also incurred an additional $2.3 million in operating expenses not classified as exit costs that related to accelerated amortization of leasehold costs and additional rent expense, relocation, recruiting, training, and overlapping employee cost associated with the relocation of the Sunnyvale operations to Austin, Texas.

Research and development (R&D) cost incurred during the quarter ended September 30, 2011 decreased $1.2 million compared to the same period in 2010 as a higher proportion of the Company’s engineering activities were associated with the manufacturing process, resulting in increased allocation of R&D costs to inventory and cost of goods sold.

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

Net income available to common stockholders was $1.6 million or $0.05 per diluted share in the third quarter of 2011, compared to $8.4 million, or $0.25 per diluted share, in the third quarter of 2010.

BALANCE SHEET AND CASH FLOWS

Cash and cash equivalents increased $75.1 million to $207.7 million as of September 30, 2011 from December 31, 2010. Cash flows provided by operating activities for the nine months ended September 30, 2011 was $69.8 million compared to $63.6 million for the nine months ended September 30, 2010.

CONFERENCE CALL

ArthroCare will hold a conference call with the financial community to present these results at 8:30 a.m. ET/5:30 a.m. PT on Thursday, November 3, 2011. To participate in the live conference call dial 800-950-3502. A live and on-demand webcast of the call will be available on ArthroCare’s Web site at www.arthrocare.com. A telephonic replay of the conference call can be accessed by dialing 800-633-8284 and entering pass code number 21544090. The replay will remain available through November 17, 2011.

ABOUT ARTHROCARE

ArthroCare develops and manufactures surgical devices, instruments, and implants that strive to enhance surgical techniques as well as improve patient outcomes. Its devices improve many existing surgical procedures and enable new minimally invasive procedures. Many of ArthroCare’s devices use its internationally patented Coblation® technology. This technology precisely dissolves target tissue and limits damage to surrounding healthy tissue. ArthroCare also develops surgical devices utilizing other patented technology including its OPUS® line of fixation products as well as re-usable surgical instruments. ArthroCare is leveraging these technologies in order to offer a comprehensive line of surgical devices to capitalize on a multi-billion dollar market opportunity across several surgical specialties, including its two core product areas consisting of Sports Medicine and Ear, Nose, and Throat as well as other areas such as spine, wound care, urology and gynecology.

FORWARD-LOOKING STATEMENTS

The information provided herein includes forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. Statements that are not historical facts are forward-looking statements. Forward-looking statements are based on beliefs and assumptions by management and on information currently available to management. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update any of them publicly in light of new information or future events. Additional factors that could cause actual results to differ materially from those contained in any forward-looking statement include, without limitation: the resolution of litigation pending against the Company; the Company’s ability to design or improve internal controls to address issues detected in its reviews of internal controls and insurance reimbursement practices or by management in its reassessment of the Company’s internal controls; the impact upon the Company’s operations of legal compliance matters or internal controls review, improvement and remediation; the ability of the Company to control expenses relating to legal compliance matters or internal controls review, improvement and remediation; the Company’s ability to remain current in its periodic reporting requirements under the Exchange Act and to file required reports with the Securities and Exchange Commission on a timely basis; the results of the investigation being conducted by the United States Department of Justice; the impact on the Company of additional civil and criminal investigations by state and federal agencies and civil suits by private third parties involving the Company’s financial reporting and its previously announced restatement and its insurance billing and healthcare fraud-and-abuse compliance practices; the ability of the Company to attract and retain qualified senior management and to prepare and implement appropriate succession planning for its Chief Executive Officer; general business, economic and political conditions; competitive developments in the medical devices market; changes in applicable legislative or regulatory requirements; the Company’s ability to effectively and successfully implement its financial and strategic alternatives, as well as business strategies, and manage the risks in its business; and the reactions of the marketplace to the foregoing.

ARTHROCARE CORPORATION
Condensed Consolidated Balance Sheets - Unaudited
(in thousands, except par value data)
September 30, 2011December 31, 2010
ASSETS
Current assets:
Cash and cash equivalents $ 207,674 $ 132,536

Accounts receivable, net of allowances of $2,226 and $2,445 at September 30, 2011 and December 31, 2010, respectively

39,917 48,870
Inventories, net 35,593 34,087
Deferred tax assets 18,496 24,661
Prepaid expenses and other current assets 5,929 4,424
Assets held for sale - 3,081
Total current assets 307,609 247,659
Property and equipment, net 36,120 41,582
Intangible assets, net 6,770 10,733
Goodwill 119,154 119,020
Deferred tax assets 16,019 16,019
Other assets 1,617 4,182
Total assets $ 487,289 $ 439,195

LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 15,223 $ 13,819
Accrued liabilities 45,751 40,197
Deferred tax liabilities 149 149
Income tax payable 2,071 1,555
Total current liabilities 63,194 55,720
Deferred tax liabilities 213 213
Other non-current liabilities 14,174 13,766
Total liabilities 77,581 69,699

Series A 3% Redeemable Convertible Preferred Stock, par value $0.001; Authorized: 100 shares; Issued and outstanding: 75 shares at September 30, 2011 and December 31, 2010; Redemption value $87,089

76,316 73,768
Stockholders' equity:
Preferred stock, par value $0.001; Authorized: 4,900 shares; Issued and outstanding: none - -

Common stock, par value $0.001; Authorized: 75,000 shares; Issued: 31,458 and 31,102 shares; Outstanding: 27,479 and 27,112 shares at September 30, 2011 and December 31, 2010, respectively

27 27

Treasury stock: 3,978 shares at September 30, 2011 and 3,990 shares December 31, 2010

(107,408 ) (107,899 )
Additional paid-in capital 398,270 386,395
Accumulated other comprehensive income 4,611 4,246
Retained earnings 37,892 12,959
Total stockholders' equity 333,392 295,728
Total liabilities, redeemable convertible preferred stock and stockholders' equity $ 487,289 $ 439,195
ARTHROCARE CORPORATION
Condensed Consolidated Statements of Operations - Unaudited
(in thousands, except per share data)
Three Months Ended

September 30,

Nine Months Ended

September 30,

2011201020112010
Revenues:
Product sales $ 79,432 $ 82,917 $ 249,864 $ 251,148
Royalties, fees and other 3,835 3,536 12,609 11,598
Total revenues 83,267 86,453 262,473 262,746
Cost of product sales 25,529 28,632 76,170 83,569
Gross profit 57,738 57,821 186,303 179,177
Operating expenses:
Research and development 8,037 9,244 21,460 26,537
Sales and marketing 25,752 26,156 81,124 79,898
General and administrative 9,479 9,723 26,372 26,048
Amortization of intangible assets 1,338 1,315 3,972 3,932
Exit costs 2,814 - 5,304 -
Investigation and restatement related costs 5,963 (99 ) 12,145 3,245
Total operating expenses 53,383 46,339 150,377 139,660
Income from operations 4,355 11,482 35,926 39,517
Foreign exchange gain (loss) (902 ) 1,323 (160 ) (2,711 )
Interest and other expense, net (126 ) (96 ) (501 ) (287 )
Other income (expense) (1,028 ) 1,227 (661 ) (2,998 )
Income from continuing operations before income taxes 3,327 12,709 35,265 36,519
Income tax provision 898 3,536 9,677 9,984
Net income from continuing operations 2,429 9,173 25,588 26,535
Income (loss) from discontinued operations - 85 1,911 (368 )
Net income 2,429 9,258 27,499 26,167

Accrued dividend and accretion charges on Series A 3% Convertible Preferred Stock

(857 ) (820 ) (2,546 ) (2,434 )
Net income available to common stockholders $ 1,572 $ 8,438 $ 24,953 $ 23,733

Weighted-average shares outstanding:

Basic 27,466 27,017 27,335 26,972
Diluted 27,855 27,323 27,755 27,299
Earnings per share from continuing operations applicable to common stockholders:
Basic $ 0.05 $ 0.25 $ 0.70 $ 0.74
Diluted $ 0.05 $ 0.25 $ 0.68 $ 0.73

Earnings per share applicable to common stockholders:

Basic $ 0.05 $ 0.26 $ 0.75 $ 0.72
Diluted $ 0.05 $ 0.25 $ 0.74 $ 0.72
ARTHROCARE CORPORATION
Supplemental Schedule of Product Sales
(in thousands)
Three Months EndedThree Months Ended
September 30, 2011September 30, 2010
AmericasInternationalTotal Product Sales% Net Product SalesAmericasInternationalTotal Product Sales% Net Product Sales
Sports Medicine $ 33,251 $ 18,850 $ 52,101 65.6 % $

40,029

$ 16,944 $

56,973

68.7

%
ENT 20,046 4,851 24,897 31.3 %

19,379

3,636

23,015

27.8

%
Other 658 1,776 2,434 3.1 % 1,016 1,913 2,929 3.5 %
Total Product Sales $ 53,955 $ 25,477 $ 79,432 100.0 % $ 60,424 $ 22,493 $ 82,917 100.0 %
Nine Months EndedNine Months Ended
September 30, 2011September 30, 2010
AmericasInternationalTotal Product Sales% Net Product SalesAmericasInternationalTotal Product Sales% Net Product Sales
Sports Medicine $ 106,980 $ 58,987 $ 165,967 66.4 % $

122,121

$ 50,012 $

172,133

68.5 %
ENT 62,732 13,903 76,635 30.7 %

58,990

10,945

69,935

27.9 %
Other 2,203 5,059 7,262 2.9 %

3,115

5,965

9,080

3.6 %
Total Product Sales $ 171,915 $ 77,949 $ 249,864 100.0 % $ 184,226 $ 66,922 $ 251,148 100.0 %

Contacts:

ArthroCare Corp.
Corinne Ervin, 512-391-3907
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