ArthroCare Reports Third Quarter 2012 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, 2012.

THIRD QUARTER 2012 HIGHLIGHTS

  • Total revenue of $86.9 million.
  • Income from operations of $13.7 million, or operating margin of 15.7 percent.
  • Net income available to common stockholders of $9.1 million, or $0.27 per diluted share.

REVENUE

Total revenue for the third quarter of 2012 was $86.9 million, compared to $83.3 million for the third quarter of 2011, an increase of 4.4 percent.

Product sales for the third quarter of 2012 were $82.6 million compared to $79.4 million in the third quarter of 2011, an increase of 4.0 percent. Product sales increased 5.8 percent in constant currency over the same quarter of the prior year.

Worldwide sales of Sports Medicine products increased $3.1 million, or 5.9 percent. In constant currency, Sports Medicine product sales increased 8.1 percent this quarter when compared to the same quarter in 2011. For the quarter ended September 30, 2012, contract manufacturing product sales under our supply agreement with Smith and Nephew increased $2.0 million, or 42.2 percent, and proprietary Sports Medicine product sales increased $1.4 million, or 5.5 percent. The increase in Americas proprietary Sports Medicine sales in the quarter was due to unit volume increases due to recent Coblation® and fixation new product introductions as well as increased sales of knee wands resulting from our knee initiative. International Sports Medicine product sales decreased $0.4 million, or 2.3 percent, in the third quarter of 2012 compared to the same period in 2011. The decrease was the result of the translation effect of a stronger U.S. dollar against the euro, British pound and Australian dollar, partially offset by higher sales volumes primarily in direct markets.

Worldwide ENT product sales increased $0.6 million, or 2.5 percent. In constant currency, ENT product sales increased 3.2 percent in the third quarter of 2012 as compared to the same quarter of 2011. Americas ENT product sales decreased $0.4 million or 1.8 percent as a decrease in Coblation sales volumes was partially offset by higher average selling prices and higher sales volumes of our Rapid Rhino® products. International ENT product sales increased $1.0 million, or 20.5 percent, as a result of higher product sales in direct and distributor markets, with the exception of southern European and Middle Eastern distributor markets.

Other product sales decreased $0.6 million in the third quarter of 2012 compared to the same quarter of 2011.

Across all product areas International product sales increased $0.3 million, or 1.3 percent in the third quarter of 2012 as compared to the same quarter of 2011. Had the same foreign currency rates been in effect in the quarter ended September 30, 2012 as were in effect in the third quarter in 2011, the U.S. dollar reported value of product sales would have been higher by $1.4 million for this quarter.

Management believes percentage sales growth in constant currency is an important metric for evaluating our operations because the impact of changing foreign currency exchange rates may not provide an accurate baseline for analyzing trends in our business. Percentage sales growth in constant currency is calculated by translating current year sales at prior year average foreign currency exchange rates. Constant currency is a non-GAAP measure and it should not be considered as a substitute for measures prepared in accordance with GAAP.

GROSS PRODUCT MARGIN

Gross product margin as a percentage of product sales was 68.3 percent for the third quarter of 2012 compared to 67.9 percent for the third quarter of 2011.

INCOME FROM OPERATIONS

Income from operations for the third quarter of 2012 was $13.7 million compared to $4.4 million for the same period in 2011. Operating margin for the third quarter of 2012 was 15.7 percent compared to 5.2 percent for the same period in 2011.

Under the short-term incentive plan for 2012 approved by the Board of Directors, Adjusted Operating Margin is a key metric for purposes of evaluating business performance. Adjusted Operating Margin is Operating Margin adjusted for investigation and restatement related costs. Investigation and restatement related costs were 2.5 percent and 7.2 percent of total revenue for the third quarters of 2012 and 2011, respectively, and Adjusted Operating Margin was 18.2 percent and 12.4 percent for these same periods. Adjusted Operating Margin is a non-GAAP measure of profitability and it should not be considered as a substitute for measures prepared in accordance with GAAP.

Total operating expenses were $47.1 million in the third quarter of 2012 compared to $53.4 million in the third quarter of 2011. Exit costs decreased $2.8 million and investigation and restatement costs decreased $3.8 million in this quarter as compared to the third quarter of 2011. Sales and marketing expenses increased $1.4 million, to 31.2 percent of total revenues this quarter compared to 30.9 percent for the same quarter of 2011.

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS

Earnings per share from continuing operations applicable to common stockholders was $0.27 per diluted share in the third quarter of 2012 compared to $0.05 per diluted share in the third quarter of 2011.

BALANCE SHEET AND CASH FLOWS

Cash and cash equivalents was $203.2 million as of September 30, 2012 compared to $219.6 million at December 31, 2011. In the first quarter of 2012, the Company paid $74 million as required under the proposed settlement of the private securities class actions. Excluding this payment, cash and cash equivalents increased $57.6 million during the nine months ended September 30, 2012. Cash used in operating activities for the nine months ended September 30, 2012 was $10.6 million compared to cash provided by operating activities of $69.8 million for the nine months ended September 30, 2011. Adjusting for the funding of the $74 million settlement of the private securities class actions, cash provided by operating activities in the first nine months of 2012 would have been $63.4 million.

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 1, 2012. To participate in the live conference call dial 855-724-2350. 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 21609480. The replay will remain available through November 15, 2012.

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 impact upon the Company’s operations of legal compliance matters which may require improvement and remediation; the ability of the Company to control expenses relating to legal or compliance matters; 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 results of the civil investigation by the Department of Justice related to the Civil Investigative Demand we received arising under the False Claims Act; the possibility that the Department of Justice could institute civil proceedings against us, based on the results of the investigation related to the Civil Investigative Demand; the risk that we could be subject to qui tam suits involving the False Claims Act; the possibility that the Department of Justice could institute a criminal enforcement action against us based on the results of the civil investigation related to the Civil Investigative Demand; the resolution of any litigation related to the civil investigation; 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 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,
2012

December 31,
2011

ASSETS
Current assets:
Cash and cash equivalents $ 203,163 $ 219,605

Accounts receivable, net of allowances of $2,002 and $2,251 at September 30, 2012 and December 31, 2011, respectively

41,196 51,350
Inventories, net 49,591 35,761
Deferred tax assets 28,321 40,622
Prepaid expenses and other current assets 5,136 5,532
Total current assets 327,407 352,870
Property and equipment, net 30,946 35,769
Intangible assets, net 2,685 5,457
Goodwill 119,924 119,159
Deferred tax assets 18,178 18,159
Other assets 2,064 1,587
Total assets $ 501,204 $ 533,001
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 13,665 $ 15,258
Accrued liabilities 38,203 112,586
Deferred Revenue 451 742
Deferred tax liabilities 76 -
Income tax payable - 1,542
Total current liabilities 52,395 130,128
Deferred tax liabilities 296 29
Other non-current liabilities 18,976 18,922
Total liabilities 71,667 149,079

Commitments and contingencies (Notes 6 and 7)

Series A 3% Redeemable Convertible Preferred Stock, par value $0.001; Authorized: 100 shares;

Issued and outstanding: 75 shares at September 30, 2012 and December 31, 2011; Redemption

value: $87,089

79,850 77,184
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: 31,801 and 31,523 shares
Outstanding: 27,851 and 27,562 shares at September 30, 2012 and December 31, 2011, respectively 28 28
Treasury stock: 3,950 and 3,968 shares at September 30, 2012 and December 31, 2011, respectively (106,645 ) (107,126 )
Additional paid-in capital 409,942 400,580
Accumulated other comprehensive income 5,180 4,615
Retained earnings 41,182 8,641
Total stockholders' equity 349,687 306,738
Total liabilities, redeemable convertible preferred stock and stockholders' equity $ 501,204 $ 533,001
ARTHROCARE CORPORATION
Condensed Consolidated Statements of Operations - Unaudited
(in thousands, except per share data)

Three Months Ended

Nine Months Ended

September 30,September 30,
2012201120122011
Revenues:
Product sales $ 82,602 $ 79,432 $ 258,448 $ 249,864
Royalties, fees and other 4,338 3,835 13,070 12,609
Total revenues 86,940 83,267 271,518 262,473
Cost of product sales 26,204 25,529 80,210 76,170
Gross profit 60,736 57,738 191,308 186,303
Operating expenses:
Research and development 8,184 8,037 23,677 21,460
Sales and marketing 27,175 25,752 86,217 81,124
General and administrative 8,191 9,479 24,833 26,372
Amortization of intangible assets 1,363 1,338 4,000 3,972
Exit costs - 2,814 (778 ) 5,304
Investigation and restatement-related costs 2,139 5,963 4,363 12,145
Total operating expenses 47,052 53,383 142,312 150,377
Income from operations 13,684 4,355 48,996 35,926
Non-operating gains (losses) 183 (1,028 ) (578 ) (661 )
Income from continuing operations before income taxes 13,867 3,327 48,418 35,265
Income tax provision 3,882 898 13,211 9,677
Net income from continuing operations 9,985 2,429 35,207 25,588
Income from discontinued operations, net of taxes - - - 1,911
Net income 9,985 2,429 35,207 27,499

Accrued dividend and accretion charges on Series A

3% Redeemable Convertible Preferred Stock (900 ) (857 ) (2,666 ) (2,546 )
Net income available to common stockholders 9,085 1,572 32,541 24,953
Other comprehensive income
Foreign currency translation adjustments 951 751 565 365
Total comprehensive income $ 10,936 $ 3,180 $ 35,772 $ 27,864

Weighted average shares outstanding:

Basic 27,714 27,466 27,698 27,335
Diluted 28,087 27,855 28,096 27,755
Earnings per share from continuing operations
applicable to common stockholders:
Basic $ 0.27 $ 0.05 $ 0.97 $ 0.70
Diluted $ 0.27 $ 0.05 $ 0.96 $ 0.68
Earnings per share applicable to common stockholders:
Basic $ 0.27 $ 0.05 $ 0.97 $ 0.75
Diluted $ 0.27 $ 0.05 $ 0.96 $ 0.74
ARTHROCARE CORPORATION
Supplemental Schedule of Product Sales - Unaudited
(in thousands)

Three Months Ended

Three Months Ended
September 30, 2012September 30, 2011
AmericasInternational

Total Product
Sales

% Net Product
Sales

AmericasInternational

Total Product
Sales

% Net Product
Sales

Sports medicine $ 36,787 $ 18,414 $ 55,201 66.8 % $ 33,251 $ 18,850 $ 52,101 65.6 %
ENT 19,677 5,846 25,523 30.9 % 20,046 4,851 24,897 31.3 %
Other 322 1,556 1,878 2.3 % 658 1,776 2,434 3.1 %
Total product sales $ 56,786 $ 25,816 $ 82,602 100.0 % $ 53,955 $ 25,477 $ 79,432 100.0 %
Nine Months EndedNine Months Ended
September 30, 2012September 30, 2011
AmericasInternational

Total Product
Sales

% Net Product
Sales

AmericasInternational

Total Product
Sales

% Net Product
Sales

Sports medicine $ 113,868 $ 58,357 $ 172,225 66.6 % $ 106,980 $ 58,987 $ 165,967 66.4 %
ENT 62,985 16,629 79,614 30.8 % 62,732 13,903 76,635 30.7 %
Other 1,322 5,287 6,609 2.6 % 2,203 5,059 7,262 2.9 %
Total product sales $ 178,175 $ 80,273 $ 258,448 100.0 % $ 171,915 $ 77,949 $ 249,864 100.0 %

Contacts:

ArthroCare Corp.
Misty Romines, 512-391-3902
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