Proposed Merger Has Substantial Impact on ArthroCare’s First Quarter

ArthroCare Corporation announced total revenues of $96.1 million for the first quarter of fiscal year 2014, which ended on March 31. The same quarter last year yielded $92.3 million, for an increase of 4 percent. Product sales for the 1Q 2014 were $90 million, compared to $87.5 million for the same quarter of 2013, an increase of 2.9 percent. Changes in foreign exchange rates did not have a material effect on the comparability of reported product sales.

Worldwide sales of sports medicine products increased $4.2 million or 7 percent in the first quarter of 2014 when compared to 1Q 2013. International sports medicine product sales increased $2.9 million, or 13.8 percent as compared to 1Q 2013. In the Americas, product sales increased by 3.4 percent due to higher contract manufactured product sales of $1.3 million while proprietary sports medicine product sales were flat when compared to the same period of 2013.

Worldwide ENT (earn, nose and throat) product sales decreased $1.3 million, or 5 percent in the first quarter of 2014 compared to the first quarter of 2013. International ENT product sales decreased $0.3 million or 5.3 percent and Americas ENT product sales decreased $1.0 million or 4.9 percent.

Other product sales decreased $0.4 million in the first quarter of 2014 compared to the same quarter of 2013. Other product sales represent less than 3 percent of total product sales.

Royalties, fees and other revenues was 6.3 percent of total revenues for the first quarter of 2014 compared to 5.3 percent for the first quarter of 2013.

Income from operations for 1Q 2014 was $9.2 million compared to $13.5 million for the same period in 2013. Operating margin for 1Q 2014 was 9.6 percent compared to 14.6 percent for the same quarter of 2013.

Adjusted operating margin is a key metric for purposes of evaluating the ArthroCare’s performance. Adjusted operating margin historically has been calculated as operating margin adjusted for investigation and restatement related costs. Investigation and restatement related costs were 5.4 percent of total revenue for 1Q 2014 compared to 4.2 percent of total revenue for the same period in 2013. In addition, in 1Q 2014 the company incurred substantial non-recurring costs in connection with the proposed merger with Smith & Nephew. Merger related costs were 6.4 percent of total revenue in the first quarter of 2014 and ArthroCare did not incur merger costs in the first quarter of 2013. Adjusted operating margin considering both the add back of investigation and restatement related costs and merger related costs was 21.4 percent for 1Q 2014 compared to 18.8 percent for the same periods in 2013. Adjusted operating margin is a non-GAAP (generally accepted accounting practices) measure of profitability and it should not be considered as a substitute for measures prepared in accordance with GAAP.

Gross profit for Q1 2014 was $67.6 million compared to $64 million in Q1 2013. Gross product margin in the current quarter was 68.4 percent compared to 67.6 percent in the first quarter of 2013.

Total operating expenses were $58.4 million in the first quarter of 2014 compared to $50.6 million in the first quarter of 2013. Research and development expense decreased $0.4 million this quarter due primarily to lower prototype expense and materials usage. General and administrative expense increased $6.7 million this quarter. The increase is primarily related to expenses incurred in connection with the proposed Merger including legal fees, investment banker fees, and proxy related services which totaled $6.2 million in the current quarter. Sales and marketing expense as a percent of revenue decreased this quarter to 31.8 percent as compared to 32.8 percent in the same quarter of 2013 due to lower severance related expenses this quarter.

ArthroCare makes surgical devices, instruments, and implants primarily focused on soft tissue repair and ablation technology for large joints, spine and ENT.