Search the web
Welcome, Guest
[Sign Out, My Account]
EDGAR_Online

Quotes & Info
Enter Symbol(s):
e.g. YHOO, ^DJI
Symbol Lookup | Financial Search
ARTC > SEC Filings for ARTC > Form 10-Q on 5-Aug-2013All Recent SEC Filings

Show all filings for ARTHROCARE CORP

Form 10-Q for ARTHROCARE CORP


5-Aug-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q. Readers should also review carefully "Forward-Looking Statements," in Part II of this quarterly report on Form 10-Q, which provides information about the forward-looking statements in this report and a discussion of the factors that might cause our actual results to differ, perhaps materially, from these forward-looking statements. Statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this quarterly report on Form 10-Q which express that we "believe," "anticipate," "expect" or "plan to" as well as other statements which are not historical fact, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the safe harbors created under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Readers are cautioned that these forward-looking statements are only predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. As such, actual events or results may differ materially as a result of the risks and uncertainties described herein and elsewhere including, but not limited to, those factors discussed in Part II - Item 1A - "Risk Factors" of this report on Form 10-Q and in Part I - Item 1A - "Risk Factors" of our annual report on Form 10-K for the year ended December 31, 2012. In this quarterly report on Form 10-Q, the terms the "Company", "we", "us" and "our" refer to ArthroCare Corporation and its subsidiaries.

Overview

We are a medical device company that develops, manufactures and markets surgical products, many of which are based on our minimally invasive patented Coblation technology. Our products are used across several medical specialties, improving many existing soft-tissue surgical procedures and enabling new minimally invasive surgical procedures. Our business consists of one operating and reportable segment for the development, manufacturing and marketing of disposable devices and implants for select surgical procedures. The product development, manufacturing and other supporting functions, such as regulatory affairs and distribution, are common across our Company. We organize and manage our sales and marketing functions according to geography and the surgical specialty that typically uses our products. Most of the Company's products are used in Sports Medicine or ENT procedures.

Key Financial Items, Trends and Uncertainties Affecting Our Business

Our management reviews and analyzes several metrics and ratios in order to manage our business and assess the quality of and potential variability of our operating performance. The most important of these financial metrics and ratios include:

Product Sales

Our principal source of revenue is from sales of our products, which primarily include disposable surgical devices and implants. Product sales are made through our employed sales representatives, independent sales agents and distributors. Product sales were essentially unchanged for the quarter ended June 30, 2013 and decreased 0.5 percent for the six-month period ended June 30, 2013 when compared to the same periods in 2012. We anticipate that disposable surgical device sales and implant sales will remain key components of our product sales for the foreseeable future. Currency rate fluctuations had minimal effect on the comparability of reported product sales in the quarter and six month period ended June 30, 2013.

We contract manufacture disposable surgical devices and implants based on our technologies for other medical device companies. Product sales from contract manufacturing for the three and six month periods ended June 30, 2013 were $5.3 million and $10.9 million, respectively, compared to $6.5 million and $11.3 million during the same periods in 2012.

We also generate revenue from royalties, fees and other revenues from the licensing of our technology to other companies and earn other revenues from shipping and handling costs billed to customers.

Gross Product Margin

Gross product margin as a percentage of product sales for the three and six month periods ended June 30, 2013 was 67.1 percent and 67.4 percent, respectively, compared to 68.8 percent and 69.3 percent for the same periods in 2012. Cost of product sales consists of all product manufacturing costs (including material costs, labor costs, manufacturing overhead, warranty and other direct product costs), adjustments to the carrying value of inventory for excess or obsolete items, certain


Table of Contents

stock based compensation costs associated with manufacturing and operations personnel, costs to ship product to our customers, and, beginning in the first quarter of 2013, excise tax imposed on our US product sales resulting from the Patient Protection and Affordable Care Act which was signed into law in March 2010 (the Medical Device Tax). Cost of product sales also includes the amortization of controller units and instruments that have been placed at customer locations to enable the use of our disposable surgical products. We maintain ownership of all placed controllers and instruments and the costs are amortized into cost of product sales over their estimated useful life. Our products are mostly produced at our Costa Rica facility. Raw materials used to produce our products are generally not subject to substantial commodity price volatility. Most of our product manufacturing costs are incurred in U.S. dollars.

The comparability of gross product margin between periods will be impacted by several items, including the Medical Device Tax that was newly implemented in 2013, the mix between proprietary and contract manufactured product sales; the stability of the average sales price we realize on proprietary products; changes in foreign exchange rates used to translate foreign currency denominated sales into U.S. dollars; changes in the estimated percentage of engineering activities related to manufacturing process design or improvement; and changes in our product emphasis which could result in excess and obsolescence charges being included in the cost of product sales in a particular period.

Operating Margin

Operating margin is our income from operations as a percentage of total revenues. Our key operating expenses include expenses incurred in connection with research and development, sales and marketing, and general and administrative activities, as well as the amortization of intangible assets.
Operating margin was negative 12.0 percent for the quarter ended June 30, 2013 and 1.3 percent for the six month period ended June 30, 2013 compared to 19.6 percent and 19.1 percent for the same periods in 2012.

Under the short-term incentive plan for 2013 approved by our Board of Directors, Adjusted Operating Margin is a key metric for purposes of evaluating management's performance. Adjusted Operating Margin is Operating Margin adjusted for investigation and restatement related costs. Investigation and restatement related costs were 28.6 percent and 16.4 percent of total revenue for the three and six month periods ended June 30, 2013, respectively, compared to 1.2 percent of total revenue for the same periods in 2012. Adjusted Operating Margin was 16.6 percent and 17.7 percent for the three and six month periods ended June 30, 2013, respectively, compared to 20.8 percent and 20.3 percent for the same periods in 2012. 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.

Net Earnings (loss)

For most periods, our net earnings (loss) will be affected by the same trends that impact our revenues, gross product margin and operating margin. In addition, net earnings (loss) will also be affected by non-operating other income and expenses, such as foreign currency gains and losses, and by income taxes. We expect that we will report foreign currency gains or losses each period due primarily to changes in the value of the euro, British pound and Australian dollar versus the U.S. dollar.

In periods when we report income before taxes, our effective income tax rate is usually less than the U.S. statutory rate as a substantial portion of our operations are outside the U.S. in jurisdictions with lower tax rates, including Costa Rica, where we manufacture the majority of our products and have a tax holiday that extends through December 2015. In years of loss, our effective tax rate has exceeded the U.S. statutory rate due to the apportionment of income or loss between jurisdictions in which we operate. In the second quarter of 2013, we settled the Internal Revenue Service ("IRS") examination of our federal income tax returns for the 2006 - 2011 tax years and recorded a net income tax benefit of $10 million. We also reversed $3.7 million of deferred tax assets in the second quarter of 2013 related to amounts accrued previously as insurance dispute reserves. We currently estimate that amounts accrued as insurance dispute reserves will be paid to settle the DOJ investigation and as a result we will obtain no income tax deduction when this settlement is paid. We expect to be able to fully utilize our net deferred tax assets, which amounted to $30.9 million as of June 30, 2013.


Table of Contents

Results of Operations

Results of operations for the three and six month periods ended June 30, 2013
and 2012 (in thousands, except percentages and per-share data) were as follows:
                                     Three months ended June 30,                        Six months ended June 30,
                                    2013                    2012                      2013                     2012
                                         % Total                 % Total                   % Total                  % Total
                             Dollars     Revenue     Dollars     Revenue       Dollars     Revenue      Dollars     Revenue

Revenues:
Product sales               $ 87,470      95.0  %   $ 87,471      95.4  %    $ 174,947       94.9 %   $ 175,846      95.3  %
Royalties, fees and other      4,600       5.0  %      4,235       4.6  %        9,470        5.1 %       8,732       4.7  %
Total revenues                92,070     100.0  %     91,706     100.0  %      184,417      100.0 %     184,578     100.0  %

Cost of product sales         28,724      31.2  %     27,355      29.8  %       57,053       30.9 %      54,006      29.3  %

Gross profit                  63,346      68.8  %     64,351      70.2  %      127,364       69.1 %     130,572      70.7  %

Operating expenses:
Research and development       8,659       9.4  %      7,899       8.6  %       17,103        9.3 %      15,493       8.4  %
Sales and marketing           30,218      32.8  %     28,842      31.5  %       60,550       32.8 %      59,042      32.0  %
General and
administrative                 8,683       9.4  %      8,154       8.9  %       16,141        8.8 %      16,642       9.0  %
Amortization of
intangible assets                505       0.5  %      1,316       1.5  %          927        0.5 %       2,637       1.4  %
Exit costs                         -         -  %       (938 )    (1.0 )%            -          - %        (778 )    (0.4 )%
Investigation and
restatement related costs     26,335      28.6  %      1,131       1.2  %       30,227       16.4 %       2,224       1.2  %
Total operating expenses      74,400      80.7  %     46,404      50.7  %      124,948       67.8 %      95,260      51.6  %

Income (loss) from
operations                   (11,054 )   (12.0 )%     17,947      19.6  %        2,416        1.3 %      35,312      19.1  %

Non-operating gains
(losses)                        (392 )                (1,147 )                     129                     (761 )

Income (loss) before
income taxes                 (11,446 )                16,800                     2,545                   34,551

Income tax provision          (4,667 )                 4,536                    (1,860 )                  9,329

Net income (loss)             (6,779 )                12,264                     4,405                   25,222

Accrued dividends and
accretion charges on
Series A 3% Redeemable
Convertible Preferred
Stock                           (929 )                  (887 )                  (1,848 )                 (1,766 )

Net income (loss)
available to common
stockholders                  (7,708 )                11,377                     2,557                   23,456

Other comprehensive
income (loss)
Foreign currency
translation adjustments         (344 )                  (778 )                  (1,443 )                   (386 )

Total comprehensive
income (loss)               $ (7,123 )              $ 11,486                 $   2,962                $  24,836

Weighted-average shares
outstanding:
Basic                         28,081                  27,639                    28,130                   27,648
Diluted                       28,081                  27,934                    28,836                   28,003

Earnings (loss) per share
applicable to common
stockholders:
Basic                       $  (0.27 )              $   0.34                 $    0.08                $    0.70
Diluted                     $  (0.27 )              $   0.34                 $    0.07                $    0.69


Table of Contents

Product Sales

Product sales by product group and geographic market for the periods shown were
as follows (in thousands, except percentages):

                                    Three months ended                                            Three months ended
                                       June 30, 2013                                                 June 30, 2012
                                                                   % Net                                                         % Net
                                                Total Product     Product                                     Total Product     Product
                 Americas      International        Sales          Sales       Americas      International        Sales          Sales

Sports
Medicine        $  37,944     $      20,973     $    58,917       67.4 %      $  38,051     $      19,661     $    57,712       66.0 %
ENT                21,194             5,355          26,549       30.4 %         21,532             5,390          26,922       30.8 %
Other                 311             1,693           2,004        2.2 %            411             2,426           2,837        3.2 %
Total product
sales           $  59,449     $      28,021     $    87,470        100 %      $  59,994     $      27,477     $    87,471        100 %
% Net product
sales                68.0 %            32.0 %           100 %                      68.6 %            31.4 %           100 %




                                     Six months ended                                              Six months ended
                                       June 30, 2013                                                 June 30, 2012
                                                                   % Net                                                         % Net
                                                Total Product     Product                                     Total Product     Product
                 Americas      International        Sales          Sales       Americas      International        Sales          Sales

Sports
Medicine        $  76,806     $      41,727     $   118,533       67.8 %      $  77,081     $      39,943     $   117,024       66.5 %
ENT                40,942            11,223          52,165       29.8 %         43,308            10,783          54,091       30.8 %
Other                 813             3,436           4,249        2.4 %          1,000             3,731           4,731        2.7 %
Total product
sales           $ 118,561     $      56,386     $   174,947        100 %      $ 121,389     $      54,457     $   175,846        100 %
% Net product
sales                67.8 %            32.2 %           100 %                      69.0 %            31.0 %           100 %

Worldwide Sports Medicine product sales increased $1.2 million or 2.1 percent and $1.5 million or 1.3 percent for the three and six month periods ended June 30, 2013, respectively, compared to the same periods in 2012 due to higher proprietary product sales.

Americas Sports Medicine product sales decreased $0.1 million or 0.3 percent and $0.3 million or 0.4 percent for the three and six month periods ended June 30, 2013, respectively when compared to the same periods in 2012. For the three months ended June 30, 2013, contract manufacturing product sales decreased $1.2 million or 18.1 percent and proprietary Sports Medicine product sales increased $1.1 million or 3.4 percent for the three months ended June 30, 2013 when compared to the same period in 2012. For the six month period ended June 30, 2013, contract manufacturing product sales decreased $0.5 million or 4.2 percent and proprietary Sports Medicine product sales increased $0.2 million or 0.3 percent when compared to the same period in 2012. The increase in Americas proprietary Sports Medicine sales in the quarter was a result of higher product sales of Coblation products designed for knee and hip arthroscopies, partially offset by lower average selling prices during the quarter. Fixation product sales were mostly unchanged in the quarter.

International Sports Medicine product sales increased $1.3 million or 6.7 percent and $1.8 million or 4.5 percent for the three and six month periods ended June 30, 2013, respectively, compared to the same periods in 2012. Product sales in direct markets increased 8 percent and 5 percent for the three and six month periods ending June 30, 2013, respectively, when compared to the same periods in 2012 and product sales in direct markets comprised approximately 83 percent of total International Sports Medicine product sales in 2013.


Table of Contents

Worldwide ENT product sales decreased $0.4 million or 1.4 percent and $1.9 million or 3.6 percent for the three and six month periods ended June 30, 2013, respectively, compared to the same periods in 2012 as a result of lower tonsillectomy product sales in the United States. Also, in the first quarter of last year we experienced higher Rapid Rhino product sales resulting from fulfilling approximately $1.0 million of Rapid Rhino back orders from the end of 2011.

Americas ENT sales decreased $0.3 million or 1.6 percent and $2.4 million or 5.5 percent for the three and six month periods ended June 30, 2013, respectively, compared to the same periods in 2012. Tonsillectomy product sales were lower in 2013 than in the prior year. In addition, Americas product sales in the first quarter of last year included approximately $0.7 million related to fulfilled Rapid Rhino back orders from the end of 2011.

International ENT product sales decreased less than $0.1 million for the three month period ended June 30, 2013 and increased $0.4 million or 4.1 percent for the six month period ended June 30, 2013 compared to the same periods in 2012. International ENT product sales in the second quarter of 2013 were lower as a result of the timing of distributor shipments. Product sales in the first quarter of 2012 included approximately $0.3 million related to fulfilled Rapid Rhino back orders from the end of 2011. Product sales in direct markets comprised approximately 60 percent and 55 percent of all International ENT product sales in the three and six months ended June 30, 2013 compared to 49 percent and 54 percent for the same periods in 2012, respectively.

Worldwide Other product sales decreased $0.8 million and $0.5 million for the three and six month periods ended June 30, 2013, respectively, when compared to the same periods in 2012. Other product sales represent approximately 3.0 percent of total product sales in the three and six months ended June 30, 2013 and 2012.

Royalties, Fees and Other Revenues

Royalties, fees, and other revenues was 5.0 percent and 5.1 percent of total revenues for the three and six month periods ended June 30, 2013, respectively, compared to 4.6 percent and 4.7 percent for the same periods in 2012.

Cost of Product Sales

Costs of product sales for the periods shown were as follows (in thousands,
except percentages):

                                          Three months ended
                                                June 30,
                                      2013                   2012
                                           % Net                  % Net
                                          Product                Product
                               Dollars     Sales      Dollars     Sales
Product cost                  $ 24,370      27.9 %   $ 23,195      26.5 %
Controller amortization          1,692       1.9 %      2,199       2.5 %
Other                            2,662       3.1 %      1,961       2.2 %
Total cost of product sales   $ 28,724      32.9 %   $ 27,355      31.2 %


                                           Six months ended
                                               June 30,
                                      2013                   2012
                                           % Net                  % Net
                                          Product                Product
                               Dollars     Sales      Dollars     Sales
Product cost                  $ 48,231      27.6 %   $ 45,511      25.9 %
Controller amortization          3,489       2.0 %      4,408       2.5 %
Other                            5,333       3.0 %      4,087       2.3 %
Total cost of product sales   $ 57,053      32.6 %   $ 54,006      30.7 %

Gross product margin as a percentage of product sales was 67.1 percent and 67.4 percent for the three and six month periods ended June 30, 2013, respectively, compared to 68.8 percent and 69.3 percent for the same periods in 2012. The decrease in gross product margin for the three months ended June 30, 2013 is due to the new Medical Device Tax which came into effect in the first quarter of 2013 and lower plant throughput than in the same periods of 2012.


Table of Contents

Operating Expenses

Operating expenses for the periods shown were as follows (in thousands, except
percentages):

                                 Three months ended                              Six months ended
                                      June 30,                                       June 30,
                           2013                     2012                    2013                   2012
                                % Total                  % Total                % Total                % Total
                    Dollars     Revenue     Dollars      Revenue     Dollars    Revenue    Dollars     Revenue

Research and
development        $  8,659        9.4 %   $  7,899        8.6  %    17,103        9.3 %   15,493        8.4  %
Sales and
marketing            30,218       32.8 %     28,842       31.5  %    60,550       32.8 %   59,042       32.0  %
General and
administrative        8,683        9.4 %      8,154        8.9  %    16,141        8.8 %   16,642        9.0  %
Amortization of
intangible
assets                  505        0.5 %      1,316        1.5  %       927        0.5 %    2,637        1.4  %
Exit costs                -          - %       (938 )     (1.0 )%         -          - %     (778 )     (0.4 )%
Investigation
and restatement
related costs        26,335       28.6 %      1,131        1.2  %    30,227       16.4 %    2,224        1.2  %
Total operating
expenses           $ 74,400       80.7 %   $ 46,404       50.7  %   124,948       67.8 %   95,260       51.6  %

Research and development expense increased $0.8 million and $1.6 million for the three and six months ended June 30, 2013, respectively, when compared to the same periods in 2012 due to increased Sports Medicine new product development costs.

Sales and marketing expense was approximately equivalent at 32.8 percent of total revenue for the three and six months ended June 30, 2013 compared to 31.5 percent and 32.0 percent for the three and six months ended June 30, 2012, respectively. Sales and marketing expense increased in the periods as a result of efforts to expand our sales and distribution coverage and sales force training in support of anticipated future new product introductions.

General and administrative expenses increased $0.5 million and decreased $0.5 million for the three and six month periods ended June 30, 2013, respectively, when compared to the same periods in 2012. The increase in general and administrative expenses for the three months ended June 30, 2013 is primarily due to acquisition costs incurred during the period.

Amortization of intangible asset expense decreased $0.8 million and $1.7 million for the three and six month periods ended June 30, 2013, respectively, when compared to the same periods in 2012. In the fourth quarter of 2012, certain intangible assets related to the acquisition of Opus Medical were fully amortized and written off.

Investigation and restatement expenses increased $25.2 million and $28.0 million for the three and six month periods ended June 30, 2013, respectively when compared to the same periods in 2012. The Company has recently engaged in preliminary resolution discussions with the DOJ regarding the DOJ investigation. As a result of these discussions, management believes that a final resolution of this matter will include a financial component, and management's current best estimate of this financial component is $30 million. Accordingly, the balance of the insurance dispute reserve as of June 30, 2013 was increased to reflect this estimate and a charge of $20.2 million recorded in the second quarter of 2013 as investigation and restatement related expenses. The actual amount could be greater or less, and the timing of the final resolution and payment cannot yet be determined. The increase in investigation and restatement expenses is also a result of additional legal costs related to our indemnification agreements with certain former officers as described in Note 7 of our condensed consolidated financial statements. We expect the indemnification expenses to continue until the matters concerning the former officers are concluded.

Non-operating gains (losses)

Non-operating gains (losses) were a loss of $0.4 million and a gain of $0.1 million for the three and six month periods ended June 30, 2013, respectively, compared to losses of $1.1 million and $0.8 million for the same periods in 2012. The non-


Table of Contents

operating loss for the three months ended June 30, 2013 is primarily a result of foreign currency losses reported by foreign subsidiaries on U.S. dollar inter-company net payables as the U.S. dollar strengthened against the euro, British pound and Australian dollar. The non-operating gain for the six months ended June 30, 2013 includes a gain of $1.7 million received from the extinguishment of our membership interests in a mutual insurance company offset . . .

  Add ARTC to Portfolio     Set Alert         Email to a Friend  
Get SEC Filings for Another Symbol: Symbol Lookup
Quotes & Info for ARTC - All Recent SEC Filings
Copyright © 2014 Yahoo! Inc. All rights reserved. Privacy Policy - Terms of Service
SEC Filing data and information provided by EDGAR Online, Inc. (1-800-416-6651). All information provided "as is" for informational purposes only, not intended for trading purposes or advice. Neither Yahoo! nor any of independent providers is liable for any informational errors, incompleteness, or delays, or for any actions taken in reliance on information contained herein. By accessing the Yahoo! site, you agree not to redistribute the information found therein.