ARTC Arthrocare Corp. (MM)

ArthroCare Corp. (NASDAQ: ARTC), a leader in developing state-of-the-art, minimally invasive surgical products, announced its financial results for the quarter ended and year ended December 31, 2013.

FOURTH QUARTER 2013 SUMMARY

• Total revenue of $101.7 million.
• Income from operations of $16.8 million or operating margin of 16.5%.
• Adjusted income from operations of $20.5 million, or adjusted operating margin of 20.1%
• Net income available to common stockholders of $10.4 million, or $0.30 per diluted share.

FULL YEAR 2013 SUMMARY

• Total revenue of $378.0 million.
• Income from operations of $32.0 million, or operating margin of 8.5%.
• Adjusted income from operations of $69.0 million, or adjusted operating margin of 18.3%
• Net income available to common stockholders of $22.3 million, or $0.64 per diluted share.

FOURTH QUARTER RESULTS

Revenues

Total revenue for the fourth quarter of 2013 was $101.7 million, compared to $96.9 million for the fourth quarter of 2012, an increase of 4.9 percent. Product sales for the fourth quarter of 2013 were $96.6 million compared to $92.2 million in the fourth quarter of 2012, an increase of 4.7 percent.

Worldwide sales of Sports Medicine products increased $3.8 million or 6.0 percent in the fourth quarter of 2013 when compared to the fourth quarter of 2012. In the fourth quarter of 2013 proprietary Sports Medicine product sales in the Americas increased $1.6 million, or 4.7 percent and International Sports Medicine product sales increased $1.3 million, or 5.8 percent as compared to the fourth quarter of 2012. Contract manufactured product sales increased by nearly $0.9 million, or 15.3 percent in the fourth quarter.

Worldwide ENT product sales increased by $0.9 million or 3.2 percent in the fourth quarter of 2013 compared to the fourth quarter of 2012. Americas ENT product sales increased $0.7 million or 3.3 percent in the fourth quarter of 2013 as compared to the same quarter of 2012. International ENT product sales increased $0.2 million or 3.0 percent.

Income from Operations

Income from operations for the fourth quarter of 2013 was $16.8 million compared to $15.1 million for the same period in 2012.

Gross product margin as a percentage of product sales was 68.6 percent for the fourth quarter of 2013 compared to 69.9 percent for the fourth quarter of 2012. The comparability of gross product margin between periods was impacted by the medical device excise tax imposed on US product sales by the Patient Protection and Affordable Care Act, which became effective in 2013.

Total operating expenses were $54.6 million in the fourth quarter of 2013 compared to $54.1 million in the fourth quarter of 2012. During the fourth quarter of 2013, as a result of the termination of the contract with one of the subtenants of our former Austin, Texas location, an additional $0.7 million was accrued for Exit Costs. Sales and marketing expenses increased $2.8 million, to 32.2 percent of total revenues this quarter compared to 30.9 percent for the same quarter of 2012. These increases were partially offset by lower investigation and restatement related costs of $2.8 million.

Net Income Available to Common Stockholders

Net income applicable to common stockholders was $10.4 million in the fourth quarter of 2013 and $10.3 million in the fourth quarter of 2012, or $0.30 per diluted share in both periods.

FULL YEAR RESULTS

Revenues

Total revenue in 2013 was $378.0 million, compared to $368.5 million for 2012, an increase of 2.6 percent. Product sales in 2013 were $358.6 million compared to $350.7 million in 2012, an increase of 2.3 percent.

Worldwide Sports Medicine product sales increased $8.2 million or 3.5 percent in 2013 compared to 2012. Sports Medicine product sales in the Americas increased $2.9 million in 2013 compared to 2012 as proprietary product sales increased $3.2 million or 2.5 percent in 2013. International Sports Medicine product sales increased $5.3 million or 6.6 percent in 2013 compared to 2012. Contract manufactured product sales decreased $0.3 million, or 1.4 percent in 2013.

Worldwide ENT product sales increased $0.1 million or 0.1 percent in 2013 compared to 2012. ENT product sales in the Americas decreased $1.4 million or 1.7 percent in 2013 compared to the prior year. International ENT product sales increased $1.6 million or 6.9 percent in 2013 compared to 2012.

Worldwide other product sales decreased $0.5 million in 2013 when compared to 2012 and represented less than 3 percent of total product sales in 2013.

Income from Operations

For the full year of 2013, income from operations was $32.0 million compared to $64.1 million in 2012.

Gross product margin as a percentage of product sales for the full year of 2013 was 67.6 percent compared to 69.2 percent in 2012.

Total operating expenses were $229.8 million in 2013 compared to $196.4 million in 2012. Investigation and restatement related costs increased $26.2 million in 2013 as a result of a charge of $20.2 million to increase the Company's accrued liabilities for the likely financial penalty it would be required to pay to resolve its ongoing DOJ investigation. As previously announced, on December 31, 2013, the Company entered into a Deferred Prosecution Agreement ("DPA") with the DOJ which resolved the ongoing investigation by the DOJ. Pursuant to the DPA, the Company agreed to pay a $30 million fine to the DOJ which was consistent with the total liability accrued. The increase in investigation and restatement related expenses is also a result of additional legal costs related to our indemnification agreements with certain former officers. Increases in sales and marketing, research and development, and exist costs for the year were partially offset by lower amortization of intangible assets.

Under the short-term incentive plan for 2013 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 9.8 percent and 2.9 percent of total revenue for 2013 and 2012, respectively, and Adjusted Operating Margin was 18.3 percent and 20.3 percent, respectively, for these years. 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 Income Available to Common Stockholders

For the year ended December 31, 2013, net income applicable to common stockholders was $22.3 million, or $0.64 per diluted share, compared to $42.8 million, or $1.25 per diluted share for the year ended December 31, 2012.

BALANCE SHEET AND CASH FLOWS

Cash and cash equivalents were $214.9 million as of December 31, 2013 compared to $218.8 million at December 31, 2012. Cash flows provided by operating activities for the year ended December 31, 2013 was $72.4 million compared to cash provided by operations of $6.3 million for the year ended December 31, 2012 which included the payment of $74 million required to settle the private securities class actions against the Company. Adjusted for this payment, cash flows provided by operating activities would have been $80.3 million for the year ended 2012. Cash used in investing activities for the year ended December 31, 2013 was $85.1 million which includes cash paid for the acquisitions of Eleven Blade Solutions, Inc. and ENTrigue Surgical, Inc. and to purchase an investment in OrthoSpace Ltd.

SUBSEQUENT EVENTS

On February 3, 2014, the Company announced the entry into an Agreement and Plan of Merger with Smith & Nephew, Inc. and its wholly-owned subsidiary, pursuant to which the Company agreed to be acquired by Smith & Nephew and become its wholly-owned subsidiary. The completion of the transaction is subject to customary conditions, including approval by the Company’s stockholders, the absence of any material adverse effect on the Company’s business and receiving antitrust approvals, including under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. A more complete summary as well as a copy of the Merger Agreement can be found in the Company’s Form 8-K/A filed on February 3, 2014.

On February 11, 2014, the Series A Preferred Stock was converted to 5,805,921 shares of the Company's Common Stock in accordance with the terms of its automatic conversion feature.

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 effect of the pending merger with Smith & Nephew on the Company’s relationships with employees, customers, suppliers and other third parties; transaction costs associated with the pending merger; the possibility that we may not receive the regulatory approvals or shareholder approval required under the Merger Agreement with Smith & Nephew; the possibility that we may be unable to successfully consummate the pending merger with Smith & Nephew; the possibility that under some circumstances we have may to pay Smith & Nephew a termination fee of $54.9 million; the potential diversion of the attention of management and employees from day-to-day activities as a result of the pending merger; the resolution of the deferred prosecution agreement (“DPA”) the Company entered into with the Department of Justice, including the fulfillment by the Company of the reporting requirement under the DPA, the impact on the Company of additional civil and criminal investigations by state and federal agencies, if any, regarding any of the matters contained in the DPA; litigation pending against the Company; the impact upon the Company’s operations of legal compliance matters required under the DPA; 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 risk that we could be subject to qui tam suits involving the False Claims Act; 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 protect its intellectual property rights; the ability of the Company to continue to fund its working capital needs and planned expenditures; the risk of product liability claims; risks associated with the Company’s international operations; risks associated with integration of the Company’s acquisitions; 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 Consolidated Balance Sheets (in thousands, except par value data)       December 31, 2013     2012 ASSETS Current assets: Cash and cash equivalents $ 214,853 $ 218,787 Accounts receivable, net of allowances of $1,255 and $1,565 at 2013 and 2012, respectively 52,810 48,881 Inventories, net 46,288 48,417 Deferred tax assets 12,371 20,090 Prepaid expenses and other current assets 6,056   6,022   Total current assets 332,378 342,197 Property and equipment, net 51,244 30,461 Intangible assets, net 14,581 1,859 Goodwill 165,953 119,893 Deferred tax assets 25,842 23,206 Other assets 4,143   2,171   Total assets $ 594,141   $ 519,787   LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 18,325 $ 12,189 Accrued liabilities 64,948 41,674 Deferred tax liabilities 3 33 Deferred revenue 350 285 Income tax payable 1,372   286   Total current liabilities 84,998 54,467 Deferred tax liabilities 249 354 Other non-current liabilities 21,305   20,200   Total liabilities 106,552 75,021 Commitments and contingencies (Notes 9 and 10) Series A 3% Redeemable Convertible Preferred Stock, par value $0.001; Authorized: 100 shares; Issued and outstanding: 75 shares at December 31, 2013 and 2012, respectively. Redemption value: $87,089 84,494 80,759 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: 32,385 and 31,949; Outstanding: 28,466 and 27,977 shares at December 31, 2013 and 2012, respectively 28 28 Treasury stock: 3,919 and 3,942 shares at December 31, 2013 and 2012, respectively (105,798 ) (106,425 ) Additional paid-in capital 429,979 413,660 Accumulated other comprehensive income 5,121 5,300 Retained earnings 73,765   51,444   Total stockholders' equity 403,095   364,007   Total liabilities, redeemable convertible preferred stock and stockholders' equity $ 594,141   $ 519,787       ARTHROCARE CORPORATION Consolidated Statements of Comprehensive Income (in thousands, except par value data)      

Three Months Ended December31, 2013

    Years Ended December 31, 2013     2012 2013     2012 Revenues: Product sales $ 96,556 $ 92,223 $ 358,564 $ 350,671 Royalties, fees and other 5,152   4,713   19,425   17,783   Total revenues 101,708 96,936 377,989 368,454 Cost of product sales 30,336   27,741   116,264   107,951   Gross profit 71,372   69,195   261,725   260,503   Operating expenses: Research and development 8,428 8,469 33,965 32,146 Sales and marketing 32,723 29,910 122,595 116,127 General and administrative 8,537 8,379 33,463 33,212 Amortization of intangible assets 534 857 1,996 4,857 Exit costs 695 — 695 (778 ) Investigation and restatement-related costs 3,654   6,442   37,046   10,805   Total operating expenses 54,571   54,057   229,760   196,369   Income (loss) from operations 16,801 15,138 31,965 64,134 Total other income (expense) (952 ) 151   (850 ) (427 ) Income (loss) from continuing operations before income taxes 15,849 15,289 31,115 63,707 Income tax provision (benefit) 4,471   4,118   5,059   17,329  

Net income (loss)

11,378 11,171 26,056 46,378 Accrued dividend and accretion charges on Series A 3% Redeemable Convertible Preferred Stock (947 ) (909 ) (3,735 ) (3,575 ) Net income (loss) attributable to common stockholders 10,431   10,262   22,321   42,803   Other comprehensive income Foreign currency adjustments 133   120   (179 ) 685   Total comprehensive income (loss) $ 11,511   $ 11,291   $ 25,877   $ 47,063   Weighted-average shares outstanding: Basic 28,480 27,912 28,311 27,752 Diluted 29,160 28,341 28,988 28,407 Earnings per share applicable to common stockholders: Basic $ 0.30   $ 0.30   $ 0.65   $ 1.28   Diluted $ 0.30   $ 0.30   $ 0.64   $ 1.25       ARTHROCARE CORPORATION Supplemental Schedule of Product Sales - Unaudited (in thousands)                                 Year Ended December 31, 2013 Year Ended December 31, 2012 Americas International

TotalProductSales

% NetProductSales

Americas International

TotalProductSales

% Net ProductSales

  Sports Medicine $ 158,063 $ 85,963 $ 244,026 68.1 % $ 155,164 $ 80,631 $ 235,795

67.3

% ENT 81,436 24,406 105,842 29.5 % 82,880 22,835 105,715 30.1 % Other 1,497   7,199   8,696   2.4 % 1,831   7,330   9,161   2.6 % Total product sales $ 240,996   $ 117,568   $ 358,564   100.0 % $ 239,875   $ 110,796   $ 350,671   100.0 %     Three Months Ended December 31, 2013 Three Months Ended December 31, 2012 Americas International

TotalProductSales

% NetProductSales

Americas International

TotalProductSales

% Net ProductSales

Sports Medicine $ 43,847 $ 23,562 $ 67,409 69.8 % $ 41,298 $ 22,274 $ 63,572 68.9 % ENT 20,566 6,392 26,958 27.9 % 19,895 6,205 26,100 28.3 % Other 311 1,888 2,199 2.3 % 508   2,043   2,551   2.8 % Total product sales $ 64,724   $ 31,842   $ 96,566   100.0 % $ 61,701   $ 30,522   $ 92,223   100.0 %

ArthroCare Corp.Misty Romines, 512-391-3902