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ArthroCare Corporation’s Third­ Quarter Results Ahead of Expectations

Wednesday, after the markets closed, ArthroCare reported third‐quarter results ahead of expectations on the top and bottom line. Revenue of $86.9 million exceeded our target by $1.1 million and the Street by $2.4 million, primarily because of better‐than‐ expected sales in both the company’s proprietary Americas sports medicine business and OEM business. Adjusted EPS of $0.33 topped our target by $0.02.

The company’s proprietary Americas sports medicine business improved in the quarter, with sales of $30.1 million, up 5.5% year‐over‐year. It appears that the distributor adjustments are continuing to gain traction, as the company saw improved interest among its customers related to its several fixation products and initial momentum in newly launched products, resulting in increases in the company’s average selling prices. OEM revenue of $6.7 million was up 42.4% from the year‐ago period.

This business is quite volatile quarterly but fairly steady on an annual basis. International sports medicine sales of $18.4 million (down 2.3%) missed our target by $0.6 million, primarily because of negative foreign‐currency movements. This segment of the company begins to lap easy comparisons during the fourth quarter and throughout next year, which should set it up for solid relative performance in 2013.

On the ENT side of the business, sales of $25.5 million (up 2.5%) exceeded our target by $0.6 million. In the Americas, coblation product sales in the quarter were soft, owing to a slowdown in tonsillectomy procedures and increased reprocessing of the company’s wands. A recent professional society guideline change—it is now recommended that patients with chronic strep throat receive antibiotic treatment five to seven times before a tonsillectomy is prescribed, compared with three times previously—had caused a disruption in patient referral patterns last quarter as well.

In addition, more ENT procedures are shifting from hospitals to ambulatory surgical centers, which is hurting ArthroCare since surgeons are much more price conscious in this environment and are shifting to lower‐cost alternatives. We will monitor this dynamic in the coming quarters since it may weigh on the performance of this franchise for several quarters. International ENT sales of $5.8 million were up 20.5% off a difficult comparison (33.4% growth in third quarter 2011), as the Asia‐Pacific region continues to expand at a rapid pace. We anticipate this trend will persist in the coming quarters and drive strong growth from this business.

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