ArthroCare Revenues Grow 27% This Quarter - Parallax Experiences Supply Issues
BY JOHN MCCORMICK, JULY 26, 2004
ArthroCare achieved total revenues of $37.7 million for 2Q:04; a 27% year over year increase compared to the $29.7 million achieved in 2Q:03 largely driven by US revenues.
The Sports Medicine business unit (64% of product revenue) exceeded management's expectations and grew 14% year-over-year for the quarter due to strong surgeon adoption of new wands and the Atlas controller system. The TOPAZ' procedure, a radiofrequency treatment for tendons, was noted by management as generating significant surgeon interest. Although revenues were slightly down sequentially from Q1 to Q2, this is a seasonal issue attributable to March capital spending in the UK affecting ArthroCare's Atlantech unit. In the Americas, sports medicine revenues were up 1% sequentially. The big event of the quarter was ArthroCare's slam dunk in its patent infringement suit against Smith & Nephew. Smith & Nephew was forced by the U.S. District Court of Delaware to stop designing, manufacturing and selling its bipolar RF electrosurgical devices. Details are discussed in our June 14 article. This ruling did not have an effect on 2Q:04 and has not changed ArthroCare's 20% revenue growth estimates for both 2004 and 2005 at this time.
The Spine business unit (15% of product revenue) grew at 55% year-over-year for the quarter. While 55% is a stellar growth number, sequential growth from the prior quarter was a meager 0.5%. Company management attributes this to supplier issues associated with the recently acquired Parallax business. The problems caused a $0.5 million to $1.0 million revenue shortfall versus expectations. In fact, Parallax sales decreased from the prior quarter. Sales of ancillary ArthroCare spine products used for cavity procedures were also weakened. The Company has certainly not been able to branch out to new customers.
ArthroCare is actively seeking a supplier upgrade and logistics overhaul for in order to gear up Parallax for a much larger sales volume in the future. Suppliers have, in turn, had problems responding to the Parallax post-acquisition revenue ramp and the supply chain restructuring that ArthroCare is seeking to implement. CEO Mike Baker indicated that the 'immediate' issues should resolve by the end of the third quarter of this year. The Parallax supply chain should be 'completely reconfigured' by the year end. Parallax may even beat its $7-$8 million revenue target. We note that switching or restructuring vendors in medical device manufacturing is not a simple matter with training and documentation requirements standing in the way, however. This is a development we are going to watch with great interest. Growth in the spine segment is also being hindered by continued reimbursement issues with DISC Nucleoplasty' (applying Coblation to herniated discs); the exception being cervical Nucleoplasty' applications. Management noted that Nucleoplasty' is growing despite the reimbursement issues.
The ENT business unit (20% of product revenue) grew 74% year-over-year for the quarter driven by successes with ENT Coblator' II system and EVac' tonsillectomy wands. Coblation technology is gaining acceptance among ENT surgeons according to ArthroCare's management who is on a mission to make their technology the standard of care for tonsillectomies across the US.
On the operations front, controller manufacturing is finally being moved to ArthroCare's Costa Rica manufacturing facility in the second half of this year. There will be a one time charge of $0.5mm to $1.0mm in the third quarter that the Company believes it could make back by year end owing to increased product margins. The Company also opened up a small finance and administration office in Austin, TX. Both of these actions allow the Company to reduce its California overhead costs.
ArthroCare reported net income of $3.1 million, or $0.14 per diluted share, for 2Q:04 versus $2.0 million, or $0.09 per diluted share in 2Q:03. ArthroCare expects to improve operating margins 4 to 5% in 2004 as compared to 2003 (e.g. up to 11 to 12% this year). As a result, the Company expects earnings per share (EPS) for fiscal 2004 to be between $0.52 and $0.56, with an assumed share count of 23.1 million.
