South Street, PhiladelphiaTechnically, for 576 days, ArthroCare was a company with no current reported sales, expenses or earnings. ArthroCare’s silence ended November 18, 2009. The company released its financial statements for the year ended December 30, 2008. Two days later management published the results for the first half of 2009. Six days after that they filed the nine-month numbers for 2009.
ArthroCare Has Sales! Who Knew?
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Technically, companies that sell their stock to the public are supposed to periodically publish their financial results. Technically. So…what happens if they don’t? In ArthroCare’s case, NASDAQ delisted the stock. ArthroCare’s shareholders could still sell (or buy) the shares on a tertiary market known as the “Pink Sheets.”
The “Pink Sheets” are like certain sections of University Avenue in St. Paul or South Street in Philadelphia. Rents are cheap. Turnover is high. The clientele keep things interesting. Pink Sheets are also like the $2 window at Pocono Downs but without the benefit of a handicapper’s tip sheet. Investors won’t find too many $300 million firms among the penny stocks on “Pink Sheet” Avenue.
Stock Performance
Poor ArthroCare. So, how did the company’s stock perform without reported sales or earnings or a mainstream trading venue like NASDAQ? Improbably, the share prices rose 354% or $420 million in total market value.
As the following table illustrates, trading on the Pink Sheets with no reported sales and earnings was, in fact, pretty good for ArthroCare’s shareholders.
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ArthroCare Stock Price Performance — |
NASDAQ One
year before
NASDAQ Six months before
NASDAQ 90 days before
NASDAQ 30 days before
Delisting Jan 16, 2009
Pink Sheets
30 days after
Pink Sheets
90 days after
Pink Sheets
180 days after
Pink Sheets
300 days after
$45.09
(10.8)%
(45.5)%
(67.3)%
$4.42
+15.4%
+104.8%
+157.0%
+353.6%
In the 12 months that led up to NASDAQ’s delisting, ArthroCare’s stock had lost nearly 90% of its value and on the day of delisting the stock had fallen to $4.42 per share. One month after delisting, the stock was up 15.4%. Six months later it was up another 157% to $11.36. This past November 16th, the 300th day since delisting (and still with no reported sales and earnings), ArthroCare’s stock was trading 353.6% above its price at delisting—although at $20.05 it was still half the price recorded one year before delisting.
Not shabby—for a delisted stock, with an interim CEO and no current reported sales and earnings.
Enjoyment of Anticipation
But that became history as of November 18th when ArthroCare reported its financial performance for these past many, many, many weeks. How has the stock performed now that there is financial information? It fell about a half a percent (0.55% to be exact).
Perhaps no news was good news.
Perhaps anticipation is 90% of enjoyment.
Perhaps, in the era of transparency—this time of full disclosure and “sunshine laws”—these days when we are told to illuminate every dark corner of human activity, there is a place for mystery. Perhaps, what we imagine and hope for is more compelling than what we have before us. Perhaps, we are all romantics.
I hope so.
Still, eventually CEO Fitzgerald had to open the kimono.
2008 Sales and Earnings
In his last public comment on likely 2008 sales and earnings performance, former CEO Mike Baker said he expected 2008 sales would reach $380 million, up 20% from 2007 levels. Earnings for 2008, he said, would come in somewhere around $1.95 – $2.00 per share.
The actual 2008 sales numbers, as released a couple weeks ago, were $314.2 million, up 12.3% from a restated $279.7 million. Earnings per share for 2008 were actually a loss of $1.31 per share and the EPS for 2007 was reduced to just $0.02 per share from a previously announced $1.50 fully diluted EPS.
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ArthroCare Summarized Statement of Operations for Years Ended December 31, |
2008
2007
2006
2005
$
millions
As Reported
As Restated
As Reported
As Restated
As Reported
As Restated
Statements
of Operations
Product sales
299, 896
307, 596
268, 495
253, 376
233, 585
206, 533
198, 741
Royalties, fees and other
14, 285
11, 646
11, 221
9, 625
10, 126
7, 801
7, 583
Total sales
$314, 181
$319, 181
$279, 716
$263, 001
$243, 711
$214, 334
$206, 324
Gross profit
219, 221
234, 518
193, 335
186, 163
172, 962
150, 128
145, 042
Operating expenses
256, 771
181, 343
198, 022
143, 693
139, 280
117, 069
117, 199
Net income (loss)
($34, 747)
$43, 180
$491
$31, 675
$27, 673
$23, 530
$19, 084
Basic EPS
($1.31)
$1.57
$0.02
$1.21
$1.06
$0.97
$0.78
Fully diluted EPS
($1.31)
$1.50
$0.02
$1.14
$0.99
$0.89
$0.72
2009 Accelerating Sales, Vanished Earnings
In the first nine months of this year, ArthroCare put up pretty decent sales numbers. Overall sales actually rose 0.9% during that period. More good news was that sales rose 7.7% during the July – September time period, which indicates that the rate of sales growth was accelerating.
Even better news is that ArthroCare’s Sports Medicine and ENT (ear, nose and throat) product sales rose at nearly double-digit rates and accounted for essentially all the sales growth for the company this year (so far). At this rate, most analysts are forecasting that ArthroCare could end the year with about $320 million in reported sales.
Not bad at all.
Earnings, however, are gone. For the first nine months of the year, the company has lost almost $42 million compared to a loss (restated) of $5.8 million for the same period a year earlier. On an operating basis the nine-month loss was $13.6 million. The cost of accrued dividends and other charges for the Series A 3% Convertible Preferred Stock amounted to $27.3 million and that brought the total loss to more than $40 million.
Keys to ArthroCare’s Future
There are three keys to ArthroCare’s future:
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Coblation technology – this has always been the basis of ArthroCare’s business and it remains the company’s future. Coblation is a technology that precisely dissolves targeted tissue and limits damage to surrounding healthy tissue. As a platform technology, Coblation significantly improves many existing surgical procedures and sets the stage for many innovative MIS procedures. With Coblation, ArthroCare can sell devices for many markets and surgical indications.
Litigation – At the front of a long line of litigation is the SEC. The Fort Worth Regional Office of the SEC’s Division of Enforcement is conducting a formal investigation into ArthroCare’s past accounting practices. Assuming that’s eventually settled, management will then confront the U.S. Department of Justice (DOJ). The DOJ is investigating ArthroCare’s spine unit’s past sales, accounting, and billing procedures, particularly as it relates to its convoluted relationship with DiscoCare. Then there’s the grand jury investigation launched by the U.S. Attorney for the Southern District of Florida. Behind the Southern District of Florida is the U.S. Attorney for the Western District of North Carolina who is conducting a separate grand jury investigation. And last but by no means least there are the several private class action lawsuits which have been filed in both federal and state courts. As bad as that may look, in past cases like this (specifically Tyco) once the Feds are settled, the rest seem to fall like dominoes. But, of course, all that remains to be seen.
Merger or Acquisition – Given all the bad news, one has to ask the question; why is ArthroCare’s stock as high as it is? The answer roiling around the blogosphere is acquisition. Ironically enough, in March 2008, as the shorts were pounding ArthroCare’s stock with rumors of accounting irregularities, the company hired Goldman Sachs to evaluate its strategic alternatives including sale of the company, recapitalization or whatever. While events ran ahead of Goldman’s efforts, the time may well be approaching when some of the prospective strategic or private equity buyers that Goldman surfaced would be interested in revisiting a cleaned up and presumably, SEC/DOJ scrubbed ArthroCare.
The now permanent CEO David Fitzgerald, 75-years-old and veteran of a long and distinguished business career, has been from all accounts an outstanding leader during these extraordinarily difficult months. While we have certainly teased the company over spending 576 days to get the numbers right, given the potential problems that could have resulted from NOT getting them right, the time spent was well worth it. Heck, given how well the stock performed shareholders might be forgiven if they’d counseled more delay.
A Cautionary and Hopeful Tale
Still, the story of ArthroCare is both a cautionary and a hopeful tale. With these corrected and filed financial results, ArthroCare’s team and new leadership have demonstrated that both the company and its stakeholders are on the rebound. All of ArthroCare’s stakeholders should give Fitz and his team the MVP award for reconstructing a strong future to look forward to.
React:
Discussion
This is a fascinating development. In my practice we've seen similar outcomes with the revised protocol. The key differentiator seems to be patient selection criteria. Has anyone else noticed the correlation with BMI thresholds?
Great point. I'd push back slightly on the conclusion, the sample size in the cited study is too small to draw population-level inferences. That said, the directional signal is compelling and worth a larger RCT.
We implemented a similar approach last year. Early results are promising but we're still gathering 12-month follow-up data. Happy to share our protocol if anyone is interested.
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