ArthroCare's Fourth Quarter 2006 Revenues Reach $69.8 Million

Revenues Reflect Growth in all Divisions, with Substantial Increase in Spine Business

AUSTIN, Texas--(BUSINESS WIRE)--Feb. 15, 2007--ArthroCare(R) Corp. (Nasdaq:ARTC), a leader in developing state-of-the-art, minimally invasive surgical products, announced that for the fourth quarter ended December 31, 2006 total revenues grew 18 percent compared to the same period in the prior year to $69.8 million. Revenues grew in all divisions both on a year-over-year and sequential quarter basis. Product sales growth was led by a particularly strong 46 percent increase compared to the fourth quarter of 2005 in the Company's spine business due to improved penetration, acceptance by the surgical community and increased reimbursement.

On an as-reported basis, ArthroCare's net income grew to $8.2 million, or $0.29 per diluted share, for the fourth quarter of 2006. This included a pre-tax $2.7 million litigation settlement partially offset by a retroactive R&D tax credit, resulting in a net expense of approximately $1.0 million, or $0.04 per diluted share.

"We are pleased to report a very successful 2006 with significant revenue and earnings growth across all business units and the accomplishment of numerous strategic milestones which position us well for 2007 and beyond," noted Mike Baker, CEO of ArthroCare.

FOURTH QUARTER FINANCIALS

Total revenues, which include product revenues, license fees and royalties, were $69.8 million for the fourth quarter of 2006, an 18 percent increase over the $59.3 million reported in the fourth quarter of 2005 and an eight percent increase over the $64.7 million reported in the third quarter of 2006.

ArthroCare reported net income of $8.2 million, or $0.29 per diluted share, for the fourth quarter of 2006. FAS 123R-related expenses in the fourth quarter resulted in a non-cash charge to net income for stock-based compensation of approximately $1.4 million after taxes, or $0.05 per diluted share. Excluding this required charge, non-GAAP net income for the fourth quarter would have been $9.6 million, or $0.34 per diluted share which represents an increase of 15 percent over the fourth quarter of 2005. A reconciliation of net income calculated in accordance with GAAP and non-GAAP net income measures is provided in the table below under the caption "Reconciliation of GAAP and Non-GAAP Measures."

REVENUE

In addition to fourth quarter product sales of $67.2 million, license fees, royalties and other revenue were $2.6 million in the fourth quarter of 2006, which represents four percent of total revenue, compared to $1.9 million, or three percent of total fourth quarter 2005 revenue. International product sales represented 21 percent of product sales during the quarter.

BUSINESS UNIT PERFORMANCE

The Sports Medicine business unit produced sales growth of 11 percent during the quarter ended December 31, 2006 compared with the same period of 2005, and represented 64 percent of total product sales.

Sales in the Spine business unit during the fourth quarter of 2006 grew 46 percent compared to the same period in 2005, with spine sales representing 12 percent of product sales in the fourth quarter of 2006.

The fourth quarter increase in ENT product sales over the comparable period of last year was 25 percent, with ENT sales representing 24 percent of product sales during the quarter.

OPERATIONS

Product margin was 71 percent in the fourth quarter of 2006, compared to 70 percent in the fourth quarter of 2005. Stock-based compensation expense related to FAS 123R of approximately $0.2 million, or 0.3 points of product margin, was recognized in cost of product sales in the fourth quarter.

Operating expenses were $39.9 million in the fourth quarter, or approximately 57 percent of total revenue and included $1.7 million in stock-based compensation expense. Excluding this expense, which was not required in the fourth quarter of 2005, non-GAAP operating expenses were $38.2 million, or 55 percent of total revenue, versus $31.5 million, or 53 percent of total revenue, in the fourth quarter of 2005. Operating expenses also included a $2.7 million litigation settlement fee, which reduced operating margin by approximately 3.9 points. A reconciliation of operating expenses calculated in accordance with GAAP and non-GAAP operating expense measures is provided below in the table under the caption "Reconciliation of GAAP and Non-GAAP Measures."

FISCAL YEAR-END 2006

For the fiscal year ended December 31, 2006, total revenues reached $263.0 million, a 23 percent increase compared with fiscal 2005 total revenues of $214.3 million. Net income for fiscal year 2006 was $31.7 million, or $1.14 per diluted share, compared to the fiscal year 2005 net income of $23.5 million, or $0.89 per diluted share. FAS 123R-related expenses in 2006 resulted in a non-cash charge to net income for stock-based compensation of approximately $5.4 million after taxes, or $0.19 per diluted share. Excluding this required charge, non-GAAP net income for 2006 would have been $37.1 million, or $1.33 per diluted share which represents an increase of 57 percent over net income reported for 2005 and earnings per share growth of 49 percent in 2006 over 2005. A reconciliation of net income calculated in accordance with GAAP and non-GAAP net income measures is provided in the table below under the caption "Reconciliation of GAAP and Non-GAAP Measures."

BALANCE SHEET

Cash, cash equivalents and short-term investments increased $7.5 million to $30.8 million as of December 31, 2006, compared to $23.3 million at December 31, 2005, and reflected the repayment of the Company's remaining loan balance of $20.0 million during the quarter. Inventories increased to $51.5 million from the $47.8 million reported at December 31, 2005, representing an increase of eight percent, which is significantly less than the 23 percent increase in annual sales volume. Goodwill increased from $59.2 million as of December 31, 2005 to $137.8 million at December 31, 2006. The increase is primarily due to payments made to former Opus shareholders for the satisfaction of contractual contingencies and adjustments to the purchase price of the ATI acquisition for the amount of contingent consideration issued.

BUSINESS OUTLOOK

The following statements are based on current expectations on February 15, 2007. These statements are forward-looking, and actual results may differ materially. These statements do not include the potential impact of any new businesses or license agreements the Company may enter into in future periods.

ArthroCare's business outlook for fiscal 2007 is as follows:

• The Company expects total revenue growth of 20 percent.
• The Company expects the Sports Medicine business unit to achieve revenue growth in the low teens.
• ENT business unit revenue growth is expected to be at least 30 percent.
• Spine business unit revenue growth is anticipated to be at least 50 percent.
• The Company anticipates sequential improvement in quarterly revenue growth rates beginning in the first quarter.
• The Company expects earnings per share growth greater than revenue growth. GAAP diluted EPS is forecasted to be in the range of $1.40 to $1.50.
• The Company expects further improvement in both product and operating margins and for earnings to continue to grow faster than revenue.

RECENT CORPORATE DEVELOPMENTS

• Two key papers were published in peer reviewed journals related to our spine business unit. A case series on cervical PDD by Dr. Bonaldi was published in the American Journal of Neuroradiology and is the first article published on the cervical procedure, and a case series on lumbar PDD by a neurosurgery group in Turkey was published in the Spine Journal.
• In its recently released 2007 ENT and Bronchoscopy report, the Millennium Research Group (MRG) reported that ArthroCare has become the market share leader in the ENT market. They estimated that our share was fractionally higher than 2nd place Medtronic and approximately twice that of Gyrus ENT.
• During the fourth quarter, the Company paid $2.75 million aspart of a Settlement and License Agreement with MarcTec LLC. This agreement granted ArthroCare a non-exclusive, non-transferable, worldwide, irrevocable, perpetual license to make, have made, use import, export, market, sell, have sold, offer for sale, distribute and otherwise exploit certain products in the orthopedic field. The agreement also settles all outstanding litigation between MarcTec and ArthroCare.
• On December 13, 2006, the Board of Directors of ArthroCare Corporation elected Terrence E. Geremski as a new director. Mr. Geremski was also named as a member of the Audit Committee. Mr. Geremski brings more than 25 years of leadership experience from various industries to ArthroCare. He recently retired as senior vice president of Finance and chief financial officer of Carpenter Technology Corporation, an international manufacturer and distributor of specialty metals and engineered products, where he served since 2001.

USE OF NON-GAAP FINANCIAL MEASURES

ArthroCare believes that to properly understand the Company's short- and long-term financial trends, investors may wish to consider the impact of certain charges. These charges result from facts and circumstances that vary in frequency and/or impact on continuing operations. In addition, ArthroCare management uses results of operations before certain charges to evaluate the operational performance of the Company. Investors should consider these non-GAAP measures in addition to, and not as a substitute for, financial performance measures in accordance with GAAP.

RECONCILIATION OF GAAP AND NON-GAAP MEASURES

Non-GAAP results for the three months ended December 31, 2006 exclude stock-based compensation charges associated with the Company's adoption of Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment ("FAS 123R"), on January 1, 2006.