ArthroCare Corp's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Oct.30.13 | About: ArthroCare Corporation (ARTC)

ArthroCare Corp (NASDAQ:ARTC)

Q3 2013 Earnings Conference Call

October 30, 2013 / 8:30 a.m. E.T.

Executives

Misty Romines – IR

David Fitzgerald – President, CEO

Todd Newton – EVP, CFO, COO

Analysts

Mike Kline – Piper Jaffray

Matt Hewitt – Craig-Hallum Capital Group

Joanne Wuensch – BMO Capital Markets

Bill Plavonic – Canaccord Annuity

Operator

Welcome to the Q3 2013 financial results and business updates conference call. (Operator Instructions). I would now like to turn the conference over to Misty Romines, Investor Relations. Please go ahead, ma'am.

Misty Romines

Good morning, and welcome to ArthroCare's conference call to discuss our third quarter 2013 operating results. Joining us on this call are David Fitzgerald, President and Chief Executive Officer of ArthroCare and Todd Newton, ArthroCare's Executive Vice President, Chief Financial Officer and Chief Operating Officer. By now you all should have seen a copy our press release, which was released yesterday afternoon but if you have not it is available on our website www.arthrocare.com. A live and on-demand webcast of the conference call is also available on our website.

Following introductory comments by management, we will open up the line for a short question and answer session. In order to get as many of you as possible an opportunity to ask questions, we will accept one question and one follow-up per caller after which we welcome callers to rejoin the queue. Before we begin, we would like to advise you of our Forward-looking statements.

Other than historical information, the matters we will be discussing today consist of Forward-looking statements. These statements are subject to the risks and uncertainties detailed in our Securities and Exchange Commission filings including our 10-Q for the quarter ended September 30th, 2013 that was filed yesterday afternoon. Actual results could materially differ from our Forward-looking statements.

The statements made in this conference call are based on the information available to ArthroCare today, and the Company does not undertake any obligation to update or correct them before its regularly scheduled call at the end of next quarter. Certain non-GAAP measures may be used during today's call. A reconciliation of these measures to the most directly comparable GAAP measure can be found in the Investor Relations section of our website, I will now turn the call over to David Fitzgerald.

David Fitzgerald

Thank you, Misty. Good morning, ladies and gentlemen. Thank you for joining us this morning. Todd will shortly update you on the results of our third quarter, but first I want to address a couple of other matters. During our last quarter review, we communicated that we were in resolution discussions with the DOJ and were increasing our contingency reserve to $30 million, which still reflects our best estimate of the financial component of a final resolution. As we also stated last quarter, we think the resolution will likely involve continuing obligations for the Company under a deferred prosecution agreement with the government.

The Board of Directors of ArthroCare determined that it needed to add a director to best position it to meet these potential obligations. Accordingly, the Company filed a proxy statement last week for a special shareholder meeting on December 12th, 2013. At this meeting our Board is recommending to increase the maximum size of the Board of Directors from eight directors to nine as well as elect Fabiana Lazerca Allen as a ninth member.

Ms. Lazerca Allen has extensive experience implementing and managing regulatory and legal compliance programs including programs with periodic governmental certification requirements. Please refer to schedule 14-A that was filed with the SEC for more details. We do not have any further information on the DOJ matter to provide you on this call. Discussions are ongoing.

The actual amount of the financial component may be greater or less than our estimate, and the timing of the final resolution cannot yet be determined. While we wish we had more information to share with you at this time, we do not feel it would be prudent to speculate with you today on any of the aspects of a possible resolution. So I will now turn the call over to Todd to run through the third quarter results in more detail, and I will come back before questions with further comments. Todd.

Todd Newton

Thank you, David. Total revenues were $91.9 million this quarter versus roughly $87 million for the third quarter of last year, an increase of about $4.9 million or 5.7%. Product sales increased 5.4% this quarter to $87.1 million compared to $82.6 million in the third quarter of 2012.

In constant currency, the increase in product sales was 5.8% for the third quarter of 2013. In Sports Medicine worldwide product sales in increased $2.9 million or 5.2% due to higher proprietary product sales. In constant currency, Sports Medicine product sales increased 5.8% for the three months ended September 30th when compared to the same period in 2012. For proprietary Sports Medicine product which are those products that are ArthroCare branded and distributed, worldwide product sales increased roughly $3..7 million or 7.5% this quarter.

However, contract manufactured product sales decreased by 11.2% to $5.9 million this quarter compared to $6.7 million in the third quarter of 2012. In the Americas proprietary Sports Medicine product sales increased $1.4 million or 4.5%, which was partially offset by the decrease in contract manufactured product sales in the quarter that I just mentioned.

The increase in Americas proprietary sport medicine product sales in the quarter was a result of higher coblation product sales partially offset by a 2% decrease in average selling price during the quarter. The coblation customer base in the Americas increased in the third quarter both in terms of number of customers and revenues per customer. Within the coblation product portfolio products sales increased for each of the three primary procedural product groupings. Those being shoulder, knee and hip lines.

Fixation product sales were mostly unchanged in the third quarter in terms of both volume and pricing versus the prior year. International Sports Medicine product sales increased $2.3 million or 12.3% in the third quarter of 2013 compared to the same period in 2012.

Product sales in direct markets which make up just over 80% of our International Sports Medicine product sales increased 6% on an as reported basis and 8.3% on a constant currency basis. In addition, Sports Medicine product sales to distributor markets also increased this quarter most notably to Asia-Pacific and Southern European distributors. In ENT worldwide products sales increased by $1.2 million or 4.7% in the third quarter of 2013 compared to the same quarter last year.

Changes in foreign exchange rates did not have a material effect on reported ENT product sales this quarter. In the Americas, ENT product sales increased just under $300,000 or 1.3% as compared to the third quarter of 2012. The difference this quarter was the new products acquired in the ENTrigue Surgical acquisition.

Coblation product sales in the Americas showed some improvements over the last couple of quarters, but continue to be soft overall as a result of a weak tonsillectomy procedure market in the United States. International ENT product sales increased by about $900,000 or 16.2% over the third quarter of last year. ENT product sales in the International direct markets which make up about 50% of all International ENT product sales increased 10% this quarter. ENT product sales to distributor markets also increased this quarter, although we estimate that a portion of this increase was making up for the fact that distributor sales were somewhat weaker in the second quarter of this year.

Other product sales which are primarily spine coblation product sales increased $400,000 in the third quarter of 2013 as compared to the same period a year-ago. Other product sales continue to represent a small portion of total product sales. Royalty fees and other revenue was $4..8 million in the third quarter of 2013 compared to $4.3 million in the same period of 2012.

Overall, we think the third quarter was a good revenue quarter for the Company. Continuing now with the review of third quarter earnings, the Company's gross profit in the third quarter of 2013 increased $2.3 million compared to the third quarter of 2012 due to higher revenues.

Gross product margin for the third quarter of 2013 was 66.8% compared to 68.3% in the third quarter of 2012. The largest single factor causing the decrease in gross product margin this quarter is the medical device tax which came into effect on January 1 for all US product sales. Gross product margin was also lower as a result of lower average selling prices on Sports Medicine product sales and changes in product mix when compared to the same period of 2012.

This quarter, we reported operating income of $12.7 million compared to $13.7 million in the third quarter of 2012 for an operating margin in the third quarter of 2013 of 13.9% compared to a 15.7% operating margin for the same quarter in 2012.

Operating expenses were $50.2 million this quarter compared to $47.1 million in the third quarter of 2012, an increase of $3.1 million. In the third quarter of this year, we incurred $3.22 million in investigation and restatement related costs which was an increase of $1 million over the third quarter of 2012.

Adjusted operating margin which is operating margin excluding investigation and restatement related costs was 17.3% in the third quarter of 2013 compared to 18.2% for the third quarter of 2012.

Research and development costs were $8.4 million in the third quarter as compared to $8.2 million in the same quarter of last year, an increase of about $200,000, and the increase in R&D expenditure is primarily due to increased sports medicine and new product development costs.

Sales and marketing expense as a percentage of total revenue was 31.9% in the third quarter of 2013 compared to 31.2% in the third quarter of 2012. This increase is part of a continuing trend related to internal efforts to prepare our sales and distribution organization to be effective in new procedure areas such as knee procedures in Sports Medicine and sinus procedures in ENT.

Our goal is to expand our sales and distribution coveraging and increase sales force training in advance of anticipated future product introductions. In addition, sales and marketing expense this quarter included incremental severance-related costs of $300,000. Funeral and administrative expenses increased by approximately $600,000 this quarter over the third quarter of 2012 as a result of $700,000 of one-time transaction costs and severance related costs associated with the ENTrigue acquisition.

Partially offsetting the increased operating expenses this quarter was lower amortization expense of intangible assets as we had fully amortized certain intangible assets related to our 2004 acquisition of Opus Medical by the end of 2012. In summary, earnings applicable to common stock holders was $0.27 per share in the third quarter of 2013, the same EPS as reported in the third quarter of 2012.

The Company's effective tax rate was lower this quarter than what we would typically expect as a result of finalizing the settlement of the IRS examination that we discussed earlier this year. Turning to our balance sheet and liquidity, there are a number of initiatives that we have funded with our cash thus far this year including the ENTrigue Surgical and Eleven Blade acquisitions, the Orthospace investment and progress payments for the construction of a new manufacturing facility in Costa Rica. In aggregate, cash used in investing activities have amounted to $77.3 million so far this year, and most of these investments have been funded by cash flow from operations generated this year.

As of September 30th, 2013, cash and quash equivalents were $208.4 million compared to $218.8 million as of the beginning of this year. And with that, I will turn the call back over to David.

David Fitzgerald

Thanks, Todd. I will start my business update by addressing the status of our recent acquisition. As you already know, at the beginning of the third quarter we made two strategic investments. First, we acquired ENTrigue Surgical. With more than 30 million Americans suffering from sinusitis and 500,000 of those being surgically treated each year, the sinus market is an important segment within the ENT field.

The acquisition of ENTrigue gives us and entry into the sinus market. Sinus surgery has been an area that we have desired to enter for some time and is consistent with the primary call point of our ENT sales organization. We think the ENTrigue products will complement our current coblation and Rapid Rhino product lines used by ENT surgeons worldwide.

Our immediate goal for ENTrigue this quarter was to train our sales force on the products and scale-up their suppliers to meet our broader business requirements, and this is what we spent the majority of our time on this past quarter. At the end of the quarter we profiled for the first time our new combined ENT portfolio at the recent AAOHNS Academy meeting in Vancouver, and we are very encouraged by the feedback and interest shown from our customers. ENTrigue did not have a large sales base at the time of our acquisition.

In the fourth quarter, we expect a high level of activity around initial product evaluations by our customer base, but expect that product sales growth will trend relatively slowly over the next couple of quarters. We intend to be more deliberately roll out ENTrigue to International markets during 2014. We also announced this quarter a smaller investment in ArthroSpace Limited.

In addition to our investment, we obtained distribution rights for the InSpace product in certain markets outside the United States. We think that ArthroSpace InSpace product could be a unique solution for patients with pain associated with an inoperable rotator cuff tear, but who are otherwise not candidates for more invasive shoulder replacement or reverse shoulder procedure. The product is currently CE marked in Europe, and we will learn more in the months ahead about this product's market potential.

Going back to the beginning of the year, we also announced the acquisition of Eleven Blade and they were all suture soft anchor technology. Since acquisition, we have been working to develop this technology into a product offering that will consistently achieve the critical needs of its intended market, that being arthroscopic labial repairs in both the shoulder and hip. The product received regulatory clearance at the end of September and is now going through its initial clinical evaluation. If the clinical evaluation progresses as we expect, it will be launched early next year.

Most of you know that building the greater presence in the arthroscopic knee market is a strategic initiative for ArthroCare as it is a significant opportunity for future growth, and we are investing to be able to participate in this procedure area. We have begun to see benefits from our comprehensive Knee Campaign for Sports Medicine. The medical education component of this campaign was initiated last year and our goal was to address head on common misconceptions and reinforce the clinical coblation during knee arthroscopy through the third quarter. Over 150 surgeons have participated in educational events held as part of this campaign.

In addition our mobile lab has made over 20 stops with 180 attendees trained. We think this program is an important part of why we have experienced increase in coblation product sales in the Americas this quarter. Another element of our knee strategy is to develop a portfolio of knee fixation products and we have been developing over the last few quarters and ACL reconstruction system as our initial knee fixation offering. We expect to file regulatory clearances later this year for the system and hope to begin its initial clinical evaluations in early 2014.

The last element of our new strategy was to develop a new and advanced energy platform that can deliver coblation operating modes specifically designed for knee tissue types. This new coblation platform should undergo its initial clinical evaluation outside the United States in the first half of 2014, and if this progresses well, we expect it to be ready for the US market introduction in the second half of 2014. Our ENT strategy is to expand indications and our ENT revenue base so that we are less dependent on attributes electric product sales in the tonsil area. ENTrigue is obviously an important piece of this strategy.

In addition, we continue to focus on expanding the ENT indications and procedures that can benefit from coblation. This quarter, we received FDA clearances for two such coblation products. The first product is what we call the Turbirnator Wand.

We expect this wand to refresh our portfolio for turbinate reduction. The turbinator was FDA cleared in July, and thereafter we completed its initial clinical evaluations with good reviews. We introduced this wand as part of the AAOHNS Academy meeting at the end of September. We are currently completing the full transfer of this product into manufacturing and expect to begin the product's roll out during the fourth quarter.

The second product is the Head and Neck Wand. This wand was FDA cleared in August, and it too, has been successfully through its clinical evaluations, and we expect it to be released on a limited basis in select markets by the end of the year. New product flow is very important in our industry, and I think our pipeline is very robust at this time. Critical to the success of our new products will be our sales force, and as indicated by our increased expense in the sales and marketing area this quarter, we have been actively looking to prepare our US and OUS sales and distribution organization for the products to come, but also so that we do not lose sight of supporting our existing products and customers in both Sports Medicine and ENT.

Let me finish by updating our outlook for 2013. We started the year with an overall revenue growth outlook of between 2% and 4.5%. During last quarter's update, we advised you we thought the year would come in at the lower end of our range and as a results of uncertainties concerning the timing of new product introductions in the second half of this year.

These uncertainties remain, and we continue to anticipate that revenue growth will be at the lower end of our 2% to 4.5% range. At this point, we have achieved growth of 1.8% during the first nine months of 2013 and just under 2% on a constant currency basis.

For operating margin, our outlook was to achieve and adjusted operating margin equivalent to our 2011 adjusted operating margin, which was 18.4%. Through the first nine months of this year, adjusted operating margin was 17.6%. Through the first nine months, we have incurred one-time acquisition related transaction costs and integration costs of $1.3 million, which if backed out of the operating expenses, would result in an adjusted operating margin of 18% over the first nine months of this year.

Free cash flow through the third quarter was $50 million. During the remainder of this yes and through next year, we expect to incur higher capital expenditures in connection with our previously-announced plans to construct a new manufacturing facility in Costa Rica. The new factory space will allow us many opportunities to address current operational inefficiencies of our existing facility while giving us space to support the new technologies that are vital to our future business success.

In addition, we expect the investment will lead to the extension of many of the local government tax benefits that our Costa Rican operation currently receives. We will now open the call for a brief question and answer session, and then I will provide a few closing remarks. Operator.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from the line of Matt Miksic with Piper Jaffray. Please proceed.

Mike Kline – Piper Jaffray

Hello. Good morning it's Mike Kline on for Matt. Can you hear me okay?

David Fitzgerald

Yes.

Mike Kline – Piper Jaffray

What color can you provide on your interactions with the DOJ? Maybe any change in the pace of discussions or any indications as to when you think you might receive the final terms of the settlement?

David Fitzgerald

As I said earlier on the call, we really do not have any more color than we said. We are continuing to have discussions with them, and our expectations are sometime in the next couple of month, hopefully, that – but we are not sure when this is going to happen. I do not want to be optimistic, and it remains as we said. We are in discussions with them, and we will continue to give you and update when we get more information.

Mike Kline – Piper Jaffray

Sure. Okay. Understood. And then gist one quick follow-up. Just as it relates to sales guidance. I guess you reported 3Q sales above what we were looking for, and I am just curious – I know you reiterated the guidance towards the bottom end of the range. But has anything changed in terms of the outlook at market or better visibility, or is it all right now being driven by the timing of new product launches?

Todd Newton

We really anticipate the new product launches are going to continue to be the most important factor to sales growth. While the market is – with the exception of the tonsillectomy market and ENT, stable I would say, we do not see the procedure market as such growing at a fast pace.

So this quarter we feel like we made good in-roads in the coblation area in particular in Sports Medicine as we commented upon, an increase in both the number of active customers and our dollars per active customer indicates that we did really well with getting that product to be adopted in more procedures than in the past, and you can think about that as market share increases, but it is also we think a big reason behind is the knee education program that we have had underway for the last year and a half, and we think that that is picking up some traction as well.

Mike Kline – Piper Jaffray

Okay. Thank you very much.

Operator

And our next question comes from the line of Matt Hewitt with Craig-Hallum Capital Group. Please proceed with your question.

Matt Hewitt – Craig-Hallum Capital Group

Good morning, and congratulations on a good performance in Q3.

David Fitzgerald

Thank you.

Todd Newton

Thank you, Matt.

Matt Hewitt – Craig-Hallum Capital Group

First question. You mentioned that your – in fact, you just mentioned it again. You are seeing the coblation base they are up not only in numbers but in the revenues per customer. You also mentioned that each procedure you are seeing an increase. In respect to knees and hips, you train a doctor, get them using the product. How quickly does it take for them to convert to align share of their normal procedure volume over to coblation from whatever they were using previously?

David Fitzgerald

I would like to say that it goes fast, but that is not true. It – you have to go in there and do an eval, and it takes time, and it is very competitive. And so, when we see our US coblation numbers come up a bit, we are he encouraged by the volume that we see because it was also our average selling price went down a bit. We are encouraged that we are making some in-roads, but I would say that it just takes time to convert a doc that sees a competitive product and to get them to start using coblation or for that matter, and any of our fixation products.

Matt Hewitt – Craig-Hallum Capital Group

Okay. Secondly, International strength I think you mentioned that some of that was catching up from some weakness in the second quarter, but even on the sports med side you had a pretty strong quarter. Is that primarily due to new products or was there something else that contributed to that growth?

Todd Newton

Well, it did have probably a little bit of a pull in from some new product activities that we were undertaking. For example, in the third quarter we were able to undertake some clinical evaluations on new products, and some of that clinical evaluation work was done outside the United States. Of course, any time that you are doing that, you are giving your sales force a chance to interact more with their physician base.

That probably had some impact in the third quarter. I would just say that the third quarter, I would remind you, Matt, that the third quarter is of all four quarters of the year the lowest quarter of the year and, this quarter – this third quarter I should say, we also had an extra selling day certainly in the United States, but we also had in some of our International markets the same dynamic, an extra selling day. That, of course, certainly helps. We had one less selling day back in the first quarter. So making it backup in the third quarter was good overall.

Matt Hewitt – Craig-Hallum Capital Group

Okay. Thank you.

Operator

And our next question comes from the line of Matt O'Brien with William Blair. Please proceed with your question.

Unidentified Speaker

Hello, guys. This is Kayla in for Matt. Just a couple quick ones for us. International sales were quite strong compared to what we were looking for and just curious what is driving the strength there, whether that is going to be sustainable over the next several quarters?

Todd Newton

Well, we have very good sales and distribution in some key countries. We feel like we have a strong organization in the UK, and in Germany, and many of the other continental European markets. They performed well. Australia is another strong market for us, and Australia had a very good quarter. These are markets where we have invested in sales and marketing capability for several years, and they are in a very good competitive situation.

But like we mention in our prepared remarks, we also had some increases in distributor market sales this quarter. For the last two or three years, Southern Europe has been an area that for us has been a point of de-emphasis just due to the in stability in that region of the world, and we are starting to see some more stabilization perhaps in that part of Europe. And that, of course contributed to our sales to distributors this quarter. We also mentioned that part of what we saw in the distributor market sales this quarter was probably connected to the fact that the second quarter had relatively low distributor market sales than what we typically would have expected.

Unidentified Speaker

Okay. Great. Thanks.

Operator

And our next question comes from the line of Joanne Wuensch with BMO Capital Markets. Please proceed with your question.

Joanne Wuensch – BMO Capital Markets

Can you hear me okay?

David Fitzgerald

Yes, we can.

Joanne Wuensch – BMO Capital Markets

Thank you very much. I heard you mentioned the DOJ investigation. I may have missed it. Is there any update on OAG piece of it?

David Fitzgerald

No. We have had no information regarding that.

Joanne Wuensch – BMO Capital Markets

Okay. And the – there was a big push about 18 months to 24 months ago into Asia. Could you please provide us an update on what you may be seeing there in terms of product launches and traction in those markets?

David Fitzgerald

Well, you say the big push. I mean this is what we have been talking about for a period of time that standing International markets. We have a very strong presence in Asia in the sense of Australia and China are very important countries to us. I am getting a lot of feedback here, Joanne. I do not know if that's a problem on your phone or not.

Joanne Wuensch – BMO Capital Markets

It is probably my phone. I am working remotely. I will drop-off and take everything else offline. Thank you for taking the question.

David Fitzgerald

Okay. Thank you.

Operator

And our next question comes from the line of Bill Plovanic with Canaccord. Please proceed with your question.

Bill Plavonic – Canaccord Annuity

Great. Thanks. Good morning. Can you hear me okay?

David Fitzgerald

Yes, we can, Bill.

Bill Plavonic – Canaccord Annuity

Good. Good quarter, gentlemen. So a couple of questions. Just, I am going to focus on the ENT business. When do you expect to start commercializing that balloon synoplasty product from ENTrigue?

David Fitzgerald

Well, we think that it is going to take a bits of time to get our sales force very comfortable in the sinus market, and we are going slow. We will continue to have that roll out, but I would expect that 2014 is the year where we will be able to get out and have everyone trained and get our guys feeling comfortable into that space.

So it is going to take some time, and we are going to continue to look at beyond just the balloon. I mean ENTrigue has a product portfolio that goes beyond just the balloon. So our expectation is that we will be able to try to become a complete sinus offering in terms of our product. So but it is going to – I caution that it is going to take a little bit of time for us to do that.

Bill Plavonic – Canaccord Annuity

And have you started commercializing that product yet? When you say go slowly, is it – are you trialing it or where are you in the commercialization of it today?

David Fitzgerald

Yes. I mean we have recorded sales. We have had revenue base as Todd had mentioned earlier in his comments. The products when you go out there, as you know, Bill, on these evaluations, they take time and, of course, you are not recording sales, and there is a lot of follow-up. We want to make sure our coblation business is protected in the tonsil area. So education and training is a big part of it, but to directly answer your question yes, we have started commercialization. Not internationally yet. We will not do that for – until early first part of the year. The new year.

Bill Plavonic – Canaccord Annuity

Okay. And then as you look at kind of 2014 and beyond and you talked about growth, is this going to be specifically new product driven, or do you think you will be adding doctors with your existing products? If you could in-balance that? Is it going to be mostly new product driven? How should we think about this?

David Fitzgerald

I think new products will be a strong component. These products prove out in their clinical evaluations. It is a pretty strong offering, but I would also say that our ability with existing products, especially coblation in terms of where it is in the marketplace ought to be able to attract new customers. With any of the new product offerings, there is going to be a roll out, and it will be a ramp-up. We do not have – we do not expect that our new energy platform will really start to gain traction until the latter part of next year, but it is a strong offering. We also think that our International growth opportunities are still there for us.. We are going to have to make some investments, but overall 2014 should be a strong year for us.

Bill Plavonic – Canaccord Annuity

Okay. And then just a couple for Todd. What was the Med-tech tax in the quarter nominally?

Todd Newton

It was just under $1 million dollars.

Bill Plavonic – Canaccord Annuity

And then, CapEx for 2014 the amortization line quarterly going forward, especially with you are adding in ENTrigue and you took off Opus.

Todd Newton

Yes, but it will not be a net off. Most of the purchase price for ENTrigue was allocated to good will, which will, of course, not be amortized.

Bill Plavonic – Canaccord Annuity

So amortization maybe $500, $600 a quarter, still running at that level.

Todd Newton

Yes. We will get back to you in terms of how best to view your model, but it will still be lower. Amortization expense will remain low going into next year even with the ENTrigue acquisition.

Bill Plavonic – Canaccord Annuity

Okay. That is all I had. Thank you.

Operator

And (Operator Instructions). And we have a follow-up question from the line of Bill Plavonic from Canaccord. Please proceed with your question.

Bill Plavonic – Canaccord Annuity

Great. Thanks. Just – trying to get a – you know, International was really strong in the quarter. What I am trying to figure out is how much of this was the shift from Q2 to Q3? How much of this could have been incremental stocking, and how much of this was just the extra day? The underlying growth, is probably the way to look at it. So for the – your underlying growth is probably what, mid l single digits for the year internationally? Is that the way we should look at the International growth going forward?

Todd Newton

Well, that is the reason, Bill, why we provide the information regarding direct markets versus distributor markets because distributor markets are going to be from time to time lumpy because as you mentioned, these are third-party distributors who are making stocking decisions, and you will have some timing volatility with those particular distributors.

We – but the direct markets that is where we sell to end-users. That is where we sell through our subsidiaries. That is a little bit of a better indicator, if you will, of what is happening in the International markets where we are – or at least in those markets that provide the bulk of our International sales because as I mentioned over 80% of our Sports Medicine sales are from the direct markets as opposed to the distributor markets.

Those percentages, for ENT this quarter it was 10%, for Sports Medicine this quarter I think I mentioned it was in the mid single digits around 6% for those direct markets. The rest is the distributor sales, and I think you are thinking about it the right way. Those distributor sales can be from period-to-period a little bit lumpy, and last quarter, second quarter the distributor sales particularly within ENT were lower than what they had been trending. Here in the third quarter, that got made up a little bit.

Bill Plavonic – Canaccord Annuity

And then as I think of the extra selling day International would that have been maybe a point or two in each of those segments, and then same – because there was only partially International, but US is more like a point and a half to two point on the growth as I try to kind of figure out the normalized rates?

Todd Newton

Well, I mean it was a day. It was an extra selling day in the United States, and in most of those direct markets. OUS it was the same thing, an extra day. There may have been one direct market where – or two where the numbers of extra selling days was actually two this quarter, but those are just based upon the calendar of holidays in each of those individual countries.

Bill Plavonic – Canaccord Annuity

Okay. That is actually helpful. And then, do you know what your CapEx number for 2014 you think will look like at this point?

Todd Newton

I think it will continue to be certainly heavier than what you have seen in the past. The Costa Rican manufacturing facility will continue to probably increase our normal CapEx next year somewhere in the $15 million to $20 million range.

Bill Plavonic – Canaccord Annuity

So Costa Rica will add $15 million to $20 million. I mean you have already got $24 million in for this year. What is 2014 CapEx end up, you think?

Todd Newton

Well, 2013 CapEx will – we will have another typical quarter worth of our sustaining like you have always trended in your model. Then we will have an extra quarter worth of the construction cost in Costa Rica, which is basically $3 million, $3.5 million a quarter.

Bill Plavonic – Canaccord Annuity

Okay. And then just the last question. It has been a while since we have asked this one, but you have the royalties expiring at the end of 2015, and I am just curious, in the past we have talked about looking into it seeing if there is some of those that will continue some that will not. I think sometimes if I my memory serves me you have stated that potentially most of that would go away. What is your current thinking on that royalty stream as we head into 2016 and beyond?

Todd Newton

Well, we are not heading into 2016. Of course, we are heading into just 2014, and our view there has not really changed at all. There will be some that we definitely believe will expire, and the royalty stream will cease, and then there will be others that continue after that. But we do not have an update in terms of our thinking on that.

Bill Plavonic – Canaccord Annuity

Is it just a kind of 75% expire, 25% doesn't? Is there any brackets you can put around that?

Todd Newton

No. Not at this time.

Bill Plavonic – Canaccord Annuity

Okay. Great. That is all I have. Thank you very much and good quarter.

Operator

And our next question is a follow-up question from the line of Matt O'Brien with William Blair. Please proceed with your question.

Unidentified Speaker

Hello guys, it is Kayla again, just with a quick follow-up. You mentioned that for the potential new Board Member has some experience regarding programs with periodic governmental certification requirements. I am just curious if you could give a bit more color as to what this means, and then how it might be able to push you guys through this DOJ process?

David Fitzgerald

Well, our expectation is as we said, we are going to get a DPA, and as far as the Board is concerned, they felt that they needed some experience to give them some color and background, and the certification is probably one or more of the Board Members will probably have to sign off on a quarterly basis. That is the obligations that the government would have under a DPA that could be the audit chair or it could be two people, and this individual will bring experience on that level and guide the Board in their deliberations and what to expect. So the Board felt that is the kind of background and experience that they needed to have, and we look forward to having this individual on the Board because I think it will also give management a sense of direction and interaction that we need with the Board regarding the DPA.

Unidentified Speaker

Great. Thank you.

Operator

And there are no further questions at this time. I would turn the call back to Mr. David Fitzgerald.

David Fitzgerald

Thank you. On behalf of the entire Management Team thank you for your interest in ArthroCare. We appreciate everyone taking the time to dial in for today's call , and if you have additional questions regarding any information contained in the SEC documents, we recently filed, please contact Misty Romines in our Investor Relations department, and she will be happy to help you out. That concludes our call for today. Thank you.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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