Arthrocare (NASDAQ:ARTC) is Living in Denial

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“Denial is a common tactic that substitutes deliberate ignorance for thoughtful planning.”
CHARLES TREMPER

As Arthrocare (NASDAQ:ARTC) prepares for its earnings report and conference call on Monday, investors should be preparing as well:  preparing to hold management accountable to stop denying the important issues that threaten the company, as reflected in current legal proceedings that seek to unmask their business model.  With an upside down balance sheet in an industry that has become a hotbed for regulation from the Department of Justice, it appears to Citron that the problems at Arthrocare have just begun.

If you can’t read between these lines than it is time to get some glasses.

CEO Michael Baker has consistently stated that any problems with the spine business are merely a figment of the short-sellers’ imaginations, and the spine business is the engine driving the company’s earnings growth.  In a startling new case brought in Broward County, Florida, we see the defense turn a routine auto negligence case into a direct assault on Arthrocare’s business model.  While the plaintiff (in this case, the “injured” in the auto accident) was ready for trial, the attorneys, acting for the defense (insurance companies), changed the whole scope of the case.

Please Have a read and make your own determination:

New Problems for Arthrocare (PDF)

Note:  This is a completely separate case than the one previously published on Citron Research.

As stated by the attorney to the court

“The defendant needs to conduct discovery to, among other things, determine whether the discograms, assuming they were performed, were intentionally performed merely to “maximize” the bills under same sort of business model in general, or the Discocare Model in particular.”

We also read claims in the case about:

  1. Exorbitant Medical Bills for Arthrocare Products
  2. Arthrocare’s targeting of personal injury attorneys as a source of business
  3. The malpractice of physicians in alignment with the coaching of Arthrocare
  4. Upcoding to defraud the insurance companies

There is nothing more conclusive that Citron can say that cannot be read in the document linked below.  What makes this case so damning compared to other cases we have seen is:

  1. The attending physician is Dr. Jeffery Kugler, who has become Arthrocare’s “poster child” of how to be a successful spine surgeon.  Dr Kugler has even written the “study” that Arthrocare distributes to spine physicians to justify performing and coding PDD’s as open surgeries.
  2. The insurance companies have taken the initiative to change the focus of the investigations from auto negligence to the grand scheme as orchestrated by Arthrocare
  3. The soap-operatic scenario of an assortment of parties, supposedly unrelated, hiding behind a single attorney in a collective attempt to avoid subpoena service sounds more like an episode of Sopranos than a strategy appropriate to a publicly traded corporation.
  4. Someone needs to begin to get serious about risk assessment with regard to Arthrocare’s liabilities in the face of a potential civil RICO case against the “Discocare model”.
The Previous Case Involving Arthrocare

Two months ago, Citron showed how Baker was served with a subpoena from State Farm that was quite damning.  The subpoena went right to the heart of the “Discocare Model” as it manifests at Arthrocare.  Yet, the company shrugged it off as if it was “normal course of business”.  Citron failed to point out that it was not just CEO Baker and David Applegate (head of spine division) who were subpoenaed, but rather there were nine total subpoenas served on Arthrocare.  The insurance company wanted to take depositions on

  1. Arthrocare Corp- person with the most knowledge of CPT coding of the Plasma Disc Decompression, Nucleoplast or any spinal disc surgery utilizing Arthrocare devices.
  2. Person with the most knowledge of the amounts charged by Arthrocare for Arthrocare Spinewands from January 2003 through present and how such amounts were determined
  3. Person with the most knowledge of any documents, job advertisements, or listing published relating to Regional Business Development Manager….
  4. Person with the most knowledge of any suggestions, recommendation or examples of physician or facility charges for the Plasma Disc Decompression
  5. Person with the most knowledge of all information and posting to the Arthrocare Website from January 2003, through present.

http://citronresearch.com/wp-content/uploads/2008/02/arthrocare-subpeona.pdf

These are all in addition to the previously shown subpoena to Michael Baker

Do these questions sound like “normal course of business” ???

Class Action Lawsuit

Most recently investors have witnessed a slew of class actions against Arthrocare.  We all know that class action attorneys can be vultures, but we can sometimes find indications of real issues within their lawsuits.  Even setting aside the “Discocare model”, the sizable insider sales, and the already questionable “bill and hold” transactions, these class actions offer a glimpse into the questionable sports medicine reimbursement business of Arthrocare, which comprises the majority of their revenue.  Here are a few of the points that Citron found to be most interesting.

  1. The company did not report revenue properly under SAB 104 because while they were guaranteeing devices to doctors (a medical no-no), they were recording revenue as if it was generated on a “non-recourse” basis.
  2. Arthorcare may have arranged transactions to obtain certain results from related parties (Device Reimbursement Solutions)

http://www.csgrr.com/cases/arthrocare/complaint.pdf

A Canary in the Mine?

The job of a short-seller / investigative blogger is a process that involves time and effort.  So in order to prove this point, we are going to have to give away one of our secrets.  A recent search of job applicants on Monster.com showed us something interesting:  an Arthrocare internal auditor is looking for a new job.  Note this is not merely a salesperson or just an administrative staff person; this is a specialist who deals with Sarbanes-Oxley compliance.  In order to protect the person’s privacy, we have redacted their name and phone #, but here is what it says.  The employee left Arthrocare just last month.

XXXXXXXX
Xxxx xxxxxx xxxx
Austin, TX 78749
512-xxx-xxxx
[email protected]

Internal Auditor with experience in Sox 404 and financial auditing.
Strong writing, analytical, and project management skills.

Experience: 

Internal Auditor
Arthrocare Corporation
Austin, TX   05/2006 – 03/2008

   • Tested company-wide internal SOX controls ensuring corporate compliance with SOX 404 guidelines while managing the corporate SOX program.
   • Worked closely with the corporate finance group while promoting the development of more efficient business processes.
   • Analyzed financial information utilizing the MFG PRO accounting system recognizing areas of potential risk and recommending mitigating processes.

Worked closely with senior officers and management while performing pinpoint audits of domestic and international business units.

Citron notes that while he might have left his job for a multitude of reasons, having your internal auditor leave without having another job already lined up is normally not a good sign.

Conclusion

Denial is wearing perilously thin as a damage control strategy at Arthrocare.  Its balance sheet is already a casualty of management that has chosen to circle the wagons rather than face the harsh reality that is closing in on its options.

Cautious investing to all.