Citron Research Reports on Arthrocare (ARTC)


Citron Research has been publishing stock information for close to 6 ½ years with a track record of remarkable predictive accuracy.   We are often asked what our “secret sauce” is.  It is simply critical thinking — not taking a company’s management for its word when their story defies logic.  Citron reports have been on the opposite side of some of the largest funds, investment bankers and their analysts, and renowned individual investors over that timespan.

Introducing Arthrocare.

This sports-medicine company (Nasdaq:ARTC) sells a suite of surgical instruments and supplies in a hotly competitive market.  Within that market, one small niche represents over 50% of the company’s revenue growth.  That is the percutaneous disc decompression (PDD) market.    Citron believes that the concerns about Arthrocare are well beyond possible reimbursement issues, but could extend all the way to insurance fraud.

Other medical device companies with larger resources have had great difficulty in getting insurance reimbursement for their percutaneous disc decompression (PDD) products.  Why?  This procedure is deemed experimental or investigational by most insurance carriers (there is insufficient clinical data on the costs vs benefits of the procedure) and therefore it is not reimbursable.

A typical insurance company position:�

But that doesn’t seem to be a problem for Arthrocare.  The company has grown their spine business 95% in one year alone(q3 2006 to q3 2007) .  The sell side analysts, investors, and even the company have said that it is because of their spine division that they will grow faster than their competitors.  This 95% growth can be compared to the modest growth in their sports medicine division of 11%.

Where the Deed gets Done

So does Arthrocare actually have a secret or is the emperor not wearing any clothes?  It all comes down to the “D word”.  The reason we call it the “D word“ is because it is the word that is not spoken about in any filing, conference, analyst note, or press release from the company.   It is a word so dangerous that the company could not even call it by name in their most recent press release defending their business practices.  This word is “Discocare”.

It is important for the future of Arthrocare to distance themselves as much as possible from Discocare as Discocare might be doing a lot of dirty work for Arthrocare.  Arthrocare would like us to believe that they had nothing to do with the establishment or the operations of Discocare.   Discocare does not sell products for any other manufacturer except Arthrocare.

Discocare is run by a gentleman named Michael Denker.  Mr Denker was the former sales manager at Arthrocare who specialized in spine products.  According to a recent deposition of Mr. Denker, he was going to leave the industry altogether before he took the job at Discocare.

Read Denker Deposition (PDF)

So, as investors, are supposed to believe that Arthrocare had nothing to do with the establishment of Discocare but the National Sales manager for spine products left this billion dollar NASDAQ company to work here?

Photo of Discocare

It is the opinion of Citron that there is more to this story that Wall St. doesn’t know.

So who owns Discocare?  This is where it gets good.  According to Florida State Records, Discocare is owned by Dr. Jonathan Cutler.

Dr. Cutler is also the owner of 2047 Palm Beach Lakes Partners who owns the Palm Beach Surgical Center.

According to records obtained from the State of Florida Agency for Health Care Administration (AHCA) the largest medical center submitting for reimbursements for procedures  using CPT codes for the Arthrocare device is none other than Palm Beach Lakes Surgical Center and its two partners Dr. Kugler and Dr. Gomez.  The second largest biller in the whole state of Florida (the majority of ARTC spine business) is Dr Dennis Zaslow.  Mr. Zaslow has twice been charged with insurance fraud.

Dr.Billing (PDF)

Dennis Zaslow (PDF)

Ironically enough, the Palm Beach Lakes Surgical Center and the pricing for the Arthrocare product there were done by Gary Carrol.  It was the same Carrol, supposedly an independent third party, who decided to charge the exorbitant fees for these procedures which ended up in the current depositions that you are reading

Gary Carrol Testimony (PDF)

Would it be shocking to know that Gary Carrol has also been charged in the past with insurance fraud?

Gary Carrol (PDF)

Through reading the different court testimonies it has become obvious to Citron that Discocare has been able to sell the Arthrocare PDD products by targeting personal injury attorneys and the clinics that work with them.  Most notably the South Florida firm of Steinger  Iscoe, a real powerhouse in the PI world — as evident by their many prominent billboard ads throughout South Florida.  Partner Gary Iscoe is brother to former Disccare employee Matthew Iscoe, who stated to the NY Post that Discocare did 75% of all Arthrocare’s U.S. spine business.


Here is a copy of a recent job listing for a Regional Business Development Manager for Arthrocare:

Arthrocare Job Listing (PDF)

While investors are led to believe that the Spine Wand is gaining market share because it is effective and insurance companies are starting to reimburse, this job listing tells another story.

  1. Notice the desired education legal is Juris Doctorate
  2. Selling and implementing PDD and the “Discocare model”.
  3. The first essential task is “ensuring that clients from targeted law firms suffering from back, leg, or neck pains as a result of injury from targeted law firms are referred into this network”
  4. Educate the attorneys and staff on PDD benefits, procedure, technique, how to identify potential PDD candidates, correct documentation for approval for the PDD procedure with maximum case settlement….”

It is the opinion of Citron that Discocare was established by Arthrocare to do its dirty work.  The Discocare model is targeting PI firms and teaching them how to work around the system and get coding for a product that otherwise should not be open for reimbursement.

So why is all of this so bad for Arthrocare?

While the company might say the spine business is only a small percent of their revenues, it is the main driver of their growth, profitability, and the valuation rationale for their stock price. It is the only division that makes their company “sexy” in a low margin, highly competitive industry, and therefore allows them to trade at their current lofty multiple to peers.

It is the opinion of Citron that the CEO of Arthrocare has not been honest with Wall St.  While he has been a constant seller of stock, he has been telling the street that growth in spine is because doctors have had better success at reimbursement; the company has not disclosed “the Discocare model”.  When investors are buying Arthrocare they are not buying a company with a superior medical products, but rather a company who has built their fastest growing division on the backbone of upcoding, which is the #1 problem in insurance fraud today.

This has created a terminal business model — sooner than later the insurance companies will put an end to these shenanigans.

Also, it is illegal for healthcare manufactures to pay off doctors to use their products.

By virtue of Discocare having the same ownership at the largest user of the Arthrocare PDD products, it is at best a serious conflict of interest on both the business and the medical front, and at worst a kickback scheme that will soon be unveiled.

Citron is curious to know if patients at PBL Surigcal Center sign a waiver that when the receive a spinal wand treatment that it is being sold by the same guy who owns the center.

The Empire Strikes Back

Arthrocare has attempted to combat the recent negative press by putting out a press release that  appear to Citron as both reactionary and a passive admittance of guilt.


Citron believes that investors should be concerned that Arthrocare claims it is planning to change their whole capital structure just to combat as they say are unfounded rumors.   Why does a company with $50 million in the bank announce a $75 million share buyback — when the only thing that has changed in the past week is a claimed series of misstatements in a tabloid newspaper?  Seems very reactive to us. 

The stock is still trading above its 200 day moving average and by no means can it be considered cheap.  If it was given the same P/E as Stryker, which can be considered the gold standard in their industry, than Arthrocare should be trading in the low 40’s (and that includes the recent spine sales)

“The timing and amount of shares repurchased will be determined by the company’s management based on its evaluation of market conditions and other factors with a majority of the repurchases expected to be completed by March 31, 2008.”

Is this statement not contradictory in nature?  Also, why the rush?  Investors should hope that Arthrocare would use their money to develop new products and more effective sales channels.  I think we all know what happens to companies when CEO’s decide to play the stock market.

Most importantly, why would shareholders start buying stock back in the mid 50’s when CEO Baker has sold over $20 million worth of personal stock over the last 2 years at prices of 40, 46, 52 and 56 ?

The company also stated “We have carefully reviewed the business practices of our service provider and have found no evidence of anything improper in their activities.”  Wow, that was fast.  A critical article was published on Tuesday, and they completed a thorough examination by Friday morning?  Nothing more needs to be said.

Piper Jaffray has been the main cheerleader for Arthrocare,  But recently they’ve crossed a serious ethical line themselves.  While ignoring the material issues regarding Arthrocare’s undisclosed captive entities manipulating the insurance reimbursement system, Piper issued a note in which they state the contents of an upcoming newspaper story as if fact.

On dissemination of that Piper note, the stock rallied a few points before selling back off. Citron has a few questions.

What are Piper/Arthrocare thinking?  Do they have tomorrow’s newspaper in hand?  From whom did they learn such information? 

 Did Arthrocare buy back any stock after Piper put out the note?  Worse, did they buy back stock BEFORE Piper put out the note?

Why didn’t Piper mention Reimbursements anywhere in the text of their note, just the title?  We suggest the analysts spend less time talking to management and predicting news stories and spend more time speaking to insurance companies and using critical thinking to assess the business risks.

The existence of an AG investigation is is just a sideshow — it is immaterial to the serious questions which go to the heart of the sustainability of Arthrocare’s business model.

Finally, if the Piper analyst was going leak out privileged information, than maybe they should tell their clients why Discocare owns a company called, and are employing the “Discocare Model” for other Arthrocare products.


There are still many questions that investors do not know that the company must address.

  1. Does Discocare sell any other products for Arthrocare besides the PDD products?
  2. Are there other “Discocares” out there remaining undisclosed?
  3. How would insurance regulation of the “Discocare model” billing negatively impact the spine sales?
  4. How dark a shadow of doubt is cast on the company’s other operations if management resorts to this type of tactic to generate revenues and growth?

There is no better investment tool out there than critical thinking.  It is obvious to Citron that the recent growth in the spine business for Arthrocare is nothing more than the Emperor expanding his wardrobe.

Cautious Investing To All