Citron Research Updates on Arthrocare (ARTC)


“The truth will set you free. But first, it will piss you off.”
Gloria Steinem

The backlash against Citron from Arthrocare and its analysts regarding our analysis of the company has been understandable; sometimes the truth is a hard pill to swallow.  While everyone is entitled to their own opinions, no one is entitled to their own facts.  The facts surrounding Arthrocare, documented through their own sales materials plus court testimonies and subpoenas, have so explicitly reflected the company’s suspect sales practices that the stock has reacted accordingly.  Unfortunately for shareholders, we believe there is much more reacting to come in the future.

Arthrocare Accounting Artifice

On February 13, 2008 Gradient Analytics issued an important of research note on Arthrocare, giving it an earnings quality grade of D/F.  For those of you who might question Gradient, you might not be aware of the tremendous track record of this specialist in financial analytics and forensic accounting.  The copyrighted report refers to Arthrocare’s use of “bill and hold” transactions.  As written in Arthrocare’s financials,

“In certain cases, at the customer’s request, the Company will enter into bill and hold transactions whereby title and risk of loss transfers to the customer, but the product does not ship until a specified later date. Revenue on such transactions is recognized only after ArthroCare has met all conditions for bill and hold transactions set forth in SAB 104, specifically that ArthroCare has no further performance obligations, that the product is complete and ready for shipment, and that a fixed schedule for delivery of the product is set.”

Bill and Hold accounting, while legal, has historically been one of the hallmarks of accounting fraud.

Related Party, or All in the Family?

What makes this more disturbing is a point not explored by Gradient.  Because of the potential for abuse, bill and hold accounting can only be employed when it is done at the explicit request of the customer, and only when the customer has a legitimate business reason for requesting it.  In this case, Arthrocare’s largest “customer” in its spine division is Discocare.

Citron has published numerous facts leaving no doubt whatsoever why transactions with Discocare are “related party transactions”.  Reasons include:

  • Discocare was started by senior Arthrocare employees
  • Discocare’s real address is the Palm Beach Lakes Surgical Center, Arthrocare’s largest single customer for Spine Products
  • Discocare has only one vendor – Arthrocare
  • Discocare sells only one product – Arthrocare spine wands

There is no way Arthrocare’s audit could pass professional scrutiny while allowing “bill and hold” accounting from a related party.  Maybe this explains why, right in the midst of Citron exposing Discocare’s key role in Arthrocare’s spine business, Arthrocare rushed to complete the eye-popping acquisition of Discocare for cash on December 31.

Contagious Accounting?

Is this also happening in the Sports Medicine Business?   Maybe.  Arthrocare forgot to take down this website:

This appears to be a reimbursement provider for knee products and guess who owns this website ….yes, Discocare.
Meanwhile, we are supposed to believe CEO Michael Baker, who back in 2000 used accounting tricks to prop his stock.  Arthrocare frontloaded licensing and royalty fees while Baker sold $10 million worth of stock.  As soon as the Arthrocare conformed to proper accounting the stock fell from $60 to $18.

Arthrocare Forbes Magazine (PDF)

Another Insurance Investigation into Arthrocare

Citron uncovers what appears to be an investigation into Arthrocare/Discocare from Progressive Auto Insurance.  In another standard auto accident case of Stefan Coello v Ronald Levine we now see that Arthrocare/Discocare has found itself in a mess.  It was from this case that Citron published the more than telling testimony of Arthrocare employee Jackie Marsh.

On August 10, 2007 we read the deposition of Jonathan Cutler, founder of Discocare.

Cutler Testimony (PDF)

The line of questioning makes perfectly clear that the insurance defense attorneys are probing the business practices of Discocare.  The case has gotten so uncomfortable for our doctors Cutler and Kugler that the defense has been forced to petition the courts for a motion to compel answers from Dr. Cutler and for the medical records of Dr. Kugler (pages 4&5)


On January 21, 2008 Arthrocare’s attorneys sought an “Emergency Motion to Enforce a Protective Order”.  Why is a medical device manufacturer trying to suppress information in an auto negligence case?  What does Arthrocare not want you to see?  Arthrocare’s court pleading claims that they do not want Citron Research to have access to court documents by stating that Citron acts to “dilute its stock for competitive purposes.”

Fun and Games at Arthrocare (PDF)

Competitive?  Citron does not make medical devices.  Yes, we are competing for the truth. We want to tell the truth and they want to hide the truth.  We encourage the attorneys of Arthrocare to use their legal muscle to sue Citron.  We will not shy away from discovery … will you?

Arthrocare Analysts

It is difficult to discuss Arthrocare without first acknowledging the “head in the sand” analysts who cover the stock.  Reading the most recent analysts comments recalls a quote from the 2007 book Hedge Hunters as stated by David Yusko:

“The personality traits of a good analyst and a good portfolio manager are completely different. What you need to be an analyst is an attention to detail, a fundamental research mindset, the ability to do active due diligence, and the skill to do financial modeling.  It’s very quantitative. Being a portfolio manager is almost the direct opposite. It’s all about nuance and extrapolation and interpolation. It’s about reading between the lines, understanding the elements that AREN’T printed in the factual statements, what the management doesn’t say when they make a public statement, what they omitted when they were writing up their notes for the financial statements.”

Citron highlights two analysts’ comments that we thought to be important.  One is from Raj Denhoy at Bear Stears, and the other is from Mark Mullikin at Piper Jaffray.  Interestingly enough, in the not-too-distant past, these two worked together at Piper.

In a January 25 note from Piper Jaffray we read:

“Furthermore, our extensive diligence of about 30 doctors in the field performing plasma disc decompression indicates that the procedure is being correctly coded under CPT 62287.”

Only two weeks later, on Feburary 11 he writes:

“Indeed, our survey shows ArthroCare doctors utilizing the 63056 code but we
believe it is warranted.”

The most recent survey from Piper claiming there is nothing wrong with the Arthrocare coding by a survey of doctors using the product is incompetent.  It is logically similar to saying there is something wrong with our criminal justice system because we surveyed people in jail and found that 90% of them said they were not guilty. 

The point is that both codes result in the same outcome– use of an experimental procedure in a personal injury case where the main benefits accrue to the attorney and the surgeon.

In a note to clients on February 4, 2008, Bear Stearns analyst Raj Denhoy tells clients that he heard a rumor that there were subpoenas issued to Arthrocare.  He commented in his note that although he had not read the subpoenas, there is nothing to worry about and that it is simply the normal course of business.  ?????   If he had not read the subpoenas when he wrote that note, how was he to know there is nothing to worry about? 

Now that he has presumably had time to read the subpoenas from State Farm attorneys, we have yet to hear from Mr. Denhoy.   Nowhere in the recent Piper note nor from any of the sell side analysts is there any acknowledgement of the subpoenas served not just on Arthrocare but also on CEO Michael Baker and spine chief David Applegate.

And so goes Wall Street.  The downgrades will eventually come when and if indictments hit or the company decides to clean up their act and lower their numbers…by then it will be too late for many.  What is unfortunate is that the analysts still don’t understand the human element.  The importance of the doctors coding 63056 vs 62287 is not to get approved for reimbursement by insurance, but rather it is for the purpose of extracting large settlement payouts for personal injury cases.  The little incision required for a 63056 is the doorway by which a personal injury attorney can sue for pain and suffering.  Far beyond Wall Street’s myopic view, there are people who are actively getting needless surgeries while personal injury attorneys and orthopedists are getting rich, with Discocare as the puppet master.

One More Fun Document

For months Citron has been stating that Discocare has been run directly out of the office of Palm Beach Lakes Surgical Center, one of the company’s largest customers for spine products, and they have been teaching doctors how to code in what we believe to be a personal injury scheme.  Look at this document and the address of Discocare and you decide what is rumor vs. fact.

Discocare Support Materials (PDF)


We are convinced that Arthrocare is committing fraud.  Not only are they committing fraud on the investing public but also on the insurance companies who pay out the exorbitant claims.  While Arthrocare is using their legal muscle in attempts to hide the facts, Citron is using its resources to expose them.  This is not a case of a company vs a short-seller.  This is a case of Arthrocare vs Arthrocare.  The management has contradicted themselves repeatedly and has been proven to be liars BY THEIR OWN DOCUMENTS.  Citron has no doubt that it is only time before an enforcement agency comes a knockin’ at the door.