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Arthrocare – The Smoking Gun

Posted in Citron Reports by CitronResearch on the May 27th, 2008

UPDATE May 30, 2008 – Arthrocare wins the Frost & Sullivan award for deception.

On May 29, Arthrocare announced that it had been awarded the Frost & Sullivan award for product innovation for the Opus Twin Lock system.  The company was so proud that they proclaimed:

“Were very excited about our TwinLock Knotless Fixation System being recognized by Frost & Sullivan for this prestigious award, said Jack Giroux, president of ArthroCare Sports Medicine. The device is designed to dramatically simplify the most challenging rotator cuff repairs by providing a dual implant system that can be placed and tensioned by the surgeon in secondsdirectly through the rotator cuff. In terms of acceptance and demand from surgeons, the system has already exceeded expectations. This Award is icing on the cake. Its a great honor.

What they forgot to mention is – THE AWARD IS A SCAM!

Frost & Sullivan is a marketing company that sells awards to companies, as part of its “marketing strategy”. Here is some feedback from former employees of Frost & Sullivan:

http://billanddave.wordpress.com/2007/06/03/frost-sullivan-award/

Here is an example of one life science company that refused the award because of deception. Their CEO explained:

“We clearly regard the fact that the publication of obtaining a prize as associated with the costs of the prize winner is ethically questionable.”

http://www.bio-pro.de/en/life/meldungen/02493/index.html

What makes this more disturbing for Arthrocare is this Frost & Sullivan award is an active, paid for, undisclosed, and unqualified promotion of a medical device, which is likely to violate FDA restrictions on medical product marketing to the public.  We would expect nothing less.

Arthrocare is to be congratulated for joining the ranks of companies like NeuroMetrix in securing such a prestigious paperweight. 

http://www.thefreelibrary.com/NeuroMetrix+Receives+Frost+&+Sullivan’s+2006+Neurological+Monitoring…-a0150006800 

Citron notes the irony of having previously covered a stock promotion that was “awarded” a Frost & Sullivan …. the prestigious MDII … last year $2.40 …. now two-fer-a-buck….with change.

http://www.citronresearch.com/index.php/2007/04/24/

http://www.mdisecure.com/literature/MDI_Frost_award_083106_B.pdf 

Does Arthrocare management really believe this kind of behavior “adds value” for a potential acquirer?  

 

Arthrocare – The Smoking Gun

For all the skeptics who think short sellers live only to spread inaccuracies and distortions of fact about Arthrocare, as well as the shareholders who dismiss concerns about improprieties at Arthrocare’s spine unit because spine is just a small portion of Arthrocare’s revenues, the following is a must read.

Today, Arthrocare’s own documents and its management’s own words clearly and irrefutably show that major fraud has taken over its largest division — sports medicine. The following documents will leave no doubt even to the most ardent supporter or analyst that Arthrocare is lying to its shareholders outright — and worse, to its biggest customers, the insurance companies who reimburse for the use of its products.

This is not merely a case of longs vs shorts or “everyone is entitled to their own opinion” — this is fraud.

In typical accounting fraud it is very rare for the defining evidence to emerge in black and white before the company implodes. In the case of Arthrocare, we have a smoking gun early, before the auditors, SEC, or insurance companies step in.

It is the belief of Citron that Arthrocare’s spine unit is now a dead business. Arthrocare’s sequentially lower spine numbers and numerous lawsuits were are only trumped by the disastrous conference call held by Needham & Co last week to defend Arthrocare’s spine business. Even though spine is an important part of the Arthrocare business model, it is dwarfed by the numbers produced by sports medicine.

Two weeks ago Citron presented a business report of an Arthrocare distributor they acquired. While sales were flat on the distributor, inventories skyrocketed. To any analytical person, channel stuffing was obvious…but only if readers drew the conclusion by inference.
http://www.citronresearch.com/wp-content/uploads/2008/05/ortoconcept.pdf

In trying to judge a company whose receivable ballooned due to a controversial reimbursement subsidiary, analyst Brian Weinstein of William Blair and Company asked about the impact of DRS on Sports Medicine on the last earnings conference call.CEO Baker responded: “I think we said in Q4 that we billed about $0.5 million. Again, whatever we collect on that billing will be rebated back to the doctors who bought the products. I think this quarter we billed something around $1 million.”The conference call transcript is here:

http://seekingalpha.com/article/73205-arthrocare-corporation-q1-2008-earnings-call-transcript

THIS IS A LIE

Here are the documents that Arthrocare hopes you never see. The Smoking Gun

Smoking Gun 1 (PDF)

Smoking Gun 2 (PDF)

Notice a few details about these invoices

  1. They far exceed the $500,000 stated on the conference call by Michael Baker that DRS supposedly billed for. These 2 invoices alone account for over $1.5 million. What is the total number? Is it $ 2 mil? 3mil? How long will it take for the truth to emerge ?
  2. The invoices are created to look like a real invoice – a genuine arm’s length transaction. Nowhere on these would an insurance company even guess that DRS is the same company as Arthrocare.
  3. They go as far as to state terms of “Net 30” as if payment is really owed and do not use common language as interdivision cost transfer or internal invoice.
  4. They use Sanford, Florida as the address for DRS, while we know, and the company has previously admitted, that DRS is actually located in the Arthrocare offices in Texas.

Citron was able to obtain these invoices that were used as support documentation by physicians for CPT code 99070 (physician supplied items)

While DRS purports to doctors that they are on the “preferred provider list”, many of the reimbursement invoices underlying this transaction have been rejected by insurance companies as “out of network”.

Here are some reasons why these invoices are pivotal to the future of Arthrocare:

  1. They cast substantial doubt upon the true growth of Arthrocare’s sports medicine business.
  2. They greatly increase the chance for a restatement, as the company has not recorded any related party transactions if these devices were actually “sold” to DRS.
  3. They show that DRS is lying to the insurance companies.
  4. They threaten the future status of all reimbursements to either DRS or Discocare
Conclusion

Through stock buybacks and the purchase of Discocare, Arthrocare used to think it could buy its problems away. Now with the announced “shopping” of the company — they are attempting to sell the problems away. It is the belief of Citron that any possible acquirer would do the same due diligence we have done, and be left with the same unanswered question. Is the company’s growth real or fabricated? If a company’s business is as robust and healthy as Arthrocare purports itself to be, why would it be acting like this?


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