Valeant Sold Some Drugs Twice - Bloomberg
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`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
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`OPINION I WALL STREET
`
`Valeant Sold Some Drugs
`T1111ice
`
`Double counting usually isn't a great idea.
`
`By Matt Levine
`"' 4'/ March 21, 2016, 1:12 PM EDT
`
`Everyone's having too much fun to leave. Photographer: Michael Nagle/Bloomberg
`
`The crazy news out ofValeant continued this morning with a wild press release
`<https://www.sec.gov/Archives/edgar/data/885590/000119312516511157
`/d164248dex99Lhtm> announcing, among other things, that Chief Executive
`Officer J. Michael Pearson is going to leave, but not yet. and that the board asked
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`ACRUX DDS PTY LTD. et al.
`
`EXHIBIT 1558
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`IPR Petition for
`
`U.S. Patent No. 7,214,506
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`

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`Valeant Sold Some Drugs Twice - Bloomberg
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`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
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`former Chief Financial Officer Howard Schiller to resign from the board, "but Mr.
`Schiller has not done so."
`
`What is it about Valeant that has this effect on people? Every Valeant catastrophe
`seems to cause Bill Ackman CIJ to increase his ties
`<http://www.bloombergview.com/articles/2015-11-24/bill-ackman-found(cid:173)
`a-cheap-way-to-buy-more-valeant-stock> to the company; today's press release
`also mentioned that Ackman is joining the board himself. [!] Pearson got so
`sick <http://www.bloomberg.com/news/articles/2016-03-11/valeant-ceo-says-no(cid:173)
`more-surprises-in-meeting-with-top-execs> last year that he "was learning to
`walk again" when he came back to the company a few weeks ago, but he plans to
`stick it out as CEO until his successor is appointed. And the board asked Schiller
`to leave after finding that he engaged in "improper conduct" as CFO, but Schiller
`denies it <http://www.bloomberg.com/news/articles/2016-03-21/valeant(cid:173)
`s-schiller-says-company-incorrect-about-conduct> , and so has "respectfully
`declined the request from the company's board to resign from the board." (Those
`will be some fun board meetings!) No matter how bad things get, Valeant can't
`get rid of anybody. The rats are fleeing toward the ship.
`
`In addition to the personnel news, today's press release <https://www.sec.gov
`/Archives/edgar/data/885590/000119312516511157/d164248dex991.htm> and
`Form 8-K <https://www.sec.gov/Archives/edgar/data/885590/000119312516511157
`/d164248d8k.htm> provide some insight into Valeant's accounting troubles.
`These troubles are ... honestly they do not seem like Valeant's main problem?
`Except indirectly, since ifValeant can't figure out its accounting and file its
`annual report by late April, it will be in default under its credit facility, [!] and
`its creditors are getting nervous <http://www.wsj.com/articles/valeant-focus(cid:173)
`shifts-to-talks-with-debtholders-1458515615>. The accounting problems are
`certainly strange, though.
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`Valeant Sold Some Drugs Twice - Bloomberg
`
`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
`
`The basic issue is that Valeant sold some of its drugs through a specialty
`pharmacy company called Philidor. In December 2014, Valeant acquired an
`option to buy Philidor for zero dollars, which is pretty darn close
`<http://www.bloombergview.com/articles/2015-10-26/valeant-s-pharmacy(cid:173)
`relationships-were-complicated> to owning Philidor outright; from then on,
`Valeant (properly) treated Philidor as just a part of Valeant for accounting
`purposes. consolidating it into Valeant's financial statements and booking
`revenue on drugs sold through Philidor only when Philidor sold them to
`patients, not when Valeant sold them to Philidor. But before Valeant acquired
`the option, it treated Philidor as an independent company; in particular, it
`booked revenue on drugs as soon as it sold them to Philidor, without waiting for
`Philidor to sell them to customers.
`
`That all sounds pretty normal: When Philidor was independent. Valeant treated
`it as a separate company; when Valeant effectively bought Philidor, it
`consolidated it. The problem is that when Philidor was "independent," before
`December 2014, it already had some ties to Valeant. Some very strange ties to
`Valeant. For instance: A number ofValeant employees worked at Philidor under
`fake names <http://www.wsj.com/articles/valeants-ties-to-pharmacy-scrutinized-
`1445817449> . Good lord, that really happened:
`
`The Valeant employees were placed at Philidor while the pharmacy was in
`its infancy, to provide help on "structures and processes,, said a Philidor
`spokeswoman. She said in a statement that the Valeant employees set up
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`Valeant Sold Some Drugs Twice - Bloomberg
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`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
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`separate Philidor email accounts, under "clearly distinguishable names,"
`to keep "their internal Philidor communications separate from the
`Valeant communications, primarily to reduce the risk of incorrectly
`sharing either company's proprietary information."
`
`The fake names included Peter Parker. Jack Reacher and Brian Wilson, though a
`"Philidor spokeswoman said the Valeant employees' 'real identities were well
`known to the other Philidor employees,"' which is only modestly reassuring.
`
`Anyway, given that Valeant was involved in setting up Philidor, using fake
`names, you might conclude that the relationship between Valeant and Philidor
`wasn't entirely arm's length and independent even before December 2014.
`Valeant seems eventually to have concluded something like that. From today's
`8-K <https://www.sec.gov/Archives/edgar/data/885590/000119312516511157
`/d164248d8k.htm> (emphasis added):
`
`Prior to consolidation, revenue on sales to Philidor was recognized by the
`Company on a sell-in basis (i.e., recorded when the Company delivered
`product to Philidor). In connection with the work oftheAdHoc Committee,
`the Company has determined that certain sales transactions for
`deliveries to Philidor in 2014leading up to the option agreement were
`not executed in the normal course ofbusiness and included actions
`taken by the Company in contemplation of the option agreement. As a
`result of these actions, revenue for certain transactions should have been
`recognized on a sell-through basis (i.e., record revenue when Philidor
`dispensed the products to patients) prior to entry into the option
`agreement rather than incorrectly recognized on the sell-in basis utilized
`by the Company. Additionally, related to these and certain earlier
`transactions, the Company also has concluded that collectability was not
`reasonably assured at the time the revenue was originally recognized, and
`thus these transactions should have been recognized on a sell-through
`basis instead of a sell-in basis. Following the consolidation ofPhilidor at
`the option agreement date, the Company began recognizing revenue as
`Philidor dispensed product to patients.
`
`You might think that this is mostly a matter of timing, not amounts: The revenue
`was booked too early, but eventually Philidor sold the drugs to patients, so all of
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`Valeant Sold Some Drugs Twice - Bloomberg
`
`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
`
`this washes out somewhere in Valeant's late-2014 and early-2015 earnings. And
`that is roughly true. for Valeant's net income. W Amusingly. though. it is not
`true for revenue: Because Valeant sold drugs to Philidor. booked revenue. then
`bought Philidor, sold the drugs to patients. and booked revenue again. it ended
`up booking revenue twice for the same sales. m
`
`The revenue that Is belngeltminatedfrom 2014 does not result in an
`increase to revenue in 2015 as a result of the Company having previously
`also recognized that revenue in 2015. Under the sell-tn method previously
`utilized by the Company prior to the consolidation ofPhllldor In December
`2014. revenue was recognized upon delivery of the products to Philidor. At
`the date of consolidation, certain of that previously sold Inventory was still
`held by Phllldor. Subsequent to the consolidation, Phllldor recognized
`revenue on that inventory when it dispensed products to patients, and that
`revenue was consolidated tnto the Company~ results.
`
`Lots of companies have accounting scandals that involve recognJzing revenue
`earlier than they should have. but Valeant is breaking some new ground in
`recognizing that revenue twice. Here is the stylized math W :
`
`Valeant sells drug to
`Philidor for $100
`
`Philidor sells drug to
`patient for $150
`
`Sell-in
`Valeant recognizes
`$100 revenue
`
`Sell-through
`-
`
`Why not both?
`Valeant recognizes
`$100 revenue
`
`Philidor recognizes
`$150 revenue
`
`Valeant recognizes
`$150 revenue
`
`Vale ant recognizes
`$150 revenue
`
`Total Valeant revenue
`
`$100
`
`$150
`
`$250
`
`The proper accounting was the approach labeled "Sell-through." Valeant's
`approach was some combination of"Sell-in" and "Why not both?11 Oops!
`
`The amounts involved are relatively small, it all happened in 2014, and the
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`Valeant Sold Some Drugs Twice - Bloomberg
`
`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
`
`accounting misdeeds are somewhat technical. Still, it is ... not a great look. For
`one thing, it again highlights the strangeness of the Philidor relationship.
`Philidor was a specialty pharmacy effectively owned by Valeant, but that
`ownership was weirdly furtive. Why? Well, one early theory
`<http://www.citronresearch.com/wp-content/uploads/2015/10/Valeant-Philador(cid:173)
`and-RandO-final-a.pdf> was that it was to allow for accounting tricks; the fact
`that Valeant did get the Philidor accounting wrong seems to support that theory.
`But it seems to me that the more worrying theory is that the Philidor subterfuge
`was about getting insurance companies to pay high prices for Valeant drugs with
`cheap substitutes, by submitting reimbursement requests from different
`pharmacies whose relationships with each other, and Valeant, were unclear. CIJ
`The accounting tricks were relatively small, and in the somewhat distant past
`(2014 is ages ago in Valeant time), and are anyway just accounting. The
`reimbursement stuff is, or at least was, more central to Valeant's business model.
`
`Also, though, when you accuse your former CFO and former corporate controller
`of "improper conduct," you probably have some cultural issues to work out. [!)
`Valeant characterizes those issues somewhat strangely:
`
`As part of this assessment of internal control over financial reporting, the
`company has determined that the tone at the top of the organization and
`the performance-based environment at the company, where challenging
`targets were set and achieving those targets was a key performance
`expectation, may have been contributingfactors resulting in the
`company's improper revenue recognition.
`
`You hear this idea a lot, (!] but it always strikes me as absurd. It can't really be
`the case that a culture "where challenging targets were set and achieving those
`targets was a key performance expectation" is itself a culture that encourages
`cheating. What a disappointing view of human excellence and ambition: Honest
`achievement is impossible, so a "performance-based" culture that demands
`achievement is really just code for a cheating-based culture that demands
`accounting manipulation.
`
`On the other hand, it is not hard to imagine a culture, a "tone at the top,"
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`Valeant Sold Some Drugs Twice - Bloomberg
`
`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
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`that would encourage cheating. For instance, if the view from the top is that
`success in the pharmaceutical industry isn't so much about developing good
`new drugs through fundamental research, but is rather about financial
`engineering and insurance gamesmanship, then you could see how that might
`lead to accounting problems. Financial engineering and accounting
`manipulation are very different activities, sure, but they share a certain family
`resemblance that is lacking in, say, basic drug research. They demand some of
`the same skills, and attract similar personality types. It can't be a total surprise
`that a drug company built on financial optimization would founder on
`accounting problems.
`
`This column does not necessarily reflect the opinion of the editorial board or Bloomberg
`LP and its owners.
`
`1. And other die-hard investors like Ruane Cunniff & Goldfarb <http://www.bloomberg.com
`/news/articles/2016-03-15/bill-ackman -loses-about-1-billion -on-valeant-worst-ever-drop> ,
`which added to its Valeant holdings in the fourth quarter.
`
`2. One of Ackman's previous bouts of paradoxical enthusiasm for Valeant led to him
`appointing <http://www.businesswire.com/news/home/20160315006331/en/Pershing(cid:173)
`Square-Holdings-LTD.-Sends-Communication-Investors> Steve Fraidin --Pershing
`Square's Vice Chairman, and my former M&A law professor- to the board.
`
`3. Strictly, it will be in default as of next week, but there's a 30-day cure period
`<https://www.sec.gov/Archives/edgar/data/885590/0001193U516511157
`/d164248dex991.htm> :
`
`IfValeant does not file its Form 10-K by March 30, 2016, there will be a
`default under the credit facility. The company will have 30 days, or
`until April29, to cure this default by filing its Form 10-K.
`
`Valeant expects to file its Form 10-K and become current on its
`financial filings by April29, 2016 (within the curing period) but to be
`prudent, the company also announced that it intends to seek a waiver
`from the lenders under its credit facility. The waiver that the company
`is seeking will include a request to extend the deadline to file its Form
`10-Kfor December 31, 2015 and the deadline to file its Form 10-Q for
`the quarter ended March 31, 2016.
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`Valeant Sold Some Drugs Twice - Bloomberg
`
`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
`
`4. From the 8-K:
`
`The Company has identified misstatements to date that would reduce
`previously reported fiscal year 2014 revenue by approximately $58
`million, net income attributable to Valeant by approximately $33
`million, and basic and diluted earnings per share by $.09 (as
`compared to the previously reported amounts of$8,264 million for
`revenue, $914 million for net income attributable to Valeant and $2.72
`and $2.67 for basic and diluted earnings per share respectively). A
`substantial part of the earnings impact of these misstatements will
`reverse in the first quarter of2015. The Company has identified
`misstatements in the first quarter of 2015, consisting primarily of the
`reversing effect on earnings of the 2014 misstatements, which would
`reduce revenue by approximately $21 million (timing of recognition of
`managed care rebates), increase net income attributable to Valeant by
`approximately $24 million and increase basic and diluted earnings
`per share by $.07 (as compared to the previously reported amounts of
`$2,191 million for revenue, $74 million for net income attributable to
`Valeant and $.22 and $.21for basic and diluted earnings per share
`respectively).
`
`5. This was fine, or fine-ish, or would have been fine but for the weird understandings
`between Valeant and Philidor:
`
`As long as those pre-consolidation sales transactions were in the
`normal course of business and not entered into in contemplation of the
`option agreement, the Company's historical accounting/or this
`revenue was in accordance with generally accepted accounting
`principles and consistent with its independent auditors' published
`guidance on this topic. Now that the Company has determined that
`certain sales transactions for deliveries to Philidor, leading up to the
`option agreement, were not executed in the normal course of business
`and included actions taken by the Company in contemplation of the
`option agreement, the revenue recorded in 2014, prior to the option
`agreement, is now being reversed.
`
`6. All numbers are of course made up; I have no idea what the actual margins looked like.
`
`7. Thus <http://www.bloomberg.com/news/articles/2015-10-29/valeant-s-philidor-used-back-
`
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`Valeant Sold Some Drugs Twice - Bloomberg
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`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
`
`door-tactics-to-boost-payments>:
`
`Philidor Rx Services LLC, which .fills prescriptions for Valeant
`Pharmaceuticals International Inc., instructed employees to submit
`claims under different pharmacy identification numbers if an insurer
`rejected Philidor's claim -- to essentially shop around for one that
`would be accepted.
`
`Employees were to first submit paperwork with Philidor's national
`provider identifier, or NPI, and if that didn't work were to then try
`with the NPis of partner pharmacies, according to a Philidor training
`manual. "We have a couple of different 'back door' approaches to
`receive payment from the insurance company," said the manual,
`dated October 2014.
`
`And <http://www.bloomberg.com/news/articles/2015-10-29/philidor-said-to-modify(cid:173)
`prescriptions-to-boost-valeant-sales> :
`
`A specialty pharmacy that fills prescriptions for Valeant
`Pharmaceuticals International Inc. has altered doctors' orders to
`wring more reimbursements out of insurers, according to former
`employees and an internal document.
`
`Workers at the mail-order pharmacy, Philidor RX Services LLC, were
`given written instructions to change codes on prescriptions in some
`cases so it would appear that physicians required or patients desired
`Valeant's brand-name drugs-- not less expensive generic versions-- be
`dispensed, the former employees said.
`
`8. Especially when that former CFO won't leave the board! On the other hand
`<https://www.sec.gov/Archives/edgar/data/885590/000119312516511157
`/d164248dex991.htm> , "In connection with the Ad Hoc Committee's work to date, certain
`remediation actions have been recommended and are being implemented by the company,
`including placing the company's former Corporate Controller on administrative leave."
`
`9.
`
`It is thrown around a lot to explain the insider trading at notoriously tough SAC Capital,
`and it is sometimes mentioned in discussions of rogue trading and market manipulation
`scandals at banks. The cultures demanded excellence, the story goes, so of course
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`Valeant Sold Some Drugs Twice - Bloomberg
`
`https://www.bloomberg.com/view/articles/2016-03-21/valeant-sold-some...
`
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