Major Flaw in Valeant Ad Hoc Committee's Statements

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Late on February 22nd, 2015 after four months of work, Valeant released a statement about their Ad Hoc Committee's review of Philidor and related accounting. As of today, Valeant has yet to file an 8-K with respect to that statement, but they may be distracted by other priorities, such as their recently disclosed SEC subpoena. 

There is a major problem with the statement they put out on February 22nd and reiterated in their NT 10-K filed yesterday. Before we get to the major problem with the statement, lets explore some other background issues from a year ago.

• On February 20th, 2015 Valeant shares closed at $173.26
• On February 22nd, 2015 Valeant reported earnings (GAAP of $1.56, and CASH EPS of $2.58; when the street was expecting between $2.45-$2.55)
• On February 23rd, 2015, the next trading day, Valeant closed at $198.75 on close to 20M shares traded; that is a 14.7% move (or close to $9B in market cap)

Bringing it back to today, if you assume that Valeant's recent restatement (which they continue to waffle on per the NT 10-K) is limited to the $58M and that such a restatement is appropriate (which are both BIG assumptions) if they had reduced GAAP EPS by $.10 in Q4 2014 it would have caused Valeant to miss Q4 Cash EPS estimates. Kind of makes you wonder how they would've traded on February 23rd, but one could only speculate.

Valeant practically begs us to speculate when it comes to their relationship with Philidor. Tantalizingly, Valeant informed us that they "identified certain sales to Philidor during 2014, prior to Valeant's entry into an option to acquire Philidor, that should have been recognized when product was dispensed to patients rather than on delivery to Philidor." (emphasis added) This statement supports the entire basis of their restatement. Here is the really outrageous aspect of their claim.

In making this statement, Valeant seems to have conveniently forgotten their October 26, 2015 investor presentation. In slide 48 of that presentation they very clearly outline that before their Purchase Option Agreement (executed in December of 2014) that sales were recognized upon transfer to Philidor.

In fact Valeant is quite adamant about how they account for Philidor sales and very explicitly instruct us that before the Purchase Option Agreement "all sales to Philidor accounted for as Valeant does with any third party" and "sales recognized upon transfer of inventory to Philidor". They even boastfully point us to the fact that consolidating the VIE delays revenue and that there is "no way to stuff the channel". 

This all begs the question: if the restated revenues were before the option agreement, why would those sales ever need to be recognized when sold to the patient? 

It's nonsensical. The only reason the sales to Philidor would ever need to be recognized upon sale to a patient would be if Philidor was a VIE prior to the option agreement. Valeant says so much in the October 26 presentation(see slide 51), but also claim that they weren't the primary beneficiary of the VIE so consolidation was not appropriate.

To put this all another way, the only way that $58M in net revenues which occurred prior to the option agreement would have to now be restated is if Valeant became the primary beneficiary (i.e., controlling interest) prior to the option agreement. 

For that to be true, it would mean that Valeant (at the very minimum) would have had to have invested in Philidor prior to the option agreement as well as be the primary beneficiary(see ASC 810-10-20). But yet again that can't be true either because Valeant specifically tells us that "Valeant did not invest or lend any money to the Philidor scaleup." Despite Valeant's protestations otherwise they would have had to either obtained "the power to direct the activities that most significantly impact the VIE’s economic performance" or obtained "the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIE." YIKES! 

And in yet another wrinkle for Valeant, in that same October 26th, 2015 presentation Valeant stated that as of the December 2014 option agreement, Philidor only had $111M in net sales YTD. So, based on the disclosed $58M restatement, Valeant must now also admit that over half of Philidor's 2014 net sales were flowing into Valeant, because they were the primary beneficiary/controlling interest.

All of this must be very off putting for their newly minted partner, Walgreens, especially since a major Presidential candidate is vowing to go after Valeant(see video below). For the detail oriented, Walgreens and Valeant inked their 20 year distribution agreement on December 14th. If Valeant failed to disclose the SEC Subpoena and investigation to Walgreens, it could be grounds for termination of that distribution partnership. Hypothetically, if your 2016 guidance was based on that new distribution agreement, and if the agreement were terminated, it would be a much better reason than a $58M restatement to pull 2016 guidance.

Nonetheless, based on the restatement, it seems that Valeant may have been purposely accelerating revenue (so they wouldn't miss) and that they did so by stuffing a channel that they claimed they didn't control (although they did or they wouldn't have to restate) and were trying to fully control. Oh, yeah, they also did all this without disclosing it to their shareholders and then when they did disclose, it seems they may have meant to say something different from what they actually said. It wouldn't be the first time.