Minimal Manipulation: MiMedx and Section 361

There is a funny thing about the Food and Drug Administration: they really want you to follow their rules. Considering that they are responsible for protecting the public health by ensuring the safety, efficacy, and security of human and veterinary drugs, biological products, and medical devices, it's probably best for all of us when companies do follow their rules.

As far as their current set of rules are concerned, next week, the FDA will significantly change their directives when it formally ends it's policy of  enforcement discretion regarding human cell, tissue, and cellular and tissue-based products(HCT/Ps) compliance. 

The Federal Regulations

Part 1271 of Title 21 of the US Code of Federal Regulations is the rulebook by which the FDA regulates the use of HCT/P's and in July of 2020, the FDA released their final industry guidance document that formalizes the agency's view of how they interpret the rules in 21 CFR Part 1271.

For HCT/P manufacturers to comply with the rules they have to pay careful attention to Section 1271.3 which sets forth the necessary definitions that the agency and HCT/P manufacturers are relying on. There is a carve out in 1271 (1271.10(a)) regarding the regulation and pre-market approval for products that are referred to as 361 HCT/Ps. Broadly speaking, if your product meets the criteria as outlined in 1271.10(a) you've got yourself a Section 361 HCT/P. If you don't meet that criteria (and you don't fulfill some extremely narrow exceptions in 1271.15) you don't qualify as a Section 361 HCT/P and you've got a heavily regulated approval process ahead of you under section 351. Section 361 is important because it allows manufacturers of certain types of biologics to market their products without filing a Biologics License Application (BLA) and seeking express marketing approval from the FDA. If a manufacturer's product is appropriately qualified it literally saves years and millions upon millions of dollars. It is a very useful carve out that relies on the FDA's risk-based approach to the approval process.

The previous policy of enforcement discretion had allowed for manufactures of HCT/Ps to continue marketing products while they worked to formalize the FDA's classification of their particular products as either a 361 HCT/P or to submit a BLA. Generally speaking to comply with the CFRs as a 361 HCT/P the product must be "minimally manipulated" and for "homologous use". 

There are some narrow exceptions, but generally if your product does not meet these requirements then your product is not a 361 HCT/P and as of June 1, 2021 illegal to sell without the approval and express marketing authorization of the FDA. I've highlighted the most important parts of the CFRs below:

The really important parts of 1271.3 are below(highlight added):

The following definitions apply only to this part:
(a) Autologous use means the implantation, transplantation, infusion, or transfer of human cells or tissue back into the individual from whom the cells or tissue were recovered.
(b) Establishment means a place of business under one management, at one general physical location, that engages in the manufacture of human cells, tissues, and cellular and tissue-based products. "Establishment" includes:
(1) Any individual, partnership, corporation, association, or other legal entity engaged in the manufacture of human cells, tissues, and cellular and tissue-based products; and
(2) Facilities that engage in contract manufacturing services for a manufacturer of human cells, tissues, and cellular and tissue-based products.
(c) Homologous use means the repair, reconstruction, replacement, or supplementation of a recipient's cells or tissues with an HCT/P that performs the same basic function or functions in the recipient as in the donor.
(d) Human cells, tissues, or cellular or tissue-based products (HCT/Ps) means articles containing or consisting of human cells or tissues that are intended for implantation, transplantation, infusion, or transfer into a human recipient. Examples of HCT/Ps include, but are not limited to, bone, ligament, skin, dura mater, heart valve, cornea, hematopoietic stem/progenitor cells derived from peripheral and cord blood, manipulated autologous chondrocytes, epithelial cells on a synthetic matrix, and semen or other reproductive tissue.

The really important parts of 1271.10 are below(highlight added):

(a) An HCT/P is regulated solely under section 361 of the PHS Act and the regulations in this part if it meets all of the following criteria:
(1) The HCT/P is minimally manipulated;
(2) The HCT/P is intended for homologous use only, as reflected by the labeling, advertising, or other indications of the manufacturer's objective intent;
(3) The manufacture of the HCT/P does not involve the combination of the cells or tissues with another article, except for water, crystalloids, or a sterilizing, preserving, or storage agent, provided that the addition of water, crystalloids, or the sterilizing, preserving, or storage agent does not raise new clinical safety concerns with respect to the HCT/P; and
(4) Either:
(i) The HCT/P does not have a systemic effect and is not dependent upon the metabolic activity of living cells for its primary function; or
(ii) The HCT/P has a systemic effect or is dependent upon the metabolic activity of living cells for its primary function, and:
(a ) Is for autologous use;
(b ) Is for allogeneic use in a first-degree or second-degree blood relative; or
(c ) Is for reproductive use.
(b) If you are a domestic or foreign establishment that manufactures an HCT/P described in paragraph (a) of this section:
(1) You must register with FDA;
(2) You must submit to FDA a list of each HCT/P manufactured; and
(3) You must comply with the other requirements contained in this part.

How Enforcement Discretion Expiration Could Negatively Impact MiMedx

That brings us to MiMedx($MDXG). As best as I can tell, it seems that starting next Tuesday, almost all of MiMedx's current products and their marketing could be deemed illegal until approved under a BLA. Despite their former CEO being sent to prison for fraud, MiMedx has put out some very questionable guidance in recent regulatory filings. 

In their Q1 2021 10-Q (filed 4/28/21) the company seems to disclaim the potential effects of the enforcement discretion's expiration while implying that it's somehow limited to "micronized products and certain other products".

It's noteworthy that this 10-Q was filed after the Director of @FDACBER Peter Marks, very publicly reiterated the FDA's decision to end HCT/P enforcement discretion; a statement which the company even incorporated by reference in their 10-Q and Q1 2021 investor call.

In his remarks Dr. Marks firmly stated the agencies commitment to eliminating the illegal marketing of unapproved products.

"Despite all of the FDA’s efforts to engage industry, there continues to be broad marketing of these unapproved products for the treatment or cure of a wide range of diseases or medical conditions. Many of these unapproved products appear to be HCT/Ps that are regulated as drugs, devices and/or biological products subject to premarket approval requirements. The wide extent of the marketing of such unapproved products is evidenced by their inappropriate advertisement in various media and by the number of consumer complaints about them submitted to the FDA. 

These regenerative medicine products are not without risk and are often marketed by clinics as being safe and effective for the treatment of a wide range of diseases or conditions, even though they haven’t been adequately studied in clinical trials. We’ve said previously and want to reiterate here – there is no room for manufacturers, clinics, or health care practitioners to place patients at risk through products that violate the law, including by not having an IND in effect or an approved biologics license. We will continue to take action regarding unlawfully marketed products. Our oversight of cellular and related products has included taking compliance actions, including numerous warning and untitled letters, and pursuing enforcement action for serious violations of the law.

Since December 2019, the agency has issued more than 350 letters to manufacturers, clinics, and health care providers, noting that it has come to our attention that they may be offering unapproved regenerative medicine products and reiterating the FDA’s compliance and enforcement policy."

As a result of the enforcement period's expiration and lack of documentation demonstrating their compliance with Section 361, I believe that MiMedx is actually in much greater peril of enforcement action than either they perceive or are disclosing. MiMedx has disclosed to investors that their micronized products do not meet the definitions of minimal manipulation based on FDA guidance and that they will cease marketing those products when enforcement discretion ends.

"we have continued to market our micronized and particulate products during the period of enforcement discretion, but must cease to do so after May 31, 2021 until the FDA approves a Biologics License Application for a specific product and indication."

This conclusion is supported by the FDA's final guidance which contains a relevant example regarding what is acceptable for minimal manipulation of structural tissues such as amniotic membrane. Based on this guidance I think any rational person would agree that processing the amniotic membrane to remove the chorion meets the definition of minimally manipulated but also that micronization disqualifies a product as minimally manipulated.

The narrative that MiMedx seems to be pushing however is that other parts of their business are somehow immune from the enforcement discretion expiration. To comply with section 361 the product must be "minimally manipulated", and for "homologous use" and I do not agree with the proposition that their other products are "minimally manipulated" or for "homologous use". You may interpret FDA Example 10-2 (above) to indicate that MiMedx's sheet products are minimally manipulated, however MiMedx dHACM products are more extensively processed than the above example. The technical distinction(and the FDA loves technical distinctions) between the above example and other products in the market is that MiMedx dHACM products are actually sheets comprised of placental tissue wherein the amnion and chorion have been separated from one another, cleaned and then laminated back together prior to dehydration. The FDA may very well take the position that the separation and lamination steps do not meet the criteria for "minimal manipulation" and "combination". In 2013, the FDA had previously challenged whether MiMedx's micronized products complied with section 361, taking the position that these products did not meet the "minimal manipulation" standard.  Although it's certainly true that the FDA chose to focus on the micronized products, the agency's lack of action against the sheet products doesn't provide any cover for MiMedx either. In the FDA's untitled letter the agency expressly disclaimed the possibility the letter was "intended to be an all-inclusive review of the products that your firm markets." Although the FDA has not yet challenged MiMedx's other products, the FDA also has not provided any public guidance to indicate whether MiMedx's practices are acceptable within the context of 361 HCT/Ps nor has MiMedx publicly disclosed any designations they might have received from the FDA's Tissue Reference Group, which is particularly troubling. Despite having many years of opportunity to unequivocally determine whether their core products are compliant under 361, MiMedx has never disclosed any formal designation for their products issued by the TRG. In 2015, Parker Petit effectively acknowledged the lack of designation when he explained the company's basis for marketing their products as HCT/Ps:

"Amniotic membrane has been used in numerous wound covering and wound healing applications for over 100 years.  These applications have been highly publicized over a long period of time and have been repeatedly referenced by the FDA.  These references form the basis for MiMedx's position on marketing, labeling and intended use."

Why "form a basis" for marketing when you could definitively receive an opinion from the TRG? Perhaps the company was fearful that the TRG would determine that MiMedx products did not meet the standards under section 361 for any one of a number of reasons.

Another troubling aspect of Parker's 2015 statement was that it came more than a year after the company denied in court that they never sought a determination from the TRG. In re MiMedx Group, Inc. Securities (13-cv-03074-TWT) the plaintiffs alleged that MiMedx had never sought a determination from the TRG to base their assertion that their processing technique constituted "minimal manipulation", which the company subsequently denied in September 2014.

Again this begs the question as to why MiMedx would ever have to "form a basis" for their products' marketing, labeling, intended use, or compliance under section 361? It's incredible that the company would deny such an allegation a year prior and subsequently make statements about their opinion. If they actually had a designation from the TRG, wouldn't it be in your shareholder's best interest to simply disclose your unequivocal designation by the TRG as 361 compliant? That's precisely what other companies have done. In their most recent 10-K filed February 24, 2021, Xtant Medical Holdings had this to say about some of their products:

"Several of our products, including OsteoSponge and OsteoWrap, are regulated as HCT/Ps because they meet these four criteria. The FDA’s Tissue Reference Group confirmed this in non-binding recommendations provided to us."[emphasis added]

PolarityTE, on the other hand basically took a NWA approach in their most recent 10-K:

"Product manufacturers are not required to consult with the TRG or OCP and instead can market their products based on their own conclusion that the product meets the 361 HCT/P criteria. We have not consulted the TRG or sought a formal designation from the OCP, though we have had informal interactions with OCP."

To their credit at least PolarityTE made a reference to the TRG, but oddly enough, if you perform a full text search of EDGAR, you'll note that the search terms "Tissue Reference Group", "TRG", "Request for Designation", "RFD", "TRIP" and "Rapid Inquiry" simply do not appear in any MiMedx filing with the SEC over the past ten years despite the company's public reference to the TRG. Strange.

Homologous Use

Even if one were to assume that MiMedx's products are compliant within the "minimal manipulation" and "combination" standards, are they really intended for homologous use? The answer isn't always crystal clear and it depends on the tissue's original functions in the body when compared to it's intended function in the recipient. In an effort to clarify whether products met these requirements the FDA also provided illustrative examples of what qualified as homologous use in the final guidance document(red box bad, green box good). 

Again assuming MiMedx products meet the the "minimal manipulation" and "combination" guidance, I think it's fairly safe to interpret the FDA guidance such that EpiFix, AmnioFix, and EpiBurn would satisfy the homologous use guidelines provided that they are being applied *only* as a protective covering. In fact, the FDA's footnote to the above example seems to question the validity of MiMedx's entire business model and marketing strategy by specifically noting that:

"Reducing scarring, angiogenesis, and inflammation are potential clinical effects in the recipient but are not basic functions of amniotic membrane in the donor; therefore, they are not considered homologous uses of amniotic membrane."

By MiMedx's own admission(10-K) the "guidance documents confirmed that sheet forms of amniotic membrane generally are appropriately regulated as solely Section 361 HCT/Ps when intended for use as a barrier or covering" [emphasis added], despite subsequently detailing in their most recent 10-Q that:

"Our EpiFix and EpiCord sheet product lines are promoted for external use, such as in advanced wound care applications, while our AmnioFix, AmnioCord and AmnioFill products are positioned for surgical applications, including lower extremity repair, plastic surgery, vascular surgery and multiple orthopedic repairs and reconstructions."[emphasis added]

The above description seems to fly directly in the face of what the FDA considers to be "homologous use."

MiMedx also disclosed in their 2020 10-K that ~20% of their 2020 sales were products they either knew to be subject or believed that they could be subject to enforcement action(micronized products, EpiCord and AmnioCord). Strangely in the 2020 10-K the company seems to paint a target on the back of their umbilical cord derived products: 

"Also, the Company currently markets EpiCord and AmnioCord, tissue products derived from human umbilical cord, as providing a protective environment or as a barrier. The Company has become aware that the FDA may view the basic function of human umbilical cord as a conduit, based on warning letters to several companies marketing human umbilical cord derived products for a variety of uses, which raises the risk that the FDA will take the position that MiMedx’s marketing of human umbilical cord products may not be a homologous use. To our knowledge, the FDA has not indicated this publically or to MiMedx however, if FDA determines that EpiCord and AmnioCord do not meet the requirements for regulation solely under Section 361, then pre-market clearance or approval under Section 351 will be required."

Unnecessary Uncertainty

I can only imagine how frustrating the uncertainty is for MiMedx shareholders, which is made all the more irksome by the fact MiMedx could have received detailed guidance from the FDA on the future regulatory status of all of their products. Even though the TRG has been around for 20+ years, as a part of the FDA's commitment to stakeholders, the FDA created and launched a Tissue Reference Group Rapid Inquiry Program (TRIP) that allowed manufactures of HCT/Ps like MiMedx to seek and receive a "rapid, preliminary, informal, non-binding assessment from the FDA regarding how specific HCT/Ps are regulated". This program operated from June 2019 through March 31, 2021. In effect, MiMedx was able to submit product information to the FDA and receive enough feedback to know whether their products could be marketed after May 31, 2021 as a 361 HCT/P or whether they would need to file BLAs. No guesswork needed.

It almost seems that MiMedx is attempting to be willfully ignorant of how the FDA will regulate their products despite the FDA providing ample opportunity to submit product specific inquiries to the TRIPs program. The TRIPs program was not overly complicated and facile enough that even a tiny, resource constrained competitor of MiMedx did just that. Earlier this year BioStem Technologies disclosed that they had received a TRIP response indicating that their VENDAJE product did "meet the criteria in 21 CFR 1271.10(a) for regulation solely under Section 361 of the Public Health Service Act and 21 CFR 1271." VENDAJE is an amniotic derived wound covering, which is similar to the MiMedx products, however it is comprised solely of the amnion layer, and not laminated dHACM, so we can't reliably conclude that VENDAJE's TRIP response provides safe harbor to MiMedx products. Furthermore the two companies' marketing materials are vastly different. VENDAJE marketing goes no further than stating it is intended as a protective covering for wounds. 

MiMedx's marketing materials however are directed toward advanced wound care applications, with "semi-permeable protective barriers" that "supports the healing cascade and protects the wound bed to aid in the development of granulation tissue" or are directed toward surgical applications such as "tendon, bone or hardware coverage".

In addition to potential action by the FDA, the company's current marketing practices will also put them squarely at odds with the expectations they disclosed to investors in their most recent 10-K.

"Under the Guidance, we expect that the FDA will continue to regulate our amniotic membrane sheet products (AmnioFix, EpiFix, EpiBurn and EpiXL) as Section 361 HCT/Ps so long as the claims we make for them are consistent with the Section 361 framework."[emphasis added]

For the sake of their shareholders, I hope that MiMedx uses their annual meeting to clarify the precise TRG designation status for all of their products, whether they participated in the TRIPs program, as well as the significant changes to their sales and marketing activities which will likely be warranted starting June 1st when enforcement discretion ends. As responsible fiduciaries, if they haven't already done so, the company should immediately take all steps necessary to submit multiple Requests for Designation to the TRG and disclose the outcome of those requests so that the veil of uncertainty surrounding their products can be lifted for the sake of consumers and the company's shareholders.

Material Adverse Events

You might suppose that MiMedx, the Marietta, Georgia-based regenerative tissue developer squarely in the crosshairs of everyone from the Department of Justice, the Department of Veteran's Affairs, the Securities and Exchange Commission, health insurers, and short-sellers couldn’t possibly have anymore controversy surface.

Think again.

Recently a civil lawsuit was initiated in Fairfax County, Virginia that suggests that MiMedx isn’t leveling with both consumers and a key regulator over the safety of their flagship products. 

The complaint is pretty straightforward: a patient named Victoria Wen-Platt claims her routine surgery for carpal tunnel syndrome was marred because of a severe reaction to the EpiFix her surgeon used to minimize scar tissue. What is not so straightforward, however, is why the Food and Drug Administration has no record of this adverse event and others.

In response to a Freedom of Information Act request, the FDA performed an exhaustive search of adverse events potentially caused by MiMedx products spanning over a seven year period that ended in February 2018. As it turns out, while the FDA does have records of adverse events related to EpiFix and AmnioFix, MiMedx self-reported those events to the FDA and determined they were unrelated to their products.

One particularly disturbing report indicates that MiMedx knowingly processed tissue that cultured positive for coagulase negative 

Staphylococcus and Staphylococcus saccharolyticus. Coagulase-negative staphylococci (CoNS) are part of the normal bacteria typically found on human skin and are often contaminants of clinical specimens. Usually CoNS aren't particularly virulent, although their prevalence has contributed the CoNS becoming agents of more clinically significant infections. Although CoNS rarely cause sepsis, they are one of the most common nosocomial infections and are often resistant to multiple classes of antibiotics. The report MiMedx submitted to the FDA details that a patient who received 50mg of AmnioFix injectable and an EpiFix graft on his right foot in July of 2017 later had his toe amputated.

MiMedx’s report indicated that:

“Hospital culture was positive for Staphylococcus aureus (gram positive cocci). This is a different species than the MiMex pre-processing [(b)(4) redacted] for the grafts which indicated Coagulase Negative Staphylococcus (for donor [(b)(6) redacted] and Staphylococcus saccharolyticus (for donor [(b)(6) redacted]. As the species are different, there is no correlation between the growth on the incoming tissue and that on the wound culture at the hospital. Because of the investigation (above and in B.6) and asence of findigs, and the fact that the tissues in question were terminally sterilized, we have determind that it is highly improbably that the adverse reaction was caused by the tissue. However, as the event did involve and infection which necessitated medical intervention (antibiotic treatment and toe amputation), Mimedx has determined that, in the abundance of caution, the event will be reported to the FDA under 21 CFR 1271."

Although the patient's infection was determined to be caused by Staphylococcus aureus, I'm surprised that MiMedx's quality control systems would allow this tissue to be processed to begin with. MiMedx notes that the tissues in question were terminally sterilized, however in the FDA's current risk-based approach to biopharmaceutical quality it seems unnecessarily reckless to allow harvested tissues that culture positive for known pathogens to move through MiMedx's manufacturing processes and ultimately on to distribution. The report further indicates that a total of 56 grafts were distributed from the same lots, however the report does not indicate that these tissues were actually utilized.

MiMedx and I can disagree what constitutes "quality by design", nonetheless the severe reaction that Mrs. Wen-Platt encountered is clearly not listed in the MEDWATCH reports which the FDA provided in response to the FOIA request. One simple and plausible explanation is that the reaction occurred outside of the responsive period that the FDA was asked to query. Or that the reaction was reported to the company after the FDA closed out the FOIA request. Another is that the company was never aware that a recipient of one of its products had such a severe reaction.

I believe that the reaction was reported to the company and the company did not report the event to the FDA.

Wen-Platt's severe reaction occurred in January of 2017, within the responsive time frame of the FOIA request. Additionally, I’ve been told by a source familiar with the matter that MiMedx was indeed notified of the adverse event within six months of its occurrence. The adverse event was initially reported to a Regional Sales Director and then quickly elevated to at least one member of MiMedx's senior management team, Dr. David Mason, the Vice President of Medical Affairs for Clinical Practice. 

Although the patient's name would have been redacted in the documents provided by the FDA, there is simply no record that comes close to matching her reaction. More troubling still is that as referenced above the person familiar with the matter indicated there are more adverse events related to MiMedx products which have not yet been publicly disclosed. 

In a press release touting the efficacy of EpiFix in treating diabetic foot ulcers, MiMedx referred to a study first disclosed at the Symposium on Advanced Wound Care in April and published August 22nd in the International Wound Journal by William Tettelbach, who is now MiMedx's Associate Chief Medical Officer. Although the publication attempts to support the efficacy of EpiFix in treating diabetic foot ulcers, there are some troubling omissions from the report. One of the study's principal investigators was Dr. Dolores Farrer. Dr. Farrer completed enrollment of patients at the William Jennings Bryan Dorn Veterans Affairs Medical Center by January 27, 2017.  

Dr. Farrer, who was also listed as a member of MiMedx's VLU Study Group, was indicted in May of 2018 by the U.S. Attorney’s Office of the District of South Carolina for Conspiracy and Bribery with respect to her financial interest in MiMedx while a physician at the Dorn VA. Although Dr. Tettelbach revised his paper almost 2 months after Farrer's indictment, Dr. Farrer's involvement in the study is not disclosed anywhere in Tettelbach's publication.  

Tettelbach's publication neither details how many patients were randomized at the Dorn VA, nor the number of patients that were treated at the Dorn VA.

The study authors do disclose however that out of 126 patients randomized in the clinical trial, three experienced adverse events that were considered to be possibly related to the product.

Similarly to Mrs. Wen-Platt's reaction, these adverse events are also conspicuously absent from the MEDWATCH reports provided by the FDA, despite federal requirements to report such adverse events. 


I often wonder why the FDA hasn't yet launched an enforcement action against MiMedx. If you read the FDA's January 2016 Establishment Inspection Record for MiMedx, or the FDA's untitled letter they sent to the Mid America Stem Cell Institute in July of this year, it's a bit shocking to see that the agency has not recently sent a similar letter to MiMedx, particularly since MiMedx has been on the FDA's radar since August of 2013. 

The following screenshot was taken from MiMedx's website today. MiMedx is claiming that they have distributed more than 1,000,000 allografts to date with "zero reported adverse reactions attributed to our products." Although there have been a lot of changes in MiMedx recently, whether or not you think MiMedx's current woes are solely related to actions taken by former leadership, MiMedx is *currently* making materially false statements with respect to their products' safety and use.

It's possible that the FDA will take action against MiMedx. It's also possible that the FDA will let MiMedx run out the remaining 28 months* of their enforcement discretion based a lack of safety concerns and also based on the company's Investigational New Drug Applications that will support their planned Biologic License Applications.

*(The final guidance issued by the FDA in December of 2017 for Human Cells, Tissues, and Cellular and Tissue-Based Products noted that the agency would "exercise enforcement discretion under limited conditions with respect to the investigational new drug (IND) application and premarket approval (biologics license application (BLA)) requirements, for certain HCT/Ps" for a 36 month period.)

Setting aside the allegations of fraud and kickbacks, to say nothing of the absence of six years of reliable financials for this publicly traded company, if MiMedx was counting on the FDA's enforcement discretion it's quite possible that discretion will evaporate in light of these previously unreported safety concerns.

(Note: I emailed both Dr. Mason and Dr. Tettelbach seeking their comment, but had not received a response from either at the time of publication) 

MEDWATCH Responsive Records Medwatch MDXG 20118 by theskeptic21 on Scribd

Special Committee on Aging Frontruns Valeant Q1 Earnings Release

Entangled within the epic data dump the Senate Committee on Aging gave the world there is some troubling guidance provided by Valeant's CFO, Rob Rosiello. In response to the interrogatories posed by the committee regarding the pricing of a handful of Valeant drugs, Mr. Rosiello (response starts on pg 17) was required to disclose the ratio of revenues that each of those drugs represented in relation to company wide numbers. To set the baseline for those ratios, Mr. Rosiello provided the following table (pg. 21) of his response that details financial information for the company:

• i. Net Product Sales
• j. COGS
• k. Gross Margin
• l. Net Income

There are a couple of very interesting aspects of this disclosure.

1. It allows you to look back to see how previously disclosed margins, COGS and revenues compare, pre- vs. post- restatement (fun times)
2. More interestingly, it gives you a direct line of sight on what Q1 2016 will look like.

Valeant just reaffirmed guidance today at $1.30-$1.55 EPS with revenue estimates of $2.3-$2.4B.

We know from Rosiello's sworn testimony provided in his response to the interrogatories that Valeant had $1260.95M in net product sales through February. To meet today's guidance, Valeant will have to net $1039.05M in sales in March (a 50.7% increase m/m versus February and a 81.9% increase m/m versus January), translating to approximately ~$260M in Net Income.

If Valeant doesn't manage to squeeze two month of revenues into March (which was perhaps the most tumultuous month in their entire history), they'll miss their own numbers they reaffirmed today. 

Supposedly, we'll find out by June 10th.

Valeant Updates Schiller's Website Profile

First off, click on the image below to read the screen grab from Valeant's updated website.

Despite the Board's protestations and public accusations, under section 14.10 of Valeant's Articles, Schiller can only be removed if he's no longer qualified as a director. According to the Business Corporations Act of British Columbia, Schiller is undoubtedly still qualified. Furthermore it would require a Special Resolution to remove him if he continues in his refusal to offer his resignation; such a special resolution would require a two thirds vote of Valeant shareholders. Although the updated website profile is a TOTAL SPOOF, based on the above facts of law regarding whether Schiller is still qualified, I expect things may remain pretty tense in Valeant's Board Room for a while to come, particularly as they are accusing him of things he clearly disagrees with.

Valeant's Humpday: SEC Subpoena, Arizona Targets Company and Jorn Resigns

 

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If this week wasn't bad enough for Valeant, Deb Jorn, the Executive Vice President and Company Group Chairman resigned today from the company. Ms. Jorn was responsible for all major US product launches as well as the Dermatology and GI therapeutic areas. These two areas were Valeant's most important, representing HALF of Valeant's forecasted 2016 US revenues. Moreover, Ms. Jorn was also responsible for the huge push of Dermatology products through the captive pharmacy channel they'd established with Philidor and it's subsidiaries.

Philidor is basically in a world of shit, which could be why Ms. Jorn resigned. We know from an action taken by the California Board of Pharmacy that Philidor, Valeant's captive specialty pharmacy, was denied a license to operate in the state of California. This led Philidor to attempt to purchase R & O pharmacy through a series of shadow transactions, which could allow Philidor to operate in California, or at least that was the plan. Those well versed in the story are aware that this deal completely fell apart after Russel Reitz, the owner and pharmacist operating R & O Pharmacy accused Valeant, Philidor and others of committing fraud in Federal court. We also know from other court records that Philidor, through R&O, pushed thousands of prescriptions for Valeant products out to over 30 separate states.

Leading into Jorn's resignation, this past Monday Valeant's situation became even more tenuous when it disclosed it had been subpoenaed by the SEC. In yet another laughably ridiculous PR effort, this past Tuesday Valeant is attempting (through private calls with sell side analysts) to spin this SEC investigation by claiming that this is somehow related to Citron Research's report on the company. The guts of this claim is completely incredible in that Valeant was SUBPOENAED. It very well may be that it was started because they complained about Citron, but you don't subpoena Valeant for information they would willingly provide about a short seller. It's amateurish drivel that got pushed out to the market through what could be Reg FD violations. 

Worse still for Valeant adn Ms. Jorn, the concerns surrounding Philidor persist like toenail fungus or IBS.  Sources have confirmed that the State of Arizona is targeting Valeant and its affiliates. In what I consider to be a model of transparency, you can actually watch the full Arizona Board of Pharmacy Meetings via Arizona's open meeting process. Additionally you can review the full agenda for each meeting at the Board's event portal.

This transparency allows you to see that back on November 18th, shortly after Valeant detailed it's relationship with Philidor, the Arizona Board reviewed an August pharmacy application by Forsta LLC.

Forsta was formed by none other than Philidor's Gary Tanner(aka Valeant's Gary Tanner), and it's pharmacist in charge was none other than Philidor's Jake Power. As evidenced by the minutes, the Board discussed Forsta's application at the meeting, as well as Valeant's relationship with Philidor. It should be noted that Forsta was one of four resident wholesaler applicants and one of 6 resident pharmacy applicants at the November meeting. Flash forward to the January 27-28, 2016 meeting, and you see that Forsta LLC was on the agenda yet again. Although Forsta's peers from the previous meeting all received approval for license, Forsta was held back with a provisional approval(rendering Forsta non-operational). According to sources familiar with the matter, Forsta was asked to attend the meeting specifically because of it's ties with Philidor and Valeant and the Board wanted very much to explore these connections. Forsta cancelled their appearance right before the meeting and did not attend.

Although the meeting agenda has not yet been made public, sources indicate the Board has asked both Forsta and Philidor to appear at the upcoming March meeting, although it is unclear whether either plans to attend. As a suggestion, I'd like to recommend that both companies just send Gary Tanner and Jake Power. Maybe Deb now that she's unencumbered. 

In addition to probing the interconnections of Valeant, Philidor and Forsta,the Board has also taken issue with Philidor's call centers. Despite Philidor's public claims about winding down their business, sources familiar with the matter indicate that the Board believes the Philidor call centers in Phoenix and Tempe are operating in violation of state laws. The Board has also been presented with evidence demonstrating that Philidor has been attempting to hire pharmacists and technicians in Arizona. This is a curious discovery particularly because Philidor filed a WARN notice in Arizona, on January 5th, 2016 indicating they were providing a 60 day notice period that they planned to eliminate 264 jobs in Arizona as well as a WARN notice for 262 employees in Pennsylvania on November 23rd. Stranger still is that AFTER their public claims of winding down operations, Philidor applied for another license in Arizona on December 15th; that application is currently listed by Arizona as in process. 

The issues faced by these companies in Arizona shouldn't be underestimated given the prestige and level of national engagement of Arizona's Board of Pharmacy members. During his time as Executive Director of the Arizona Board, Hal wand, who is currently currently the NABP President-elect, overlapped with his friend and recent Arizona Board President Dennis McAllister. Mr. McAllister, is a current member and the former President overseeing the above referenced proceedings that reviewed Philidor and Forsta. Mr. McAllister also sits on the National Association of Boards of Pharmacy's ACPE Board. In addition to his role at the Arizona Board of Pharmacy, Mr. McAllister is also the Senior Director of Express Scripts's Pharmacy Regulatory Affairs group where he directly oversees Express Scripts' relationship with 18 separate state Pharmacy Boards. Yes, the same Express Scripts that was hoodwinked by Philidor/R&O and yes the same Express Scripts blocking access to overpriced Glumetza. 

To a certain extent you may be thinking, "Ahh...it's Arizona, so what! Why do I care and why would the Arizona Board care so much about Valeant, Philidor and Forsta?" Well, it wouldn't just be the AZ board, but the Feds may get involved as well. You'll remember from the Isolani lawsuit documents that R&O, which was not licensed in Arizona, shipped prescriptions to Blue Cross and Humana patients in Arizona. While this was going on, Philidor (who was located in Arizona, but not licensed in California) was controlling outbound shipments to Arizona from R&O(who was located in California but not licensed in Arizona). Because the parties had not yet closed the purchase agreement for R&O the effect was that one unlicensed non-resident pharmacy forced another unlicensed non-resident pharmacy to illegally ship prescriptions via mail, across state lines, when they could have simply filled those prescriptions from their own authorized jurisdictions. Smart right? (insert Valeant business model joke)

You can readily observe from their meetings that due process is a cornerstone of the Arizona Board of Pharmacy's review and enforcement processes. Although the matters are still under the Board's review, in the absence of meaningful records production or participation in the due process extended to them, an industry expert indicated that it is highly unlikely that either Philidor or Forsta's applications will receive final approval. Beyond the denial of the respective applications, the principals of those companies could also face disciplinary action in Arizona, and other jurisdictions, further entangling Valeant in their ongoing self-destruction. 

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.