Valeant is completely erasing two years of business -- and one executive is taking the blame

In another dramatic turn of events, Valeant Pharmaceuticals has announced that it will replace its CEO, Michael Pearson, and that hedge fund billionaire Bill Ackman will join the board.

That’s the headline, but buried underneath that in one of the most corporate jargon-filled press releases we’ve ever seen, lies the answer to one question investors want answered: Who is responsible for this mess?

Here’s your answer in the release:

The improper conduct of the company’s former Chief Financial Officer and former Corporate Controller, which resulted in the provision of incorrect information to the Committee and the company’s auditors, contributed to the misstatement of results.

That former CFO (who wasn’t named directly in the release) is named Howard Schiller. He just finished a stint serving as interim CEO when Michael Pearson was on medical leave. He even got grilled by Congress over Valeant’s drug pricing practice. Schiller was CFO of Valeant from December 2011 to June 2015. He’s on the board now, and was asked to resign, but refused.

More from the release:

“In addition, as part of this assessment of internal control over financial reporting, the company has determined that the tone at the top of the organisation 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 contributing factors resulting in the company’s improper revenue recognition.”

Schiller disputes the accusations of improper conduct, saying in a statement that “at no time did I engage in any improper conduct that relates to any restatement of revenue the Company is considering.”

And what in the revenue was improper? A whole lot.

  • All audited financial results for 2014.
  • All unaudited financials for Q4 2014.
  • Unaudited financial statements for Q1 2015 “due to the misstatements described in the company’s Form 8-K filed today.”
  • That means disregard Q2 2015 (because Q1 2015’s numbers are on there).
  • And of course, Q3 2015 has to go too.
Howard Schiller, valeant cfo, valeant interim ceoGetty Images/ Mark WilsonWASHINGTON, DC – FEBRUARY 04: Howard Schiller, CEO of Valeant Pharmaceuticals, listens to questions during a House Oversight and Government Reform Committee hearing on Capitol Hill, February 4, 2016 in Washington, DC. Former Turing CEO Martin Shkreli invoked his 5th Amendment right not to testify to the committee that is examining the prescription drug market

That’s two years in Valeant’s history. Since then, the company’s stock has fallen 80% on government scrutiny over its pricing practices and accusations of malfeasance from a short seller.

Monday’s announcement addresses the second part. In 2014 Valeant purchased the option to buy Philidor, a mail-order pharmacy that distributed Valeant products almost-exclusively, for $100 million.

Its existence was a secret to the world until October of last year, and its revenue was rolled in Valeant’s. We still don’t even know how much revenue was generated from Philidor alone.

Despite all of that, though, Valeant is saying that we should be alright with some of the numbers. The problem, as Valeant says in the 8K that came along with the press release, is that it recognised revenue from Philidor sales twice. Before it purchased the option to buy Philidor, Valeant recognised product sale upon delivery to Philidor. Afterward, it recognised it upon sales to the customer.

The thing is, Philidor was holding Valeant inventory (we don’t know how much) from before the options purchase. It then double recognised the sale of that inventory when it was sold to the customer.

From the 8K emphasis ours:

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 for 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. However, because that revenue was also recorded by Philidor subsequent to consolidation, upon dispensing of products to patients, the elimination of the revenue in 2014, prior to consolidation, does not result in additional revenue being recorded in 2015. However, the profit that was recognised in 2014 will now be recognised in 2015 as a reduction to previously recorded Cost of Goods Sold (“CGS”) for that revenue (adjusting CGS from Philidor’s acquisition cost to Valeant’s actual cost). Additionally, provisions for managed care rebates of $21 million previously recorded in 2014 will now be recognised against that revenue in 2015. The adjustment amounts described above are preliminary, unaudited and subject to change.

You got all that? Cool, nothing to see here.

The company says that is committed to getting new, accurate numbers in its annual report. That report has been delayed for weeks, and if the Valeant doesn’t release it by April 29, bondholders can call in their money.

In the meantime, Valeant is trying to negotiate an extension. It’s unlikely that they will get it, and if they do, bondholders will likely want higher interest payments in order to take on that risk. The stock will continue to sell unless investors see some numbers too, so this is going to be costly any way you slice it.

Part of what’s odd about this is that, in internal emails subpoenaed by the government, it was Schiller who got on Pearson’s case for making “misstatements” to investors about volume and price. Indeed Pearson has had to walk back from some of those comments himself.

Either way, since Schiller won’t resign from the board, it looks like he’s not going to go quietly. This will be interesting to watch.

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