Valeant - Aggressive accounting or Clean accounting practices?

There are critics of Valeant's accounting who say it is aggressive. Others say it is fine.

Anyone have any insight into which is true? Any examples appreciated.

 

The business is what is aggressive: specialty pharma and price hikes, rapid M&A, high debt, tax arb, almost no R&D.

The accounting is fine. The adjusted metrics remove stock comp, adjust for D&A etc, but the unadjusted metrics and general accounting look normal for a megacorp (including having a large list of subs). It is "normal" these days to preach adjusted metrics, so VRX isn't out of the norm there.

-Accountant

 

The recognition of sales on shipment to McKesson looks aggressive when the consumer discounts as opposed to the doctor loyalty programs were not stopped or were reinstated based on their response to the SEC as to why recognition on shipping to McKesson instead of upon McKesson sale. The SEC questioned them and they said it was appropriate because they stopped customer discount and thus sales price fixed. Current couponing and adjudication make that argument laughable. Also, to the extent they move sales from Philidor (which MP said recognized on final sale) to McKesson, there would appear a blip in revenue recognition

see http://www.sec.gov/Archives/edgar/data/885590/000134100413001002/filename1.htm

and i.e. et al... http://www.jubliarx.com/

http://www.whois.com/whois/jubliarx.com

Depending on how variable adjudication for these products is it wouldnt just be aggressive to tout the blip it would be aggressive to recognize on simply shipping to the distrib

 

And McKesson is one of their big three distributors and looks to be the number to call for the coupons and quite probably the source to pick up philidor business.

McKesson hasn't had a lilly white reputation in the past as per:

http://www.cbsnews.com/news/not-dead-yet-drug-price-manipulation-scams-enter-their-sunset-years/

and that included cooperating with drug companies to inflate the average wholesale cost. This could be extra significant if Valeant recognizes revenue on delivery to McKesson. At this point it is also not clear how many of their product lines they use that approach with at McKesson

 

Agree with poster above that company's business practices are aggressive, accounting probably less so.

I think one can boil it down to two major accounting angles when questioning aggressiveness at Valeant.

1. Revenue recognition
2. Buying companies and validating the mix of goodwill and PPA 'writeup' afterwards.

Fraud is usually in the first. The second is more of an investment issue.

In Valeant's case, I suspect there is some aggression in accounting angle #1. I am more certain that the second is problematic for equity investors at some point but the numbers are there for people to see through it if they want to. In Valeant's case, 'tangible book value' at the end of September was a negative $34 billion. That's a lot.

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Investing in companies like these is a lot more difficult for the 'layman' than it is on non-financial growth stocks (and make no mistake - with its balance sheet, Valeant is a financial company). The difference between GAAP and adjusted GAAP is really a difficult one when there is a lot of intellectual property with a long shelf life in the company.

In this case, the question is whether it is appropriate ("for the patients and the doctors and the healthcare system") to charge people 100x more than a generic costs just because you have a bigger team of MRs and margin you can use to generate rebates for pharmacies and payers. If not, then the longevity of the assets looks suspect so the goodwill/PPA mix could look dodgy.

If the assets are normal declining assets, then buying one company over another because one company uses adjusted numbers to be 8x cash EPS and the other uses plain 10x GAAP EPS, it is like buying a 3yr Treasury bond with a 7% coupon vs a 3yr Treasury bond with a 1% coupon. Sure, "cash EPS" will be higher on the first than the second but what you get out of the investment is largely the same...

UNLESS you have a fund manager who says, let me buy that 7% coupon Treasury for you at 120cts on the dollar. Sure it will go to par eventually but I'm a really great asset buyer and I can reinvest those 7% coupons better than anyone!

That's kind of what Valeant investors are buying.

Levered.

And when they need to de-lever, then you end up paying the investment manager for paying down debt rather than re-investing the cashflow. Which means the investment manager is worth less.

Business aggressiveness is a bigger risk. If sales of any business line Valeant owns drops, there goes the coupon. What most Americans don't know is that drug prices on existing drugs drop in the rest of the world every year - often by rule. This is to make sure that the system doesn't get gouged. It is a way of amortizing the price and income towards a generic price when generics come out. And it means generics are more competitively-priced. Drug prices don't go up 800% just because there is no competition, or because the alternative is death or really expensive hospital treatment. They are what they are.

 

Philidor is considered a specialty pharmacy.


R&O is not.
SafeRX is not.
Orbit pharmacy is not.
D&A pharmacy is not.

etc.
etc.
etc.

Not only did they book revenue from any product shipped to those pharmacies (which was immediately shipped out, so their argument that revenue is booked ONLY when the patient receives it is mute), since they owned the pharmacy, they considered ANY income from that pharmacy as their own.

R&O was doing $5M/week. $250M/year.

Do the math.

Now it comes out there's not 1 sketchy pharmacy (R&O, $5/week, $250M/year) but 78?! With people finding more and more?

This bitch is bigger than Enron and Tyco combined

Bye bye Mike Pearson, I will enjoy you doing your perp walk you fat ass parasitic motherfucker.

 

With regard to the accounting, I would agree with a poster above that revenue recognition is where many cases of fraud show up. My thoughts on the Valeant saga keep coming back to two particular things that seem very strange. This is going to be long because people need to understand exactly why there is so much uncertainty and why people can't just say the accounting is "clean" or not.

First, as a poster above mentioned revenue recognition on delivery to the wholesaler McKesson is QUITE unusual. Even the Medicis before the acquisition did not do that and they had a reputation as aggressive, and there are plenty of reports online about their accounting issues and settlement, etc. This raises the possible issue of booking revenue by delivering inventory to McKesson which can be much more precisely timed and tuned as to when the delivery to the ultimate customer takes place. That would in and of itself not be extremely huge, but it could make for the kinds of magical timing you sometimes see in companies consistently beating quarter after quarter until finally the thing comes crashing down when the secret is revealed.

More worrisome is that we cannot tell exactly how this early recognition is getting recorded. For instance we can't tie down the revenue recognition because we can't really understand the AWP, WAC or net adjustments from the recognition on final settlement from filings. There were funny totals in the R&O suit with vastly different amounts like 69 million vs. 25 million and supposedly even several million less in actual checks received at R&O. Again, we can't really know still at this point even after the explanatory slideshow but the differences again raise a concern that something may be happening between the revenue recognition and the actual payments finally received that would paint a very different enterprise operationally than we are actually getting with the pro forma pictures delivered. Is Valeant booking revenue at 69 million but only receiving 25 million from payers? Where and when are the adjustments that net this all out so that we can be confident as the explanation in the slideshow was to me mumbledygook that made no sense at all?

There is indeed ample room for possible bad acts here in revenue recognition but I would expect PWC wouldn't ordinarily let something tremendous slide through like that. That is ordinarily, but two factors have occurred that again make me hesitate in being so sure. First, VRX has claimed Philidor and R&O were consolidated as VIEs, but at this point it does not appear PWC has ever audited Philidor. Per PWCs own guidelines on VIE, there are a whole lot of considerations at the time of making the VIE determination including the risk to VRX, and there is absolutely no evidence any of this took place. Secondly, when the news initially got hot and heavy, there was going to be an actual new audit performed to show everyone nothing was amiss, but that plan was halted shortly thereafter (a change in course) and an ad hoc committee investigation was announced instead. This is a FAR CRY from what should have happened. Instead, PWC should be all over Philidor doing audits and confirms, etc. The audit should have been sped up as more news came out. If not PWC then a BDO which would be a lessor approach, but in any case something far far different than an ad hoc committee that doesn't have capabilities and resources to clear the air. In fact the fortune article here makes exactly this point http://fortune.com/2015/10/26/valeant-accounting-scandal-questions/

It almost seems as if PWC has balked at doing a new audit OR someone knows that they can't actually do a real and full audit here. Again, one should have occurred anyway if Philidor and others were really on the books as VIE. Something just does not pass the smell test in this situation and analysts and journalists should be following up here. It is almost as if Pearson possesses that magical reality distortion shield that causes people to relax simply because he has said it is so or not so. I suspect it is because the books are so opaque and the amount of work required is quite large they cannot press his claims with confidence, I just don't understand how other professionals in the accounting field aren't speaking up. Even if one can't say something definite isn't correct here, one can say this whole process of confirming all is well is not correct and not the way you truly clear the air instead of sweeping something under the rug.

A second issue that is not directly accounting but which raises issues about the accounting is also present to me. This too has the potential to cause a different consensus viewpoint about the actual operation of the enterprise versus how it has been accepted in the market. It relates to the actual sales and why we can't ever really see them in any way that allows us to check and compare them. When Allergan claimed Valeants organic sales were actually falling, Pearson responded that the IMS data for Valeant wasn't very good compared to others in the industry. This immediately threw up a flag in my mind as to why not? Why would Valeant be such a special creature to put up great growth but IMS doesn't show it? Well as things played out, it appears the reason is that some proportion of Valeant's sales where being put through non-reporting channels. Philidor was a non-reporting channel. So the question then is well how much? Pearson has repeatedly said now that the specialty channels were only around 7% of the sales. For some products such as Jublia there are claims they were processing 44% of that line. These amounts do not pass the smell test based upon the R&O suit amount claim, the expected drop in revenue Pearson said, etc. The detail needed here would be easy to provide, but VRX has not made it available in the past for checking growth and they have not given good hard detail for the current crisis. At some point, Philidors business should show up in IMS reporting channels unless there are other Philidors out there. The Bloomberg view of sales that recently game out showed some increases but not in the range one would expect if Jublia was being put through IMS channels now...

So, after that missive, again one can't say precisely what is wrong, but one can conclude that Valeant is NOT doing what should be done to clear the air if the management was confident the accounting was clean. It's the things that are NOT being done, NOT being said and NOT being provided that makes professionals extremely cautious to conclude things could possibly be fine here.

 

PWC would have a lot of explaining to do if things got past them

 

PWC would have a lot of explaining to do if things got past them.

 

What do you expect when one of the first actions that took place after the B+L acquisition was to let ALL of B+L internal audit function go? We thought that Valeant's internal audit team would take over that testing only to find out there was NO Valeant IA fiction.