The most important question Valeant ignored on its investor call

Valeant Pharmaceuticals ignored a key question on its investor call Monday morning.

It did not disclose how many specialty pharmacies are in its network, despite being asked by Evercore ISI analyst Umer Raffat.

This is a question for the embattled pharmaceutical giant. Before last Monday, investors had never heard of this network. That's when Valeant disclosed that it had paid $100 million to acquire an option to buy Philidor, a pharmacy that distributes and sells Valeant products exclusively.

Valeant consolidates Philidor's revenues into its own accounting. Philidor does the same with all of the pharmacies in its specialty network.

Last week Valeant's market cap dropped $20 billion when short-seller Andrew Left accused Valeant of using its network to book "phantom" revenue for products it never sold.

As proof he offered a lawsuit filed by R&O's pharmacy, a pharmacy in Philidor's network, which claimed Valeant was invoicing it for $69 million worth of sales it had never executed. In fact R&O claimed Valeant had never invoiced it at all, and that it did not know of Philidor's relationship with Valeant.

Valeant said it would create an ad hoc committee to investigate Philidor's business practices. It maintained, though, that Philidor's activities are totally above board, adding also that Valeant has no legal liability under Philidor.

Regardless, the question is, if R&O didn't know that it was a part of Valeant's network, how are investors to know what is a part of Valeant's network?

It's also difficult to determine how much revenue these pharmacies are generating independently of Valeant's 7% figure, as their revenue is consolidated along with Valeant's on the firm's balance sheet.

A sidestep

Instead of disclosing the number of pharmacies in its network, Valeant merely said the following:

That's all we got about what makes up Valeant/Philidor's network of pharmacies. But we know that Philidor bought a 10% stake in two California pharmacies, West Wilshire and R&O.

In both cases, Philidor's behavior raises a ton of questions.

Philidor was denied a permit to operate in the state of California because Matthew Davenport, the brother of Philidor CEO Andy Davenport made "false or misleading statements" about the Philidor's ownership structure and who was responsible for Philidor's accounting.

Valeant said this rejection would be reviewed by its ad hoc Philidor committee.

To purchase its stakes in the California pharmacies we know of, Philidor employees created two unaffiliated acquisition vehicles - Lucena for West Wilshire and Isolani for R&O. Both vehicles applied for permits to operate in California. R&O's permit is pending.

On the permit applications, two Philidor employees, Eric Rice and Seri Leon, said they had no affiliation to any company that had been denied a permit to operate in California.

R&O pharmacist-in-charge Russell Reitz claims in his lawsuit against Philidor/Valeant that Philidor never disclosed that its permit had been rejected. He also claims that Philidor never disclosed its relationship with Valeant.

But why hide it?

And then there's the sales

Valeant said on the call that it never disclosed the existence of its specialty pharmacy network because it accounts for less than 10% of sales - 7.2%, specifically.

That claim is hard to verify, though, because all of the network's revenues are consolidated along with Valeant's. Valeant made no promise to break those out, and said only that its accounting is appropriate.

What makes this all the more confusing is R&O's lawsuit. Reitz claims that he started withholding payment from Philidor because Philidor execs were asking him to sign off on audits for sales he didn't make. Some of those sales, he said, even dated before Philidor purchased R&O.

He also claims that Philidor was using R&O's insurance credentials, known as an NPI number, to execute sales for other pharmacies in its network, a problem Philidor CEO Andy Davenport recognized in an email.

Philidor employees also told The Wall Street Journal about this practice.

This is why Reitz doesn't deny that he withheld payment from Philidor. He claims it was because the company was asking him to engage in fraud.

Reitz's attorney, Gary Kaufman, submitted an extensive declaration in California court that also calls Valeant's 7.2% number into question.

It puts R&O's sales at up to $245 million for 2015. Roddy Boyd, a reporter at the Southern Investigative Reporting Foundation, calculates that this makes R&O (and thus Philidor) far more important Valeant than it claims.

The Kaufman declaration's release of the Philidor/Valeant invoices to R&O imply a prospective quarterly sales run-rate of about $55 million (an average $4.6 million weekly shipment multiplied by 12 weeks.) This would have accounted for 18.5% of Valeant's total organic growth in the second quarter. From there, it's a sure bet that given the prominence of West Wilshire to Philidor's billing unit, its sales volume would easily surpass R&O.

Notionally, organic growth equal to 40% or more of that $299 million could have come from two pharmacies that even the most gimlet-eyed Valeant sleuth didn't suspect existed.

Again, Valeant gave no indication that it would break out these numbers to pacify investors. It also said it would not comment on R&O's allegations as legal proceedings are ongoing.

The parties will meet for a hearing in a Los Angeles court December 14.