Valeant's problems have morphed into something completely different than we thought

Right before Valeant held an investor call to save its collapsing stock Monday, a new report questioning the drugmaker emerged.

This report undermines Valeant's effort to distance itself from a company called Philidor, a telemarketing operation that sells Valeant's drugs.

Philidor is at the heart of allegations of accounting fraud at Valeant - something the Canadian company has dismissed outright. Andrew Left, a short-seller who stands to profit from the drop in Valeant's shares, accused Valeant to use specialty pharmacies like Philidor to book "phantom" revenue.

But Valeant has also tried to shield itself from legal claims against Philidor, by saying that even though it has an option to acquire Philidor, it has limited power at the company until it does that. Philidor does not report to anyone at Valeant, and Valeant does not have the right to remove its CEO, for example.

Reporting by the Southern Investigative Reporting Foundation (SIRF)'s contradicts this, saying court documents and interviews with employees show that Valeant has been "closely involved with Philidor at every stage of its life-cycle, controlling it in all but name, since day one."

That jibes with a Wall Street Journal story published Sunday night that says Valeant and Philidor's ties are closer than either company will admit. The Journal says that employees moved between the two companies using different names and e-mail addresses at each.

"As we have said previously, our accounting with respect to the Company's Philidor arrangements is fully compliant with the law," J. Michael Pearson, Valeant's chairman and chief executive officer said in a statement released before the call.

"However, other issues have been raised publicly about Philidor's business practices, and it is appropriate that they be fully reviewed. This decision to create an ad hoc committee of the board, which I fully support, will help free management to focus on continuing to serve doctors and patients and run our business."

SIRF's latest report also describes in detail how Philidor gained access to the California market through another pharmacy in its "network", R&O, and the importance of specialty pharmacies to Valeant in general. Valeant maintained that specialty pharmacies only account for about 7% of its revenue on Monday.

Last week, SIRF's reporting revealed that R&O and Philidor are engaged in a lawsuit over millions in unpaid revenue. When Valeant then stepped in and invoiced Philidor for $69 million, R&O claimed it had no idea that Valeant owned Philidor at all.

Valeant purchased the right to buy Philidor for $100 million at the end of last year, but neither Valeant nor any of its employees owned a stake in Philidor currently, the company said. On the call, Valeant also said that it had no legal liability for issues at Philidor.

Valeant's shares were down about 3% to $113 at midday Monday. The stock has fallen from a price of about $177 before the allegations began last week.

Be careful who you sell to

R&O's lawsuit against Philidor describes what is essentially a CEOs worst nightmare. R&O pharmacy pharmacist-in-charge Russell Reitz sold 10% of his company to Philidor. Days before the transaction, Philidor created Isolani, a separate entity, to purchase Philidor.

Reitz did not know that Philidor had been denied a license to operate in California, though in order to complete the sale of R&O Philidor employee, Eric Rice had signed a application to transfer R&O's license to Isolani. On it, he said that said he was not affiliated with any organization that had been denied a permit to operate in the state.

According to government documents, Philidor's application was denied because Michael Davenport, Philidor CEO Andy Davenport's brother, made false or misleading statements about the company's ownership structure and who was responsible for its accounting.

As part of the sale agreement, Reitz maintained control of R&O, so he was upset when Jamie Flemming, Isolani's controller and a Philidor employee signed off on audits for sales from pharmacies Reitz had never heard of in R&O's name. Some of these sales occurred before R&O was even purchased by Philidor, he claims.

From court documents:

He also became upset when he realized that Philidor employees were using R&O's credentials to deal with insurance providers. Philidor CEO Andy Davenport responded to an email about the issue saying that, while he felt fine with the practice, he would order his employees to stop.

SIRF spoke to Philidor employees who corroborated Reitz's charge about the credentials. They also said that Philidor's handbook to employees has a page that discussing this practice called "Our Back Door Approaches."

Reitz maintains that is why he stopped making payments to Philidor.

Who are these people?

SIRF reports that, over time, Reitz had reason to believe that Isolani was bigger than Philidor.

From the report:

Back in mid-December, shortly after the deal was inked, Reitz was surprised to see Jamie Fleming, Isolani's controller, show up at his office with boxes of inventory. He had a man with him who introduced himself as Gary Tanner, and who was clearly in charge. It all seemed on the up and up, if a bit sudden.

After meeting Tanner, Reitz went back and looked him up. He couldn't understand what Gary Tanner, a specialty pharmacy expert with Valeant's Medicis Pharmaceuticals uni twas doing involved with R&O. In July, Tanner's signing of an employment contract was something the company would later find it important enough to disclose to investors.

The contradicts Valeant's claim on its conference call that Philidor is operated completely independently from Valeant. SIRF claims that Tanner oversees all of Philidor's operation on Valeant's behalf.

But how much is it worth to you?

Valeant maintains that its specialty pharmacy network only accounts for around 7% of its revenue. SIRF's reporting calls that into question. It cites a declaration filed by Reitz's lawyer, Gary Kaufman, which puts R&O's implied annual sales at up to $245 million.

From SIRF:

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.

Valeant did not disclose how many specialty pharmacies like R&O and West Wilshire - which is also based in California - are in its network on the call, though it was asked.

That's just one of many questions that remain here.