Medicis' (MRX) $11 million settlement of a lawsuit alleging it cooked its books by channel-stuffing -- claiming extra product was sold to customers when the company knew the unwanted stock would be sent back -- understates the scale of the allegations against CEO Jonah Shacknai and COO Mark Prygocki.
For years, according to the suit, Shacknai and Prygocki told investors that the cosmetic pharmaceutical company had no unusual stocking policies. In fact, the plaintiffs alleged, Medicis was shipping drugs to sellers it knew would not be sold, inflating its revenues on paper, allowing the company to show consecutive quarters of profits. When the expired drugs came back unsold, Medicis should have granted the seller a credit, which would have been written off as an expense reducing its revenues. Instead, the suit says, Medicis simply sent the customers new, unexpired drugs, booking them at the same value as the returned product -- an accounting wash, even though the company had to send two batches of product just to sell one. The company denied the allegations prior to settling.
The case was based on the testimony of seven confidential witnesses inside Medicis' accounting and finance departments, some of whom said they raised the issue with management only to have their concerns brushed aside.
Medicis first revealed the problem in 2008, when an accounting board challenged the company's "technical interpretation" of way it accounted for stock that was returned if it was unsold by wholesalers and retailers. MRX dropped 13 percent on the news.
It's dry, complicated stuff, and I twice attempted to get to the bottom of it with both Shacknai and Prygocki. Shacknai told me at the time: "it's a technical issue" and "none of this will have an affect on cashflows."
A couple of months later, when the most dramatic effect of the restatement appeared to be a change in Medicis' tax assets, Prygocki told me, "The deferred tax asset has no impact on cashflow or corporate earnings."
Neither of those statements have turned out to be true, if by "true" you mean "the truth, the whole truth and nothing but the truth." After the restatements, according to the suit, Medicis' post-2002 revenues changed dramatically to account for unsold product being returned to the company:
Medicis' Restated Revenues
As reported: $247.5 million
As restated: $210.3 million
As reported: $303.7 million
As restated: $315.2 million
- Q2 2007
As reported: $108.8 million
As restated: $113 million
- Q3 2007
As reported: $120.4 million
As restated: $110.9 million
Shacknai: No -â€" no unusual stocking that we are aware of. And Mark is in the business of monitoring levels...On Aug. 7, 2007, Prygocki told analysts:
Prygocki: ... our inventory levels in the trade are reasonable. We have said that consistently.
We weren't booking revenue in advance of future quarters or even our prescription trends. So they're right in line with our prescription trends."The informants
During this time, seven people inside Medicis realized something was wrong with the way Medicis booked sales "just because it went out the door," as one of them says in the suit. They eventually became informants for investors who lost money when MRX tanked. They have been kept anonymous, but their jobs were:
- An accounts receivable senior accountant at Medicis from 2000 to 2006.
- A contract senior accounts receivable coordinator at Medicis during 2008.
- An accounts receivable team leader at Medicis between 2000 and 2004.
- A senior financial analyst at Medicis in 2005.
- The head of information technology for Medicis's finance department from 2001 until 2008
- An order control department staffer at the Scottsville, Arizona headquarters from 2003 until 2006.
- And an order control analyst at Medicis from June 2005 until November 2006.
In the settlement, Shacknai and Prygocki appear to have dodged a major bullet. When almost identical allegations surfaced at Bristol-Myers Squibb (BMY) in 2002, it led to criminal indictments. There are similar civil allegations being litigated at Johnson & Johnson (JNJ).
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