Ultimately, it was the accountants, not the scientists, who were left with no choice but to deliver the bitter pill to the Theranos board: The company had even less money than time.
Getting a handle on the numbers was less important than publicity to founder and CEO Elizabeth Holmes, until she was forced to mortgage all of Theranos’s assets to Fortress Investment Group in return for a desperately needed $100 million loan in December 2017. The terms of the loan agreement included the requirement to finally produce audited financial statements, something that had not been attempted since at least 2009, according to Theranos’s last chief financial officer.
There was an attempt by KPMG to audit and provide an opinion about a decade ago, but the process was not completed, and there was no final report, said Philippe Poux, who served as Theranos’s final CFO. A spokeswoman for KPMG declined to comment, citing client confidentiality.
MarketWatch reported early this year that none of the Theranos investors, who invested more than $700 million with Holmes between late 2013 and 2015, had ever requested audited financial statements or asked whether the company even used an outside accountant to verify the financial information that was distributed.
Details: The investors duped by the Theranos fraud never asked for one important thing
This past spring, Poux, in the CFO post for mere months, and a brand-new outside accounting firm had no alternative but to deliver the bad news when they saw the audit result: Theranos didn’t have sufficient cash to survive long enough for its heavily hyped product to secure regulatory approval.
Elizabeth Holmes founded Theranos in 2003 after dropping out of Stanford University as a 19-year-old sophomore. Her goal was to revolutionize the diagnosis and treatment of disease. She said the company name was created by combining the words “therapy” and “diagnosis.” But Theranos also turned out to have a lot in common with Thera, a volcano whose eruption in ancient times covered a Greek island in smoldering ash.
Holmes’s tragic error was touting financial projections that never materialized based on technology that she never delivered.
Theranos’s failings, and Holmes’s, reached an apex with a flawed and ultimately unsuccessful rollout of a strategic partnership with Walgreens Boots Alliance Inc. The screw-up resulted in several regulatory investigations and lawsuits against the company, Holmes and her former chief operating officer, Ramesh “Sunny” Balwani, including suits filed by Walgreens WBA, +1.60% and the Securities and Exchange Commission. Holmes and Balwani now also face criminal indictments for fraud.
After Holmes burned through executives, cash, investor goodwill and regulatory patience, nothing of value was left but the company’s patents.
A bright beginning
Less than three years after starting the company, Holmes pitched investors in an effort to raise $30 million for what was referred to as a “pre-IPO transaction,” with a presentation published by Axios that claimed Theranos already had six deals with five companies and would have $120 million to $300 million in revenue in the following year and a half. The business model at that time was focused on clinical and preclinical trials for pharmaceutical companies, not consumers.
The company raised the money, and, on Sept. 29, 2014, Holmes was named one of the richest women in America by Forbes as a result of her 50% stake, worth $4.5 billion, in the startup, which was valued at that point at $9 billion.
An unraveling, and a shake-up
Holmes promoted Theranos’s technology at a TEDMED conference held in Washington in 2014.
She was asked to speak at prestigious events such as the Clinton Global Initiative in September 2015 in New York City.
Getty Images
President Bill Clinton addresses Elizabeth Holmes during the closing session of the Clinton Global Initiative 2015.
The unraveling, though, began that October, when the Wall Street Journal’s John Carreyrou published a deeply reported piece under this headline: “Hot Startup Theranos Has Struggled With Its Blood-Testing Technology.” Carreyrou’s sources reportedly told him that at the end of 2014 the company’s blood-testing machine, called Edison, was processing only a small fraction of the tests sold to consumers.
Employees told Carreyrou they were also concerned about the machine’s accuracy. The company’s outside attorney, David Boies, admitted Theranos was not yet using the device for all the tests it offered.
In a recent New York Times profile of Boies, the noted lawyer said he had been so impressed with Holmes when he first met her in 2011 that he took half of his and his firm’s fees in Theranos stock, which reportedly amounted to 400,000 shares, or roughly $7 million at the peak of the company’s valuation.
Bloomberg BusinessWeek
Bloomberg Businessweek headline in December 2015: “Can Elizabeth Holmes Save Her Unicorn? Theranos wants to convince the world it’s for real.”
In January 2016 the Centers for Medicare & Medicaid Services sent a letter to Theranos that identified numerous regulatory violations, and in April of that year the Wall Street Journal reported that the SEC and the U.S. attorney in San Francisco were investigating whether Theranos had misled investors and regulators about its technology, operations and finances.
‘It was doomed from Day 1.’ Daniel Warmenhoven, former Theranos board member, of the company’s diagnostics deal with Walgreens
Walgreens sued for breach of contract in federal court in November 2016.
“The Walgreens deal made no sense,” said Daniel Warmenhoven, who joined the Theranos board in December 2016 and stayed on until the end. In an interview with MarketWatch, Warmenhoven, a former CEO of NetApp Inc., said, “It was doomed from Day 1 because it was based on using the minilabs, which weren’t completed when the deal was signed. Theranos had to build an alternative lab to do the tests, which was a big distraction.”
Carreyrou’s ongoing pursuit of the Theranos story, coupled with the regulatory investigation, prompted Holmes to revamp her board, turning an advisory-only body of elder statesmen including former secretaries of state George Shultz and Henry Kissinger, who had no medical or scientific experience, into one with more traditional board-member experience.
Bill Foege, a former director of the Centers for Disease Control and Prevention, joined the Theranos board in 2014. Foege, a Presidential Medal of Honor winner, never wavered in his support for Holmes and the company, even after the Centers for Medicare and Medicaid Services began criticizing the results.
In an op-ed published in July 2016 in the Hill, Foege wrote: “In my opinion, the very foundation of Theranos’s inventions — and its hundreds of patents — is credible.”
When the end came on Sept. 12, 2018, Foege was the longest-tenured Theranos official after Holmes.
Read: Theranos closes deal with Fortress to shut down embattled firm
Holmes, under that 2016 media scrutiny, also began bringing in executives tasked with finally converting Theranos from a development-stage company into one ready to commercialize its products.
David Taylor, formerly of Munger, Tolles & Olson LLP, became general counsel, replacing Heather King, a former partner at a law firm where David Boies was a founding partner, Boies Schiller & Flexner LLP, in May 2016. Taylor also took charge of fundraising efforts and investor communications, ending the prior ad hoc approach.
Dr. Fabrizio Bonanni, who had served in several senior roles at Amgen Inc. and Baxter International, joined the Theranos board in July 2016. Bonanni led a newly formed compliance and quality committee of the Theranos board to oversee compliance with applicable laws and regulations.
Bonanni told MarketWatch the company’s executives and board were already attentive to compliance and quality management when he came on board. His committee “met at least monthly until the end,” said Bonanni.
Bonanni had just arrived when Sunny Balwani announced he would step down as COO. A spokeswoman told the Wall Street Journal that Balwani’s departure was “merely part of a broader reorganization that will see the company appoint a new chief medical officer, to whom its labs will report, a new head of research and a new operating chief.”
Theranos hired FTI Consulting in mid-2016 to conduct a strategic review of its finances and report the results to the board. Alvarez & Marsal, another consulting firm, followed FTI in late 2016.
A&M was tasked with building out Theranos’s financial infrastructure and a conversion of its books from a cash basis — where revenues and expenses are recognized when cash is received or paid out — to the accrual basis set forth by Generally Accepted Accounting Principles, or GAAP. In accrual accounting, a company reports revenue as it’s earned and expenses when they are incurred.
For Theranos, converting to the accrual basis meant it was even more important to start preparing an accurate monthly cash-flow statement. Given its previous rosy revenue forecasts, it was also necessary to convert to the accrual basis for tax purposes. A corporation can only use cash-basis accounting for its tax return as long as it has less than $5 million in annual revenue.
Alvarez & Marsal provided Theranos with a temporary CFO and a bookkeeper on a remote consulting basis to pay bills and process payroll. A&M also began generating financial reports for Theranos’s management team, board and investors.
Boies had joined the Theranos board in October 2015, the same month the initial Carreyrou story hit, and he resigned at the end of August 2016, shortly after Holmes retained a new law firm, Wilmer Hale LLP, as outside counsel, replacing his firm, Boies, Schiller & Flexner LLP.
In December 2016 Theranos added Warmenhoven, a Bechtel board member and a former longtime Hewlett-Packard executive as well as the former CEO and executive chairman of NetApp, to its board. Warmenhoven had first met Holmes at a Stanford event where she was being interviewed on stage by George Shultz, who had served in the Reagan and Nixon cabinets and was on Theranos’s advisory board.
“I think the technology could really benefit humanity,” Warmenhoven said at the time of his appointment. “They are under siege. They need some experience to help them going forward.”
Cleaning out the litigation closet
In February 2017 the Theranos board approved a plan to recapitalize investors in its most recent funding rounds. In an effort to head off further lawsuits, the company asked investors, in return, to agree not to sue Holmes or the company. Holmes returned approximately 34 million of her own shares to Theranos in that transaction to prevent investors’ stakes from being diluted as a result of the tender offer.
Theranos reached a separate agreement with Rupert Murdoch, the executive chairman of News Corp — publisher of MarketWatch and the Wall Street Journal — and 21st Century Fox Inc. and Theranos’s largest shareholder at the time. Theranos bought back his shares for just $1, according to the Wall Street Journal, but Murdoch, who reportedly had paid some $125 million for the shares, was set to get more if the company settled with other shareholders.
Partner Fund Management LP, whose $96.1 million investment was said to have driven Theranos to its peak valuation of $9 billion, refused the recapitalization agreement because it had already initiated a lawsuit against Theranos in October 2016. Its lawsuit alleged that the company had claimed when it solicited the investment that it could do 98% of blood tests using its proprietary technology on finger-stick samples. Partner Fund Management said it had found former Theranos employees who said otherwise.
In April 2017, when the company reached a settlement with the U.S. Department of Health and Human Services and the Centers for Medicare and Medicaid Services, it agreed, among other things, that it would not offer clinical tests to patients for a minimum of two years.
That same month, Theranos agreed to pay $4,652,000 in consumer restitution — more than Theranos had in fact collected for all lab tests throughout the life of the company — and a civil penalty of $200,000 to settle a consumer-fraud suit brought by the Arizona attorney general. Theranos also agreed that it would not own or operate a clinical laboratory in Arizona for a period of two years.
Partner Fund Management settled with Theranos in May 2017 for a confidential amount. That settlement triggered an additional payment to Murdoch, according to the Wall Street Journal.
Theranos settled the Walgreens lawsuit in June 2017. Walgreens had sought to recover its full $140 million investment, including a $40 million convertible-debt note and a separate payment as part of an effort to expand the partnership. Walgreens later settled for less than $30 million, according to a Wall Street Journal report.
A real CFO
Philippe Poux arrived as chief financial officer in mid-2017 to oversee the financial infrastructure put in place by A&M. Poux told MarketWatch that at that time Theranos still had no budgeting process, no accurate cash-flow forecasting, and no auditable financial statements.
“There was so much history to go through,” Poux told MarketWatch. “Maybe investors should insist that when you hit $1 billion in funding you hire a full-time CFO.”
Poux’s first priority was to put together an accurate cash-position statement and a monthly cash-flow forecast for the board. He was soon updating the cash forecast every two weeks.
Poux also stepped up the process of preparing financial statements for the calendar year 2017 that could eventually be audited. In the U.S., most private companies — with limited exceptions, such as financial firms — are not required to undergo outside audits.
Improving the reliability of financial information for internal and external users is the obvious expected benefit when private companies subject their financial statements to an audit. The additional cost is often justified by the expectation of additional real economic benefits such as better access to credit, lower interest rates on debt and higher credit ratings, particularly when the audit is voluntary rather than mandatory, according to academic research.
The goal of the 2017 audit was to get a clean opinion on Theranos’s financials — that is, the auditors’ “reasonable assurance” that the numbers did not include a material misstatement due to error or fraud.
Poux told MarketWatch that this was a challenge, since, for example, there had been no tracking of such fixed assets as technology, equipment and furniture. Holmes and the officers and board did have good records of who investors were, how much they had invested and when, and at what valuations. However, that information about investor stakes was reflected inaccurately in the financial statements, even though Theranos’s cap table — the list of relevant details on the company’s stock, options, warrants, etc., and the owners of those securities — had been maintained by its outside lawyers.
Theranos closed a deal in December 2017 to borrow $100 million from Fortress Investment Group LLC, a division of SoftBank, and the private-equity firm became its most important creditor. The deal gave Fortress a lien on all of Theranos’s assets, including its portfolio of patents.
One additional covenant was a requirement to get an independent auditor’s opinion on its 2017 financial statements by this June. Fortress released $65 million when the deal closed, with the rest contingent on achieving certain milestones, as well as the audit.
“We would have been in default of the Fortress agreement if a clean opinion was not delivered by that date,” Poux told MarketWatch. Asked whether any other investor or creditor had previously requested audited financial statements, Poux responded, “During my time no one else asked for audited financial statements, even though after the recapitalization they all had the right to this information.”
Doug Pallotta, a partner with OUM & Co. LLC, a California-based firm that serves several publicly traded pharmaceutical and medical-device makers, took on the Theranos audit assignment. “Typically,” he said, “we sign a new client in the hope we’ll work together for 50 years. In this case we took the job knowing the risks, but with a plan to do our best for everyone under the circumstances.”
On March 14, 2018, the SEC filed charges against Theranos, Holmes and Balwani for fraud. The SEC’s suit alleged that the company had “never told” Walgreens it was having problems successfully developing a proprietary analyzer that was capable of conducting a comprehensive set of blood tests from drops of blood drawn from a finger. Instead, Theranos was actually testing some blood on modified third-party analyzers.
The SEC’s complaint against Balwani described marketing materials provided to potential investors that included a cover letter drafted and signed by Holmes, a company overview in the form of a slide-deck presentation, reports on clinical trials Theranos performed with pharmaceutical companies, and financial projections on spreadsheets created from scratch by Balwani, but no audited financial statements.
Theranos and Holmes settled the SEC’s fraud charges immediately. Holmes agreed to a settlement that stripped her of voting control of Theranos, banned her from being an officer or director of any public company for 10 years and required her to pay a $500,000 penalty. Balwani, who had become the company’s president in 2009 after guaranteeing a line of credit for Holmes, is still fighting the allegations.
Key Theranos milestonesThe bitter end
As Poux and his staff finalized the financial statements, significant adjustments had to be made for additional expenses, in particular legal expenses, incurred after Dec. 31. Poux told MarketWatch that it became painfully obvious the company’s cash-burn rate would outstrip the funds available.
Pallotta and the OUM team began work on the audit in April. To avoid the auditor’s “going concern” warning, Theranos needed to prove it would have enough cash to support itself for 12 months from the date of the audit report, which was expected to be in June.
Holmes unsuccessfully solicited additional financial support from investors in April. Her effort to sell the company that spring also failed. Achieving the Fortress milestones — and securing more funds — before the cash was depleted was essential.
On June 15, 2018, federal prosecutors filed criminal charges against Holmes and Balwani, alleging they had defrauded investors out of hundreds of millions of dollars and also defrauded doctors and patients.
Poux and Taylor, who became Theranos’s CEO shortly after Holmes was indicted, had been signing what Poux called “certificates of compliance” on a monthly set of financial statements presented to the board.
The indictments of Holmes and Balwani, who was not only Theranos’s former president and chief operating officer but also Holmes’s boyfriend, came after a 2½-year investigation by the U.S. attorney’s office in San Francisco, sparked in part by the reporting of the Wall Street Journal’s Carreyrou. Those charges are still pending.
Each faces a maximum sentence of 20 years in prison and a fine of $250,000, plus the cost of potential restitution to investors for each count of wire fraud and each conspiracy count, according to the U.S. attorney’s office.
Holmes’s lawyer did not respond to repeated MarketWatch requests for comment via phone and email.
See also: U.S. files criminal charges against Theranos’s Elizabeth Holmes and Ramesh Balwani
On Sept. 12, Theranos turned over ownership of the company’s patents to Fortress, the private-equity firm that had lent it $100 million nine months before. Fortress could have taken all of the company’s assets but instead left the remaining cash — about $5 million — for distribution to unsecured creditors.
Read: Theranos closes deal with Fortress to shut down embattled firm
The compromise was simpler and cleaner than a bankruptcy proceeding for Fortress. Fortress sees value in Theranos’s intellectual property and will likely seek a return on its investment by pursuing royalties from companies that have commercialized earlier patents, according to a company adviser familiar with the Fortress-Theranosagreement.
Several requests via phone and email seeking comment from Fortress went unanswered.
Taylor, who served as Theranos’s CEO barely three months after stepping in for Holmes after the indictments, told MarketWatch, “For two years, we worked day and night to turn the company around. We filled the management team with experienced professionals and routinized our governance, compliance and finance functions. We resolved multiple investigations and lawsuits related to the company’s past. And in December 2017 we closed on a $100 million debt facility, secured by the company’s intellectual property, that gave us a clear path forward.”
But in the end, Taylor said, “we were late with the product, and we ran out of time.”
Even if Theranos had received the remaining $35 million in funding from Fortress by the summer of 2018, the company would not have had enough cash to support itself for 12 months, according to auditor OUM & Co.’s opinion of the company’s 2017 financial statements, which OUM delivered to Theranos’s management and board at the end of June.
Payments by the company of legal fees incurred by Holmes, Balwani and other former executives and directors have now stopped.
Warmenhoven told MarketWatch he blames engineers for the final sinking of Theranos. “They lost the recipe. The tests were not coming out right. That 60 to 90 days extra to figure it out took away the runway we thought we had.”
Such boldface-name investors as Mexican billionaire Carlos Slim; Betsy DeVos, now secretary of education; Oracle founder Larry Ellison; the Walton family of Walmart fame, who invested $150 million in Theranos; Greek shipping heir Andreas Dracopoulos; and members of South Africa’s Oppenheimer family, which controlled the diamond company De Beers Group, lost their entire investments.
A senior executive who worked at Theranos till the end but who did not want to be named, citing legal reasons, told MarketWatch it was investors’ responsibility to undertake due diligence. But he said he understands why they may have trod lightly. “One gets the feeling they were so excited about the possibilities and waded in without doing their homework,” the executive told MarketWatch. “But in my opinion it was better to wade in,” absorbing the attendant risk.
Warmenhoven disagreed. He told MarketWatch in an interview that it’s a cop-out to attribute investors’ failure to ask the right questions to their excitement over the promise of the technology. “They didn’t do adequate due diligence,” said Warmenhoven. “They signed up for $100 million commitments without firsthand visibility [into] the product-development process and status.”
Even would-be skeptics, earlier on, often ended up enthusiastic supporters after meeting Holmes or seeing the technology in person. Theranos hosted experts and VIPs including Vice President Joe Biden, who toured the company’s Newark, Calif., laboratory in July 2015 to see the technology up close. According to Carreyrou’s reporting, what Biden saw was a fake lab, staged for his visit.
Carreyrou’s book about his Theranos pursuit, “Bad Blood,” is based on more than 30 stories he wrote about the company beginning with his first in October 2015. The book was published on May 19, a couple of months after the SEC’s charges against Holmes and Balwani, but one month before the U.S. attorney’s office in San Francisco filed criminal fraud charges against the pair. He’s working on an update.
