OPKO HEALTH, INC. quarterly report, Q1 FY2017

OPKO Health, Inc. — Q1 2017 Form 10-Q

Reporting period: Three months ended March 31, 2017; balance-sheet comparisons are to December 31, 2016. OPKO operates pharmaceutical and diagnostics businesses, including BioReference Laboratories. Figures below are in U.S. dollars; financial-statement amounts are in millions unless noted.

Financial performance and liquidity

Metric	Q1 2017	Q1 2016 / comparison
Total revenue	$296.1	$291.0; up $5.1 (1.7%)
Operating loss	$(41.7)	$(27.5)
Net loss	$(31.0)	$(12.0)
Net loss per share	$(0.06)	$(0.02)
Cash used in operating activities	$(33.9)	$(9.2)
Cash and cash equivalents	$131.1 at March 31	$168.7 at December 31, 2016

• Service revenue was $255.3 million, product revenue $22.2 million, and intellectual-property and other revenue $18.6 million. Service revenue increased $2.8 million and product revenue increased $2.3 million year over year.
• Cost of service and product revenue totaled $154.8 million, up $7.3 million. Revenue less these costs was $141.3 million, or 47.7% of total revenue, compared with $143.5 million, or 49.3%, in Q1 2016; this is a simple revenue-minus-cost measure, not a separately reported gross margin.
• Revenue included $17.7 million recognized under the Pfizer agreement in both periods. OPKO recognized no Rayaldee product revenue in Q1 2017 because it could not yet reasonably estimate rebates, discounts, returns, and other sales deductions.
• At March 31, current assets were $459.9 million and current liabilities $265.0 million, implying working capital of about $195.0 million. Total assets were $2.76 billion and total liabilities $653.1 million.
• Debt included $31.9 million principal outstanding on the 2033 Senior Notes and $47.6 million outstanding on credit lines. The filing also reports $5.4 million of other notes and debt; amounts and classifications differ across debt disclosures, so these figures should not be treated as a single complete debt total.

Material changes and unusual items

• Operating loss widened by $14.2 million year over year, as revenue growth was more than offset by higher costs and expenses. SG&A rose $8.7 million, principally reflecting Rayaldee launch costs and BioReference expenses; lower severance costs partly offset the increase.
• Cost of product revenue increased $4.9 million. Inventory obsolescence expense was $4.6 million, compared with none in Q1 2016.
• Research and development expense declined to $26.0 million from $27.8 million, primarily due to lower hGH-CTP-related expense. Management expects R&D expense to increase as development expands.
• Net loss included a $4.0 million gain from fair-value changes in derivatives, compared with a $1.4 million loss in Q1 2016. The 2017 gain principally reflected a lower estimated fair value of the embedded derivative in the 2033 notes as OPKO’s share price declined. Other income included a $3.0 million gain on sale of non-strategic assets.
• Cash declined $37.7 million during the quarter. The company recorded a $32.5 million cumulative-effect adjustment to increase deferred tax assets and reduce accumulated deficit upon adopting share-based-compensation accounting guidance.

Outlook, risks, and contingencies

• Management stated that cash on hand and available borrowing capacity were expected to cover operating needs and debt service beyond the next 12 months, while cautioning that assumptions could change. OPKO has not generated sustained positive operating cash flow and may need additional financing if it expands trials, accelerates development, or makes acquisitions.
• Management expected higher SG&A as it expanded sales and infrastructure, including the Rayaldee commercial team, and anticipated increasing R&D expense. It expected to add to the Rayaldee sales team in the second half of 2017 as market access and prescription trends improved.
• OPKO estimated $30–$40 million to construct and validate its Waterford, Ireland research, development, and manufacturing center, with completion expected in 2019. Funding was expected from cash or third-party sources.
• Rayaldee had launched in the U.S. in November 2016, but Q1 shipments did not produce recognized product revenue because sales deductions and returns could not yet be estimated. This makes commercial uptake and revenue recognition important to monitor.
• For the Phase 3 adult growth-hormone-deficiency study of hGH-CTP, the primary endpoint did not show a statistically significant difference versus placebo. OPKO cited an unusually large placebo-group trunk-fat reduction, planned an outlier sensitivity analysis, and intended to discuss results with regulators to determine next steps.
• In April 2017, the U.S. Attorney’s Office for the Southern District of New York alleged that BioReference had improperly billed Medicare and Tricare for certain hospital inpatient laboratory services from 2006 onward. BioReference was assessing the allegations; potential liability was not estimable and the outcome could be material.
• Other key risks include reimbursement and payer pressure on laboratory testing, collections and bad debts, product-development and approval uncertainty, competition, intellectual-property challenges, foreign-exchange exposure, and the possibility of impairment of goodwill or intangible assets. Goodwill and acquired intangible assets, including in-process R&D, totaled about $2.1 billion, approximately 76% of assets.
• Management reported disclosure controls were effective at quarter-end. However, ERP implementation changes during the quarter materially affected, or were reasonably likely to materially affect, internal control over financial reporting; Transition Therapeutics integration was ongoing.

Important facts for investors to verify

• Whether BioReference’s federal billing investigation leads to claims, penalties, settlements, or other material obligations.
• When OPKO can estimate Rayaldee sales deductions and returns, recognize product revenue, and demonstrate commercial uptake.
• The hGH-CTP sensitivity analysis and subsequent regulatory discussions, and whether the program advances toward approval.
• Operating cash burn, available borrowing capacity, debt and covenant compliance, and the timing of any additional financing needs.
• Progress, cost, and funding for the Waterford facility, alongside planned increases in commercialization and R&D spending.
• Whether growth in services and products can offset higher expenses, and whether receivables collectability and inventory reserves remain adequate.
• Potential impairment indicators for the substantial goodwill, intangible-asset, and in-process R&D balances.