OPKO HEALTH, INC. annual report, FY2016

OPKO Health, Inc. — FY2016 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2016; it is not a standalone fourth-quarter filing. OPKO operates diagnostics and pharmaceutical businesses. Diagnostics includes Bio-Reference Laboratories, acquired in August 2015; pharmaceuticals includes established international operations and a development pipeline. Rayaldee, approved by the FDA in June 2016 for certain adults with stage 3 or 4 chronic kidney disease, launched in the U.S. in November 2016.

Financial performance and liquidity

Metric	FY2016	FY2015
Revenue	$1,221.7 million	$491.7 million
Operating loss	$73.3 million	$98.5 million
Net loss	$25.1 million	$31.4 million
Net loss per share, basic and diluted	$0.05	$0.06
Cash provided by operating activities	$32.0 million	$164.0 million
Cash and cash equivalents at year-end	$168.7 million	$193.6 million

• Revenue comprised $1,012.1 million in services, $83.5 million in products, and $126.1 million from intellectual-property transfers and other sources. Management attributed most service-revenue growth to the Bio-Reference acquisition; IP-transfer revenue included $50.0 million from the VFMCRP Rayaldee agreement and $70.6 million recognized under the Pfizer agreement.
• Costs of revenue were $611.5 million, implying an overall gross margin of approximately 49.9%, versus approximately 52.2% in 2015. Operating expenses were $683.5 million, including $490.9 million of SG&A and $111.2 million of R&D. SG&A included $17.9 million of Bio-Reference executive severance costs.
• Cash from operations fell substantially year over year. The filing cites Bio-Reference operations and the $50.0 million VFMCRP upfront payment as sources of 2016 operating cash, alongside a $39.4 million IRS tax-refund receipt; cash use included corporate, R&D and Rayaldee launch costs. OPKO states it has not generated sustained operating cash sufficient to offset expenses.
• Year-end current assets were $483.6 million and current liabilities $263.3 million (current ratio approximately 1.84). The company reported $47.3 million drawn on revolving and other lines of credit, $31.9 million principal outstanding on the 2033 Senior Notes, and $5.8 million of other notes and debt. The notes’ balance-sheet carrying amount also includes an embedded derivative and discount.
• Cash declined by $24.9 million during 2016. Investing activities used $20.7 million and financing activities used $35.2 million, chiefly reflecting net repayments on credit lines. Total assets were $2.77 billion and shareholders’ equity $2.09 billion at year-end.

Material changes versus the prior comparable period

• Revenue increased $729.9 million, largely reflecting the first full year of Bio-Reference in the consolidated results; 2015 included Bio-Reference only after its August acquisition. The comparison is therefore not like-for-like.
• Operating loss narrowed by $25.2 million and net loss by $6.3 million. The 2016 tax benefit was $56.1 million versus $113.7 million in 2015; 2015 included a $93.4 million release of a U.S. deferred-tax valuation allowance following the Bio-Reference merger.
• Operating cash flow decreased $132.0 million. Deferred revenue declined by $74.2 million in 2016, compared with a $227.7 million increase in 2015, when the Pfizer upfront payment materially affected cash flows.
• R&D expense rose to $111.2 million from $99.5 million, primarily with higher hGH-CTP and Factor VIIa-CTP spending. Amortization rose to $64.4 million from $28.0 million, including Rayaldee amortization after FDA approval.
• OPKO acquired Transition Therapeutics in August 2016 for approximately $58.5 million in stock. Shares issued for acquisitions and earnouts contributed to dilution; weighted-average shares increased to 550.8 million from 488.1 million.

Outlook, management commentary and key risks

• Management believed cash on hand and available credit were sufficient for anticipated operating needs and debt service beyond the next 12 months, while cautioning that assumptions could change. It expected R&D and SG&A to increase and said additional financing might be needed for acquisitions, accelerated development or additional trials.
• Rayaldee had commercial and Medicare Part D coverage contracted for more than 60% of U.S. covered lives; OPKO expected coverage to reach 70% by mid-2017. Despite the launch, no Rayaldee product revenue was recognized in 2016 because rebates, discounts and returns could not yet be reasonably estimated; $1.6 million of customer receipts was deferred.
• International Rayaldee partner VFMCRP paid $50 million upfront; OPKO is eligible for up to $232 million in milestones plus royalties. A U.S. dialysis-indication option could provide up to $555 million in additional milestones and royalties if exercised. These amounts are contingent, not assured revenue.
• The adult Phase 3 hGH-CTP study did not show a statistically significant difference from placebo on its primary endpoint. OPKO cited an unusually large placebo-group value and planned sensitivity analysis and discussions with regulators; the outcome and regulatory path remained uncertain. A pediatric Phase 3 trial had begun.
• Management planned a $30–$40 million research, development and manufacturing center in Waterford, Ireland, with completion expected in 2019. Funding was expected from cash or third-party sources.
• Material risks include persistent losses and uncertain cash generation; clinical, regulatory and commercialization risk; Rayaldee adoption and reimbursement; laboratory pricing and reimbursement pressure; acquisition integration; dependence on Pfizer, VFMCRP and other partners; and possible impairment of goodwill and intangibles, which totaled about $2.1 billion, or 76% of assets.
• Other notable exposures include the $45.1 million contingent-consideration liability, possible additional milestone obligations, regulatory inquiries and subpoenas relating to laboratory operations, and previously disclosed patient-information security incidents for which OPKO said it was awaiting further OCR action. The 2033 Notes’ embedded derivatives can cause non-cash earnings volatility. The audit opinion was unqualified; management and the auditor reported effective internal control over financial reporting, although Transition Therapeutics was excluded from the year-end assessment.

Important facts for investors to verify

• Whether subsequent quarters show measurable Rayaldee sales, improved reimbursement coverage and reliable estimates of rebates, discounts and returns.
• Bio-Reference’s underlying organic revenue, margins, collections and bad-debt trends, separating acquisition effects from ongoing performance.
• Cash burn and liquidity after the 2016 decline in operating cash flow, including actual availability and terms of credit facilities and the effect of debt conversions.
• Results of the hGH-CTP sensitivity analysis and regulatory discussions, plus clinical and regulatory progress for the wider pipeline.
• Progress and funding for the Waterford facility, contingent milestone liabilities, and any material outcomes from outstanding regulatory inquiries or OCR matters.