OPKO HEALTH, INC. annual report, FY2017

OPKO Health, Inc. — FY 2017 Form 10-K

Reporting period: Fiscal year ended December 31, 2017; filed March 1, 2018. The filing also reports unaudited fourth-quarter results. OPKO operates diagnostics and pharmaceutical segments, including BioReference Laboratories and a drug-development portfolio.

Financial performance and liquidity

Metric	FY 2017	FY 2016
Revenue	$1,067.5 million	$1,221.7 million
Gross profit (revenue less cost of revenue)	$447.4 million; 41.9% margin	$610.2 million; 49.9% margin
Operating loss	$280.1 million	$73.3 million
Net loss	$308.9 million; $0.55 per share	$25.1 million; $0.05 per share
Cash from operating activities	$(92.1) million	$32.0 million
Cash and cash equivalents at year-end	$91.5 million	$168.7 million
Total assets / shareholders’ equity	$2,584.6 million / $1,885.4 million	$2,766.6 million / $2,091.8 million

• Revenue from services was $889.1 million, down $123.1 million, reflecting lower GeneDx reimbursement and reduced BioReference volume and reimbursement. Product revenue rose to $107.8 million, including $9.1 million of Rayaldee net sales. Intellectual-property revenue fell to $70.7 million, including $57.8 million recognized under the Pfizer agreement and a $10.0 million TESARO milestone.
• Fourth-quarter revenue was $193.7 million and net loss was $213.9 million ($0.38 per share), compared with revenue of $275.5 million and net loss of $13.7 million in Q4 2016.
• Current assets were $343.5 million and current liabilities $301.3 million at year-end. Accounts receivable, net, declined to $165.5 million from $220.3 million; the allowance for doubtful accounts increased to $66.4 million from $36.3 million.
• At year-end, lines of credit totaled $114.7 million outstanding; the 2033 Senior Notes had $31.9 million principal outstanding and $29.2 million carrying value. Total liabilities were $699.2 million. The filing states that substantially all BioReference assets are restricted under its credit agreement, subject to exceptions.
• Capital expenditures were $46.5 million. Financing activities provided $61.0 million, primarily from net borrowings on credit lines. Interest expense was $6.6 million.
• R&D expense rose to $125.2 million from $111.2 million. SG&A increased to $521.0 million from $490.9 million.

Material changes and unusual items

• Total revenue declined 12.6%, while gross margin fell by about 8 percentage points. Operating loss widened substantially, and operating cash flow shifted from positive to negative.
• FY 2017 included a $13.2 million impairment of the VARUBI intangible asset, $5.4 million of inventory obsolescence expense, and an $8.8 million write-off of other current assets. The tax provision was $18.9 million, versus a $56.1 million tax benefit in 2016; OPKO recorded a valuation allowance against certain deferred tax assets. The Tax Act reduced the U.S. corporate rate to 21%; related accounting remained provisional.
• Revenue from services also reflects estimates and adjustments for third-party payer payments and overpayment claims. Medicare and Medicaid represented approximately 31% of 2017 service revenue.

Outlook, developments and risks

• Management said it expects R&D and SG&A expenses to increase and believed available cash, credit availability and financing would cover operations and debt service for more than 12 months. This assessment depends on assumptions; the company cautioned it may need more capital and might delay or reduce trials or programs if funding is unavailable.
• Rayaldee, approved for SHPT in adults with stage 3 or 4 CKD and vitamin D insufficiency, had commercial coverage for more than 70% of U.S. covered lives at year-end. A phase 2 study for dialysis patients was expected in the first half of 2018. Japan Tobacco paid a $6 million upfront license fee and may owe further milestones and royalties; VFMCRP holds international rights under a separate agreement.
• Key programs include pediatric Phase 3 hGH-CTP partnered with Pfizer, OPK88004 in Phase 2 studies, OPK88003 planned for a Phase 2b study, and a Claros PSA test PMA submitted to the FDA in November 2017. The adult hGH-CTP Phase 3 trial missed statistical significance on its primary endpoint; post-hoc analyses excluding outliers were significant, but analyses retaining them were mixed.
• OPKO expected to spend $40–45 million on its Waterford, Ireland research, development and manufacturing center, with completion expected in 2019. Construction funding was expected from cash or third-party sources.
• After year-end, TESARO disclosed serious hypersensitivity reactions associated with VARUBI IV and announced suspension of its distribution in late February 2018; it continued supporting the oral product. OPKO recorded a $13.2 million VARUBI impairment in 2017.
• BioReference faces a U.S. Attorney’s Office allegation that it improperly billed Medicare and TRICARE for certain hospital inpatient laboratory services from 2006 onward. OPKO said the matter was under review and potential liability could not be determined; the outcome could be material.
• Other notable risks include reimbursement and pricing pressure, clinical and regulatory uncertainty, cash needs, reliance on collaborators and key executives, acquisition integration, cybersecurity and patient-data protection, and impairment risk. Goodwill and other intangible assets totaled approximately $2.0 billion, about 79% of total assets.
• In February 2018, OPKO agreed to issue $55 million of 5% convertible notes, due in five years and convertible at $5 per share; proceeds were intended for general corporate purposes. BioReference also amended its credit agreement to address availability requirements and related covenants.

Key facts for investors to verify

• Whether BioReference can stabilize testing volumes, reimbursement, collections and bad-debt exposure, and resolve the SDNY billing matter.
• Rayaldee prescription growth, net sales, payer access, and progress of the dialysis indication; distinguish sales and royalties from upfront or milestone revenue.
• OPKO’s cash burn, borrowing-base availability, debt obligations and the effect of the $55 million convertible notes, including potential dilution.
• Regulatory and clinical outcomes for hGH-CTP, Claros and other pipeline candidates, including how regulators assess the adult hGH-CTP trial analyses.
• Effects of the VARUBI IV distribution suspension on royalties, the related impairment, and future commercial prospects for the oral product.
• Potential impairment sensitivity given the concentration of assets in goodwill and intangibles, and the final effects of the Tax Act and new revenue-recognition standard.

Audit: Ernst & Young issued unqualified opinions on the consolidated financial statements and internal control over financial reporting as of December 31, 2017. No cash dividends were declared or anticipated for fiscal 2018.