OPKO HEALTH, INC. quarterly report, Q2 FY2016

OPKO Health, Inc. — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016. The unaudited results include OPKO’s diagnostics and pharmaceutical businesses. Year-over-year comparisons are heavily affected by the August 2015 acquisition of Bio-Reference, which was not included in the comparable 2015 reported results.

Financial performance and liquidity

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Total revenue	$357.1 million	$42.4 million	$648.1 million	$72.5 million
Operating income (loss)	$28.3 million	$(25.4) million	$0.7 million	$(82.3) million
Net income (loss) attributable to common shareholders	$15.5 million	$(42.8) million	$3.6 million	$(159.9) million
Diluted earnings (loss) per share	$0.02	$(0.09)	$0.00	$(0.35)
Operating cash flow	Not separately reported for the quarter	$33.6 million	$204.7 million

Q2 revenue comprised $266.0 million from services, $22.8 million from products and $68.3 million from intellectual-property transfers and other sources. The $50.0 million Vifor upfront license payment was a major contributor to Q2 revenue.
Calculated operating margin was about 7.9% in Q2 and 0.1% for the first half; calculated net margin was about 4.4% and 0.5%, respectively. Margins are influenced by acquisition accounting and license revenue.
At June 30, cash and cash equivalents were $156.0 million and marketable securities were $15.6 million, or $171.6 million combined, down from $193.6 million cash at year-end. Operating cash flow was $33.6 million; investing cash use was $33.7 million and financing cash use was $37.9 million.
Current assets were $505.6 million versus current liabilities of $281.2 million. Accounts receivable, net, was $213.4 million; the allowance for doubtful accounts rose to $48.8 million from $25.2 million at year-end. The first-half bad-debt provision was $40.5 million.
Reported lines of credit outstanding were $47.7 million; principal on the 2033 Senior Notes was $32.2 million, and other notes and debt totaled approximately $2.9 million. The notes carry a 3.00% coupon and mature in 2033. The Bio-Reference revolving facility matures in 2020; total availability under that facility and other lines was $166.4 million, of which $47.7 million was drawn.

Material changes and unusual items

Service revenue increased sharply following Bio-Reference’s acquisition. The acquisition also contributed substantially to service costs and selling, general and administrative expenses. First-half SG&A included $17.2 million of severance costs and $8.9 million of accelerated stock-option vesting expense for certain Bio-Reference executives.
OPKO recorded a $50.0 million Vifor upfront payment as Q2 license revenue. The agreement covers Rayaldee in specified markets outside the U.S. and includes up to $232 million in regulatory and sales milestones plus royalties, subject to agreement terms. A separate U.S. dialysis-indication option could carry up to $555 million in milestones if exercised.
Rayaldee received FDA approval in June for specified patients with stage 3 or 4 chronic kidney disease. OPKO reclassified $187.6 million of related in-process R&D to finite-lived intangible assets, to be amortized over approximately 12 years. The approval also increased the fair value of acquisition-related contingent consideration expense by $10.8 million in Q2 and $12.5 million in the first half.
Six-month revenue from the Pfizer hGH-CTP transaction was $35.3 million, recognized over the expected performance period through 2019. Related deferred revenue was $194.2 million at June 30.
First-half derivative fair-value changes were a net expense of $0.2 million, compared with $66.3 million expense in 2015; the 2015 result was principally tied to the embedded derivative in the convertible notes. These non-cash valuation changes can cause substantial earnings volatility.
The IRS approved an accounting-method change, which the filing says generated $51.2 million of income tax benefits: $39.4 million recorded as a receivable and $11.8 million as a reduction in deferred tax liabilities. The income statement nevertheless reports a Q2 tax provision of $15.9 million and a first-half tax benefit of $4.6 million; the filing text does not clearly reconcile these amounts.

Outlook, risks and contingencies

Management expected to launch Rayaldee in the U.S. in Q4 2016 and expected R&D and SG&A spending to increase. OPKO agreed to acquire Transition Therapeutics for approximately 6.4 million OPKO shares, valued at about $60.1 million using $9.34 per share; closing was expected in the second half of 2016, subject to shareholder approval and customary conditions.
Management stated that cash, marketable securities and available credit were expected to cover anticipated operating and debt-service needs beyond 12 months, while cautioning that estimates depend on assumptions. OPKO said it had not generated sustained positive cash flow sufficient to offset expenses and could need additional funding for acquisitions, trials or accelerated development.
Key risks include successful commercial launch and reimbursement of Rayaldee, clinical and regulatory outcomes, laboratory reimbursement and collections, competition, integration of acquired operations, and access to financing. Goodwill and intangible assets represented approximately 76% of total assets; management highlighted impairment sensitivity to product, market and development assumptions.
Contractual obligations totaled $235.6 million in the filing’s schedule. Separately, contingent consideration could aggregate up to $189.4 million, payable in cash or shares at OPKO’s option, subject to milestones. OPKO also had $54.4 million of open purchase commitments for 2016.
OPKO settled a government investigation concerning alleged healthcare-program claims in May 2016 without financial impact, and settled other disclosed matters without material impact. It continued responding to subpoenas and document requests related to laboratory operations; potential losses for certain matters were not accrued because probability or amount could not be reasonably determined.
Management reported disclosure controls were effective at June 30. Integration of Bio-Reference and EirGen controls was ongoing and had materially affected, or was reasonably likely to materially affect, internal control over financial reporting.

Most important facts for investors to verify

How much of revenue growth and reported profit reflects acquired Bio-Reference operations or upfront and deferred license revenue, versus recurring organic performance.
The collection quality of laboratory receivables, particularly the increased bad-debt allowance and provision, and the sustainability of laboratory margins.
Rayaldee launch timing, uptake, payer coverage, and the assumptions behind contingent consideration and intangible-asset valuations.
The cash-flow outlook, actual borrowing availability and covenant headroom, and potential funding needs alongside planned R&D, launch spending and acquisitions.
The tax-benefit presentation and reconciliation, plus potential earnings volatility from convertible-note derivatives, equity investments and other fair-value estimates.
Progress on outstanding regulatory inquiries and litigation, and completion of acquired-business internal-control integration.