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OPK > SEC Filings for OPK > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for OPKO HEALTH, INC.


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

You should read this discussion together with the condensed consolidated financial statements, related notes, and other financial information included elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2011 (the "Form 10-K"). The following discussion contains assumptions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under "Risk Factors," in Part II, Item 1A of our Form 10-K for the year ended December 31, 2011. These risks could cause our actual results to differ materially from those anticipated in these forward-looking statements.

We are a multi-national pharmaceutical and diagnostics company that seeks to establish industry-leading positions in large and rapidly growing medical markets by leveraging our discovery, development and commercialization expertise and our novel and proprietary technologies. We are developing a range of solutions to diagnose, treat and prevent various conditions, including molecular diagnostics tests, laboratory developed tests, point-of-care tests, and proprietary pharmaceuticals and vaccines. We plan to commercialize these solutions on a global basis in large and high growth markets, including emerging markets. We have already established pharmaceutical platforms in Spain, Chile and Mexico, which are generating revenue and which we expect to generate positive cash flow and facilitate future market entry for our products currently in development. We also operate a specialty active pharmaceutical ingredients ("APIs") manufacturer in Israel, which is currently generating revenue and positive cash flow, and which we expect will play a valuable role in the development of our pipeline of peptoids and other molecules for our proprietary molecular diagnostic and therapeutic products. We continue to actively explore opportunities to acquire complementary pharmaceuticals, compounds, technologies, and businesses.

We expect to incur substantial losses as we continue the development of our product candidates, continue our other research and development activities, and establish a sales and marketing infrastructure in anticipation of the commercialization of our diagnostic and pharmaceutical product candidates. We currently have limited commercialization capabilities, and it is possible that we may never successfully commercialize any of our diagnostic and pharmaceutical product candidates. We do not currently generate revenue from any of our diagnostic and pharmaceutical product candidates. Our research and development activities are budgeted to expand over a period of time and will require further resources if we are to be successful. As a result, we believe that our operating losses are likely to be substantial over the next several years. We may need to obtain additional funds to further develop our research and development programs, and there can be no assurance that additional capital will be available to us when needed on acceptable terms, or at all.


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RECENT DEVELOPMENTS

On October 18, 2012, we entered into a definitive merger agreement to acquire Prost-Data, Inc., doing business as OURLab, a Nashville-based CLIA laboratory with 18 phlebotomy sites throughout the U.S. We believe OURLab provides us with a commercial platform to support the U.S. commercial launch of our panel of kallikrein biomarkers and associated algorithm (4Kscore™) for the detection of prostate cancer. We agreed to pay an aggregate purchase price of $40.0 million, of which $9.4 million shall be payable in cash, and $30.6 million payable in shares of our Common Stock, subject to our ability to hold back up to $4.0 million of the cash otherwise payable at closing as escrow for potential indemnity claims.

On October 17, 2012 we completed the acquisition of a forty-five percent stake in a private Israeli company that produces a third-generation hepatitis B vaccine in its biologics manufacturing facility in Rehovot, Israel.

In August 2012, we acquired all of the outstanding stock of Farmadiet Group Holding, S.L., a Spanish company ("Farmadiet") engaged in the development, manufacture, marketing, and sale of pharmaceutical, nutraceutical, and veterinary products in Europe.

RESULTS OF OPERATIONS

FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011

Revenues. Revenues for the three months ended September 30, 2012 were $11.8 million, compared to $6.8 million for the comparable 2011 period. The increase in revenues during the three months period ended September 30, 2012 is primarily due to $2.0 million of revenues generated by our Farmadiet business, which we acquired in August 2012, $1.5 million of revenues generated by our FineTech Pharmaceuticals Ltd. ("FineTech") API business, which we acquired in December 2011, and an increase of $1.5 million of revenues generated in Chile primarily related to our acquisition of ALS in April 2012.

Gross margin. Gross margin for the three months ended September 30, 2012 was $4.3 million, compared to $2.8 million for the comparable period of 2011. Gross margin for the three months ended September 30, 2012 increased from the comparable period of 2011 primarily as a result of $1.2 million of gross margin generated by Farmadiet and $0.9 million of gross margin generated by our FineTech. This increase was partially offset by a decrease in gross margin generated by our Chilean pharmaceutical business primarily as a result of a $0.7 million provision for inventory obsolecence recorded in the 2012 period.

Selling, general and administrative expenses. Selling, general and administrative expenses for the three months ended September 30, 2012 were $7.3 million, compared to $4.3 million for the comparable period of 2011. The increase in selling, general and administrative expenses is primarily the result of increased personnel expenses as a result of the acquisitions of Farmadiet, Claros Diagnostics, Inc. ("OPKO Diagnostics") and FineTech as well as increased professional fees. Selling, general and administrative expenses during the three months ended September 30, 2012 and 2011 primarily consisted of personnel expenses, including equity-based compensation expense of $1.1 million and $1.3 million, respectively, and professional fees.

Research and development expenses. Research and development expenses during the three months ended September 30, 2012 were $3.6 million, compared to $3.3 million for the comparable period of 2011. Research and development expenses for the three months ended September 30, 2012 increased principally due to activities related to our OPKO Diagnostics development programs, which we acquired in October 2011. These increases were partially offset by lower equity based compensation due to decreased mark to market adjustments for certain of our consultant stock option awards. As a result, the three months ended September 30, 2012 included an immaterial amount of equity-based compensation expense, compared to the three months ended September 30, 2011, which included equity-based compensation expense of $1.3 million.

Contingent consideration expenses. Contingent consideration expenses for the three months ended September 30, 2012 were $0.6 million, which represent the change in the fair value of the contingent consideration liabilities due to the time value of money. Contingent consideration liabilities relates to potential amounts payable to former stockholders of Farmadiet, FineTech and OPKO Diagnostics pursuant to our agreements to acquire them in August 2012, December 2011 and October 2011, respectively. The comparable period of 2011 did not include such expenses.


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Other operating expenses. Other operating expenses were $2.2 million for the three months ended September 30, 2012, compared to $0.9 million for the comparable period of 2011. Other operating expenses primarily include the amortization of intangible assets. Amortization expenses increased due to the acquisitions of Farmadiet, ALS, FineTech and OPKO Diagnostics in August 2012, April 2012, December 2011 and October 2011, respectively.

Other income and (expense), net. Other income and (expense), net was ($0.1) million for the three months ended September 30, 2012, compared to other income and (expense), net of ($0.7) million for the comparable 2011 period. Other income and (expense), net primarily consists of our interest incurred on our lines of credit in Chile and interest incurred on our lines of credit and deferred payments in Spain, partially offset by interest earned on our cash and cash equivalents and the benefit from our Chilean and Mexico operations functional currencies strengthening during the three months ended September 30, 2012. Other income and (expense), net includes $0.2 million of other income recognized for the change in fair value of the warrants received in connection with our investment in Neovasc, Inc. ("Neovasc").

Discontinued operations. We had $0.2 million of income from discontinued operations for the three months ended September 30, 2012, compared to a loss of $1.5 million for the comparable period of 2011. The income for the three months ended September 30, 2012 reflect the recovery of certain retained accounts receivable from our ophthalmic instrumentation business following the October 2011 sale, of the business to Optos, Inc., a subsidiary of Optos plc (collectively "Optos"). The 2011 results reflect the operating loss of our opthalmic instrumentation business for that period. Following our sale to Optos, we no longer have ongoing operations related to that business.

Income taxes. Our income tax benefit reflects the income tax benefit resulting from our businesses in Chile, Spain and Mexico. Our Israeli operations will benefit from a tax holiday during 2012. We have recorded a full valuation allowance against our deferred tax assets in the U.S. for both periods.

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011

Revenues. Revenues for the nine months ended September 30, 2012 were $30.8 million, compared to $22.2 million for the comparable 2011 period. The increase in revenues during the nine months ended September 30, 2012 is primarily due to $4.7 million of revenues generated by Fine Tech, which we acquired in December 2011, $2.0 million of revenues generated by Farmadiet following our August 2012 acquisition, $2.1 million of revenues generated in Chile primarily related to the ALS acquisition in April 2012 and $0.7 million of deferred revenue recognized in connection with our agreements with Neovasc and our molecular diagnostics collaboration agreements, partially offset by decreased revenues from our Mexican operations of $0.8 million.

Gross margin. Gross margin for the nine months ended September 30, 2012 was $11.8 million, compared to $9.1 million for the comparable period of 2011. Gross margin for the nine months ended September 30, 2012, increased from the 2011 period primarily as a result of the gross margin of $3.1 million generated by FineTech, $1.2 million of gross margin generated by Farmadiet and $0.7 million of deferred revenue recognized in connection with our agreements with Neovasc and our molecular diagnostics collaboration agreements. These increases were partially offset by a decrease in gross margin generated by our Chilean pharmaceutical business, primarily as a result of a $1.2 million provision for inventory obsolecence recorded in the 2012 period along with decreased gross margin of $0.6 million from our Mexican operations compared to the 2011 period.

Selling, general and administrative expenses. Selling, general and administrative expenses for the nine months ended September 30, 2012 were $17.4 million, compared to $14.1 million for the comparable period of 2011. The increase in selling, general and administrative expenses is primarily the result of increased personnel expenses, professional fees and expenses as a result of the acquisitions of Farmadiet, OPKO Diagnostics and FineTech. Selling, general and administrative expenses during the nine months ended September 30, 2012 and 2011 consist primarily of personnel expenses, including equity-based compensation expense of $2.3 million and $2.2 million, respectively, and professional fees.

Research and development expenses. Research and development expenses during the nine months ended September 30, 2012 and 2011 were $12.9 million and $7.1 million, respectively. The increase in research and development expenses primarily reflects activities related to our OPKO Diagnostics development programs, which we acquired in October 2011. In addition, we have also increased staffing and related activities for our CURNA, Inc. ("CURNA") and molecular diagnostics development programs during the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. Partially offsetting these increases, equity based compensation decreased


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during the nine months ended September 30, 2012, as compared to the nine months ended September 30, 2011, to $1.0 million from $3.0 million, respectively, due to lower mark to market adjustments for our consultant stock option grants. Research and development expenses for the nine months ended September 30, 2011 primarily consisted of activities related to our molecular diagnostics development programs and post-acquisition activities related to CURNA.

Contingent consideration expenses. Contingent consideration expenses for the nine months ended September 30, 2012 were $2.7 million, which represent the change in the fair value of the contingent consideration liabilities due to the time value of money. Contingent consideration liabilities relates to potential amounts payable to former stockholders of Farmadiet, FineTech and OPKO Diagnostics pursuant to our agreements to acquire those entities in August 2012, December 2011 and October 2011, respectively. The comparable period of 2011 did not include any such expenses.

Other operating expenses. Other operating expenses were $6.3 million for the nine months ended September 30, 2012, compared to $2.6 million for the comparable period of 2011. Other operating expenses primarily include the amortization of intangible assets. Amortization expense increased due to the acquisitions of Farmadiet, ALS, FineTech and OPKO Diagnostics in August 2012, April 2012, December 2011and October 2011, respectively.

Other income and (expense), net. Other income and (expense), net was $0.4 million for the nine months ended September 30, 2012, compared to ($0.8) million for the comparable 2011 period. Other income and (expense), net for the nine months ended September 30, 2012 includes $1.5 million of other income recognized for the change in fair value of the warrants received in connection with our investment in Biozone Pharmaceuticals, Inc., partially offset by other expense recognized for the decrease in fair value of the warrants received in connection with our investments in Neovasc. Other income and (expense), net also includes our interest incurred on our lines of credit in Chile and lines of credit and deferred payments in Spain, partially offset by interest earned on our cash and cash equivalents and the benefit from our Chilean and Mexico operations functional currencies strengthening during the nine months ended September 30, 2012.

Discontinued operations. We had $0.2 million of income from discontinued operations for the nine months ended September 30, 2012, compared to a loss of $2.8 million for the comparable period of 2011. The income for the nine months ended September 30, 2012 reflects the recovery of certain retained accounts receivable from our ophthalmic instrumentation business following the October 2011 sale of the business to Optos, while the 2011 results reflect the operating loss of our ophthalmic instrumentation business for that period. Following our sale of the instrumentation business to Optos, we no longer have ongoing operations related to that business.

Income taxes. Our income tax provision reflects the income tax in Chile, Spain and Mexico. Our Israeli operations will benefit from a tax holiday during 2012. We have recorded a full valuation allowance against our deferred tax assets in the U.S. for both periods.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2012, we had cash, cash equivalents and marketable securities of approximately $42.4 million. Cash used in operations during 2012 primarily reflects expenses related to selling, general and administrative activities related to our corporate operations, research and development activities, and our operations in Chile, Israel, Spain and Mexico. During the nine months ended September 30, 2012, we utilized approximately $13.2 million of cash for our acquisitions of Farmadiet and ALS, as well as for our investments in Biozone and ChromaDex. Since our inception, we have not generated sufficient gross margins to offset our operating and other expenses and our primary source of cash has been from the public and private placement of stock and credit facilities available to us.

In October 2012, we entered into a definitive merger agreement to acquire Prost-Data, Inc., doing business as OURLab, a Nashville-based CLIA laboratory with 18 phlebotomy sites throughout the U.S. In connection with the transaction, we agreed to pay an aggregate purchase price of $40.0 million, of which $9.4 million shall be payable in cash, and $30.6 million payable in shares of Common Stock, subject to our ability to hold back up to $4 million of the cash otherwise payable at closing as escrow for potential indemnity claims.

In conjunction with the acquisition of Farmadiet we will pay €6.8 million ($8.7 million) over the period ending February 2014. The payments are required to be paid in Euro and as such, the final U.S. dollar amount to be paid will be based on the exchange rate at the time the payments are made. The payments may be made at our option in cash or shares of our Common Stock.

In addition, we also entered into two ancillary transactions related to the acquisition of Farmadiet. In exchange for a forty percent interest held by one of the sellers in one of Farmadiet's subsidiaries, we agreed to issue up to an aggregate of 250,000 shares of our Common Stock, of which (a) 125,000 shares were issued on the closing date, and (b) 125,000 will be issued upon achieving certain milestones. We also acquired an interest held by an affiliate of Farmadiet in a product in development in exchange for which we agreed to pay up to an aggregate of $1.1 million payable at our option in cash or shares of our Common Stock, of which (a) $0.3 million was paid at closing through delivery of 70,421 shares of our Common Stock, and $0.8 million will be paid in cash or shares of our Common Stock upon achieving certain milestones. The final U.S. dollar amount to be paid will be based on the exchange rate of the time the milestones are achieved.


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In connection with the acquisition of ALS, we paid (i) $2.4 million in cash at the closing, less certain liabilities, and (ii) $0.8 million in cash at the closing into a separate escrow account to satisfy possible indemnity claims. We agreed to pay an additional $0.8 million, the remainder of the $4.0 million purchase price, upon the legal registration in the name of ALS of certain trademarks and product registrations previously held by the seller Arama Laboratorios y Compañía Limitada.

In connection with our acquisitions of CURNA, OPKO Diagnostics and FineTech, we agreed to pay future consideration to the sellers upon the achievement of certain events, including minimum cash payments of $5.0 million to the former stockholder of FineTech upon the achievement of certain sales milestones, and up to an additional $19.1 million in shares of the our Common Stock to the former stockholders of OPKO Diagnostics upon and subject to the achievement of certain milestones.

As of September 30, 2012, we had outstanding lines of credit in the aggregate amount of $15.9 million with 15 financial institutions in Chile and Spain, with an additional $6.4 million available for additional borrowings. The weighted average interest rate on these lines of credit is approximately 7% for the nine months ended September 30, 2012. These lines of credit are short-term and are generally due within three months. We use these lines of credit primarily as a source of working capital for inventory purchases. The highest balance at any time during the three months ended September 30, 2012, was $15.9 million. We intend to continue to enter into these lines of credit as needed. There is no assurance that these lines of credit or other funding sources will be available to us on acceptable terms, or at all, in the future.

Our unutilized $12.0 million line of credit with the Frost Group, LLC expired on March 31, 2012 and no amounts were borrowed after June 2, 2010 when it was repaid in full. The Frost Group members include a trust controlled by Dr. Frost, who is the Company's Chief Executive Officer and Chairman of our Board of Directors, Dr. Hsiao, who is the Vice Chairman of our Board of Directors and Chief Technical Officer and Mr. Rubin who is Executive Vice President - Administration and a director of the Company.

We expect to incur losses from operations for the foreseeable future. We expect to incur substantial research and development expenses, including expenses related to the hiring of personnel and additional clinical trials. We expect that selling, general and administrative expenses will also increase as we expand our sales, marketing and administrative staff and add infrastructure.

We believe the cash, cash equivalents, and marketable securities on hand at September 30, 2012 and the amounts available to be borrowed under our lines of credit are sufficient to meet our anticipated cash requirements for operations and debt service beyond the next 12 months. We based this estimate on assumptions that may prove to be wrong or are subject to change, and we may be required to use our available cash resources sooner than we currently expect. If we acquire additional assets or companies, accelerate our product development programs or initiate additional clinical trials, we will need additional funds. Our future cash requirements will depend on a number of factors, including possible acquisitions, the continued progress of research and development of our product candidates, the timing and outcome of clinical trials and regulatory approvals, the costs involved in preparing, filing, prosecuting, maintaining, defending, and enforcing patent claims and other intellectual property rights, the status of competitive products, the availability of financing, and our success in developing markets for our product candidates. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of, or eliminate one or more of our clinical trials or research and development programs or possible acquisitions.

We intend to finance additional research and development projects, clinical trials and our future operations with a combination of available cash on hand, payments from potential strategic research and development, licensing and/or marketing arrangements, public offerings, private placements, debt financing and revenues from future product sales, if any. There can be no assurance, however, that additional capital will be available to us on acceptable terms, or at all.


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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

Accounting estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates.

Equity-based compensation. We recognize equity based compensation as an expense in our financial statements and that cost is measured at the fair value of the awards and expensed over their vesting period. Equity-based compensation arrangements to non-employees are recorded at their fair value on the measurement date. We estimate the grant-date fair value of our stock option grants using a valuation model known as the Black-Scholes-Merton formula or the "Black-Scholes Model" and allocate the resulting compensation expense over the corresponding requisite service period associated with each grant. The Black-Scholes Model requires the use of several variables to estimate the grant-date fair value of stock options including expected term, expected volatility, expected dividends and risk-free interest rate. We perform significant analyses to calculate and select the appropriate variable assumptions used in the Black-Scholes Model. We also perform significant analyses to estimate forfeitures of equity-based awards. We are required to adjust our forfeiture estimates on at least an annual basis based on the number of share-based awards that ultimately vest. The selection of assumptions and estimated forfeiture rates is subject to significant judgment and future changes to our assumptions and estimates may have a material impact on our Consolidated Financial Statements.

Goodwill and intangible assets. The allocation of the purchase price for acquisitions requires extensive use of accounting estimates and judgments to allocate the purchase price to the identifiable tangible and intangible assets acquired, including in-process research and development, and liabilities assumed based on their respective fair values. Additionally, we must determine whether an acquired entity is considered to be a business or a set of net assets, because a portion of the purchase price can only be allocated to goodwill in a business combination.

Purchase price allocations and appraisals inherently require significant estimates and assumptions, including but not limited to, determining the timing and estimated costs to complete the in-process research and development projects, projecting regulatory approvals, estimating future cash flows, and developing appropriate discount rates. We believe the estimated fair values assigned to the ALS, OPKO Diagnostics, FineTech and Farmadiet assets acquired and liabilities assumed are based on reasonable assumptions. However, the fair value estimates for the purchase price allocation may change during the allowable allocation period, which is up to one year from the acquisition date, if additional information becomes available that would require changes to our estimates.

Inventories. Inventories are valued at the lower of cost or market (net realizable value). Cost is determined by the first-in, first-out method. We consider such factors as the amount of inventory on hand, estimated time required to sell such inventories, remaining shelf-life, and current market conditions to determine whether inventories are stated at the lower of cost or market.

Allowance for doubtful accounts and revenue recognition. Generally, we recognize revenue from product sales when goods are shipped and title and risk of loss transfer to our customers. Our estimates for sales returns are based upon the historical patterns of products returned matched against the sales from which they originated, and management's evaluation of specific factors that may increase the risk of product returns. We analyze accounts receivable and historical bad debt levels, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts using the specific identification method. Our reported net loss is directly affected by management's estimate of the collectability of accounts receivable. The . . .

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