I have been an OPKO Health, Inc. (NASDAQ:OPK) long for some time now. I have been able to profit a fair amount on the stock already. I as I would assume many investors in the stock were excited for the FDA decision on March 29, 2016 concerning the company's flagship drug, Rayaldee. I figured this approval would be a final step in pushing the stock higher and back towards the highs we saw last year. To the surprise of most including, OPKO, the company did not receive approval but rather received a Complete Response Letter (CRL) from the FDA. The stock as would be expected dropped on the news. Upon further review of the events I consider the pullback a buying opportunity. I will discuss more in depth my reasoning.
Conference Call and Year End Results
Before reviewing the results of the Complete Response Letter, I want to review the conference call and what was discussed. I thought that the company had a good year and many things were discussed during the call that gives more light into the potential and future of the company.
Revenues and Earnings
The first point that can be discussed is the revenue and earning numbers. This was the first full quarter following the acquisition of Bio-Reference Laboratories (BRL). Due to the acquisition OPKO saw a massive increase in its revenue and earnings numbers, revenues grew by 983 percent compared to previous years, the comparison to previous years really isn't in and of itself that useful. Obviously OPKO will have higher revenues and earnings after it acquired a profitable and growing business. The company did not break out the revenue numbers of BRL but during the call Steven Rubin said that revenue for BRL for the quarter was around $220 million. He also stated that BRL has continued to see double digit growth and that they expect it to continue. The revenue helped the company achieve an operating loss of only $8 million for the quarter as compared to $32 million the year before, and after the benefit from income taxes the company produced net income of almost $3 million.
There are a few important things to note from this for me. The first is that the company has been working on the launch of Rayaldee, which is not a cheap process. OPKO has been burning cash into this process and receiving no revenues at this point for the drug, as it is pending approval. Once the drug comes online in the second half of this year (I will discuss this more later on) and the company begins to receive revenues on the drug, even if small this year as it just enters the market, the operating profit will get a boost if nothing else from a likely decrease in costs related to getting approval for the drug. Another important point from the increased revenues and earnings is that the company is not using much cash. The profitability of BRL has provided much more cash to be used. The company has a strong cash position of $193.6 million. The smaller cash burn means that the company has sufficient capital to fund ongoing development programs and the commercial launch of Rayaldee.
The company also received milestone payments from TESARO as it launched the drug VARUBI in the United States. OPKO received $20 million in payments and is eligible to receive another $95 million as certain milestones are reached. Additionally OPKO is set to receive double digit royalties on net sales in the US and the EU. OPKO also has an agreement with Pfizer Inc. (PFE) worth a total of $570 million in milestone payments and an eventual profit share, so far OPK has received $295 million. These agreements provide OPKO with lots of future earnings potential and capital infusion. Considering the factors discussed above, investors should not have to worry about dilution from a capital raise.
4Kscore Test
The American Medical Association assigned a Current Procedural Terminology (CPT) I code to the 4Kscore Test. This will be published in August and effective in January 2017. The CPT coding is the national standard code set for billing of procedures or services to Medicare and other third-party payers. Each year newly established CPT codes are published in the CPT manual. There are three levels of codes, it is either designated as a Category I, II, or III. To be considered as a Category I code, the service or procedure must meet certain criteria including:
Procedure or service approved by the FDA Procedure or service commonly performed by health care professionals nationwide Procedure or service's clinical efficacy is proven and documented
This designation of a CPT I code is an important step in the 4Kscore Test receiving reimbursement. This was discussed more during the conference call. The BRL acquisition has a reimbursement team that has been working to get reimbursement coverage for the 4Kscore Test. Steve Rubin said during the call, "we've had a number of positive payer meetings and we are making great progress in increasing the number of payers reimbursing for the test. This is where we really see the strategy for the acquisition coming together as BRL has 13 staff members dedicated to this effort". OPKO has also begun to run the tests from the BRL facilities, which allows OPKO to benefit from the infrastructure of BRL.
There has also been a study that demonstrates the effectiveness of the 4Kscore test. It was published in the January 2016 edition of the peer-reviewed journal reviews in neurology. The study has significance as it provides evidence and support for payers, and supports the adoption of the 4Kscore test. It is significant in the process of becoming reimbursed. Once the procedure is approved as a Category I code, the Centers for Medicare and Medicaid Services (CMS) makes the determination on the assignment of the relative value unit (RVU). Medicare payment is determined by multiplying the RVU by a conversion factor. The RVU is determined by the amount of work, practice expense and malpractice expense associated with the procedure. Therefore these studies that show the efficacy and cost effectiveness of the 4Kscore Test are important in the CMS coverage decision making process. During the call the company said that they expect a coverage decision mid-year and that is when they really expect the ramp up to take off for the test. OPKO hopes to keep the pricing for the test as close to $1,900 as it can.
The sales force ramp up has begun as well. For the past year OPKO has been selling the 4Kscore test with a ten man sales force team. Now with the acquisition of BRL they have added and trained 200 sales people. The BRL sales team had only been selling for a few weeks at the time of the conference call. Dr. Frost also stated that they had doubled the daily number being ordered. Although he does not expect that case to continue in the future he did say and confirmed after being asked again that the company was experiencing double digit volume growth every month for the tests.
The company did not give a number of tests sold during the quarter, so I would assume that the number is still small. This is not surprising as the company is still working to get the test reimbursed and has also been working with a sales team of 10. Now that the company has received CPT I code, which should lead to more reimbursement, they have increased the sales force by 200 men. Seeing as the company is already experiencing double digit volume growth every month and the price is expected to be close to $1,900, it shouldn't be too long before this becomes a real revenue driver for OPKO.
Rayaldee and the Complete Response Letter
The big news affecting the stock is the FDA decision on OPKO's lead drug, Rayaldee. Investors have been waiting for the FDA decision that was to be made on March 29, 2016. Most expected the drug to be approved without problems. To the surprise of many OPKO received the CRL. The stock quickly dropped over 10 percent in response to the news.
A CRL is described in the Code of Federal Regulations, Title 21, Subchapter D, Sec. 314.110 (Excuse me if I do not know the correct way to reference Federal Code and Law). I will take some pieces from that section to better describe what the CRL entails.
(A) Complete response letter. FDA will send the applicant a complete response letter if the agency determines that we will not approve the application or abbreviated application in its present form for one or more of the reasons given in 314.125 or 314.127, respectively.
(1) Description of specific deficiencies. A complete response letter will describe all of the specific deficiencies that the agency has identified in an application or abbreviated application..
(4) Recommendation of actions for approval. When possible, a complete response letter will recommend actions that the applicant might take to place the application or abbreviated application in condition for approval.
(B) Applicant actions. After receiving a complete response letter, the applicant must take one of following actions:
(1) Resubmission. Resubmit the application or abbreviated application, addressing all deficiencies identified in the complete response letter.
(I) A resubmission of an application or efficacy supplement that FDA classifies as a Class 1 resubmission constitutes an agreement by the applicant to start a new 2-month review cycle beginning on the date FDA receives the resubmission.
(ii) A resubmission of an application or efficacy supplement that FDA classifies as a Class 2 resubmission constitutes an agreement by the applicant to start a new 6-month review cycle beginning on the date FDA receives the resubmission.
OPKO made the announcement and also gave us more insight that is reassuring as an investor in the company. It stated in the announcement "The FDA indicated in the CRL that observations of deficiencies at OPKO's third-party contract manufacturer were issued on March 25, 2016 as a result of an FDA field inspection initiated on March 14, 2016. The observations were not specific to Rayaldee manufacturing. The CRL did not cite any safety, efficacy or labeling issues with regard to Rayaldee, nor did it request any additional studies to be conducted prior to FDA approval."
OPKO also held a short conference call and Q&A to better inform investors of the situation. During the call Dr. Frost stated the company was "quite surprised to receive the letter" and that it was entirely based upon deficiencies with the third party contract manufacturer, Catalent Pharma (CTLT), who is one of the industry's largest and most highly regarded contract manufacturers. The CRL was not specific to the manufacturing of Rayaldee either. The facility is located in St. Petersburg, Florida and happens to be one of Catalent's centers of excellence. Neither company was aware of the deficiencies. Catalent will prepare and file a response to the letter by April 15th. Following that response the FDA will approve the submission in 2-6 months depending on whether it is a Class 1 or Class 2 as discussed above. Whether the FDA determines the resubmission is a Class 1 or Class 2 depends on the response from the firm, in this case Catalent. The FDA will review the action plan from Catalent, if the FDA accepts the action plan they will go with the 2 month and if not then they will require the 6 month review process. If the FDA has to go back and re-inspect the facilities then it will be a Class 2. Dr. Frost also stated that he did not think there was anything unusual about the letter or requests. OPKO does not have a back-up manufacturer as it does not think it is necessary.
The approval process is really dependent on Catalent at this point. So I thought a review of Catalent would be important. Following is a description and information about the company from the company's 10-K:
"We are the leading global provider of advanced delivery technologies and development solutions for drugs, biologics and consumer health products. Our oral, injectable, and respiratory delivery technologies address the full diversity of the pharmaceutical industry including small molecules, large molecule biologics and consumer health products. Through our extensive capabilities and deep expertise in product development, we help our customers take products to market faster, including nearly half of new drug products approved by the Food and Drug Administration (the "FDA") in the last decade. Our advanced delivery technology platforms, broad and deep intellectual property, and proven formulation, manufacturing and regulatory expertise enable our customers to develop more products and better treatments. Across both development and delivery, our commitment to reliably supply our customers' needs is the foundation for the value we provide; annually, we produce more than 70 billion doses for nearly 7,000 customer products.
Since 2010, we have made investments to expand our sales and marketing activities, leading to growth in the number of active development programs for our customers in both of our two main strategic areas. This has further enhanced our extensive, long-duration relationships and long-term contracts with a broad and diverse range of industry-leading customers. In the fiscal year ended June 30, 2015, we did business with 82 of the top 100 branded drug marketers, 19 of the top 20 generics marketers, 40 of the top 50 biologics marketers, and 23 of the top 25 consumer health marketers globally. Selected key customers include Pfizer, Johnson & Johnson, GlaxoSmithKline, Novartis, Roche, Actavis and Teva."
The company had revenues of $1,830.8 million and operating revenue of $259.9 million in 2015. As of June 30, 2015, it employed 8,700 employees in 31 facilities on five continents.
The fact that Catalent is a large company that has a history of working with top pharmaceutical companies is reassuring. This is not just a small time contract manufacturer located in Asia, rather it is an industry leader. The size and resources of the company mean it should be able to handle the deficiencies raised by the FDA. OPKO seems confident in this as well. Both Steven Rubin and Dr. Frost expressed their confidence in Catalent to take care of the CRL. The reputation of Catalent as a company depends on them taking care of it as efficiently and effectively as possible.
OPKO also stated that it has always planned to launch Rayaldee in the second half of 2016 and it will continue forward with the same plan. It will continue to build the commercial sales organization and work on pre-launch activities.
My take on the situation is in the end a positive. It was not ideal for the company to receive the CRL but after learning the details of this letter, OPKO in essence received approval for Rayaldee. There will be no costs for OPKO related to the CRL as it is entirely the fault of Catalent. The FDA had no issues at all with Rayaldee. So once Catalent takes care of the deficiencies at its facilities then Rayaldee will hit the market. While not a clean approval it was really in essence an approval of the drug. The material impact from the events will probably not be that large for 2016 either, as the company always planned to launch in the second half of 2016. They will proceed with that plan and be prepared to launch upon the approval of the resubmission. Even if the FDA determines it to be a Class 2 the approval will still come this year.
Risks
There is always risk involved in investing in any stock. The current situation carries the risk that Catalent cannot easily address the issues raised by the FDA and the issues drags on longer than expected. Worst case scenario is that OPKO has to find another third party manufacturer. This seems very unlikely to me due to the size and reputation of Catalent as a company. Therefore this risk is not that large to me.
Another issue that may arise from this delay is that it gives the competition more time to enter the market before Rayaldee can establish itself among health professionals. It is always a benefit to be first to the market and establish a foothold before competition can enter the market. The more time that Rayaldee has in the market the better it can establish itself.
Conclusion
OPKO had a good year as a company. Its pipeline continues to progress towards profitability. It has joint agreements with companies that have already provided cash and there are good potential earnings in the future with those tie ups. The benefits from the acquisition of BRL are starting to materialize as the company is ramping up its efforts with the 4Kscore Test. The BRL team has added 200 men to the sales team for the test and also been important in the test receiving reimbursement. The test recently received a Category I code which will help it receive reimbursement. The company saw its stock drop as it received a CRL from the FDA on its application for Rayaldee, which was expected by most to be approved. This letter was not due to any fault in Rayaldee but entirely due to deficiencies at the third-party manufacturer. The FDA did not have any issues with Rayaldee itself and is not requiring anything more from OPKO it terms of additional studies. If not for the deficiencies at Catalent then the drug would have been approved. While not a direct approval at the moment, the FDA in essence approved Rayaldee as a drug. I feel that Catalent is a large and reputable company and will therefore be able to handle the issues that the FDA has quickly and efficiently. Rayaldee is still on track to be launched in the second half of this year. The process may have been postponed slightly but the approval will come later this year and the drop in the stock price now provides the time to buy.
