Opko Health: The DOJ "Believes" They Have Been in Violation of The FCA For A Decade?
As we see it the principal investment thesis in OPK is that the clinical lab produces cash flow to fund the internal development projects while shareholders wait for Dr. Frost to catch lightning in a bottle. The disclosures in the 10-Q on Thursday offer a significant challenge to that thesis - possible fines, consent decrees and corporate integrity agreements all sap the lab unit of cash and its ability to produce revenue at historical levels.
From the OPK 10Q Filed Yesterday
In April 2017, the Civil Division of the United States Attorney's Office for the Southern District of New York (the "SDNY") informed BioReference Laboratories ("BioReference") that it believes that, from 2006 to the present, BioReference had, in violation of the False Claims Act, improperly billed Medicare and Tricare (both are federal government health care programs) for clinical laboratory services provided to hospital inpatient beneficiaries at certain hospitals. BioReference is reviewing and assessing the allegations made by the SDNY, and, at this point, BioReference has not determined whether there is any merit to the SDNY's claims nor can it determine the extent of any potential liability. While management cannot predict the outcome of these matters at this time, the ultimate outcome could be material to our business, financial condition, results of operations, and cash flows.
Why is This Important? It Yields Multiple Questions That Should Be Addressed:
- In what form does the DOJ inform you that it believes you have defrauded the federal government for 10 years?
- Specifically if you had simply been issued a Civil Investigative Demand (NASDAQ:CID) why did the lawyers not use the same boiler plate language we see in all other 10-Q's?
- Did BioReferance receive CID's or subpoenas before you acquired the company and did you know that at the time of acquisition?
- How should shareholders think about your ability to pay any fines associated with the FCA violation that the DOJ believe was committed?
BioReferance Labs was a controversial company for years before it was acquired - so this isn't a surprise to lab investors. However - OPK investors should be asking about the possible impact of said fine.
The False Claims Act provides that the government is entitled to "treble damages" for fraudulently billing Medicare and Tricare not more than $11k per incident prior to Nov 2015 and $22k per incident their after. In the case of Lab billing the actual bill represents multiple small codes between $2k and $100 per code so treble damages on any given code is unlikely to hit the cap - therefore we think the maximum penalty is germane.
If we accept the experience of other Healthcare companies (often drug companies for off label marketing) with the DOJ we can expect that - should the DOJ move forward here - there will be 2 requests made of OPK:
- The company will have to enter into a Corporate Integrity Agreement assuring that they will not mimic the behavior of the prior management team - in fact we may already be seeing the company implement new controls as diagnostics rev was flat YOY for Q1 vs 5.6% growth last quarter
- The government will initially seek treble damages for the billing they deem to be in violation - in drug land we have come to expect settlement for double damages, in this case I expect the government would give OPK a break as they are the new owner and didn't personally commit the violations in question, still they will have to recover at least the damages
Below we have pulled the Accounts Receivable (NYSE:AR) segment reporting from BioReference Labs (NASDAQ:BRLI) from 2006 -2014, OPK stopped reporting this level of detail so we applied the trailing 5 year CAGR to 2015 and 2016 Medicare AR. As you can see from the note our assumptions only represent 7.3% of the total Medicare AR for BRLI so they are not materially skewing results.
We are unable to capture the Tricare AR as the company never broke it out - that's OK though - lets keep this conservative.
The matrix simply presents the potential impact of an FCA settlement between 1x and 2x the damages assuming that the false claims are no more than 30% of billing and no less than 15%. Admittedly the % of claims that were fraudulently billed is the largest source of unknown variability in this analysis, but it still provides a valuable framework.
The compelling story here is that OPK just reported a quarter with -$38m in Cash Flow From Operations and a total of $131m in Cash and Cash Equivalents. Under the circumstances above - even a kind settlement of 1x damages can sweep a majority of the cash (or be larger than the cash reserves).
Regardless of the assumptions you make the company has very little cushion by which to absorb a fine. And while the Rayaldee launch continues to suffer fits and starts there is no source of cash flow to build such a buffer. Therefore we see the fact that the DOJ believes that the company has been in violation of the False Claims Act as a material issue for the company to detail to shareholders. Every day that the company fails to provide an update we grow more and more suspicious of the status of the complaint.
With 100% of cash potentially at risk it's time for management to step up and explain what's going on - purchasing BRLI was their idea and they need to explain what kind of liability they have saddled shareholders with.
Disclosure: I am/we are short OPK.
Additional disclosure: I am/we are short OPK. All information for this article was derived from publicly available information. Investors are encouraged to conduct their own due diligence into these factors. Additional disclosure: This article represents the opinion of the author as of the date of this article. The information set forth in this article does not constitute a recommendation to buy or sell any security. This article contains certain "forward-looking statements," which may be identified by the use of such words as "believe," "expect," "anticipate," "should," "planned," "estimated," "potential," "outlook," "forecast," "plan" and other similar terms. All are subject to various factors, any or all of which could cause actual events to differ materially from projected events. This article is based upon information reasonably available to the author and obtained from sources the author believes to be reliable; however, such information and sources cannot be guaranteed as to their accuracy or completeness. The author makes no representation as to the accuracy or completeness of the information set forth in this article and undertakes no duty to update its contents. The author may also cover his/her short position at any point in time without providing notice. The author encourages all readers to do their own due diligence.