Quarterly Report


Table of Contents
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-Q
 
(Mark One)
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017 .
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                      .
Commission file number 001-33528
 
OPKO Health, Inc.
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
 
75-2402409
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
4400 Biscayne Blvd.
Miami, FL 33137
(Address of Principal Executive Offices) (Zip Code)
 
(305) 575-4100
(Registrant’s Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     ý   YES     ¨   NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     ý   YES     ¨   NO
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company”
(in Rule 12b-2 of the Exchange Act) (Check one):
Large accelerated filer
x
Accelerated filer
¨
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
Emerging growth company
¨

 

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If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    ¨   YES     ý   NO
As of October 31, 2017 , the registrant had 559,404,941 shares of Common Stock outstanding.

 

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TABLE OF CONTENTS
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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains “forward-looking statements,” as that term is defined under the Private Securities Litigation Reform Act of 1995 (“PSLRA”), Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include statements about our expectations, beliefs or intentions regarding our product development efforts, business, financial condition, results of operations, strategies or prospects. You can identify forward-looking statements by the fact that these statements do not relate strictly to historical or current matters. Rather, forward-looking statements relate to anticipated or expected events, activities, trends or results as of the date they are made. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties that could cause our actual results to differ materially from any future results expressed or implied by the forward-looking statements. Many factors could cause our actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These factors include those described below and in “Item 1A-Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016, and described from time to time in our other reports filed with the Securities and Exchange Commission. We do not undertake an obligation to update forward-looking statements. We intend that all forward-looking statements be subject to the safe-harbor provisions of the PSLRA. These forward-looking statements are only predictions and reflect our views as of the date they are made with respect to future events and financial performance.

Risks and uncertainties, the occurrence of which could adversely affect our business, include the following:
we have a history of losses and may not generate sustained positive cash flow sufficient to fund our operations and research and development programs;
the risks inherent in developing, obtaining regulatory approvals for and commercializing new, commercially viable and competitive products and treatments;
our research and development activities may not result in commercially viable products;
that earlier clinical results of effectiveness and safety may not be reproducible or indicative of future results;
that we may fail to obtain regulatory approval for hGH-CTP or successfully commercialize Rayaldee and hGH-CTP;
that we may not generate profits or cash flow from our laboratory operations or substantial revenue from our pharmaceutical and diagnostic products;
that currently available over-the-counter and prescription products, as well as products under development by others, may prove to be as or more effective than our products for the indications being studied;
our ability to build a successful pharmaceutical sales and marketing infrastructure;
our ability and our distribution and marketing partners’ ability to comply with regulatory requirements regarding the sales, marketing and manufacturing of our products and product candidates and the operation of our laboratories;
the performance of our third-party distribution partners, licensees and manufacturers over which we have limited control;
our success is dependent on the involvement and continued efforts of our Chairman and Chief Executive Officer;
integration challenges for Transition Therapeutics, BioReference, EirGen and other acquired businesses;
changes in regulation and policies in the United States and other countries, including increasing downward pressure on healthcare reimbursement;
our ability to manage our growth and our expanded operations;
increased competition, including price competition;
changing relationships with payers, including the various state and multi-state Blues programs, suppliers and strategic partners;
efforts by third-party payors to reduce utilization and reimbursement for clinical testing services;
failure to timely or accurately bill for our services;
failure in our information technology systems, including cybersecurity attacks or other data security incidents;
failure to obtain and retain new clients and business partners, or a reduction in tests ordered or specimens submitted by existing clients;
failure to establish, and perform to, appropriate quality standards to assure that the highest level of quality is observed in the performance of our testing services;
failure to maintain the security of patient-related information;
our ability to obtain and maintain intellectual property protection for our products;
our ability to defend our intellectual property rights with respect to our products;
our ability to operate our business without infringing the intellectual property rights of others;
our ability to attract and retain key scientific and management personnel;
our need for, and ability to obtain, additional financing;
adverse results in material litigation matters or governmental inquiries;
failure to obtain and maintain regulatory approval outside the U.S.;

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legal, economic, political, regulatory, currency exchange, and other risks associated with international operations; and
our ability to finance and successfully complete construction of a research, development and manufacturing center in Waterford, Ireland.

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PART I. FINANCIAL INFORMATION
Unless the context otherwise requires, all references in this Quarterly Report on Form 10-Q to the “Company”, “OPKO”, “we”, “our”, “ours”, and “us” refer to OPKO Health, Inc., a Delaware corporation, including our wholly-owned subsidiaries.
Item 1. Financial Statements
OPKO Health, Inc. and Subsidiaries
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)
 
September 30, 2017
 
December 31, 2016
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
100,362

 
$
168,733

Accounts receivable, net
233,916

 
220,284

Inventory, net
46,954

 
47,228

Other current assets and prepaid expenses
49,324

 
47,356

Total current assets
430,556

 
483,601

Property, plant and equipment, net
142,437

 
122,831

Intangible assets, net
714,552

 
763,976

In-process research and development
648,377

 
644,713

Goodwill
715,573

 
704,603

Investments
32,196

 
41,139

Other assets
38,299

 
5,756

Total assets
$
2,721,990

 
$
2,766,619

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
66,536

 
$
53,360

Accrued expenses
176,300

 
197,955

Current portion of lines of credit and notes payable
16,112

 
11,981

Total current liabilities
258,948

 
263,296

2033 Senior Notes, net of discount
28,590

 
43,701

Deferred tax liabilities, net
118,799

 
165,331

Other long-term liabilities, principally deferred revenue, contingent consideration and line of credit
226,617

 
202,483

Total long-term liabilities
374,006

 
411,515

Total liabilities
632,954

 
674,811

Equity:
 
 
 
Common Stock - $0.01 par value, 750,000,000 shares authorized; 559,955,118 and 558,576,051
shares issued at September 30, 2017 and December 31, 2016, respectively
5,600

 
5,586

Treasury Stock - 549,907 and 586,760 shares at September 30, 2017 and December 31, 2016, respectively
(1,791
)
 
(1,911
)
Additional paid-in capital
2,883,026

 
2,845,096

Accumulated other comprehensive loss
(5,422
)
 
(27,009
)
Accumulated deficit
(792,377
)
 
(729,954
)
Total shareholders’ equity
2,089,036

 
2,091,808

Total liabilities and equity
$
2,721,990

 
$
2,766,619

 

The accompanying unaudited Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
6


OPKO Health, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except share and per share data)
 
For the three months ended September 30,
 
For the nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Revenue from services
$
229,035

 
$
259,025

 
$
740,992

 
$
777,559

Revenue from products
22,795

 
20,569

 
73,992

 
63,275

Revenue from transfer of intellectual property and other
11,665

 
18,441

 
58,819

 
105,338

Total revenues
263,495

 
298,035

 
873,803

 
946,172

Costs and expenses:
 
 
 
 
 
 
 
Cost of service revenue
135,203

 
138,554

 
419,070

 
417,121

Cost of product revenue
16,107

 
12,626

 
44,441

 
35,033

Selling, general and administrative
131,336

 
124,845

 
396,359

 
370,358

Research and development
32,329

 
24,424

 
90,944

 
83,594

Contingent consideration
(11,213
)
 
3,093

 
(4,475
)
 
15,604

Amortization of intangible assets
18,023

 
18,116

 
53,904

 
47,337

Total costs and expenses
321,785

 
321,658

 
1,000,243

 
969,047

Operating loss
(58,290
)
 
(23,623
)
 
(126,440
)
 
(22,875
)
Other income and (expense), net:
 
 
 
 
 
 
 
Interest income
249

 
163

 
634

 
341

Interest expense
(1,840
)
 
(2,018
)
 
(4,771
)
 
(6,022
)
Fair value changes of derivative instruments, net
(7,550
)
 
(5,701
)
 
1,969

 
(5,889
)
Other income (expense), net
597

 
(2,972
)
 
3,105

 
3,543

Other income and (expense), net
(8,544
)
 
(10,528
)
 
937

 
(8,027
)
Loss before income taxes and investment losses
(66,834
)
 
(34,151
)
 
(125,503
)
 
(30,902
)
Income tax benefit
24,405

 
19,988

 
42,309

 
24,626

Net loss before investment losses
(42,429
)
 
(14,163
)
 
(83,194
)
 
(6,276
)
Loss from investments in investees
(4,013
)
 
(814
)
 
(11,771
)
 
(5,147
)
Net loss
$
(46,442
)
 
$
(14,977
)
 
$
(94,965
)
 
$
(11,423
)
Loss per share, basic and diluted:
 
 
 
 
 
 
 
Loss per share
$
(0.08
)
 
$
(0.03
)
 
$
(0.17
)
 
$
(0.02
)
Weighted average common shares outstanding, basic and diluted
559,405,309

 
552,229,266

 
559,065,232

 
548,550,641



The accompanying unaudited Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
7


OPKO Health, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(Unaudited)
(In thousands)
 
For the three months ended September 30,
 
For the nine months ended September 30,
 
2017
 
2016
 
2017
 
2016
Net loss
$
(46,442
)
 
$
(14,977
)
 
$
(94,965
)
 
$
(11,423
)
Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Change in foreign currency translation and other comprehensive income (loss)
8,557

 
2,796

 
21,646

 
5,306

Available for sale investments:
 
 
 
 
 
 
 
Change in unrealized loss, net of tax
(6
)
 
449

 
(749
)
 
(2,955
)
Less: reclassification adjustments for losses included in net loss, net of tax
96

 
3,902

 
690

 
3,902

Comprehensive loss
$
(37,795
)
 
$
(7,830
)
 
$
(73,378
)
 
$
(5,170
)


The accompanying unaudited Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
8


OPKO Health, Inc. and Subsidiaries
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)

 
For the nine months ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net loss
$
(94,965
)
 
$
(11,423
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
76,677

 
72,612

Non-cash interest
1,944

 
2,063

Amortization of deferred financing costs
168

 
175

Losses from investments in investees
11,771

 
5,147

Equity-based compensation – employees and non-employees
22,292

 
34,939

Realized loss (gain) on equity securities and disposal of fixed assets
(2,683
)
 
943

Change in fair value of derivative instruments
(1,969
)
 
5,889

Change in fair value of contingent consideration
(4,475
)
 
15,604

Deferred income tax benefit
(46,366
)
 
(30,982
)
Changes in assets and liabilities, net of the effects of acquisitions:
 
 
 
Accounts receivable, net
(13,594
)
 
(28,974
)
Inventory, net
1,729

 
(2,726
)
Other current assets and prepaid expenses
(2,857
)
 
(24,310
)
Other assets
(449
)
 
(402
)
Accounts payable
12,013

 
(16,141
)
Foreign currency measurement
608

 
(433
)
Deferred revenue
(42,142
)
 
(56,256
)
Accrued expenses and other liabilities
(11,892
)
 
36,015

Net cash provided by (used in) operating activities
(94,190
)
 
1,740

Cash flows from investing activities:
 
 
 
Investments in investees
(4,625
)
 
(9,171
)
Acquisition of businesses, net of cash

 
15,878

Purchase of marketable securities
(6
)
 
(15,631
)
Maturities of short-term marketable securities

 
15,634

Proceeds from the sale of property, plant and equipment
3,979

 
1,082

Acquisition of intangible assets

 
(5,000
)
Capital expenditures
(32,061
)
 
(17,015
)
Net cash used in investing activities
(32,713
)
 
(14,223
)
Cash flows from financing activities:
 
 
 
Proceeds from the exercise of Common Stock options and warrants
1,916

 
6,112

Borrowings on lines of credit
75,544

 
15,816

Repayments of lines of credit
(20,643
)
 
(58,901
)
Net cash provided by (used in) financing activities
56,817

 
(36,973
)
Effect of exchange rate changes on cash and cash equivalents
1,715

 
504

Net decrease in cash and cash equivalents
(68,371
)
 
(48,952
)
Cash and cash equivalents at beginning of period
168,733

 
193,598

Cash and cash equivalents at end of period
$
100,362

 
$
144,646

SUPPLEMENTAL INFORMATION:
 
 
 
Interest paid
$
1,409

 
$
2,519

Income taxes paid, net
$
5,899

 
$
8,045

Non-cash financing:
 
 
 
Shares issued upon the conversion of:
 
 
 
Common Stock options and warrants, surrendered in net exercise
$
1,546

 
$
350

Issuance of capital stock for contingent consideration settlement:
 
 
 
Transition Therapeutics, Inc.
$

 
$
58,530

OPKO Health Europe
$
303

 
$
313

OPKO Renal
$

 
$
25,986

Issuance of stock for investment in Xenetic
$

 
$
4,856

 
 
 
 
 
 
 
 


The accompanying unaudited Notes to Condensed Consolidated Financial Statements are an integral part of these statements.
9


OPKO Health, Inc. and Subsidiaries
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
NOTE 1 BUSINESS AND ORGANIZATION
We are a diversified healthcare company that seeks to establish industry-leading positions in large and rapidly growing medical markets. Our diagnostics business includes BioReference Laboratories, Inc. (“BioReference”), the nation’s third-largest clinical laboratory with a core genetic testing business and a 400 -person sales and marketing team to drive growth and leverage new products, including the 4Kscore prostate cancer test and the Claros 1 in-office immunoassay platform (in development). Our pharmaceutical business features Rayaldee , an FDA-approved treatment for secondary hyperparathyroidism (“SHPT”) in adults with stage 3 or 4 chronic kidney disease (“CKD”) and vitamin D insufficiency and VARUBI™ for chemotherapy-induced nausea and vomiting (oral formulation launched by partner TESARO in November 2015 and IV formulation approved October 2017), OPK88003, a once or twice weekly oxyntomodulin for type 2 diabetes and obesity which is a clinically advanced drug candidate among the new class of GLP-1 glucagon receptor dual agonists (Phase 2b), and OPK88004, a selective androgen receptor modulator being developed for benign prostatic hyperplasia and other urologic and metabolic conditions. Our pharmaceutical business also features hGH-CTP, a once-weekly human growth hormone injection (in Phase 3 and partnered with Pfizer), and a once-daily Factor VIIa drug for hemophilia (Phase 2a). We are incorporated in Delaware and our principal executive offices are located in leased offices in Miami, Florida.
In August 2016, we completed the acquisition of Transition Therapeutics, Inc. (“Transition Therapeutics”), a clinical stage biotechnology company developing OPK88003, a once or twice weekly oxyntomodulin for type 2 diabetes and obesity, and OPK88004, a selective androgen receptor modulator for androgen deficiency indications.  Holders of Transition Therapeutics common stock received 6,431,899 shares of OPKO Common Stock. The transaction was valued at approximately $58.5 million , based on a closing price per share of our Common Stock of $9.10 as reported by NASDAQ on the closing date.
Through BioReference, we provide laboratory testing services, primarily to customers in the larger metropolitan areas across New York, New Jersey, Maryland, Pennsylvania, Delaware, Washington, DC, Florida, California, Texas, Illinois and Massachusetts as well as to customers in a number of other states. We offer a comprehensive test menu of clinical diagnostics for blood, urine, and tissue analysis. This includes hematology, clinical chemistry, immunoassay, infectious diseases, serology, hormones, and toxicology assays, as well as Pap smear, anatomic pathology (biopsies) and other types of tissue analysis. We market our laboratory testing services directly to physicians, geneticists, hospitals, clinics, correctional and other health facilities.
We operate established pharmaceutical platforms in Ireland, Chile, Spain, and Mexico, which are generating revenue and which we expect to facilitate future market entry for our products currently in development. In addition, we have a development and commercial supply pharmaceutical company and a global supply chain operation and holding company in Ireland. We own a specialty active pharmaceutical ingredients (“APIs”) manufacturer in Israel, which we expect will facilitate the development of our pipeline of molecules and compounds for our molecular diagnostic and therapeutic products.
Our research and development activities are primarily performed at facilities in Miramar, FL, Woburn, MA, Waterford, Ireland, Kiryat Gat, Israel, and Barcelona, Spain.


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NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation . The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring adjustments or otherwise disclosed herein) considered necessary to present fairly the Company’s results of operations, financial position and cash flows have been made. The results of operations and cash flows for the three and nine months ended September 30, 2017 , are not necessarily indicative of the results of operations and cash flows that may be reported for the remainder of 2017 or any future periods. The unaudited Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and the Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 .
Principles of consolidation . The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of OPKO Health, Inc. and of our wholly-owned subsidiaries. All intercompany accounts and transactions are eliminated in consolidation.
Use of estimates . The preparation of financial statements in conformity with GAAP 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 revenues and expenses during the reporting period. Actual results could differ significantly from these estimates.
Cash and cash equivalents . Cash and cash equivalents include short-term, interest-bearing instruments with original maturities of 90 days or less at the date of purchase. We also consider all highly liquid investments with original maturities at the date of purchase of 90 days or less as cash equivalents. These investments include money markets, bank deposits, certificates of deposit and U.S. treasury securities.
Inventories . Inventories are valued at the lower of cost and 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 and net realizable value. Inventories at our diagnostics segment consist primarily of purchased laboratory supplies, which is used in our testing laboratories. Inventory obsolescence expense for the nine months ended September 30, 2017 and 2016 was $5.0 million and $0.2 million , respectively.
Pre-launch inventories . We may accumulate commercial quantities of certain product candidates prior to the date we anticipate that such products will receive final U.S. FDA approval.  The accumulation of such pre-launch inventories involves the risk that such products may not be approved for marketing by the FDA on a timely basis, or ever.  This risk notwithstanding, we may accumulate pre-launch inventories of certain products when such action is appropriate in relation to the commercial value of the product launch opportunity.  In accordance with our policy, this pre-launch inventory is expensed.  
Goodwill and intangible assets . Goodwill represents the difference between the purchase price and the estimated fair value of the net assets acquired accounted for by the acquisition method of accounting and arose from our acquisitions. Refer to Note 4. Goodwill, in-process research and development (“IPR&D”) and other intangible assets acquired in business combinations, licensing and other transactions at both September 30, 2017 and December 31, 2016 was $2.1 billion .
Assets acquired and liabilities assumed in business combinations, licensing and other transactions are generally recognized at the date of acquisition at their respective fair values. We determined the fair value of intangible assets, including IPR&D, using the “income method.”
Goodwill is tested at least annually for impairment, or when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, by assessing qualitative factors or performing a quantitative analysis in determining whether it is more likely than not that its fair value exceeds the carrying value.
Intangible assets are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, although IPR&D is required to be tested at least annually until the project is completed or abandoned. Upon obtaining regulatory approval, the IPR&D asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life. If the project is abandoned, the IPR&D asset is charged to expense.

11


We reclassified $187.6 million of IPR&D related to Rayaldee from In-process research and development to Intangible assets, net in our Condensed Consolidated Balance Sheets upon the FDA’s approval of Rayaldee in June 2016. The assets are being amortized on a straight-line basis over their estimated useful life of approximately 12 years.
We amortize intangible assets with definite lives on a straight-line basis over their estimated useful lives, ranging from 3 to 20 years. We use the straight-line method of amortization as there is no reliably determinable pattern in which the economic benefits of our intangible assets are consumed or otherwise used up. Amortization expense was $53.9 million and $47.3 million for the nine months ended September 30, 2017 and 2016, respectively.
Fair value measurements . The carrying amounts of our cash and cash equivalents, accounts receivable, accounts payable and short-term debt approximate their fair value due to the short-term maturities of these instruments. Investments that are considered available for sale as of September 30, 2017 and December 31, 2016 are carried at fair value. Our debt under the credit agreement with JPMorgan Chase Bank, N.A. approximates fair value due to the variable rate of interest.
In evaluating the fair value information, considerable judgment is required to interpret the market data used to develop the estimates. The use of different market assumptions and/or different valuation techniques may have a material effect on the estimated fair value amounts. Accordingly, the estimates of fair value presented herein may not be indicative of the amounts that could be realized in a current market exchange. Refer to Note 8.
Contingent consideration . Each period we revalue the contingent consideration obligations associated with certain prior acquisitions to their fair value and record increases in the fair value as contingent consideration expense and decreases in the fair value as a reduction in contingent consideration expense. Changes in contingent consideration result from changes in the assumptions regarding probabilities of successful achievement of related milestones, the estimated timing in which the milestones are achieved and the discount rate used to estimate the fair value of the liability. Contingent consideration may change significantly as our development programs progress, revenue estimates evolve and additional data is obtained, impacting our assumptions. The assumptions used in estimating fair value require significant judgment. The use of different assumptions and judgments could result in a materially different estimate of fair value which may have a material impact on our results from operations and financial position.
Derivative financial instruments . We record derivative financial instruments on our Condensed Consolidated Balance Sheets at their fair value and recognize the changes in the fair value in our Condensed Consolidated Statements of Operations when they occur, the only exception being derivatives that qualify as hedges. For the derivative instrument to qualify as a hedge, we are required to meet strict hedge effectiveness and contemporaneous documentation requirements at the initiation of the hedge and assess the hedge effectiveness on an ongoing basis over the life of the hedge. At September 30, 2017 and December 31, 2016 , our foreign currency forward contracts held to economically hedge inventory purchases did not meet the documentation requirements to be designated as hedges. Accordingly, we recognize all changes in the fair values of our derivatives instruments, net, in our Condensed Consolidated Statements of Operations. Refer to Note 9.
Property, plant and equipment . Property, plant and equipment are recorded at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the assets and includes amortization expense for assets capitalized under capital leases. The estimated useful lives by asset class are as follows: software - 3 years, machinery, medical and other equipment - 5 - 8 years, furniture and fixtures - 5 - 12 years, leasehold improvements - the lesser of their useful life or the lease term, buildings and improvements - 10 - 40 years, automobiles and aircraft - 3 - 15 years. Expenditures for repairs and maintenance are charged to expense as incurred. Depreciation expense was $22.7 million and $25.3 million for the nine months ended September 30, 2017 and 2016, respectively. Assets held under capital leases are included within Property, plant and equipment, net in our Condensed Consolidated Balance Sheets and are amortized over the shorter of their useful lives or the expected term of their related leases.
Impairment of long-lived assets. Long-lived assets, such as property and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, then an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Income taxes. Income taxes are accounted for under the asset-and-liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and the respective tax bases and for operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date.

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We operate in various countries and tax jurisdictions globally.  For interim reporting purposes, we record income taxes based on the expected annual effective income tax rate taking into consideration global forecasted tax results.  For the three and nine months ended September 30, 2017 , the tax rate differed from the U.S. federal statutory rate of 35% primarily due to the relative mix in earnings and losses in the U.S. versus foreign tax jurisdictions, the impact of certain discrete tax events and operating results in tax jurisdictions which do not result in a tax benefit.
We periodically evaluate the realizability of our net deferred tax assets. Our tax accruals are analyzed periodically and adjustments are made as events occur to warrant such adjustment. On December 29, 2016, the Israeli Parliament reduced the standard corporate income tax rate from 25% to 24% , effective January 1, 2017 and 23% effective January 1, 2018. The new rates have been used in determining Income tax benefit in 2017.
Revenue recognition . Revenue for laboratory services is recognized at the time test results are reported, which approximates when services are provided. Services are provided to patients covered by various third-party payer programs including various managed care organizations, as well as the Medicare and Medicaid programs. Billings for services under third-party payer programs are included in revenue net of allowances for contractual discounts and allowances for differences between the amounts billed and estimated program payment amounts. Adjustments to the estimated payment amounts based on final settlement with the programs are recorded upon settlement as an adjustment to revenue. For the nine months ended September 30, 2017 , approximately 31% of our revenues were derived directly from the Medicare and Medicaid programs.
We recognize revenue from product sales when persuasive evidence of an arrangement exists, delivery has occurred, collectability is reasonably assured, and the price to the buyer is fixed or determinable, which is generally when goods are shipped and title and risk of loss transfer to our customers. Our estimates for sales returns and allowances are based upon the historical patterns of product returns and allowances taken, matched against the sales from which they originated, and our evaluation of specific factors that may increase or decrease the risk of product returns. Product revenues are recorded net of estimated rebates, chargebacks, discounts, co-pay assistance and other deductions (collectively, “Sales Deductions”) as well as estimated product returns. Allowances are recorded as a reduction of revenue at the time product revenues are recognized.
We launched Rayaldee in the U.S. through our dedicated renal sales force in November 2016. Rayaldee is distributed in the U.S. principally through the retail pharmacy channel, which initiates with the largest wholesalers in the U.S. (collectively, “ Rayaldee Customers”). In addition to distribution agreements with Rayaldee Customers, we have entered into arrangements with many healthcare providers and payers that provide for government-mandated and/or privately-negotiated rebates, chargebacks and discounts with respect to the purchase of Rayaldee .
We lack the experiential data which would allow us to estimate Sales Deductions and product returns. Therefore, as of September 30, 2017 , we have determined that we do not yet meet the criteria for the recognition of revenue for shipments of Rayaldee at the time of shipment to Rayaldee Customers as allowances for Sales Deductions and product returns are not known or cannot be reasonably estimated. We will not recognize revenue upon shipment until such time as we can reasonably estimate and record provisions for Sales Deductions and product returns utilizing historical information and market research projections.
During the nine months ended September 30, 2017 , we did not recognize any product revenues related to Rayaldee sales. Payments received from Rayaldee Customers in advance of recognition of revenue are recorded as deferred revenue included in Accrued expenses in our Condensed Consolidated Balance Sheets. The related deferred revenue balance as of September 30, 2017 was $6.5 million . The corresponding costs of product revenues for which we have not recognized product revenue have similarly not yet been reflected in our Condensed Consolidated Statements of Operations.
Revenue from transfer of intellectual property includes revenue related to the sale, license or transfer of intellectual property such as upfront license payments, license fees, milestone and royalty payments received through our license, and collaboration and commercialization agreements. We analyze our multiple-element arrangements to determine whether the elements can be separated and accounted for individually as separate units of accounting.
Non-refundable license fees for the out-license of our technology are recognized depending on the provisions of each agreement. We recognize non-refundable upfront license payments as revenue upon receipt if the license has standalone value and qualifies for treatment as a separate unit of accounting under multiple-element arrangement guidance. License fees with ongoing involvement or performance obligations that do not have standalone value are recorded as deferred revenue, included in Accrued expenses or Other long-term liabilities, when received and generally are recognized ratably over the period of such performance obligations only after both the license period has commenced and we have delivered the technology.
The assessment of our obligations and related performance periods requires significant management judgment. If an agreement contains research and development obligations, the relevant time period for the research and development phase is based on management estimates and could vary depending on the outcome of clinical trials and the regulatory approval process. Such changes could materially impact the revenue recognized, and as a result, management reviews the estimates related to the

13


relevant time period of research and development on a periodic basis. For the three and nine months ended September 30, 2017 , revenue from transfer of intellectual property includes $11.2 million and $46.5 million of revenue, respectively related to the Pfizer Transaction. For the three and nine months ended September 30, 2016 , revenue from transfer of intellectual property includes $17.7 million and $53.0 million of revenue, respectively related to the Pfizer Transaction. Refer to Note 12.
Revenue from milestone payments related to arrangements under which we have continuing performance obligations are recognized as Revenue from transfer of intellectual property upon achievement of the milestone only if all of the following conditions are met: the milestone payments are non-refundable; there was substantive uncertainty at the date of entering into the arrangement that the milestone would be achieved; the milestone payment is commensurate with either our performance to achieve the milestone or the enhancement of the value of the delivered item by us; the milestone relates solely to past performance; and the amount of the milestone payment is reasonable in relation to the effort expended or the risk associated with the achievement of the milestone. If any of these conditions are not met, the milestone payments are not considered to be substantive and are, therefore, deferred and recognized as Revenue from transfer of intellectual property over the term of the arrangement as we complete our performance obligations.
Total deferred revenue included in Accrued expenses and Other long-term liabilities was $120.4 million and $162.4 million at September 30, 2017 and December 31, 2016 , respectively. The deferred revenue balance at September 30, 2017 relates primarily to the Pfizer Transaction. Refer to Note 12.
Concentration of credit risk and allowance for doubtful accounts . Financial instruments that potentially subject us to concentrations of credit risk consist primarily of accounts receivable. Substantially all of our accounts receivable are with either companies in the healthcare industry or patients. However, credit risk is limited due to the number of our clients as well as their dispersion across many different geographic regions.
While we have receivables due from federal and state governmental agencies, we do not believe that such receivables represent a credit risk since the related healthcare programs are funded by federal and state governments, and payment is primarily dependent upon submitting appropriate documentation. At September 30, 2017 and December 31, 2016 , receivable balances (net of contractual adjustments) from Medicare and Medicaid were 22.0% and 22.9% , respectively, of our consolidated Accounts receivable, net.
The portion of our accounts receivable due from individual patients comprises the largest portion of credit risk. At September 30, 2017 and December 31, 2016 , receivables due from patients represent approximately 2.4% and 4.1% , respectively, of our consolidated Accounts receivable, net.
We assess the collectability of accounts receivable balances by considering factors such as historical collection experience, customer credit worthiness, the age of accounts receivable balances, regulatory changes and current economic conditions and trends that may affect a customer’s ability to pay. Actual results could differ from those estimates. Our reported net income (loss) is directly affected by our estimate of the collectability of accounts receivable. The allowance for doubtful accounts was $57.6 million and $36.3 million at September 30, 2017 and December 31, 2016 , respectively. The provision for bad debts for the nine months ended September 30, 2017 and 2016 was $78.3 million and $62.5 million , respectively.
Equity-based compensation . We measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost is recognized in the Condensed Consolidated Statements of Operations over the period during which an employee is required to provide service in exchange for the award. We record excess tax benefits, realized from the exercise of stock options, as cash flows from operations. Equity-based compensation arrangements to non-employees are recorded at their fair value on the measurement date. The measurement of equity-based compensation to non-employees is subject to periodic adjustment as the underlying equity instruments vest. During the nine months ended September 30, 2017 and 2016 , we recorded $22.3 million and $34.9 million , respectively, of equity-based compensation expense.
Research and development expenses. Research and development expenses include external and internal expenses, partially offset by third-party grants and fundings arising from collaboration agreements. External expenses include clinical and non-clinical activities performed by contract research organizations, lab services, purchases of drug and diagnostic product materials and manufacturing development costs. Research and development employee-related expenses include salaries, benefits and equity-based compensation expense. Other internal research and development expenses are incurred to support overall research and development activities and include expenses related to general overhead and facilities. We expense these costs in the period in which they are incurred. We estimate our liabilities for research and development expenses in order to match the recognition of expenses to the period in which the actual services are received. As such, accrued liabilities related to third party research and development activities are recognized based upon our estimate of services received and degree of completion of the services in accordance with the specific third party contract.

14


We record expense for in-process research and development projects acquired in asset acquisitions which have not reached technological feasibility and which have no alternative future use. For in-process research and development projects acquired in business combinations, the in-process research and development project is capitalized and evaluated for impairment until the development process has been completed. Once the development process has been completed the asset will be amortized over its remaining useful life.
Segment reporting . Our chief operating decision-maker (“CODM”) is Phillip Frost, M.D., our Chairman and Chief Executive Officer. Our CODM reviews our operating results and operating plans and makes resource allocation decisions on a Company-wide or aggregate basis. We manage our operations in two reportable segments, pharmaceutical and diagnostics. The pharmaceutical segment consists of our pharmaceutical operations we acquired in Chile, Mexico, Ireland, Israel and Spain and our pharmaceutical research and development. The diagnostics segment primarily consists of clinical laboratory operations we acquired through the acquisition of BioReference and our point-of-care operations. There are no significant inter-segment sales. We evaluate the performance of each segment based on operating profit or loss. There is no inter-segment allocation of interest expense and income taxes.
Variable interest entities . The consolidation of a variable interest entity (“VIE”) is required when an enterprise has a controlling financial interest. A controlling financial interest in a VIE will have both of the following characteristics: (a) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of the VIE that could potentially be significant to the VIE. Refer to Note 5.
Investments . We have made strategic investments in development stage and emerging companies. We record these investments as equity method investments or investments available for sale based on our percentage of ownership and whether we have significant influence over the operations of the investees. Investments for which it is not practical to estimate fair value and which we do not have significant influence are accounted for as cost method investments. For investments classified under the equity method of accounting, we record our proportionate share of their losses in Losses from investments in investees in our Condensed Consolidated Statements of Operations. Refer to Note 5. For investments classified as available for sale, we record changes in their fair value as unrealized gain or loss in Other comprehensive income (loss) based on their closing price per share at the end of each reporting period. Refer to Note 5.
Recent accounting pronouncements . In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09, as amended, clarifies the principles for recognizing revenue and develops a common revenue standard for GAAP that removes inconsistencies and weaknesses in revenue requirements, provides a more robust framework for addressing revenue issues, improves comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets, provides more useful information to users of financial statements through improved disclosure requirements and simplifies the preparation of financial statements by reducing the number of requirements to which an entity must refer. ASU 2014-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. Companies can choose to apply the ASU using either the full retrospective approach or a modified retrospective approach.
We have commenced our implementation analysis, including identification of revenue streams and reviews of customer contracts under ASU 2014-09’s framework. Our analysis includes reviewing current accounting policies and practices to identify potential differences that would result from applying the requirements under this new standard. The Company has reviewed certain contracts with its customers that the Company believes are representative of its revenue streams and continues to review additional contracts across its global business units. ASU 2014-09 requires increased disclosure which in turn is expected to require certain new processes. The determination of the impact of adoption of ASU 2014-09 on our financial condition, results of operations, cash flows and disclosures, is ongoing, and, as such, we have not yet concluded on a transition method and are not able to reasonably estimate the effect that the adoption of the new standard will have on our financial statements. Based on our preliminary assessment of this ASU, however, the majority of the amounts that were historically classified as provision for bad debts, primarily related to patient responsibility, will be considered an implicit price concession in determining net revenues. Accordingly, we will report uncollectible balances associated with individual patients as a reduction of the transaction price and therefore as a reduction in net revenues when historically these amounts were classified as provision for bad debts within Selling, general and administrative expenses.
In July 2015, the FASB issued ASU No. 2015-11, “Inventory (Topic 330): Simplifying the Measurement of Inventory,” which changes the measurement principle for entities that do not measure inventory using the last-in, first-out (“LIFO”) or retail inventory method from the lower of cost or market to lower of cost and net realizable value. ASU 2015-11 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, with early adoption permitted. The adoption of ASU 2015-11 in the first quarter of 2017 did not have a significant impact on our Condensed Consolidated Financial Statements.

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In November 2015, the FASB issued ASU No. 2015-17, “Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes,” which requires deferred tax liabilities and assets to be classified as noncurrent in a classified statement of financial position.  The adoption of this ASU simplifies the presentation of deferred income taxes and reduces complexity without decreasing the usefulness of information provided to users of financial statements.  We early adopted the provisions of this ASU prospectively in the fourth quarter of 2015, and did not retrospectively adjust the prior periods.  The adoption of ASU 2015-17 did not have a significant impact on our Condensed Consolidated Financial Statements.
In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-10),” which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The ASU requires equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. ASU 2016-01 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact of this new guidance on our Condensed Consolidated Financial Statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842),” which will require organizations that lease assets with lease terms of more than 12 months to recognize assets and liabilities for the rights and obligations created by those leases on their balance sheets. The ASU will also require new qualitative and quantitative disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact of this new guidance on our Condensed Consolidated Financial Statements.
In March 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718),” which simplifies several aspects of the accounting for share-based payment award transactions, including the income tax consequences, classification of awards as either equity or liabilities, classification on the statement of cash flows and accounting for forfeitures. ASU 2016-09 is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, with early adoption permitted. We adopted this standard in the first quarter of 2017. As required by ASU 2016-09, excess tax benefits are classified as an operating activity in our Condensed Consolidated Statement of Cash Flows and we have applied this provision prospectively. In addition, we have elected to estimate forfeitures over the course of a vesting period, rather than account for forfeitures as they occur. We adjust our forfeiture estimates based on the number of share-based awards that ultimately vest on at least an annual basis. Upon the adoption of ASU 2016-09 in 2017, we recorded a cumulative-effect adjustment to increase our deferred tax assets and reduce our accumulated deficit by $32.5 million with respect to excess tax benefits recognized in our Condensed Consolidated Balance Sheets.
In August 2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230),” which addresses the classification of eight specific cash flow issues with the objective of reducing the existing diversity in practice. ASU 2016-15 will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. We are currently evaluating the impact of this new guidance on our Condensed Consolidated Financial Statements.
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles - Goodwill and Other (Topic 350),” which simplifies how an entity is required to test for goodwill impairment. ASU 2017-04 will be effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019, with early adoption permitted after January 1, 2017. We are currently evaluating the impact of this new guidance on our Condensed Consolidated Financial Statements.
NOTE 3 EARNINGS (LOSS) PER SHARE
Basic earnings (loss) per share is computed by dividing our net income (loss) by the weighted average number of shares outstanding during the period. For diluted earnings per share, the dilutive impact of stock options, warrants and, for periods in 2016, conversion options of the 2033 Senior Notes is determined by applying the “treasury stock” method. In the periods in which their effect would be antidilutive, no effect has been given to outstanding options, warrants or the potentially dilutive shares issuable pursuant to the 2033 Senior Notes (defined in Note 6) in the dilutive computation.
A total of 1,016,090 and 1,636,706 potential shares of Common Stock have been excluded from the calculation of diluted net loss per share for the three and nine months ended September 30, 2017 , respectively, because their inclusion would be antidilutive. A full presentation of diluted earnings per share has not been provided because the required adjustments to the numerator and denominator resulted in diluted earnings per share equivalent to basic earnings per share.
During the three months ended September 30, 2017 , no Common Stock options and Common Stock warrants to purchase shares of our Common Stock were exercised.
During the nine months ended September 30, 2017 , 1,646,372 Common Stock options and Common Stock warrants to purchase shares of our Common Stock were exercised, resulting in the issuance of 1,373,515 shares of Common Stock. Of the 1,646,372 Common Stock options and Common Stock warrants exercised, 272,857 shares of Common Stock were surrendered in lieu of a cash payment via the net exercise feature of the agreements.
During the three months ended September 30, 2016 , 660,921 Common Stock options and Common Stock warrants to purchase shares of our Common Stock were exercised, resulting in the issuance of 658,357 shares of Common Stock. Of the 660,921 Common Stock options and Common Stock warrants exercised, 2,564 shares of Common Stock were surrendered in lieu of a cash payment via the net exercise feature of the agreements.
During the nine months ended September 30, 2016 , 2,899,458 Common Stock options and Common Stock warrants to purchase shares of our Common Stock were exercised, resulting in the issuance of 2,771,514 shares of Common Stock. Of the 2,899,458 Common Stock options and Common Stock warrants exercised, 127,944 shares of Common Stock were surrendered in lieu of a cash payment via the net exercise feature of the agreements.

16


NOTE 4 COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS
(In thousands)
September 30,
2017
 
December 31,
2016
Accounts receivable, net:
 
 
 
Accounts receivable
$
291,560

 
$
256,552

Less: allowance for doubtful accounts
(57,644
)
 
(36,268
)
 
$
233,916

 
$
220,284

Inventories, net:
 
 
 
Consumable supplies
$
19,446

 
$
23,448

Finished products
22,882

 
16,143

Work in-process
4,087

 
3,896

Raw materials
6,984

 
4,686

Less: inventory reserve
(6,445
)
 
(945
)
 
$
46,954

 
$
47,228

Other current assets and prepaid expenses:
 
 
 
Taxes recoverable
17,581

 
16,187

Other receivables
12,318

 
13,021

Prepaid supplies
12,269

 
6,952

Prepaid insurance
3,276

 
3,688

Other
3,880

 
7,508

 
$
49,324

 
$
47,356

Intangible assets, net:
 
 
 
Customer relationships
$
447,699

 
$
443,560

Technologies
340,861

 
340,397

Trade names
50,520

 
50,442

Licenses
23,518

 
23,506

Covenants not to compete
16,373

 
16,348

Product registrations
10,857

 
7,641

Other
5,742

 
5,289

Less: accumulated amortization
(181,018
)
 
(123,207
)
 
$
714,552

 
$
763,976

Accrued expenses:
 
 
 
Deferred revenue
$
52,403

 
$
73,434

Employee benefits
46,237

 
43,792

Clinical trials
7,606

 
5,935

Taxes payable
4,590

 
4,430

Contingent consideration
2,011

 
259

Capital leases short-term
3,483

 
3,025

Milestone payment
9,819

 
4,865

Professional fees
2,584

 
4,035

Other
47,567

 
58,180

 
$
176,300

 
$
197,955

 
 
 
 

17


(In thousands)
September 30,
2017
 
December 31,
2016
Other long-term liabilities:
 
 
 
Deferred revenue
$
68,011

 
$
89,016

Line of credit
93,311

 
38,809

Contingent consideration
38,290

 
44,817

Mortgages and other debts payable
1,162

 
717

Capital leases long-term
8,435

 
7,216

Other
17,408

 
21,908

 
$
226,617

 
$
202,483

All of the intangible assets and goodwill acquired relate to our acquisitions of principally OPKO Renal, OPKO Biologics, EirGen Pharma Limited (“EirGen”) and BioReference. We do not anticipate capitalizing the cost of product registration renewals, rather we expect to expense these costs, as incurred. Our goodwill is not tax deductible for income tax purposes in any jurisdiction we operate in.
At September 30, 2017 , the changes in value of the intangible assets and goodwill are primarily due to foreign currency fluctuations between the Chilean Peso, the Euro and the Shekel against the U.S. dollar.
The following table summarizes the changes in Goodwill during the nine months ended September 30, 2017 .
 
2017
(In thousands)
Balance at January 1
 
Foreign exchange and other
 
Balance at September 30th
Pharmaceuticals
 
 
 
 
 
CURNA
$
4,827

 
$

 
$
4,827

EirGen
78,358

 
9,639

 
87,997

FineTech
11,698

 

 
11,698

OPKO Chile
4,785

 
217

 
5,002

OPKO Biologics
139,784

 

 
139,784

OPKO Health Europe
6,936

 
853

 
7,789

OPKO Renal
2,069

 

 
2,069

Transition Therapeutics
3,360

 
261

 
3,621

 
 
 
 
 
 
Diagnostics
 
 
 
 
 
BioReference
401,821

 

 
401,821

OPKO Diagnostics
17,977

 

 
17,977

OPKO Lab
32,988

 

 
32,988

 
$
704,603

 
$
10,970

 
$
715,573



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NOTE 5 ACQUISITIONS, INVESTMENTS AND LICENSES
Transition Therapeutics acquisition
In August 2016, we completed the acquisition of Transition Therapeutics, a clinical stage biotechnology company. Holders of Transition Therapeutics common stock received 6,431,899 shares of OPKO Common Stock. The transaction was valued at approximately $58.5 million , based on a closing price per share of our Common Stock of $9.10 as reported by NASDAQ on the closing date.
The following table summarizes the purchase price allocation and the fair value of the net assets acquired and liabilities assumed at the date of acquisition:
(In thousands)
 
Transition Therapeutics
Cash and cash equivalents
 
$
15,878

IPR&D assets
 
41,000

Goodwill
 
3,453

Other assets
 
634

Accounts payable and other liabilities
 
(1,035
)
Deferred tax liability
 
(1,400
)
Total purchase price
 
$
58,530

Goodwill from the acquisition of Transition Therapeutics principally relates to intangible assets that do not qualify for separate recognition (for instance, Transition Therapeutics’ assembled workforce) and the deferred tax liability generated as a result of the transaction. Goodwill is not tax deductible for income tax purposes and was assigned to the pharmaceutical reporting segment.
Our IPR&D assets will not be amortized until the underlying development programs are completed. Upon obtaining regulatory approval, the IPR&D assets are then accounted for as finite-lived intangible assets and amortized on a straight-line basis over its estimated useful life.
Investments
The following table reflects the accounting method, carrying value and underlying equity in net assets of our unconsolidated investments as of September 30, 2017 :
(in thousands)
 
 
 
 
Investment type
 
Investment Carrying Value
 
Underlying Equity in Net Assets
Equity method investments
 
$
24,101

 
$
23,910

Variable interest entity, equity method
 
361

 

Available for sale investments
 
3,108

 
 
Cost method investment
 
2,606

 
 
Warrants and options
 
2,020

 
 
Total carrying value of investments
 
$
32,196

 
 
Equity method investments
Our equity method investments consist of investments in Pharmsynthez (ownership 9% ), Cocrystal Pharma, Inc. (“COCP”) ( 9% ), Sevion Therapeutics, Inc. (“Sevion”) ( 31% ), Non-Invasive Monitoring Systems, Inc. (“NIMS”) ( 1% ), Neovasc ( 4% ), VBI Vaccines Inc. (“VBI”) ( 15% ), InCellDx, Inc. ( 28% ), BioCardia, Inc. (“BioCardia”) ( 5% ), and Xenetic Biosciences, Inc. (“Xenetic”) ( 4% ). The total assets, liabilities, and net losses of our equity method investees as of and for the nine months ended September 30, 2017 were $415.4 million , $(203.2) million , and $(106.1) million , respectively. We have determined that we and/or our related parties can significantly influence the success of our equity method investments through our board representation and/or voting power. Accordingly, we account for our investment in these entities under the equity method and record our proportionate share of their losses in Loss from investments in investees in our Condensed Consolidated Statements of Operations. The aggregate

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value of our equity method investments based on the quoted market price of their common stock and the number of shares held by us as of September 30, 2017 is $67.4 million .
Available for sale investments
Our available for sale investments consist of investments in RXi Pharmaceuticals Corporation (“RXi”) (ownership 2% ), ChromaDex Corporation ( 1% ), MabVax Therapeutics Holdings, Inc. (“MabVax”) ( 4% ), and ARNO Therapeutics, Inc. (“ARNO”) ( 5% ). We have determined that our ownership, along with that of our related parties, does not provide us with significant influence over the operations of our available for sale investments. Accordingly, we account for our investment in these entities as available for sale, and we record changes in these investments as an unrealized gain or loss in Other comprehensive income (loss) each reporting period.
Based on our evaluation of the value of our investment in Xenetic, including Xenetic’s decreasing stock price during the nine months ended September 30, 2017 , we determined that the decline in fair value of our Xenetic common shares was other-than-temporary and recorded an impairment charge of $0.6 million in Other income (expense), net in our Condensed Consolidated Statements of Operations for the nine months ended September 30, 2017 to write our investment in Xenetic down to its fair value as of September 30, 2017 .
Based on our evaluation of the value of our investments in Xenetic and RXi, including their decreasing stock price during the nine months ended September 30, 2016, we determined that the decline in fair value of our common shares in Xenetic and RXi was other-than-temporary and recorded an impairment charge of $3.9 million in Other income (expense), net in our Condensed Consolidated Statements of Operations for the nine months ended September 30, 2016 to write our investments in Xenetic and RXi down to their respective fair values as of September 30, 2016.
Cost method investments
Our cost method investments consist primarily of our investment in Eloxx Pharmaceuticals (“Eloxx”) (ownership 3% ). Investments for which it is not practical to estimate fair value and with which we do not have significant influence, are accounted for as cost method investments.
Sales of investments
Gains (losses) included in earnings from sales of our investments are recorded in Other income (expense), net in our Condensed Consolidated Statements of Operations. We did not have any such activity in the nine months ended September 30, 2017 and 2016. The cost of securities sold is based on the specific identification method.
Warrants and options
In addition to our equity method investments and available for sale investments, we hold options to purchase 1.0 million additional shares of Neovasc, which are fully vested as of September 30, 2017 , options to purchase 5.0 million additional shares of BioCardia, none of which are vested as of September 30, 2017 , and 1.0 million , 0.3 million , 0.2 million , 0.7 million , 0.5 million and 0.2 million of warrants to purchase additional shares of COCP, Sevion, MabVax, InCellDx, Inc., Xenetic and RXi, respectively. We recorded the changes in the fair value of the options and warrants in Fair value changes of derivative instruments, net in our Condensed Consolidated Statements of Operations. We also recorded the fair value of the options and warrants in Investments, net in our Condensed Consolidated Balance Sheets. See further discussion of the Company’s options and warrants in Note 8 and Note 9.
Investments in variable interest entities

We have determined that we hold variable interests in Zebra Biologics, Inc. (“Zebra”). We made this determination as a result of our assessment that Zebra does not have sufficient resources to carry out its principal activities without additional financial support.
We own 1,260,000 shares of Zebra Series A-2 Preferred Stock and 900,000 shares of Zebra restricted common stock (ownership 29% at September 30, 2017 ). Zebra is a privately held biotechnology company focused on the discovery and development of biosuperior antibody therapeutics and complex drugs. Dr. Richard Lerner, M.D., a member of our Board of Directors, is a founder of Zebra and, along with Dr. Frost, serves as a member of Zebra’s Board of Directors.
In order to determine the primary beneficiary of Zebra, we evaluated our investment and our related parties’ investment, as well as our investment combined with the related party group’s investment to identify if we had the power to direct the activities that most significantly impact the economic performance of Zebra. Based on the capital structure, governing documents and overall business operations of Zebra, we determined that, while a VIE, we do not have the power to direct the

20


activities that most significantly impact Zebra’s economic performance and have no obligation to fund expected losses. We did determine, however, that we can significantly influence the success of Zebra through our board representation and voting power. Therefore, we have the ability to exercise significant influence over Zebra’s operations and account for our investment in Zebra under the equity method.
Other
In March 2016, we entered into an agreement with Relative Core pursuant to which we delivered $5.0 million cash to Relative Core in exchange for a $5.0 million promissory note (“Relative Note”) which bears interest at 10% and is due in 2018. The Relative Note is secured by 122,446 shares of common stock of Xenetic and 494,462 shares of OPKO common stock. We recorded the Relative Note within Other current assets and prepaid expenses in our Condensed Consolidated Balance Sheets.

21


NOTE 6 DEBT     
In January 2013, we entered into note purchase agreements (the “2033 Senior Notes”) with qualified institutional buyers and accredited investors (collectively, the “Purchasers”) in a private placement in reliance on exemptions from registration under the Securities Act of 1933, as amended (the “Securities Act”). The 2033 Senior Notes were issued on January 30, 2013 . The 2033 Senior Notes, which totaled $175.0 million in original principal amount, bear interest at the rate of 3.00%  per year, payable semiannually on February 1 and August 1 of each year. The 2033 Senior Notes will mature on February 1, 2033 , unless earlier repurchased, redeemed or converted. Upon a fundamental change as defined in the Indenture, dated as of January 30, 2013, by and between the Company and Wells Fargo Bank N.A., as trustee, governing the 2033 Senior Notes (the “Indenture”), subject to certain exceptions, the holders may require us to repurchase all or any portion of their 2033 Senior Notes for cash at a repurchase price equal to 100% of the principal amount of the 2033 Senior Notes being repurchased, plus any accrued and unpaid interest to but not including the related fundamental change repurchase date.
The following table sets forth information related to the 2033 Senior Notes which is included our Condensed Consolidated Balance Sheets as of September 30, 2017 :
(In thousands)
Embedded conversion option
 
2033 Senior Notes
 
Discount
 
Debt Issuance Cost
 
Total
Balance at December 31, 2016
$
16,736

 
$
31,850

 
$
(4,612
)
 
$
(273
)
 
$
43,701

Amortization of debt discount and debt issuance costs

 

 
1,514

 
111

 
1,625

Change in fair value of embedded derivative
(3,185
)
 

 

 

 
(3,185
)
Reclassification of embedded derivatives to equity
(13,551
)
 

 

 

 
(13,551
)
Balance at September 30, 2017
$

 
$
31,850

 
$
(3,098
)
 
$
(162
)
 
$
28,590

The 2033 Senior Notes will be convertible at any time on or after November 1, 2032, through the second scheduled trading day immediately preceding the maturity date, at the option of the holders. Additionally, holders may convert their 2033 Senior Notes prior to the close of business on the scheduled trading day immediately preceding November 1, 2032, under the following circumstances: (1) conversion based upon satisfaction of the trading price condition relating to the 2033 Senior Notes; (2) conversion based on the Common Stock price; (3) conversion based upon the occurrence of specified corporate events; or (4) if we call the 2033 Senior Notes for redemption. The 2033 Senior Notes will be convertible into cash, shares of our Common Stock, or a combination of cash and shares of Common Stock, at our election unless we have made an irrevocable election of net share settlement. The initial conversion rate for the 2033 Senior Notes will be 141.48 shares of Common Stock per $1,000 principal amount of 2033 Senior Notes (equivalent to an initial conversion price of approximately $7.07 per share of Common Stock), and will be subject to adjustment upon the occurrence of certain events. In addition, we will, in certain circumstances, increase the conversion rate for holders who convert their 2033 Senior Notes in connection with a make-whole fundamental change (as defined in the Indenture) and holders who convert upon the occurrence of certain specific events prior to February 1, 2017 (other than in connection with a make-whole fundamental change). Holders of the 2033 Senior Notes may require us to repurchase the 2033 Senior Notes for 100% of their principal amount, plus accrued and unpaid interest, on February 1, 2019, February 1, 2023 and February 1, 2028, or following the occurrence of a fundamental change as defined in the indenture governing the 2033 Senior Notes.
On or after February 1, 2017 and before February 1, 2019, we may redeem for cash any or all of the 2033 Senior Notes but only if the last reported sale price of our Common Stock exceeds 130% of the applicable conversion price for at least 20 trading days during the 30 consecutive trading day period ending on the trading day immediately prior to the date on which we deliver the redemption notice. The redemption price will equal 100% of the principal amount of the 2033 Senior Notes to be redeemed, plus any accrued and unpaid interest to but not including the redemption date. On or after February 1, 2019, we may redeem for cash any or all of the 2033 Senior Notes at a redemption price of 100% of the principal amount of the 2033 Senior Notes to be redeemed, plus any accrued and unpaid interest up to but not including the redemption date.
The terms of the 2033 Senior Notes, include, among others: (i) rights to convert into shares of our Common Stock, including upon a fundamental change; and (ii) a coupon make-whole payment in the event of a conversion by the holders of the 2033 Senior Notes on or after February 1, 2017 but prior to February 1, 2019. We determined that these specific terms were considered to be embedded derivatives. Embedded derivatives are required to be separated from the host contract, the 2033 Senior Notes, and carried at fair value when: (a) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract; and (b) a separate, stand-alone instrument with the same terms would qualify as a derivative instrument. We concluded that the embedded derivatives within the 2033 Senior Notes

22


meet these criteria for periods prior to February 1, 2017 and, as such, were valued separate and apart from the 2033 Senior Notes and recorded at fair value each reporting period.
For accounting and financial reporting purposes, prior to 2017 we combined these embedded derivatives and valued them together as one unit of accounting.
On February 1, 2017, certain terms of the embedded derivatives expired pursuant to the original agreement and we determined that the embedded derivatives no longer met the criteria to be separated from the host contract and, as a result, the embedded derivatives are no longer required to be valued separate and apart from the 2033 Senior Notes and are not required to be measured at fair value subsequent to February 1, 2017.
The change in derivative income for the period from January 1, 2017 to February 1, 2017 related to the embedded derivatives was $3.2 million and the fair value at that date was $13.6 million . For financial reporting purposes, we had remeasured the embedded derivatives subsequent to February 1, 2017 and recorded derivative income of $4.9 million and $5.1 million for the three months ended March 31, 2017 and June 30, 2017, respectively. In the three and nine months ended September 30, 2017, we reversed aggregate derivative income of $6.8 million to correct the derivative to its value as of February 1, 2017. The adjustment of previously recorded derivative income for the three months ended March 31, 2017 and June 30, 2017 were not significant to those previous periods and increased our basic loss per share by $(0.01) for the three months ended September 30, 2017 in the consolidated statements of operations. In addition, because the embedded derivatives are no longer required to be accounted for separately each period, in September 2017 the embedded derivative fair value of $13.6 million as of February 1, 2017 was reclassified to additional paid in capital.
From 2013 to 2016, holders of the 2033 Senior Notes converted 143.2 million in aggregate principal amount into an aggregate of 21,539,873 shares of the Company’s Common Stock.
On April 1, 2015, we initially announced that our 2033 Senior Notes were convertible through June 2015 by holders of such notes. This conversion right was triggered because the closing price per share of our Common Stock exceeded $9.19 , or 130% of the initial conversion price of $7.07 , for at least 20 of 30 consecutive trading days during the applicable measurement period. We have elected to satisfy our conversion obligation under the 2033 Senior Notes in shares of our Common Stock. Our 2033 Senior Notes continued to be convertible by holders of such notes for the remainder of 2015, 2016 and the first quarter of 2017, and may be convertible thereafter, if one or more of the conversion conditions specified in the Indenture is satisfied during future measurement periods. Pursuant to the Indenture, a holder who elects to convert the 2033 Senior Notes will receive 141.4827 shares of our Common Stock plus such number of additional shares as is applicable on the conversion date per $1,000 principal amount of 2033 Senior Notes based on the early conversion provisions in the Indenture.
Through February 1, 2017, we used a binomial lattice model in order to estimate the fair value of the embedded derivative in the 2033 Senior Notes. A binomial lattice model generates two probable outcomes — one up and another down —arising at each point in time, starting from the date of valuation until the maturity date. A lattice model was initially used to determine if the 2033 Senior Notes would be converted, called or held at each decision point. Within the lattice model, the following assumptions are made: (i) the 2033 Senior Notes will be converted early if the conversion value is greater than the holding value; or (ii) the 2033 Senior Notes will be called if the holding value is greater than both (a) the redemption price (as defined in the Indenture) and (b) the conversion value plus the coupon make-whole payment at the time. If the 2033 Senior Notes are called, then the holders will maximize their value by finding the optimal decision between (1) redeeming at the redemption price and (2) converting the 2033 Senior Notes.
Using this lattice model, we had valued the embedded derivatives using the “with-and-without method,” where the value of the 2033 Senior Notes including the embedded derivatives is defined as the “with,” and the value of the 2033 Senior Notes excluding the embedded derivatives is defined as the “without.” This method estimated the value of the embedded derivatives by looking at the difference in the values between the 2033 Senior Notes with the embedded derivatives and the value of the 2033 Senior Notes without the embedded derivatives.
The lattice model requires the following inputs: (i) price of our Common Stock; (ii) Conversion Rate (as defined in the Indenture); (iii) Conversion Price (as defined in the Indenture); (iv) maturity date; (v) risk-free interest rate; (vi) estimated stock volatility; and (vii) estimated credit spread for the Company.

23


The following table sets forth the inputs to the lattice model used to value the embedded derivative as of February 1, 2017:
 
February 1, 2017
Stock price
$8.63
Conversion Rate
141.4827
Conversion Price
$7.07
Maturity date
February 1, 2033
Risk-free interest rate
1.22%
Estimated stock volatility
49%
Estimated credit spread
761 basis points

On November 5, 2015, BioReference and certain of its subsidiaries entered into a credit agreement with JPMorgan Chase Bank, N.A. (“CB”), as lender and administrative agent, as amended (the “Credit Agreement”), which replaced BioReference’s prior credit facility. The Credit Agreement provides for a $175.0 million secured revolving credit facility and includes a $20.0 million sub-facility for swingline loans and a $20.0 million sub-facility for the issuance of letters of credit. BioReference may increase the credit facility to up to $275.0 million on a secured basis, subject to the satisfaction of specified conditions. The Credit Agreement matures on November 5, 2020 and is guaranteed by all of BioReference’s domestic subsidiaries. The Credit Agreement is also secured by substantially all assets of BioReference and its domestic subsidiaries, as well as a non-recourse pledge by us of our equity interest in BioReference. Availability under the Credit Agreement is based on a borrowing base comprised of eligible accounts receivables of BioReference and certain of its subsidiaries, as specified therein. Principal under the Credit Agreement is due upon maturity on November 5, 2020.

At BioReference’s option, borrowings under the Credit Agreement (other than swingline loans) will bear interest at (i) the CB floating rate (defined as the higher of (a) the prime rate and (b) the LIBOR rate (adjusted for statutory reserve requirements for Eurocurrency liabilities) for an interest period of one month plus 2.50% ) plus an applicable margin of 0.35% for the first 12 months and 0.50% thereafter or (ii) the LIBOR rate (adjusted for statutory reserve requirements for Eurocurrency liabilities) plus an applicable margin of 1.35% for the first 12 months and 1.50% thereafter. Swingline loans will bear interest at the CB floating rate plus the applicable margin. The Credit Agreement also calls for other customary fees and charges, including an unused commitment fee of 0.50% of the lending commitments.

On March 17, 2017, BioReference and certain of its subsidiaries entered into Amendment No. 3 to Credit Agreement, which amended the Credit Agreement to permit BioReference and its subsidiaries to dividend cash to the Company in the form of an intercompany loan, in an aggregate amount not to exceed $55,000,000 . On August 7, 2017, BioReference and certain of its subsidiaries entered into Amendment No. 4 to Credit Agreement, which amended the Credit Agreement to permit BioReference and its subsidiaries to dividend cash to the Company in the form of an additional intercompany loan, in an aggregate amount not to exceed $35,000,000 . The other terms of the Credit Agreement remain unchanged.

24



The Credit Agreement contains customary covenants and restrictions, including, without limitation, covenants that require BioReference and its subsidiaries to maintain a minimum fixed charge coverage ratio if availability under the new credit facility falls below a specified amount and to comply with laws and restrictions on the ability of BioReference and its subsidiaries to incur additional indebtedness or to pay dividends and make certain other distributions to the Company, subject to certain exceptions as specified therein. Failure to comply with these covenants would constitute an event of default under the Credit Agreement, notwithstanding the ability of BioReference to meet its debt service obligations. The Credit Agreement also includes various customary remedies for the lenders following an event of default, including the acceleration of repayment of outstanding amounts under the Credit Agreement and execution upon the collateral securing obligations under the Credit Agreement. Substantially all the assets of BioReference and its subsidiaries are restricted from sale, transfer, lease, disposal or distributions to the Company, subject to certain exceptions. BioReference and its subsidiaries net assets as of September 30, 2017 were approximately $1.0 billion , which includes goodwill of $401.8 million and intangible assets of $457.0 million .

In addition to the Credit Agreement with CB, we have line of credit agreements with eleven other financial institutions as of September 30, 2017 and ten other financial institutions as of December 31, 2016 in United States, Chile and Spain. These lines of credit are used primarily as a source of working capital for inventory purchases.
The following table summarizes the amounts outstanding under the Bio Reference, Chilean and Spanish lines of credit:
(Dollars in thousands)
 
 
 
 
 
 Balance Outstanding
Lender
 
Interest rate on
borrowings at September 30, 2017
 
Credit line
capacity
 
September 30,
2017
 
December 31,
2016
JPMorgan Chase
 
3.36%
 
$
175,000

 
$
93,311

 
$
38,809

Itau Bank
 
5.50%
 
1,810

 
374

 
419

Bank of Chile
 
6.60%
 
3,800

 
2,687

 
1,619

BICE Bank
 
5.50%
 
2,500

 
1,720

 
1,538

BBVA Bank
 
5.50%
 
3,250

 
2,164

 
1,063

Estado Bank
 
5.50%
 
3,500

 
2,559

 
1,870

Santander Bank
 
5.50%
 
4,500

 
2,133

 
1,196

Scotiabank
 
5.00%
 
1,800

 
986

 
789

Corpbanca
 
5.00%
 

 

 
18

Banco Bilbao Vizcaya
 
2.90%
 
295

 

 

Santander Bank
 
2.67%
 
354

 

 

Total
 
 
 
$
196,809

 
$
105,934

 
$
47,321

At September 30, 2017 and December 31, 2016 , the weighted average interest rate on our lines of credit was approximately 4.5% and 4.7% , respectively.
At September 30, 2017 and December 31, 2016 , we had notes payable and other debt (excluding the 2033 Senior Notes, the Credit Agreement and amounts outstanding under lines of credit) as follows:
(In thousands)
September 30,
2017
 
December 31,
2016
Current portion of notes payable
$
3,726

 
$
3,681

Other long-term liabilities
2,085

 
2,090

Total
$
5,811

 
$
5,771

The notes and other debt mature at various dates ranging from 2017 through 2024 bearing variable interest rates from 1.8% up to 6.3% . The weighted average interest rate on the notes and other debt at September 30, 2017 and December 31, 2016 , was 2.9% and 3.2% , respectively. The notes payable are secured by our office space in Barcelona.

25



NOTE 7 ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
For the nine months ended September 30, 2017 , changes in Accumulated other comprehensive income (loss), net of tax, were as follows:
(In thousands)
Foreign
currency
 
Unrealized
gain (loss) in
Accumulated
OCI
 
Total
Balance at December 31, 2016
$
(28,128
)
 
$
1,119

 
$
(27,009
)
Other comprehensive income (loss) before reclassifications
21,646

 
(749
)
 
20,897

Reclassification adjustments for losses included in net loss, net of tax


 
690

 
690

Net other comprehensive income (loss)
21,646

 
(59
)
 
21,587

Balance at September 30, 2017
$
(6,482
)
 
$
1,060

 
$
(5,422
)
NOTE 8 FAIR VALUE MEASUREMENTS
We record fair values at an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement determined based on assumptions that market participants would use in pricing an asset or liability. We utilize a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.
A summary of our investments classified as available for sale and carried at fair value, is as follows:
 
As of September 30, 2017
(In thousands)
Amortized
Cost
 
Gross
unrealized
gains in
Accumulated
OCI
 
Gross
unrealized
losses in
Accumulated
OCI
 
Fair
value
Common stock investments, available for sale
$
2,048

 
$
1,308

 
$
(248
)
 
$
3,108

Total assets
$
2,048

 
$
1,308

 
$
(248
)
 
$
3,108

 
As of December 31, 2016
(In thousands)
Amortized
Cost
 
Gross
unrealized
gains in
Accumulated
OCI
 
Gross
unrealized
losses in
Accumulated
OCI
 
Fair
value
Common stock investments, available for sale
$
3,409

 
$
1,313

 
$
(194
)
 
$
4,528

Total assets
$
3,409

 
$
1,313

 
$
(194
)
 
$
4,528

Any future fluctuation in fair value related to our available for sale investments that is judged to be temporary, and any recoveries of previous temporary write-downs, will be recorded in Accumulated other comprehensive income (loss). If we determine that any future valuation adjustment was other-than-temporary, we will record a loss during the period such determination is made.
As of September 30, 2017 , we have money market funds that qualify as cash equivalents, forward foreign currency exchange contracts for inventory purchases (refer to Note 9) and contingent consideration related to the acquisitions of CURNA, OPKO Diagnostics and OPKO Renal that are required to be measured at fair value on a recurring basis. In addition, in connection with our investment and our consulting agreements with Neovasc and BioCardia, we record the related Neovasc and BioCardia options at fair value as well as the warrants from COCP, Sevion, MabVax, InCellDx, Inc., Xenetic and RXi.

26


Our financial assets and liabilities measured at fair value on a recurring basis are as follows:
 
Fair value measurements as of September 30, 2017
(In thousands)
Quoted
prices in
active
markets for
identical
assets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds
$
12,621

 
$

 
$

 
$
12,621

Common stock investments, available for sale
3,108

 

 

 
3,108

Common stock options/warrants

 
2,020

 

 
2,020

Total assets
$
15,729

 
$
2,020

 
$

 
$
17,749

Liabilities:
 
 
 
 
 
 
 
Forward contracts

 
264

 

 
264

Contingent consideration

 

 
40,301

 
40,301

Total liabilities
$

 
$
264

 
$
40,301

 
$
40,565

 
Fair value measurements as of December 31, 2016
(In thousands)
Quoted
prices in
active
markets for
identical
assets
(Level 1)
 
Significant
other
observable
inputs
(Level 2)
 
Significant
unobservable
inputs
(Level 3)
 
Total
Assets:
 
 
 
 
 
 
 
Money market funds
$
5,314

 
$

 
$

 
$
5,314

Common stock investments, available for sale
4,528

 

 

 
4,528

Common stock options/warrants

 
4,017

 

 
4,017

Forward contracts

 
39

 

 
39

Total assets
$
9,842

 
$
4,056

 
$

 
$
13,898

Liabilities:
 
 
 
 
 
 
 
Embedded conversion option
$

 
$

 
$
16,736

 
$
16,736

Contingent consideration

 

 
45,076

 
45,076

Total liabilities
$

 
$

 
$
61,812

 
$
61,812

The carrying amount and estimated fair value of our 2033 Senior Notes with the embedded conversion option, as well as the applicable fair value hierarchy tiers, are contained in the table below. The fair value of the 2033 Senior Notes is determined using a binomial lattice approach in order to estimate the fair value of the embedded derivative in the 2033 Senior Notes. Refer to Note 6.
 
September 30, 2017
(In thousands)
Carrying
Value
 
Total
Fair Value
 
Level 1
 
Level 2
 
Level 3
2033 Senior Notes
$
28,590

 
$
37,011

 
$

 
$

 
$
37,011

There have been no transfers between Level 1 and Level 2 and no transfers to or from Level 3 of the fair value hierarchy.
As of September 30, 2017 and December 31, 2016 , the carrying value of our other financial instrument assets and liabilities approximates their fair value due to their short-term nature or variable rate of interest.
The following table reconciles the beginning and ending balances of our Level 3 assets and liabilities as of September 30, 2017 :

27


 
September 30, 2017
(In thousands)
Contingent
consideration
 
Embedded
conversion
option
Balance at December 31, 2016
$
45,076

 
$
16,736

Total losses for the period:
 
 
 
Included in results of operations
(4,475
)
 
(3,185
)
Foreign currency impact
3

 

Payments
(303
)
 

Reclassification of embedded derivatives to equity

 
(13,551
)
Balance at September 30, 2017
$
40,301

 
$

The estimated fair values of our financial instruments have been determined by using available market information and what we believe to be appropriate valuation methodologies. We use the following methods and assumptions in estimating fair value:
Contingent consideration – We estimate the fair value of the contingent consideration utilizing a discounted cash flow model for the expected payments based on estimated timing and expected revenues. We use several discount rates depending on each type of contingent consideration related to OPKO Diagnostics, CURNA and OPKO Renal transactions. If estimated future sales were to decrease by 10% , the contingent consideration related to OPKO Renal, which represents the majority of our contingent consideration liability, would decrease by $2.4 million . As of September 30, 2017 , of the $40.3 million of contingent consideration, $2.0 million is recorded in Accrued expenses and $38.3 million is recorded in Other long-term liabilities. As of December 31, 2016 , of the $45.1 million of contingent consideration, $0.3 million is recorded in Accrued expenses and $44.8 million is recorded in Other long-term liabilities.


28


NOTE 9 DERIVATIVE CONTRACTS
The following table summarizes the fair values and the presentation of our derivative financial instruments in the Condensed Consolidated Balance Sheets:
(In thousands)
Balance Sheet Component
 
September 30,
2017
 
December 31,
2016
Derivative financial instruments:
 
 
 
 
 
Common Stock options/warrants
Investments, net
 
$
2,020

 
$
4,017

Embedded conversion option
2033 Senior Notes, net of discount and estimated fair value of embedded derivatives
 
$

 
$
(16,736
)
Forward contracts
Unrealized gains on forward contracts are recorded in Other current assets and prepaid expenses. Unrealized (losses) on forward contracts are recorded in Accrued expenses.
 
$
(264
)
 
$
39

We enter into foreign currency forward exchange contracts to cover the risk of exposure to exchange rate differences arising from inventory purchases on letters of credit. Under these forward contracts, for any rate above or below the fixed rate, we receive or pay the difference between the spot rate and the fixed rate for the given amount at the settlement date.
To qualify the derivative instrument as a hedge, we are required to meet strict hedge effectiveness and contemporaneous documentation requirements at the initiation of the hedge and assess the hedge effectiveness on an ongoing basis over the life of the hedge. At September 30, 2017 and December 31, 2016 , our derivative financial instruments do not meet the documentation requirements to be designated as hedges. Accordingly, we recognize the changes in Fair value of derivative instruments, net in our Condensed Consolidated Statements of Operations. The following table summarizes the losses and gains recorded for the nine months ended September 30, 2017 and 2016:
 
Three months ended September 30,
 
Nine months ended September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Derivative gain (loss):
 
 
 
 
 
 
 
Common Stock options/warrants
$
(342
)
 
$
(12
)
 
$
(854
)
 
$
(4,728
)
2033 Senior Notes
(6,829
)
 
(5,795
)
 
3,185

 
(1,061
)
Forward contracts
(379
)
 
106

 
(362
)
 
(100
)
Total
$
(7,550
)
 
$
(5,701
)
 
$
1,969

 
$
(5,889
)

29


NOTE 10 RELATED PARTY TRANSACTIONS
We hold investments in Zebra (ownership 29% ), Sevion ( 31% ), Neovasc ( 4% ), ChromaDex Corporation ( 1% ), MabVax ( 4% ), COCP ( 9% ) ARNO ( 5% ), NIMS ( 1% ), BioCardia ( 5% ) and Eloxx ( 3% ). These investments were considered related party transactions as a result of our executive management’s ownership interests and/or board representation in these entities. See further discussion of our investments in Note 5.
In June 2017, we invested $1.5 million in Eloxx for 99,915 Preferred C Shares and in July 2017, we invested an additional $1.5 million in Sevion for 10,000,000 shares of Sevion common stock. An entity controlled by Dr. Frost also made in investment in Eloxx and committed to investing additional funds in Sevion by December 31, 2017. Sevion and Eloxx entered into an acquisition agreement on May 31, 2017 under which Eloxx will become a wholly owned subsidiary of Sevion. Upon completion of the transaction, Sevion will change its name to Eloxx Pharmaceuticals, Inc. Previously, in November 2016, we made a $0.2 million loan to Sevion, and in February 2017, we entered into an agreement with Sevion pursuant to which we delivered $0.3 million cash to Sevion in exchange for a promissory note. The loan and promissory note were converted into 4.1 million shares of Sevion common stock in August 2017. In September 2017, we converted 66,667 shares of Series C Preferred Stock of Sevion into 1,250,006 shares of common stock. The agreements with Sevion were considered related party transactions as a result of our executive management’s ownership interests and board representation in Sevion.
In July 2017, we invested an additional $0.1 million in MabVax for 152,143 shares of common stock and in May 2017, we invested an additional $0.5 million in MabVax for 285,714 shares of Series G Preferred Stock and 322,820 shares of Series I Preferred Stock. We had also invested an additional $1.0 million in MabVax in August 2016 for 207,900 shares of its common stock and warrants to purchase 415,800 shares of its common stock.
In April 2017, we invested an additional $1.0 million in COCP for 4,166,667 shares of its common stock, and in August 2016, we had invested an additional $2.0 million in COCP for 4,878,050 shares of its common stock.
In January 2016, we invested an additional $0.3 million in ARNO for 714,285 shares of its common stock, and in August 2016, we had invested an additional $0.3 million in ARNO for 714,285 shares of its common stock and warrants to purchase 357,142 shares of its common stock.
In October 2016, we entered into a consulting agreement to provide strategic advisory services to BioCardia. In connection with the consulting agreement, BioCardia granted us 5,027,726 common stock options. In December 2016, we purchased 19,230,769 shares of BioCardia from Dr. Frost for $2.5 million . We have also purchased shares of BioCardia in the open market. BioCardia is a related party as a result of our executive management’s ownership interest and board representation in BioCardia and its predecessor, Tiger X Medical, Inc. In October 2016, BioCardia completed its merger with Tiger X Medical, Inc., to which Tiger X Medical, Inc. was the surviving entity and the name of the issuer was changed to BioCardia.
In November 2016, we entered into a Pledge Agreement with the Museum of Science, Inc. and the Museum of Science Endowment Fund, Inc. pursuant to which we will contribute an aggregate of $1.0 million over a four-year period for constructing, equipping and the general operation of the Frost Science Museum. Dr. Frost and Mr. Pfenniger serve on the Board of Trustees of the Frost Science Museum and Mr. Pfenniger is the Vice Chairman of the Board of Trustees.
We lease office space from Frost Real Estate Holdings, LLC (“Frost Holdings”) in Miami, Florida, where our principal executive offices are located. Effective January 1, 2017, we entered into an amendment to our lease agreement with Frost Holdings. The lease, as amended, is for approximately 29,500 square feet of space. The lease provides for payments of approximately $81 thousand per month in the first year increasing annually to $86 thousand per month in the third year, plus applicable sales tax. The rent is inclusive of operating expenses, property taxes and parking.
Our wholly-owned subsidiary, BioReference, purchases and uses certain products acquired from InCellDx, Inc., a company in which we hold a 28% minority interest.
We reimburse Dr. Frost for Company-related use by Dr. Frost and our other executives of an airplane owned by a company that is beneficially owned by Dr. Frost. We reimburse Dr. Frost for out-of-pocket operating costs for the use of the airplane by Dr. Frost or Company executives for Company-related business. We do not reimburse Dr. Frost for personal use of the airplane by Dr. Frost or any other executive. For the three and nine months ended September 30, 2017 , we recognized approximately $168 thousand and $309 thousand , respectively, for Company-related travel by Dr. Frost and other OPKO executives. For the three and nine months ended September 30, 2016 , we recognized approximately $154 thousand and $274 thousand , respectively, for Company-related travel by Dr. Frost and other OPKO executives.


30


NOTE 11 COMMITMENTS AND CONTINGENCIES
In connection with our acquisitions of CURNA, OPKO Diagnostics and OPKO Renal, we agreed to pay future consideration to the sellers upon the achievement of certain events. As a result, as of September 30, 2017 , we recorded $40.3 million as contingent consideration, with $2.0 million recorded within Accrued expenses and $38.3 million recorded within Other long-term liabilities in the accompanying Condensed Consolidated Balance Sheets. Refer to Note 4.
In August 2017, we entered into a Commitment Letter (the “Commitment Letter”) with Veterans Accountable Care Group, LLC (“VACG”) in connection with submission of a bid by its affiliate, the Veterans Accountable Care Organization, LLC (“VACO”) in response to a request for proposal (“RFP”) from the Veterans Health Administration (“VA”) regarding its Community Care Network. If VACO is successful in its bid, we will acquire a fifteen percent ( 15% ) membership interest in VACO. In addition, BioReference, our wholly-owned subsidiary, will provide laboratory services for the Community Care Network, a region which currently includes approximately 2,133,000 veterans in the states of Massachusetts, Maine, New Hampshire, Vermont, New York, Pennsylvania, New Jersey, Rhode Island, Connecticut, Maryland, Virginia, West Virginia, and North Carolina.
Pursuant to the Commitment Letter, we committed to provide, or to arrange from a third party lender, a line of credit for VACG in the amount of $50.0 million (the “Facility”). Funds drawn under the Facility would be contributed by VACG to VACO in order to satisfy the financial stability requirement of VACO in connection with its submission of the RFP. VACG would not be permitted to draw down on the Facility unless and until the VHA awards a contract to VACO. The Facility would have a maturity of five (5) years. Interest on the Facility would be payable at a rate equal to six and one-half percent ( 6.5% ) per annum, payable quarterly in arrears.
We currently anticipate that a decision by the VHA with respect to the RFP will occur during the fourth quarter of 2017, although there can be no assurance that a decision will be made by such time or that, if made, such decision will not be challenged by participants in the RFP process or otherwise.
The Facility is subject to the negotiation of definitive documentation conditions customary for transactions of such type and otherwise acceptable to VACG and the lender under the Facility.
We accrue a liability for legal contingencies when we believe that it is both probable that a liability has been incurred and that we can reasonably estimate the amount of the loss. We review these accruals and adjust them to reflect ongoing negotiations, settlements, rulings, advice of legal counsel and other relevant information. To the extent new information is obtained and our views on the probable outcomes of claims, suits, assessments, investigations or legal proceedings change, changes in our accrued liabilities would be recorded in the period in which such determination is made. For the matters referenced in the paragraph below, the amount of liability is not probable or the amount cannot be reasonably estimated; and, therefore, accruals have not been made. In addition, in accordance with the relevant authoritative guidance, for matters which the likelihood of material loss is at least reasonably possible, we provide disclosure of the possible loss or range of loss; however, if a reasonable estimate cannot be made, we will provide disclosure to that effect.
From time to time, we may receive inquiries, document requests, or subpoenas from the Department of Justice, the Office of Inspector General and Office for Civil Rights (“OCR”) of the Department of Health and Human Services, the Centers for Medicare and Medicaid Services, various payors and fiscal intermediaries, and other state and federal regulators regarding investigations, audits and reviews. In addition to the matters discussed in this note, we are currently responding to subpoenas or document requests for various matters relating to our laboratory operations.  Some pending or threatened proceedings against us may involve potentially substantial amounts as well as the possibility of civil, criminal, or administrative fines, penalties, or other sanctions, which could be material.  Settlements of suits involving the types of issues that we routinely confront may require monetary payments as well as corporate integrity agreements.  Additionally, qui tam or “whistleblower” actions initiated under the civil False Claims Act may be pending but placed under seal by the court to comply with the False Claims Act’s requirements for filing such suits.  Also, from time to time, we may detect issues of non-compliance with federal healthcare laws pertaining to claims submission and reimbursement practices and/or financial relationships with physicians, among other things.  We may avail ourselves of various mechanisms to address these issues, including participation in voluntary disclosure protocols.  Participating in voluntary disclosure protocols can have the potential for significant settlement obligations or even enforcement action.  The Company generally has cooperated, and intends to continue to cooperate, with appropriate regulatory authorities as and when investigations, audits and inquiries arise.
We are a party to other litigation in the ordinary course of business. We do not believe that any such litigation will have a material adverse effect on our business, financial condition, results of operations or cash flows.
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

31


had, in violation of the False Claims Act, improperly billed Medicare and Tricare (both are federal government healthcare 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.
We expect to continue 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, particularly as it relates to the launch of Rayaldee. We do not anticipate that we will generate substantial revenue from the sale of proprietary pharmaceutical products or certain of our diagnostic products for some time and we have generated only limited revenue from our pharmaceutical operations in Chile, Mexico, Israel, Spain, and Ireland, and from sale of the 4Kscore test. If we acquire additional assets or companies, accelerate our product development programs or initiate additional clinical trials, we will need additional funds. 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 have employment agreements with certain executives of BioReference which provide for compensation and certain other benefits and for severance payments under certain circumstances. During the nine months ended September 30, 2017 and 2016 , we recognized $3.7 million and $17.9 million , respectively, of severance costs pursuant to these employment agreements as a component of Selling, general and administrative expense.
At September 30, 2017 , we were committed to make future purchases for inventory and other items in 2017 that occur in the ordinary course of business under various purchase arrangements with fixed purchase provisions aggregating $106.6 million .
NOTE 12 STRATEGIC ALLIANCES
Vifor Fresenius Medical Care Renal Pharma Ltd
We plan to develop a portfolio of product candidates through a combination of internal development and external partnerships. In May 2016, EirGen, our wholly-owned subsidiary, and Vifor Fresenius Medical Care Renal Pharma Ltd (“VFMCRP”), entered into a Development and License Agreement (the “VFMCRP Agreement”) for the development and commercialization of Rayaldee (the “Product”) worldwide, except for (i) the United States, (ii) any country in Central America or South America (excluding Mexico), (iii) Russia, (iv) China, (v) Japan, (vi) Ukraine, (vii) Belorussia, (viii) Azerbaijan, (ix) Kazakhstan, and (x) Taiwan (the “VFMCRP Territory”). The license to VFMCRP potentially covers all therapeutic and prophylactic uses of the Product in human patients (the “VFMCRP Field”), provided that initially the license is for the use of the Product for the treatment or prevention of SHPT related to patients with stage 3 or 4 chronic kidney disease and vitamin D insufficiency/deficiency (the “VFMCRP Initial Indication”).
Under the terms of the VFMCRP Agreement, EirGen granted to VFMCRP an exclusive license in the VFMCRP Territory in the VFMCRP Field to use certain EirGen patents and technology to make, have made, use, sell, offer for sale, and import Products and to develop, commercialize, have commercialized, and otherwise exploit the Product. EirGen received a non-refundable and non-creditable initial payment of $50 million . EirGen is also eligible to receive up to an additional $37 million in regulatory milestones (“Regulatory Milestones”) and $195 million in launch and sales-based milestones (“Sales Milestones”), and will receive tiered royalties on sales of the product at percentage rates that range from the mid-teens to the mid-twenties or a minimum royalty, whichever is greater, upon the commencement of sales of the Product within the VFMCRP Territory and in the VFMCRP Field.
As part of the arrangement, the companies will share responsibility for the conduct of trials specified within an agreed-upon development plan, with each company leading certain activities within the plan. EirGen will lead the manufacturing activities within and outside the VFMCRP Territory and the commercialization activities outside the VFMCRP Territory and outside the VFMCRP Field in the VFMCRP Territory and VFMCRP will lead the commercialization activities in the VFMCRP Territory and the VFMCRP Field. For the initial development plan, the companies have agreed to certain cost sharing arrangements. VFMCRP will be responsible for all other development costs that VFMCRP considers necessary to develop the Product for the use of the Product for the VFMCRP Initial Indication in the VFMCRP Territory in the VFMCRP Field except as otherwise provided in the VFMCRP Agreement.
The VFMCRP Agreement will remain in effect with respect to the Product in each country of the VFMCRP Territory, on a country by country basis, until the date on which VFMCRP shall have no further payment obligations to EirGen under the terms of the VFMCRP Agreement, unless earlier terminated pursuant to the VFMCRP Agreement. VFMCRP’s royalty

32


obligations expire on a country-by-country and product-by-product basis on the later of (i) expiration of the last to expire valid claim covering the Product sold in such country, (ii) expiration of all regulatory and data exclusivity applicable to the Product in the country of sale, and (iii) ten ( 10 ) years after the Product first commercial sale in such country. In addition to termination rights for material breach and bankruptcy, VFMCRP is permitted to terminate the VFMCRP Agreement in its entirety, or with respect to one or more countries in the VFMCRP Territory, after a specified notice period, provided that VFMCRP shall not have the right to terminate the VFMCRP Agreement with respect to certain major countries without terminating the entire VFMCRP Agreement. If the VFMCRP Agreement is terminated by EirGen or VFMCRP, provision has been made for transition of product and product responsibilities to EirGen.
In connection with the VFMCRP Agreement, the parties entered into a letter agreement (the “Letter Agreement”) pursuant to which EirGen granted to VFMCRP an exclusive option (the “Option”) to acquire an exclusive license under certain EirGen patents and technology to use, import, offer for sale, sell, distribute and commercialize the Product in the United States solely for the treatment of secondary hyperparathyroidism in dialysis patients with chronic kidney disease and vitamin D insufficiency (the “Dialysis Indication”). Upon exercise of the Option, VFMCRP will reimburse EirGen for all of the development costs incurred by EirGen with respect to the Product for the Dialysis Indication in the United States. VFMCRP would also pay EirGen up to an additional aggregate amount of $555 million upon the achievement of certain milestones and would be obligated to pay royalties at percentage rates that range from the mid-teens to the mid-twenties on sales of the Product in the United States for the Dialysis Indication.
The Option is exercisable until the earlier of (i) the date that EirGen submits a new drug application or supplemental new drug application or their then equivalents to the U.S. Food and Drug Administration for the Product for the Dialysis Indication in the United States, (ii) the parties mutually agree to discontinue development of Product for the Dialysis Indication, or (iii) VFMCRP provides notice to OPKO that it has elected not to exercise the Option.
OPKO has guaranteed the performance of certain of EirGen’s obligations under the VFMCRP Agreement and the Letter Agreement.
For revenue recognition purposes, we evaluated the various agreements with VFMCRP to determine whether there were multiple deliverables in the arrangement. The VFMCRP Agreement provides for the following: (1) an exclusive license in the VFMCRP Territory in the VFMCRP Field to use certain patents and technology to make, have made, use, sell, offer for sale, and import Products and to develop, commercialize, have commercialized, and otherwise exploit the Product; (2) EirGen will supply Products to support the development, sale and commercialization of the Products to VFMCRP in the VFMCRP Territory (the “Manufacturing Services”); and (3) the Option to acquire an exclusive license under certain EirGen patents and technology to use, import, offer for sale, sell, distribute and commercialize the Product in the United States solely for the Dialysis Indication. Based on our evaluation, the exclusive license is the only deliverable at the outset of the arrangement. We concluded the Manufacturing Services were a contingent deliverable dependent on the future regulatory and commercial action by VFMCRP and the Option was substantive and not considered a deliverable under the license arrangement.
We recognized the $50.0 million upfront license payment in Revenue from transfer of intellectual property in our Condensed Consolidated Statements of Operations in the second quarter of 2016. Revenues related to the Manufacturing Services will be recognized as Product is sold to VFMCRP. No revenue related to the Option will be recognized unless and until VFMCRP exercises its Option under the Letter Agreement.
We determined that the cost sharing arrangement for development of the Dialysis Indication is not a deliverable in the VFMCRP Agreement. Payments for the Dialysis Indication will be recorded as Research and development expense as incurred.
EirGen is also eligible to receive up to an additional $37 million in Regulatory Milestones and $195 million in Sales Milestones. Payments received for Regulatory Milestones and Sales Milestones are non-refundable. The Regulatory Milestones are payable if and when VFMCRP obtains approval from certain regulatory authorities and will be recognized as revenue in the period in which the associated milestone is achieved, assuming all other revenue recognition criteria are met. We account for the Sales Milestones as royalties and Sales Milestones payments will be recognized as revenue in full in the period in which the associated milestone is achieved, assuming all other revenue recognition criteria are met. To date, no revenue has been recognized related to the achievement of the milestones.
Pfizer Inc.
In December 2014, we entered into an exclusive worldwide agreement with Pfizer Inc. (“Pfizer”) for the development and commercialization of our long-acting hGH-CTP for the treatment of growth hormone deficiency (“GHD”) in adults and children, as well as for the treatment of growth failure in children born small for gestational age (“SGA”) (the “Pfizer Transaction”).

33


The Pfizer Transaction closed in January 2015 following the termination of the waiting period under the Hart-Scott-Rodino Act. Under the terms of the Pfizer Transaction, we received non-refundable and non-creditable upfront payments of $295.0 million and are eligible to receive up to an additional $275.0 million upon the achievement of certain regulatory milestones. Pfizer received the exclusive license to commercialize hGH-CTP worldwide. In addition, we are eligible to receive initial tiered royalty payments associated with the commercialization of hGH-CTP for Adult GHD with percentage rates ranging from the high teens to mid-twenties. Upon the launch of hGH-CTP for Pediatric GHD in certain major markets, the royalties will transition to regional, tiered gross profit sharing for both hGH-CTP and Pfizer’s Genotropin®.
The agreement with Pfizer will remain in effect until the last sale of the licensed product, unless earlier terminated as permitted under the agreement. In addition to termination rights for material breach and bankruptcy, Pfizer is permitted to terminate the Agreement in its entirety, or with respect to one or more world regions, without cause after a specified notice period. If the Agreement is terminated by us for Pfizer’s uncured material breach, or by Pfizer without cause, provision has been made for transition of product and product responsibilities to us for the terminated regions, as well as continued supply of product by Pfizer or transfer of supply to us in order to support the terminated regions.
We will lead the clinical activities and will be responsible for funding the development programs for the key indications, which includes Adult and Pediatric GHD and Pediatric SGA. Pfizer will be responsible for all development costs for additional indications as well as all post-marketing studies. In addition, Pfizer will fund the commercialization activities for all indications and lead the manufacturing activities covered by the global development plan.
For revenue recognition purposes, we viewed the Pfizer Transaction as a multiple-element arrangement. Multiple-element arrangements are analyzed to determine whether the various performance obligations, or elements, can be separated or whether they must be accounted for as a single unit of accounting. We evaluated whether a delivered element under an arrangement has standalone value and qualifies for treatment as a separate unit of accounting. Deliverables that do not meet these criteria are not evaluated separately for the purpose of revenue recognition. For a single unit of accounting, payments received are recognized in a manner consistent with the final deliverable. We determined that the deliverables under the Pfizer Transaction, including the licenses granted to Pfizer, as well as our obligations to provide various research and development services, will be accounted for as a single unit of account. This determination was made because the ongoing research and development services to be provided by us are essential to the overall arrangement as we have significant knowledge and technical know-how that is important to realizing the value of the licenses granted. The performance period over which the revenue will be recognized is expected to continue from the first quarter of 2015 through 2020, when we anticipate completing the various research and development services that are specified in the Pfizer Transaction and our performance obligations are completed. We will continue to review the timing of when our research and development services will be completed in order to assess that the estimated performance period over which the revenue is to be recognized is appropriate. Any significant changes in the timing of the performance period will result in a change in the revenue recognition period. We increased the expected performance period over which the revenue will be recognized in the third quarter of 2017 by approximately one year.
We are recognizing the non-refundable $295.0 million upfront payments on a straight-line basis over the performance period. We recognized $46.5 million of revenue related to the Pfizer Transaction in Revenue from transfer of intellectual property in our Condensed Consolidated Statements of Operations during the nine months ended September 30, 2017 , and had deferred revenue related to the Pfizer Transaction of $112.3 million at September 30, 2017 . As of September 30, 2017 , $44.9 million of deferred revenue related to the Pfizer Transaction was classified in Accrued expenses and $67.4 million was classified in Other long-term liabilities in our Condensed Consolidated Balance Sheets.
The Pfizer Transaction includes milestone payments totaling $275.0 million upon the achievement of certain milestones. The milestones range from $20.0 million to $90.0 million each and are based on achievement of regulatory approval in the U.S. and regulatory approval and price approval in other major markets. We evaluated each of these milestone payments and believe that all of the milestones are substantive as (i) there is substantive uncertainty at the close of the Pfizer Transaction that the milestones would be achieved as approval from a regulatory authority must be received to achieve the milestones which would be commensurate with the enhancement of value of the underlying intellectual property, (ii) the milestones relate solely to past performance and (iii) the amount of the milestone is reasonable in relation to the effort expended and the risk associated with the achievement of the milestone. The milestone payments will be recognized as revenue in full in the period in which the associated milestone is achieved, assuming all other revenue recognition criteria are met. To date, no revenue has been recognized related to the achievement of the milestones.
TESARO
In November 2009, we entered into an asset purchase agreement (the “NK-1 Agreement”) under which we acquired VARUBI™ (rolapitant) and other neurokinin-1 (“NK-1”) assets from Merck. In December 2010, we entered into an exclusive license agreement with TESARO, in which we out-licensed the development, manufacture, commercialization and distribution

34


of our lead NK-1 candidate, VARUBI™ (the “TESARO License”). Under the terms of the license, we received a $6.0 million upfront payment from TESARO and we received $30 million of milestone payments from TESARO upon achievement of certain regulatory and commercial sale milestones and we are eligible to receive additional commercial milestone payments of up to $85 million if specified levels of annual net sales are achieved. During the nine months ended September 30, 2017 , $10.0 million of revenue was recognized related to the achievement of the milestones under the TESARO License. During the nine months ended September 30, 2016 , no revenue was recognized related to the achievement of the milestones under the TESARO License. TESARO is also obligated to pay us tiered royalties on annual net sales achieved in the United States and Europe at percentage rates that range from the low double digits to the low twenties, and outside of the United States and Europe at low double-digit percentage rates. TESARO assumed responsibility for clinical development and commercialization of licensed products at its expense. Under the NK-1 Agreement, we will continue to receive royalties on a country-by-country and product-by-product basis until the later of the date that all of the patent rights licensed from us and covering VARUBI™ expire, are invalidated or are not enforceable and 12 years from the first commercial sale of the product.
If TESARO elects to develop and commercialize VARUBI™ in Japan through a third-party licensee, TESARO will share equally with us all amounts it receives in connection with such activities, subject to certain exceptions and deductions.
The term of the license will remain in force until the expiration of the royalty term in each country, unless we terminate the license earlier for TESARO’s material breach of the license or bankruptcy. TESARO has a right to terminate the license at any time during the term for any reason on three months’ written notice.
Pharmsynthez
In April 2013, we entered into a series of concurrent transactions with Pharmsynthez, a Russian pharmaceutical company traded on the Moscow Stock Exchange pursuant to which we acquired an equity method investment in Pharmsynthez (ownership 9% ). We also granted rights to certain technologies in the Russian Federation, Ukraine, Belarus, Azerbaijan and Kazakhstan (the “Pharmsynthez Territories”) to Pharmsynthez and agreed to perform certain development activities. We will receive from Pharmsynthez royalties on net sales of products incorporating the technologies in the Pharmsynthez Territories, as well as a percentage of any sublicense income from third parties for the technologies in the Pharmsynthez Territories.
In July 2015, we entered into a Note Purchase Agreement with Pharmsynthez pursuant to which we delivered $3.0 million to Pharmsynthez in exchange for a $3.0 million note (the “Pharmsynthez Note Receivable”). The Pharmsynthez Note Receivable will be settled in 2017 and Pharmsynthez may satisfy the note either in cash or shares of its capital stock. We recorded the Pharmsynthez Note Receivable within Other current assets and prepaid expenses in our Condensed Consolidated Balance Sheets.
RXi Pharmaceuticals Corporation
In March 2013, we completed the sale to RXi of substantially all of our assets in the field of RNA interference (the “RNAi Assets”) (collectively, the “Asset Purchase Agreement”). Pursuant to the Asset Purchase Agreement, RXi will be required to pay us up to $50.0 million in milestone payments upon the successful development and commercialization of each drug developed by RXi, certain of its affiliates or any of its or their licensees or sublicensees utilizing patents included within the RNAi Assets (each, a “Qualified Drug”). In addition, RXi will also be required to pay us royalties equal to: (a) a mid single-digit percentage of “Net Sales” (as defined in the Asset Purchase Agreement) with respect to each Qualified Drug sold for an ophthalmologic use during the applicable “Royalty Period” (as defined in the Asset Purchase Agreement); and (b) a low single-digit percentage of net sales with respect to each Qualified Drug sold for a non-ophthalmologic use during the applicable Royalty Period.
Other
We have completed strategic deals with numerous institutions and commercial partners. In connection with these agreements, upon the achievement of certain milestones we are obligated to make certain payments and have royalty obligations upon sales of products developed under the license agreements. At this time, we are unable to estimate the timing and amounts of payments as the obligations are based on future development of the licensed products.
NOTE 13 SEGMENTS
We manage our operations in two reportable segments, pharmaceutical and diagnostics. The pharmaceutical segment consists of our pharmaceutical operations we acquired in Chile, Mexico, Ireland, Israel and Spain and our pharmaceutical research and development. The diagnostics segment primarily consists of our clinical laboratory operations we acquired through the acquisitions of BioReference and OPKO Lab and our point-of-care operations. There are no significant inter-

35


segment sales. We evaluate the performance of each segment based on operating profit or loss. There is no inter-segment allocation of interest expense and income taxes.
Information regarding our operations and assets for our operating segments and the unallocated corporate operations as well as geographic information are as follows:
 
For the three months ended September 30,
 
For the nine months ended September 30,
(In thousands)
2017
 
2016
 
2017
 
2016
Revenue from services:
 
 
 
 
 
 
 
Pharmaceutical
$

 
$

 
$

 
$

Diagnostics
229,035

 
259,025

 
740,992

 
777,559

Corporate

 

 

 

 
$
229,035

 
$
259,025

 
$
740,992

 
$
777,559

Revenue from products:
 
 
 
 
 
 
 
Pharmaceutical
$
22,795

 
$
20,569

 
$
73,992

 
$
63,275

Diagnostics

 

 

 

Corporate

 

 

 

 
$
22,795

 
$
20,569

 
$
73,992

 
$
63,275

Revenue from transfer of intellectual property:
 
 
 
 
 
 
 
Pharmaceutical
$
11,665

 
$
18,441

 
$
58,819

 
$
105,338

Diagnostics

 

 

 

Corporate

 

 

 

 
$
11,665

 
$
18,441

 
$
58,819

 
$
105,338

Operating loss:
 
 
 
 
 
 
 
Pharmaceutical
$
(18,452
)
 
$
(18,593
)
 
$
(49,709
)
 
$
15,422

Diagnostics
(27,619
)
 
3,098

 
(35,664
)
 
11,117

Corporate
(12,219
)
 
(8,128
)
 
(41,067
)
 
(49,414
)
 
$
(58,290
)
 
$
(23,623
)
 
$
(126,440
)
 
$
(22,875
)
Depreciation and amortization:
 
 
 
 
 
 
 
Pharmaceutical
$
6,935

 
$
6,994

 
$
20,404

 
$
12,841

Diagnostics
18,430

 
18,818

 
56,183

 
59,711

Corporate
29

 
20

 
90

 
60

 
$
25,394

 
$
25,832

 
$
76,677

 
$
72,612

Income (loss) from investment in investees:
 
 
 
 
 
 
 
Pharmaceutical
$
(3,661
)
 
$
399

 
$
(10,784
)
 
$
(5,643
)
Diagnostics
(352
)
 
(1,213
)
 
(987
)
 
496

Corporate

 

 

 

 
$
(4,013
)
 
$
(814
)
 
$
(11,771
)
 
$
(5,147
)
Revenues:
 
 
 
 
 
 
 
United States
$
229,218

 
$
259,221

 
$
751,732

 
$
777,703

Ireland
15,182

 
20,594

 
57,812

 
114,526

Chile
11,514

 
9,936

 
33,534

 
26,516

Spain
4,123

 
3,910

 
13,746

 
12,257

Israel
1,935

 
3,699

 
13,807

 
12,862

Mexico
1,483

 
675

 
3,072

 
2,308

Other
40

 

 
100



 
$
263,495

 
$
298,035

 
$
873,803

 
$
946,172



36


(In thousands)
September 30,
2017
 
December 31,
2016
Assets:
 
 
 
Pharmaceutical
$
1,309,650

 
$
1,294,916

Diagnostics
1,339,401

 
1,408,522

Corporate
72,939

 
63,181

 
$
2,721,990

 
$
2,766,619

Goodwill:

 

Pharmaceutical
$
262,786

 
$
251,817

Diagnostics
452,787

 
452,786

Corporate

 

 
$
715,573

 
$
704,603


Two customers represented more than 10% of our total consolidated revenue during the three and nine months ended September 30, 2017 . As of September 30, 2017 , one customer represented more than 10% of our accounts receivable balance. As of December 31, 2016 , one customer represented more than 10% of our accounts receivable balance.
NOTE 14 SUBSEQUENT EVENTS
On October 12, 2017, EirGen, our wholly-owned subsidiary, and Japan Tobacco Inc. (“JT”) entered into a Development and License Agreement granting JT the exclusive rights for the development and commercialization of Rayaldee in Japan (the “JT Territory”). The license grant to JT covers the therapeutic and preventative use of the Product for (i) SHPT in non-dialysis and dialysis patients with CKD, (ii) rickets, and (iii) osteomalacia (the “JT Initial Indications”), as well as such additional indications as may be added to the scope of the license subject to the terms of the Agreement (the “JT Additional Indications”, and together with the JT Initial Indications, the “JT Field”).
OPKO will receive an initial upfront payment of $6 million . OPKO will receive another $6 million upon the initiation of OPKO’s planned phase 2 study for Rayaldee in dialysis patients in the U.S. OPKO is also eligible to receive up to an additional aggregate amount of $31 million upon the achievement of certain regulatory and development milestones by JT for the Product in the JT Territory, and $75 million upon the achievement of certain sales based milestones by JT in the JT Territory. OPKO will also receive tiered, double digit royalty payments at rates ranging from low double digits to mid-teens on net Product sales within the JT Territory and in the JT Field. JT will, at its sole cost and expense, be responsible for performing all development activities necessary to obtain all regulatory approvals for Rayaldee in Japan and for all commercial activities pertaining to Rayaldee in Japan, except for certain preclinical expenses which OPKO has agreed to reimburse JT up to a capped amount.
We have reviewed all subsequent events and transactions that occurred after the date of our September 30, 2017 Condensed Consolidated Balance Sheet date, through the time of filing this Quarterly Report on Form 10-Q.

37


ITEM 2. MANAGEMENT’