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Section 1: 10-Q (FORM 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

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 001-35366

 

FORTRESS BIOTECH, INC.

(Exact name of registrant as specified in its charter)

 

Delaware 20-5157386
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)

 

2 Gansevoort Street, 9th Floor

New York, New York 10014

(Address including zip code of principal executive offices)

 

(781) 652-4500

(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. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x 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:

 

Large accelerated filer ¨ Accelerated filer x
Non-accelerated filer ¨ (Do not check if a smaller reporting company) Smaller reporting company ¨
    Emerging growth company ¨

 

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 registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

As of August 9,2018, there were 54,342,589 shares of Common Stock of the issuer outstanding.

 

 

 

 

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Quarterly Report on Form 10-Q

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION 3
     
Item 1. Unaudited Condensed Consolidated Financial Statements 3
     
  Condensed Consolidated Balance Sheets as of June 30, 2018 (unaudited) and December 31, 2017 3
     
  Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2018 and 2017 (unaudited) 5
     
  Condensed Consolidated Statement of Changes in Stockholders’ Equity for the Six Months Ended June 30, 2018 (unaudited) 6
     
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017 (unaudited) 7
     
  Notes to Unaudited Condensed Consolidated Financial Statements 9
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 39
     
Item 3. Quantitative and Qualitative Disclosures About Market Risks 47
     
Item 4. Controls and Procedures 48
     
PART II. OTHER INFORMATION 48
     
Item 1. Legal Proceedings 48
     
Item 1A. Risk Factors 49
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 70
     
Item 3. Defaults Upon Senior Securities 71
     
Item 4. Mine Safety Disclosures 71
     
Item 5. Other Information 71
     
Item 6. Exhibits 71
     
  Signatures 73

 

2

 

 

PARTI.FINANCIAL INFORMATION
Item1.Unaudited Condensed Consolidated Financial Statements

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

($ in thousands except for share and per share amounts)

 

   June 30,
2018
   December 31,
2017
 
   (Unaudited)     
ASSETS          
Current assets          
Cash and cash equivalents  $98,591   $113,915 
Accounts receivable   5,321    7,758 
Short-term investments (certificates of deposit)   35,000    36,002 
Cash deposits with clearing organizations   836    1,041 
Receivables from broker-dealers and clearing organizations   11,412    7,395 
Forgivable loans receivable   1,598    1,616 
Securities owned, at fair value   3,812    1,985 
Inventory   299    171 
Other receivables - related party   775    618 
Prepaid expenses and other current assets   13,880    12,680 
Total current assets   171,524    183,181 
           
Property and equipment, net   14,163    9,513 
Restricted cash   17,389    17,387 
Long-term investments, at fair value   565    1,390 
Intangible assets   13,614    15,223 
Goodwill   18,645    18,645 
Other assets   966    611 
Total assets  $236,866   $245,950 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Current liabilities          
Accounts payable and accrued expenses  $38,126   $36,127 
Accounts payable and accrued expenses – related party   73    222 
Accrued commissions and payroll payable   10,652    10,065 
Deferred clearing and marketing credits   681    786 
Securities sold, not yet purchased, at fair value   8    151 
Warrants issued - National   -    5,597 
Interest payable   1,143    887 
Interest payable - related party   94    97 
Notes payable, short-term (net of debt discount of $0 and $973 at June 30, 2018 and December 31, 2017, respectively)   -    8,528 
Subsidiary convertible note, short-term, at fair value   10,573    4,700 
Deferred revenue   650    - 
Derivative warrant liability   -    87 
Other current liabilities   158    181 
Total current liabilities   62,158    67,428 
           
Notes payable, long-term (net of debt discount of $1,035 and $62 at June 30, 2018 and December 31, 2017, respectively)   73,456    43,222 
Subsidiary convertible note, long-term, at fair value   -    10,059 
Other long-term liabilities   4,987    4,739 
Total liabilities   140,601    125,448 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

3

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets (Continued)

($ in thousands except for share and per share amounts)

 

   June 30,
2018
   December 31,
2017
 
   (Unaudited)     
Stockholders’ equity          
Preferred stock, $0.001 par value, 15,000,000 authorized, 5,000,000 designated Series A shares, 1,000,000 shares issued and outstanding as of June 30, 2018 and December 31, 2017, respectively; liquidation value of $25.00 per share   1    1 
Common stock, $0.001 par value, 100,000,000 shares authorized, 53,987,074 and 50,991,285 shares issued and outstanding as of June 30, 2018 and December 31, 2017, respectively   54    51 
Common stock issuable, 259,813 and 158,015 shares as of June 30, 2018 and December 31, 2017, respectively   776    500 
Additional paid-in-capital   397,858    364,148 
Accumulated deficit   (354,756)   (312,127)
Total stockholders’ equity attributed to the Company   43,933    52,573 
           
Non-controlling interests   52,332    67,929 
Total stockholders’ equity   96,265    120,502 
Total liabilities and stockholders’ equity  $236,866   $245,950 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

4

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

($ in thousands except for share and per share amounts)

(Unaudited)

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
   2018   2017   2018   2017 
Revenue                    
Fortress                    
Product revenue, net  $6,689   $4,054   $12,198   $6,139 
Revenue - from a related party   126    350    520    1,043 
Net Fortress revenue   6,815    4,404    12,718    7,182 
                     
National                    
Commissions   31,407    23,993    57,025    48,499 
Net dealer inventory gains   2,929    2,366    5,119    4,877 
Investment banking   11,037    10,592    23,741    17,653 
Investment advisory   5,197    3,490    10,530    6,875 
Interest and dividends   601    675    1,232    1,391 
Transfer fees and clearing services   1,777    1,687    4,074    4,185 
Tax preparation and accounting   3,868    3,144    4,391    4,000 
Other   203    346    429    717 
Total National revenue   57,019    46,293    106,541    88,197 
Net revenue   63,834    50,697    119,259    95,379 
                     
Operating expenses                    
Fortress                    
Cost of goods sold - product revenue   1,668    878    3,140    1,347 
Research and development   17,488    11,683    42,446    18,793 
Research and development – licenses acquired   1    1,800    98    3,094 
General and administrative   13,056    11,134    26,604    21,386 
Total Fortress operating expenses   32,213    25,495    72,288    44,620 
                     
National                    
Commissions, compensation and fees   49,345    41,762    92,906    79,020 
Clearing fees   578    618    1,321    1,356 
Communications   813    682    1,573    1,404 
Occupancy   1,141    936    2,096    1,944 
Licenses and registration   530    427    1,167    832 
Professional fees   578    991    1,971    2,254 
Interest   2    4    4    8 
Underwriting costs   42    -    187    - 
Depreciation and amortization   857    500    1,716    1,006 
Other administrative expenses   2,332    2,475    4,113    3,705 
Total National operating expenses   56,218    48,395    107,054    91,529 
Total operating expenses   88,431    73,890    179,342    136,149 
Loss from operations   (24,597)   (23,193)   (60,083)   (40,770)
                     
Other income (expenses)                    
Interest income   294    190    572    326 
Interest expense and financing fee   (2,144)   (1,380)   (4,227)   (2,078)
Change in fair value of derivative liabilities   (6,866)   1,452    (7,931)   5,794 
Change in fair value of subsidiary convertible note   (140)   (188)   110    (285)
Change in fair value of investments   (707)   157    (825)   (511)
Other loss   (118)   13    (112)   13 
Total other income (expenses)   (9,681)   244    (12,413)   3,259 
Loss before income taxes   (34,278)   (22,949)   (72,496)   (37,511)
                     
Income tax expense   1,438    -    1,438    - 
Net loss   (35,716)   (22,949)   (73,934)   (37,511)
                     
Less: net loss attributable to non-controlling interests   (14,105)   (5,584)   (31,305)   (8,164)
Net loss attributable to common stockholders  $(21,611)  $(17,365)  $(42,629)  $(29,347)
                     
Basic and diluted net loss per common share  $(0.50)  $(0.43)  $(0.99)  $(0.73)
                     
Weighted average common shares outstanding-basic and diluted   43,377,629    40,551,844    42,948,780    40,457,524 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

5

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Condensed Consolidated Statement of Changes in Stockholders’ Equity

($ in thousands)

(Unaudited)

 

   Series A Preferred
Stock
   Common Stock   Common
Shares
   Additional
Paid-In
   Accumulated   Non-
Controlling
   Total
Stockholders’
 
   Shares   Amount   Shares   Amount   Issuable   Capital   Deficit   Interests   Equity 
Balance at December 31, 2017   1,000,000   $1    50,991,285   $51   $500   $364,148   $(312,127)  $67,929   $120,502 
Stock-based compensation expense   -    -    -    -    -    8,623    -    -    8,623 
Issuance of restricted stock   -    -    1,558,274    2    -    (2)   -    -    - 
Issuance of common stock under ESPP   -    -    43,707    -    -    128    -    -    128 
Issuance of subsidiaries’ common shares for license expenses   -    -    -    -    -    23    -    -    23 
Issuance of NHLD’s common shares for tax withholding   -    -    -    -    -    (82)   -    -    (82)
Subsidiary’s offering, net   -    -    -    -    -    22,657    -    -    22,657 
Exercise of subsidiary’s warrants for cash   -    -    -    -    -    181    -    -    181 
Issuance of common stock for at-the-market offering   -    -    1,130,835    1    -    4,069    -    -    4,070 
At-the-market offering cost   -    -    -    -    -    (141)   -    -    (141)
Common shares issuable 2017 Subordinated Note Financing interest expense   -    -    -    -    978    -    -    -    978 
Common shares issued for 2017 Subordinated Note Financing interest expense   -    -    262,973    -    (989)   989    -    -    - 
Common shares issuable for Opus interest expense   -    -    -    -    287    -    -    -    287 
Preferred A dividends declared and paid   -    -    -    -    -    (1,172)   -    -    (1,172)
Offering cost and financing fee paid to NHLD   -    -    -    -    -    1,297    -    -    1,297 
Acquisition of business - NHLD   -    -    -    -    -    (767)   -    -    (767)
Warrant liability reclassification - NHLD   -    -    -    -    -    13,615    -    -    13,615 
Non-controlling interest in subsidiaries   -    -    -    -    -    (15,708)   -    15,708    - 
Net loss attributable to non-controlling interest   -    -    -    -    -    -    -    (31,305)   (31,305)
Net loss attributable to common stockholders   -    -    -    -    -    -    (42,629)   -    (42,629)
Balance at June 30, 2018   1,000,000   $1    53,987,074   $54   $776   $397,858   $(354,756)  $52,332   $96,265 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

6

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

($ in thousands)

(Unaudited)

 

   For the Six Months Ended June 30, 
   2018   2017 
         
Cash Flows from Operating Activities:          
Net Loss  $(73,934)  $(37,511)
Reconciliation of net loss to net cash used in operating activities:          
Depreciation expense   831    543 
Amortization of intangible asset   1,388    819 
Amortization of debt discount   481    702 
Amortization of product revenue license fee   266    267 
Amortization of forgivable loans to registered representatives   310    362 
Amortization of deferred clearing credit   (105)   (104)
Stock-based compensation expense   8,623    7,736 
Recovery of doubtful accounts   (46)   (256)
Common shares issuable for 2017 Subordinated Note Financing interest expense   978    189 
Common shares issuable for Opus interest expense   287    - 
Change in fair value of investments   825    511 
Change in fair value of derivative liabilities   7,931    (5,794)
Change in fair value of subsidiary convertible note   (110)   285 
Research and development - licenses acquired, expense   98    3,095 
Change in fair value of subsidiaries’ assets and liabilities   10    10 
Increase (decrease) in cash and cash equivalents resulting from changes in operating assets and liabilities:          
           
Accounts receivable   2,437    (1,506)
Receivables from broker-dealers and clearing organizations   (4,017)   544 
Forgivable loans receivable   (292)   (47)
Securities owned, at fair value   (1,827)   (1,049)
Inventory   (128)   (96)
Other receivables - related party   (157)   185 
Prepaid expenses and other current assets   (1,213)   (2,590)
Accounts payable and accrued expenses   1,154    (1,721)
Accounts payable and accrued expenses - related party   (99)   24 
Securities sold, but not yet purchased, at fair value   (143)   (221)
Deferred revenue   650    - 
Interest payable   256    3 
Interest payable - related party   (3)   259 
Other long-term liabilities   248    2 
Net cash used in operating activities   (55,301)   (35,359)
           
Cash Flows from Investing Activities:          
Purchase of research and development licenses   (75)   (665)
Purchase of property and equipment   (4,663)   (454)
Purchase of short-term investment (certificates of deposit)   (35,000)   (20,038)
Redemption of short-term investment (certificates of deposit)   36,002    - 
Security deposits collected   (343)   - 
Security deposits refund   -    3 
Acquisition of business - National   (187)   (19)
Acquisition of intangible assets - National   (45)   - 
Collection on notes receivable   47    8 
Net cash used in investing activities   (4,264)   (21,165)

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

7

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Continued)

($ in thousands)

(Unaudited)

 

   Six Months Ended June 30, 
   2018   2017 
         
Cash Flows from Financing Activities:          
Inter-company costs related to the issuance of Series A preferred stock   1,297    - 
Payment of Preferred A dividends   (1,172)   - 
Proceeds from at-the-market offering   4,070    - 
Payment of cost related to at-the-market offering   (141)   - 
Proceeds from subsidiaries’ offering   23,011    93,853 
Payment of costs related to subsidiaries’ offering   (354)   (862)
Proceeds from exercise of subsidiary’s warrants   181    - 
Proceeds from exercise of stock options   -    27 
Proceeds from issuance of common stock under ESPP   128    42 
Repurchase of NHLD common stock for tax withholding   (82)   - 
Proceeds from NSC Note   -    18,967 
Payment of debt issuance costs associated with NSC Note   -    (1,939)
Payment of debt issuance costs associated with 2017 Subordinated Note Financing   (404)   - 
Proceeds from Opus Credit Facility   -    2,500 
Proceeds from 2018 Venture Notes   21,707    - 
Payment of debt issue costs associated with 2018 Venture Notes   (127)   - 
Payment of debt issuance costs associated with subsidiaries’ Convertible Note   -    (4)
Payment of subsidiaries’ Convertible Note   (4,076)   - 
Net cash provided by financing activities   44,038    112,584 
           
Net (decrease) increase in cash and cash equivalents, cash deposits with clearing organizations and restricted cash   (15,527)   56,060 
           
Cash and cash equivalents, cash deposits with clearing organizations and restricted cash at beginning of period   132,343    105,184 
Cash and cash equivalents, cash deposits with clearing organizations and restricted cash at end of period  $116,816   $161,244 
           
Supplemental disclosure of cash flow information:          
Fortress          
Cash paid for interest  $1,819   $58 
Cash paid for interest – related party  $281   $- 
           
NHLD          
Cash paid for interest  $5   $8 
Cash paid for income taxes  $630   $576 
           
Supplemental disclosure of non-cash financing and investing activities:          
Fortress          
Issuance of restricted stock  $2   $1 
Issuance of warrants by subsidiary in conjunction with NSC debt  $-   $750 
Issuance of warrants in conjunction with 2017 Subordinated Note Financing  $-   $1,197 
Debt discount related to Opus Credit Facility  $-   $201 
Unpaid debt offering cost  $5   $79 
Conversion of subsidiaries notes payable  $-   $314 
Common shares issuable for license acquired  $-   $1,682 
Common shares issued for NHLD interest expense  $990   $- 
Fixed assets (acquired but not paid)  $818   $- 
NHLD          
Fixed assets (acquired but not paid)  $-   $42 
Business acquired  $187   $19 
Reclassification of warrant liability from debt to equity  $13,615   $- 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

8

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1.Organization and Description of Business

 

Fortress Biotech, Inc. (“Fortress” or the “Company”) is a biopharmaceutical company dedicated to acquiring, developing and commercializing novel pharmaceutical and biotechnology products. Fortress develops and commercializes products both within Fortress and through certain of its subsidiary companies, also referred to as the “Fortress Companies.” Additionally, the Company maintains a controlling interest in National Holdings Corporation, a diversified independent brokerage company (together with its subsidiaries, referred to as “NHLD” or “National”). One of National’s subsidiaries, National Securities Corporation (“NSC”), is an independent broker-dealer offering retail and institutional advisory, investment, insurance and tax planning services. From time to time, NSC provides services to the Company and its affiliates. In addition to its internal development programs, the Company leverages its biopharmaceutical business expertise and drug development capabilities and provides funding and management services to help the Fortress Companies achieve their goals. The Company and the Fortress Companies may seek licenses, acquisitions, partnerships, joint ventures and/or public and private financings to accelerate and provide additional funding to support their research and development programs.

 

As of June 30, 2018, in addition to National, the Company has several consolidated Fortress Companies, some of which contain product licenses, including: Aevitas Therapeutics, Inc. (“Aevitas”), Avenue Therapeutics, Inc. (“Avenue”), Caelum Biosciences, Inc. (“Caelum”), Cellvation, Inc. (“Cellvation”), Checkpoint Therapeutics, Inc. (“Checkpoint”), Cyprium Therapeutics, Inc. (“Cyprium”), Helocyte, Inc. (“Helocyte”), Journey Medical Corporation (“Journey” or “JMC”), Mustang Bio, Inc. ( “Mustang”), Tamid Bio, Inc. (“Tamid”) and JG Pharma, Inc., a subsidiary of JMC. The Company also has operational subsidiaries CB Securities Corporation (“CB Securities”), Immune Limited and FBIO Acquisition, Inc. (the acquisition vehicle the Company used to obtain National) and acquisition companies for which the Company is actively seeking product candidate licenses, including Coronado SO Co. (“Coronado SO”), Escala Therapeutics, Inc. (“Escala”), GeneXion Oncology, Inc. (“GeneXion”), Fortress Biotech China, Inc. (“Fortress China”), FBIO Acquisition Corp. IV and FBIO Acquisition Corps. VI - XIV.

 

Liquidity and Capital Resources

 

Since inception, the Company’s operations have been financed primarily through the sale of equity and debt securities and the proceeds from the exercise of warrants and stock options. The Company has incurred losses from operations and negative cash flows from operating activities since inception and expects to continue to incur substantial losses for the next several years as it continues to fully develop and prepare regulatory filings and obtain regulatory approvals for its existing and new product candidates. The Company’s current cash and cash equivalents are sufficient to fund operations for at least the next 12 months. However, the Company will need to raise additional funding through strategic relationships, public or private equity or debt financings, grants or other arrangements to fully develop and prepare regulatory filings and obtain regulatory approvals for the Company’s existing and new product candidates, fund operating losses, and, if deemed appropriate, establish or secure through third parties manufacturing for the Company’s potential products, sales and marketing capabilities. If such funding is not available or not available on terms acceptable to the Company, the Company’s current development plan and plans for expansion of its general and administrative infrastructure will be curtailed. The Company also has the ability, subject to limitations imposed by Rule 144 of the Securities Act of 1933 and other applicable laws and regulations, to raise money from the sale of common stock of the public companies in which it has ownership.

 

2.Summary of Significant Accounting Policies

 

Basis of Presentation and Principles of Consolidation

 

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the unaudited interim condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments necessary for the fair statement of the balances and results for the periods presented. Certain information and footnote disclosures normally included in the Company’s annual financial statements prepared in accordance with GAAP have been condensed or omitted. These condensed consolidated financial statement results are not necessarily indicative of results to be expected for the full fiscal year or any future period.

 

The unaudited condensed consolidated financial statements and related disclosures have been prepared with the presumption that users of the unaudited condensed consolidated financial statements have read or have access to the audited financial statements for the preceding fiscal year for each of the Companies, Avenue, Checkpoint, Mustang and National. Accordingly, these unaudited condensed consolidated financial statements should be read in conjunction with the Company’s Form 10-K, which was filed with the United States Securities and Exchange Commission (“SEC”) on March 16, 2018, from which the Company derived the balance sheet data at December 31, 2017, as well as National’s Form 10-K and 10-K/A filed with the SEC on December 22, 2017 and January 17, 2018, respectively and their Form 10-Q, filed with the SEC on February 14, 2018, Checkpoint’s Form 10-K filed with the SEC on March 16, 2018, Mustang’s Form 10-K, filed with the SEC on March 29, 2018, and Avenue’s Form 10-K, filed with the SEC on March 1, 2018.

 

9

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The Company’s unaudited condensed consolidated financial statements include the accounts of the Company and its subsidiaries: Avenue, Aevitas, Caelum, CB Securities, Cellvation, Coronado SO, Checkpoint, Cyprium, Escala, GeneXion, Helocyte, Immune Limited, JMC, Mustang, NHLD, Tamid, Coronado SO, Escala, Fortress China, FBIO Acquisition Corp. IV, FBIO Acquisition Corps. VI – XIV, and JG Pharma, Inc., a subsidiary of JMC. All intercompany balances and transactions have been eliminated.

 

The National assets acquired, and liabilities assumed, and revenues and expenses are reported on a one quarter lag. Therefore, the National assets acquired, and liabilities assumed included in these condensed consolidated financial statements as of June 30, 2018 are actually the assets and liabilities as of March 31, 2018 and the revenues and expenses included in these condensed consolidated financial statements for the quarter ending June 30, 2018 are actually the revenues and expenses for the quarter ending March 31, 2018.

 

The preparation of the Company’s unaudited condensed consolidated 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 unaudited condensed consolidated financial statements and the reported amounts of expenses during the reporting period.

 

Use of Estimates

 

The Company’s unaudited condensed consolidated financial statements include certain amounts that are based on management’s best estimates and judgments. The Company’s significant estimates include, but are not limited to, useful lives assigned to long-lived and intangible assets, fair value measurements, stock-based compensation, common stock issued to acquire licenses, investments, accrued expenses, derivative warrant liabilities, revenue with customers, provisions for income taxes and contingencies. Due to the uncertainty inherent in such estimates, actual results may differ from these estimates.

 

Significant Accounting Policies

 

There have been no material changes to the Company’s significant accounting policies previously disclosed in the Company’s Form 10-K filed with the SEC on March 16, 2018, with the exception of revenue recognition.

 

Recently Adopted Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606) (ASU 2014-09) as modified by ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, and ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients.” The impact of adoption on January 1, 2018 is primarily related to National’s investment banking expenses of $0.1 million that were deferred as of September 30, 2017 (National’s financials are included in the Company’s financials at a three-month lag) under the previously existing accounting guidance, which would have been expensed in prior periods under the new revenue standard. Since the impact was immaterial, the Company elected not to record this amount in retained earnings as of January 1, 2018. The adoption of this standard did not have a material impact on the Company’s revenue. Accordingly, the new revenue standard will be applied prospectively in the Company’s financial statements from January 1, 2018 forward and reported financial information for historical comparable periods will not be revised and will continue to be reported under the accounting standards in effect during those historical periods. Further, the adoption of ASU 2014-09 did not have a material impact on net Fortress revenue.

 

The new revenue guidance does not apply to revenue associated with financial instruments, including National’s warrants and securities that are accounted for under other U.S. GAAP, and as a result, did not have an impact on the elements of the Company’s Condensed Consolidated Statements of Operations most closely associated with financial instruments. The new revenue standard primarily impacts the following of the revenue recognition and presentation accounting policies:

 

10

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

·Investment Banking Revenues. Advisory fees from mergers and acquisitions engagements are recognized at the point in time when the related transaction is completed, as the performance obligation is to successfully broker a specific transaction.

 

·Investment Banking Advisory Expenses. Historically, expenses associated with investment banking advisory assignments were deferred until reimbursed by the client, the related fee revenue is recognized, or the engagement is otherwise concluded. Under the new revenue standard, expenses are deferred only to the extent they are explicitly reimbursable by the client and the related revenue is recognized when all performance obligations are met. All other investment banking advisory related expenses are expensed as incurred.

 

·Investment Banking Underwriting and Advisory Expenses. Expenses have historically been recorded net of client reimbursements and/or netted against revenues. Under the new revenue standard, all investment banking expenses will be recognized within their respective expense category on the consolidated income statement and any expense reimbursements will be recognized as investment banking revenues (i.e., expenses are no longer recorded net of client reimbursements and are not netted against revenues).

 

The new revenue standard requires enhanced disclosures, which are included in Note 21 to the Company’s condensed consolidated financial statements for the three months ended June 30, 2018.

 

Contract Assets

 

Contract assets represent the Company’s right to consideration in exchange for goods or services that the Company has transferred to a customer, excluding unconditional rights to consideration that are presented as receivables.

 

Contract Liabilities

 

Contract liabilities represent the Company’s obligation to deliver products or provide data to customers in the future for which cash has already been received.

 

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. ASU 2017-09 provides clarity and reduces both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, to a change to the terms or conditions of a share-based payment award. The amendments in ASU 2017-09 should be applied prospectively to an award modified on or after the adoption date. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company adopted ASU No. 2017-09 as of January 1, 2018. The adoption of this update did not impact the Company’s condensed consolidated financial statements and related disclosures.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows - Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company adopted ASU No. 2016-15 as of January 1, 2018. The adoption of this update did not impact the Company’s condensed consolidated financial statements and related disclosures.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities. ASU No. 2016-01 requires several targeted changes including that equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) be measured at fair value with changes in fair value recognized in net income. The new guidance also changes certain disclosure requirements and other aspects of current U.S. GAAP. Amendments are to be applied as a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. ASU 2016-01 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017. The Company adopted ASU No. 2016-01 as of January 1, 2018. The adoption of this update did not impact the Company’s condensed consolidated financial statements and related disclosures.

 

11

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Recent Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 requires an entity to recognize right-of-use assets and lease liabilities on its balance sheet and disclose key information about leasing arrangements. Lessees and lessors are required to disclose qualitative and quantitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. Early adoption is permitted. The Company is currently evaluating the impact, of adoption of ASU 2016-02 on its condensed consolidated financial statements and related disclosures.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires that expected credit losses relating to financial assets are measured on an amortized cost basis and available-for-sale debt securities be recorded through an allowance for credit losses. ASU 2016-13 limits the amount of credit losses to be recognized for available-for-sale debt securities to the amount by which carrying value exceeds fair value and also requires the reversal of previously recognized credit losses if fair value increases. The new standard will be effective on January 1, 2020 and may be adopted earlier. The Company is currently evaluating the impact, if any, that ASU 2016-13 will have on its condensed consolidated financial statements and related disclosures.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480) and Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features; II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Part I of this update addresses the complexity of accounting for certain financial instruments with down round features. Down round features are features of certain equity-linked instruments (or embedded features) that result in the strike price being reduced on the basis of the pricing of future equity offerings. Current accounting guidance creates cost and complexity for entities that issue financial instruments (such as warrants and convertible instruments) with down round features that require fair value measurement of the entire instrument or conversion option. Part II of this update addresses the difficulty of navigating Topic 480, Distinguishing Liabilities from Equity, because of the existence of extensive pending content in the FASB Accounting Standards Codification. This pending content is the result of the indefinite deferral of accounting requirements about mandatorily redeemable financial instruments of certain nonpublic entities and certain mandatorily redeemable noncontrolling interests. The amendments in Part II of this update do not have an accounting effect. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018. The Company is currently assessing the potential impact of adopting ASU 2017-11 on its condensed consolidated financial statements and related disclosures.

 

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such payments to nonemployees would be aligned with the requirements for share-based payments granted to employees. The changes take effect for public companies for fiscal years starting after Dec. 15, 2018, including interim periods within that fiscal year. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than an entity’s adoption date of Topic 606. The Company is currently evaluating the impact of adopting this standard on its condensed consolidated financial statements and related disclosures but does not expect it to have a material impact.

 

3.National Holdings Corporation Acquisition - Intangible Assets

 

Intangible assets consist of trademark and customer lists acquired in the offer under the purchase method of accounting and are recorded at fair value net of accumulated amortization since the purchase date. Software license is recorded at cost. Amortization is calculated using the straight-line and accelerated methods over the following estimated useful lives:

 

    Useful life
Trademark   10 years
Customer lists   6 years
Software license   3 years

 

The carrying amount related to acquired intangible assets as of June 30, 2018 are as follows ($ in thousands):

 

Intangible assets at December 31, 2017  $14,340 
Addition   45 
Amortization expense   (1,388)
Intangible assets at June 30, 2018  $12,997 

 

12

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The future amortization of these intangible assets is as follows ($ in thousands):

 

   Trademark   Customer
List
   Software
License
   Total 
Six Months Ended December 31, 2018  $151   $1,261   $10   $1,422 
Year Ended December 31, 2019   300    2,500    15    2,815 
Year Ended December 31, 2020   301    2,506    15    2,822 
Year Ended December 31, 2021   300    2,500    5    2,805 
Year Ended December 31, 2022   300    1,726    -    2,026 
Thereafter   1,107        -    1,107 
Total  $2,459   $10,493   $45   $12,997 

 

The Company reviews its finite-lived intangible assets for impairment when events or changes in circumstances indicate that the carrying amount of a finite-lived intangible asset may not be recoverable. Recoverability of a finite-lived intangible asset is measured by a comparison of its carrying amount to the undiscounted future cash flows expected to be generated by the asset. If the asset is considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the asset exceeds the fair value of the asset. There were no indicators of impairment during the six months ended June 30, 2018.

 

4.Broker-Dealers and Clearing Organizations, Other Receivables and Prepaid Expenses and Other Current Liabilities

 

At March 31, 2018 and September 30, 2017, National’s receivables of $11.4 million and $7.4 million, respectively, from broker-dealers and clearing organizations represent net amounts due for commissions and fees associated with National’s retail brokerage business as well as asset-based fee revenue associated with National’s Investment advisory business. National also has other receivables at March 31, 2018 and September 30, 2017 of $6.0 million and $5.2 million, respectively, which principally represent trailing commissions, tax and accounting fees and investment banking fees, net of an allowance for uncollectable accounts of $0.5 million, and $0.5 million, respectively, and are included in prepaid expenses and other current assets on the Company’s Condensed Consolidated Balance Sheet.

 

5.Forgivable Loans Receivable

 

From time to time, National’s operating subsidiaries may make loans, evidenced by promissory notes, primarily to newly recruited independent financial advisors as an incentive for their affiliation. The notes receivable balance is comprised of unsecured non-interest-bearing and interest-bearing loans (weighted average interest rate of 4%). These notes have various schedules for repayment or forgiveness based on production or retention requirements being met and mature at various dates through 2023. Forgiveness of loans amounted to $0.3 million and $0.4 million for the six months ended March 31, 2018 and 2017, respectively, and the related compensation was included in commissions, compensation and fees in the condensed consolidated statements of operations. In the event the advisor’s affiliation with the subsidiary terminates, the advisor is required to repay the unamortized balance of any notes payable. Amortization of loan forgiveness was included in commissions, compensation and fees in the statement of operations. In the event the advisor’s affiliation with the subsidiary terminates, the advisor is required to repay the unamortized balance of the note.

 

National provides an allowance for doubtful accounts on the notes based on historical collection experience and continually evaluates the receivables for collectability and possible write-offs where a loss is deemed probable. As of March 31, 2018 and September 30, 2017, no allowance for doubtful accounts was required.

 

There were no unamortized forgivable loans outstanding at March 31, 2018 and September 30, 2017 attributable to registered representatives who ended their affiliation with National’s subsidiaries prior to the fulfillment of their obligation.

 

13

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

6.Property and Equipment

 

Fortress’s property and equipment, exclusive of National’s property and equipment, consisted of the following ($ in thousands):

 

   Estimated Useful
Lives (in years)
  June 30,
2018
   December 31,
2017
 
Computer equipment  3  $648   $543 
Furniture and fixtures  5   1,128    1,009 
Machinery and equipment  5   1,897    143 
Leasehold improvements  5 – 15   9,181    5,351 
Construction in process (1)  N/A   864    1,241 
Total property and equipment      13,718    8,287 
Less: accumulated depreciation      (1,674)   (1,171)
Property and equipment, net     $12,044   $7,116 

 

(1)Relates to the Mustang cell processing facility.

 

Fortress's depreciation expense for the three months ended June 30, 2018 and 2017, was approximately $0.3 million and $0.2 million, respectively, and was recorded in research and development, manufacturing and general and administrative expense in the Condensed Consolidated Statements of Operations. Fortress’s depreciation expense for the six months ended June 30, 2018 and 2017, was approximately $0.5 million and $0.4 million, respectively, and was recorded in research and development, manufacturing and general and administrative expense in the Condensed Consolidated Statements of Operations.

 

National’s property and equipment as of March 31, 2018 and September 30, 2017 consisted of the following ($ in thousands):

 

   Estimated Useful
Lives (in years)
  March 31,
2018
   September 30,
2017
 
Equipment  5  $1,344   $1,306 
Furniture and fixtures  5   291    284 
Leasehold improvements  Lesser of useful life or term   1,011    1,006 
Capital Leases (primarily composed of computer equipment)  5   276    276 
Fixed assets – gross      2,922    2,872 
Accumulated depreciation and amortization      (803)   (475)
Fixed asset - net     $2,119   $2,397 

 

National's depreciation expense for the three months ended March 31, 2018 and 2017, was approximately $0.2 million and $0.1 million respectively, and was recorded in National general and administrative expense in the Condensed Consolidated Statements of Operations. National’s depreciation expense for the six months ended March 31, 2018 and 2017, was approximately $0.3 million and $0.2 million, respectively, and was recorded in National general and administrative expense in the Condensed Consolidated Statements of Operations.

 

7.Fair Value Measurements

 

Certain of the Company’s financial instruments are not measured at fair value on a recurring basis but are recorded at amounts that approximate their fair value due to their liquid or short-term nature, such as accounts payable, accrued expenses and other current liabilities.

 

Origo Acquisition Corporation

 

A shareholder meeting of “Origo Acquisition Corporation” (“Origo”) was held on June 12, 2018, at which the Origo shareholders approved the extension of the date by which to consummate a business combination from June 12, 2018 to September 12, 2018.

 

As of June 30, 2018, the Company valued its investment in Origo, a publicly traded company, utilizing the following assumptions: probability of a successful business combination of 13.93%, and no dividend rate, which yielded an instrument value upon business combination of $1.80 per ordinary share for the private placement shares. The rights and warrants were valued utilizing a binomial-lattice model at a value of $0.18 for each right and $0.30 for each warrant. Based upon the valuation, the Company recorded a decrease in fair-value of investment of $0.8 million for the six months ended June 30, 2018. At June 30, 2018, the fair value of the Company’s investment in Origo was, $0.6 million. During the three and six months ended June 30, 2018, the Company recorded an expense of $0.3 million in connection with its working capital note to Origo, reflecting the decrease in likelihood of a consummation of a business combination. Should Origo fail to successfully complete a business combination prior September 12, 2018, the value of the Company’s investment in Origo may be minimal.

 

14

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

  

Securities Owned

 

National

 

The fair value of National’s warrants, representing the cumulative value of warrants received in publicly traded companies that are not related parties, in which NSC as placement agent received warrants as the placement agent. National calculated the fair value of the warrants using a Black Scholes model. A summary of the weighted averages (in aggregate) of significant unobservable inputs (Level 3 inputs) used in measuring National’s warrants that are categorized within Level 3 of the fair value hierarchy as of March 31, 2018 is as follows:

 

   March 31, 2018
Risk-free interest rate  1.63% – 2.56%
Expected dividend yield  –%
Expected term in years  0.18 – 4.11
Remaining volatility  56.4% – 386.1%
Strike price  $0.01 – $10.00

 

($ in thousands)  Fair Value of
Derivative
Warrants
 
Beginning balance at September 30, 2017  $202 
Trading revenue gain   1,349 
Ending balance at March 31, 2018  $1,551 

 

Warrant Liabilities

 

Helocyte

 

The fair value of Helocyte’s warrant liability, which was issued in connection with Helocyte’s convertible note (see Note 11), as of June 30, 2018 approximated $0, as the probability of the conversion of the underlying notes approximated $0. The table below provides a summary:

 

($ in thousands)  Fair Value of
Derivative
Warrant
Liability
 
Beginning balance at January 1, 2018  $87 
Change in fair value of derivative liabilities   (87)
Ending balance at June 30, 2018  $ 

 

15

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Notes at Fair Value

 

Helocyte

 

Helocyte’s convertible note is measured at fair value using the Monte Carlo simulation valuation methodology. A summary of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in measuring Helocyte’s convertible debt that is categorized within Level 3 of the fair value hierarchy as of June 30, 2018, the fair value approximated cost, as the convertible note approaches maturity, is as follows:

 

($ in thousands)  Helocyte
Convertible
Note, at Fair
value
 
Beginning balance at January 1, 2018  $4,700 
Payment of convertible notes   (4,076)
Change in fair value of convertible notes   (291)
Ending balance at June 30, 2018  $333 

 

Caelum

 

Caelum’s convertible debt, which is guaranteed by the Company, is measured at fair value using the Monte Carlo simulation valuation methodology. A summary of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in measuring Caelum’s convertible debt that is categorized within Level 3 of the fair value hierarchy as of June 30, 2018 is as follows:

 

   June 30, 2018 
Risk-free interest rate   1.89%- 2.37%
Expected dividend yield   -%
Expected term in years   0.21 – 1.21 
Expected volatility   53.0%

 

($ in thousands)  Caelum
Convertible
Note, at fair
value
 
Beginning balance at January 1, 2018  $10,059 
Change in fair value of convertible notes   181 
Ending balance at June 30, 2018  $10,240 

 

The following tables classify the fair value hierarchy of Fortress's financial instruments, exclusive of National's financial instruments, measured at fair value as of June 30, 2018 and December 31, 2017:

 

   Fair Value Measurement as of June 30, 2018 
($ in thousands)  Level 1   Level 2   Level 3   Total 
Assets                    
Long-term investments, at fair value  $-   $-   $565   $565 
Total  $-   $-   $565   $565 
                     
Liabilities                    
Warrant liabilities  $-   $-   $-   $- 
Helocyte Convertible Note, at fair value   -    -    333    333 
Caelum Convertible Note, at fair value   -    -    10,240    10,240 
Total  $-   $-   $10,573   $10,573 

 

   Fair Value Measurement as of December 31, 2017 
($ in thousands)  Level 1   Level 2   Level 3   Total 
Assets                    
Long-term investments, at fair value  $   $   $1,390   $1,390 
Total  $   $   $1,390   $1,390 
                     
Liabilities                    
Warrant liabilities  $   $   $87   $87 
Caelum Convertible Note, at fair value           10,059    10,059 
Helocyte Convertible Note, at fair value           4,700    4,700 
Total  $   $   $14,846   $14,846 

 

16

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following table shows the fair values hierarchy of National's financial instruments measured at fair value on a recurring basis on the Condensed Consolidated Balance Sheets as of March 31, 2018 and September 30, 2017:

 

   Fair Value Measurement as of March 31, 2018 
   Level 1   Level 2   Level 3   Total 
Assets                    
National                    
Securities owned, at fair value                    
Corporate stocks  $32   $   $   $32 
Municipal bonds       1,183        1,183 
Restricted stock       1,046        1,046 
Warrants       -    1,551    1,551 
Total  $32   $2,229   $1,551   $3,812 
                     
Liabilities                    
National                    
Securities sold, but not yet purchased at fair value:                    
Corporate stocks   2            2 
Corporate debt       6        6 
Contingent consideration           889    889 
Total  $2   $6   $889   $897 

 

   Fair Value Measurement as of September 30, 2017 
   Level 1   Level 2   Level 3   Total 
Assets                    
National                    
Securities owned, at fair value                    
Corporate stocks  $116   $   $   $116 
Municipal bonds       1,239        1,239 
Restricted stock       82        82 
Warrants           548    548 
Total  $116   $1,321   $548   $1,985 
                     
Liabilities                    
National                    
Securities sold, but not yet purchased at fair value                    
Municipal bonds       151        151 
Contingent consideration           311    311 
Warrants issued - National           5,597    5,597 
Total  $   $151   $5,908   $6,059 

 

17

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Warrants issued - National

 

On March 15, 2018, National, Computershare Inc., a Delaware corporation (“Computershare”), and its wholly-owned subsidiary, Computershare Trust Company, N.A., a federally chartered trust company (and together with Computershare, the “Warrant Agent”) agreed to amend and restate the terms of the form of warrant agreement dated December 13, 2016 (the “Original Agreement”). The Amended and Restated Warrant Agreement (the “Amended Agreement”) explicitly provides that National shall not be required to pay cash if it cannot issue registered shares of Common Stock upon exercise of a Warrant and as such meeting the criteria for equity classification.

 

Accordingly, at March 15, 2018, the date of the amendment, the fair value of the warrants issued by National (represents 44% of the warrants issued to non-Fortress shareholders) was $13.6 million. Such valuation (using level 3 inputs) was determined by use of the Black-Scholes option pricing model using the following assumptions:

 

   March 15, 2018 
Dividend yield   %
Expected volatility   59.23%
Risk-free interest rate   2.42%
Life (in years)   3.49%

 

The following table shows the fair value of the warrant liability on the Condensed Consolidated Balance Sheets as of March 31, 2018 and September 30, 2017:

 

($ in thousands)  National’s
Warrants
 
Beginning balance at September 30, 2017  $5,597 
Change in fair value of derivative liability   8,018 
Ending balance at March 15, 2018   13,615 
Reclassification of warrant to equity   (13,615)
Ending balance at March 31, 2018  $ 

 

National listed the warrants on the Nasdaq Capital Market under the symbol “NHLDW” in February 2017.

 

The table below provides a roll-forward of the changes in fair value of Level 3 financial instruments for the six months ended June 30, 2018:

 

($ in thousands)  Investment in
Origo
   Helocyte
Convertible
Note, at fair
value
   Caelum
Convertible
Note, at fair
value
   Warrants
issued and
issuable
   Warrant
liabilities
   Total 
Balance at December 31, 2017  $1,390   $4,700   $10,059   $5,597   $87   $21,833 
Payment of convertible note   -    (4,076)   -    -    -    (4,076)
Reclassification of warrant liability from debt to equity   -    -    -    (13,615)   -    (13,615)
                               
Change in fair value of investments   (825)   -    -    -    -    (825)
Change in fair value of convertible notes   -    (291)   181    -    -    (110)
Change in fair value of derivative liabilities   -    -    -    8,018    (87)   7,931 
Balance at June 30, 2018  $565   $333   $10,240   $0   $0   $11,138 

 

For the six months ended June 30, 2018, no transfers occurred between Level 1, Level 2 and Level 3 instruments.

 

18

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

8.Licenses Acquired

 

In accordance with ASC 730-10-25-1, Research and Development, costs incurred in obtaining technology licenses are charged to research and development expense if the technology licensed has not reached technological feasibility and has no alternative future use. The licenses purchased by the Company and its’ subsidiaries require substantial completion of research and development, regulatory and marketing approval efforts in order to reach technological feasibility. As such, for the three and six months ended June 30, 2018 and 2017, the purchase price of licenses acquired was classified as research and development-licenses acquired in the Condensed Consolidated Statements of Operations, as reflected in the table below:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
Fortress  $   $300   $   $300 
                     
Fortress Companies:                    
Checkpoint               400 
Helocyte           21     
Mustang       1,500    75    2,075 
Cellvation           1     
Caelum               219 
Cyprium               100 
Aevitas   1        1     
Total  $1   $1,800   $98   $3,094 

 

Checkpoint

 

The table below provides a summary of Checkpoint’s expense related to its licenses, for the three and six months ended June 30, 2018 and 2017 by license as recorded in the Condensed Consolidated Statements of Operations:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
Jubliant Biosys License CK-103  $   $   $   $400 
Total Licenses Acquired Expense  $   $   $   $400 

 

See Note 21 for revenue recognized in connection with the Jubilant license under a sublicense agreement with TGTX, a related party.

 

Mustang

 

The table below provides a summary of Mustang’s expense related to its licenses, for the three and six months ended June 30, 2018 and 2017 by license as recorded in the Condensed Consolidated Statements of Operations:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
City of Hope (COH) IL-13 License  $   $   $   $250 
COH IV/ICV License               125 
COH HER2 License       600        600 
COH CS-1 License       600        600 
COH License for PSCA       300        500 
Manufacturing License           75     
Total licenses acquired expense  $   $1,500   $75   $2,075 

 

19

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Caelum

 

For the three and six months ended June 30, 2018 and 2017, respectively, Caelum recorded expense of approximately $0 and $0, and $0 and $0.2 million in connection with its license for CAEL-101 from Columbia University.

 

Cyprium

 

For the three and six months ended June 30, 2018 and 2017, respectively, Cyprium recorded expense of approximately $0 and $0, and $0 and $0.1 million in connection with its license for CUTX-101 (copper histidinate injection) from the Eunice Kennedy Shriver National Institute of Child Health and Human Development (“NICHD”).

 

9.Sponsored Research and Clinical Trial Agreements

 

Aevitas

 

On January 25, 2018, Aevitas entered into a Sponsored Research Agreement with the University of Massachusetts (“UMass SRA”) for certain continued research and development activities related to the development of adeno-associated virus (“AAV”) gene therapies in complement-mediated diseases. The total amount to be funded by Aevitas under the UMass SRA is $0.8 million. Pursuant to the terms of the UMass SRA, Aevitas paid $0.8 million which was due upon execution. For the three and six months ended June 30, 2018, Aevitas recorded expense of approximately $0.3 million and $0.4 million in connection with the UMass SRA. The expense was recorded in research and development expenses in the Company’s Condensed Consolidated Statements of Operations. No expense related to this Agreement was recorded in 2017.

 

Caelum

 

On March 12, 2018, Caelum entered into a Sponsored Research Agreement with Columbia University to conduct preclinical research in connection with CAEL 101. The total cost of the study approximates $0.1 million. For the three and six months ended June 30, 2018, Caelum recorded expense of approximately $27,000 and $38,000, respectively in connection with the agreement. The expense was recorded in research and development expense in the Condensed Consolidated Statements of Operations.

 

Cellvation

 

For the three and six months ended June 30, 2018 and 2017, respectively, Cellvation recorded expense of $0.1 million and $0.2 million and $0.1 million and $0.2 million, respectively in connection with its sponsored research arrangement with the University of Texas. The expense was recorded in research and development expense in the Condensed Consolidated Statements of Operations.

 

Checkpoint

 

In connection with its license agreement with NeuPharma, Inc. (“NeuPharma”), Checkpoint entered into a Sponsored Research Agreement with NeuPharma for certain research and development activities and subsequently entered into an agreement with TGTX, a related party, to assume all costs associated with this Sponsored Research Agreement, including all amounts previously paid by the Company. For the three and six months ended June 30, 2018 and 2017, approximately $0 and approximately $31,000 and $0.2 million and $0.4 million, respectively, was recognized in research and development expense in connection with the Sponsored Research Agreement in the Condensed Consolidated Statements of Operations.

 

Helocyte

 

The table below provides a summary of Helocyte’s expense related to its clinical research arrangements, for the three and six months ended June 30, 2018 and 2017, by agreement as recorded in the Condensed Consolidated Statements of Operations:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
COH Triplex clinical research and support  $   $535   $   $1,035 
COH PepVax clinical research and support               235 
COH Pentamer clinical research and support   204    12    204    12 
Total licenses acquired expense  $204   $547   $204   $1,282 

 

20

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

During the first quarter of 2018, Helocyte elected to discontinue the further development of its HLA-restricted, single-antigen PepVax program and as such will cease to incur costs associated with this program.

 

Mustang

 

The table below provides a summary of Mustang’s expense related to its sponsored research agreements, for the three and six months ended June 30, 2018 and 2017, by license as recorded in the Condensed Consolidated Statements of Operations:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
COH CAR T  $500   $500   $1,000   $1,000 
COH - CD123   114    575    264    595 
COH - IL13Rα2   143    1,001    503    1,010 
City of Hope – Manufacturing   115        229     
Fred Hutch - CD20   418        684     
Total  $1,290   $2,076   $2,680   $2,605 

 

See Note 21 for revenue recognized in connection with its sponsored research agreement with Neupharma under a sublicense agreement with TGTX, a related party.

 

Tamid

 

On November 30, 2017, in connection with its three separate license agreements with UNC, Tamid entered into a Sponsored Research Agreement with UNC (“UNC SRA”) for certain continued research and development activities related to Nanodysferlin for treatment of Dysferlinopathy, and AAV-HLA-G for ocular diseases. Total amount to be funded by Tamid under the UNC SRA is $2.3 million over a term of three years. Pursuant to the terms of the UNC SRA, Tamid paid $0.8 million which was due upon execution. For the three and six months ended June 30, 2018, Tamid recorded expense of $0.2 million and $0.4 million, respectively in connection with the UNC SRA. The expense was recorded in research and development expenses in the Company’s Condensed Consolidated Statements of Operations.

 

10.Intangibles, net

 

Journey

 

Pursuant to the terms of Journey’s license agreements for its branded products, Journey made upfront payments totaling $1.6 million. With the commencement of sales of these products, Journey began amortization of these costs over their respective three year estimated useful life. For the three months ended June 30, 2018 and 2017, Journey recognized expense of approximately $0.1 million and $0.1 million, respectively, which was recorded in costs of goods sold in the Company’s Condensed Consolidated Statements of Operations. For the six months ended June 30, 2018 and 2017, Journey recognized expense of approximately $0.3 million and $0.3 million, respectively, which was recorded in costs of goods sold in the Company’s Condensed Consolidated Statements of Operations.

 

11.Debt and Interest

 

Debt

 

2018 Venture Notes

 

During the period ended March 31, 2018, the Company closed a private placement of promissory notes for an aggregate of $21.7 million (the “2018 Venture Notes”) through National Securities Corporation (“NSC”), a wholly-owned subsidiary of National and a related party by virtue of the Company’s ownership of National. The Company intends to use the proceeds from the 2018 Venture Notes to acquire and license medical technologies and products through existing or recently formed Company subsidiaries. The Company may also use the proceeds to finance its subsidiaries. The notes mature 36 months from issuance, provided that during the first 24 months the Company may extend the maturity date by six months. No principal amount will be due for the first 24 months (or the first 30 months if the maturity date is extended). Thereafter, the note will be repaid at the rate of 1/12 of the principal amount per month for a period of 12 months. Interest on the note is 8% payable quarterly during the first 24 months (or the first 30 months if the note is extended) and monthly during the last 12 months.

 

21

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

NSC acted as the sole placement agent for the 2018 Venture Notes. The Company paid NSC a fee of $1.7 million during the three months ended March 31, 2018 in connection with its placement of the 2018 Venture Notes. At March 31, 2018, the fee, which was recorded as debt discount and will be amortized over the life of the 2018 Venture Notes, was eliminated in consolidation.

 

The 2018 Venture Notes allows the Company to transfer a portion of the proceeds from the 2018 Venture Notes to a Fortress subsidiary upon the completion by such subsidiary of an initial public offering in which it raises sufficient equity capital so that it has cash equal to five times the amount of the portion of the proceeds of the 2018 Venture Notes so transferred (the “SubCo Funding Threshold”). At the time of transfer the Company’s obligation under the NSC Note will be reduced by the amount transferred.

 

During the six months ended June 30, 2018, the Company has transferred $1.4 million to Aevitas, $1.1 million to Tamid, $1.0 Million to Cyprium and $1.2 million to Cellvation. Notwithstanding such transfers, the Company continues to hold such debt balances as liabilities on its own balance sheet on a consolidated basis, until such time as the SubCo Funding Threshold is met with respect to a particular subsidiary.

 

In connection with this transfer NSC will receive warrants to purchase each such subsidiary’s stock equal to 25% of that subsidiary’s proceeds of the 2018 Venture Notes divided by the lowest price at which the subsidiary sells its equity in its first third party equity financing. The warrants issued will have a term of 10 years and an exercise price equal to the par value of the Fortress subsidiary’s common stock. The value of the warrants, if any, is eliminated in consolidation. As of June 30, 2018, the warrants were contingently issuable as neither an initial public offering nor a third-party financing had occurred.

 

Opus Credit Facility Agreement Maturity Date Extension

 

On March 12, 2018, the Company and Opus Point Healthcare Innovation Healthcare Fund (“OPHIF”) amended and restated the Opus Credit Facility (the “A&R Opus Credit Facility”). The A&R Opus Credit Facility extended the maturity date of the notes issued under the Opus Credit Facility from September 14, 2018 by one year to September 14, 2019. The A&R Opus Credit Facility also permits the Company to make portions of interest and principal repayments in the form of shares of the Company’s common stock and/or in common stock of the Company’s publicly-traded subsidiaries, subject to certain conditions. Fortress retains the ability to prepay the Notes at any time without penalty. The notes payable under the A&R Opus Credit Facility continue to bear interest at 12% per annum.

 

22

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Total debt consists of the following as of June 30, 2018 and December 31, 2017:

 

($ in thousands)  June 30,
2018
   December 31,
2017
   Interest Rate   Maturity
IDB Note  $14,929   $14,929    2.25%  August - 2020
2017 Subordinated Note Financing   3,254    3,254    8.00%  March - 2020
2017 Subordinated Note Financing   13,893    13,893    8.00%  May - 2020
2017 Subordinated Note Financing   1,820    1,820    8.00%  June - 2020
2017 Subordinated Note Financing   3,017    3,018    8.00%  August - 2020
2017 Subordinated Note Financing   6,371    6,371    8.00%  September - 2020
2018 Venture Notes   6,517        8.00%  February - 2021
2018 Venture Notes   15,190        8.00%  March - 2021
Opus Credit Facility   9,500    9,500    12.00%  September - 2019
Helocyte Convertible Note, at fair value       1,000    8.00%  December - 2017
Helocyte Convertible Note, at fair value   300    2,194    8.00%  September - 2018
Helocyte Convertible Note, at fair value       1,062    8.00%  April - 2018
Helocyte Convertible Note, at fair value   23    444    8.00%  November - 2018
Helocyte Convertible Note, at fair value           8.00%  September - 2018
Helocyte Convertible Note, at fair value   10        8.00%  October - 2018
Caelum Convertible Note, at fair value   1,036    1,017    8.00%  January - 2019
Caelum Convertible Note, at fair value   7,024    6,900    8.00%  February - 2019
Caelum Convertible Note, at fair value   2,180    2,142    8.00%  March - 2019
Total notes payable   85,064    67,544         
Less: Discount on notes payable   1,035    1,035         
Total notes payable  $84,029   $66,509         

 

23

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Interest Expense

 

The following table shows the details of interest expense for all debt arrangements during the periods presented. Interest expense includes contractual interest and amortization of the debt discount and amortization of fees represents fees associated with loan transaction costs, amortized over the life of the loan:

 

   Three Months Ended June 30,   Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
IDB Note                    
Interest  $85   $87   $169   $169 
Total IDB Note   85    87    169    169 
                     
NSC Debt                    
Interest       84        155 
Amortization of fees       40        73 
Total NSC Debt       124        228 
                     
2017 Subordinated Note Financing                    
Interest   1,049    406    2,097    406 
Amortization of fees   30    175    51    175 
Total 2017 Subordinated Note Financing   1,079    581    2,148    581 
                     
Opus Credit Facility                    
Interest   284    276    565    508 
Amortization of fees   101    241    420    454 
Total Opus Note   385    517    985    962 
                     
2018 Venture Notes                    
Interest   429        485     
Amortization of fees   9        10     
Total 2018 Venture Notes   438        495     
                     
LOC Fees                    
Interest   9    7    16    15 
Total LOC   9    7    16    15 
                     
Helocyte Convertible Note                    
Interest   19    57    87    111 
Financing fee               1 
Total Helocyte Convertible Note   19    57    87    112 
                     
Avenue Convertible Note                    
Interest       5        5 
Financing fee       -        3 
Total Avenue Convertible Note       5        8 
                     
Caelum Convertible Note                    
Interest   195        391     
Total Caelum Convertible Note   195        391     
                     
Falk CSR                    
Interest   (66)       (64)    
Total Falk CSR   (66)       (64)    
                     
D&O Insurance                    
Interest       2        3 
Total D&O Insurance       2        3 
Total Interest Expense and Financing Fee  $2,144   $1,380   $4,227   $2,078 

 

12.Accrued Expenses and Other Long-Term Liabilities

 

Accrued expenses and other long-term liabilities, excluding National, consisted of the following:

 

   June 30,
2018
   December 31,
2017
 
Accrued Expenses:          
Professional fees  $1,535   $1,625 
Salaries, bonuses and related benefits   3,569    5,279 
Accrued expenses - related party   73    95 
Research and development   5,143    4,046 
Dr. Falk Pharma milestone (See Note 16)   3,365    3,059 
Accrued royalties payable   1,268    1,411 
Deferred coupon funding   1,777    1,087 
Other   779    1,030 
Total accrued expenses  $17,509   $17,632 
           
Other long-term liabilities:          
Deferred rent and long-term lease abandonment charge   4,987    4,739 
Total other long-term liabilities  $4,987   $4,739 

 

24

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

National’s accounts payable and other accrued expenses as of March 31, 2018 and September 31, 2017, consisted of the following:

 

   March 31, 2018   September 30, 2017 
Legal  $615   $877 
Audit   299    176 
Telecommunications   194    205 
Data Services   526    464 
Regulatory   638    540 
Settlements   1,703    2,403 
Deferred rent   686    497 
Other   2,903    3,242 
Total  $7,564   $8,404 

 

13.Non-Controlling Interests

 

Non-controlling interests in consolidated entities, as recorded on the Condensed Consolidated Balance Sheets are as follows:

 

   As of June 30, 2018 
   NCI Equity Share   Net gain/(loss) attributable
to non-controlling interests
   Non-controlling interests
in consolidated entities
   Non-
controlling
ownership
 
Aevitas  $(407)  $(184)  $(591)   37.0%
Avenue2   12,865    (9,631)   3,234    64.5%
Caelum   (2,121)   (1,474)   (3,595)   33.9%
Cellvation   (418)   (91)   (509)   21.6%
Checkpoint1   24,543    (9,482)   15,061    67.5%
Coronado SO   (290)   -    (290)   13.0%
Cyprium   (183)   (50)   (233)   10.8%
Helocyte   (3,203)   (91)   (3,294)   19.8%
JMC   (459)   165    (294)   6.3%
Mustang2   37,669    (6,729)   30,940    60.0%
National Holdings   15,805    (3,628)   12,177    43.4%
Tamid   (164)   (110)   (274)   24.0%
Total  $83,637   $(31,305)  $52,332      

 

   As of December 31, 2017 
   NCI Equity Share   Net gain/(loss) attributable
to non-controlling interests
   Non-controlling interests
in consolidated entities
   Non-
controlling
ownership
 
Aevitas  $(126)  $(168)  $(294)   35.4%
Avenue2   17,454    (4,646)   12,808    66.1%
Caelum   (815)   (1,262)   (2,077)   34.7%
Cellvation   (259)   (96)   (355)   21.5%
Checkpoint1   21,635    (12,314)   9,321    62.0%
Coronado SO   (236)   (54)   (290)   13.0%
Cyprium   (143)   (15)   (158)   11.1%
Helocyte   (1,907)   (1,193)   (3,100)   20.0%
JMC   (469)   7    (462)   6.3%
Mustang2   48,740    (11,911)   36,829    61.6%
National Holdings   17,021    (1,216)   15,805    43.4%
Tamid   (6)   (92)   (98)   24.0%
Total  $100,889   $(32,960)  $67,929      

 

(1)Checkpoint is consolidated with Fortress’ operations because Fortress maintains voting control through its ownership of Checkpoint’s Class A Common Shares which provide super-majority voting rights.

 

(2)Avenue and Mustang are consolidated with Fortress’ operations because Fortress maintains voting control through its ownership of Preferred Class A Shares which provide super-majority voting rights.

 

25

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

14.Net Loss per Common Share

 

Basic net loss per share is calculated by dividing net loss by the weighted-average number of shares of common stock outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is computed by dividing net loss by the weighted-average number of common stock and common stock equivalents outstanding for the period.

 

The Company’s common stock equivalents, including unvested restricted stock, options, and warrants have been excluded from the computation of diluted net loss per share as the effect would be to reduce the net loss per share. Therefore, the weighted average common stock outstanding used to calculate both basic and diluted net loss per share is the same.

 

The following shares of potentially dilutive securities have been excluded from the computations of diluted weighted average shares outstanding, as the effect of including such securities would be anti-dilutive at the end of the six months ended June 30, 2018 and 2017:

 

   Six Months Ended June 30, 
   2018   2017 
Warrants to purchase Common Stock   894,189    603,316 
Opus warrants to purchase Common Stock   1,880,000    1,880,000 
Options to purchase Common Stock   1,085,502    1,101,193 
Convertible Preferred Stock   1,000,000    - 
Unvested Restricted Stock   11,023,682    9,864,417 
Unvested Restricted Stock Units   1,864,980    1,258,372 
Total   17,748,353    14,707,298 

 

15.Stockholders’ Equity

 

Stock-based Compensation

 

The following table summarizes the stock-based compensation expense from stock option, employee stock purchase programs and restricted Common Stock awards and warrants for the three and six months ended June 30, 2018 and 2017:

 

   For the Three Months Ended June 30,   For the Six Months Ended June 30, 
($ in thousands)  2018   2017   2018   2017 
Employee Awards  $1,121   $1,150   $2,063   $2,424 
Executive awards of Fortress Companies’ stock   444    540    962    1,096 
Non-employee awards   23    23    46    36 
Fortress Companies:                    
Avenue   322    19    671    24 
Checkpoint   72    2,382    1,209    3,362 
Mustang   972    397    2,966    397 
Other   198    113    30    213 
National   418    183    676    184 
Total stock-based compensation  $3,570   $4,807   $8,623   $7,736 

 

For the three months ended June 30, 2018 and 2017, approximately $0.8 million and $2.4 million, respectively, of stock based compensation expense was included in research and development expenses in connection with equity grants made to employees and consultants and approximately $2.8 million and $2.4 million, respectively, was included in general and administrative expenses in connection with grants made to employees, members of the board of directors and consultants.

 

26

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

For the six months ended June 30, 2018 and 2017, approximately $3.1 million and $3.2 million, respectively, of stock based compensation expense was included in research and development expenses in connection with equity grants made to employees and consultants and approximately $5.5 million and $4.3 million, respectively, was included in general and administrative expenses in connection with grants made to employees, members of the board of directors and consultants.

 

Stock Options

 

The following table summarizes Fortress stock option activities excluding activity related to Fortress Companies:

 

   Number of
Shares
   Weighted
average exercise
price
   Total weighted
average intrinsic
value
   Weighted average
remaining
contractual life
(years)
 
Options vested and expected to vest at December 31, 2017   1,110,501   $3.78   $1,351,080    3.95 
Exercised                
Options vested and expected to vest at June 30, 2018   1,110,501   $3.78   $719,324    3.46 
Options vested and exercisable   1,085,501   $3.75   $719,324    3.43 

 

As of June 30, 2018, Fortress had no unrecognized stock-based compensation expense related to options.

 

Restricted Stock and Restricted Stock Units

 

The following table summarizes Fortress restricted stock awards and restricted stock units activities, excluding activities related to Fortress Companies:

 

   Number of Shares   Weighted average
grant price
 
Unvested balance at December 31, 2017   11,874,034   $2.63 
Restricted stock granted   1,392,856    3.99 
Restricted stock vested   (213,333)   2.76 
Restricted stock units granted   405,000    4.18 
Restricted stock units forfeited   (95,000)   3.49 
Restricted stock units vested   (130,584)   3.45 
Unvested balance at June 30, 2018   13,232,973   $2.80 

 

As of June 30, 2018, and 2017, the Company had unrecognized stock-based compensation expense related to restricted stock and restricted stock unit awards of approximately $12.4 million and $2.7 million, respectively, which is expected to be recognized over the remaining weighted-average vesting period of 2.9 years and 2.3 years, respectively

 

Warrants

 

The following table summarizes Fortress warrant activities, excluding activities related to Fortress Companies:

 

   Number of
Shares
   Weighted
average exercise
price
   Total weighted
average intrinsic
value
   Weighted average
remaining
contractual life
(years)
 
Outstanding as of December 31, 2017   2,774,189   $3.30   $2,204,530    4.47 
Granted                
Forfeited                
Outstanding as of June 30, 2018   2,774,189   $3.30   $96,600    3.97 
Exercisable as of June 30, 2018   869,189   $3.96   $96,600    3.56 

 

27

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Employee Stock Purchase Plan

 

Eligible employees can purchase the Company’s Common Stock at the end of a predetermined offering period at 85% of the lower of the fair market value at the beginning or end of the offering period. The ESPP is compensatory and results in stock-based compensation expense.

 

As of June 30, 2018, 289,359 shares have been purchased and 110,641 shares are available for future sale under the Company’s ESPP. Share-based compensation expense recorded was approximately $43,000 and $40,000, respectively for the three months ended June 30, 2018 and 2017, and was approximately $81,000 and $75,000, respectively, for the six months ended June 30, 2018 and 2017.

 

Capital Raises

 

Fortress

 

At the Market Offering

 

Pursuant to the terms of the Company’s Amended and Restated At Market Issuance Sales Agreement, or Sales Agreement, with B. Riley FBR, Inc. (“B. Riley,” f/k/a MLV & Co. LLC, and FBR Capital Markets & Co.) (the “ATM”), for the six month period ended June 30, 2018, the Company issued 1,130,835 shares of common stock at an average price of $3.60 per share for gross proceeds of $4.1 million. In connection with these sales, the Company paid aggregate fees of approximately $71,000 to B. Riley.

 

Fortress Companies

 

Checkpoint Therapeutics, Inc.

 

Checkpoint Public Offering of Common Stock

 

On March 12, 2018, Checkpoint closed an underwritten public offering in which it sold 5,290,000 shares of its common stock at a price of $4.35 per share for gross proceeds of approximately $23.0 million. Total net proceeds from this offering were approximately $20.8 million, net of underwriting discounts and estimated offering expenses of approximately $2.2 million. The shares were sold under a Registration Statement (No. 333-221493) on Form S-3, filed by Checkpoint with the Securities and Exchange Commission.

 

Approximately $77.0 million of the shelf remains available for sale under the Form S-3, following the March 12, 2018 offering. Checkpoint may offer the securities under the S-3 from time to time in response to market conditions or other circumstances if it believes such a plan of financing is in the best interests of its stockholders.

 

16.Commitments and Contingencies

 

Indemnification

 

In accordance with its certificate of incorporation, bylaws and indemnification agreements, the Company has indemnification obligations to its officers and directors for certain events or occurrences, subject to certain limits, while they are serving at the Company’s request in such capacity. There have been no claims to date, and the Company has director and officer insurance to address such claims. Pursuant to agreements with clinical trial sites, the Company provides indemnification to such sites in certain conditions.

 

Legal Proceedings – Fortress

 

In the ordinary course of business, the Company and its subsidiaries may be subject to both insured and uninsured litigation. Suits and claims may be brought against the Company by customers, suppliers, partners and/or third parties (including tort claims for personal injury arising from clinical trials of the Company’s product candidates and property damage) alleging deficiencies in performance, breach of contract, etc., and seeking resulting alleged damages.

 

28

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Dr. Falk Pharma, GmbH v. Fortress Biotech, Inc. (Frankfurt am Main Regional Court, Ref. No. 3-06 0 28/16). Dr. Falk Pharma, GmbH (“Dr. Falk Pharma”) and Fortress were among the parties to that certain Collaboration Agreement dated March 20, 2012, whereby they agreed to collaborate to develop a product for treatment of Crohn’s disease. A dispute arose between Dr. Falk Pharma and Fortress with respect to their relative rights and obligations under the Collaboration Agreement; specifically, Dr. Falk Pharma contended that it had fulfilled its contractual obligations to Fortress and is entitled to the final milestone payment due under the Collaboration Agreement - EUR 2.5 million. Fortress contended that no such payment is due because a condition of the EUR 2.5 million payment was the delivery of a Clinical Study Report that addressed the primary and secondary objectives of a Phase II trial, and Fortress contended that Dr. Falk Pharma failed to deliver such a Clinical Study Report. Dr. Falk Pharma filed a lawsuit against Fortress in the above-referenced Court in Frankfurt, Germany to recover the EUR 2.5 million plus interest and attorneys’ fees, and Fortress filed an answer to the complaint, denying that it had any liability to Dr. Falk Pharma. On July 27, 2017, Fortress received a judgment from the court in Frankfurt awarding the full amount (EUR 2.5 million) plus interest to Dr. Falk Pharma. Fortress appealed the decision to the Higher Regional Court of Frankfurt on August 28, 2017, and the initial response of Dr. Falk Pharma to the appeal was filed on February 16, 2018. At an appellate hearing in the Higher Regional Court on June 12, 2018, the court issued an oral ruling upholding the lower court’s judgment and indicating that an impending written, enforceable judgment would do the same. On July 12, 2018, the Higher Regional Court approved and recorded terms of settlement between Fortress and Dr. Falk Pharma pursuant to which Fortress will pay $3.3 million to Dr. Falk Pharma over the course of a year, and approximately $37,000 to the court in mandated administrative fees.

 

Litigation and Regulatory Matters - National

 

National is a defendant or respondent in various pending and threatened arbitrations, administrative proceedings and lawsuits seeking compensatory damages. Several cases have no stated alleged damages. Claim amounts are infrequently indicative of the actual amounts National will be liable for, if any. Further, National has a history of collecting amounts awarded in these types of matters from its brokers that are still affiliated, as well as from those that are no longer affiliated. Many of these claimants also seek, in addition to compensatory damages, punitive or treble damages, and all seek interest, costs and fees. These matters arise in the normal course of business. National intends to vigorously defend itself in these actions, and the ultimate outcome of these matters cannot be determined at this time.

 

Liabilities for potential losses from complaints, legal actions, government investigations and proceedings are established where the National believes that it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. In making these decisions, management bases its judgments on its knowledge of the situations, consultations with legal counsel and its historical experience in resolving similar matters. In many lawsuits, arbitrations and regulatory proceedings, it is not possible to determine whether a liability has been incurred or to estimate the amount of that liability until the matter is close to resolution. However, accruals are reviewed regularly and are adjusted to reflect the National’s estimates of the impact of developments, rulings, advice of counsel and any other information pertinent to a particular matter. Because of the inherent difficulty in predicting the ultimate outcome of legal and regulatory actions, management cannot predict with certainty the eventual loss or range of loss related to such matters. At March 31, 2018 and September 30, 2017, the National accrued approximately $1.7 million and $2.4 million, respectively. These amounts are included in accounts payable and accrued expenses in the condensed consolidated statements of financial condition. Amounts charged to operations for settlements and potential losses during the three months ended March 31, 2018 and 2017 were $0.4 million and $1.0 million, respectively, which is included in other administrative expenses. Amounts charged to operations for settlements and potential losses during the six months ended March 31, 2018 and 2017 were $0.7 million and $1.0 million, respectively, which is included in other administrative expenses. National has included in "Professional fees" litigation and FINRA related expenses of $0.0 million and $0.3 million for the three months ended March 31, 2018 and 2017, respectively. National has included in "Professional fees" litigation and FINRA related expenses of $0.3 million and $0.8 million for the six months ended March 31, 2018 and 2017, respectively.

 

17.Related Party Transactions

 

Other Related Parties

 

The Company’s Chairman, President and Chief Executive Officer, individually and through certain trusts over which he has voting and dispositive control, beneficially owned approximately 13.7% of the Company’s issued and outstanding Common Stock as of June 30, 2018. The Company’s Executive Vice Chairman, Strategic Development owns approximately 16.0% of the Company’s issued and outstanding Common Stock at June 30, 2018.

 

National Holdings Corporation

 

The Company maintains a controlling interest in National Holdings Corporation, a diversified independent brokerage company.  One of National’s subsidiaries, National Securities Corporation, is an independent broker-dealer offering retail and institutional advisory, investment, insurance and tax planning services. From time to time, NSC provides services to the Company and its affiliates.

 

29

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Shared Services Agreement with TGTX

 

TGTX and the Company entered into an arrangement to share the cost of certain research and development employees. The Company’s Executive Vice Chairman, Strategic Development, is Executive Chairman and Interim Chief Executive Officer of TGTX. Under the terms of the Agreement, TGTX will reimburse the Company for the salary and benefit costs associated with these employees based upon actual hours worked on TGTX related projects. For the three months ended June 30, 2018 and 2017, the Company invoiced TGTX $0.7 million and $0.4 million, respectively. For the six months ended June 30, 2018 and 2017, the Company invoiced TGTX $1.0 million and $0.6 million, respectively. At June 30, 2018, the amount receivable from TGTX related to this arrangement approximated $0.4 million.

 

Desk Space Agreements with TGTX and OPPM

 

In connection with the Company’s Desk Space Agreements with TGTX and Opus Point Partners Management, LLC (“OPPM”), as of June 30, 2018, the Company had paid $0.6 million in rent under the Desk Space Agreements, and invoiced OPPM and TGTX approximately $42,000 and $0.3 million, respectively, for their prorated share of the rent base. In addition, for the six months ended June 30, 2018, the Company had incurred approximately $96,000 in connection with the build out of the space and recorded a receivable of $43,000 due from TGTX and $10,000 due from OPPM. At June 30, 2018, the amount due from TGTX approximated $0 and the amount due from OPPM approximated $94,000.

 

Opus Credit Facility

 

On March 12, 2018, the Company and OPHIF amended and restated the Opus Credit Facility (the “A&R Opus Credit Facility”). The A&R Opus Credit Facility extends the maturity date of the notes issued under the Opus Credit Facility from September 14, 2018 by one year to September 14, 2019. The A&R Opus Credit Facility also permits the Company to make portions of interest and principal repayments in the form of shares of the Company’s common stock and/or in common stock of the Company’s publicly-traded subsidiaries, subject to certain conditions. Fortress retains the ability to prepay the Notes at any time without penalty. The notes payable under the A&R Opus Credit Facility continue to bear interest at 12% per annum (see Note 11). For the six months ended June 30, 2018 and 2017, the Company paid $0.3 million and $0.5 million, respectively. The Q2 interest payment due May 31, 2018 will be paid in stock, the shares were recorded as shares issuable as of June 30, 2018.

 

Checkpoint Public Offering of Common Stock

 

NSC, a subsidiary of National (of which the Company owns 56.3%), served as the sole book running manager in connection with Checkpoint’s 2018 equity offering, which closed on March 12, 2018. As the Sole Book Running Manager, NSC received a fee of approximately $1.8 million, or 8% on the gross proceeds raised of $23.0 million. The fees were eliminated in consolidation.

 

Mustang Option on Collaboration Agreement with TGTX

 

On February 2, 2018, Mustang entered into an Option Agreement the (“TGTX Mustang Option”) with TG Therapeutics, Inc. (“TGTX”), a related party, whereby TGTX was granted the option to enter into a global collaboration on the joint development and commercialization of product candidates pertaining to Mustang’s CD20 license agreement with the Fred Hutchinson Cancer Research Center. In consideration of the TGTX Mustang Option, TGTX paid an option fee of $50,000, which was recorded by Mustang as Collaboration Revenue Related Party in the Condensed Consolidated Statement of Operations. The TGTX Option expired on August 1, 2018 without action. Mr. Weiss, the Company’s Executive Vice Chairman, Strategic Development, serves as the Chief Executive Officer of TGTX.

 

2018 Venture Notes

 

For the six-month period ended March 31, 2018, the Company raised approximately $21.7 million in promissory notes. National Securities Corporation (“NSC”), a wholly-owned subsidiary of National, and a related party as a result of the Company’s ownership of National, acted as the sole placement agent for the 2018 Venture Notes. The Company paid NSC a fee of $1.7 million during the six months ended June 30, 2018, in connection with the 2018 Venture Notes. At June 30, 2018, the fee, which was recorded as debt discount on the Company’s Condensed Consolidated Balance Sheet and will be amortized over the life of the 2018 Venture Notes, was eliminated in consolidation.

 

30

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Founders Agreement

 

The Company has entered into Founders Agreements and, in some cases, Exchange Agreements with certain of its subsidiaries as described in the Company’s Form 10-K for the year ended December 31, 2017, filed with the SEC on March 16, 2018. The following table summarizes, by subsidiary, the effective date of the Founders Agreements and PIK dividend or equity fee payable to the Company in accordance with the terms of the Founders Agreements, Exchange Agreements and the subsidiaries’ certificates of incorporation.

 

Fortress Company  Effective Date (1)  PIK Dividend as a % of
fully diluted outstanding
capitalization
   Class of Stock Issued
Helocyte  March 20, 2015   2.5%  Common Stock
Avenue  February 17, 2015   2.5%  Common Stock
Mustang  March 13, 2015   2.5%  Common Stock
Checkpoint  March 17, 2015   0.0%(2)  Common Stock
Cellvation  October 31, 2016   2.5%  Common Stock
Caelum  January 1, 2017   2.5%  Common Stock
Cyprium  March 13, 2017   2.5%  Common Stock
Aevitas  July 28, 2017   2.5%  Common Stock
Tamid  November 30, 2017 (3)   2.5%  Common Stock

 

(1) Represents the effective date of each subsidiary’s Founders Agreement. Each PIK dividend and equity fee is payable on the annual anniversary of the effective date of the original Founders Agreement.

 

(2) Instead of a PIK dividend, Checkpoint pays the Company an annual equity fee in shares of Checkpoint’s common stock equal to 2.5% of Checkpoint’s fully diluted outstanding capitalization.

 

(3) Represents the Trigger Date.

 

Management Services Agreements

 

The Company has entered in Management Services Agreements (the “MSAs”) with certain of its subsidiaries as described in the Company’s Form 10-K for the year ended December 31, 2017, filed with the SEC on March 16, 2018. The following table summarizes, by subsidiary, the effective date of the MSA and the annual consulting fee payable by the subsidiary to the Company in quarterly installments:

 

Fortress Company  Effective Date  Annual MSA Fee (Income)/Expense 
Helocyte  March 20, 2015  $500 
Avenue (1)  February 17, 2015   500 
Mustang  March 13, 2015   500 
Checkpoint  March 17, 2015   500 
Cellvation  October 31, 2016   500 
Caelum  January 1, 2017   500 
Cyprium  March 13, 2017   500 
Aevitas  July 28, 2017   500 
Tamid  November 30, 2017   500 
Fortress      (4,500)
Consolidated (Income)/Expense     $ 

 

31

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

National

 

On June 12, 2018, Michael S. Weiss, the Company’s Executive Vice Chairman, Strategic Development, retired from his position on the National board of directors. As of June 30, 2018, the Company owns approximately 56.3% of National.

 

Additionally, the Company’s Chairman, President and Chief Executive Officer and the Company’s Executive Vice Chairman, Strategic Development are both Co-Portfolio Managers and Partners of OPPM, which owns approximately [4.6%] of National. In the normal course, National has occasionally provided the Company and the Company’s subsidiaries with placement agent services in connection with third party raises. These fees are eliminated in consolidation.

 

18.Net Capital Requirements of Broker-Dealer Subsidiaries

 

NSC is subject to the SEC’s Uniform Net Capital Rule (Rule 15c3-1) (the “Rule”), which, among other things, requires the maintenance of minimum net capital. At March 31, 2018, National Securities had net capital of $11.9 million which was $10.9 million in excess of its required net capital of $1,000,000. National Securities is exempt from the provisions of the SEC’s Rule 15c3-3 since it is an introducing broker-dealer that clears all transactions on a fully disclosed basis and promptly transmits all customer funds and securities to clearing brokers.

 

Advances, dividend payments and other equity withdrawals from the Company’s broker-dealer subsidiaries are restricted by the regulations of the SEC, and other regulatory agencies. These regulatory restrictions may limit the amounts that a subsidiary may dividend or advance to the Company.

 

19.Off Balance Sheet Risk and Concentrations of Credit Risk

 

National is engaged in trading and providing a broad range of securities brokerage and investment services to a diverse group of retail and institutional clientele, as well as corporate finance and investment banking services to corporations and businesses. Counterparties to National’s business activities include broker-dealers and clearing organizations, banks and other financial institutions. National uses clearing brokers to process transactions and maintain customer accounts for National on a fee basis. National permits the clearing firms to extend credit to its clientele secured by cash and securities in the client’s account. National’s exposure to credit risk associated with the non-performance by its customers and counterparties in fulfilling their contractual obligations can be directly impacted by volatile or illiquid trading markets, which may impair the ability of customers and counterparties to satisfy their obligations to National. National has agreed to indemnify the clearing brokers for losses they incur while extending credit to National’s clients. It is National’s policy to review, as necessary, the credit standing of its customers and counterparties. Amounts due from customers that are considered uncollectible by the clearing broker are charged back to National by the clearing broker when such amounts become determinable. Upon notification of a charge back, such amounts, in total or in part, are then either (i) collected from the customers, (ii) charged to the broker initiating the transaction and/or (iii) charged to operations, based on the particular facts and circumstances.

 

National maintains cash in bank deposits, which, at times, may exceed federally insured limits. National has not experienced and does not expect to experience losses on such accounts.

 

A short sale involves the sale of a security that is not owned in the expectation of purchasing the same security (or a security exchangeable) at a later date at a lower price. A short sale involves the risk of a theoretically unlimited increase in the market price of the security that would result in a theoretically unlimited loss.

 

20.Segment Information

 

The Company operates in three reportable segments, Dermatology Product Sales, Pharmaceutical and Biotechnology Product Development and National. The accounting policies of the Company’s segments are the same as those described in Note 2. The following tables summarize, for the periods indicated, operating results by reportable segment:

 

32

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Cost of goods sold is directly related to product sales only. Revenues derived from co-promote revenue had no cost of goods sold.

 

($ in thousands)
Three Months Ended June 30, 2018
  Dermatology
Products
Sales
   Pharmaceutical
and
Biotechnology
Product
Development
   National   Consolidated 
Net Revenue  $6,689    126   $57,019   $63,834 
Direct cost of goods   (1,668)           (1,668)
Sales and marketing costs   (2,910)           (2,910)
Research and development       (17,489)       (17,489)
General and administrative   (383)   (9,763)       (10,146)
National expenses           (56,218)   (56,218)
Segment income (loss) from operations   1,728    (27,126)   801    (24,597)
Segment assets  $11,307   $159,763    65,796   $236,866 

 

($ in thousands)
Three Months Ended June 30, 2017
  Dermatology
Products
Sales
   Pharmaceutical
and
Biotechnology
Product
Development
   National   Consolidated 
Net Revenue  $4,054   $350   $46,293   $50,697 
Direct cost of goods   (878)           (878)
Sales and marketing costs   (2,610)           (2,610)
Research and development       (13,483)       (13,483)
General and administrative   (293)   (8,231)       (8,524)
National expenses           (48,395)   (48,395)
Segment loss from operations   273    (21,364)   (2,102)   (23,193)
Segment assets  $5,447   $167,787   $76,612   $249,846 

 

($ in thousands)
Six Months Ended June 30, 2018
  Dermatology
Products
Sales
   Pharmaceutical
and
Biotechnology
Product
Development
   National   Consolidated 
Net Revenue  $12,198   $520   $106,541   $119,259 
Direct cost of goods   (3,140)           (3,140)
Sales and marketing costs   (5,670)           (5,670)
Research and development       (42,544)       (42,544)
General and administrative   (783)   (20,151)       (20,934)
National expenses           (107,054)   (107,054)
Segment loss from operations  $2,605    (62,175)  $(513)  $(60,083)
Segment assets  $11,307    159,763   $65,796   $236,866 

 

($ in thousands)
Six Months Ended June 30, 2017
  Dermatology
Products
Sales
   Pharmaceutical
and
Biotechnology
Product
Development
   National   Consolidated 
Net Revenue  $6,139   $1,043   $88,197   $95,379 
Direct cost of goods   (1,347)   -    -    (1,347)
Sales and marketing costs   (4,877)   -    -    (4,877)
Research and development       (21,887)   -    (21,887)
General and administrative   (612)   (15,897)   -    (16,509)
National expenses   -    -    (91,529)   (91,529)
Segment income (loss) from operations  $(697)  $(36,741)  $(3,332)  $(40,770)
Segment assets  $5,447   $167,787   $76,612   $249,846 

 

33

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

21.Revenues from Contracts and Significant Customers

 

Fortress

 

On January 1, 2018, the Company adopted Topic 606 applying the modified retrospective method to all contracts that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 were presented under Topic 606, while prior period amounts were not adjusted and reported under the accounting standards in effect for the prior periods.

 

Impact to Journey Medical Product Sales

 

Topic 606 does not generally change the practice under which the Company recognizes product revenue from sales of Targadox®, Luxamend® and Ceracade®. The Company’s performance obligation to deliver products is satisfied at the point in time that the goods are delivered to the customer, which is when the customer obtains title to and has the risks and rewards of ownership of the products.

 

The Company’s contracts include variable consideration in the form of refunds for rights of return, price protection, and consideration payable to the customer. As such, for the three months ended June 30, 2018 and 2017, the Company recorded a return reserve of $0.7 million and $0.3 million, respectively. The Company estimates variable consideration using a percentage of sales approach. Under this method, the transaction price is constrained for the potential future returns and consideration payable to the customer because it is not probable that a significant reversal in the amount of cumulative revenue recognized will not occur.

 

Because the Company’s agreements for sales of product to its distributors can be cancelled early, prior to the termination date, they are deemed to have an expected duration of one year or less, and as such, the Company has elected the practical expedient in ASC 606-10-50-14(a) to not disclose information about its remaining performance obligations.

 

Checkpoint

 

Impact to Checkpoint’s Collaboration and License Agreement Revenues

 

Collaboration Agreement with TGTX related to Dana-Farber License

 

In connection with Checkpoint’s license agreement with Dana-Farber, Checkpoint entered into a collaboration agreement with TGTX, a related party, to develop and commercialize the anti-PD-Ll and anti-GITR antibody research programs in the field of hematological malignancies, while the Company retains the right to develop and commercialize these antibodies in the field of solid tumors. Michael Weiss, Chairman of the Board of Directors of Checkpoint and Fortress’ Executive Vice Chairman, Strategic Development, is also the Executive Chairman, President and Chief Executive Officer and a stockholder of TGTX. Under the terms of the collaboration agreement, TGTX paid Checkpoint $0.5 million, representing an upfront licensing fee, and the Checkpoint is eligible to receive substantive potential milestone payments up to an aggregate of approximately $21.5 million for each product upon TGTX’s successful achievement of certain clinical development, regulatory and first commercial sale milestones. This is comprised of up to approximately $7.0 million upon TGTX’s successful completion of clinical development milestones, and up to approximately $14.5 million upon first commercial sales in specified territories. In addition, Checkpoint is eligible to receive up to an aggregate of $60.0 million upon TGTX’s successful achievement of certain sales milestones based on aggregate net sales, in addition to royalty payments based on a tiered high single digit percentage of net sales. Following the second anniversary of the effective date of the agreement, Checkpoint receives an annual license maintenance fee, which is creditable against milestone payments or royalties due to Checkpoint. For the three months ended June 30, 2018 and 2017, the Company recognized approximately $0 and $9,000, respectively, in revenue from Checkpoint’s collaboration agreement with TGTX in the Condensed Consolidated Statements of Operations. For the six months ended June 30, 2018 and 2017, the Company recognized approximately $44,000 and $38,000, respectively, in revenue from Checkpoint’s collaboration agreement with TGTX in the Condensed Consolidated Statements of Operations.

 

34

 

 

FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Collaboration Agreement with TGTX related to Jubliant License

 

In connection with Checkpoint’s license agreement with Jubilant, Checkpoint entered into a sublicense agreement with TGTX, a related party, to develop and commercialize the compounds licensed in the field of hematological malignancies, while the Company retains the right to develop and commercialize these compounds in the field of solid tumors. Michael Weiss, Chairman of the Board of Directors of Checkpoint and Fortress’ Executive Vice Chairman, Strategic Development, is also the Executive Chairman, President and Chief Executive Officer and a stockholder of TGTX. Under the terms of the Sublicense Agreement, TGTX paid Checkpoint $1.0 million, representing an upfront licensing fee, and Checkpoint is eligible to receive substantive potential milestone payments up to an aggregate of approximately $87.2 million upon TGTX’s successful achievement of clinical development and regulatory milestones. This is comprised of up to approximately $25.5 million upon TGTX’s successful completion of three clinical development milestones for two licensed products, and up to approximately $61.7 million upon the achievement of five regulatory approvals and first commercial sales in specified territories for two licensed products. In addition, Checkpoint is eligible to receive potential milestone payments up to an aggregate of $89.0 million upon TGTX’s successful achievement of certain sales milestones based on aggregate net sales by TGTX, for two licensed products, in addition to royalty payments based on a mid-single digit percentage of net sales by TGTX. TGTX also pays Checkpoint 50% of IND enabling costs and patent expenses. For the three months ended June 30, 2018 and 2017, Checkpoint recognized approximately $0.1 million and $0.1 million, respectively, in revenue related to the sublicense agreement in the condensed consolidated statements of operations. For the six months ended June 30, 2018 and 2017, Checkpoint recognized approximately $0.4 million and $0.6 million, respectively, in revenue related to the sublicense agreement in the condensed consolidated statements of operations.

 

Sponsored Research Collaboration with NeuPharma, Inc. and TGTX

 

In connection with Checkpoint’s license agreement with NeuPharma, Inc. (“Neupharma”) Checkpoint entered into a Sponsored Research Agreement with NeuPharma for certain research and development activities. Effective January 11, 2016, TGTX agreed to assume all costs associated with this Sponsored Research Agreement and paid Checkpoint for all amounts previously paid. This assumption of costs by TGTX survives any termination or expiration of the option agreement. For the three months ended June 30, 2018 and 2017, Checkpoint recognized approximately nil and $0.2 million, respectively, in revenue in connection with the Sponsored Research Agreement in the Condensed Statements of Operations. For the six months ended June 30, 2018 and 2017, the Company recognized approximately $31,000 and $0.4 million, respectively, in revenue in connection with the Sponsored Research Agreement in the condensed consolidated statements of operations.

 

The collaborations described above with TGTX each contain a single material performance obligation under Topic 606, which is the granting of a license that is functional intellectual property. Checkpoint’s performance obligation is satisfied at the point in time when the customer has the ability to use and benefit from the right to use the intellectual property.

 

The milestone payments are based on successful achievement of clinical development, regulatory, and sales milestones. Because these payments are contingent on the occurrence of a future event, they represent variable consideration and are constrained and included in the transaction price only when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. The sales based royalty payments are recognized as revenue when the subsequent sales occur. Checkpoint also receives variable consideration for certain research and development and patent maintenance related activities that are dependent upon Checkpoint’s actual expenditures under the collaborations and are constrained and included in the transaction price only when it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur. Revenue is recognized approximately when the amounts become due because it relates to an already satisfied performance obligation. For the six months ended June 30, 2018, Checkpoint did not receive any milestone or royalty payments.

 

Disaggregation of Total Revenues

 

The Company has three marketed products, Targadox®, Luxamend® and Ceracade. Substantially all of the Company’s product revenues are recorded in the U.S. Substantially all of the Company’s collaboration revenues are from its collaboration with TGTX. Revenues by product and collaborator are summarized as follows (in thousands):

 

   Three months ended
June 30, 2018
   Six months ended
June 30, 2018
 
Targadox®  $6,363   $11,861 
Other branded revenue   326    337 
Total product revenues  $6,689   $12,198 
TGTX   126    520 
Total Revenue  $6,815   $12,718 

 

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FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Contract Balances and Performance Obligations

 

The Company recognized collaboration and license agreement revenues of $0.1 million and $0.5 million during the three and six months ended June 30, 2018, respectively, that were included in the deferred revenue balance as of January 1, 2018.

 

Significant Customers

 

For the three months ended June 30, 2018, two of the Company’s Dermatology Products customers each accounted for more than 10.0% of its total gross product revenue in the amount of $11.5 million and $2.4 million. For the three months ended June 30, 2017, two of the Company’s Dermatology Products customers each accounted for more than 10.0% of its total gross revenue in the amount of $4.2 million and $2.2 million. The revenue from these customers is captured in the product revenue, net line item within the Condensed Consolidated Statement of Operations.

 

For the six months ended June 30, 2018, three of the Company’s Dermatology Products customers each accounted for more than 10.0% of its total gross product revenue in the amount of $11.5 million and $6.9 million and $5.1 million. For the six months ended June 30, 2017, two of the Company’s Dermatology Products customers each accounted for more than 10.0% of its total gross revenue in the amount of $5.3 million and $3.8 million. The revenue from these customers is captured in the product revenue, net line item within the Condensed Consolidated Statement of Operations.

 

At June 30, 2018, two of the Company’s Dermatology Products customers each accounted for more than 10.0% of its total accounts receivable balance in the amount of $3.9 million and $1.0 million, respectively.

 

At June 30, 2017, two of the Company’s Dermatology Products customers each accounted for more than 10.0% of its total accounts receivable balance in the amount of $2.1 million and $0.7 million, respectively.

 

Net Revenue from Pharmaceutical and Biotechnology Product Development represents collaboration revenue from TGTX in connection with Checkpoint and Mustang, which is classified as related party revenue.

 

National Revenue Recognition with Customers

 

National recognizes revenue from contracts with customers when, or as, National satisfies its performance obligations by transferring the promised goods or services to the customers. A good or service is transferred to a customer when, or as, the customer obtains control of that good or service. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized by measuring progress in satisfying the performance obligation in a manner that depicts the transfer of the goods or services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that National determines the customer obtains control over the promised good or service. The amount of revenue recognized reflects the consideration National expects to be entitled to in exchange for those promised goods or services (i.e., the “transaction price”). In determining the transaction price, National considers multiple factors, including the effects of variable consideration. Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainties with respect to the amount are resolved. In determining when to include variable consideration in the transaction price, the Company considers the range of possible outcomes, the predictive value of past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of influence, such as market volatility or the judgment and actions of third parties.

 

The following provides detailed information on the recognition of National’s revenues from contracts with customers:

 

Commissions and Other Fees. National earns commission revenue based on the execution of transactions for clients primarily in equity and equity-related products. Trade execution, when provided together, represent a single performance obligation as the services are not separately identifiable in the context of the contract. Commission revenues are recognized at a point in time on trade-date. Commission revenues are generally paid on settlement date and National records a receivable between trade-date and payment on settlement date.

 

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FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Investment Banking. National provides clients with a full range of investment banking services. Investment banking services include underwriting and placement agent services in both the equity and debt, including private equity placements, initial public offerings, follow-on offerings and equity-linked convertible securities transactions and private debt. Underwriting and placement agent revenues are recognized at a point in time on trade-date, as the client obtains the control and benefit of the investment banking offering at that point. Costs associated with investment banking transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded and are recorded on a gross basis within Underwriting costs in the Condensed Consolidated Statements of Operations as National is acting as a principal in the arrangement. Any expenses reimbursed by National’s clients are recognized as Investment banking revenues.

 

National’s revenues from advisory services primarily consist of fees generated in connection with mergers and acquisition and advisory transactions. Advisory fees from mergers and acquisitions engagements are recognized at a point in time when the related transaction is completed, as the performance obligation is to successfully execute a specific transaction. Fees received prior to the completion of the transaction are deferred within other liabilities on the Condensed Consolidated Balance Sheets. A significant portion of the fees National receives for advisory services are considered variable as they are contingent upon a future event and are excluded from the transaction price until the uncertainty associated with the variable consideration is subsequently resolved, which is expected to occur upon achievement of the specified milestone. Payment for advisory services is generally due promptly upon completion of a specified milestone or, for retainer fees, periodically over the course of the engagement. National recognizes a receivable between the date of completion of the milestone and payment by the customer. Expenses associated with investment banking advisory engagements are deferred only to the extent they are explicitly reimbursable by the client and the related revenue is recognized at a point in time. All other investment banking advisory related costs are expensed as incurred. All investment banking advisory expenses are recognized within their respective expense category on the Condensed Consolidated Statements of Operations and any expenses reimbursed by the clients are recognized as Investment banking revenues.

 

Asset Management Fees. National receives management and performance fees in connection with investment advisory services provided to various funds and accounts, which are satisfied over time and measured using a time elapsed measure of progress as the customer receives the benefits of the services evenly throughout the term of the contract. Management and performance fees are considered variable as they are subject to fluctuation (e.g., changes in assets under management, market performance) and/ or are contingent on a future event during the measurement period (e.g., meeting a specified benchmark) and are recognized only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Management fees are generally based on month-end assets under management or an agreed upon notional amount and are included in the transaction price at the end of each month when the assets under management or notional amount is known. Performance fees are received when the return on assets under management for a specified performance period exceed certain benchmark returns, “high-water marks” or other performance targets. The performance period related to performance fees is annual, semiannual or at the recognition of a liquidation event. Accordingly, performance fee revenue will generally be recognized only at the end of the performance period to the extent that the benchmark return has been met.

 

Disaggregation of Revenue

 

The following presents National’s revenues from contracts with customers disaggregated by major business activity for the three months ended June 30, 2018:

 

($ in thousands)  For the Three
Months Ended
June 30, 2018
   For the Six
Months Ended
June 30, 2018
 
Revenues from customer contracts:          
Commissions  $31,407   $57,025 
Investment banking:          
Underwriting   6,893    9,593 
Private placement   3,484    13,299 
Advisory   833    2,147 
Other   (4)   156 
Sub-total National revenue from contracts with customers   42,613    82,220 
Other National revenue   14,406    24,321 
Total National revenue  $57,019   $106,541 

 

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FORTRESS BIOTECH, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Information on Remaining Performance Obligations and Revenue Recognized from Past Performance

 

National does not disclose information about remaining performance obligations pertaining to contracts that have an original expected duration of one year or less. The transaction price allocated to remaining unsatisfied or partially unsatisfied performance obligations with an original expected duration exceeding one year was not material at March 31, 2018. Investment banking advisory fees that are contingent upon completion of a specific milestone are also excluded as the fees are considered variable and not included in the transaction price at March 31, 2018.

 

Contract Balances

 

The timing of National’s revenue recognition may differ from the timing of payment by customers. National records a receivable when revenue is recognized prior to payment and the Company has an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, National records deferred revenue until the performance obligations are satisfied.

 

Contract Costs

 

Incremental contract costs are expensed when incurred when the amortization period of the asset that would have been recognized is one year or less; otherwise, incremental contract costs are recognized as an asset and amortized over time as services are provided to a customer.

 

22.Income taxes

 

The Company and its subsidiaries are subject to US federal and state income taxes. Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. 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 their respective tax bases and operating loss and tax credit carry-forwards. 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 income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance when, in the opinion of Management, it is more likely than not that some portion, or all, of the deferred tax asset will not be realized.

 

The Company files a consolidated income tax return with subsidiaries for which the Company has an 80% or greater ownership interest. Subsidiaries for which the Company does not have an 80% or more ownership are not included in the Company’s consolidated income tax group and file their own separate income tax return. As a result, certain corporate entities included in these financial statements are not able to combine or offset their taxable income or losses with other entities’ tax attributes.

 

Income tax expense for the six months ended June 30, 2018 and 2017 is based on the estimated annual effective tax rate. The Company has recorded $1.4 million and nil income tax expense to reflect National’s estimated current income tax expense for the three and six months ended June 30, 2018. No income tax expense was recorded in 2017.

 

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

 

Forward-Looking Statements

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our consolidated financial statements and the related notes included elsewhere in this Form 10-Q. Our consolidated financial statements have been prepared in accordance with U.S. GAAP. The following discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,” “may,” “plan”, “seek” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof and we assume no obligation to update any such forward-looking statements. Our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially, from those projected in the forward-looking statements. In evaluating our business, you should carefully consider the information set forth under the heading “Risk Factors” herein and in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Overview

 

Fortress Biotech, Inc. (“Fortress” or the “Company”) is a biopharmaceutical company dedicated to acquiring, developing and commercializing novel pharmaceutical and biotechnology products. Fortress develops and commercializes products both within Fortress and through certain of our subsidiary companies, also referred to herein as the “Fortress Companies.” Additionally, the Company maintains a controlling interest in National Holdings Corporation, a diversified independent brokerage company (together with its subsidiaries, herein referred to as “NHLD” or “National”). In addition to its internal development programs, the Company leverages its biopharmaceutical business expertise and drug development capabilities and provides funding and management services to help the Fortress Companies achieve their goals. The Company and the Fortress Companies may seek licensings, acquisitions, partnerships, joint ventures and/or public and private financings to accelerate and provide additional funding to support their research and development programs.

 

Business Strategy

 

Our business approach is designed for maximum flexibility, allowing us to invest in a broad array of new technologies with clinical and commercial potential. It enables us to move quickly to take advantage of time-sensitive opportunities when necessary and provides us with a range of options that allow us to select what we believe is the most advantageous corporate or financial structure for each drug candidate. We seek to acquire and invest in drugs, technologies and operating subsidiaries with high growth potential.

 

At June 30, 2018, in addition to National, we had several consolidated Fortress Companies, which contain licenses to product candidate intellectual property, including Aevitas Therapeutics, Inc. (“Aevitas”), Avenue Therapeutics, Inc. (“Avenue”), Caelum Biosciences, Inc. (“Caelum”), Cellvation, Inc. (“Cellvation”), Checkpoint Therapeutics, Inc. (“Checkpoint”), Cyprium Therapeutics, Inc. (“Cyprium”), Helocyte, Inc. (“Helocyte”), Journey Medical Corporation (“Journey” or “JMC”), Mustang Bio, Inc. (“Mustang”), and Tamid Bio, Inc. (“Tamid”). We also have operational subsidiaries CB Securities Corporation, Immune Limited and FBIO Acquisition, Inc. (the acquisition vehicle we used to obtain National) and acquisition companies for which we are actively seeking product candidate licenses, including Coronado SO Co., Escala Therapeutics, Inc., GeneXion Oncology, Inc., Fortress Biotech China, Inc., FBIO Acquisition Corp. IV and FBIO Acquisition Corps. VI - XIV.

 

Avenue

 

In May 2018, Avenue announced that its first pivotal Phase 3 trial of IV tramadol achieved the primary endpoint of a statistically significant improvement in Sum of Pain Intensity Difference over 48 hours (SPID48) compared to placebo in patients with moderate to moderately severe postoperative pain following bunionectomy surgery. In addition, the trial met its key secondary endpoints and demonstrated a clear dose response. Avenue plans to initiate a second pivotal Phase 3 trial of IV tramadol in patients following abdominoplasty surgery in the second half of 2018.

 

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Caelum

 

On June 25, 2018, Caelum announced a complete analysis of cardiac data from Columbia University’s (“Columbia”) Phase 1b trial that supports CAEL-101’s (mAb 11-1F4) potential to improve myocardial function as assessed by global longitudinal strain (“GLS”) and generate a sustained decrease in N-terminal pro-brain natriuretic peptide (NTproBNP) levels in amyloid light chain (“AL”) amyloidosis patients experiencing cardiac involvement. These data were presented at the American Society of Echocardiography (ASE) 29th Annual Scientific Sessions.

 

Checkpoint

 

In April 2018, Checkpoint presented preclinical data on its BET inhibitor CK-103 at the American Association for Cancer Research Annual Meeting. CK-103 demonstrated combinatorial effects in an in vivo model with anti-PD-1 antibodies, which may support the development of CK-103 as an anti-cancer agent alone and in combination with Checkpoint’s anti-PD-L1 antibody CK-301.

 

Cyprium

 

On July 2, 2018, Cyprium announced that it had been granted Fast Track Designation by the U.S. Food and Drug Administration (“FDA”) for its Copper Histidinate, also referred to as CUTX-101, for patients diagnosed with classic Menkes disease who have not demonstrated significant clinical progression. The FDA's Fast Track program facilitates the development of drugs intended to treat serious conditions and that have the potential to address unmet medical needs.

 

Mustang

 

In July 2018, Mustang announced that it has completed a pre-Investigational New Drug (pre-IND) meeting with the FDA for MB-102 (CD123 CAR T). MB-102 is a CAR T therapy in development for the treatment of acute myeloid leukemia (AML), blastic plasmacytoid dendritic cell neoplasm (BPDCN) and high-risk myelodysplastic syndrome (MDS). Mustang will continue its efforts on its IND filing to the FDA for MB-102, which Mustang expect to file the IND in the fourth quarter of 2018. In addition, Mustang anticipates that their manufacturing facility will be ready to process patient cells in the second half of 2018, which will help enable initiation of Mustang’s Phase 1/2 clinical trial of MB-102 in AML, BPDCN and MDS to begin in 2019.

 

On June 22, 2018, Mustang announced the opening of its CAR T cell therapy manufacturing facility at UMass Medicine Science Park in Worcester, Mass; the facility will support the clinical development and commercialization of Mustang’s CAR T product candidates and enable proprietary cell therapy research.

 

Also, in June, Mustang announced that the company has been added to the Russell 2000®, 3000® and Microcap® Indexes, effective after U.S. market close on Friday, June 22, 2018, following Russell’s annual reconstitution of its U.S. and global equity indexes.

 

In May 2018, Mustang announced the publication of preclinical data demonstrating that glioblastoma (GBM)-targeted CD4+ CAR T cells mediate superior antitumor activity over CD8+ CAR T cells. The results were published in the May 17, 2018, edition of JCI Insight, a peer-reviewed journal of the American Society for Clinical Investigation. Mustang licensed the IL13Rα2-specific CAR (MB-101) technology used in this preclinical study from the City of Hope.

 

Reportable Business Segments

 

For presentation purposes, Results of Operations is presented on a detailed revenue and expense basis rather than on a reportable business segment basis. Our operations are subject to wide fluctuations due to our early stage of development. The following provides a summary of revenues and expenses for the periods presented.

 

Results of Operations

 

General

 

For the six months ended June 30, 2018, we generated $119.3 million of net revenue, of which $106.5 million of revenue relates to National, $0.5 million of revenue is in connection with Checkpoint and Mustang’s collaborative agreements with TGTX and $12.2 million of revenue relates primarily to the sale of Journey branded and generic products. At June 30, 2018, we had an accumulated deficit of $354.8 million. While we may in the future generate revenue from a variety of sources, including license fees, milestone payments, research and development payments in connection with strategic partnerships and/or product sales, our and our subsidiaries’ current product candidates are at an early stage of development and may never be successfully developed or commercialized. Accordingly, we expect to continue to incur substantial losses from operations for the foreseeable future, and there can be no assurance that we will ever generate significant revenues.

 

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For the six months ended June 30, 2018, we had $3.1 million of costs of goods sold in connection with the sale of JMC branded and generic products, compared to $1.3 million for the six months ended June 30, 2017.

 

Research and Development Expenses

 

Research and development costs primarily consist of personnel related expenses, including salaries, benefits, travel, and other related expenses, stock-based compensation, payments made to third parties for license and milestone costs related to in-licensed products and technology, payments made to third party contract research organizations for preclinical and clinical studies, investigative sites for clinical trials, consultants, the cost of acquiring and manufacturing clinical trial materials, costs associated with regulatory filings and patents, laboratory costs and other supplies.

 

For the three months ended June 30, 2018 and 2017, research and development expenses were approximately $17.5 million and $11.7 million, respectively. Additionally, during the three months ended June 30, 2018 and 2017, we expensed approximately $1,000 and $1.8 million, respectively, in costs related to the acquisition of licenses. Noncash, stock-based compensation expense included in research and development for the three months ended June 30, 2018 and 2017, was $0.8 million and $2.4 million, respectively.

 

Included in the $17.5 million and $11.7 million figures for the three months ended June 30, 2018 and 2017, respectively, are the following subsidiary level expenses related to license development: Aevitas: $0.3 million and nil; Avenue: $3.4 million and $0.3 million; Caelum: $1.3 million and $0.1 million; Cellvation: $0.2 million and nil; Checkpoint: $5.6 million and $3.3 million; Cyprium: $0.1 million and $0.1 million; Escala: nil and approximately $46,000; Helocyte: $0.3 million and $0.8 million; Mustang $1.6 million and $2.1 million; and Tamid $0.2 million and nil. Additionally, for the three months ended June 30, 2018 and 2017, expenses related to CNDO-109 and TSO were $0.1 million and $0.1 million, and $0.3 million and $0.2 million, respectively. Also included in research and development expenses for the three months ended June 30, 2018 and 2017, were $2.1 million and $1.6 million, respectively, of employee costs.

 

For the six months ended June 30, 2018 and 2017, research and development expenses were approximately $42.4 million and $18.8 million, respectively. Additionally, during the six months ended June 30, 2018 and 2017, we expensed $0.1 million and $3.1 million, respectively, in costs related to the acquisition of licenses. Noncash stock-based compensation expense included in research and development for the six months ended June 30, 2018 and 2017, was $3.1 million and $3.2 million, respectively.

 

Included in the $42.4 million and $18.8 million research and development expense figures for the six months ended June 30, 2018 and 2017, respectively are the following subsidiary level expenses related to license development: Aevitas: $0.4 million and nil; Avenue: $12.5 million and $0.3 million; Caelum: $2.8 million and $0.1 million, Cellvation: $0.3 million and nil; Checkpoint: $11.6 million and $5.9 million; Cyprium: $0.2 million and $0.1 million; Escala: nil and $0.2 million; Helocyte: $0.5 million and $1.7 million; Mustang: $3.2 million and $2.7 million, and Tamid: $0.4 million and nil. Additionally, for the six months ended June 30, 2018 and 2017, expenses related to CNDO-109 and TSO were $0.1 million and $0.2 million, and $0.3 million and $0.4 million respectively. Employee costs of $4.1 million and $2.8 million were also included in research and development expenses for the six-months ended June 30, 2018 and 2017, respectively. We anticipate research and development expenses will increase in future periods, reflecting continued and increasing product development costs.

 

General and Administrative Expenses

 

General and administrative expenses consist principally of personnel-related costs, professional fees for legal, consulting, audit and tax services, rent and other general operating expenses not otherwise included in research and development expenses. For the three months ended June 30, 2018 and 2017, general and administrative expenses were approximately $13.1 million and $11.1 million, respectively. Noncash stock-based compensation expense included in general and administrative expenses for the three months ended June 30, 2018 and 2017, was $2.4 million and $2.2 million, of which $1.3 million and $1.3 million relates to Fortress, approximately $24,000 and $0.1 million relates to JMC, $0.4 million and $0.3 million relates to Mustang, and $0.5 million and $0.4 million relates to Checkpoint, respectively.

 

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Included in the remaining $10.7 million and $8.9 million figures for the three months ended June 30, 2018 and 2017, respectively are the following subsidiary level expenses, which include subsidiary employee costs: JMC: $3.2 million and $2.8 million; Checkpoint: $0.8 million and $0.8 million; Helocyte: approximately $45,000 and $0.2 million; Mustang: $1.2 million and $1.3 million, Avenue: $0.7 million and $0.3 million, Caelum: $0.4 million and $0.2 million. Also included in general and administrative expenses for the three months ended June 30, 2018 and 2017, respectively were costs related to Fortress of: $1.7 million and $1.5 million of employee costs, $0.5 million and $0.3 million of legal costs, $0.2 million and $0.2 million for rent and $1.6 million and $1.1 million of public company costs.

 

For the six months ended June 30, 2018 and 2017, general and administrative expenses were approximately $26.6 million and $21.4 million, respectively. Noncash stock-based compensation expense included in general and administrative expenses for the six months ended June 30, 2018 and 2017, was $4.8 million and $4.3 million, of which $2.4 million and $2.8 million relates to Fortress, $0.1 million and $0.1 million relates to JMC, $0.9 million and $0.3 million relates to Mustang, and $0.9 million and $1.0 million relates to Checkpoint, respectively. We anticipate general and administrative expenses will increase in future periods, reflecting continued and increasing costs associated with:

 

  · support of our expanded research and development activities;
  · support of business development activities; and
  · an expanding infrastructure and increased professional fees and other costs associated therewith.

 

Included in the remaining $21.8 million and $17.1 million figures for the six months ended June 30, 2018 and 2017, respectively are the following subsidiary level expenses: JMC: $6.4 million and $5.4 million; Checkpoint: $1.9 million and $1.6 million; Helocyte: $0.2 million and $0.3 million; Escala: $13,000 and $37,000; Avenue: $1.5 million and $0.6 million; Caelum: $0.8 million and $0.4 million; Cellvation: $0.1 million and $0.1 million; Cyprium: $0.1 million and $0.1 million; and Mustang: $2.7 million and $2.0 million. Also included in general and administrative expenses for the six months ended June 30, 2018 and 2017, respectively were $3.8 million and $2.9 million of employee costs, $0.8 million and $0.7 million of legal costs, $0.3 million and $0.4 million of rent, and $2.8 million and $2.4 million of public company costs related to Fortress.

 

General and administrative expenses related to National for the three months ended March 31, 2018 and 2017 were $56.2 million and $48.4 million, respectively, of which $49.3 million and $41.8 million related to commissions, compensation and fees.

 

General and administrative expenses related to National for the six months ended March 31, 2018 and 2017 were $107.1 million and $91.5 million, respectively, of which $92.9 million and $79.0 million related to commissions, compensation and fees.

 

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Comparison of three months ended June 30, 2018 and 2017

 

   Three Months Ended June 30,   Change 
($ in thousands)  2018   2017   $   % 
Revenue                    
Fortress                    
Product revenue, net  $6,689   $4,054   $2,635    65%
Revenue - from a related party   126    350    (224)   -64%
Net Fortress revenue   6,815    4,404    2,411    55%
                     
National                    
Commissions   31,407    23,993    7,414    31%
Net dealer inventory gains   2,929    2,366    563    24%
Investment banking   11,037    10,592    445    4%
Investment advisory   5,197    3,490    1,707    49%
Interest and dividends   601    675    (74)   -11%
Transfer fees and clearing services   1,777    1,687    90    5%
Tax preparation and accounting   3,868    3,144    724    23%
Other   203    346    (143)   -41%
Total National revenue   57,019    46,293    10,726    23%
Net revenue   63,834    50,697    13,137    26%
                     
Operating expenses                    
Fortress                    
Cost of goods sold - product revenue   1,668    878    790    90%
Research and development   17,488    11,683    5,805    50%
Research and development – licenses acquired   1    1,800    (1,799)   -100%
General and administrative   13,056    11,134    1,922    17%
Total Fortress operating expenses   32,213    25,495    6,718    26%
                     
National                    
Commissions, compensation and fees   49,345    41,762    7,583    18%
Clearing fees   578    618    (40)   -6%
Communications   813    682    131    19%
Occupancy   1,141    936    205    22%
Licenses and registration   530    427    103    24%
Professional fees   578    991    (413)   -42%
Interest   2    4    (2)   -50%
Underwriting costs   42    -    42    100%
Depreciation and amortization   857    500    357    71%
Other administrative expenses   2,332    2,475    (143)   -6%
Total National operating expenses   56,218    48,395    7,823    16%
Total operating expenses   88,431    73,890    14,541    20%
Loss from operations   (24,597)   (23,193)   (1,404)   6%
                     
Other income (expenses)                    
Interest income   294    190    104    55%
Interest expenses   (2,144)   (1,380)   (764)   55%
Change in fair value of derivative liabilities   (6,866)   1,452    (8,318)   -573%
Change in fair value of subsidiary convertible note   (140)   (188)   48    26%
Change in fair value of investments   (707)   157    (864)   -550%
Other (loss) income   (118)   13    (131)   -1008%
Total other (expense) income   (9,681)   244    (9,925)   -4068%
Loss before income taxes   (34,278)   (22,949)   (11,329)   49%
                     
Income tax expense   1,438    -    1,438    100%
Net loss   (35,716)   (22,949)   (12,767)   56%
                     
Less: net loss attributable to non-controlling interest   (14,105)   (5,584)   (8,521)   153%
Net loss attributable to common stockholders  $(21,611)  $(17,365)  $(4,246)   24%

 

Net revenues increased $13.1 million or 26% from the three months ended June 30, 2017 to the three months ended June 30, 2018. The increase in net revenue is related to an increase in product revenue of $2.6 million associated with Journey’s branded and generic products, offset by a decrease of $0.2 million in collaboration revenue between Checkpoint, Mustang and TGTX. National’s revenue increased by $10.7 million or 23%, of which $7.4 million is commissions, the increase is due to retail commissions increasing due to increased headcount and continuing strong equity markets. Investment advisory revenue increased $1.7 million also due to continuing strength in the equity markets.

 

Cost of goods sold increased by $0.8 million or 90% from the three months ended June 30, 2017 to the three months ended June 30, 2018 due to the increase in Journey branded and generic product revenue in the first quarter of 2018 as compared to the first quarter of 2017.

 

Research and development expenses increased $5.8 million or 50% from the three months ended June 30, 2017 to the three months ended June 30, 2018. This increase is attributable to increases in spending of: $3.1 million for Avenue related to the advancement of bunionectomy and safety study costs for IV tramadol, $0.2 million for Cellvation preclinical work, $1.3 million for Caelum related to preclinical and CMC-related work for CAEL-101 and their pipeline, $0.3 million for Aevitas pre-clinical activity, and $0.2 million for Tamid pre-clinical activity, offset by a decrease of $0.5 million in spending on Helocyte programs. Personnel costs related to Fortress increased by $0.2 million during the three months ended June 30, 2018 as compared to the three months ended June 30, 2017, and Mustang personnel costs increased by $0.5 million for the same period, as a result of increased employee headcount while non-cash stock compensation expenses increased due to grants to new employees by Fortress and Mustang offset by a decrease in expense for Checkpoint options granted to non-employees.

 

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During the three months ended June 30, 2018, we made nominal expenditures in connection with a new research and development licenses, compared with $1.8 million in expenditures related to licenses acquired during the three months ended June 30, 2017, comprised of new license purchases by Mustang of $1.5 million as well as a milestone payment owed under an existing license agreement paid by Fortress of $0.3 million, during the three months ended June 30, 2017.

 

General and administrative expenses increased $1.9 million or 17% from the three months ended June 30, 2017 to the three months ended June 30, 2018. The increase is related to $0.2 million for the continued building of our sales and marketing infrastructure at JMC (including increasing the headcount of its out-sourced sales force from 25 to 31), $0.5 million for the increase in headcount excluding the JMC sales force (of which $0.1 million relates to Fortress, $0.1 million to Avenue and $0.3 million to Mustang). Finally, stock compensation expense increased by $0.2 million from the three months ended June 30, 2017 due to new stock grants by Avenue.

 

National’s operating expenses increased by $7.8 million or 16% for the three months ended June 30, 2018 as compared to the three months ended June 30, 2017. Commissions, compensation, and fees increased $7.6 million or 18%; commissions, compensation, and fees include expenses based on commission revenue earned, net dealer inventory gains and investment banking revenues, as well as compensation to our non-broker employees. The increase in commissions revenue was primarily responsible for the increase in this expense category. In addition, occupancy expenses increased $0.2 million or 22%.

 

Total other expense increased $9.9 million, or 4068% from the three months ended June 30, 2017 to the three months ended June 30, 2018. The increase is primarily related to the change in fair value of derivative liabilities of $8.3 million, or 573%, and a decrease in the fair value of investments of $0.9 million or 550%, driven by the write off of our investment in Origo, as well as an increase in interest expense of $0.8 million or 55%. The increase in interest is primarily related to amounts owed under the Opus Credit Facility, the 2017 Subordinated Note Financing, and the 2018 Venture Notes. 

 

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Comparison of Six Months Ended June 30, 2018 and 2017        
   Six Months Ended June 30,   Change 
($ in thousands)  2018   2017   $   % 
Revenue                    
Fortress                    
Product revenue, net  $12,198   $6,139   $6,059    99%
Revenue - from a related party   520    1,043    (523)   -50%
Net Fortress revenue   12,718    7,182    5,536    77%
                     
National                    
Commissions   57,025    48,499    8,526    18%
Net dealer inventory gains   5,119    4,877    242    5%
Investment banking   23,741    17,653    6,088    34%
Investment advisory   10,530    6,875    3,655    53%
Interest and dividends   1,232    1,391    (159)   -11%
Transfer fees and clearing services   4,074    4,185    (111)   -3%
Tax preparation and accounting   4,391    4,000    391    10%
Other   429    717    (288)   -40%
Total National revenue   106,541    88,197    18,344    21%
Net revenue   119,259    95,379    23,880    25%
                     
Operating expenses                    
Fortress                    
Cost of goods sold - product revenue   3,140    1,347    1,793    133%
Research and development   42,446    18,793    23,653    126%
Research and development - licenses acquired   98    3,094    (2,996)   -97%
General and administrative   26,604    21,386    5,218    24%
Total Fortress operating expenses   72,288    44,620    27,668    62%
                     
National                    
Commissions, compensation and fees   92,906    79,020    13,886    18%
Clearing fees   1,321    1,356    (35)   -3%
Communications   1,573    1,404    169    12%
Occupancy   2,096    1,944    152    8%
Licenses and registration   1,167    832    335    40%
Professional fees   1,971    2,254    (283)   -13%
Interest   4    8    (4)   -50%
Underwriting costs   187    -    187    100%
Depreciation and amortization   1,716    1,006    710    71%
Other administrative expenses   4,113    3,705    408    11%
Total National operating expenses   107,054    91,529    15,525    17%
Total operating expenses   179,342    136,149    43,193    32%
Loss from operations   (60,083)   (40,770)   (19,313)   47%
                     
Other income (expenses)                    
Interest income   572    326    246    75%
Interest expenses   (4,227)   (2,078)   (2,149)   103%
Change in fair value of derivative liabilities   (7,931)   5,794    (13,725)   -237%
Change in fair value of subsidiary convertible note   110    (285)   395    -139%
Change in fair value of investments   (825)   (511)   (314)   61%
Other loss   (112)   13    (125)   -962%
Total other income (expenses)   (12,413)   3,259    (15,672)   -481%
Loss before income taxes   (72,496)   (37,511)   (34,985)   93%
                     
Income tax expense   1,438    -    1,438    100%
Net loss   (73,934)   (37,511)   (36,423)   97%
                     
Less: net loss attributable to non-controlling interest   (31,305)   (8,164)   (23,141)   283%
Net loss attributable to common stockholders   (42,629)  $(29,347)  $(13,282)   45%

 

Net revenues increased $23.9 million or 25% from the six months ended June 30, 2017 to the six months ended June 30, 2018. The increase in net revenue is related to an increase in product revenue of $6.1 million or 99% associated with Journey’s branded and generic products, offset by a decrease of $0.5 million or 50% in collaboration revenue between Checkpoint, Mustang and TGTX. National’s revenue increased by $18.3 million or 21%, of which $8.5 million is commissions, the increase is due to retail commissions increasing due to favorable markets. Investment banking revenue increased $6.1 million due to favorable markets, focus on a diversified product base and additional new hires during the current year, yielding strong investment opportunities for clients. Investment advisory revenue increased $3.7 million due to stronger equity markets and higher levels of assets under management.

 

Cost of goods sold increased by $1.8 million or 133% from the six months ended June 30, 2017 to the six months ended June 30, 2018 due to the increase in Journey branded and generic product revenue in the first six months of 2018 as compared to the first six months of 2017.

 

Research and development expenses increased $23.7 million or 126% from the six months ended June 30, 2017 to the six months ended June 30, 2018. This increase is attributable to increases in spending of: $12.2 million for Avenue related to the advancement of bunionectomy and safety study costs for IV tramadol, $0.6 million for Mustang (not including $1.1 million of employee cost increases) due to increased sponsored research expense related to IL-13, CD123 and CD20, and $5.7 million for Checkpoint related to increased pre-clinical and product development activity for their product candidates, $2.7 million for Caelum related to preclinical and CMC-related work, $0.1 million for Cyprium for sponsored research, $0.4 million for Aevitas pre-clinical activity, $0.4 million for Tamid pre-clinical activity, and $0.3 million for Cellvation pre-clinical activity. This is offset slightly by a $0.2 million decrease in spending on the Escala program and a $1.3 million decrease on Helocyte programs. Personnel costs related to Fortress increased by $0.4 million during the six months ended June 30, 2018 as compared to the six months ended June 30, 2017, as a result of an increase in employee headcount.

 

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During the six months ended June 30, 2018, we made expenditures totaling $0.1 million in connection with research and development licenses, compared with $3.1 million in expenditures related to licenses acquired during the six months ended June 30, 2017, comprised of new license purchases by Mustang ($2.1 million), Caelum ($0.2 million), and Cyprium ($0.1 million) as well as a milestone payment owed under an existing license agreement paid by Checkpoint ($0.4 million) and Fortress ($0.3 million), during the six months ended June 30, 2017.

 

General and administrative expenses increased $5.2 million or 24% from the six months ended June 30, 2017 to the six months ended June 30, 2018. The increase is related to $0.8 million for the continued building of our sales and marketing infrastructure at JMC (including increasing the headcount of its out-sourced sales force from 25 to 31), $1.8 million for the increase in headcount excluding JMC’s salesforce (of which $0.9 million relates to Fortress, $0.2 million to Avenue, $0.6 million to Mustang and $0.1 million to Caelum). Finally, stock compensation expense increased by $0.5 million from the six months ended June 30, 2017 due to new stock grants by Mustang and Avenue.

 

National’s operating expenses increased by $15.5 million or 17% for the six months ended June 30, 2018 as compared to the six months ended June 30, 2017. Commissions, compensation, and fees increased $13.9 million or 18%; commissions, compensation, and fees include expenses based on commission revenue, net dealer inventory gains, investment banking and investment advisory, as well as compensation to our non-broker employees. The increase in commissions expense is primarily due to higher revenues earned in both commissions and investment banking revenues. Strategic new hires and increases in benefits expenses also contributed to the increase. Licenses and registration expenses increased $0.3 million or 40% due to licenses for software applications as National continues to invest in and implement technology enhancements. Professional fees decreased $0.3 million or 13% due to a reduction in the use of outside providers and more work being handled by employees. Other administrative expenses increased $0.4 million or 11% due to recruitment charges for new hires, stock-based compensation for the board of directors and real estate taxes offset in part by a decrease in settlement provision.

 

Total other expense increased $15.7 million, or 481% from the six months ended June 30, 2017 to the six months ended June 30, 2018. The increase is primarily related to the change in fair value of derivative liabilities of $13.7 million, or 237%, and a decrease in the fair value of investments of $0.3 million or 61%, driven by the write down of our investment in Origo, as well as an increase in interest expense of $2.1 million or 103%. The increase in interest is primarily related to amounts owed under the Opus Credit Facility, the 2017 Subordinated Note Financing, and the 2018 Venture Notes. 

 

Liquidity and Capital Resources

 

We may require additional financing to fully develop and prepare regulatory filings, obtain regulatory approvals for our existing and new product candidates, fund operating losses, and, if deemed appropriate, establish or secure through third parties manufacturing for our potential products, sales and marketing capabilities. We have funded our operations to date primarily through the sale of equity and debt securities. We believe that our current cash and cash equivalents, is sufficient to fund operations for at least the next twelve months. A failure to raise capital as and when needed would have a material adverse impact on our financial condition and our ability to pursue our business strategies. We may seek funds through equity or debt financings, collaborative or other arrangements with corporate sources, or through other sources of financing.

 

   For the Six Months Ended June 30, 
($ in thousands)  2018   2017 
Statement of cash flows data:          
Total cash (used in) provided by:          
Operating activities  $(55,301)  $(35,359)
Investing activities   (4,264)   (21,165)
Financing activities   44,038    112,584 
Net increase in cash and cash equivalents, cash deposits with clearing organizations and restricted cash  $(15,527)  $56,060 

 

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Operating Activities

 

Net cash used in operating activities increased $19.9 million from the six months ended June 30, 2017 to the six months ended June 30, 2018. The increase was primarily due to the decrease of $13.7 million in the fair value of derivative liabilities, an increase of $36.4 million in net loss, a decrease in the fair value of investments of $0.3 million, and an increase of $3.1 million in changes in operating assets and liabilities partially offset by an increase of $0.6 million of depreciation and amortization expense related to intangible assets associated with our ownership in National, a $3.0 million decrease of expense related to research and development-licenses acquired, an increase of $0.9 million in stock based compensation expense, and a decrease of $0.4 million related to the value of subsidiary convertible notes.

 

Investing Activities

 

Net cash used in investing activities decreased $16.9 million from the six months ended June 30, 2017 to the six months ended June 30, 2018 The decrease is primarily due to a $15.0 million increase in the purchase of short-term investments with the purchase of certificates of deposit by Mustang, offset by the $36.0 million redemption of certificates of deposit, also held by Mustang, an increase of $4.2 million in the purchase of property and equipment as the build-out of the cell processing facility in Worcester, Massachusetts by Mustang continues, as well as a decrease of $0.6 million in funds used to purchase research and development licenses.

 

Financing Activities

 

Net cash provided by financing activities was $44.0 million for the six months ended June 30, 2018, compared to $112.6 million of net cash provided by financing activities for the six months ended June 30, 2017. During the six months ended June 30, 2018, net proceeds from subsidiaries’ offerings were $22.7 million, net proceeds from the 2018 Venture Notes were $21.6 million, and $4.1 million was used to pay subsidiaries’ Convertible Notes. Additionally, $1.3 million of costs were incurred in connection with the issuance of Series A preferred stock, and $1.2 million was paid in Preferred A dividends, offset by $3.9 million in net proceeds from at-the-market offering.

 

Contractual Obligations and Commitments

 

There have been no material changes to our contractual obligations and commitments outside the ordinary course of business from those disclosed under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Contractual Obligations and Commitments” in our Annual Report on Form 10-K for the year ended December 31, 2017 except for the addition of the 2018 Venture Notes. Total owed under the 2018 Venture Notes at June 30, 2018 is $21.7 million. The notes mature 36 months from issuance, provided that during the first 24 months the Company may extend the maturity date by six months. No principal amount will be due for the first 24 months (or the first 30 months if the maturity date is extended). Interest accrues at 8% payable quarterly for the first 24 months (or the first 30 months if the note is extended), and monthly during the last 12 months.

 

Off-Balance Sheet Arrangements

 

We are not party to any off-balance sheet transactions. We have no guarantees or obligations other than those which arise out of normal business operations.

 

Item 3.Quantitative and Qualitative Disclosures About Market Risks

 

Market risk represents the risk of loss that may result from the change in value of financial instruments due to fluctuations in their market price. Market risk is inherent in all financial instruments. Market risk may be exacerbated in times of trading illiquidity when market participants refrain from transacting in normal quantities and/or at normal bid-offer spreads. Our exposure to market risk is directly related to derivatives, debt and equity linked instruments related to our financing activities.

 

Our assets and liabilities are denominated in U.S. dollars. Consequently, we have not considered it necessary to use foreign currency contracts or other derivative instruments to manage changes in currency rates. We do not now, nor do we plan to, use derivative financial instruments for speculative or trading purposes. However, these circumstances might change.

 

The primary quantifiable market risk associated with our financial instruments is sensitivity to changes in interest rates. Interest rate risk represents the potential loss from adverse changes in market interest rates. We use an interest rate sensitivity simulation to assess our interest rate risk exposure. For purposes of presenting the possible earnings effect of a hypothetical, adverse change in interest rates over the 12-month period from our reporting date, we assume that all interest rate sensitive financial instruments will be impacted by a hypothetical, immediate 100 basis point increase in interest rates as of the beginning of the period. The sensitivity is based upon the hypothetical assumption that all relevant types of interest rates that affect our results would increase instantaneously, simultaneously and to the same degree. We do not believe that our cash and equivalents have significant risk of default or illiquidity.

 

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The sensitivity analyses of the interest rate sensitive financial instruments are hypothetical and should be used with caution. Changes in fair value based on a 1% or 2% variation in an estimate generally cannot be extrapolated because the relationship of the change in the estimate to the change in fair value may not be linear. Also, the effect of a variation in a particular estimate on the fair value of financial instruments is calculated independent of changes in any other estimate; in practice, changes in one factor may result in changes in another factor, which might magnify or counteract the sensitivities. In addition, the sensitivity analyses do not consider any action that we may take to mitigate the impact of any adverse changes in the key estimates.

 

Based on our analysis, for the years ended December 31, 2016, December 31, 2017 and for the interim period through June 30, 2018, we determined the effect of a 100+1- basis point change in interest rates on the value of our financial instruments and the resultant effect on our net loss to be immaterial.

 

Item 4.Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness, as of June 30, 2018, of the design and operation of our disclosure controls and procedures, as such term is defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Based on this evaluation, our principal executive officer and principal financial officer have concluded that, as of such date, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

 

Changes in Internal Control over Financial Reporting

 

No change in internal control over financial reporting occurred during the most recent quarter with respect to our operations, which materially affected, or is reasonable likely to materially affect, our internal controls over financial reporting.

 

PART II.OTHER INFORMATION

 

Item 1.Legal Proceedings

 

Dr. Falk Pharma, GmbH v. Fortress Biotech, Inc. (Frankfurt am Main Regional Court, Ref. No. 3-06 0 28/16). Dr. Falk Pharma, GmbH (“Dr. Falk Pharma”) and Fortress are among the parties to that certain Collaboration Agreement dated March 20, 2012, whereby they agreed to collaborate to develop a product for treatment of Crohn’s disease. A dispute has arisen between Dr. Falk Pharma and Fortress with respect to their relative rights and obligations under the Collaboration Agreement. Specifically, Dr. Falk Pharma contends that it fulfilled its contractual obligations to Fortress and is entitled to the final milestone payment due under the Collaboration Agreement - EUR 2.5 million. Fortress contends that no such payment is due because a condition of the EUR 2.5 million payment was the delivery of a Clinical Study Report that addressed the primary and secondary objectives of a Phase II trial, and Fortress contends that Dr. Falk Pharma failed to deliver such a Clinical Study Report. Dr. Falk Pharma disputes that it failed to deliver such a report and further disputes that the delivery of such a report is a condition of Fortress’s obligation to make the EUR 2.5 million payment. After the parties’ attempts to negotiate a settlement of the dispute were unsuccessful, Dr. Falk Pharma filed a lawsuit against Fortress in the above-referenced Court in Frankfurt, Germany to recover the EUR 2.5 million plus interest and attorneys’ fees, and Fortress was served with the English translation of the lawsuit on August 11, 2016. Fortress retained local counsel and, on December 14, 2016, filed an answer to the complaint, denying that it had any liability to Dr. Falk Pharma. On July 27, 2017, Fortress received a judgment from the court in Frankfurt awarding the full amount (EUR 2.5 million) plus interest to Dr. Falk Pharma. Fortress appealed the decision to the Higher Regional Court of Frankfurt on August 28, 2017, and the initial response of Dr. Falk Pharma to the appeal was filed on February 16, 2018. At an appellate hearing in the Higher Regional Court on June 12, 2018, the court issued an oral ruling upholding the lower court’s judgment and indicating that an impending written, enforceable judgment would do the same. On July 12, 2018, the Higher Regional Court approved and recorded terms of settlement between Fortress and Dr. Falk Pharma pursuant to which Fortress will pay $3.3 million to Dr. Falk Pharma over the course of a year, and approximately $37,000 to the court in mandated administrative fees.

 

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Item 1A.Risk Factors

 

Investing in our Common Stock or any other of our equity securities involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this Annual Report on Form 10-K including the consolidated financial statements and the related notes, as well as the risks, uncertainties and other information set forth in the reports and other materials filed or furnished by our majority-controlled subsidiaries National, Checkpoint, Mustang, and Avenue with the SEC, before deciding to invest in shares of our Common Stock or any other of our equity securities. If any of the following risks or the risks included in the public filings of National, Checkpoint, Mustang or Avenue were to materialize, our business, financial condition, results of operations, and future growth prospects could be materially and adversely affected. In that event, the market price of our Common Stock or that of any other of our equity securities could decline, and you could lose part of or all of your investment in our Common Stock or in our any other of our equity securities.

 

Risks Related to our Growth Strategy

 

If we acquire, enter into joint ventures with or obtain a controlling interest in companies in the future, it could adversely affect our operating results and the value of our Common Stock thereby diluting stockholder value and disrupting our business.

 

As part of our growth strategy, we might acquire, enter into joint ventures with, or obtain a significant ownership stake in other companies. Acquisitions of, joint ventures with and investments in other companies involve numerous risks, including, but not necessarily limited to:

 

·risk of entering new markets in which we have little to no experience;

 

·diversion of financial and managerial resources from existing operations;

 

·successfully negotiating a proposed acquisition or investment timely and at a price or on terms and conditions favorable to us;

 

·the impact of regulatory reviews on a proposed acquisition or investment;

 

·the outcome of any legal proceedings that may be instituted with respect to the proposed acquisitions or investment;

 

·with respect to an acquisition, difficulties in integrating operations, technologies, services and personnel; and

 

·potential inability to maintain relationships with customers of the companies we may acquire or invest in.

 

If we fail to properly evaluate potential acquisitions, joint ventures or investments, we might not achieve the anticipated benefits of any such transaction, we might incur costs in excess of what we anticipate, and management resources and attention might be diverted from other necessary or valuable activities.

 

If certain of our subsidiaries cannot innovate and develop products and services and/or continue to commercialize biopharmaceutical products or grow our and their respective businesses, we may not be able to generate revenue.

 

Our growth strategy also depends on our and our subsidiaries’ ability to generate revenue. If we and our subsidiaries cannot innovate and develop products and services or continue to commercialize current and future biopharmaceutical products or grow their respective businesses, we may not be able to generate revenue growth as anticipated.

 

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We may not be able to generate returns for our investors if certain of our subsidiaries, most of which have limited or no operating history, no commercialized revenue generating products, and are not yet profitable, cannot obtain additional third-party financing.

 

As part of our growth strategy, we have made and will likely continue to make substantial investments in our subsidiaries, which at the time of investment generally have limited or no operating history, no commercialized revenue generating products, and require additional third-party financing to fund product and services development or acquisitions. Our business depends in large part on one or more of our subsidiaries’ ability to innovate, in-license, acquire or invest in successful biopharmaceutical products, develop financial services and/or acquire companies in increasingly competitive and highly regulated markets. If certain of our subsidiaries do not successfully obtain additional third-party financing to commercialize products, successfully acquire companies or participate in the financial services industry, as applicable, the value of our businesses and our ownership stakes in our subsidiaries may be materially adversely affected.

 

If we cannot continue to fund our and certain of our subsidiaries’ research and development programs, we and our subsidiaries may be required to reduce product development, which will adversely impact our growth strategy.

 

Our and certain of our subsidiaries’ research and development (“R&D”) programs will require substantial additional capital to conduct research, preclinical testing and human studies, establish pilot scale and commercial scale manufacturing processes and facilities, and establish and develop quality control, regulatory, marketing, sales and administrative capabilities to support these programs. We expect to fund our and certain of our subsidiaries’ R&D activities from a combination of cash generated from royalties and milestones from our partners in various past, ongoing and future collaborations and additional equity or debt financings from third parties. These financings could depress our stock price. If additional funds are required to support our or our subsidiaries’ operations and such funds cannot be obtained on favorable terms, we and certain of our subsidiaries may not be able to develop products, which will adversely impact our growth strategy.

 

Collaborative relationships with third parties could cause us or certain of our subsidiaries to expend significant resources and incur substantial business risk with no assurance of financial return.

 

We anticipate substantial reliance upon strategic collaborations for marketing and commercializing our and certain of our subsidiaries’ existing product candidates, and we and our subsidiaries may rely even more on strategic collaborations for R&D of other product candidates. We and certain of our subsidiaries may sell product offerings through strategic partnerships with pharmaceutical and biotechnology companies. If we or our subsidiaries are unable to establish or manage such strategic collaborations on terms favorable to us in the future, our revenue and drug development may be limited.

 

If we or certain of our subsidiaries enter into R&D collaborations during the early phases of drug development, success will in part depend on the performance of research collaborators. Neither we nor certain of our subsidiaries will directly control the amount or timing of resources devoted by research collaborators to activities related to product candidates. Research collaborators may not commit sufficient resources to our or our subsidiaries’ R&D programs. If any research collaborator fails to commit sufficient resources, the preclinical or clinical development programs related to the collaboration could be delayed or terminated. Also, collaborators may pursue existing or other development-stage products or alternative technologies in preference to those being developed in collaboration with us or our subsidiaries. Finally, if we or certain of our subsidiaries fail to make required milestone or royalty payments to collaborators or to observe other obligations in agreements with them, the collaborators may have the right to terminate or stop performance of those agreements.

 

Establishing strategic collaborations is difficult and time-consuming. Our and certain of our subsidiaries’ discussions with potential collaborators may not lead to the establishment of collaborations on favorable terms, if at all. Potential collaborators may reject collaborations based upon their assessment of our and our subsidiaries’ financial, regulatory or intellectual property position. In addition, there has been a significant number of recent business combinations among large pharmaceutical companies that have resulted in a reduced number of potential future collaborators. Even if we or our subsidiaries successfully establish new collaborations, these relationships may never result in the successful development or commercialization of product candidates or the generation of sales revenue. To the extent that we or our subsidiaries enter into collaborative arrangements, the related product revenues are likely to be lower than if we or our subsidiaries directly marketed and sold products. Such collaborators may also consider alternative product candidates or technologies for similar indications that may be available to collaborate on and whether such a collaboration could be more attractive than the one with us or our subsidiaries for any future product candidate.

 

Management of our relationships with collaborators will require:

 

·significant time and effort from our management team, as well as from the management teams of our subsidiaries;

 

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·coordination of our and certain of our subsidiaries’ marketing and R&D programs with the respective marketing and R&D priorities of our collaborators; and

 

·effective allocation of our and our subsidiaries’ resources to multiple projects.

 

As we continue to execute our growth strategy, we may be subject to further government regulation which would adversely affect our operations.

 

If we engage in business combinations and other transactions that result in holding passive investment interests in a number of entities, we may become subject to regulation under the Investment Company Act of 1940, as amended (the “Investment Company Act”). If we do become subject to the Investment Company Act, we would be required to register as an investment company and could be expected to incur significant registration and compliance costs in the future.

 

We may not be able to manage our anticipated growth, which may in turn adversely impact our business.

 

We will need to continue to expend funds on improving our infrastructure to address our anticipated growth. Acquisitions of companies or products could place a strain on our management, and administrative, operational and financial systems. In addition, we may need to hire, train and manage more employees, focusing on their integration with us and corporate culture. Integration and management issues associated with increased acquisitions may require a disproportionate amount of our management’s time and attention and distract our management from other activities related to running our business.

 

We may not be able to hire or retain key officers or employees for our Company, and in some cases, our subsidiaries, to implement our business strategy and develop products and businesses.

 

Our success depends on the continued contributions of our executive officers, financial, scientific and technical personnel and consultants, and on our ability to attract additional personnel for us and, in some cases, our subsidiaries as we continue to implement our growth strategy and acquire and invest in companies with varied businesses. During our and our subsidiaries’ operating history, many essential responsibilities have been assigned to a relatively small number of individuals. However, as we continue to implement our growth strategy and our subsidiaries grow, the demands on our key employees will expand and we will need to recruit additional qualified employees for us and, possibly, for our subsidiaries. The competition for such qualified personnel is intense, and the loss of services of certain key personnel or our or our subsidiaries’ inability to attract additional personnel to fill critical positions could adversely affect our business.

 

We currently depend heavily upon the efforts and abilities of our management team and the management teams of our subsidiaries. The loss or unavailability of the services of any of these individuals could have a material adverse effect on our business, prospects, financial condition and results. In addition, we have not obtained, do not own, nor are we the beneficiary of key-person life insurance for any of our and our subsidiaries’ key personnel. We only maintain a limited amount of directors’ and officers’ liability insurance coverage. There can be no assurance that this coverage will be sufficient to cover the costs of the events that may occur, in which case, there could be a substantial impact on our and our subsidiaries’ ability to continue operations.

 

Our and our subsidiaries’ employees, consultants, or third-party partners may engage in misconduct or other improper activities, including but not necessarily limited to noncompliance with regulatory standards and requirements or internal procedures, policies or agreements to which such employees, consultants and partners are subject, any of which could have a material adverse effect on our business.

 

We and our subsidiaries are exposed to the risk of employee fraud or other misconduct. Misconduct by employees, consultants, or third party partners could include intentional failures to comply with FDA regulations, provide accurate information to the FDA, comply with manufacturing standards we have established, comply with federal and state healthcare fraud and abuse laws and regulations, report financial information or data accurately, comply with internal procedures, policies or agreements to which such employees, consultants or partners are subject, or disclose unauthorized activities to us and our subsidiaries. In particular, sales, marketing and business arrangements in the healthcare industry are subject to extensive laws and regulations intended to prevent fraud, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. Employee, consultant, or third-party misconduct could also involve the improper use of information obtained in the course of clinical trials, which could result in regulatory sanctions and serious harm to our reputation. The precautions we and our subsidiaries take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us and our subsidiaries from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations. If any such actions are instituted against us or our subsidiaries, and we or our subsidiaries are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business and results of operations, including the imposition of significant fines or other sanctions.

 

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We and our subsidiaries receive a large amount of proprietary information from potential or existing licensors of intellectual property and potential acquisition target companies, all pursuant to confidentiality agreements. The confidentiality and proprietary invention assignment agreements that we and our subsidiaries have in place with each of our employees and consultants prohibit the unauthorized disclosure of such information, but such employees or consultants may nonetheless disclose such information through negligence or willful misconduct. Any such unauthorized disclosures could subject us and our subsidiaries to monetary damages and/or injunctive or equitable relief. The notes, analyses and memoranda that we and our subsidiaries have generated based off such information are also valuable to our businesses, and the unauthorized disclosure or misappropriation of such materials by our and our subsidiaries’ employees and consultants could significantly harm our strategic initiatives — especially if such disclosures are made to our competitor companies.

 

Certain of our officers and directors serve in similar roles with our subsidiaries, affiliates, related parties and other parties with whom we transact business; ongoing and future relationships and transactions between these parties could result in conflicts of interest.

 

We share directors and/or officers with certain of our subsidiaries, affiliates, related parties or other companies with which we transact business, and such arrangements could create conflicts of interest in the future, including with respect to the allocation of corporate opportunities. While we believe that we have put in place policies and procedures to identify such conflicts and that any existing agreements that may give rise to such conflicts and any such policies or procedures were negotiated at arm’s length in conformity with fiduciary duties, such conflicts of interest may nonetheless arise. The existence and consequences of such potential conflicts could expose us and our subsidiaries to lost profits, claims by our investors and creditors, and harm to our and our subsidiaries’ results of operations.

 

Risks Related to Our Biopharmaceutical Business and Industry

 

We are an early-stage company, with limited operating history on which stockholders can base an investment decision; we also have numerous early-stage subsidiaries that rely heavily on third parties for the development and manufacturing of their products and product candidates.

 

We are primarily an early-stage biopharmaceutical company and certain of our subsidiaries, on whose success we largely rely, are also early-stage biopharmaceutical companies. To date, we and certain of our subsidiaries have engaged primarily in R&D and investment activities and have not generated any revenues from product sales. We and certain of our subsidiaries have incurred significant net losses since our inception. As of June 30, 2018, we had an accumulated deficit of approximately $354.8 million. We and certain of our subsidiaries have not demonstrated the ability to perform the functions necessary for the successful commercialization of any of our products. The successful commercialization of our and certain of our subsidiaries’ products will require us and our subsidiaries to perform or contract with third parties for performance of a variety of critical functions, including, but not necessarily limited to:

 

·identifying, developing, and commercializing product candidates;

 

·entering into successful licensing and other arrangements with product development partners;

 

·continuing to undertake pre-clinical development and designing and executing clinical trials;

 

·participating in regulatory approval processes;

 

·formulating and manufacturing products for clinical development programs and commercial sale; and

 

·conducting sales and marketing activities.

 

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Our operations have been limited to acquiring, developing and securing the proprietary rights for, and undertaking pre-clinical development and clinical trials of product candidates, and making investments in other companies. These operations provide a limited basis for our stockholders and prospective investors to assess our ability to commercialize product candidates, develop potential product candidates and make successful investments in other companies, as well as for you to assess the advisability of investing in our securities. Each of these requirements will require substantial time, effort and financial resources.

 

If we or certain of our subsidiaries are unable to establish or maintain sales and marketing capabilities or fail to enter into agreements with third parties to market, distribute and sell products that may be successfully developed, neither we nor our subsidiaries may be able to effectively market and sell products and continue to generate product revenue.

 

Neither we nor our biopharmaceutical subsidiaries (other than Journey Medical Corporation) currently have the infrastructure for the sales, marketing and distribution of any of our product candidates, and we and certain of our subsidiaries must build and maintain this infrastructure or make arrangements with third parties to perform these functions in order to continue to commercialize any products that we may successfully develop. The establishment and development of a sales force, either by us, certain of our subsidiaries or jointly with a partner, or the establishment of a contract sales force to market any products we or our subsidiaries may develop, is expensive and time-consuming and could delay any product launch or compromise the successful commercialization of products. If we, certain of our subsidiaries, or our respective partners, are unable to establish and maintain sales and marketing capabilities or any other non-technical capabilities necessary to commercialize any products that may be successfully developed, we or certain of our subsidiaries will need to contract with third parties to market and sell such products. We or certain of our subsidiaries may not be able to establish arrangements with third parties on acceptable terms, or at all.

 

If any of our or certain of our subsidiaries’ product candidates that are successfully developed do not achieve broad market acceptance among physicians, patients, healthcare payors and the medical community, the revenues that any such product candidates generate from sales will be limited.

 

Even if our or certain of our subsidiaries’ product candidates receive regulatory approval, they may not gain market acceptance among physicians, patients, healthcare payors and the medical community. Coverage and reimbursement of our or certain of our subsidiaries’ product candidates by third-party payors, including government payors, generally is also necessary for commercial success. The degree of market acceptance of any approved products will depend on a number of factors, including, but not necessarily limited to:

 

·the efficacy and safety as demonstrated in clinical trials;

 

·the timing of market introduction of such product candidate as well as competitive products;

 

·the clinical indications for which the product is approved;

 

·acceptance by physicians, major operators of hospitals and clinics and patients of the product as a safe and effective treatment;

 

·the potential and perceived advantages of product candidates over alternative treatments;

 

·the safety of product candidates seen in a broader patient group, including its use outside the approved indications;

 

·the cost of treatment in relation to alternative treatments;

 

·the availability of adequate reimbursement and pricing by third parties and government authorities;

 

·the approval, availability, market acceptance and reimbursement for a companion diagnostic, if any;

 

·changes in regulatory requirements by government authorities for our product candidates;

 

·relative convenience and ease of administration;

 

·the prevalence and severity of side effects and adverse events;

 

·the effectiveness of our sales and marketing efforts; and

 

·unfavorable publicity relating to the product.

 

If any product candidate is approved but does not achieve an adequate level of acceptance by physicians, hospitals, healthcare payors and patients, we or certain of our subsidiaries may not generate sufficient revenue from these products and in turn we may not become or remain profitable.

  

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Reimbursement may be limited or unavailable in certain market segments for our product candidates, which could make it difficult for us to sell our products profitably.

 

We intend to seek approval to market our future products in both the United States and in countries and territories outside the United States. If we obtain approval in one or more foreign countries, we will be subject to rules and regulations in those countries relating to our product. In some foreign countries, particularly in the European Union, the pricing of prescription pharmaceuticals and biologics is subject to governmental control. In these countries, pricing negotiations with governmental authorities can take considerable time after the receipt of marketing approval for a product candidate. In addition, market acceptance and sales of our product candidates will depend significantly on the availability of adequate coverage and reimbursement from third-party payors for any of our product candidates and may be affected by existing and future healthcare reform measures.

 

Government authorities and third-party payors, such as private health insurers and health maintenance organizations, decide which pharmaceuticals they will pay for and establish reimbursement levels. Reimbursement by a third-party payor may depend upon a number of factors, including the third-party payor’s determination that use of a product is:

 

a covered benefit under its health plan;

 

safe, effective and medically necessary;

 

appropriate for the specific patient;

 

cost-effective; and

 

neither experimental nor investigational.

 

Obtaining coverage and reimbursement approval for a product from a government or other third-party payor is a time consuming and costly process that could require that we provide supporting scientific, clinical and cost-effectiveness data for the use of our products to the payor. We may not be able to provide data sufficient to gain acceptance with respect to coverage and reimbursement. If reimbursement of our future products is unavailable or limited in scope or amount, or if pricing is set at unsatisfactory levels, we may be unable to achieve or sustain profitability. Additionally, while we may seek approval of our products in combination with each other, there can be no guarantee that we will obtain coverage and reimbursement for any of our products together, or that such reimbursement will incentivize the use of our products in combination with each other as opposed to in combination with other agents which may be priced more favorably to the medical community.

 

In both the United States and certain foreign countries, there have been a number of legislative and regulatory changes to the healthcare system that could impact our ability to sell our products profitably. In particular, the Medicare Modernization Act of 2003 revised the payment methodology for many products reimbursed by Medicare, resulting in lower rates of reimbursement for many types of drugs, and added a prescription drug benefit to the Medicare program that involves commercial plans negotiating drug prices for their members. Since 2003, there have been a number of other legislative and regulatory changes to the coverage and reimbursement landscape for pharmaceuticals.

 

The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, collectively, the “ACA,” was enacted. The ACA and any revisions or replacements of that Act, any substitute legislation, and other changes in the law or regulatory framework could have a material adverse effect on our business.

 

Among the provisions of the ACA of importance to our potential product candidates are:

 

an annual, nondeductible fee on any entity that manufactures or imports specified branded prescription drugs and biologic agents, apportioned among these entities according to their market share in certain government healthcare programs;

 

an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program to 23.1% and 13.0% of the average manufacturer price for branded and generic drugs, respectively;

 

expansion of healthcare fraud and abuse laws, including the federal False Claims Act and the federal Anti-Kickback Statute, new government investigative powers and enhanced penalties for non-compliance;

 

a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for a manufacturer’s outpatient drugs to be covered under Medicare Part D;

 

extension of a manufacturer’s Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations;

 

expansion of eligibility criteria for Medicaid programs by, among other things, allowing states to offer Medicaid coverage to additional individuals and by adding new mandatory eligibility categories for certain individuals with income at or below 138% of the federal poverty level, thereby potentially increasing a manufacturer’s Medicaid rebate liability;

 

expansion of the entities eligible for discounts under the 340B Drug Pricing Program;

 

the new requirements under the federal Open Payments program and its implementing regulations;

 

a new requirement to annually report drug samples that manufacturers and distributors provide to physicians;

 

a new regulatory pathway for the approval of biosimilar biological products, all of which will impact existing government healthcare programs and will result in the development of new programs; and

 

a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research.

 

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The Supreme Court upheld the ACA in the main challenge to the constitutionality of the law in 2012. Specifically, the Supreme Court held that the individual mandate and corresponding penalty was constitutional because it would be considered a tax by the federal government. The Supreme Court also upheld federal subsidies for purchasers of insurance through federally facilitated exchanges in a decision released in June 2015. Any remaining legal challenges to the ACA are viewed generally as not significantly impacting the implementation of the law if the plaintiffs prevail.

 

President Trump ran for office on a platform that supported the repeal of the ACA, and one of his first actions after his inauguration was to sign an Executive Order instructing federal agencies to waive or delay requirements of the ACA that impose economic or regulatory burdens on states, families, the health-care industry and others. Modifications to or repeal of all or certain provisions of the ACA have been attempted in Congress as a result of the outcome of the recent presidential and congressional elections, consistent with statements made by the incoming administration and members of Congress during the presidential and congressional campaigns and following the election.

 

In January 2017, Congress voted to adopt a budget resolution for fiscal year 2017, or the Budget Resolution, that authorizes the implementation of legislation that would repeal portions of the ACA. The Budget Resolution is not a law. However, it is widely viewed as the first step toward the passage of legislation that would repeal certain aspects of the ACA. In March 2017, following the passage of the budget resolution for fiscal year 2017, the United States House of Representatives passed legislation known as the American Health Care Act of 2017, which, if enacted, would amend or repeal significant portions of the ACA. Attempts in the Senate in 2017 to pass ACA repeal legislation, including the Better Care Reconciliation Act of 2017, so far have been unsuccessful. At the end of 2017, Congress passed the Tax Cuts and Jobs Act, which repealed the penalty for individuals who fail to maintain minimum essential health coverage as required by the ACA. Following this legislation, Texas and 19 other states filed a lawsuit alleging that the ACA is unconstitutional as the individual mandate was repealed, undermining the legal basis for the Supreme Court’s prior decision. This lawsuit is ongoing and the outcome may have a significant impact on our business.

 

Most recently, the Bipartisan Budget Act of 2018, the “BBA,” which set government spending levels for Fiscal Years 2018 and 2019, revised certain provisions of the ACA. Specifically, beginning in 2019, the BBA increased manufacturer point-of-sale discounts off negotiated prices of applicable brand drugs in the Medicare Part D coverage gap from 50% to 70%, ultimately increasing the liability for brand drug manufacturers. Further, this mandatory manufacturer discount applies to biosimilars beginning in 2019.

 

The Trump Administration has also taken several regulatory steps to redirect ACA implementation. The Department of Health and Human Services finalized a payment reduction for drugs acquired through the 340B Drug Pricing Program and has taken steps to increase the availability of cheaper health insurance options, typically with fewer benefits. The Administration has also signaled its intention to address drug prices and to increase competition, including by increasing the availability of biosimilars. As these are regulatory actions, a new administration could undo or modify these efforts.

 

There have been, and likely will continue to be, legislative and regulatory proposals at the federal and state levels directed at broadening the availability of healthcare and containing or lowering the cost of healthcare products and services. We cannot predict the initiatives that may be adopted in the future. The continuing efforts of the government, insurance companies, managed care organizations and other payors of healthcare services to contain or reduce costs of healthcare may adversely affect:

 

the demand for any products for which we may obtain regulatory approval;

 

our ability to set a price that we believe is fair for our products;

 

our ability to generate revenues and achieve or maintain profitability;

 

the level of taxes that we are required to pay; and

 

the availability of capital.

 

In addition, governments may impose price controls, which may adversely affect our future profitability.

 

The United Kingdom’s announced withdrawal from the EU could have a negative effect on global economic conditions and financial markets, EU regulatory procedures and our business.

 

In June 2016, a majority of voters in the United Kingdom, or the UK, elected in a national referendum to withdraw from the EU. In March 2017, the UK government formally initiated the withdrawal process. That pending withdrawal, currently scheduled to occur in or before March 2019, has created significant uncertainty about the future relationship between the UK and the EU, including with respect to the laws and regulations that will apply as the UK determines which EU laws to replace or replicate upon withdrawal. The pending withdrawal has also given rise to calls for the governments of other EU member states to consider withdrawal. These developments, or the perception that any of them could occur, have had and may continue to have a material adverse effect on global economic conditions and the stability of global financial markets, and may significantly reduce global market liquidity and restrict the ability of key market participants to operate in certain financial markets. Any of these factors could depress economic activity and restrict access to capital, which could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

 

The UK’s withdrawal from the EU also means that the EMA, from which we and certain of our subsidiaries must obtain approval to sell any product in the EU, must relocate from its current headquarters in the UK to a new location within the EU. This relocation of the EMA could significantly disrupt its operations, which could cause delays in the EMA’s review and approval of marketing authorization applications. Such a disruption could impact any future applications for EMA approval of our and our subsidiaries’ drug candidates, which could have a material adverse effect on our business, financial condition and results of operations and growth prospects.

 

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The Supreme Court upheld the ACA in the main challenge to the constitutionality of the law in 2012. Specifically, the Supreme Court held that the individual mandate and corresponding penalty was constitutional because it would be considered a tax by the federal government. The Supreme Court also upheld federal subsidies for purchasers of insurance through federally facilitated exchanges in a decision released in June 2015. Any remaining legal challenges to the ACA are viewed generally as not significantly impacting the implementation of the law if the plaintiffs prevail.

 

President Trump ran for office on a platform that supported the repeal of the ACA, and one of his first actions after his inauguration was to sign an Executive Order instructing federal agencies to waive or delay requirements of the ACA that impose economic or regulatory burdens on states, families, the health-care industry and others. Modifications to or repeal of all or certain provisions of the ACA have been attempted in Congress as a result of the outcome of the recent presidential and congressional elections, consistent with statements made by the incoming administration and members of Congress during the presidential and congressional campaigns and following the election.

 

In January 2017, Congress voted to adopt a budget resolution for fiscal year 2017, or the Budget Resolution, that authorizes the implementation of legislation that would repeal portions of the ACA. The Budget Resolution is not a law. However, it is widely viewed as the first step toward the passage of legislation that would repeal certain aspects of the ACA. In March 2017, following the passage of the budget resolution for fiscal year 2017, the United States House of Representatives passed legislation known as the American Health Care Act of 2017, which, if enacted, would amend or repeal significant portions of the ACA. Attempts in the Senate in 2017 to pass ACA repeal legislation, including the Better Care Reconciliation Act of 2017, so far have been unsuccessful. At the end of 2017, Congress passed the Tax Cuts and Jobs Act, which repealed the penalty for individuals who fail to maintain minimum essential health coverage as required by the ACA. Following this legislation, Texas and 19 other states filed a lawsuit alleging that the ACA is unconstitutional as the individual mandate was repealed, undermining the legal basis for the Supreme Court’s prior decision. This lawsuit is ongoing and the outcome may have a significant impact on our business.

 

Most recently, the Bipartisan Budget Act of 2018, the “BBA,” which set government spending levels for Fiscal Years 2018 and 2019, revised certain provisions of the ACA. Specifically, beginning in 2019, the BBA increased manufacturer point-of-sale discounts off negotiated prices of applicable brand drugs in the Medicare Part D coverage gap from 50% to 70%, ultimately increasing the liability for brand drug manufacturers. Further, this mandatory manufacturer discount applies to biosimilars beginning in 2019.

 

The Trump Administration has also taken several regulatory steps to redirect ACA implementation. The Department of Health and Human Services finalized a payment reduction for drugs acquired through the 340B Drug Pricing Program and has taken steps to increase the availability of cheaper health insurance options, typically with fewer benefits. The Administration has also signaled its intention to address drug prices and to increase competition, including by increasing the availability of biosimilars. As these are regulatory actions, a new administration could undo or modify these efforts.

 

There have been, and likely will continue to be, legislative and regulatory proposals at the federal and state levels directed at broadening the availability of healthcare and containing or lowering the cost of healthcare products and services. We cannot predict the initiatives that may be adopted in the future. The continuing efforts of the government, insurance companies, managed care organizations and other payors of healthcare services to contain or reduce costs of healthcare may adversely affect:

 

the demand for any products for which we may obtain regulatory approval;

 

our ability to set a price that we believe is fair for our products;

 

our ability to generate revenues and achieve or maintain profitability;

 

the level of taxes that we are required to pay; and

 

the availability of capital.

 

In addition, governments may impose price controls, which may adversely affect our future profitability.

Our, and our subsidiaries current and future relationships with customers and third-party payors in the United States and elsewhere may be subject, directly or indirectly, to applicable anti-kickback, fraud and abuse, false claims, transparency, health information privacy and security and other healthcare laws and regulations, which could expose us or our subsidiaries to criminal sanctions, civil penalties, contractual damages, reputational harm, administrative burdens and diminished profits and future earnings.

 

Healthcare providers, physicians and third-party payors in the US and elsewhere will play a primary role in the recommendation and prescription of any product candidates for which we, or our subsidiaries, obtain marketing approval. Our, and our subsidiaries’, future arrangements with third-party payors and customers may expose us to broadly applicable fraud and abuse and other healthcare laws and regulations, including, without limitation, the federal Anti-Kickback Statute and the federal False Claims Act, which may constrain the business or financial arrangements and relationships through which we and our subsidiaries sell, market and distribute any product candidates for which we obtain marketing approval. In addition, we or our subsidiaries may be subject to transparency laws and patient privacy regulation by the federal and state governments and by governments in foreign jurisdictions in which we conduct our business. The applicable federal, state and foreign healthcare laws and regulations that may affect our ability to operate, or our subsidiaries’ ability to operate, include, but are not necessarily limited to:

 

·the federal Anti-Kickback Statute, which prohibits, among other things, persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in cash or in kind, to induce or reward, or in return for, either the referral of an individual for, or the purchase, order or recommendation of, any good or service, for which payment may be made under federal and state healthcare programs, such as Medicare and Medicaid;

 

·federal civil and criminal false claims laws and civil monetary penalty laws, including the federal False Claims Act, which impose criminal and civil penalties, including civil whistleblower or qui tam actions, against individuals or entities for knowingly presenting, or causing to be presented, to the federal government, including the Medicare and Medicaid programs, claims for payment that are false or fraudulent or making a false statement to avoid, decrease or conceal an obligation to pay money to the federal government; the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, which imposes criminal and civil liability for executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;

 

·HIPAA, as amended by the Health Information Technology for Economic and Clinical Health Act of 2009, or HITECH, and their respective implementing regulations, which impose obligations on covered healthcare providers, health plans, and healthcare clearinghouses, as well as their business associates that create, receive, maintain or transmit individually identifiable health information for or on behalf of a covered entity, with respect to safeguarding the privacy, security and transmission of individually identifiable health information;

 

·the federal Open Payments program, which requires manufacturers of certain drugs, devices, biologics and medical supplies for which payment is available under Medicare, Medicaid or the Children’s Health Insurance Program, with specific exceptions, to report annually to the Centers for Medicare & Medicaid Services, or CMS, information related to “payments or other transfers of value” made to physicians, which is defined to include doctors, dentists, optometrists, podiatrists and chiropractors, and teaching hospitals and applicable manufacturers and applicable group purchasing organizations to report annually to CMS ownership and investment interests held by the physicians and their immediate family members. Data collection began on August 1, 2013 with requirements for manufacturers to submit reports to CMS by March 31, 2014 and 90 days after the end each subsequent calendar year. Disclosure of such information was made by CMS on a publicly available website beginning in September 2014; and

 

·analogous state and foreign laws and regulations, such as state anti-kickback and false claims laws, which may apply to sales or marketing arrangements and claims involving healthcare items or services reimbursed by non-governmental third-party payors, including private insurers; state and foreign laws that require pharmaceutical companies to comply with the pharmaceutical industry’s voluntary compliance guidelines and the relevant compliance guidance promulgated by the federal government or otherwise restrict payments that may be made to healthcare providers; state and foreign laws that require drug manufacturers to report information related to payments and other transfers of value to physicians and other healthcare providers or marketing expenditures; and state and foreign laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

 

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Efforts to ensure that our business and our subsidiaries’ business arrangements with third parties will comply with applicable healthcare laws and regulations may involve substantial costs. It is possible that governmental authorities will conclude that our or our subsidiaries’ business practices may not comply with current or future statutes, regulations or case law involving applicable fraud and abuse or other healthcare laws and regulations. If our or our subsidiaries’ operations are found to be in violation of any of these laws or any other governmental regulations that may apply to us, we may be subject to significant civil, criminal and administrative penalties, including, without limitation, damages, fines, imprisonment, exclusion from participation in government healthcare programs, such as Medicare and Medicaid, and the curtailment or restructuring of our operations, which could have a material adverse effect on our business. If any of the physicians or other healthcare providers or entities with whom we expect to do business, including our collaborators, is found not to be in compliance with applicable laws, it may be subject to criminal, civil or administrative sanctions, including exclusions from participation in government healthcare programs, which could also materially affect our business.

 

Failure to be included in formularies developed by managed care organizations and coverage by other organizations may negatively impact the utilization of our and certain of our subsidiaries’ products, which could harm our and our subsidiaries’ market shares and could have a material adverse effect on our business and financial condition.

 

Managed care organizations and other third-party payors try to negotiate the pricing of medical services and products to control their costs. Managed care organizations and pharmacy benefit managers typically develop formularies to reduce their cost for medications. Formularies can be based on the prices and therapeutic benefits of the available products. Due to their lower costs, generic products are often favored. The breadth of the products covered by formularies varies considerably from one managed care organization to another, and many formularies include alternative and competitive products for treatment of particular medical conditions. Failure to be included in such formularies or to achieve favorable formulary status may negatively impact the utilization and market share of our and certain of our subsidiaries’ products. If our and our subsidiaries’ products are not included within an adequate number of formularies or adequate reimbursement levels are not provided, or if those policies increasingly favor generic products, this could have a material adverse effect on our business and financial condition.

 

Our product candidates and certain of our subsidiaries’ product candidates are at an early stage of development and may not be successfully developed or commercialized.

 

Our existing product candidates, and most of our subsidiaries’ product candidates remain in the early stage of development and will require substantial further capital expenditures, development, testing and regulatory clearances prior to commercialization. The development and regulatory approval process takes several years, and it is not likely that our product candidates or all our subsidiaries’ product candidates, even if successfully developed and approved by the FDA, would be commercially available for several years. Of the large number of drugs in development, only a small percentage successfully completes the FDA regulatory approval process and is commercialized. Accordingly, even if we and our subsidiaries are able to obtain the requisite financing to fund development programs, we cannot assure you that any of our or our subsidiaries’ product candidates will be successfully developed or commercialized, which could result in the failure of our business and a loss of your investment in our Company.

 

Because we and certain of our subsidiaries in-license certain product candidates from third parties, any dispute with the licensors or the non-performance of such license agreements may adversely affect our and our subsidiaries’ ability to develop and commercialize the applicable product candidates.

 

All of our existing product candidates and certain of our subsidiaries’ product candidates, including related intellectual property rights, were in-licensed from third parties. Under the terms of the license agreements, the licensors generally have the right to terminate such agreements in the event of a material breach. The licenses require us and certain of our subsidiaries to make annual, milestone or other payments prior to commercialization of any product and our and our subsidiaries’ ability to make these payments depends on the ability to generate cash in the future. These license agreements also generally require the use of diligent and reasonable efforts to develop and commercialize product candidates.

 

If there is any conflict, dispute, disagreement or issue of non-performance between us or one of our subsidiaries, on the one hand, and the respective licensing partner, on the other hand, regarding the rights or obligations under the license agreements, including any conflict, dispute or disagreement arising from a failure to satisfy payment obligations under such agreements, the ability to develop and commercialize the affected product candidate may be adversely affected.

 

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The types of disputes which may arise between us and our subsidiaries and the third parties from whom we and our subsidiaries license intellectual property include, but are not limited to:

 

·the scope of rights granted under such license agreements and other interpretation-related issues;

 

·the extent to which our technology and processes infringe on intellectual property of the licensor that is not subject to such license agreements;

 

·the sublicensing of patent and other rights under our license agreements and/or collaborative development relationships, and the rights and obligations associated with such sublicensing;

 

·the diligence and development obligations under license agreements (which may include specific diligence milestones) and what activities or achievements satisfy those diligence obligations;

 

·whether or not the milestones associated with certain milestone payment obligations have been achieved or satisfied;

 

·the applicability or scope of indemnification claims or obligations under such license agreements;

 

·the permissibility and advisability of, and strategy regarding, the pursuit of potential third-party infringers of the intellectual property that is the subject of such license agreements;

 

·the calculation of royalty, sublicense revenue and other payment obligations under such license agreements;

 

·the extent to which license rights, if any, are retained by licensors under such license agreements;

 

·whether or not a material breach has occurred under such license agreements and the extent to which such breach, if deemed to have occurred, is or can be cured within applicable cure periods, if any;

 

·disputes regarding patent filing and prosecution decisions, as well as payment obligations regarding past and ongoing patent expenses;

 

·the inventorship and ownership of inventions and know-how resulting from the joint creation or use of intellectual property by our licensors and us and our partners; and

 

·the priority of invention of patented technology.

 

In addition, the agreements under which we and our subsidiaries currently license intellectual property or technology from third parties are complex, and certain provisions in such agreements may be susceptible to multiple interpretations or may conflict in such a way that puts us in breach of one or more agreements, which would make us susceptible to lengthy and expensive disputes with one or more of such third-party licensing partners. The resolution of any contract interpretation disagreement that may arise could narrow what we believe to be the scope of our and our subsidiaries’ rights to the relevant intellectual property or technology, or increase what we believe to be our and our subsidiaries’ financial or other obligations under the relevant agreements, either of which could have a material adverse effect on our business, financial condition, results of operations and prospects. Moreover, if disputes over intellectual property that we or our subsidiaries have licensed prevent or impair our ability to maintain our current licensing arrangements on commercially acceptable terms, we or our subsidiaries may be unable to successfully develop and commercialize the affected product candidates, which could have a material adverse effect on our business, financial conditions, results of operations and prospects.

 

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Product candidates that we or certain of our subsidiaries advance into clinical trials may not receive regulatory approval.

 

Pharmaceutical development has inherent risk. We and certain of our subsidiaries will be required to demonstrate through well-controlled clinical trials that product candidates are effective with a favorable benefit-risk profile for use in their target indications before seeking regulatory approvals for their commercial sale. Success in early clinical trials does not mean that later clinical trials will be successful, as product candidates in later-stage clinical trials may fail to demonstrate sufficient safety or efficacy despite having progressed through initial clinical testing. Also, we or our subsidiaries may need to conduct additional clinical trials that are not currently anticipated. Companies frequently suffer significant setbacks in advanced clinical trials, even after earlier clinical trials have shown promising results. As a result, product candidates that we or our subsidiaries advance into clinical trials may not receive regulatory approval.

 

In addition, even if our or certain of our subsidiaries’ product candidates were to obtain approval, regulatory authorities may approve any of such product candidates or any future product candidate for fewer or more limited indications than we or our subsidiaries request, may not approve the price we or our subsidiaries intend to charge for our products, may grant approval contingent on the performance of costly post-marketing clinical trials, or may approve a product candidate with a label that does not include the labeling claims necessary or desirable for the successful commercialization of that product candidate. Any of these scenarios could compromise the commercial prospects for one or more of our or our subsidiaries current or future product candidates.

 

Moreover, in all interactions with regulatory authorities, the company is exposed to liability risks under the Foreign Corrupt Practices Act or similar anti-bribery laws.

 

Any product candidates we or certain of our subsidiaries advance into clinical development are subject to extensive regulation, which can be costly and time consuming, cause unanticipated delays or prevent the receipt of the required approvals to commercialize product candidates.

 

The clinical development, manufacturing, labeling, storage, record-keeping, advertising, promotion, import, export, marketing and distribution of any product candidate, including our product candidates, and certain of our subsidiaries’ product candidates, is subject to extensive regulation by the FDA in the United States and by comparable health authorities in foreign markets. In the United States, neither we nor our subsidiaries are permitted to market our product candidates until such product candidate’s Biologics License Application (“BLA”) or New Drug Application is approved by the FDA. The process of obtaining approval is expensive, often takes many years and can vary substantially based upon the type, complexity and novelty of the products involved. Certain of our subsidiaries’ development of individualized immunotherapies, if any, will face similar challenges. In addition to the significant clinical testing requirements, our and our subsidiaries’ ability to obtain marketing approval for product candidates depends on obtaining the final results of required non-clinical testing, including characterization of the manufactured components of our and our subsidiaries’ product candidates and validation of our and our subsidiaries’ manufacturing processes. The FDA may determine that our or our subsidiaries’ product manufacturing processes, testing procedures or facilities are insufficient to justify approval. Approval policies or regulations may change, and the FDA has substantial discretion in the pharmaceutical approval process, including the ability to delay, limit or deny approval of a product candidate for many reasons. Despite the time and expense invested in clinical development of product candidates, regulatory approval is never guaranteed.

 

The FDA and other regulatory agencies can delay, limit or deny approval of a product candidate for many reasons, including, but not limited to:

 

·the FDA or comparable foreign regulatory authorities may disagree with the design or implementation of our clinical trials or those of certain of our subsidiaries;

 

·our or certain of our subsidiaries’ inability to demonstrate to the satisfaction of the FDA that a product candidate is safe and effective for any indication;

 

·the FDA may not accept clinical data from trials which are conducted by individual investigators or in countries where the standard of care is potentially different from that of the United States;

 

·the results of clinical trials may not meet the level of statistical significance required by the FDA for approval;

 

·the FDA may disagree with the interpretation of data from preclinical studies or clinical trials;

 

·the FDA may fail to approve the manufacturing processes or facilities or those of third-party manufacturers with which we, or certain of our subsidiaries or our respective collaborators contract for clinical and commercial supplies; or

 

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·the approval policies or regulations of the FDA may significantly change in a manner rendering the clinical data insufficient for approval or the product characteristics or benefit-risk profile unfavorable for approval.

 

With respect to foreign markets, approval procedures vary among countries and, in addition to the aforementioned risks, can involve additional product testing, administrative review periods and agreements with pricing authorities. In addition, recent events raising questions about the safety of certain marketed pharmaceuticals may result in increased cautiousness by the FDA and comparable foreign regulatory authorities in reviewing new pharmaceuticals based on safety, efficacy or other regulatory considerations and may result in significant delays in obtaining regulatory approvals. Any delay in obtaining, or inability to obtain, applicable regulatory approvals would prevent us or our subsidiaries from commercializing our product candidates.

 

Any product candidate we or certain of our subsidiaries advance into clinical trials may cause unacceptable adverse events or have other properties that may delay or prevent their regulatory approval or commercialization or limit their commercial potential.

 

Unacceptable adverse events caused by any of our or certain of our subsidiaries’ product candidates that we advance into clinical trials could cause regulatory authorities to interrupt, delay or stop clinical trials and could result in the denial of regulatory approval by the FDA or other regulatory authorities for any or all targeted indications and markets. This, in turn, could prevent us or certain of our subsidiaries from commercializing the affected product candidate and generating revenues from its sale. For example, in Phase 1/2 oncology trials, dose limiting toxicity (“DLT”) stopping rules are commonly applied.

 

Neither we nor certain of our subsidiaries have completed testing of all our product candidates for the treatment of the indications for which we intend to seek product approval in humans, and we currently do not know the extent of adverse events, if any, that will be observed in patients who receive any of our or our subsidiaries’ product candidates. If any of our or our subsidiaries’ product candidates cause unacceptable adverse events in clinical trials, neither we nor our subsidiaries may be able to obtain regulatory approval or commercialize such products or, if such product candidates are approved for marketing, future adverse events could cause us or certain of our subsidiaries to withdraw such products from the market.

 

Delays in the commencement of our and certain of our subsidiaries’ clinical trials could result in increased costs and delay our or certain of our subsidiaries’ ability to pursue regulatory approval.

 

The commencement of clinical trials can be delayed for a variety of reasons, including, but not necessarily limited to, delays in:

 

·obtaining regulatory clearance to commence a clinical trial;

 

·identifying, recruiting and training suitable clinical investigators;

 

·reaching agreement on acceptable terms with prospective clinical research organizations (“CROs”) and trial sites, the terms of which can be subject to extensive negotiation, may be subject to modification from time to time