Fortress Biotech, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Fair Value Measurements

Fair Value Measurements

12 Months Ended

Dec. 31, 2017

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.

Laser Device for Treatment of Migraine Headaches

On March 17, 2014, the Company invested $250,000 for a 35% ownership position in a third-party company developing a laser device to treat migraine headaches. The Company elected the fair value option for recording this investment. In conjunction with this investment, the Company entered into a Purchase Agreement with the third-party company, in which the Company received 13,409,962 Class A Preferred Units, representing 83% of a total 16,091,954 Class A Preferred Units. In August 2017, a clinical trial utilizing this device concluded that there was no strong statistical data demonstrating that the device provided relief from migraine headaches. Accordingly, the third-party company ceased operations and the Company wrote off its investment of $0.3 million. The fair value of this investment was nil and $0.3 million as of December 31, 2017 and 2016.

Origo Acquisition Corporation (formerly CB Pharma Acquisition Corporation)

On June 10, 2016, CB Pharma Acquisition Corp (“CB Pharma”) held an extraordinary general meeting of shareholders (the “Meeting”). At the Meeting, the shareholders approved each of the following items: (i) an amendment to the CB Pharma’s Amended and Restated Memorandum and Articles of Association (the “Charter”) to extend the date by which CB Pharma has to consummate a business combination from June 12, 2016 to December 12, 2016 (the “ Extension ”), (ii) an amendment to the Charter to allow the holders of the CB Pharma’s ordinary shares issued in the their initial public offering to elect to convert their shares into their pro rata portion of the funds held in trust, if the Extension is approved, and (iii) the change of CB Pharma’s name from “CB Pharma Acquisition Corp.” to “Origo Acquisition Corporation” (“Origo”). In connection with the Meeting, the Company transferred 1,050,000 of its CB Pharma ordinary shares to Origo. The Company retained ownership of 265,000 Origo shares.

On July 24, 2017, Origo entered into a Merger Agreement with High Times Holding Corp. (“HTH”), which was later amended on September 27, 2017 (“Amended Merger Agreement”). Pursuant to the terms of the Amended Merger Agreement, the Merger Sub will merge with and into HTH, with HTH continuing as the surviving entity (the “Merger”) and all holders of HTH equity securities and warrants, options and rights to acquire or securities that convert into HTH equity securities (collectively, “HTH Securities”) will convert into Origo common shares and, with respect to options, options to acquire Origo common shares.

On September 11, 2017, Origo’s shareholders approved a second amendment to the Articles of Association and extended the date by which to consummate a business combination to March 12, 2018. A shareholder meeting was held on March 12, 2018, at which the Origo shareholders approved the extension of the date by which to consummate a business combination to June 12, 2018.

As of December 31, 2017, and 2016, the Company valued its investment in Origo, a publicly traded company, utilizing the following assumptions: probability of a successful business combination of 46.53% and 51.53%, and no dividend rate, which yielded an underlying value of $10.65 and $8.16 per ordinary share for the private placement shares. The rights and warrants were valued utilizing a binomial-lattice model utilizing a risk-free rate of return of 1.28% and 0.85% and a strike price of $11.50 per share arriving at a value of $1.06 and $0.82 for each right and $1.07 and $0.58 for each warrant. Time to expected business combination/ liquidation was 0.05 and 0.20 during December 31, 2017 and 2016, respectively. Based upon the valuation, the Company recorded an increase in fair-value of investment of $0.2 million and a decrease in fair-value of investment of $1.1 million during December 31, 2017 and 2016, respectively. At December 31, 2017 and 2016, the fair value of the Company’s investment in Origo was, $1.4 million and $1.2 million, respectively. The Company’s working capital note with Origo of $0.3 million can be converted to stock upon a successful business combination.

Contingently Issuable Warrant

Pursuant to the Amended NSC Note (see Note 11), if a Fortress Company has the proceeds of the NSC Note transferred to it, such Fortress Company will issue a note to NSC and NSC will also receive a warrant to purchase a number of shares of the Fortress Company’s stock equal to 25% of the outstanding Fortress Company note divided by the lowest price for which the Fortress Company sells its equity in its first third party financing. The warrants issued will have a term of 10 years and an exercise price equal to the par value of the Fortress Company’s common stock and are accounted for in accordance with ASC 815, Derivatives and Hedging.

Avenue

Avenue classified the fair value of the Contingently Issuable Warrants that may have been granted in connection with Avenue’s $3.0 million of its NSC Note transferred from Fortress to Avenue on October 31, 2015 (issuance date) and December 31, 2016 as a derivative liability as there was a potential that Avenue would not have a sufficient number of authorized common shares available to settle these instruments.

The fair value of Avenue’s Contingently Issuable Warrants was determined by applying management’s estimate of the probability of issuance of the Contingently Issuable Warrants together with an option pricing model, with the following key assumptions:

	December 31,
	2017			2016
Risk-free interest rate		-	%		2.45	%
Expected dividend yield		-			-
Expected term in years		-			10.00
Expected volatility		-	%		87	%
Probability of issuance of the warrant		-			50	%

On June 26, 2017, Avenue closed on an Initial Public Offering (“IPO”) raising gross proceeds of $38.0 million and issuing 6.3 million common shares at $6.00 per share. As such, pursuant to the terms of Avenue’s $3.0 million NSC Note, Avenue issued to National a warrant to purchase 125,000 of its common shares at par. The issuance of the warrant relates to the completion of Avenue’s IPO in which Avenue’s raised gross proceeds from a third-party party exceeding five times the value of the debt. Upon the issuance of the warrant by Avenue, the Company was removed as the guarantor on the note.

($ in thousands)	Avenue’s Contingently Issuable Warrants
Beginning balance at January 1, 2016	$	114
Additions		-
Change in fair value		188
Ending balance at December 31, 2016		302
Conversion into common shares		(750)
Change in fair value		448
Ending balance at December 31, 2017	$	-

Mustang

Mustang classified the fair value of the Contingently Issuable Warrants that may have been granted in connection with Mustang’s $3.6 million NSC Note transferred from Fortress to Mustang on July 5, 2016 (issuance date). In October 2016, Mustang issued 138,462 warrants with an exercise price at par. Upon the issuance of warrants, Fortress derecognized a liability related to contingently issuance warrants of $0.8 million.

The fair value of Mustang’s Contingently Issuable Warrants was determined by applying management’s estimate of the probability of issuance of the Contingently Issuable Warrants together with an option-pricing model, with the following key assumptions:

	Issuance Dates
Risk-free interest rate		1.37	%
Expected dividend yield		-
Expected term in years		10.00
Expected volatility		76.70	%
Probability of issuance of the warrant		100	%

($ in thousands)	Mustang’s Contingently Issuable Warrants
Beginning balance at January 1, 2016	$	-
Additions		634
Change in fair value		159
Issuance of Warrants (October 25, 2016)		(793)
Ending balance at December 31, 2016	$	-

Checkpoint

On October 30, 2015, Checkpoint issued 139,592 warrants to NSC after an initial closing of Checkpoint’s offering on September 30, 2015. The following table sets forth the changes in the estimated fair value for Checkpoint’s Level 3 classified derivative Contingently Issuable Warrant liabilities:

($ in thousands)	Checkpoint’s Contingently Issuable Warrants
Beginning balance at January 1, 2015	$	-
Additions		175
Change in fair value		438
Issuance of Warrants (October 30, 2015)		(613)
Ending balance at December 31, 2015	$	-

The fair value of Checkpoint’s Contingently Issuable Warrants was determined at various issuance dates from March 19, 2015 to August 31, 2015 (“Issuance Dates”) for $0.2 million and on October 30, 2015 for $0.6 million by applying management’s estimate of the probability of issuance of the Contingently Issuable Warrants together with the option pricing model with the following key assumptions:

	Issuance Dates			October 30, 2015
Risk-free interest rate		2.26	%		2.16	%
Expected dividend yield		-			-
Expected term in years		10.00			10.00
Expected volatility		83	%		100.86	%
Probability of issuance of the warrant		25	%		100	%

Warrant Liabilities

Avenue

On December 30, 2016, Avenue held a closing of the sale of convertible promissory notes. In the closing, WestPark Capital, Inc., (“WestPark”) the placement agent, received a warrant (“WestPark Warrant”) to purchase the number of shares of Avenue’s common stock equal to $10,000 divided by the price per share at which any note sold to investors first converts into Avenue’s common stock. The Avenue Warrant has a ten-year term and has a per share exercise price equal to the price per share at which any note sold to investors first converts into Avenue’s common stock. The fair value of Avenue’s WestPark Warrant liability was measured at fair value using a Monte Carlo simulation valuation methodology. A summary of the weighted average (in aggregate) significant unobservable inputs (level 3 inputs) used in measuring the Company’s warrant liabilities that are categorized within Level 3 of the fair value hierarchy for the year ended December 31, 2016 is as follows:

	December 31, 2016
Risk-free interest rate		2.45	%
Expected dividend yield		-	%
Expected term in years		10.00
Expected volatility		87	%

Additionally, on June 26, 2017, in connection with its IPO, Avenue issued 2,488 warrants to purchase common shares of Avenue at $4.02, a 33% discount to the IPO price of $6.00 to Westpark Capital in connection with their role as placement agent for Avenue’s 2016 Convertible Notes, which automatically converted to common shares of Avenue upon completion of the IPO.

($ in thousands)	Fair Value of Derivative Warrant Liability
Beginning balance at January 1, 2016	$	-
Additions		12
Change in fair value of derivative liabilities		-
Ending balance at December 31, 2016	$	12
Conversion into common shares		(15)
Change in fair value		3
Ending balance at December 31, 2017	$	-

Helocyte

The fair value of Helocyte’s warrant liability was measured at fair value using a Monte Carlo simulation valuation methodology. A summary of the weighted average (in aggregate) significant unobservable inputs (level 3 inputs) used in measuring the Company’s warrant liabilities that are categorized within Level 3 of the fair value hierarchy for the year ended December 31, 2017 and 2016 are as follows:

	December 31
	2017			2016
Risk-free interest rate		2.04% - 2.08	%		1.82% - 1.91	%
Expected dividend yield		-	%		-	%
Expected term in years		3.50 3.92			4.50 - 4.92
Expected volatility		70.0	%		70.0	%
Strike price	$	0.46		$	0.44

($ in thousands)	Fair Value of Derivative Warrant Liability
Beginning balance at January 1, 2016	$	-
Additions		428
Change in fair value of derivative liabilities		(261)
Ending balance at December 31, 2016	$	167
Change in fair value of derivative liabilities		(80)
Ending balance at December 31, 2017	$	87

Caelum

The fair value of Caelum's warrant liability, which was issued in connection with Caelum’s convertible note, was measured using a Monte Carlo simulation valuation methodology. A summary of the weighted average (in aggregate) significant unobservable inputs (Level 3 inputs) used in measuring Caelum’s warrant liabilities that are categorized within Level 3 of the fair value hierarchy as of December 31, 2017 is as follows:

	December 31, 2017
Risk-free interest rate		2.154% - 2.168	%
Expected dividend yield		-	%
Expected term in years		4.58 - 4.71
Expected volatility		70.0	%
Strike price	$	1.01

($ in thousands)	Fair Value of Derivative Warrant Liability
Beginning balance at January 1, 2017	$	-
Additions		226
Change in fair value of derivative liabilities		(3)
Ending balance at December 31, 2017	$	223

Convertible Notes at Fair Value

Helocyte

Helocyte’s convertible debt 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 the convertible debt that is categorized within Level 3 of the fair value hierarchy for the year ended December 31, 2017 and 2016 is as follows:

	December 31
	2017			2016
Risk-free interest rate		1.53% - 1.72	%		0.74% - 1.17	%
Expected dividend yield		-	%		-	%
Expected term in years		0.50 0.911			0.75 - 1.91
Expected volatility		52.4	%		61.7	%

	Convertible Note
($ in thousands)	At Fair Value
Beginning balance at January 1, 2016	$	-
Additions		4,409
Change in fair value of convertible notes		78
Ending balance at December 31, 2016		4,487
Change in fair value of convertible notes		213
Ending balance at December 31, 2017	$	4,700

Avenue

Avenue’s convertible debt 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 the convertible debt that is categorized within Level 3 of the fair value hierarchy for the year ended December 31, 2016 is as follows:

	December 31, 2016
Risk-free interest rate		0.62% - 1.20	%
Expected dividend yield		-	%
Expected term in years		0.50 - 2.00
Expected volatility		63.1	%

On June 26, 2017, upon completion of Avenue’s IPO, Avenue’s convertible debt automatically converted into approximately 49,749 common shares of Avenue, at $4.02, a 33% discount to the IPO price, pursuant to the terms of the Convertible Note. As of September 30, 2017, Avenue’s obligation to its note holders was satisfied.

($ in thousands)	Convertible Note, at fair value
Beginning balance at January 1, 2016	$	-
Additions		200
Ending balance at December 31, 2016		200
Conversion into common shares		(299)
Change in fair value of convertible notes		99
Ending balance at December 31, 2017	$	-

Caelum

Caelum’s convertible debt 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 December 31, 2017 is as follows:

	December 31, 2017
Risk-free interest rate		1.506%- 1.851	%
Expected dividend yield		-	%
Expected term in years		0.46 - 1.70
Expected volatility		70.0	%

($ in thousands)	Convertible Note, at fair value
Beginning balance at January 1, 2017	$	-
Additions		9,914
Change in fair value of convertible notes		145
Ending balance at December 31, 2017	$	10,059

The following tables classify into the fair value hierarchy of Fortress’ financial instruments, exclusive of National’s financial instruments, measured at fair value on a recurring basis on the Consolidated Balance Sheets as of December 31, 2017 and 2016:

	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

	Fair Value Measurement as of December 31, 2016
($ in thousands)	Level 1		Level 2		Level 3		Total
Assets
Long-term investments, at fair value	$	-	$	-	$	1,414	$	1,414
Total	$	-	$	-	$	1,414	$	1,414

Liabilities
Contingently Issuable Warrants	$	-	$	-	$	302	$	302
Warrant liabilities		-		-		179		179
Helocyte Convertible Note, at fair value		-		-		4,487		4,487
Avenue Convertible Note, at fair value		-		-		200		200
Total	$	-	$	-	$	5,168	$	5,168

The following tables show the fair values hierarchy of National’s financial instruments measured at fair value on a recurring basis on the Consolidated Balance Sheets as of September 30, 2017 and 2016:

	Fair Value Measurement as of September 30, 2017
($ in thousands)	Level 1		Level 2		Level 3		Total
Assets
Securities owned, at fair value
Corporate stock	$	116	$	-	$	-	$	116
Municipal bonds		-		1,239		-		1,239
Restricted stock		-		82		-		82
Warrants		-		-		5,665		5,665
Total	$	116	$	1,321	$	5,665	$	7,102

Liabilities
Securities sold, but not yet purchased at fair value
Contingent consideration	$	-	$	-	$	311	$	311
Municipal bonds		-		151		-		151
Warrants issued		-		-		5,597		5,597
Total	$	-	$	151	$	5,908	$	6,059

	Fair Value Measurement as of September 30, 2016
($ in thousands)	Level 1		Level 2		Level 3		Total
Assets
Corporate stock		101				-		101
Municipal bonds		-		2,111		-		2,111
Restricted stock		-		145		-		145
Total	$	101	$	2,256	$	-	$	2,357

Liabilities
Corporate stock		298		-		-		298
Warrants issuable						14,359		14,359
Total	$	298	$	-	$	14,359	$	14,657

Warrants Issued

In accordance with the Merger Agreement, since less than 80% of National’s issued and outstanding shares of common stock were tendered, National remains a publicly-traded company and stockholders post-tender offer received from National a five-year warrant to purchase an additional share of the Company’s common stock at $3.25 as a dividend to all holders of National’s common stock.

At September 30, 2016 net cash settlement of the warrant was assumed since National did not have the ability to settle the warrants with unregistered shares and did not have an effective registration statement making settlement outside of National’s control. Accordingly, National was obligated to issue the warrants. The fair value of the 5.4 million warrants issuable (represents 44% of the warrants issued to non-Fortress shareholders) are being classified as a liability in the consolidated statement of financial condition at September 30, 2017 and 2016. Such valuation (using level 3 inputs) was determined by use of the Black-Scholes option pricing model using the following assumptions:

	September 30
	2017			2016
Dividend yield		-	%		-	%
Expected volatility		91.0	%		118.85	%
Risk-free interest rate		1.890	%		1.14	%
Life (in years)		4.20			5

The table below provides a roll forward of the changes in fair value of Level 3 financial instruments for the years ended December 31, 2017 and 2016:

					Convertible Notes, at fair value
($ in thousands)	Investment in Origo		Investment in laser device		Helocyte		Avenue		Caelum		Issued Warrants		Warrant liabilities		Total
Balance at December 31, 2016	$	1,164	$	250	$	4,487	$	200	$	-	$	14,661	$	179	$	20,941
Additions during the period		-		-		-		-		9,914		-		-		9,914
Conversion into common shares		-		-		-		(299)		-		(750)		(15)		(1,064)
Loss on write off investment		-		(250)		-		-		-		-		-		(250)
Change in fair value of investments		226		-		-		-		-		-		-		226
Change in fair value of convertible notes		-		-		213		99		145		-		-		457
Change in fair value of derivative liabilities		-		-		-		-		-		448		(8,839)		(8,391)
Balance at December 30, 2017	$	1,390	$	-	$	4,700	$	-	$	10,059	$	14,359	$	(8,675)	$	21,833

							Convertible Notes, at Fair Value
($ in thousands)	Investment in Origo		Investment in laser device		Contingently Issuable Warrants		Helocyte		Avenue		Warrant liabilities		Total
Balance at December 31, 2015	$	2,235	$	250	$	114	$	-	$	-	$	-	$	2,599
Additions during the period		-		-		14,040		4,409		200		440		19,089
Issuance of warrants		-		-		(793)		-		-		-		(793)
Change in fair value of investments		(1,071)		-		-		-		-		-		(1,071)
Change in fair value of convertible notes		-		-		-		78				-		78
Change in fair value of derivative liabilities		-		-		1,300		-				(261)		1,039
Balance at December 31, 2016	$	1,164	$	250	$	14,661	$	4,487	$	200	$	179	$	20,941

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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