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, 2015

5. Fair Value Measurements

From time to time, the Company invests in marketable securities, which are classified as trading securities and are stated at fair value as determined by quoted market prices. There were no marketable securities at December 31, 2015. As of December 31, 2014, the Company held $20.0 million in marketable securities, which primarily consisted of a U.S. treasury bill and a mutual fund.

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.

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. The fair value of this investment was $250,000 as of December 31, 2015 and 2014. The value of the Company’s investment was determined based on a valuation which takes into consideration, when applicable, cash received, cost of the investment, market participant inputs, estimated cash flows based on entity specific criteria, purchase multiples paid in other comparable third-party transactions, market conditions, liquidity, operating results and other qualitative and quantitative factors. The values at which the Company’s investments are carried on its books are adjusted to estimated fair value at the end of each quarter taking into account general economic and stock market conditions and those characteristics specific to the underlying investments. Based upon these inputs at December 31, 2015, the fair value of the Company’s investment approximated cost.

On April 18, 2014, the Company paid $243,000 for an option to purchase the exclusive rights to a Phase 2, topical product, Uracil Topical Cream, from a third party and paid an additional $50,000 in August 2014 to extend the term of the option for a total purchase price of $293,000. The Company elected the fair value option for this investment. On September 30, 2014, the Company recognized a loss of $293,000 in connection with the expiration of the option. For the year ended December 31, 2014, this loss was reflected in the Consolidated Statements of Operations.

In September 2014, the Company formed CB Pharma, a blank check company and received 1.1 million insider shares of CB Pharma in exchange for $25,000. In December 2014, CB Pharma closed its IPO, including an over-allotment option, and a private placement raising net proceeds of $42.9 million. In connection with the IPO, in a private placement, the Company purchased 265,000 units of CB Pharma at $10.00 per unit. Each unit included one ordinary share, one right to receive one-tenth of an ordinary share upon consummation of a business combination and a warrant exercisable for one-half of an ordinary share at $11.50 per share upon the later of a business combination or twelve months from December 12, 2014 and expiring in five years, for an aggregate purchase price of $2.7 million. None of the ordinary shares or units purchased by the Company have liquidation rights. The Company elected the fair value option for recording this investment and valued their investment in CB Pharma in accordance with ASC Topic 820, Fair Value Measurements and Disclosures. The value of these ordinary shares and rights were based on the trading prices in January 2015, upon the commencement of CB Pharma’s instruments trading separately. Since the insider shares are restricted through a specified period following a business combination, the “Ghaidarov Mode ” was utilized to estimate a discount for lack of marketability with the following assumptions: risk free rate of return of 0.1%, the restriction period of approximately one year from a business combination, volatility of 9.3%, and no dividend rate; yielding an underlying value of $2.93 per ordinary share for the insider shares and $2.99 per ordinary share for the private placement units. The rights and warrants were valued utilizing a binomial-lattice model which assumes a volatility of 20.7%, a risk free rate of return of 1.68% and a strike price of $11.50 per share, and applied a probability factor (implied likelihood of a successful business combination occurring within 18 months from the IPO date) arriving at an estimated value of $0.18 for each warrant and $0.30 for each right. Based upon the valuation, the Company recorded a change in fair-value of investment of $1.2 million; increasing the fair value of the investment to $3.9 million as of December 31, 2014. At December 31, 2015, the fair value of the Company’s investment in CB Pharma was $2.2 million and was valued utilizing the following assumptions: volatility of 25.6%, no dividend rate, yielding an underlying value of $9.12 per ordinary share for the insider shares, and $9.29 per ordinary share for the private placement shares. The rights and warrants were valued utilizing a binomial-lattice model which assumes a volatility of 25.6%, a risk free rate of return of 1.76% and a strike price of $11.50 per share arriving at a value of $0.88 for each right and $0.89 for a warrant. An 18.45% probability of a successful business combination was applied to the values above arriving at an estimated value of $1.67 for the insider shares, $1.70 for the private placement shares, $0.16 for each warrant and $0.17 for each right. Based upon the valuation, the Company recorded a decrease in fair-value of investment of $1.7 million during the year ended December 31, 2015. Additionally, as of November 30, 2015, CB Pharma had net assets of approximately $42.6 million. Operations since inception have been insignificant. The Company has a working capital commitment of up to $0.5 million to fund CB Pharma operations, of which $0.2 million has been paid. As of December 31, 2015, the fair value of this commitment was insignificant.

Pursuant to the Amended NSC Note (see Note 8), 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 the 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. In accordance with ASC 815, Avenue and Checkpoint classified the fair value of the warrant (“Contingently Issuable Warrants”) that may have been granted in connection with the $3 million of the NSC Note transferred from Fortress to Avenue on October 31, 2015 and $2.8 million of the NSC Note transferred from Fortress to Checkpoint from March 19, 2015 to August 31, 2015 as a derivative liability as there was a potential that Avenue and Checkpoint would not have a sufficient number of authorized common shares available to settle these instruments.

Avenue

The fair value of the Avenue’s Contingently Issuable Warrants was determined 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:

	February 17, 2015			December 31, 2015
Risk-free interest rate		1.97	%		2.27	%
Expected dividend yield		-	%		-	%
Expected term in years		10.00			9.84
Expected volatility		83.00	%		83.00	%
Probability of issuance of the warrant		25.00	%		25.00	%

($ in thousands)	Fair Value of Derivative Warrant Liability
Beginning balance at January 1, 2015	$	-
Recognition of derivative warrant liability		114
Fair value adjustment of derivative warrant liability		-
Ending balance at December 31, 2015	$	114

Checkpoint

On October 30, 2015, Checkpoint issued 139,592 warrants to NSC after an initial closing of the 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
Fair value at the beginning of period:	$	-
Additions		175
Change in fair value		438
Issuance of Warrants (October 30, 2015)		(613)
Fair value at end of period:	$

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	%

The following tables classify into the fair value hierarchy financial instruments measured at fair value on a recurring basis on the Consolidated Balance Sheets as of December 31, 2015 and 2014:

	Fair Value Measurement as of December 31, 2015
($ in thousands)	Level 1		Level 2		Level 3		Total
Assets
Long-term investments, at fair value	$	-	$	-	$	2,485	$	2,485

Liabilities
Derivative warrant liability	$	-	$	-	$	114	$	114

	Fair Value Measurement as of December 31, 2014
($ in thousands)	Level 1		Level 2		Level 3		Total
Assets
Marketable securities, at fair value:
U.S. treasury bills	$	19,998	$	-	$	-	$	19,998
Mutual funds		4		-				4
Total marketable securities, at fair value		20,002		-		-		20,002
Long-term investments, at fair value		-		-		4,160		4,160
Total	$	20,002	$	-	$	4,160	$	24,162

The table below provides a rollforward of the changes in fair value of Level 3 financial instruments for the years ended December 31, 2014 and 2015:

	Fair Value of Investment
	Short-term		Long-term
($ in thousands)	Other		Other		CB Pharma		Total
Balance at December 31, 2013	$	-	$	-	$	-	$	-
Purchases		293		250		2,675		3,218
Change in fair value of investments		(293)				1,235		942
Balance at December 31, 2014	$	-	$	250	$	3,910	$	4,160
Change in fair value of investments		-		-		(1,675)		(1,675)
Balance at December 31, 2015	$	-	$	250	$	2,235	$	2,485

- 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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