Fortress Biotech, Inc. Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

Fair Value Measurements

3 Months Ended

Mar. 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 Headache

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 received 13,409,962 Class A Preferred Units in the third-party company, representing 83% of the total 16,091,954 Class A Preferred Units. The fair value of this investment was $0.3 million as of March 31, 2017 and December 31, 2016. The value of the Company’s investment was determined based on a valuation which takes into consideration, when applicable, cash paid, 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. Based on these inputs at March 31, 2017, the fair value of the Company’s investment approximated cost.

Origo Acquisition Corporation (formerly CB Pharma Acquisition Corporation)

On December 19, 2016, Origo Acquisition Corporation (“Origo”) entered into a merger agreement (“Origo Merger Agreement”) with Aina Le’a Inc. (“Aina Le’a”), a residential and commercial real estate developer in Hawaii. On February 17, 2017, Origo sent a letter, as supplemented on February 22, 2017 (the “Termination Letter”), to Aina Le’a terminating the Origo Merger Agreement. On March 10, 2017, Origo’s shareholders approved an amendment to Origo’s organizational documents extending the date by which Origo must consummate a merger to September 12, 2017.

As of March 31, 2017, the Company valued its investment in Origo, a publicly traded company, utilizing the following assumptions: probability of a successful business combination of 18.4%, and no dividend rate, which yielded an instrument value upon business combination of $9.83 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 $0.11 for each warrant. Based upon the valuation, the Company recorded a decrease in fair-value of investment of $0.7 million. At March 31, 2017, the fair value of the Company’s investment in Origo was, $0.5 million. 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 Company’s promissory note with NSC of March 2015, as amended in July 2015 (the “NSC Note”), if the Company transfers any proceeds from the NSC Note to a Fortress Company, such Fortress Company will issue to NSC Biotech Venture Fund I LLC a new promissory note on identical terms as the NSC Note and NSC Biotech Venture Fund I LLC will also receive a warrant to purchase a number of shares of such 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 classified the fair value of the contingently issuable warrants granted in connection with the transfer from Fortress of $3.0 million to Avenue under the NSC Note 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:

	March 31,
	2017
Risk-free interest rate		2.40	%
Expected dividend yield		-
Expected term in years		8.59
Expected volatility		83	%
Probability of issuance of the warrant		50	%

	Avenue’s
	Contingently
	Issuable
($ in thousands)	Warrants
Beginning balance at January 1, 2017	$	302
Change in fair value		(4)
Ending balance at March 31, 2017	$	298

Avenue Warrant Liabilities

On December 30, 2016, Avenue held a closing of the sale of convertible promissory notes. In the closing, WestPark Capital, Inc., the placement agent (“WestPark”), received a warrant (the “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 WestPark Warrant has a ten-year term and 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. 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 Avenue’s warrant liabilities that are categorized within Level 3 of the fair value hierarchy as of March 31, 2017 is as follows:

	March 31,
	2017
Risk-free interest rate		2.39	%
Expected dividend yield		-
Expected term in years		9.76
Expected volatility		86	%

There was no change in fair value of Avenue’s warrant liability for the three months ended March 31, 2017.

Helocyte Warrant Liabilities

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 Helocyte’s warrant liabilities that are categorized within Level 3 of the fair value hierarchy as of March 31, 2017 is as follows:

	March 31,
	2017
Risk-free interest rate		1.769% 1.859	%
Expected dividend yield		-	%
Expected term in years		4.25 - 4.67
Expected volatility		70.0	%
Strike price	$	0.44

	Fair Value of
	Derivative
	Warrant
($ in thousands)	Liability
Beginning balance at January 1, 2017	$	167
Change in fair value of derivative liabilities		(75)
Ending balance at March 31, 2017	$	92

Convertible Notes at Fair Value

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 Helocyte’s convertible debt that is categorized within Level 3 of the fair value hierarchy as of March 31, 2017 is as follows:

	March 31,
	2017
Risk-free interest rate		0.910% - 1.189	%
Expected dividend yield		-	%
Expected term in years		0.50 - 1.66
Expected volatility		61.7	%

	Helocyte
	Convertible
	Note, at fair
($ in thousands)	value
Beginning balance at January 1, 2017	$	4,487
Change in fair value of convertible notes		93
Ending balance at March 31, 2017	$	4,580

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 Avenue’s convertible debt that is categorized within Level 3 of the fair value hierarchy as of March 31, 2017 is as follows:

	March 31,
	2017
Risk-free interest rate		0.91% - 1.21	%
Expected dividend yield		-	%
Expected term in years		0.50 - 1.75
Expected volatility		61.7	%

	Avenue
	Convertible
	Note, at fair
($ in thousands)	value
Beginning balance at January 1, 2017	$	200
Change in fair value of convertible notes		4
Ending balance at March 31, 2017	$	204

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 March 31, 2017 and December 31, 2016:

	Fair Value Measurement as of March 31, 2017
($ in thousands)	Level 1		Level 2		Level 3		Total
Assets
Long-term investments, at fair value	$	-	$	-	$	746	$	746
Total	$	-	$	-	$	746	$	746

Liabilities
Contingently Issuable Warrants	$	-	$	-	$	298	$	298
Warrant liabilities		-		-		104		104
Helocyte Convertible Note, at fair value		-		-		4,580		4,580
Avenue Convertible Note, at fair value		-		-		204		204
Total	$	-	$	-	$	5,186	$	5,186

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 December 31, 2016:

	Fair Value Measurement as of December 31, 2016
	Level 1		Level 2		Level 3		Total
Assets
National
Securities owned, at fair value
Corporate stocks	$	172	$	-	$	-	$	172
Municipal bonds		930		-		-		930
Restricted stock		-		104		-		104
Total	$	1,102	$	104	$	-	$	1,206

Liabilities
National
Securities sold, but not yet purchased at fair value
Corporate stocks	$	1	$	-	$	-	$	1
Warrants issuable - National						10,096		10,096
Total	$	1	$	-	$	10,096	$	10,097

Warrants issuable - National

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

As National does not have the ability to settle the warrants with unregistered shares and maintenance of an effective registration statement may be considered outside of the Company’s control, net cash settlement of the warrants is assumed. The fair value of the 5.4 million National warrants represents 43.4% of the warrants issued to non-Fortress shareholders. These are being classified as a liability in the condensed consolidated statement of financial condition at March 31, 2017. Such valuation (using level 3 inputs) was determined by use of the Black-Scholes option pricing model using the following assumptions:

	December 31,
	2016
Dividend yield		-	%
Expected volatility		98.23	%
Risk-free interest rate		1.93	%
Life (in years)		4.7

	National’s
($ in thousands)	Warrants
Beginning balance at October 1, 2016	$	14,359
Change in fair value of derivative liability		(4,263)
Ending balance at December 31, 2016	$	10,096

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

The table below provides a rollforward of the changes in fair value of Level 3 financial instruments for the three months ended March 31, 2017:

					Helocyte		Avenue
					Convertible		Convertible		Contingently
	Investment in		Investment in		Note, at fair		Note, at fair		Issuable		Warrant
($ in thousands)	Origo		laser device		value		value		Warrants		liabilities		Total
Balance at December 31, 2016	$	1,164	$	250	$	4,487	$	200	$	14,661	$	179	$	20,941
Change in fair value of investments		(668)		-		-		-		-		-		(668)
Change in fair value of convertible notes		-		-		93		4		-		-		97
Change in fair value of derivative liabilities		-		-		-		-		(4,267)		(75)		(4,342)
Balance at March 31, 2017	$	496	$	250	$	4,580	$	204	$	10,394	$	104	$	16,028

For the three months ended March 31, 2017, no transfers occurred between Level 1, Level 2 and Level 3 instruments.

- 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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