Delcath Systems, Inc. — Form 10-Q Summary
Business context and reporting period
Delcath is an interventional oncology company developing Melphalan/HDS, a regional chemotherapy system for primary and metastatic liver cancers. The product is investigational and not approved for sale in the United States; CHEMOSAT is in early-stage commercial development in Europe under a CE Mark.
This report covers the three and nine months ended September 30, 2016. The company initiated its global Phase 3 FOCUS trial for hepatic-dominant ocular melanoma in January 2016 and continued Phase 2 programs in hepatocellular carcinoma and intrahepatic cholangiocarcinoma.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $0.435 million | $0.399 million | $1.316 million | $1.308 million |
| Gross profit | $0.323 million | $0.309 million | $0.943 million | $0.948 million |
| Gross margin | 74.3% | 77.4% | 71.7% | 72.5% |
| Operating loss | $(4.724) million | $(3.650) million | $(12.057) million | $(10.982) million |
| Net loss | $(1.005) million | $(2.422) million | $(9.485) million | $(9.611) million |
| Net loss per share | $(0.66) | $(1.96) | $(6.38) | $(10.75) |
Revenue was essentially flat year over year. Nine-month selling, general and administrative expense declined to $7.025 million from $7.818 million, while research and development expense increased to $5.975 million from $4.112 million, primarily because of the Phase 3 trial. The company recorded $8.680 million of warrant-liability fair-value income in the quarter and $9.171 million for the nine months; these non-cash gains materially reduced reported net loss.
Interest expense was $4.963 million in the quarter and $6.584 million for the nine months, primarily reflecting amortization of debt discounts and financing costs associated with the June 2016 convertible-note financing.
- Cash and cash equivalents at September 30, 2016: $3.689 million, compared with $12.607 million at December 31, 2015.
- Restricted cash: $30.287 million, primarily related to the convertible notes; much of this cash was subject to release conditions.
- Net cash used in operating activities for the nine months: $10.597 million, versus $12.188 million in the comparable 2015 period.
- Total assets: $36.980 million; total liabilities: $32.494 million; stockholders’ equity: $4.486 million.
- Convertible notes: $35.0 million principal, carried at $6.413 million net of $28.587 million in debt discounts at September 30, 2016.
- Warrant liability: $22.502 million, classified as a Level 3 derivative liability.
Material changes versus the prior comparable period
- Research and development spending increased approximately 45% for the nine months as the FOCUS Phase 3 trial began.
- Operating loss increased approximately 9.8% for the nine months despite lower SG&A.
- Reported nine-month net loss improved only slightly because the $9.171 million warrant-liability gain and lower operating cash use were largely offset by $6.584 million of interest expense and higher R&D spending.
- In June 2016, Delcath issued $35.0 million of senior secured convertible notes for $32.2 million of cash proceeds and issued Series C Warrants initially exercisable for approximately 6.8 million shares.
- The company completed a one-for-sixteen reverse stock split effective July 21, 2016 and increased authorized common shares to 500 million.
- After quarter-end, an October 5, 2016 equity offering generated approximately $1.1 million of net proceeds from 425,000 shares and 148,750 warrants.
Guidance, outlook, risks and unusual items
Management stated that the June financing provides capital resources expected to fund operations through the end of 2017. However, the filing also states that recurring losses, negative operating cash flow and the need for additional capital raise substantial doubt about the company’s ability to continue as a going concern. Management may seek additional debt, equity financing or strategic alliances.
The notes mature December 29, 2017 and require twelve installment payments beginning seven months after issuance. Payments may be made in cash or shares subject to conditions. Failure to satisfy those conditions could require cash repayment. The notes are secured by substantially all company assets; defaults may trigger 15% interest, redemption premiums and foreclosure rights.
Potential dilution is substantial. The notes and warrants may require issuance of significant common shares, and the filing states that 22,130,196 shares were reserved for conversions and warrant exercises as of the report date. The Series C Warrant terms also provide for a potential increase in warrant shares at maturity.
Key operating risks include FDA approval uncertainty, clinical-trial enrollment and results, product safety, manufacturing and supply constraints, European reimbursement, limited commercial revenue, competition, intellectual-property matters and dependence on additional financing. The prior U.S. application received a complete response letter in 2013; the new FOCUS trial is intended to address remaining regulatory requirements.
Most important facts for investors to verify
- Whether the FOCUS Phase 3 trial meets enrollment, execution, safety and overall-survival objectives and supports a future U.S. regulatory submission.
- The timing and conditions for release of restricted cash and whether available capital is sufficient through the end of 2017.
- Whether installment payments on the secured convertible notes can be made in shares or will require cash, including the resulting dilution.
- The potential increase in Series C Warrant shares and the ultimate impact of the $22.5 million warrant liability.
- Progress toward European reimbursement and conversion of limited product revenue into sustainable commercial growth.
- The company’s going-concern status and ability to obtain additional financing or strategic funding.