Fortress Biotech, Inc. annual report, FY2016

Business context and reporting period

Fortress Biotech, Inc. filed this Form 10-K for the fiscal year ended December 31, 2016. It operates a portfolio of biopharmaceutical subsidiaries and acquired a controlling 56.6% interest in National Holdings Corporation (National), a diversified financial-services firm, on September 9, 2016. National’s financial results are consolidated on a one-quarter lag: reported 2016 results include National’s revenues and expenses only for September 10–30, 2016.

The portfolio includes early-stage drug-development programs and Journey Medical’s marketed dermatology products. The filing also reports quarterly data; Q4 2016 figures are unaudited.

Financial performance and position

Unless otherwise stated, amounts are in millions of dollars. Figures below are consolidated.

Metric	2016	2015
Revenue	$16.480	$0.863
Operating expenses	$82.190	$51.394
Operating loss	$(65.710)	$(50.531)
Net loss	$(71.290)	$(53.883)
Net loss attributable to Fortress common stockholders	$(55.095)	$(48.428)
Basic and diluted loss per share	$(1.38)	$(1.24)
Cash and cash equivalents at year-end	$88.294	$98.182
Total assets	$170.731	$118.610
Current liabilities	$56.565	$10.579
Total stockholders’ equity	$82.968	$84.273

Revenue mix: $10.323 million from National, $3.587 million primarily from Journey product sales, and $2.570 million of related-party collaboration revenue, primarily from Checkpoint agreements with TGTX.
Q4 2016: Revenue was $14.405 million; operating expenses were $32.217 million; net loss attributable to common stockholders was $17.431 million, or $0.43 per share. The Q4 revenue concentration reflects, among other factors, the newly consolidated National results; the filing’s one-quarter reporting lag limits National’s included period to September 10–30.
Margins: Consolidated gross margin is not presented as a single measure. Journey’s reported product revenue of $3.587 million less $0.790 million of product cost of goods sold implies $2.797 million before sales and marketing costs; its dermatology segment reported a $4.451 million operating loss.
Cash flow: Operating activities used $45.813 million, investing activities used $6.060 million, and financing activities provided $41.985 million. Cash and cash equivalents declined $9.888 million during the year. Restricted cash was $15.860 million and is not included in cash and cash equivalents.
Debt: Notes payable and subsidiary convertible notes had $30.224 million of gross principal/face amounts in the debt table, less $2.009 million of discounts, for $28.215 million carrying value. Major obligations included the $14.929 million IDB note, secured by a $15.0 million money-market account; $7.0 million borrowed under the Opus facility at 12%; and $3.608 million remaining under the NSC note. The filing identifies the Opus facility as an affiliate-related transaction.
Liquidity: Current assets were $109.634 million against current liabilities of $56.565 million. Management stated existing cash and cash equivalents were expected to fund operations in the normal course for at least 12 months, while also warning that substantial additional funding may be needed. Cash was held across subsidiaries, so the consolidated balance does not necessarily represent unrestricted parent-company liquidity.

Material changes versus the prior comparable period

Revenue rose by $15.617 million from 2015, principally reflecting the National acquisition and growth in Journey product sales and Checkpoint collaboration revenue. National contributed only a short period under the one-quarter reporting lag; it was not included in 2015 results.
Operating expenses increased 60% to $82.190 million. Fortress R&D expense rose 61% to $29.602 million, while acquired-license R&D expense fell to $5.532 million from $11.408 million. General and administrative expense increased 58% to $34.003 million; drivers included staffing, legal and professional fees, business expansion, and rent. National added $12.263 million of operating expenses.
Operating loss widened by $15.179 million and net loss widened by $17.407 million. Higher interest and financing expense contributed to the increase in other expenses. Non-controlling interests absorbed $16.195 million of consolidated net loss, compared with $5.455 million in 2015.
Cash fell from $98.182 million to $88.294 million despite $41.985 million of financing inflows. The year included the National acquisition, subsidiary financings, borrowing under the Opus facility, and repayment of $6.392 million of the NSC note.
National’s acquisition increased reported assets and liabilities and added $18.645 million of preliminary goodwill. Purchase accounting and the acquired intangible-asset valuations were preliminary at filing.

Outlook, commentary, risks and unusual items

Management expects substantial operating losses and R&D spending to continue and does not provide quantified revenue or earnings guidance. Several programs remain in clinical development, and approvals, trial outcomes, commercialization, and future revenues are uncertain.
Development milestones included Checkpoint’s EGFR inhibitor entering a Phase 1/2 trial, Avenue anticipating a Phase 3 IV tramadol study in 2017, and Mustang advancing CAR-T programs in Phase 1. Journey continued product launches. These are company-reported plans and progress, not assurances of success.
Mustang completed a private placement in January 2017, bringing aggregate gross proceeds to $94.5 million, including $39.1 million collected in 2016. Fortress’s ownership in Mustang was reported at approximately 40% following the final closing.
Fortress cited continuing capital needs, potential dilution or restrictive financing terms, clinical and regulatory uncertainty, dependence on collaborators and third-party manufacturers, competition, reimbursement risks, and acquisition/integration risks. The new National business also brings brokerage-market, regulatory, trading, credit, and litigation exposures.
At year-end, Fortress reported $2.634 million accrued for a disputed Dr. Falk Pharma milestone; management said it disputes the adequacy of the clinical study report and does not believe payment is due. A lawsuit concerning an alleged claim to 15% of Mustang remained in discovery; Fortress and Mustang reported no accrual and intend to defend it.
Related-party arrangements warrant attention, including Checkpoint collaboration and licensing arrangements with TGTX, the Opus credit facility, National placement-agent activity, and office-sharing arrangements. The filing describes overlapping management roles and potential conflicts of interest.
The independent auditor gave an unqualified opinion on the financial statements and internal controls. However, management and the auditor excluded the 2016 acquisition from the internal-control assessment; the acquisition represented approximately 23% of consolidated assets and 63% of consolidated revenue cited in that disclosure.

Important facts for investors to verify

Reconcile the quarter’s $14.405 million revenue with the acquisition accounting and the one-quarter reporting lag for National; confirm how much is recurring versus acquisition-period or related-party revenue.
Review unrestricted cash by legal entity, subsidiary financing needs, restricted-cash collateral, debt maturities, interest costs, and the terms and related-party status of the Opus facility.
Track trial progress, regulatory milestones, funding runway, and potential milestone, royalty, and commercialization obligations across the portfolio.
Assess the final purchase-price allocation for National, including goodwill, acquired intangibles, and the warrant liability, and monitor subsequent impairment or valuation changes.
Follow the Mustang litigation and the disputed Falk accrual, along with National’s legal and regulatory matters and any changes in recorded contingencies.
Examine related-party transactions, share issuance and warrant dilution, and the internal-control coverage of National after its exclusion from the year-end control assessment.