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Fair Value Measurements
 9 Months Ended
Sep. 30, 2016
Fair Value Disclosures [Abstract]  
Fair Value Measurements

(9)

Fair Value Measurements

Derivative Warrant Liability

As disclosed in Note 8 of the Company’s interim condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q, the Company allocated part of the proceeds of public offerings in 2013 and 2015 of the Company’s common stock to warrants issued in connection with those transactions. In addition, the Company recognized a discount to debt related to the initial fair value of warrants issued in connection with the June 2016 Convertible Notes discussed in further detail in Note 7 of the Company’s interim condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q. The valuation of the October 2013, February 2015, Series A and Series C warrants (collectively, the “Warrants”) was determined using option pricing models. These models use inputs such as the underlying price of the shares issued at the measurement date, volatility, risk free interest rate and expected life of the instrument. The Company has classified the Warrants as a current liability due to certain provisions relating to price adjustments and potential cash payments, as well as the holders’ ability to exercise the warrants within twelve months of the reporting date and has accounted for them as derivative instruments in accordance with ASC 815, adjusting the fair value at the end of each reporting period. Additionally, the Company has determined that the warrant derivative liability should be classified within Level 3 of the fair-value hierarchy by evaluating each input for the option pricing models against the fair-value hierarchy criteria and using the lowest level of input as the basis for the fair-value classification as called for in ASC 820. There are six inputs: closing price of Delcath stock on the day of evaluation; the exercise price of the warrants; the remaining term of the warrants; the volatility of Delcath’s stock over that term; annual rate of dividends; and the risk-free rate of return. Of those inputs, the exercise price of the warrants and the remaining term are readily observable in the warrant agreements. The annual rate of dividends is based on the Company’s historical practice of not granting dividends. The closing price of Delcath stock would fall under Level 1 of the fair-value hierarchy as it is a quoted price in an active market (ASC 820-10). The risk-free rate of return is a Level 2 input as defined in ASC 820-10, while the historical volatility is a Level 3 input as defined in ASC 820. Since the lowest level input is a Level 3, Delcath determined the warrant derivative liability is most appropriately classified within Level 3 of the fair value hierarchy.

For the three months and nine months ended September 30, 2016, the Company recorded pre-tax derivative warrant income of $8.7 million and pre-tax derivative income of $9.2 million, respectively. The resulting derivative warrant liabilities totaled $22.5 million at September 30, 2016.  Management expects that the Warrants will either be exercised or expire worthless. The fair value of the Warrants at September 30, 2016 was determined by using option pricing models with the following assumptions:

 

 

 

Series C

Warrants

 

 

Series A

Warrants

 

 

February 2015

Warrants

 

 

October 2013

Warrants

 

Expected volatility

 

 

91.93%

 

 

 

96.65%

 

 

 

99.65%

 

 

 

91.70%

 

Risk-free interest rates

 

 

1.28%

 

 

 

1.01%

 

 

 

0.95%

 

 

 

0.76%

 

Expected life (in years)

 

 

5.70

 

 

 

3.81

 

 

 

3.38

 

 

 

2.08

 

 

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2016, aggregated by the level in the fair value hierarchy within which those measurements fall in accordance with ASC 820.

 

 

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

(in thousands)

 

Level 1

 

 

Level 2

 

 

Level 3

 

 

Balance at

September 30, 2016

 

Liabilities

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Derivative instrument liabilities

 

$

—

 

 

$

—

 

 

$

22,502

 

 

$

22,502

 

For the periods ended September 30, 2016 and 2015, there were no transfers in or out of Level 1, 2 or 3 inputs.

 

The table below presents the activity within Level 3 of the fair value hierarchy for the nine months ended September 30, 2016:

 

Fair Value Measurements Using Significant Unobservable Inputs (Level 3)

 

(in thousands)

 

Warrant Liability

 

Balance at December 31, 2015

 

$

3,785

 

Total change in the liability included in earnings

 

 

(9,171

)

Fair value of warrants issued

 

 

28,133

 

Fair value of warrants exercised

 

 

(245

)

Balance at September 30, 2016

 

$

22,502