Delcath Systems, Inc. (NASDAQ: DCTH) is having a rough day today after announcing that the company would be relisted on the OTC markets following a plan to go through a reverse split that was voted down. As is normally the case, our partners at Trade Ideas were the first to alert us to the declines. At the moment (8:01), DCTH is trading at $0.10 per share after a loss of $0.03 per share or 23.26% thus far today.
Nonetheless, that's not why I'm writing this post today. Today, I'd like to discuss a 10K that clearly showed some major issues at the company and ultimately warn investors that even the management team doesn't think things are going to go well. First and foremost, a special thanks goes to one of our readers, Dave H, who has been emailing me back and fourth, and ultimately was the person that brought this information to my attention. In fact, he even sent a PDF copy of the 10K highlighting the areas that were a cause for concern. With that said, thank you Dave for being an active part of the CNA Finance community and looking out for the best interest of investors!
Serious Concerns With Regard To Ability To Continue Operations
In the 10K, dated 3/29/2017, DCTH offered the following, suggesting that there is substantial doubt with regard to their ability to stay afloat as a business. In fact, the company even admitted that it's “likely” that holders of common stock will lose all of their investment Here's the quote from the SEC filing...
“Our independent registered public accounting firm has expressed substantial doubt about our ability to continue as a going concern. Our independent registered public accounting firm issued a report dated March 28, 2017 in connection with the audit of our financial statements as of December 31, 2016, which included an explanatory paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern. In addition, our notes to our financial statements for the year ended December 31, 2016 included a disclosure describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to obtain substantial additional funding in connection with our continuing operations. Adequate additional financing may not be available to us on acceptable terms, or at all. If we are unable to raise additional capital and/or enter into strategic alliances when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or any commercialization efforts. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty. If we are not able to continue as a going concern, it is likely that holders of our common stock will lose all of their investment.”
DCTH Has Very Little Control Over CHEMOSAT/Melphalan/HDS
Further into the 10K, it becomes clear that the products the company is taking part in have some serious issues. Ultimately, DCTH has very little control over the production of their products, which could lead to long delays in obtaining key components of their products. Here's what they had to offer in the 10K:
“We purchase components for CHEMOSAT/Melphalan/HDS from third parties, some of which are sole-source suppliers. The components of CHEMOSAT/Melphalan/HDS, including catheters, filters, introducers and chemotherapy agents, must be manufactured and assembled in accordance with approved manufacturing and predetermined performance specifications and must meet cGMP and quality systems requirements. Some states also have similar regulations. Many of the components of CHEMOSAT/Melphalan/HDS are manufactured by sole-source suppliers that may have proprietary manufacturing processes. If we or any of our suppliers fails to meet those regulatory obligations, we may be forced to suspend or terminate our clinical trials, and, once a product is approved for marketing, the manufacture, assembly or distribution thereof. Further, if we need to find a new source of supply, we may face long interruptions in obtaining necessary components for CHEMOSAT/Melphalan/HDS, in obtaining FDA or foreign regulatory agency approval of these components and in establishing the manufacturing process, which could jeopardize our ability to supply CHEMOSAT/Melphalan/HDS to the market.
We do not have written contracts with all of our suppliers for the manufacture of components for CHEMOSAT/Melphalan/HDS. We do not have written contracts with all our suppliers for the manufacture of components for CHEMOSAT/Melphalan/HDS. If we are unable to obtain an adequate supply of the necessary components or negotiate acceptable terms, we may not be able to manufacture the system in commercial quantities or in a cost-effective manner, and commercialization of CHEMOSAT/Melphalan/HDS in the EEA may be delayed. In addition, certain components are available from only a limited number of sources. Components of CHEMOSAT/Melphalan/HDS are currently manufactured for us in small quantities and we may require significantly greater quantities to further commercialize the product. We may not be able to find alternate sources of comparable components. If we are unable to obtain adequate supplies of components from our existing suppliers or need to switch to an alternate supplier and obtain FDA or other regulatory agency approval of that supplier, commercialization of CHEMOSAT/Melphalan/HDS may be delayed.”
The Company Has Little By Way Of Marketing Capabilities
In their 10K, DCTH made it clear that they have no idea how to market their products. This is a major concern. After all, without marketing, sales will be a drag, and it looks like that's exactly what the company is setting up for. Here's the quote from the figurative horse's mouth:
“We have limited experience in marketing and commercializing our products, and as a result, we may not be successful in commercializing CHEMOSAT in the EEA. We have not previously sold, marketed or distributed any products and have limited experience in building a sales and marketing organization and in entering into and managing relationships with third-party distributors. Even though we have obtained the right to affix the CE Mark, we currently have limited sales, marketing, commercial or distribution capabilities in any countries in the EEA. In order to pursue our strategy to commercialize CHEMOSAT in the EEA, we must acquire or internally develop a sales, marketing and distribution infrastructure and/or enter into strategic alliances to perform these services. The development of sales, marketing and distribution infrastructure is difficult, time consuming and requires substantial financial and other resources. If we cannot successfully develop the infrastructure to market and commercialize CHEMOSAT, our ability to generate revenues in the EEAmay be harmed, and we may not generate sufficient revenue to sustain our business or we may be required to enter into strategic alliances to have such activities carried out on our behalf, which may not be on favorable terms.”
Competition Could Prove To Be An Issue
Further into the 10K, DCTH explains that patents are limited with regard to the protection and the lifespan of protection that they offer. Ultimately, the company made it clear that they are subject to competition from generic versions of their methods and devices.
“Our success depends in part on our ability to commercialize CHEMOSAT/Melphalan/HDS prior to the expiration of our patent protection. Due to the uncertainty of the patent prosecution process, there are no guarantees that any of our pending patent applications will result in the issuance of a patent. Even if we are successful in obtaining a patent, patents have a limited lifespan. In the United States, the natural expiration of a utility patent typically is generally 20 years after it is filed. Various extensions may be available; however, the life of a patent, and the protection it affords, is limited. Without patent protection for our CHEMOSAT/Melphalan/HDS methods and devices, we may be open to competition from generic versions of such methods and devices.”
DCTH Does Not Own Some Key Patents, They Are Licensed From A Third Party
Another key issue here is the fact that Delcath Systems doesn't seem to own patent rights to key components of their products. These patents are licensed by DCTH, but this could be a major concern if these relationships are not upheld.
“We maintain a patent license arrangement with a third party, and our future business may depend, in part, upon the maintenance of that arrangement. Certain aspects of our next generation products may be covered by United States patents and United States patent applications owned by a third party and exclusively licensed to us. If we breach the terms of the license agreement, the license may be terminated by the licensor. If we do not meet certain commercialization obligations by 2019, the license may be converted to a non-exclusive license by the licensor. We cannot guarantee that the license will not be terminated or converted in the future. Without the patent license we will not be able to prevent others from practicing the technology covered by the licensed patent. Moreover, without the patent license, we may be subject to allegations of patent infringement by the patent owner. We cannot guarantee that the third party will fulfill its responsibilities under the license arrangement.”
Management Gives Stockholders The Middle Finger!
This one is just as surprising as the rest, if not more so. DCTH has moved forward with anti-takeover provisions, meaning that a takeover is unlikely to say the least. On top of that, they have put provisions in place that “make it more difficult for [their] stockholders to replace management.” So essentially, the snippet below says that management will do what they want with little opportunity for recourse given to investors.
“Anti-takeover provisions in our Certificate of Incorporation and By-laws may reduce the likelihood of a potential change of control, or make it more difficult for our stockholders to replace management. Certain provisions of our Certificate of Incorporation and By-laws could have the effect of making it more difficult for our stockholders to replace management at a time when a substantial number of our stockholders might favor a change in management. These provisions include: • providing for a staggered board; and • authorizing the board of directors to fill vacant directorships or increase the size of our board of directors. Furthermore, our board of directors has the authority to issue up to 10,000,000 shares of preferred stock in one or more series and to determine the rights and preferences of the shares of any such series without stockholder approval.Any series of preferred stock is likely to be senior to the common stock with respect to dividends, liquidation rights and, possibly, voting rights. Our board’s ability to issue preferred stock may have the effect of discouraging unsolicited acquisition proposals, thus adversely affecting the market price of our common stock.”
Assets Up For Grabs
The company goes further to explain that their assets are essentially owned by their note holders. In fact, if the company defaults on obligations to these obligations, the note holders have rights to all assets of the company. Here's the quote:
“Our obligations to the holders of our notes are secured by a security interest in substantially all of our assets, so if we default on those obligations, the note holders could foreclose on our assets. Our obligations under the notes and the transaction documents relating to the notes are secured by a first priority security interest in substantially all of our assets. As a result, if we default under our obligations under the notes or the transaction documents, the holders of the notes, acting through their appointed agent, could foreclose on their security interests and liquidate some or all of these assets, which would harm our business, financial condition and results of operations and could require us to reduce or cease operations.”
Ability To Continue Is A Growing Concern
In the 10K, the company blatantly explains that the independent registered public account firm they hired has serious concerns with the company's ability to continue in business from a financial standpoint.
“Our independent registered public accounting firm has issued its report dated March 28, 2017 in connection with the audit of our financial statements as of December 31, 2016 that included an explanatory paragraph describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern. In addition, our notes contained in this Annual Report on Form 10-K for the year ended December 31, 2016 include a disclosure describing the existence of conditions that raise substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern is dependent upon our ability to obtain substantial additional funding in connection with our continuing operations. Adequate additional financing may not be available to us on acceptable terms, or at all. If we are unable to raise additional capital and/or enter into strategic alliances when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or any commercialization efforts. Our financial statements as of December 31, 2016 have been prepared under the assumption that we will continue as a going concern. If we are not able to continue as a going concern, it is likely that holders of our common stock will lose all of their investment. Our financial statements do not include any adjustments that might result from the outcome of this uncertainty.”
DCTH Has Sold Some Of The Little IP It Has
Further into the 10K, Delcath Systems made it clear that while they have little intellectual property, what they do have is up for sale. Strangely enough, it recently sold some of this IP to Delcath Holdings Limited. Considering the name of the purchaser, something smells fishy!
“On January 1, 2012, Delcath Systems, Inc. sold a portion of its intellectual property to Delcath Holdings Limited resulting in a taxable gain of $15.8 million in the U.S. based on the fair market value of the intangible that was transferred. The arms-length price, which was determined in accordance with Section 482, is a significant accounting estimate. The gain is deferred under U.S. GAAP principles until the asset is sold outside of the consolidated financial statements. The remaining deferred gain on the intercompany sale of intangible assets is $4.4 million and $6.7 million as of December 31, 2016 and December 31, 2015, respectively.”
Money Is A Big Problem
While management at DCTH pays themselves exorbitant salaries, they clearly understand that they are doing so at the cost of investors. The following paragraph says it all.
“The Company’s existence is dependent upon management’s ability to obtain additional funding sources or to enter into strategic alliances. Adequate additional financing may not be available to us on acceptable terms, or at all. If we are unable to raise additional capital and/or enter into strategic alliances when needed or on attractive terms, we would be forced to delay, reduce or eliminate our research and development programs or any commercialization efforts. There can be no assurance that the Company’s efforts will result in the resolution of the Company’s liquidity needs. If we are not able to continue as a going concern, it is likely that holders of our common stock will lose all of their investment. The accompanying consolidated financial statements do not include any adjustments that might result should the Company be unable to continue as a going concern.”
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What We'll Be Watching For Moving Forward
Moving forward, the CNA Finance team will continue to keep a close eye on DCTH. At this point, we're essentially watching to see how long it takes for the company to crumble. With no RS, funding isn't available and with protection from takeovers, that's likely not an option either. We're also doing some serious digging into the relationship between Delcath Systems and Hudson bay and advise all investors to do so as well. Nonetheless, we'll continue to follow the story and bring the news to you as it breaks!
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