10-Q 1 swkh20140331_10q.htm FORM 10-Q swkh20140331_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2014

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

SWK Holdings Corporation

(Exact Name of Registrant as Specified in its Charter)

 

Delaware

77-0435679

(State or Other Jurisdiction of Incorporation or Organization)

(I.R.S. Employer Identification No.)

  

  

 

 

15770 North Dallas Parkway, Suite 1290

Dallas, TX 75248

84604

(Address of Principal Executive Offices)

(Zip Code)

 

(972) 687-7250 (Registrant’s Telephone Number, Including Area Code)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value per share

(Title of class)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    ☒  YES    ☐   NO

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ☒   YES    ☐   NO

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large Accelerated Filer  ☐

Accelerated Filer  ☐

Non-Accelerated Filer  ☐

Smaller Reporting Company ☒

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ☐   YES    ☒   NO

 

As of May 9, 2014, there were 43,174,894 shares of the registrant’s Common Stock, $0.001 par value per share, outstanding.

 

 
1

 

 

SWK Holdings Corporation

Form 10-Q

Quarter Ended March 31, 2014

 

Table of Contents

 

PART I. FINANCIAL INFORMATION

  

  

  

  

Item 1.

Financial Statements

4

  

  

  

  

Unaudited Condensed Consolidated Balance Sheets—March 31, 2014 and December 31, 2013

4

  

  

  

  

Unaudited Condensed Consolidated Statements of Income—Three Months Ended March 31, 2014 and 2013

5
     
 

Unaudited Condensed Consolidated Statements of Comprehensive Income —Three Months Ended March 31, 2014 and 2013

6

  

  

  

  

Unaudited Condensed Consolidated Statements of Cash Flows—Three Months Ended March 31, 2014 and 2013

7

  

  

  

  

Notes to the Unaudited Condensed Consolidated Financial Statements

8

  

  

  

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  23

  

  

  

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

  30

  

  

  

Item 4

Controls and Procedures

  30

  

  

PART II. OTHER INFORMATION

  

  

  

  

Item 1.

Legal Proceedings

  30

  

  

  

Item 1A.

Risk Factors

  30

  

  

  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  30

  

  

  

Item 3.

Defaults Upon Senior Securities

  31

  

  

  

Item 4.

Mine Safety Disclosures

  31

  

  

  

Item 5.

Other Information

  31

  

  

  

Item 6.

Exhibits

  31

  

  

  

  

Signatures

  32

  

  

  

  

Certifications

 

 

 
2

 

 

FORWARD-LOOKING STATEMENTS

 

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, and our beliefs and assumptions, and include, but are not limited to, statements under the headings “Management's Discussion and Analysis of Financial Condition and Results of Operations” and Outlook . Words such as “anticipate,” “believe,” “estimate,” “expects,” “intend,” “plan,” “will” and variations of these words and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, many of which are beyond our control, are difficult to predict and could cause actual results to differ materially (both favorable and unfavorably) from those expressed or forecasted in the forward-looking statements. These risks and uncertainties include, but are not limited to, those described in “Risk Factors” and elsewhere in this report, and those described from time to time in our past and future reports filed with the Securities and Exchange Commission, including in our Annual Report on Form 10-K for the year ended December 31, 2013. Forward-looking statements that were believed to be true at the time made may ultimately prove to be incorrect or false. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

 

 
3

 

 

PART I. FINANCIAL INFORMATION

 

ITEM I.              FINANCIAL STATEMENTS

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

   

March 31,

2014

   

December 31,

2013

 

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 3,867     $ 7,664  

Accounts receivable

    356       528  

Prepaid expenses and other current assets

    289       16  

Finance receivables

     957       660  

Deferred tax asset

     111       164  

Total current assets

     5,580       9,032  

Finance receivables

    40,708       28,626  

Marketable investments

    3,119       3,119  

Investment in unconsolidated entities

    9,952       10,425  

Deferred tax asset

    8,986       9,639  

Debt issuance costs

    488       523  

Other assets

    422       211  

Total assets

  $ 69,255     $ 61,575  
                 

LIABILITIES AND STOCKHOLDERS’ EQUITY

               

Current liabilities:

               

Accounts payable and accrued liabilities

  $ 809     $ 363  

Total current liabilities

    809       363  

Loan credit agreement

    11,000       5,000  

Warrant liability

    250       292  

Other long-term liabilities

    -       3  

Total liabilities

    12,059       5,658  
                 

Commitments and contingencies

               
                 

Stockholders’ equity:

               

Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding

    -       -  

Common stock, $0.001 par value; 250,000,000 shares authorized; 43,174,894 and 43,034,894 shares issued and outstanding at March 31, 2014 and December 31, 2013, respectively

    43       43  

Additional paid-in capital

    4,321,530       4,321,454  

Accumulated deficit

    (4,269,736

)

    (4,271,193

)

Accumulated other comprehensive income

    -       -  

Total SWK Holdings Corporation stockholders’ equity

    51,837       50,304  

Non-controlling interests in consolidated entities

    5,359       5,613  

Total stockholders’ equity

    57,196       55,917  

Total liabilities and stockholders’ equity

  $ 69,255     $ 61,575  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 
4

 

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME

(in thousands, except per share data)

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 
                 

Revenues

               

Finance receivable interest income, including fees

  $ 2,031     $ 374  

Marketable investments interest income

    91       -  

Income related to investments in unconsolidated entities

    1,503       -  

Management fees

    42       56  

Total Revenues

    3,667       430  

Costs and expenses:

               

General and administrative

    669       390  

Total costs and expenses

    669       390  

Income from operations

    2,998       40  

Interest and other income (expense), net

    (34 )     23  

Income before provision for income tax

    2,964       63  

Provision for income tax

    706       3  

Consolidated net income

    2,258       60  

Net income attributable to non-controlling interests

    801       -  
                 

Net income attributable to SWK Holdings Corporation Stockholders

  $ 1,457     $ 60  
                 

Net income per share attributable to SWK Holdings Corporation Stockholders

               

Basic

  $ 0.04     $ 0.00  

Diluted

  $ 0.04     $ 0.00  

Weighted Average Shares

               

Basic

    41,462       41,316  

Diluted

    41,530       41,396  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 
5

 

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands, except per share data)

 

   

Three Months Ended March 31,

 
   

2014

   

2013

 
                 

Net income

  $ 2,258     $ 60  

Other comprehensive income, net of tax:

               

Unrealized gains on investment in securities

               

Unrealized holding gains arising during period

    -       -  
                 

Less: reclassification adjustment for gains included in net income

    -       -  

Total other comprehensive income

    -       -  

Comprehensive income

    2,258       60  
                 

Comprehensive income attributable to non-controlling interests

    801       -  
                 

Comprehensive income attributable to SWK Holdings Corporation Stockholders

  $ 1,457     $ 60  

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 
6

 

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

   

Three Months Ended

March 31,

 
   

2014

   

2013

 
                 

Cash flows from operating activities:

               

Net income

  $ 2,258     $ 60  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Income from investments in unconsolidated entities

    (1,503

)

    -  

Deferred income taxes

    706        -  

Interest income in excess of cash collected

    (431

)

     -  

Loan discount amortization and fee accretion

    (72

)

    -  

Change in fair value of warrants

    (154

)

    -  

Stock-based compensation

    76       60  

Debt issuance cost amortization

    35       -  

Other non-cash expense

    -       4  

Changes in operating assets and liabilities:

               

Accounts receivable

    172       105  

Restricted cash

    -       250  

Prepaid expenses and other assets

    (273

)

    (138

)

Interest reserve

    -       (250

)

Accounts payable and accrued liabilities

    443       77  

Net cash provided by operating activities

    1,257       168  
                 

Cash flows from investing activities:

               
Net increase in finance receivables     (11,975 )     -  

Cash distributions from investments in unconsolidated entities

    1,976       -  

Purchases of property and equipment

    -       (4

)

Net cash used in investing activities

    (9,999

)

    (4

)

                 

Cash flows from financing activities:

               

Proceeds from loan credit agreement

    6,000       -  

Distributions to non-controlling interests

    (1,055 )     -  

Net cash provided by financing activities

    4,945       -  
                 

Net (decrease) increase in cash and cash equivalents

    (3,797

)

    164  

Cash and cash equivalents at beginning of period

    7,664       24,584  

Cash and cash equivalents at end of period

  $ 3,867     $ 24,748  

 

Noncash activity:

The Company received a warrant for 347,222 common shares at an exercise price of $0.43 per share in conjunction with the additional draw on a finance receivable during the three months ended March 31, 2014. The fair value of the warrant of $99,000 was deferred and reflected in other assets in the unaudited condensed consolidated balance sheet.

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 
7

 

 

NOTES TO THE UNADUITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

 

Note 1. SWK Holdings Corporation and Summary of Significant Accounting Policies

 

Nature of Operations

 

SWK Holdings Corporation (“SWK” or the “Company”) is engaged in investing in the pharmaceutical and biotechnology royalty securitization market.  The Company’s strategy is to provide capital to a broad range of life science companies, institutions and inventors. The Company is currently focused on monetizing cash flow streams derived from commercial-stage products and related intellectual property through royalty purchases and financings, as well as through the creation of synthetic revenue interests in commercialized products. The Company intends to fill a niche that it believes is underserved in the sub-$50 million transaction size. The Company’s goal is to redeploy its existing assets to earn interest, fee, and other income pursuant to this strategy, and the Company continues to identify and review financing and similar opportunities on an ongoing basis. In addition the Company is also engaged in the business of providing investment advisory services to institutional clients.

  

The Company has net operating loss carryforwards (“NOLs”) and believes that the ability to utilize these NOLs is an important and substantial asset. The Company believes that the foregoing business strategies can create value for its stockholders, and produce prospective taxable income (or the ability to generate capital gains) that might permit the Company to utilize the NOLs. The Company is unable to assure investors that it will find suitable financing opportunities or that it will be able to utilize its existing NOLs.

 

Basis of Presentation

 

The Company’s unaudited condensed consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States (“GAAP”).  The unaudited condensed consolidated financial statements include the accounts of all subsidiaries and affiliates in which the Company holds a controlling financial interest as of the financial statement date. Normally a controlling financial interest reflects ownership of a majority of the voting interests. The Company consolidates a variable interest entity (“VIE”) when it possesses both the power to direct the activities of the VIE that most significantly impact its economic performance and the Company is either obligated to absorb the losses that could potentially be significant to the VIE or the Company holds the right to receive benefits from the VIE that could potentially be significant to the VIE, after elimination of intercompany accounts and transactions.

 

The Company owns interests in various partnerships and limited liability companies, or LLCs.  The Company consolidates its investments in these partnerships or LLCs, where the Company, as the general partner or managing member, exercises effective control, even though the Company’s ownership is less than 50%.  The related governing agreements provide the Company with broad powers, and the other parties do not participate in the management of the entity and do not have the substantial ability to remove the Company.  The Company has reviewed each of the underlying agreements to determine if it has effective control.  If circumstances changed and it was determined this control did not exist, this investment would be recorded using the equity method of accounting.  Although this would change individual line items within the Company’s condensed consolidated financial statements, it would have no effect on our operations and/or total stockholders’ equity attributable to the Company. The Company operates in one operating segment with a single management team that reports to the chief executive officer, who is the Company’s chief operating decision maker.

 

Unaudited Interim Financial Information

 

The unaudited condensed consolidated financial statements have been prepared by the Company and reflect all normal, recurring adjustments that, in the opinion of management, are necessary for a fair presentation of the interim financial information. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for any subsequent quarter or for the year ending December 31, 2014. Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted under the rules and regulations of the Securities and Exchange Commission (“SEC”). These unaudited condensed consolidated financial statements and notes included herein should be read in conjunction with the audited consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013, filed with the SEC on March 31, 2014. The year-end unaudited condensed consolidated balance sheet data was derived from the Company's audited financial statements, but does not include all disclosures required by GAAP.

 

Variable Interest Entities

 

An entity is referred to as a VIE if it possesses one of the following criteria: (i) it is thinly capitalized, (ii) the residual equity holders do not control the entity, (iii) the equity holders are shielded from the economic losses, (iv) the equity holders do not participate fully in the entity's residual economics, or (v) the entity was established with non-substantive voting interests. The Company consolidates a VIE when it has both the power to direct the activities that most significantly impact the activities of the VIE and the right to receive benefits or the obligation to absorb losses of the entity that could be potentially significant to the VIE. Along with the VIEs that are consolidated in accordance with these guidelines, the Company also holds variable interests in other VIEs that are not consolidated because it is not the primary beneficiary. The Company continually monitors both consolidated and unconsolidated VIEs to determine if any events have occurred that could cause the primary beneficiary to change. See Note 4 for further discussion of VIEs.

 

 
8

 

 

Use of Estimates

 

The preparation of the Company’s unaudited condensed consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the unaudited condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are required in the determination of revenue recognition, stock-based compensation, impairment of financing receivables and long-lived assets, valuation of warrants, useful lives of property and equipment, income taxes and contingencies and litigation, among others.  Some of these judgments can be subjective and complex, and, consequently, actual results may differ from these estimates. The Company estimates often are based on complex judgments, probabilities and assumptions that it believes to be reasonable but that are inherently uncertain and unpredictable. For any given individual estimate or assumption made by the Company, there may also be other estimates or assumptions that are reasonable.

  

The Company regularly evaluates its estimates and assumptions using historical experience and other factors, including the economic environment. As future events and their effects cannot be determined with precision, the Company’s estimates and assumptions may prove to be incomplete or inaccurate, or unanticipated events and circumstances may occur that might cause us to change those estimates and assumptions. Market conditions, such as illiquid credit markets, volatile equity markets, and economic downturn, can increase the uncertainty already inherent in the Company’s estimates and assumptions. The Company adjusts its estimates and assumptions when facts and circumstances indicate the need for change. Those changes generally will be reflected in our condensed consolidated financial statements on a prospective basis unless they are required to be treated retrospectively under the relevant accounting standard. It is possible that other professionals, applying reasonable judgment to the same facts and circumstances, could develop and support a range of alternative estimated amounts.

 

Equity Method Investments

 

The Company accounts for portfolio companies whose results are not consolidated, but over which it exercises significant influence, under the equity method of accounting. Whether or not the Company exercises significant influence with respect to a portfolio company depends on an evaluation of several factors including, among others, representation of the Company on the portfolio company’s board of directors and the Company’s ownership level. Under the equity method of accounting, the Company does not reflect a portfolio company’s financial statements within the company’s unaudited consolidated financial statements; however, the Company’s share of the income or loss of such portfolio company is reflected in income in the unaudited condensed consolidated statements of income. The Company includes the carrying value of equity method portfolio companies as part of the investment in unconsolidated entities on the unaudited condensed consolidated balance sheets.

 

When the Company’s carrying value in an equity method portfolio company is reduced to zero, the Company records no further losses in its unaudited condensed consolidated statements of income unless the Company has an outstanding guarantee obligation or has committed additional funding to such equity method portfolio company. When such equity method portfolio company subsequently reports income, the Company will not record its share of such income until it exceeds the amount of the Company’s share of losses not previously recognized.

 

Finance Receivables

 

The Company extends credit to customers through a variety of financing arrangements, including revenue interest term loans. The amounts outstanding on loans are referred to as finance receivables and are included in Finance Receivables on the unaudited condensed consolidated balance sheets.  It is the Company’s expectation that the loans originated will be held for the foreseeable future or until maturity. In certain situations, for example to manage concentrations and/or credit risk, some or all of certain exposures may be sold. Loans for which the Company has the intent and ability to hold for the foreseeable future or until maturity are classified as held for investment (“HFI”). If the Company no longer has the intent or ability to hold loans for the foreseeable future, then the loans are transferred to held for sale (“HFS”). Loans entered into with the intent to resell are classified as HFS.

  

If it is determined that a loan should be transferred from HFI to HFS, then the balance is transferred at the lower of cost or fair value. At the time of transfer, a write-down of the loan is recorded as a write-off when the carrying amount exceeds fair value and the difference relates to credit quality, otherwise the write-down is recorded as a reduction in interest and other Income, and any loan loss reserve is reversed. Once classified as HFS, the amount by which the carrying value exceeds fair value is recorded as a valuation allowance and is reflected as a reduction to interest and other income.

 

 
9

 

 

If it is determined that a loan should be transferred from HFS to HFI, the loan is transferred at the lower of cost or fair value on the transfer date, which coincides with the date of change in management’s intent. The difference between the carrying value of the loan and the fair value, if lower, is reflected as a loan discount at the transfer date, which reduces its carrying value. Subsequent to the transfer, the discount is accreted into earnings as an increase to finance revenue over the life of the loan using the effective interest method.

 

Finance receivables are stated at their principal amounts inclusive of deferred loan origination fees.  Interest income is credited as earned based on the effective interest rate method except when a finance receivable becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued.

 

Marketable Investments

 

Available-for-sale securities are reported at fair value with unrealized gains or losses recorded in accumulated other comprehensive income, net of applicable income taxes. The available-for-sale portfolio as of March 31, 2014 and December 31, 2013 includes one debt security. In any case where fair value might fall below amortized cost, the Company would consider whether that security is other-than-temporarily impaired using all available information about the collectability of the security. The Company would not consider that an other-than temporary impairment for a debt security has occurred if (1) the Company does not intend to sell the debt security, (2) it is not more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis and (3) the present value of estimated cash flows will fully cover the amortized cost of the security. The Company would consider that an other-than-temporary impairment has occurred if any of the above mentioned three conditions are not met.

 

For a debt security for which an other-than-temporary impairment is considered to have occurred, the Company would recognize the entire difference between the amortized cost and the fair value in earnings if the Company intends to sell the debt security or it is more likely than not that the Company will be able to sell the debt security before recovery of its amortized cost basis. If the Company does not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security before recovery of its amortized cost basis, the Company would separate the difference between the amortized cost and the fair value of the debt security into the credit loss component and the non-credit loss component. The credit loss component would be recognized in earnings and the non-credit loss component would be recognized in other comprehensive income, net of applicable income taxes.

 

Derivatives

 

All derivatives held by the Company are recognized in the unaudited condensed consolidated balance sheets at fair value. The accounting treatment for subsequent changes in the fair value depends on their use, and whether they qualify as effective “hedges” for accounting purposes. Derivatives that are not hedges must be adjusted to fair value through the unaudited condensed consolidated statements of income. If a derivative is a hedge, then depending on its nature, changes in its fair value will be either offset against change in the fair value of hedged assets or liabilities through the unaudited condensed consolidated statements of income, or recorded in other comprehensive income. The Company had no derivatives designated as hedges as of March 31, 2014 and December 31, 2013. The Company holds three warrants issued to the Company in conjunction with the term loan investments discussed in Note 2. These warrants are included in other assets in the unaudited condensed consolidated balance sheets. The Company issued a warrant on its own common stock in the year ended December 31, 2013, in conjunction with its credit facility discussed in Note 5. This warrant meets the definition of a derivative and is reflected as warrant liability at fair value in the unaudited condensed consolidated balance sheets as of March 31, 2014 and December 31, 2013. 

 

Revenue Recognition

 

The Company records interest income on an accrual basis based on the effective interest rate method to the extent that it expects to collect such amounts. The Company recognizes investment management fees as earned over the period the services are rendered.  In general, the majority of investment management fees earned are charged either monthly or quarterly.  Incentive fees, if any, are recognized when earned at the end of the relevant performance period, pursuant to the underlying contract.  Other administrative service revenues are recognized when contractual obligations are fulfilled or as services are provided.

 

Certain Risks and Concentrations

 

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents, accounts receivable, finance receivables and marketable investments. The Company invests its excess cash with major U.S. banks and financial institutions. The Company has not experienced any losses on its cash and cash equivalents.

 

 
10

 

 

The Company performs ongoing credit evaluations of its customers and generally requires collateral.  For the three months ended March 31, 2014, three partner companies accounted for 73 percent of total revenue. For the three months ended March 31, 2013, one partner company accounted for 87 percent of total revenue.

  

The Company does not expect its current or future credit risk exposures to have a significant impact on its operations. However, there can be no assurance that its business will not experience any adverse impact from credit risk in the future.

 

Net Income per Share

 

Basic net income per share is computed using the weighted average number of outstanding shares of common stock. Diluted net income per share is computed using the weighted average number of outstanding shares of common stock and, when dilutive, shares of common stock issuable upon exercise of options and warrants deemed outstanding using the treasury stock method.

 

The following table shows the computation of basic and diluted earnings per share for the following (in thousands, except per share amounts):

 

   

Three Months Ended

 
   

March 31, 2014

   

March 31, 2013

 

Numerator:

               

Net income attributable to SWK Holdings Corporation Shareholders

  $ 1,457     $ 60  

Denominator:

               

Weighted-average shares outstanding

    41,462       41,316  

Effect of dilutive securities

    68       80  

Weighted-average diluted shares

    41,530       41,396  

Basic earnings per share

  $ 0.04     $ 0.00  

Diluted earnings per share

  $ 0.04     $ 0.00  

 

For the three month period ended March 31, 2014 and 2013, outstanding stock options and warrants to purchase shares of common stock in an aggregate of approximately 4,175,000 and 3,205,000 shares, respectively, have been excluded from the calculation of diluted net income per share as all such securities were anti-dilutive.

 

Reclassifications

 

Certain prior period amounts in the unaudited condensed consolidated financial statements have been reclassified to conform to the current period’s presentation.

  

Recent Accounting Pronouncements

 

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.  Under this new guidance, companies must present this unrecognized tax benefit in the consolidated financial statements as a reduction to deferred tax assets created by net operating losses or other tax credits from prior periods that occur in the same taxing jurisdiction. If the unrecognized tax benefit exceeds such credits it should be presented in the consolidated financial statements as a liability. This update is effective for annual and interim reporting periods for fiscal years beginning after December 15, 2013. The adoption of this standard did not have any impact on the Company’s operating results and financial position.

 

Note 2. Finance Receivables

 

Finance receivables are reported at their determined principal balances net of any unearned income, cumulative charge-offs and unamortized deferred fees and costs. Unearned income and deferred fees and costs are amortized to interest income based on all cash flows expected using the effective interest method.

 

The carrying value of finance receivables are as follows (in thousands):

 

   

March 31, 2014

   

December 31, 2013

 

Portfolio

               
                 
Term Loans    $ 33,794     $ 21,420  

 

               
Royalty Purchases      7,871       7,866  

Total

    41,665       29,286  

Less: current portion

     (957     (660 )

Total noncurrent portion of finance receivables

     40,708     $ 28,626  

 

 
11

 

 

Term Loans

 

Nautilus Neurosciences, Inc.

 

On December 5, 2012, the Company entered into a credit agreement pursuant to which the lenders party thereto provided to a neurology-focused specialty pharmaceutical company a term loan in the principal amount of $22,500,000.  The loan was repaid on December 17, 2013. The Company initially provided $19,000,000 and a client of the Company provided the remaining $3,500,000 of the loan. The Company subsequently assigned $12,500,000 of the loan to its clients and retained the remaining $6,500,000. The loan was managed by the Company on behalf of its clients pursuant to the terms of each client’s investment management agreement.

 

The Company recognized $374,000 in interest income, recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2013.  

 

Tribute

 

On August 8, 2013, the Company entered into a credit agreement pursuant to which the Company provided to Tribute Pharmaceuticals Canada Inc. ("Tribute") a secured term loan in the principal amount of $8,000,000. The loan matures on August 8, 2018. The Company provided $6,000,000 at closing and an additional $2,000,000 on February 4, 2014.

 

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales and royalties of Tribute applied in the following priority first, to the payment of all accrued but unpaid interest until paid in full; second to the payment of all principal of the loans.  

 

The loan accrues interest at the LIBOR rate, plus an applicable margin, subject to a 13.5% minimum. In addition, the Company earned an origination fee at closing, and the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized $276,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014.

 

In connection with the loan and at closing, Tribute also issued the Company a warrant to purchase 755,794 common shares an exercise price of $0.60 per share that may be exercised at any time prior to August 8, 2020 with an initial fair value of $334,000.   In conjunction with the additional draw on February 4, 2014, Tribute issued an additional warrant to purchase 347,222 common shares with an exercise price of $0.432 per share that may be exercised at any time prior to February 4, 2021 with an initial fair value of $99,000.

 

The fair market value of the warrants was $415,000 at March 31, 2014, and is included in other assets in the unaudited condensed consolidated balance sheet. An unrealized holdings gain of $112,000 was included in interest and other income (expense), net in the unaudited condensed consolidated statements of income for the three months ended March 31, 2014. The Company determined the fair value of the warrant outstanding at March 31, 2014 and December 31, 2013, using the Black-Scholes option pricing model with the following assumptions:

 

   

March 31, 2014

   

December 31, 2013

 

Dividend rate

    0

%

    0 %

Risk-free rate

    2.3

%

    2.5 %

Expected life (years)

    6.4       6.6  

Expected volatility

    99

%

    97 %

 

In the event of a change of control, a merger or a sale of all or substantially all of Tribute’s assets, the loan shall be due and payable. The Company will be entitled to certain additional payments in connection with repayments of the loan, both on maturity and in connection with a prepayment or partial prepayment. Pursuant to the terms of the credit agreement, Tribute entered into a guaranty and collateral agreement granting the Company a security interest in substantially all of Tribute’s assets. The credit agreement contains certain affirmative and negative covenants. The obligations under the credit agreement to repay the loan may be accelerated upon the occurrence of an event of default under the credit agreement. 

 

SynCardia Credit Agreement

 

First Lien Credit Agreement

 

On December 13, 2013, the Company entered into a credit agreement pursuant to which the Company provided to SynCardia Systems, Inc. ("SynCardia"), a privately-held manufacturer of the world's first and only FDA, Health Canada and CE (Europe) approved Total Artificial Heart, a secured term loan in the principal amount of $4,000,000. The loan was an expansion of the SynCardia's existing credit facility, resulting in a total outstanding amount under the existing credit facility of $16,000,000 at closing. At the lenders' option, the lenders can increase the term loan to $22,000,000; the Company has the right but not the obligation to advance $1,500,000 of any potential increase. The Company funded the $4,000,000, net of an original issue discount of $60,000 and an arrangement fee of $40,000 at closing.

 

 
12

 

 

The loan matures on March 5, 2018, with principal due upon maturity. The loan bears interest at a rate of 13.5%.

 

Pursuant to the terms of the credit agreement and subject to a security agreement, SynCardia granted the lenders a first priority security interest in substantially all of its assets. The security agreement contains certain affirmative and negative covenants.

 

In the event of a change of control, a merger or a sale of all or substantially all of SynCardia's assets, the loan shall be due and payable. The lenders will be entitled to certain additional payments in connection with repayments of the loan, both on maturity and in connection with a prepayment or partial prepayment. The obligations to repay the loan may be accelerated upon the occurrence of an event of default under the credit agreement.

 

In addition to the discount and arrangement fee, the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized $164,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014.

 

Second Lien Credit Agreement

 

On December 13, 2013, the Company also entered into a second lien credit agreement, pursuant to which the Company and other lender parties thereto provided to SynCardia, a term loan in the principal amount of $10,000,000 (the "Second Lien Loan"). The Company provided $6,000,000 principal amount of the Second Lien Loan, funded at closing net of an origination fee of $90,000. The Second Lien Loan matures on December 13, 2021.  

 

The Second Lien Loan shall be repaid by a tiered revenue interest that is charged on quarterly net sales and royalties of, and any other income and revenue actually received by SynCardia. Pursuant to the terms of the Second Lien Loan, SynCardia granted the lenders a second priority security interest in its assets subject to a security agreement which contains certain affirmative and negative covenants.

 

In the event of a Change of Control, the Second Lien Loan shall be due, with the total amount payable to the lenders equal to a specified premium defined by the terms of the Second Lien Loan. The obligations to repay the Second Lien Loan may be accelerated upon the occurrence of an event of default under the terms of the Second Lien Loan.

 

The Company recognized $408,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014.

 

Common Stock Purchase

 

In conjunction with the first lien secured term loan, the Company purchased from SynCardia an aggregate of 40,000 shares of SynCardia's Common Stock, in consideration for the mutual covenants and agreements set forth in the credit agreement. The shares purchased by the Company reflect an ownership percentage in SynCardia of less than 0.05%. The Company deems the shares to be non-marketable as SynCardia is privately held and in development stage, and has reflected the shares at a zero cost basis at March 31, 2014 and December 31, 2013. 

 

Private Dental Products Company

 

On December 10, 2013, the Company entered into a credit agreement to provide a private dental products company ("Dental Products Company") a senior secured term loan with a principal amount of $6,000,000 funded upon close net of an arrangement fee of $60,000. The Loan matures on December 10, 2018.

 

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales and royalties of the Dental Products Company. Pursuant to the terms of the agreement, the Company was granted a first priority security interest in substantially all of the Dental Products Company's assets. The loan accrues interest at the Libor Rate, plus an applicable margin; the Libor Rate is subject to minimum floor values such that that minimum interest rate is 14%.

 

In the event of a change of control, a merger or a sale of all or substantially all of the Dental Products Company's assets, the loan shall be due and payable. The Company will be entitled to certain additional payments in connection with repayments, both on maturity and in connection with prepayments.

 

The Company also received a warrant to purchase up to 225 shares of the Dental Products Company's common stock, which if exercised, is equivalent to approximately four percent ownership on a fully diluted basis. The warrant expires December 10, 2020. The warrant is valued at zero at March 31, 2014 and December 31, 2013, in the unaudited condensed consolidated balance sheets.

 

 
13

 

 

In addition to the arrangement fee, the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized $221,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014. 

 

Parnell Pharmaceuticals Holdings Pty Ltd

 

On January 23, 2014, the Company entered into a credit agreement pursuant to which the lenders party thereto provided to Parnell Pharmaceuticals Holdings Pty Ltd, a leading global veterinary pharmaceutical business (“Parnell”), a term loan in the principal amount of $25,000,000. The Company provided $10,000,000 and the Company's investment advisory clients provided the remaining $15,000,000 of the loan. The Company serves as the Agent, Sole Lead Arranger and Sole Bookrunner under the credit agreement. The loan matures on January 23, 2021.

 

Parnell is obligated to make payments calculated on its quarterly net sales and royalties until such time as the lenders receive a 2.0x cash on cash return. The revenue based payment is subject to certain quarterly and annual caps. The total amount payable is subject to adjustment under certain events including qualified partial payments, a change of control or full prepayment of the loan. The revenue based payment is made quarterly. All amounts applied under the revenue based payment will be made to each lender according to its pro-rata share of the loan.

 

Pursuant to the terms of the credit agreement, Parnell granted the lenders a first priority security interest in substantially all of Parnell's assets. The credit agreement contains certain affirmative and negative covenants. Parnell’s U.S., U.K., Australian, New Zealand subsidiaries have guaranteed the obligations under the credit agreement. The obligations to repay the loan may be accelerated upon the occurrence of an event of default under the terms of the credit agreement.

 

The Company recognized a syndication fee of $375,000 and $290,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014.

 

Royalty Purchases

 

Bess Royalty Purchase

 

On April 2, 2013, the Company, along with Bess Royalty, LP ("Bess"), purchased a royalty stream paid on the net sales of Besivance®, an ophthalmic antibiotic, from InSite Vision, Inc. Besivance is marketed globally by Bausch & Lomb. The initial purchase price totaled $15,000,000; the Company funded $6,000,000 of the purchase price at closing to own 40.3125% of the royalty stream. Additional contingent consideration includes (i) $1,000,000 to be paid by Bess upon certain net sales milestones achieved by Bausch & Lomb and (ii) annual payments to be remitted to InSite Vision, Inc. once aggregate royalty payments received by the Company and Bess exceed certain thresholds. Bess paid the $1,000,000 contingent consideration in February 2014, which did not result in a change in the Company's interest in the royalty. The purchased royalty stream does not include any further amounts once the aggregate royalty payments received by the Company and Bess reach a certain threshold as defined in the underlying agreement. As the purchased royalty stream has been capped by the defined threshold amount, in effect limiting the Company’s implicit rate of return, the Company’s share of the purchase price has been reflected as a Finance Receivable in the unaudited condensed consolidated financial statements. The Company recognized approximately $260,000 in interest income in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014, representing the Company’s pro rata portion of royalties paid.  

  

Tissue Regeneration Therapeutics Royalty Purchase

 

On June 12, 2013, the Company purchased from Tissue Regeneration Therapeutics, Inc. (“TRT”) two royalty streams derived from the licensed use of TRT’s technology in the family cord banking services sector. The initial purchase totaled $2,000,000 paid upon closing. Additional contingent consideration includes (i) $1,250,000 payable upon aggregate royalty payments reaching a certain threshold and (ii) annual sharing payments due to TRT once aggregate royalty payments received by the Company exceed the purchase price paid by the Company. The purchased royalty stream does not include any further amounts once the aggregate royalty payments received by the Company reach a certain threshold as defined in the underlying agreement. The purchase has been reflected as a Finance Receivable in the unaudited condensed consolidated financial statements. The Company recognized approximately $91,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014.

 

Credit Quality of Finance Receivables 

 

On a quarterly basis, the Company evaluates the carrying value of each finance receivable for impairment. Currently there are no finance receivables considered impaired and no corresponding allowance for credit losses for impaired loans.

 

 
14

 

 

A term loan is considered to be impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. This evaluation is generally based on delinquency information, an assessment of the borrower’s financial condition and the adequacy of collateral, if any. The Company would generally place term loans on nonaccrual status when the full and timely collection of interest or principal becomes uncertain and they are 90 days past due for interest or principal, unless the term loan is both well-secured and in the process of collection. When placed on nonaccrual, the Company would reverse any accrued unpaid interest receivable against interest income and amortization of any net deferred fees is suspended. Generally, the Company would return a term loan to accrual status when all delinquent interest and principal become current under the terms of the credit agreement and collectability of remaining principal and interest is no longer doubtful.

 

Receivables associated with royalty stream purchases would be considered to be impaired when it is probable that the Company will be unable to collect the book value of the remaining investment based upon adverse changes in the estimated underlying royalty stream.

 

When the Company identifies a finance receivable as impaired, it measures the impairment based on the present value of expected future cash flows, discounted at the receivable’s effective interest rate. If it is determined that the value of an impaired receivable is less than the recorded investment, the Company would recognize impairment with a charge to the allowance for credit losses. When the value of the impaired receivable is calculated by discounting expected cash flows, interest income would be recognized using the receivable’s effective interest rate over the remaining life of the receivable.

 

The Company would individually develop the allowance for credit losses for any identified impaired loans if any existed. In developing the allowance for credit losses, the Company would consider, among other things, the following credit quality indicators:

 

• business characteristics and financial conditions of obligors;

• current economic conditions and trends;

• actual charge-off experience;

• current delinquency levels;

• value of underlying collateral and guarantees;

• regulatory environment; and

• any other relevant factors predicting investment recovery.

 

The Company monitors the credit quality indicators of performing and non-performing assets. At March 31, 2014 and December 31, 2013, the Company did not have any non-performing assets.

  

Note 3. Marketable Investments

 

On July 9, 2013, the Company entered into a note purchase agreement to purchase, at par, $3,000,000 of a total $100,000,000 aggregate principal amount offering of a Senior Secured notes due in November 2026.  The notes pay interest quarterly at a rate of 11.5% per annum commencing November 15, 2013. The agreement allows the first interest payment date to include paid-in-kind notes for any cash shortfall, of which the Company received $119,000 on November 15, 2013.  Subsequent interest payments from February 15, 2014, through May 15, 2015, will be supported by a cash interest reserve account funded at close of $4,500,000.  The notes are subject to redemption on or after July 10, 2015, at a price at or above par, as defined.  The notes are secured only by certain royalty and milestone payments associated with the sales of pharmaceutical products. The notes are reflected at fair value as Available-for-sale securities. The Company recognized approximately $91,000 in interest income recorded as revenue in the unaudited condensed consolidated statement of income for the three months ended March 31, 2014. During the three months ended March 31, 2014 and the year ended December 31, 2013, the Company had no sales of available-for-sale securities and no securities have been considered impaired.

  

The amortized cost basis amounts, gross unrealized holding gains, gross unrealized holding losses and fair values of available-for-sale securities at March 31, 2014 and December 31, 2013, are as follows (in thousands):

 

   

Amortized Cost

   

Gross Unrealized Gains

   

Gross Unrealized Loss

   

Fair Value

 

Available for Sale Securities:

                               

Corporate debt securities

  $ 3,119     $ -     $ -     $ 3,119  
    $ 3,119     $ -     $ -     $ 3,119  

 

 
15

 

 

Note 4. Variable Interest Entities

 

The Company consolidates the activities of VIEs of which we are the primary beneficiary. The primary beneficiary of a VIE is the variable interest holder possessing a controlling financial interest through (i) its power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) its obligation to absorb losses or its right to receive benefits from the VIE that could potentially be significant to the VIE. In order to determine whether the Company owns a variable interest in a VIE, the Company performs qualitative analysis of the entity’s design, organizational structure, primary decision makers and relevant agreements.

 

Consolidated VIE

 

SWK HP Holdings LP (“SWK HP”) 

 

SWK HP was formed in December 2012 to acquire a limited partnership interest in Holmdel Pharmaceuticals LP ("Holmdel").   Holmdel acquired the U.S. marketing authorization rights to a beta blocker pharmaceutical product indicated for the treatment of hypertension for a total purchase price of $13,000,000. The Company, through its wholly owned subsidiary SWK Holdings GP LLC ("SWK Holdings GP") acquired a direct general partnership interest in SWK HP, which in turn acquired a limited partnership interest in Holmdel. The total investment in SWK HP of $13,000,000 included $6,000,000 provided by SWK Holdings GP and $7,000,000 provided by non-controlling interests.   Subject to customary limited partner protections afforded the investors by the terms of the limited partnership agreement, the Company maintains voting and managerial control of SWK HP and therefore includes it in its consolidated financial statements.

 

SWK HP is considered a VIE due to the lack of voting or similar decision-making rights by its equity holders regarding activities that have a significant effect on the economic success of the partnership. The Company’s ownership in SWK HP constitutes variable interests. The Company has determined that it is the primary beneficiary of the SWK HP as (i) the Company has the power to direct the activities that most significantly impact the economic performance of SWK HP via its obligations to perform under the partnership agreement, and (ii) the Company has the right to receive residual returns that could potentially be significant to SWK HP. As a result, the Company consolidates SWK HP in its financial statements and the limited partner interests of SWK HP owned by third parties are reflected as a non-controlling interest in the Company’s unaudited condensed consolidated balance sheets.

 

Unconsolidated VIEs

 

Holmdel  

 

SWK HP has significant influence over the decisions made by Holmdel. SWK HP will receive quarterly distributions of cash flow generated by the pharmaceutical product according to a tiered scale that is subject to certain cash on cash returns received by SWK HP. Until SWK HP receives a 1x cash on cash return on its interest in Holmdel, SWK HP will receive approximately 84% of the pharmaceutical product’s cash flow. As the cash on cash multiple received by SWK HP Holdings LP increases, SWK HP’s interest in the cash flow generated by the pharmaceutical product decreases, but in no instance will it decline below 39%. Holmdel is considered a VIE because SWK HP’s control over the partnership is disproportionate to its economic interest. This VIE remains unconsolidated as the power to direct the activities of the partnership is not held by the Company. The Company is using the equity method to account for this investment.  SWK HP’s current ownership in Holmdel approximates 84%.  The Company accounts for its interest in the entity based on the timing of quarterly distributions, which are paid on a quarter lag basis. For the three months ended March 31, 2014, the Company recognized $1,503,000 of equity method gains, of which $801,000 was attributable to the non-controlling interest in SWK HP. No equity method gains were recognized in the three months ended March 31, 2013. In addition, SWK HP received cash distributions totaling $1,976,000 during the three months ended March 31, 2014, of which $1,055,000 was subsequently paid to holders of the non-controlling interests in SWK HP. Changes in the carrying amount of the Company’s investment in Holmdel for the three months ended March 31, 2014, are as follows (in thousands):  

 

 

 

 

Balance at December 31, 2013

  $ 10,425  
         

Add: Income from investments in unconsolidated entities

    1,503  
         

Less: Cash distribution on investments in unconsolidated entities

    (1,976

)

         

Balance at March 31, 2014

  $ 9,952  

     

 
16

 

 

The following table provides the financial statement information related to Holmdel:

 

   

As of March 31,

2014

(in millions)

     

Three months ended

March 31, 2014

(in millions)

 
                   

Assets

  $ 13.7  

Revenue

  $  2.4  

Liabilities

  $ 2.3  

Expenses

  $  0.6  

Equity

  $ 11.4  

Net income

  $  1.8  

  

 

Note 5. Loan Credit Agreement with Related Party

 

The Company entered a credit facility with an affiliate of a stockholder on September 6, 2013. The credit facility provides financing for the Company, primarily for the purchase of eligible investments. The facility matures on September 6, 2017 and provides that the loan shall accrue interest at the LIBOR rate plus a 6.50% margin. As of March 31, 2014 and December 31, 2013, the applicable interest rate was 6.73% and 6.75%, respectively. The principal is repayable in full at maturity. The facility works as a delayed draw credit facility with the Company having the ability to drawdown, as necessary, over the first 18 months (the "Draw Period") up to $30,000,000, based on certain conditions. The credit facility provided for an initial $15,000,000 to be available at closing. The Company executed a draw of $5,000,000 on December 9, 2013. During the three months ended March 31, 2014, the Company has executed an additional draw of $6,000,000 to fund certain eligible investments. The balances of $11,000,000 and $5,000,000 are reflected as Loan credit agreement in the unaudited condensed consolidated balance sheet as of March 31, 2014 and December 31,2013, respectively. On or before the last day of the Draw Period, the Company can request the loan amount to be increased to $30 million upon the Company realizing net proceeds of at least $10 million in cash through the issuance of new equity securities. Repayment of the facility is due upon maturity, four years from the closing date. The stockholder’s affiliate, as lender, has received a security interest in basically all assets of the Company as collateral for the facility. In conjunction with the credit facility, the Company issued warrants to the stockholder’s affiliate for 1,000,000 shares of the Company’s common stock at a strike price of $1.3875. In connection with the credit agreement, the Company and the stockholder and certain of the stockholder’s affiliates, including the lender entered into a Voting Rights Agreement restricting the stockholder’s and such affiliates’ voting rights under certain circumstances and providing the stockholder and such affiliates a right of first offer on certain future share issuances.

 

Due to certain provisions within the warrant agreement, the warrants meets the definition of a derivative and do not qualify for a scope exception as it is not considered indexed in the Company’s stock. As such, the warrants with a value of $250,000 and $292,000 at March 31, 2014 and December 31, 2013, are reflected as a warrant liability in the unaudited condensed consolidated balance sheet. An unrealized gain of $42,000 was included in interest and other income in the unaudited condensed consolidated statements of income for the three months ended March 31, 2014. The Company determined the fair value using the Black-Scholes option pricing model with the following assumptions:

 

 

   

March 31, 2014

   

December 31, 2013

 

Dividend rate

    0

%

    0 %

Risk-free rate

    2.3

%

    2.5 %

Expected life (years)

    6.4       6.7  

Expected volatility

    28.6

%

    27 %

 

During the three months ended March 31, 2014, the Company recognized interest expense totaling $189,000. Interest expense included $153,000 of interest due the lender and $36,000 of debt issuance cost amortization.

 

Note 6. Stockholders’ Equity

 

Stock Compensation Plans

 

The Company’s 1999 Stock Incentive Plan (the “1999 Stock Incentive Plan”), as successor to the 1997 Stock Option Plan (the “1997 Stock Option Plan”), provided for options to purchase shares of the Company’s common stock to be granted to employees, independent contractors, officers, and directors. The plan expired in July 2009. As a result of the termination of all employees on December 31, 2009, the stock options held by employees were cancelled on March 31, 2010.  The only remaining options outstanding as of March 31, 2014, under the 1999 Stock Incentive Plan are those held by some of the Company’s current directors.

 

 
17

 

 

The Company’s 2010 Stock Incentive Plan (the “2010 Stock Incentive Plan”) provides for options, restricted stock, and other customary forms of equity to be granted to the Company’s directors, officers, employees, and independent contractors. All forms of equity incentive compensation are granted at the discretion of the Company’s Board of Directors (the "Board") and have a term not greater than 10 years from the date of grant.

  

The following table summarizes activities under the option plans for the indicated periods:

 

   

Options Outstanding

 
   

Number of

Shares

   

Weighted

Average

Exercise

Price

   

Weighted

Average

Remaining Contractual

Term

(in years)

   

Aggregate

Intrinsic

Value

 

Balances, December 31, 2013

    1,680,000     $ 1.01       7.8     $ 458,600  

Options cancelled and retired

    (10,000     2.65                  

Options exercised

    -       -                  

Options granted

    -       -                  

Balances, March 31, 2014

    1,670,000       1.01       7.5       337,000  
                                 

Options vested and exercisable and expected to be vested and exercisable at March 31, 2014

    1,518,900     $ 1.03       7.5     $ 301,558  

Options vested and exercisable at March 31, 2014

    170,000     $ 2.52       6.5     $ 89,500  

 

At March 31, 2014, there were no options available for grant under the 1999 Stock Incentive Plan, and the Company had no total unrecognized stock-based compensation expense under this Plan.  At March 31, 2014, there were 2.6 million shares reserved for equity awards under the 2010 Stock Incentive Plan and the Company had approximately $0.1 million of total unrecognized stock option expense, net of estimated forfeitures, which will be recognized over the weighted average remaining period of 1.1 years. 

 

The following table summarizes significant ranges of outstanding and exercisable options as of March 31, 2014:

 

 

 

 

 

 

Options Outstanding, Vested and Exercisable

 

 

Exercise Prices

 

 

Number

Outstanding

 

 

Weighted

Average

Remaining

Contractual

Life (in Years)

 

 

Weighted

Average

Exercise

Price Per

Share

 

 

Number

Exercisable

 

 

Weighted 

Average 

Exercise 

Price Per Share 

 

 

$

0.70

 

 

 

20,000

 

 

 

5.3

 

 

$

0.70

 

 

 

20,000

 

 

$

0.70

 

 

 

0.83

 

 

 

1,500,000

 

 

 

8.2

 

 

 

0.83

 

 

 

-

 

 

 

0.83

 

 

 

1.24

 

 

 

20,000

 

 

 

4.3

 

 

 

1.24

 

 

 

20,000

 

 

 

1.24

 

 

 

2.67

 

 

 

20,000

 

 

 

3.3

 

 

 

2.67

 

 

 

20,000

 

 

 

2.67

 

 

 

2.95

 

 

 

90,000

 

 

 

2.4

 

 

 

2.95

 

 

 

90,000

 

 

 

2.95

 

 

 

3.50

 

 

 

20,000

 

 

 

2.9

 

 

 

3.50

 

 

 

20,000

 

 

 

3.50

 

 

Total

 

 

 

1,670,000

 

 

 

7.5

 

 

$

1.01

 

 

 

170,000

 

 

$

2.52

 

 

Employee stock-based compensation expense recognized for time-vesting options for the three months ended March 31, 2014, and 2013, uses the Black-Scholes option pricing model for estimating the fair value of options granted under the Company's equity incentive plans. Risk-free interest rates for the options were taken from the Daily Federal Yield Curve Rates on the grant dates for the expected life of the options as published by the Federal Reserve. The expected volatility was based upon historical data and other relevant factors such as the Company's changes in historical volatility and its capital structure, in addition to mean reversion. Employee stock-based compensation expense recognized for market performance-vesting options uses a binomial lattice model for estimating the fair value of options granted under the Company's equity incentive plans.

 

In calculating the expected life of stock options, the Company determines the amount of time from grant date to exercise date for exercised options and adjusts this number for the expected time to exercise for unexercised options. The expected time to exercise for unexercised options is calculated from grant as the midpoint between the expiration date of the option and the later of the measurement date or the vesting date. In developing the expected life assumption, all amounts of time are weighted by the number of underlying options.

 

 
18

 

 

On January 31, 2012, the Board approved a change in the compensation plan for non-employee directors. In lieu of cash payments historically paid to the Company's directors for Board service, the Board approved an annual grant of 35,000 shares of restricted common stock for each of our non-executive Board members on January 31 of each year, starting with 2012. The restricted shares fully vest on the first anniversary of the grant and are forfeited if the Board member does not complete the full year of service.

 

The following table summarizes restricted stock activities under the equity incentive plans for the indicated periods:

 

   

Restricted Shares Outstanding

 
   

Number of Shares

   

Weighted Average Grant Date Fair Value

 

Balances, December 31, 2013

    1,682,500     $ 0.39  

Shares cancelled and forfeited

    -       -  

Shares vested

    (140,000 )     0.83  

Shares granted

    140,000       1.13  

Balances, March 31, 2014

    1,682,500     $ 0.45  

 

For restricted stock granted in 2014 and 2013 under the 2010 Stock Incentive Plan, the Company recognizes compensation expense in accordance with the fair value of such stock as determined on the grant date, amortized over the applicable derived service period using the graded amortization method. The fair value and derived service period of awards with market performance vesting was calculated using a lattice model and included adjustments to the fair value of the Company's common stock resulting from the vesting conditions being based on the underlying stock price. All 1,682,500 restricted shares are included in the Company's shares outstanding as of March 31, 2014, but are not included in the computation of basic income per share as the shares are not yet earned by the recipients. The Company had $0.1 million of unrecognized stock based compensation expense, net of estimated forfeitures, related to restricted shares which will be recognized over the weighted average remaining period of 0.8 year.

 

The stock-based compensation expense recognized by the Company for the three months ended March 31, 2014, and 2013 was $76,000 and $60,000, respectively.

 

Non-controlling Interests

 

As discussed in Note 4, SWK HP has a limited partnership interest in Holmdel.    The total investment by SWK HP was $13,000,000, of which SWK Holdings GP provided $6,000,000.  The remaining $7,000,000 is reflected as non-controlling interest in the unaudited condensed consolidated balance sheets.   Changes in the carrying amount of the non-controlling interest in the unaudited condensed consolidated balance sheet for the three months ended March 31, 2014, are as follows:  

 

Balance at December 31, 2013

  $ 5,613  

Add: Income attributable to non-controlling interests

    801  

Less: Cash distribution to non-controlling interests

    (1,055

)

Balance at March 31, 2014

  $ 5,359  

  

Note 7. Fair Value Measurements

 

The Company measures and reports certain financial and non-financial assets and liabilities on a fair value basis. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). GAAP specifies a three-level hierarchy that is used when measuring and disclosing fair value. The fair value hierarchy gives the highest priority to quoted prices available in active markets (i.e., observable inputs) and the lowest priority to data lacking transparency (i.e., unobservable inputs). An instrument’s categorization within the fair value hierarchy is based on the lowest level of significant input to its valuation. The following is a description of the three hierarchy levels.

 

 

 

Level 1

Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Active markets are considered to be those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 Level 2

Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in inactive markets.

 Level 3

Unobservable inputs are not corroborated by market data. This category is comprised of financial and non-financial assets and liabilities whose fair value is estimated based on internally developed models or methodologies using significant inputs that are generally less readily observable from objective sources.

 

 
19

 

 

Transfers into or out of any hierarchy level are recognized at the end of the reporting period in which the transfers occurred. There were no transfers between any levels during the three months ended March 31, 2014 and 2013.

 

The fair value of equity method investments is not readily available nor have we estimated the fair value of these investments and disclosure is not required. The Company is not aware of any identified events or changes in circumstances that would have a significant adverse effect on the carrying value of any of our equity method investments included in our unaudited condensed consolidated balance sheets at March 31, 2014 or December 31, 2013.

 

Following are descriptions of the valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models, key inputs to those models and significant assumptions utilized.

 

Finance Receivables

 

The fair values of finance receivables are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the finance receivables. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. These receivables are classified as Level 3. Finance receivables are not measured at fair value on a recurring basis, but estimates of fair value are reflected below.

 

Marketable Investments and Warrant Liability 

 

Debt securities 

 

If active market prices are available, fair value measurement is based on quoted active market prices and, accordingly, these securities would be classified as Level 1. If active market prices are not available, fair value measurement is based on observable inputs other than quoted prices included within Level 1, such as prices for similar assets or broker quotes utilizing observable inputs, and accordingly these securities would be classified as Level 2. If market prices are not available and there are no observable inputs, then fair value would be estimated by using valuation models including discounted cash flow methodologies, commonly used option-pricing models and broker quotes. Such securities would be classified as Level 3, if the valuation models and broker quotes are based on inputs that are unobservable in the market. If fair value is based on broker quotes, the Company checks the validity of received prices based on comparison to prices of other similar assets and market data such as relevant bench mark indices.

 

Derivative securities 

 

For exchange-traded derivatives, fair value is based on quoted market prices, and accordingly, would be classified as Level 1. For non-exchange traded derivatives, fair value is based on option pricing models and are classified as Level 3.  

 

 
20

 

 

The following table presents financial assets and liabilities measured at fair value on a recurring basis as of March 31, 2014 (in thousands):

 

   

Total Carrying Value in Consolidated Balance Sheet

   

Quoted prices

in active

markets for

identical assets

or liabilities

(Level 1)

   

Significant

other

observable

inputs

(Level 2)

   

Significant

unobservable

inputs

(Level 3)

 

Financial Assets:

                               

Tribute warrants

  $ 415     $ -     $ -     $ 415  

Available-for-sale securities

    3,119       -       3,119       -  
                                 

Financial Liabilities:

                               

Warrant liability

  $ 250     $ -     $ -     $ 250  

 

The following table presents financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 (in thousands):

 

   

Total Carrying Value in Consolidated Balance Sheet

   

Quoted prices

in active

markets for

identical assets

or liabilities

(Level 1)

   

Significant

other

observable

inputs

(Level 2)

   

Significant

unobservable

inputs

(Level 3)

 

Financial Assets:

                               

Tribute warrant

  $ 204     $ -     $ -     $ 204  

Available-for-sale securities

    3,119       -       3,119       -  
                                 

Financial Liabilities:

                               

Warrant liability

  $ 292     $ -     $ -     $ 292  

 

 

The changes on the value of the Tribute warrant asset during the three months ended March 31, 2014, were as follows (in thousands):

 

Fair value – December 31, 2013

  $ 204  

Issuances

    99  

Change in fair value

    112  

Fair value – March 31, 2014

  $ 415  

 

 

The changes on the value of the warrant liability during the three months ended March 31, 2014, were as follows (in thousands):

 

Fair value – December 31, 2013

  $ 292  

Issuances

    -  

Change in fair value

    (42 )

Fair value – March 31, 2014

  $ 250  

 

For assets and liabilities measured on a non-recurring basis during the year, accounting guidance requires quantitative disclosures about the fair value measurements separately for each major category. There were no remeasured assets or liabilities at fair value on a non-recurring basis during the three months ended March 31, 2014 and 2013.

 

The following information as of March 31, 2014 and December 31, 2013, is provided to help readers gain an understanding of the relationship between amounts reported in the accompanying consolidated financial statements and the related market or fair value. The disclosures include financial instruments and derivative financial instruments, other than investment in affiliates.

 

 
21

 

 

March 31, 2014

 

Carry

Value

   

Fair

Value

   

Level 1

   

Level 2

   

Level 3

 

Financial Assets

                                       

Cash and cash equivalents

  $ 3,867     $ 3,867     $ 3,867     $ -     $ -  

Finance receivables

    41,665        41,675       -       -       41,675  

Marketable investments

    3,119       3,119       -       3,119       -  

Other assets

    415       415       -       -       415  
                                         

Financial Liabilities

                                       

Warrant liability

  $ 250     $ 250     $ -     $ -     $ 250  

 

   

December 31, 2013

 

Carry

Value

   

Fair

Value

   

Level 1

   

Level 2

   

Level 3

 

Financial Assets

                                       

Cash and cash equivalents

  $ 7,664     $ 7,664     $ 7,664     $ -     $ -  

Finance receivables

    29,286       29,324       -       -       29,324  

Marketable investments

    3,119       3,119       -       3,119       -  

Other assets

    204       204       -       -       204  
                                         

Financial Liabilities

                                       

Warrant liability

  $ 292     $ 292     $ -     $ -     $ 292  

 

 

Note 8. Income Taxes

 

The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense. The Company had no unrecognized tax benefits as of March 31, 2014 and December 31, 2013.

 

As of December 31, 2013, the Company's valuation allowance against deferred tax assets decreased by approximately $20,960,000 due to write off of expired deferred tax assets and partial release of the Company's valuation allowance.

 

The Company will continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence that may exist on a quarterly basis. Any adjustment to the deferred tax asset valuation allowance would be recorded in the unaudited condensed consolidated statement of income for the period that the adjustment is determined to be required.

  

Deferred tax assets consist of the following (in thousands):

 

   

March 31,

   

December 31,

 
   

2014

   

2013

 

Deferred tax assets

               

Credit carryforward

  $ 2,660     $ 2,660  

Stock based compensation

    287       287  

Other

    59       59  

Net operating losses

    145,931       146,637  
                 

Gross deferred tax assets

    148,937       149,643  

Valuation allowance

    (139,840     (139,840

)

Net deferred tax assets

  $ 9,097     $ 9,803  

 

 

The Tax Reform Act of 1986 limits the use of net operating loss and tax credit carryforwards in certain situations where stock ownership changes occur. In the event the Company has had a change in ownership, the future utilization of the Company's net operating loss and tax credit carryforwards could be limited.

 

A portion of deferred tax assets relating to NOLs, pertains to NOL carryforwards resulting from tax deductions upon the exercise of employee stock options of approximately $1,800,000. When recognized, the tax benefit of these loss carryforwards will be accounted for as a credit to additional paid-in capital rather than a reduction of the income tax expense.

 

As of March 31, 2014, the Company had net operating loss carryforwards for federal income tax purposes of approximately $433,000,000. The federal net operating loss carryforwards, if not offset against future income, will expire by 2032, with the majority of such NOLs expiring by 2021.

  

 
22

 

 

ITEM 2.            MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Management's Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is provided as a supplement to and should be read in conjunction with, our audited consolidated financial statements, and the MD&A included in our Annual Report on Form 10-K for the year ended December 31, 2013 (“Annual Report”), as well as our unaudited condensed consolidated financial statements and the accompanying notes include in this report.

 

Overview

 

We were incorporated in July 1996 in California and reincorporated in Delaware in September 1999. In December 2009, we sold substantially all of our assets to an unrelated third party, the Asset Sale. Since the date of the Asset Sale, we had been seeking to redeploy our cash to maximize value for our stockholders and were seeking, analyzing and evaluating potential acquisition candidates. Our goal was to redeploy our existing assets to acquire, or invest in, one or more operating businesses with existing or prospective taxable income, or from which we can realize capital gains, that can be offset by use of our net operating loss carryforwards (“NOLs”).

 

In July 2012, we commenced our new corporate strategy of building a specialty finance and asset management business. Our strategy is to be a leading healthcare capital provider by offering sophisticated, customized financing solutions to a broad range of life science companies, institutions and inventors. We will initially focus on monetizing cash flow streams derived from commercial-stage products and related intellectual property through royalty purchases and financings, as well as through the creation of synthetic revenue interests in commercialized products. We expect to deploy our assets to earn interest, fees, and other income pursuant to this strategy, and we continue to identify and review financing and similar opportunities on an ongoing basis. In addition, through our wholly-owned subsidiary, SWK Advisors LLC, we provide non-discretionary investment advisory services to institutional clients in separately managed accounts to similarly invest in life science finance. SWK Advisors LLC is registered as an investment advisor with the Texas State Securities Board. We intend to fund transactions through our own working capital, as well as by building our asset management business by raising additional third party capital to be invested alongside our capital.

 

We intend to fill a niche that we believe is underserved in the sub-$50 million transaction size. Since many of our competitors that provide longer term, royalty-related financing options have much greater financial resources than us, they tend to not focus on transaction sizes below $50 million as it is generally inefficient for them to do so. In addition, we do not believe that a sufficient number of other companies offer similar types of long-term financing options to fill the demand of the sub-$50 million market. As such, we believe we face less competition from such longer term, royalty investors in transactions that are less than $50 million. 

 

We will evaluate and invest in a broad range of healthcare related companies and products with innovative intellectual property, including, the biotechnology, medical device, medical diagnostics and related tools, animal health and pharmaceutical industries (together “life science") and to tailor our financial solutions to the needs of our business partners. Our business partners are primarily engaged in selling products that directly or indirectly cure diseases and/or improve people's or animals' wellness, or they receive royalties paid on the sales of such products. For example, our biotechnology and pharmaceutical business partners manufacture medication that directly treat disease states, whereas our life science tools partners sell a wide variety of research instrumentation to help other companies conduct research into disease states.

 

Our investment objective is to maximize our portfolio total return and thus increase our net income and net operating income by generating income from three sources:

 

1. primarily owning or financing through debt investments, royalties generated by the sales of life science products and related intellectual property;

 

2. to a lesser extent, receiving interest and other income by advancing capital in the form of secured debt to companies in the life science sector; and

 

3. to a lesser extent, realize capital appreciation from equity-related investments in the life science sector.

 

In our portfolio we seek to achieve attractive risk-adjusted current yields and opportunities with the potential for equity-like returns.

 

The majority of our transactions are expected to be structured similarly to factoring transactions whereby we provide capital in exchange for an interest in an existing revenue stream. We do not anticipate providing capital in situations prior to the commercialization of a product. The existing revenue stream can take several forms, but is most commonly either a royalty derived from the sales of a life science product (1) from the marketing efforts of a third party, such as a royalty paid to an inventor on the sales of a medicine or (2) from the marketing efforts of a partner company, such as a medical device company that directly sells its own products. Our structured debt investments may include warrants or other features, giving us the potential to realize enhanced returns on a portion of our portfolio. Capital that we provide directly to our partners is generally used for growth and general working capital purposes, as well as for acquisitions or recapitalizations in select cases. We generally fund the full amount of transactions up to $10 million through our working capital.

 

 
23

 

 

Our investment advisory agreements are currently non-discretionary and each client determines individually if it wants to participate in a transaction. Each account receives its pro rata allocation for a transaction based on which clients opt into a transaction, and each account receives its pro rata allocation of income produced by a transaction in which they participate. Clients pay us management and incentive fees according to a written investment advisory agreement, and we negotiate fees based on each client’s needs and the complexity of the client’s requirements. Fees paid by clients may differ depending upon the terms negotiated with each client and are paid directly by the client upon receipt of an invoice from us. We may seek to raise discretionary capital from similar investors in the future.

 

In circumstances where a transaction is greater than $10 million, we seek to syndicate amounts in excess of $10 million to our investment advisory clients. In addition, we may participate in transactions in excess of $10 million with investors other than our investment advisory clients. In those instances, we do not expect to earn investment advisory income from the participations of such investors.

 

We source our investment opportunities through a combination of our senior management's proprietary relationships within the industry, outbound business development efforts and inbound inquiry from companies, institutions and inventors interested in learning about our capital financing alternatives. Our investment advisory clients generally do not originate investment opportunities for us.

 

Execution of New Strategy

 

In the third quarter of 2012, we purchased an interest in three revenue-producing investment advisory client contracts from PBS Capital Management, LLC, a firm that our current chief executive officer, or CEO, and our current Managing Director control, for $150,000 plus earn out payments through 2016. Our interest in these contracts can be repurchased, for one dollar, by PBS Capital Management, LLC, in the event that the employment contracts of our current CEO and current Managing Director are not renewed. We generated approximately $42,000 and $56,00 for the three months ended March 31, 2014 and 2013, respectively, in revenue due to our interest in the advisory contracts. Going forward, we expect revenue generated from these contracts to be immaterial to our financials; however, we expect the investment advisory clients to continue to co-invest with us in future transactions.

 

On December 5, 2012, we consummated our first transaction under our specialty finance strategy by providing a $22.5 million term loan to Nautilus. The loan was repaid on December 17, 2013. Prior to repayment, interest and principal under the loan was paid by a tiered revenue interest that is charged on quarterly net sales and royalties of the borrower applied in the following priority (i) first, to the payment of all accrued but unpaid interest until paid in full; and (ii) second to the payment of all principal of the loans. The loan accrued interest at either a base rate or the LIBOR rate, as determined by the borrower, plus an applicable margin; the base rate and LIBOR rate were subject to minimum floor values such that the minimum interest rate was 16%. We syndicated $16 million of the loan to our investment advisory clients and retained the remainder. Upon repayment, we received our proportionate share of a $2,000,000 exit fee which amounted to $578,000.

 

Including the Nautilus transaction, we have now executed nine transactions under our new strategy, deploying approximately $57.5 million across a variety of opportunities:

 

 

$11 million in three transactions where we purchased or financed through a debt investment, royalties generated by the sales of life science products and related intellectual property;

 

 

$40.5 million in five transactions where we receive interest and other income by advancing capital in the form of secured debt backed by royalties paid by companies in the life science sector; and

 

 

$6 million in one transaction where we acquired an indirect interest in the U.S. marketing authorization rights to a pharmaceutical product where we ultimately receive cash flow distributions from the product.

 

In six of the transactions we participated alongside other investors; our investment advisory clients co-invested in two of these transactions. We completed the other three transactions by ourselves.

 

 
24

 

 

The table below provides an overview of the transactions.

 

 

  

Amount

Funded by

SWK at

March 31, 2014

Total
Transaction

Amount

(including

contingent

consideration)

 

Material Terms

Income Recognized during the three months ended March 31, 2014

Royalty Purchases and Financings

  

 

  

  

 

 

 

 

 

 

Besivance

$6,000,000

$16,000,000

Closed on April 2, 2013

$260,000 in

 

 

 

Purchased a royalty stream paid on the net sales of Besivance®, an ophthalmic antibiotic marketed by Bausch & Lomb

interest income

 

 

 

SWK owns 40.3% of the royalty; Bess Royalty, LP owns 59.7%

 

 

 

 

Annual payments to be retained by the royalty seller once aggregate royalty payments received exceed certain thresholds

 

Tissue Regeneration

$2,000,000

$2,000,000

Closed on June 12, 2013

$91,000 in

Therapeutics ("TRT")

 

 

Purchased two royalty streams derived from the licensed use of TRT’s technology in the family cord banking services sector

interest income

 

 

 

$1,250,000 additional payable by us to TRT, contingent upon aggregate royalty payments reaching a certain threshold

 

 

 

 

Annual sharing payments due TRT once aggregate royalty payments received by us exceed the purchase price paid by us

 

Senior Secured Debt

 

 

 

 

 

 

 

 

 

 

 

Royalty Financing

$3,000,000

$100,000,000

Closed on July 9, 2013

$91,000 in

 

 

 

Purchased senior secured notes (first lien) due November 2026

interest income

 

 

 

Pay interest quarterly at a 11.5% annual interest rate

 

 

 

 

Secured only by certain royalty and milestone payments associated with the sales of pharmaceutical products

 

Term Loans

  

 

  

  

 

 

 

 

 

 

Tribute

$8,000,000

$8,000,000

Closed on August 8, 2013

$276,000 in

Pharmaceuticals

 

 

Entered into senior secured first lien loan that matures on August 8, 2018

interest income

Canada Inc.

("Tribute")

 

 

Repaid by tiered revenue interest that is charged on quarterly net sales and royalties

 

 

 

 

Bears interest at a floating interest rate, subject to a 13.5% per annum minimum

 

 

 

 

Earned an origination fee at closing, and entitled to an exit fee upon the maturity of the loan

 

 

 

 

Received 1,103,222 warrants to purchase shares of Tribute common stock

 

 

 

 

 

 

 

 

 
25

 

 

SynCardia Systems,

$4,000,000

$16,000,000

Closed on December 13, 2013

$164,000 in

Inc. ("SynCardia")

 

 

Entered into senior secured first lien credit facility loan due on March 5, 2018; expansion of SynCardia’s existing facility

interest income

 

 

 

At the option of the lenders, the term loan can be increased to $22,000,000; we have the right but not the obligation to advance $1,500,000 under the expansion facility

 

 

 

 

Repaid with principal due upon maturity and bears interest at a rate of 13.5% per annum

 

 

 

 

Original issue discount of $60,000 and an arrangement fee of $40,000 paid to us at closing

 

 

 

 

Entitled to an exit fee upon the maturity of the loan

 

 

 

 

Purchased an aggregate of 40,000 shares of SynCardia's common stock, reflecting an ownership percentage in SynCardia of less than 0.05%

 

 

 

 

 

 

 

SynCardia

$6,000,000

$10,000,000

Closed on December 13, 2013

$408,000 in

 

 

 

Entered into senior secured second lien loan which matures on December 13, 2021

interest income

 

 

 

Repaid by a tiered revenue interest that is charged on quarterly net sales and royalties of, and any other income and revenue actually received by SynCardia

 

 

 

 

Earned origination fee of $90,000 at closing

 

           

Private Dental

$6,000,000

$6,000,000

Closed December 10, 2013

$221,000 in

Products Company

(the “Dental Products

 

 

Entered into senior secured first lien loan that matures on December 10, 2018

interest income

Company”)

 

 

Repaid by a tiered revenue interest that is charged on quarterly net sales and royalties of the Dental Products Company.

 

 

 

 

Bears interest at a floating interest rate, subject to a 14% per annum minimum

 

 

 

 

Earned an arrangement fee of $60,000 at closing

 

 

 

 

We are entitled to an exit fee upon the maturity of the loan

 

 

 

 

Received a warrant to purchase up to 225 shares in the Dental Products Company's common stock, which if exercised, is equivalent to approximately four percent ownership on a fully diluted basis. The warrant expires December 10, 2020

 

 

 

 

 

 

 

Parnell

$10,000,000

$25,000,000

Closed on January 23, 2014

$290,000 in

interest income

 

Pharmaceuticals
Holdings Pty Ltd

   

Entered into senior secured first lien loan that matures on January 23, 2021

$375,000 in  

syndication income 

("Parnell")

 

 

Repaid by a tiered revenue interest that is charged on quarterly net sales and royalties until such time as the lenders receive a 2.0x cash on cash return

 

 

 

 

Total amount payable by Parnell to the lenders is subject to adjustment under certain events including qualified partial payments, a change of control or full prepayment of the loan

 

 

 

 

Earned a $375,000 origination fee at closing

 

 

 
26

 

 

Other

  

  

 

  

  

 

 

 

 

 

 

Holmdel

$6,000,000

$13,000,000

Closed December 20, 2012

$1,503,000 of

Pharmaceuticals, LP

("Holmdel")

 

 

Holmdel acquired the U.S. marketing authorization rights to a beta blocker pharmaceutical product

equity method

gains, of which

           

 

 

 

SWK HP Holdings GP LLC, our direct wholly-owned subsidiary, acquired a direct general partnership interest in SWK HP Holdings LP ("SWK LP")

$801,000 was

attributable to the

non-controlling

 

 

 

SWK LP acquired a direct limited partnership interest in Holmdel

interest in SWK

HP

 

 

 

We receive quarterly distributions based on a royalty paid on net sales of the product

 

 

Other than the $1,250,000 payable to TRT noted above, there are no other earn out payments contracted to be paid by SWK to any of our partner companies.

 

 Critical Accounting Policies and Estimates 

 

Our critical accounting policies and estimates are described in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the year ended December 31, 2013, filed with the Securities and Exchange Commission on March 31, 2014. We believe there have been no new critical accounting policies or material changes to our existing critical accounting policies and estimates during the three months ended March 31, 2014, compared to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2013.

 

Recent Accounting Pronouncements

 

In July 2013, the FASB issued ASU 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.  Under this new guidance, companies must present this unrecognized tax benefit in the consolidated financial statements as a reduction to deferred tax assets created by net operating losses or other tax credits from prior periods that occur in the same taxing jurisdiction. If the unrecognized tax benefit exceeds such credits it should be presented in the consolidated financial statements as a liability. This update is effective for annual and interim reporting periods for fiscal years beginning after December 15, 2013. The adoption of this standard did not have any impact on our operating results and financial position.

 

Revenues

 

We generated revenues of $3.7 million for the three months ended March 31, 2014, driven primarily by $2.0 million in interest and fees earned on our finance receivables, marketable securities and management fees and $1.5 million in income related to our investment in an unconsolidated partnership. We generated revenues of $430,000 for the three months ended March 31, 2013, driven by $56,000 due to our interest in three revenue-producing client contracts acquired from PBS Capital Management, LLC, and $374,000 related to interest income earned on our finance receivables.  

 

General and Administrative Expenses

 

General and administrative expenses consist primarily of compensation, stock-based compensation and related costs for management, staff, Board of Directors, legal and audit expenses, and corporate governance. General and administrative expenses increased by 72% to $0.7 million for the three months ended March 31, 2014 from $0.4 million for the comparable period in 2013, due to increased professional fees and stock-based compensation expenses.

 

Interest and Other Income (Expense), Net

 

Interest and other income (expense), net was an expense of $34,000 for the three months ended March 31, 2014, which consisted primarily of a $154,000 fair market value adjustments relating to the Tribute warrant and to our warrant liability, and interest expense of $189,000 relating to our loan credit agreement. During the three months ended March 31, 2013, interest and other income (expense), net was income of $23,000 which consisted solely of interest income.

 

 
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Provision for Income Taxes

 

We have incurred net operating losses on a consolidated basis for all years from inception through 2012. Accordingly, we have historically recorded a valuation for the full amount of gross deferred tax assets, as the future realization of the tax benefit was not “currently more likely than not.” As of December 31, 2013, we concluded that it is more likely than not that the Company will be able to realize approximately $9,803,000 benefit of the U.S. federal and state deferred tax assets in the future.

 

As of March 31, 2014, we had operating loss carryforwards for federal income tax purposes of approximately $433,000,000. The federal net operating loss carry forwards if not offset against future income, will expire by 2032, with the majority expiring by 2021.

 

Liquidity and Capital Resources

 

As of March 31, 2014, we had $3.9 million in cash and cash equivalents compared to $7.7 million in cash and cash equivalents as of December 31, 2013. As of March 31, 2014, we had working capital of $4.8 million, compared to working capital of $8.7 million as of December 31, 2013.

 

  Primary Driver of Cash Flow

 

Our ability to generate cash in the future depends primarily upon our success in implementing our revised business model of generating income by providing capital to a broad range of life science companies, institutions and inventors. We generate income primarily from three sources:

 

 

1.

owning or financing through debt investments, royalties generated by the sales of life science products and related    intellectual property;

 

 

2.

receiving interest and other income by advancing capital in the form of secured debt to companies in the life science sector; and,

 

 

3.

to a lesser extent, realize capital appreciation from equity-related investments in the life science sector.

 

As of May 14, 2014, we have consummated nine transactions under our new strategy and expect those assets to generate income greater than our expenses in 2014. We continue to evaluate multiple attractive opportunities that, if consummated, would similarly generate additional income. Since the timing of any investment is difficult to predict, we may not be able to generate positive cash flow above what our existing assets will produce in 2014. Given low current interest rates, we expect the interest rate that we receive on our cash will continue to be at a low rate and to not produce material income. In addition, we expect to generate income other than interest income from our interest in three revenue-producing investment advisory contracts from PBS Capital Management, LLC, as well as income generated from our other investment advisory contracts.

 

Operating Cash Flow

 

Net cash provided by operating activities was $1.3 million for the three months ended March 31, 2014 and consisted primarily of net income of $2.3 million partially offset by noncash adjustments of $1.3 million and changes in operating assets and liabilities of $0.3 million. The noncash adjustments were primarily attributable to $1.5 million from equity income on an investment in an unconsolidated entity and $0.4 million in loan discount amortization and fee accretion, offset by $0.7 million in interest income in excess of cash collected. The significant factors that contributed to the change in operating assets and liabilities included increases in accounts payable and accrued liabilities of $0.4 million and an increase in prepaid expenses and other assets of $0.3 million. The increase in prepaid expenses and other assets was primarily due to prepaid offering costs incurred. The increase in accounts payable and accrued expenses was primarily due to the timing of payments.We had positive cash flow from operating activities of $168,000 for the three months ended March 31, 2013, which included net income of $60,000, $64,000 increase in non-cash expenses included in net income, offset by a $33,000 increase in assets and a $77,000 increase in accounts payable and accrued liabilities.   

 

 Investing Cash Flow

 

The Company's investing activities provided negative cash flow of $10.0 million during the three months ended March 31, 2014, which primarily related to our issuance of $12.0 million in finance receivables, offset by $2.0 million in cash distributions received from an investment in an unconsolidated entity.  The Company's investing activities provided negative cash flow of $4,000 for the three months ended March 31, 2013, which primarily related to purchases of property and equipment.  

 

Financing Cash Flow

 

The Company's financing activities had positive cash flow of $4.9 million for the three months ended March 31, 2014, which consisted of $6.0 million in loan proceeds from our credit agreement, offset by $1.1 million in cash distributions to non-controlling interests. We did not have comparable activity for the three months ended March 31, 2013.

 

 
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Off-Balance-Sheet Arrangements

 

As of March 31, 2014, the Company did not have any off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K.

 

Outlook

 

During 2012, we adopted a new corporate strategy to provide capital to a broad range of life science companies, institutions and inventors in order to earn interest, fee, and other income pursuant to this strategy. As of May 14, 2014, we have consummated our nine transactions under our revised strategy. We believe the income generated by these nine transactions will be more than our operational expenses, and we will begin to grow our book value going forward. We continue to evaluate multiple attractive opportunities that, if consummated, would similarly generate additional income. We expect that the income generated by such future investments would be earned with minimal additional operational expenses.

 

 
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ITEM 3.            QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

Prior to commencing our strategic plan, the primary objective of our activities was to preserve cash. During the three months ended March 31, 2014, our cash and cash equivalents were deposited in accounts at well capitalized financial institutions. The fair value of our cash and cash equivalents at March 31, 2014, approximated its carrying value.

 

Investment and Interest Rate Risk

 

We are subject to financial market risks, including changes in interest rates. As we seek to provide capital to a broad range of life science companies, institutions and investors, our net investment income is dependent, in part, upon the difference between the rate at which we earn on our cash and cash equivalents and the rate at which we lend those funds to third parties. As a result, we would be subject to risks relating to changes in market interest rates. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations by providing capital at variable interest rates.  We constantly monitor our portfolio and position our portfolio to respond appropriately to a reduction in credit rating of any portfolio of products.

 

Inflation

 

We do not believe that inflation has had a significant impact on our revenues or operations.

 

 ITEM 4.            CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”)) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.

 

In connection with the preparation of this report, our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective.

 

Changes in Internal Control over Financial Reporting

 

There was no change in our internal control over financial reporting during the three months ended March 31, 2014, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. 

  

 

PART II: OTHER INFORMATION

 

ITEM 1.            LEGAL PROCEEDINGS

 

We are involved in, or have been involved in, arbitrations or various other legal proceedings that arise from the normal course of our business. We cannot predict the timing or outcome of these claims and other proceedings. The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative impact on our results of operations, balance sheets and cash flows due to defense costs, and divert management resources.  Currently, we are not involved in any arbitration and/or other legal proceeding that we expect to have a material effect on our business, financial condition, results of operations and cash flows.

 

ITEM 1A.          RISK FACTORS.

 

Information regarding the Company’s risk factors appears in “Part I. – Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2013, filed with the SEC on March 31, 2014. There have been no material changes from the risk factors previously disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

 

ITEM 2.            UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None.

 

 
30

 

 

ITEM 3.            DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4.            MINE SAFETY DISCLOSURES

 

Not Applicable.

 

ITEM 5.            OTHER INFORMATION.

 

None.

  

 

ITEM 6.            EXHIBITS

 

  

  

  

  

Incorporated by Reference

  

  

  

Exhibit

Number

  

Exhibit Description

  

Form

  

File No.

  

Exhibit

  

Filing

Date

  

Provided

Herewith

  

  

  

  

  

  

  

  

  

  

  

  

  

  

  

31.01

  

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.

  

  

  

  

  

  

  

  

  

X

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

  

  

  

  

  

  

  

  

  

  

  

  

  

31.02

  

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act and Section 302 of the Sarbanes-Oxley Act of 2002.

  

  

  

  

  

  

  

  

  

X

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

  

  

  

  

  

  

  

  

  

  

  

  

  

32.01

  

Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

  

  

  

  

  

  

  

  

  

X

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

  

  

  

  

  

  

  

  

  

  

  

  

  

32.02

  

Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*

  

  

  

  

  

  

  

  

  

X

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

101.INS**

  

XBRL Instance

  

  

  

  

  

  

  

  

  

  

  

101.SCH**

  

XBRL Taxonomy Extension Schema

  

  

  

  

  

  

  

  

  

X

  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

  

  

  

  

  

  

  

  

  

  

  

  

  

  

101.CAL**

  

XBRL Taxonomy Extension Calculation

  

  

  

  

  

  

  

  

  

X

  

101.DEF**

  

XBRL Taxonomy Extension Definition

  

  

  

  

  

  

  

  

  

X

  

101.LAB**

  

XBRL Taxonomy Extension Labels

  

  

  

  

  

  

  

  

  

X

  

101.PRE**

  

XBRL Taxonomy Extension Presentation

  

  

  

  

  

  

  

  

  

X

  

 

*

These certifications accompany this Quarterly Report on Form 10-Q. They are not deemed “filed” with the Securities and Exchange Commission and are not to be incorporated by reference in any filing of SWK Holdings Corporation under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any filings.

 

 
31

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

May 14, 2014

  

SWK Holdings Corporation

  

  

  

/s/ J. BRETT POPE

  

J. Brett Pope

  

Chief Executive Officer

  

(Principal Executive Officer)

  

  

  

/s/ CHARLES M. JACOBSON

  

Charles M. Jacobson

  

Chief Financial Officer

  

(Principal Financial Officer)

 

 

 

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