10-Q 1 e00433_swk-10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

 

For the Quarterly Period Ended June 30, 2016

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

Commission File Number: 000-27163

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.)
   
   
14755 Preston Road, Suite 105
Dallas, TX 75254
75254
(Address of Principal Executive Offices) (Zip Code)

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

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.      x   YES     o   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). x   YES     o   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   o Accelerated Filer   o Non-Accelerated Filer   o Smaller Reporting Company  x

 

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

 

As of August 10, 2016, there were 13,132,063 shares of the registrant’s Common Stock, $0.001 par value per share, outstanding.

 

 
 

SWK Holdings Corporation

Form 10-Q

Quarter Ended June 30, 2016

Table of Contents

 

PART I. FINANCIAL INFORMATION    
       
Item 1. Financial Statements 1  
       
  Unaudited Condensed Consolidated Balance Sheets—June 30, 2016 and December 31, 2015 1  
       
  Unaudited Condensed Consolidated Statements of Income (Loss)—Three and Six Months Ended June 30, 2016 and 2015 2  
       
  Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)—Three and Six Months Ended June 30, 2016 and 2015 3  
       
  Unaudited Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2016 and 2015 4  
       
  Notes to the Unaudited Condensed Consolidated Financial Statements 5  
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 20  
       
Item 3. Quantitative and Qualitative Disclosures About Market Risk 27  
       
Item 4 Controls and Procedures 28  
     
PART II. OTHER INFORMATION    
       
Item 1. Legal Proceedings 28  
       
Item 1A. Risk Factors 28  
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28  
       
Item 3. Defaults Upon Senior Securities 28  
       
Item 4. Mine Safety Disclosures 28  
       
Item 5. Other Information 28  
       
Item 6. Exhibits 29  
       
  Signatures 30  
       
  Certifications    

 

 
 

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 heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. 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 favorably 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 Part II, Item 1A “Risk Factors” and elsewhere in this report. 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.

REVERSE STOCK SPLIT

On October 7, 2015, we effected a 1-for-100 reverse stock split of our common stock, immediately followed by a 10-for-1 forward split of our common stock. For holders of greater than 100 shares prior to October 7, 2015, the net effect was a 1-for-10 reverse split. All share and per share information for the periods ending June 30, 2015 have been retroactively adjusted to give effect thereto.

 

 
 

PART I. FINANCIAL INFORMATION

 

ITEM 1.      FINANCIAL STATEMENTS

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)

 

   June 30,  December 31,
   2016  2015
ASSETS          
Cash and cash equivalents  $76,617   $47,287 
Accounts receivable   1,364    1,127 
Finance receivables   74,702    99,346 
Marketable investments   3,702    5,286 
Investment in unconsolidated entities   7,486    7,988 
Deferred tax asset   16,833    16,833 
Warrant assets   866    1,900 
Other assets   645    720 
Total assets  $182,215   $180,487 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
Accounts payable and accrued liabilities  $719   $788 
Warrant liability   189    259 
Total liabilities   908    1,047 
           
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;
13,126,058 and 13,115,909 shares issued and outstanding at
June 30, 2016 and December 31, 2015, respectively
   13    13 
Additional paid-in capital   4,433,068    4,432,926 
Accumulated deficit   (4,255,747)   (4,257,798)
Accumulated other comprehensive loss   (55)   —   
Total SWK Holdings Corporation stockholders’ equity   177,279    175,141 
Non-controlling interests in consolidated entities   4,028    4,299 
Total stockholders’ equity   181,307    179,440 
Total liabilities and stockholders’ equity  $     182,215   $180,487 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 1 
 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(in thousands, except per share data)

 

   Three Months Ended
June 30,
  Six Months Ended
June 30,
   2016  2015  2016  2015
Revenues                    
Finance receivable interest income, including fees  $6,457   $3,965   $9,927   $8,111 
Marketable investments interest income   —      88    92    177 
Income related to investments in unconsolidated entities   2,143    1,339    3,802    2,890 
Other   11    9    26    24 
Total Revenues   8,611    5,401    13,847    11,202 
Costs and expenses:                    
Provision for loan credit losses   1,659    2,594    1,659    2,594 
Impairment expense   6,590    —      6,929    —   
Interest expense   —      —      —      381 
General and administrative   789    945    1,718    2,162 
Total costs and expenses   9,038    3,539    10,306    5,137 
Other (expense) income, net                    
Unrealized net gain (loss) on derivatives   471    (1,559)   441    (1,188)
Income before provision for income taxes   44    303    3,982    4,877 
Provision for income taxes   —      —      —      1,506 
Consolidated net income   44    303    3,982    3,371 
Net income attributable to non-controlling interests   1,090    678    1,931    1,489 
Net income (loss) attributable to SWK Holdings Corporation Stockholders  $(1,046)  $(375)  $2,051   $1,882 

Net income (loss) per share attributable to SWK Holdings Corporation Stockholders (1):

                    
Basic  $(0.08)  $(0.03)  $0.16   $0.14 
Diluted  $(0.08)  $(0.03)  $0.16   $0.14 
Weighted Average Shares (1):                    
Basic   13,126    13,001    13,123    12,999 
Diluted   13,126    13,001    13,126    13,004 

 

(1) Common stock and per share data for the three and six months ended June 30, 2015 have been adjusted retroactively to reflect a net 1-for-10 reverse stock split effective October 7, 2015.

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 2 
 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

 

   Three Months Ended
June 30,
  Six Months Ended
June 30,
   2016  2015  2016  2015
Consolidated net income  $44  $303   $    3,982    $3,371 
Other comprehensive loss, net of tax:                    
Unrealized losses on investment in securities                    
Unrealized holding loss arising during period   (69)   —      (55)   —   
Total other comprehensive loss   (69)   —      (55)   —   
Comprehensive income (loss)   (25)   303    3,927    3,371 
Comprehensive income attributable to non-controlling interests   1,090    678    1,931    1,489 
Comprehensive income (loss) attributable to SWK Holdings Corporation Stockholders  $(1,115)  $(375)  $1,996   $1,882 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 3 
 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

   Six Months Ended June 30,
   2016  2015
Cash flows from operating activities:          
Consolidated net income  $3,982   $3,371 
Adjustments to reconcile net income to net cash provided by operating activities:          
Income from investments in unconsolidated entities   (3,802)   (2,890)
Provision for loan credit losses   1,659    2,594 
Impairment expense   6,929    —   
Change in fair value of warrants   (441)   1,188 
Deferred income taxes   —      1,506 
Loan discount amortization and fee accretion   (2,038)   (670)
Interest income in excess of cash collected   —      (523)
Stock-based compensation   205    346 
Debt issuance cost amortization   —      381 
Property and equipment depreciation   9    3 
Changes in operating assets and liabilities:          
Accounts receivable   (237)   (725)
Other assets   (347)   (70)
Accounts payable and other liabilities   (131)   50 
Net cash provided by operating activities   5,788    4,561 
           
Cash flows from investing activities:          
Cash distributions from investments in unconsolidated entities   4,304    3,445 
Cash received for settlement of warrants   1,014    —   
Net (increase) decrease in finance receivables   20,430    (36,532)
Marketable investment principal payment   —      80 
Other   (4)   (50)
Net cash provided by (used in) investing activities   25,744    (33,057)
           
Cash flows from financing activities:          
Costs of common stock issuance   —      (10)
Distribution to non-controlling interests   (2,202)   (1,787)
Net cash used in financing activities   (2,202)   (1,797)
           
Net increase (decrease) in cash and cash equivalents   29,330    (30,293)
Cash and cash equivalents at beginning of period   47,287    58,728 
Cash and cash equivalents at end of period  $76,617   $28,435 
           
Supplemental noncash flow activity:          
Common stock received in connection with loan repayment financial receivables  $150   $—   
Consideration (notes and preferred stock) received in connection with loan repayment  $—     $8,400 
Warrants received in conjunction with the origination of financial receivables  $—     $4,539 

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 4 
 

SWK HOLDINGS CORPORATION

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

 

Nature of Operations

 

SWK Holdings Corporation (the “Company”) was incorporated in July 1996 in California and reincorporated in Delaware in September 1999. In July 2012, the Company commenced its strategy of building a specialty finance and asset management business. The Company’s 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. The Company is primarily 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 has been deploying its assets to earn interest, fees, 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, through the Company’s wholly-owned subsidiary, SWK Advisors LLC, the Company provides 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. The Company intends to fund transactions through its own working capital, as well as by building its asset management business by raising additional third party capital to be invested alongside the Company’s capital.

The Company fills a niche that it believes is underserved in the sub-$50 million transaction size. Since many of its competitors that provide longer term, royalty-related financing options have much greater financial resources than the Company, they tend to not focus on transaction sizes below $50 million as it is generally inefficient for them to do so. In addition, the Company does 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, the Company believes it faces less competition from such longer term, royalty investors in transactions that are less than $50 million.

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.

As of June 30, 2016, the Company had NOL carryforwards for federal income tax purposes of $405.0 million. The federal NOL carryforwards, if not offset against future income, will expire by 2032, with the majority of such NOLs expiring by 2021.

The Company also had federal research credit carryforwards of $2.7 million. The federal credits will expire by 2029.

As of August 10, 2016, the Company and its partners have executed transactions with 22 different parties under its specialty finance strategy, funding $272 million in various financial products across the life science sector. The Company’s portfolio includes senior and subordinated debt backed by royalties and synthetic royalties paid by companies in the life science sector, purchased royalties generated by sales of life science products and related intellectual property and an unconsolidated equity investment in a company which retains the marketing authorization rights to a pharmaceutical product.

The Company is headquartered in Dallas, Texas.

Basis of Presentation and Principles of Consolidation

 

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 may be less than 50 percent. The related governing agreements provide the Company with broad powers, and the other parties do not participate in the management of the entities 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 change and it is determined this control does not exist, any such investment would be recorded using the equity method of accounting. Although this would change individual line items within the Company’s unaudited condensed consolidated financial statements, it would have no effect on its operations and/or total stockholders’ equity attributable to the Company.

 5 
 

Reverse Stock Split

On October 7, 2015, the Company effected a 1-for-100 reverse stock split of its common stock, immediately followed by a 10-for-1 forward stock split of its common stock. For holders of greater than 100 shares prior to October 7, 2015, the net effect was a 1-for-10 reverse split. The number of shares of common stock underlying the Company’s options and warrants to acquire shares of common stock were adjusted accordingly. All applicable share data, per share amounts and related information in the unaudited condensed consolidated financial statements for the three and six months ended June 30, 2015 and notes thereto have been adjusted retroactively to give effect to the stock splits.

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, 2016. 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, 2015, filed with the SEC on March 24, 2016.

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’s 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 changes to those estimates and assumptions. Market conditions, such as illiquid credit markets, volatile equity markets, and economic downturns, 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 unaudited 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. 

Recent Accounting Pronouncements

 

In March 2016, the FASB issued ASU 2016-07, “Equity Method and Joint Ventures (Topic 323).” This guidance simplifies the accounting for equity method investments by eliminating the requirement in Topic 323 that requires an entity to retroactively adopt the equity method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership or degree of influence. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes qualified for equity method accounting. ASU 2016-07 is effective for fiscal years and interim periods within those years beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements when adopted.

 

 6 
 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This guidance also requires an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Qualitative and quantitative information is required about:

 

  · Contracts with customers—including revenue and impairments recognized, disaggregation of revenue and information about contract balances and performance obligations (including the transaction price allocated to the remaining performance obligations).
     
  · Significant judgments and changes in judgments—determining the timing of satisfaction of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance obligations.
     
  · Certain assets—assets recognized from the costs to obtain or fulfill a contract.

 

In August 2015, the FASB issued updated guidance deferring the effective date of the revenue recognition standard. In March and April 2016, the FASB issued additional updated guidance, which clarifies certain aspects of the ASU and the related implementation guidance issued by the FASB-IASB Joint Transition Resource Group for Revenue Recognition. This guidance is effective for the Company for annual reporting periods beginning after December 15, 2017. The Company is currently evaluating the impact that this guidance will have on its results of operations, financial position and cash flows.

 

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This guidance changes how entities measure equity investments that do not result in consolidation and are not accounted for under the equity method. Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for equity investments that do not have readily determinable fair values; however, the exception requires the Company to consider relevant transactions that can be reasonably known to identify any observable price changes that would impact the fair value. This guidance also changes certain disclosure requirements and other aspects of current GAAP. The amendments in this update are effective for the Company for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the new guidance and has not determined the impact that this guidance will have on its results of operations, financial position and cash flows, nor decided upon the method of adoption.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact that this guidance will have on its results of operations, financial position and cash flows.

In March 2016, the FASB issued ASU No. 2016-09, “Compensation - Stock Compensation (Topic 718).” The amendments of ASU No. 2016-09 were issued as part of the FASB’s simplification initiative focused on improving areas of GAAP for which cost and complexity may be reduced while maintaining or improving the usefulness of information disclosed within the financial statements. The amendments focused on simplification specifically with regard to share-based payment transactions, including income tax consequences, classification of awards as equity or liabilities and classification on the statement of cash flows. The guidance in ASU No. 2016-09 is effective for fiscal years beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of this new standard will have on the consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326).” The new standard adds an impairment model, known as current expected credit loss (CECL) model, that is based on expected losses rather than incurred losses. Under the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result in more timely recognition of losses. The ASU describes the impairment allowance as a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. Credit losses relating to available-for-sale debt securities should be measured in a manner similar to current GAAP; however, the amendments in this update require that credit losses be presented as an allowance rather than as a write-down, which will allow an entity the ability to record reversals of credit losses in current period net income. The amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). A prospective transition approach is required for debt securities for which an other-than-temporary impairment has been recognized before the effective date. The Company is currently evaluating the new guidance and has not determined the impact it will have on its consolidated financial statements when adopted.

 

 7 
 

Note 2. Net Income (Loss) per Share

Basic net income (loss) per share is computed using the weighted average number of outstanding shares of common stock. Diluted net income (loss) 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  Six Months Ended
   June 30,  June 30,
   2016  2015  2016  2015
Numerator:                    
Net income (loss) attributable to SWK Holdings Corporation Stockholders  $(1,046)  $(375)  $2,051   $1,882 
                     
Denominator:                    
Weighted-average shares outstanding   13,126    13,001    13,123    12,999 
Effect of dilutive securities   —      —      3    4 
                     
Weighted-average diluted shares   13,126    13,001    13,126    13,003 
                     
Basic income (loss) per share attributable to SWK Holdings Corporation Stockholders  $(0.08)  $(0.03)  $0.16   $0.14 
Diluted income (loss) per share attributable to SWK Holdings Corporation Stockholders  $(0.08)  $(0.03)  $0.16   $0.14 

 

For the three months ended June 30, 2016 and 2015, outstanding stock options and warrants to purchase shares of common stock in an aggregate of approximately 388,000 and 480,000, respectively, have been excluded from the calculation of diluted income (loss) per share as all such securities were anti-dilutive. For the six months ended June 30, 2016 and 2015, outstanding stock options and warrants to purchase shares of common stock in aggregate of approximately 369,000, and 480,000, respectively, have been excluded from the calculation of diluted income per share as all such securities were anti-dilutive.

 

Note 3. 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):

 

Portfolio  June 30,
2016
  December 31,
2015
Term Loans  $59,421   $89,204 
Royalty Purchases   16,940    17,224 
Total before allowance for credit losses   76,361    106,428 
Allowance for credit losses   1,659    7,082 
Total carrying value  $74,702   $99,346 

 8 
 

Credit Quality of Finance Receivables 

 

The Company originates finance receivables to companies primarily in the life sciences sector. This concentration of credit exposes the Company to a higher degree of risk associated with this sector.

 

On a quarterly basis, the Company evaluates the carrying value of each finance receivable for impairment. 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 the 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. In certain circumstances, the Company may place a finance receivable on nonaccrual status but conclude it is not impaired.

 

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, or the estimated fair value of the collateral, less estimated costs to sell. 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 individually develops the allowance for credit losses for any identified impaired loans. In developing the allowance for credit losses, the Company considers, 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 following table presents nonaccrual and performing loans by portfolio segment (in thousands):

 

   June 30, 2016  December 31, 2015
   Nonaccrual  Performing  Total  Nonaccrual  Performing  Total
Term Loans  $18,854   $40,567   $59,421   $20,093   $62,029   $82,122 
                               
Royalty Purchases   —      15,281    15,281    —      17,224    17,224 
                               
Total carrying value  $18,854   $55,848   $74,702   $20,093   $79,253   $99,346 

 

 9 
 

As of June 30, 2016, the Company had two term loans associated with two portfolio companies in nonaccrual status with a carrying value, net of credit loss allowance, of $18.9 million. As of December 31, 2015, the Company had three term loans associated with three portfolio companies in nonaccrual status with a carrying value, net of credit loss allowance, of $20.1 million. No cash was collected on nonaccrual loans during the six months ended June 30, 2016. Of the two nonaccrual term loans at June 30, 2016, neither are deemed to be impaired.

 

SynCardia Systems, Inc. (“SynCardia”)

     

  On June 24, 2016, SWK Funding LLC, a wholly-owned subsidiary of SWK Holdings Corporation, sold 100 percent of its debt and equity interests in SynCardia to an affiliate of Versa Capital Management for an upfront cash consideration of $7.2 million plus additional certain future contingent payments. The Company’s interests in SynCardia included $22.0 million of a senior secured first lien loan, $13.0 million of second lien convertible notes, 2,323,649 shares of Series F preferred stock, 4,000 shares of common stock and 34,551 common stock purchase warrants. The carrying value, as of the date of sale, of the debt and equity interests in SynCardia was approximately $12.5 million. During the three and six months ended June 30, 2016, the Company recognized $5.3 million of impairment expense related to the sale of its SynCardia assets.

 

ABT Molecular Imaging, Inc. (“ABT”)

 

On October 10, 2014, the Company entered into a credit agreement pursuant to which the Company provided ABT a second lien term loan in the principal amount of $10.0 million. The loan matures on October 8, 2021. The synthetic royalty payment due to the Company on December 15, 2015 was blocked by ABT’s first lien lender pursuant to the terms of the intecreditor agreement by and between the Company and the first lien lender as a result of a forbearance agreement entered into between ABT and the first lien lender. Per the terms of the forbearance agreement, the first lien lender deferred principal payments until maturity of the first lien in March 2016 and ABT raised additional equity capital.  

 

 In February 2016, ABT violated the terms of the forbearance agreement with the first lien lender. In order to control the work out of the default under the first lien loan and prevent the equity sponsors from taking control of the first lien term loan, the Company purchased from an unrelated party the first lien term loan at par for a purchase price of $0.7 million. Since then the equity sponsors funded cash shortfalls into the second quarter of 2016. The Company continues to work with ABT’s equity sponsors to resolve the existing defaults.

 

On June 7, 2016, the Company entered into an amendment to the first lien term loan, which provided for an additional $0.5 million of liquidity under the first lien credit agreement. ABT drew down the full $0.5 million by July 13, 2016. On July 30, 2016, the Company entered into an additional amendment to the first lien term loan, which provided for an additional $0.5 million of liquidity under the first lien credit agreement. ABT drew down $0.2 million as of August 10, 2016.

 

The collateral for the loan has been individually reviewed, noting that the fair market value of the loan, less costs to sell, was greater than the recorded investments in the loans as of June 30, 2016. Based on the impairment analysis, the Company has determined that recording a provision for credit losses as of June 30, 2016 is not required.

 

B&D Dental (“B&D”)

 

On December 10, 2013, the Company entered into a five-year credit agreement to provide B&D a senior secured term loan with a principal amount of $6.0 million funded upon close, net of an arrangement fee of $60,000. Subsequently, the terms of the loan have been amended, and the Company has funded additional amounts to B&D. As of June 30, 2016, the total amount funded was $7.9 million.

 

B&D is currently in default under the terms of the credit agreement, and as a result, the Company classified the loan to non-accrual status as of September 30, 2015. The previously accrued and unearned interest have not been reversed nor has an allowance been recorded for this loan because the Company believes its collateral position is greater than the unpaid balance. The Company obtained a third party valuation to support such assertion.

 

During the first quarter of 2016, the Company executed additional amendments to the loan to advance an additional $0.3 million in order to directly pay critical vendors and protect the value of the collateral. No additional amendments were made in the second quarter of 2016. The Company believes its collateral position is greater than the unpaid balance; thus, accrued and unearned interest have not been reversed nor has an allowance been recorded as of June 30, 2016.

 

 10 
 

Besivance

 

On April 2, 2013, the Company purchased an effective 2.4 percent royalty on sales of Besivance® from InSite Vision for $6.0 million. Besivance is marketed by Bausch & Lomb, a unit of Valeant Pharmaceuticals. Recently the sales performance of Besivance has weakened due to substantial increases in sales chargebacks and various rebates (gross sales to net sales deductions) and lower sales volumes, which has resulted in material reductions in the product’s net sales and associated royalties’ payable to the Company. During the six months ended June 30, 2016, the Company reduced its expectations for future royalty receipts and recognized an allowance for credit loss on the royalty purchase of $1.7 million.

 

Unfunded Loan Commitments

 

As of June 30, 2016, the Company had total unfunded loan commitments of $6.8 million. Of the total $6.8 million, $2.5 million is committed to DxTerity Diagnostics should it exceed an established revenue threshold at any time on or before the quarter ending December 31, 2016; $2.5 million is committed to Keystone Dental should it reach an established revenue threshold on or before the quarter ending December 31, 2016 and raises specified proceeds from selling equity capital after closing; $1.0 million is committed to Thermedx should it reach an established revenue threshold on or before November 5, 2017; and $0.8 million is committed to Cambia® for earn out payments if cumulative net sales reach a certain threshold within a specified period of time.

 

Note 4. Marketable Investments

 

Investment in securities at June 30, 2016 and December 31, 2015 consist of the following (in thousands):

 

   June 30,
2016
  December 31,
2015
Corporate debt securities  $2,143   $2,857 
Equity securities   1,559    2,429 
Total  $3,702   $5,286 

 

The amortized cost basis amounts, gross unrealized holding gains, gross unrealized holding losses and fair values of available-for-sale securities as of June 30, 2016 and December 31, 2015, are as follows (in thousands):

 

June 30, 2016 

Amortized

Cost

 

Gross

Unrealized

Gains

 

Gross

Unrealized

Loss

  Fair Value
Available for sale securities:                    
Corporate debt securities  $2,143   $—     $—     $2,143 
Equity securities   1,614    —      (55)   1,559 
   $3,757   $—     $(55)  $3,702 

 

December 31, 2015 

Amortized

Cost

 

Gross

Unrealized

Gains

 

Gross

Unrealized

Loss

  Fair Value
Available for sale securities:                    
Corporate debt securities  $2,857   $—     $—     $2,857 
Equity securities   2,429    —      —      2,429 
   $5,286   $—     $—     $5,286 

 

During the six months ended June 30, 2016, and the year ended December 31, 2015, the Company had no sales of available-for-sale securities.

Equity Securities

 

The Company’s equity securities include 736,076 shares of Cancer Genetics common stock and 77,922 shares of Hooper Holmes common stock. During the three and six months ended June 30, 2016, the Company recognized an other-than-temporary impairment expense of $0.6 million and $1.0 million, respectively, related to the Cancer Genetics common stock. As of June 30, 2016, the Cancer Genetics and Hooper Holmes equity securities are reflected at fair value of $1.5 million and $0.1 million, respectively, as available-for-sale securities.

 

 11 
 

Debt Securities

 

On July 9, 2013, the Company entered into a note purchase agreement to purchase, at par, $3.0 million of a total of $100.0 million aggregate principal amount of senior secured notes due in November 2026.  The agreement allows the first interest payment date to include paid-in-kind notes for any cash shortfall, of which the Company received $0.1 million on November 15, 2013.  The notes are secured only by certain royalty and milestone payments associated with the sales of pharmaceutical products. During the three and six months ended June 30, 2016, the Company recognized an other-than-temporary impairment expense of $0.7 million related to the senior secured notes. The notes are reflected at their estimated fair value of $2.1 million and classified as available-for-sale securities.

 

Note 5. Variable Interest Entities

 

The Company consolidates the activities of VIEs of which it is 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”) 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 $13.0 million. 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 $13.0 million included $6.0 million provided by SWK Holdings GP and $7.0 million 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 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 consolidated balance sheet.

Unconsolidated VIEs

 

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 percent of the pharmaceutical product’s cash flow. As the cash on cash multiple received by SWK HP increases, SWK HP’s interest in the cash flow generated by the pharmaceutical product decreases, but in no instance will it decline below 39 percent. 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 46 percent.  The Company accounts for its interest in the entity based on the timing of quarterly distributions, which are paid on a quarter lag basis.

 12 
 

For the three and six months ended June 30, 2016, the Company recognized $2.1 million and $3.8 million, respectively, of equity method gains. The amount of equity method gains attributable to the non-controlling interests in SWK HP were $1.1 million and $1.9 million, respectively.  For the three and six months ended June 30, 2015, the Company recognized $1.3 million and $2.9 million of equity gains, respectively. The amount of equity method gains attributable to the non-controlling interests in SWK HP were $0.7 million and $1.5 million for the three and six months ended June 30, 2015, respectively.

In addition, SWK HP received cash distributions totaling $4.3 million during the six months ended June 30, 2016, of which $2.2 million 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 six months ended June 30, 2016 are as follows (in thousands):  

 

Balance at December 31, 2015  $7,988 
      
Add: Income from investments in unconsolidated entities   3,802 
      
Less: Cash distribution on investments in unconsolidated entities   (4,304)
      
Balance at June 30, 2016  $7,486 

 

The following table provides the financial statement information related to Holmdel for the comparative periods which SWK HP has reflected its share of Holmdel income in the Company’s consolidated statements of income:

 

in millions   As of June 30, 2016         Three Months Ended
June 30, 2016
    Six Months Ended
June 30, 2016
 
Assets   $ 11.5     Revenue   $ 3.0     $ 6.2  
Liabilities   $ 3.5     Expenses   $ 0.4     $ 0.7  
Equity   $ 8.0     Net income   $ 2.6     $ 5.5  

 

 

in millions   As of December 31, 2015         Three Months Ended
June 30, 2015
    Six Months Ended
June 30, 2015
 
Assets   $ 11.7     Revenue   $ 2.5     $ 4.8  
Liabilities   $ 3.3     Expenses   $ 0.4     $ 0.7  
Equity   $ 8.4     Net income   $ 2.1     $ 4.1  

 

Note 6. Related Party Transactions

 

On September 6, 2013, the Company issued warrants to an affiliate of a stockholder, Carlson Capital, L.P. (“Carlson”), (collectively, the “Stockholder”) for 100,000 shares of the Company’s common stock at a strike price of $13.875. The warrants have a price dilution mechanism that was triggered by the price that shares were sold by the Company in a rights offering in 2014, and as a result, the strike price of the warrants was reduced to $13.48. In connection with the credit facility, 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.

 13 
 

Due to certain provisions within the warrant agreement, the warrants meet the definition of a derivative and do not qualify for a scope exception, as it is not considered indexed to the Company’s stock. As such, the warrants with a value of $0.2 million and $0.3 million as of June 30, 2016 and December 31, 2015, respectively, are reflected as a warrant liability in the unaudited condensed consolidated balance sheets. Unrealized losses of $11,000 and $70,000 were included in other (expense) income in the consolidated statements of income (loss) for the three and six months ended June 30, 2016, respectively. Unrealized losses of $30,000 and $0.2 million were included in other income (expense) in the unaudited condensed consolidated statements of income (loss) for the three and six months ended June 30, 2015, respectively. The Company determined the fair value using the Black-Scholes option pricing model with the following assumptions:

 

   June 30, 2016  December 31, 2015
Dividend rate   0%   0%
Risk-free rate   1.0%   1.8%
Expected life (years)   4.2    4.7 
Expected volatility   33.8%   33.3%

 

Note 7. Stockholders’ Equity

Stock Compensation Plans

 

During the six months ended June 30, 2015, the Board approved the following grants as compensation for Board services: (i) a grant of 33,660 shares of common stock as the pro-rated director compensation for the non-employee directors appointed on September 6, 2014; (ii) a grant of 20,000 shares to each non-employee director for services as a director for the period January 1, 2015 to June 30, 2015; and (iii) a grant of 32,595 shares of common stock in lieu of cash payments to the non-employee directors upon the voluntary election of such directors. The Company recorded board compensation expense relating to the quarterly grants of approximately $68,000 and $107,000, respectively, during the three and six months ended June 30, 2015.

 

During the six months ended June 30, 2016, the Board approved compensation for Board services by granting 12,155 shares of common stock as compensation for the non-employee directors. During the six months ended June 30, 2016, the Company recorded approximately $123,000 in board compensation expense relating to the quarterly grants.

 

The stock-based compensation expense recognized by the Company for the three and six months ended June 30, 2016 was $0.1 million and $0.2 million, respectively. The stock-based compensation expense recognized by the Company for the three and six months ended June 30, 2015 was $0.1 million and $0.3 million, respectively.

 

The following table summarizes activities under the option plans for the six months ended June 30, 2016:

 

   Options Outstanding   
  

Number of

Shares

 

Weighted

Average

Exercise

Price

 

Weighted

Average

Remaining Contractual

Term

(in years)

 

Aggregate

Intrinsic

Value (in thousands)

Balances, December 31, 2015   364,000   $12.05    7.4   $420.0 
Options cancelled and retired   (170,250)   12.67           
Options exercised   (18,750)   8.30           
Options granted   —      —             
Balances, June 30, 2016   175,000   $11.39    7.2   $149.3 
                     
Options vested and exercisable and expected to be vested and exercisable as of June 30, 2016   175,000   $11.39    7.2   $149.3 
Options vested and exercisable as of June 30, 2016   31,250   $10.46    6.8   $37.3 

 

 14 
 

At June 30, 2016, there were 0.3 million shares reserved for equity awards under the 2010 Stock Incentive Plan, and the Company had $0.1 million of total unrecognized stock option expense, net of estimated forfeitures, which will be recognized over the weighted average remaining period of 1.6 years.

 

The following table summarizes significant ranges of outstanding and exercisable options as of June 30, 2016:

 

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

 
$ 8.30       75,000       5.9     $ 8.30       18,750     $ 8.30  
  13.70       100,000       8.1       13.70       12,500       13.70  
Total       175,000       7.2     $ 11.39       31,250     $ 10.46  

 

J. Brett Pope resigned as the Company’s Chief Executive Officer and a member of the Board of Directors effective January 12, 2016. Under the terms of Mr. Pope’s severance agreement, the Company approved the cashless exercise of 18,750 vested stock options and the remaining 156,250 unvested stock options were forfeited. Of the 18,750 vested stock options, 14,751 options were surrendered to the Company to pay the exercise price, resulting in a net issuance of 3,999. The surrendered shares were immediately canceled by the Company.

Non-controlling Interests

 

As discussed in Note 5, SWK HP has a limited partnership interest in Holmdel. Changes in the carrying amount of the non-controlling interest in the unaudited condensed consolidated balance sheet for the six months ended June 30, 2016, is as follows (in thousands):

 

Balance at December 31, 2015  $4,299 
Add: Income attributable to non-controlling interests   1,931 
Less: Cash distribution to non-controlling interests   (2,202)
Balance at June 30, 2016  $4,028 

 

Note 8. 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.

 

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 and six months ended June 30, 2016. 

The fair value of equity method investments is not readily available nor has the Company 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 its equity method investments included in the consolidated balance sheets as of June 30, 2016 and December 31, 2015.

 15 
 

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

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.

Cash and cash equivalents

 

The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.

Securities available for sale

 

Certain common equity securities are reported at fair value utilizing Level 1 inputs (exchange quoted prices).

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 Warrants

 

Marketable Investments

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. Available-for-sale securities are measured at fair value on a recurring basis, while securities with no readily available fair market value are not, but estimates of fair value are reflected below.

 

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.  

The following table presents financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2016 (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:                    
Warrant assets  $866   $—     $—     $866 
Marketable investments   3,702    1,559    —      2,143 
                     
Financial Liabilities:                    
Warrant liability  $189   $—     $—     $189 

 

 16 
 

The following table presents financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 (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:                    
Warrant assets  $1,900   $—     $—     $1,900 
Marketable investments   5,286    2,429    —      2,857 
                     
Financial Liabilities:                    
Warrant liability  $259   $—     $—     $259 

  

The changes on the value of the warrant assets during the six months ended June 30, 2016 were as follows (in thousands):

 

Fair value – December 31, 2015  $1,900 
Issuance   —   
Settlements   (1,405)
Change in fair value   371
Fair value – June 30, 2016  $866 

 

On June, 30, 2016, Luminex Corporation acquired Nanosphere, Inc. for $1.70 per share, and concurrently, the Company entered into a warrant purchase agreement to sell 600,000 warrants that were issued pursuant to its 2015 warrant agreement with Nanosphere. The warrants were purchased at a price of $1.69 per share, for a total cash settlement of approximately $1.0 million. Prior to settlement, the Company reflected the warrants at their estimated fair value of $1.0 million. The Company recognized a gain of $3,900 on the sale of the warrants during the six months ended June 30, 2016.

 

As a result of BTG plc’s acquisition of Galil Medical Ltd. (“Galil”) on June 24, 2016, the Company exercised its right to purchase and subsequently sell 5,882,353 Series B Preferred Shares that were issued pursuant to its 2014 Warrant to Purchase agreement with Galil. The shares were purchased at a price of $.081 per share, for a net cash settlement of $0.4 million, which was recorded as an other receivable in other assets as of June 30, 2016. The Company recognized a $0.4 million gain on the sale of the warrants during the six months ended June 30, 2016.

 

The Company holds warrants issued to the Company in conjunction with certain term loan investments. These warrants meet the definition of a derivative and are included in the consolidated balance sheets. The fair values for warrants outstanding, that have a readily determinable value, are measured using the Black-Scholes option pricing model. The following weighted average assumptions were used in the models to determine fair value:

  

   June 30,
2016
  December 31,
2015
Dividend rate   0%   0%
Risk-free rate   1.3%   2.1%
Expected life (years)   5.8    6.3 
Expected volatility   97.4%   85.6%

 

The changes on the value of the warrant liability during the six months ended June 30, 2016 were as follows (in thousands):

 

Fair value – December 31, 2015  $259 
Issuances   —   
Changes in fair value   (70)
Fair value – June 30, 2016  $189 

 

The following table presents the financial assets and liabilities measured at fair value on a nonrecurring basis as of June 30, 2016 (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                    
Impaired loans  $3,596   $—     $—     $3,596 

 

There were no liabilities measured at fair value on a nonrecurring basis as of June 30, 2016.

 

 17 
 

The following table presents the financial assets and liabilities measured at fair value on a nonrecurring basis as of December 31, 2015 (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                    
Impaired loans  $12,500   $—     $—     $12,500 

 

There were no liabilities measured at fair value on a nonrecurring basis as of December 31, 2015.

 

Off-balance sheet financial instruments

 

Fair values for off-balance sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

As of June 30, 2016 (in thousands):

 

  

Carry

Value

  Fair Value  Level 1  Level 2  Level 3
Financial Assets                         
Cash and restricted cash  $76,617   $76,617   $76,617   $—     $—   
Finance receivables   74,702    74,702    —      —      74,702 
Marketable investments   3,702    3,702    1,559    —      2,143 
Warrant assets   866    866    —      —      866 
                          
Financial Liabilities                         
Warrant liability  $189   $189   $—     $—     $189 

 

As of December 31, 2015 (in thousands): 

 

  

Carry

Value

  Fair Value  Level 1  Level 2  Level 3
Financial Assets                         
Cash and restricted cash  $47,287   $47,287   $47,287   $—     $—   
Finance receivables   99,346    99,346    —      —      99,346 
Marketable investments   5,286    5,286    2,429    —      2,857 
Warrant assets   1,900    1,900    —      —      1,900 
                          
Financial Liabilities                         
Warrant liability  $259   $259   $—     $—     $259 

 

 18 
 

Note 9. Subsequent Events

 

Tenex Health, Inc.

 

On July 1, 2016, the Company entered into a credit agreement pursuant to which the Company will provide to Tenex Health, Inc. (“Tenex”) a term loan in the maximum principal amount of $9.0 million. The loan matures on June 30, 2021. The Company provided $6.0 million on July 1, 2016. Tenex can draw down the remaining $3.0 million of the credit facility at any time until September 30, 2017, if Tenex achieves certain revenue thresholds, and as long as it is in compliance with all covenants under the credit agreement.

 

The loan bears interest at the greater of (a) three month LIBOR and (b) 1.0 percent, plus a margin of 12.0 percent, payable in cash, quarterly in arrears, beginning on September 15, 2016.

 

In connection with the loan, the Company also received a warrant to purchase 2,693,878 shares of Tenex common stock, with a strike price of $0.3675.

 

IntelGenx Corporation

 

On August 5, 2016, the Company closed a $6.0 million royalty purchase agreement with IntelGenx Corporation (“IntelGenx”). The Company funded $6.0 million at closing in exchange for 100 percent of royalties on sales of Forfivo XL®, an antidepressant medication, and a percentage of future sales milestones.

 

 19 
 

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, 2015 (“Annual Report”), as well as our unaudited condensed consolidated financial statements and the accompanying notes include in this report.

 

Overview

 

SWK Holdings Corporation (the “Company”, “SWK”, “us” or “we”) was incorporated in July 1996 in California and reincorporated in Delaware in September 1999. In July 2012, we commenced our 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. Our focus is 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 are deploying 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 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 not to 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 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 book value by generating income from three sources:

1.primarily owning or financing through debt investments, royalties or revenue interests 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, realizing 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 with protection that credit provides.

The majority of our transactions are 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 $20 million through our working capital. 

 20 
 

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 it participates. 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 $20 million, we seek to syndicate amounts in excess of $20 million to our investment advisory clients. In addition, we may participate in transactions in excess of $20 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.

 

 21 
 

As of August 10, 2016, we have executed 22 transactions, deploying approximately $272 million, across a variety of opportunities. In counting our transactions, we generally consider a series of transactions with one partner company as a single transaction. In eight of the transactions, we participated alongside other investors; our investment advisory clients co-invested in two of these transactions. The other fourteen transactions were completed solely by SWK. Subsequent to closing on one of the eight transactions, however, we syndicated a portion of the loan to an investment advisory client and then subsequently purchased it back and partnered with another investor on a follow-on round for the same partner company.

 

The table below provides an overview of the outstanding transactions.

 

SWK HOLDINGS CORPORATION

PORTFOLIO OVERVIEW

June 30, 2016

 

 (In thousands, except share data)                      
                     Income Recognized
Royalty Purchases and Financings Licensed Technology Footnote Funded Amount   GAAP Balance   Rate   YTD   Q2
Besivance® Ophthalmic antibiotic (1) $ 6,000   $ 3,596   N/A   $ 351   $ 202
Tissue Regeneration Therapeutics Umbilical cord banking (2)   3,250     3,266   N/A     218     214
Cambia® NSAID migraine treatment (3)   8,500     8,419   N/A     591     258
Secured Royalty Financing Women's health (4)   3,000     2,143     11.5%     92    

 

 

                          Income Recognized  
Term Loans Type Footnote Principal   Maturity Date GAAP Balance   Rate   YTD   Q2  
Tribute Pharmaceuticals Canada, Inc. First Lien (5) $ 14,000   12/31/18 $     13.5%   $ 1,183   $  
SynCardia Systems, Inc. First Lien (6)   22,000   03/05/18       13.5%          
SynCardia Systems, Inc. Second Lien Royalty (7)   6,000   02/13/15     N/A          
SynCardia Systems, Inc. Second Lien Convert (8)   13,000   03/05/18       10.0%          
B&D Dental Corporation First Lien (9)   7,931   12/10/18   7,931     13.5%          
ABT Molecular Imaging Second Lien Royalty (10)   10,000   10/08/21   10,923   N/A          
ABT Molecular Imaging First Lien (10)   1,083   06/30/16   1,083     6.5%     22     13  
Galil Medical Group First Lien     12,500   12/09/19       13.0%     1,816     1,381  
DxTerity Diagnostics First Lien     5,000   04/06/21   4,948     13.5%     360     180  
Hooper Holmes, Inc. Second Lien (11)   5,000   04/17/18   2,898     15.0%     1,011     464  
Nanosphere, Inc. First Lien (12)   10,000   05/14/21       12.5%     3,049     2,848  
Soluble Systems, Inc. First Lien     12,000   05/30/20   11,876     13.3%     997     568  
Thermedx, LLC First Lien (13)   2,500   05/05/21   2,547   N/A     74     74  
Keystone Dental, Inc. First Lien     17,500   05/20/21   17,214     13.0%     255     255  

 

 

 22 
 

                  Income Recognized
Other   Footnote Funded Amount   GAAP Balance   YTD   Q2
Holmdel Pharmaceuticals, LP   (14) $ 6,000   $ 7,486   $ 3,802   $ 2,143
Cancer Genetics (Common Stock)           1,465   N/A   N/A
Hooper Holmes (Common Stock)   (11)       94   N/A   N/A

SynCardia Systems, Inc. (Series F Preferred Stock)

  (8)              

 

                  Change in Fair Value  
Warrants to Purchase Common Stock   Footnote Number of Shares  

Exercise Price

per Share

  GAAP Balance   YTD   Q2  
Tribute Pharmaceuticals Canada, Inc.       1,843,222   Various   $ 517   $ (821 ) $ (78 )
SynCardia Systems, Inc.   (7)     Various              
B&D Dental Corporation       225     4.00              
ABT Molecular Imaging       5,000,000     0.20              
Galil Medical Group   (15)       0.09         391     391  
DxTerity Diagnostics   (16) TBD   TBD              
Hooper Holmes, Inc.       543,478     6.90     349     150     (374 )
Nanosphere, Inc.           0.01         651     543  
Soluble Systems, Inc.   (17)   1,209,068     0.99              
Keystone Dental, Inc.       694,445     1.26              

 

 

       Assets   YTD Income   Q2  
Total Finance Receivables   $ 74,702   $ 9,927   $ 6,457  
Total Marketable Securities   $ 3,702     92      
Total Net Investment in Subsidiary   $ 3,455     3,802     2,143  
Warrant Assets   $ 866     N/A     N/A  
Total Assets/Income before Allowance for Credit Losses   $ 82,725   $ 13,821   $ 8,600  

 

 23 
 

 

(1) Effective 2.4 percent royalty on sales of Besivance.
(2) Milestone payment of $1,250 paid upon royalty payments achieving certain thresholds.
(3) With regard to initial royalty stream purchase in July 2014, first Earn Out payment was not earned.  The second Earn Out payment of $250 is contingent upon aggregate net sales levels achieving certain thresholds. On December 9, 2015, we executed a second purchase of 25 percent of future payments.  First and second Earn Out payments of $250 each are contingent upon aggregate net sales levels achieving certain thresholds.
(4) Purchased $3,000 of a total $100,000 aggregate amount.  Notes are secured by certain royalty and milestone payments associated with the sales of pharmaceutical products. An other-than-temporary impairment charge in the amount of $0.7 million was recognized in Q2 2016.
(5) Repaid on February 5, 2016. Warrants are exercisable into shares of Aralez Pharmaceuticals.
(6) In conjunction with the first lien credit agreement, SynCardia issued us 40,000 shares of common stock.  Loan placed on non-accrual status. In August 2015, purchased $15,500 face value for $6,600. Loan sold for $7,200 cash on June 25, 2016. Recognized $5,300 impairment expense during Q2 2016.
(7) Repaid on February 13, 2015 for total consideration to SWK of $10,200, comprised of $1,800 in cash, $6,900 of second lien convertible notes and 1,079,138 shares of Series F Preferred Stock.  SWK recognized impairment expense of $3,230 on Series F Preferred Stock in Q4 of 2015.
(8) Received $6,100 principal value with first lien purchase noted above in (7).  Placed on non-accrual status and written off in September 2015.
(9) In the aggregate, executed seven amendments to the loan to advance additional $1,962 during 2015 and Q1 2016. B&D is pursuing asset sales to retire debt.
(10) December 2015 payment to us was blocked by first lien lender; we purchased senior first lien credit facility at par in February 2016. Interest is being paid current on the first lien.
(11) Executed two amendments during Q1 2016 and received $150 of Hooper stock as amendment fees. Collateral position improved to first lien as a result of Hooper refinancing its working capital facility on April 29, 2016.
(12) Repaid on June 30, 2016. Warrants were exercised for cash.
(13) Funded $2,500 on May 5, 2016. $1,000 unfunded commitment remains as of May 6, 2016.
(14) Holmdel acquired the U.S. marketing authorization rights to a beta blocker pharmaceutical product.  SWK HP Holdings GP LLC, our direct wholly-owned subsidiary, acquired a direct general partnership interest in SWK HP Holdings LP (“SWK HP”).  SWK HP acquired a direct limited partnership interest in Holmdel.
(15) Galil warrants were exercised for $391 cash as part of company sale. Payment on warrants is pending the completion of certain tax filings with Israel.
(16) $375 warrant value; number of DxTerity preferred shares to be determined upon certain future events.
(17) Warrant value subject to value caps under certain circumstances.

 

 24 
 

Unless otherwise specified, our senior secured debt assets generally are repaid by a revenue interest that is charged on a company’s quarterly net sales and royalties.

 

Other than $0.8 million potentially payable to the seller of the Cambia® royalty noted above, there are no other earn-out payments contracted to be paid by us to any of our partner companies. As of August 10, 2016, we have $6.8 million of unfunded commitments on loan transactions. For additional information regarding these transactions, see Notes 3, 4 and 5 of the Notes to the Unaudited Condensed Consolidated Financial Statements.

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, 2015, filed with the SEC on March 24, 2016. We believe there have been no new critical accounting policies or material changes to our existing critical accounting policies and estimates during the six months ended June 30, 2016, compared to those discussed in our Annual Report on Form 10-K for the year ended December 31, 2015.

 

Recent Accounting Pronouncements

 

Refer to Part I. Financial Information, Item 1. Financial Statements, Note 1 of the Notes to the Unaudited Condensed Consolidated Financial Statements for a listing of recent accounting pronouncements.

Comparison of the Three Months Ended June 30, 2016 and 2015

 

Revenues

 

We generated revenues of $8.6 million for the three months ended June 30, 2016, driven primarily by $6.5 million in interest and fees earned on our finance receivables, and $2.1 million in income related to our investment in an unconsolidated partnership. We generated revenues of $5.4 million for the three months ended June 30, 2015, driven primarily by $4.1 million in interest and fees earned on finance receivables and marketable securities, and $1.3 million in income related to our investment in an unconsolidated partnership. The increase in revenue is primarily driven by two loan pay-offs, which were partially responsible for an increase in interest and fees of $2.4 million on our finance receivables and marketable securities and an increase of $0.8 million in income related to our investment in an unconsolidated partnership when compared to the three months ended June 30, 2015.  

 

Provision for Loan Credit Losses and Impairment Expense

 

We recognized an allowance for credit loss on a royalty purchase of $1.7 million during the three months ended June 30, 2016. We recognized impairment expense on the warrants and fair value of a finance receivable of $0.7 million and $1.9 million, respectively, during the three months ended June 30, 2015.

 

We recognized security impairment expense during the three months ended June 30, 2016 on debt and equity securities of $0.7 million and $0.6 million, respectively, to reflect the securities at their fair market values as of June 30, 2016. Also, during the three months ended June 30, 2016, we recorded an impairment expense for a loan write-off of $5.3 million. No security impairment expense was recognized during the three months ended June 30, 2015.

  

Please refer to Item 1. Financial Statements, Note 3 of the Notes to the Unaudited Condensed Consolidated Financial Statements for further information regarding the impairments recognized during the three months ended June 30, 2016.

 

General and Administrative

 

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 decreased to $0.8 million for the three months ended June 30, 2016 from $0.9 million for the three months ended June 30, 2015, due to decreased salary, bonus and stock-based compensation expenses, and interest expense. This decrease was offset by increases in professional fees.

 

Other Expense

 

 Other expense for the three months ended June 30, 2016, reflected a net fair market value gain of $0.5 million on our warrant derivatives compared to a $1.6 million net fair market value loss for the three months ended June 30, 2015.

 

 25 
 

Comparison of the Six Months Ended June 30, 2016 and 2015

 

Revenues

 

We generated revenues of $13.8 million for the six months ended June 30, 2016, driven primarily by $10.0  million in interest and fees earned on our finance receivables and marketable securities, and $3.8 million in income related to our investment in an unconsolidated partnership. We generated revenues of $11.2 million for the six months ended June 30, 2015, driven primarily by $8.3 million in interest and fees earned on finance receivables and marketable securities, and $2.9 million in income related to our investment in an unconsolidated partnership. The increase in revenue is primarily driven by three loan pay-offs, which were partially responsible for an increase in interest and fees of $1.7 million on our finance receivables and marketable securities and an increase of $0.9 million in income related to our investment in an unconsolidated partnership when compared to the six months ended June 30, 2015.

 

Provision for Loan Credit Losses and Impairment Expense

 

We recognized an allowance for credit loss on a royalty purchase of $1.7 million during the six months ended June 30, 2016. We recognized impairment expense on the warrants and fair value of a finance receivable of $0.7 million and $1.9 million, respectively, during the six months ended June 30, 2015.

  

We recognized security impairment expense during the six months ended June 30, 2016 on debt and equity securities of $0.7 million and $1.0 million, respectively, to reflect the securities at their fair market values of $2.1 million and $1.5 million, respectively, as of June 30, 2016. Also, during the six months ended June 30, 2016, we recorded an impairment expense for a loan write-off of $5.3 million. No security impairment expense was recognized during the six months ended June 30, 2015.

  

Please refer to Item 1. Financial Statements, Note 3 of the Notes to the Unaudited Condensed Consolidated Financial Statements for further information regarding the impairments taken during the six months ended June 30, 2016.

 

General and Administrative

 

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 decreased to $1.7 million for the six months ended June 30, 2016 from $2.2 million for the six months ended June 30, 2015, due to decreased salary, bonus and stock-based compensation expenses, and interest expense. This decrease was offset by increases in professional fees.

 

Interest Expense

 

Interest expense was $0 for the six months ended June 30, 2016 compared to $0.4 million for the six months ended June 30, 2015. All interest expense for the six months ended June 30, 2015 was from debt issuance cost amortization.

 

Other Expense

 

Other expense for the six months ended June 30, 2016, reflected a net fair market value gain of $0.4 million on our warrant derivatives compared to a $1.2 million net fair market value loss for the six months ended June 30, 2015.

Income Tax Benefit

 

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.” We believe that it is more likely than not that the Company will be able to realize approximately $16.8 million benefit of the U.S. federal and state deferred tax assets in the future.

 

As of June 30, 2016, we had NOLs for federal income tax purposes of $405.0 million. The federal net operating loss carryforwards if not offset against future income, will expire by 2032, with the majority expiring by 2021.

We also had federal research credit carryforwards of $2.7 million. The federal credits will expire by 2029.

Liquidity and Capital Resources

 

As of June 30, 2016, we had $76.6 million in cash and cash equivalents, compared to $47.3 million in cash and cash equivalents as of December 31, 2015.

 

Net cash provided by operating activities was $5.8 million for the six months ended June 30, 2016, which primarily consisted of net income of $4.0 million and noncash adjustments of $2.5 million. The noncash adjustments were primarily attributable to $8.6 million in provision for credit losses and impairment expense, and $0.2 million in stock compensation expense, offset by $3.8 million from equity income on an investment in an unconsolidated entity, and $2.0 million in loan discount amortization.

 

The Company’s investing activities provided positive cash flow of $24.7 million for the six months ended June 30, 2016, driven by net receipts of $20.4 million in finance receivables and $1.0 million in proceeds from the settlement of warrants. This was coupled with $4.3 million in cash distributions received from an investment in an unconsolidated entity.

 

The Company’s financing activities had negative cash flow of $2.2 million for the six months ended June 30, 2016, driven by the $2.2 million in cash distributions to non-controlling interests.  

 

 26 
 

Primary Drivers 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. primarily 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 June 30, 2016, our portfolio contains $74.7 million of finance receivables, $3.7 million of marketable investments and a net $3.5 million of investment in unconsolidated subsidiaries, net of non-controlling interests. We expect these assets to generate income greater than our expenses in 2016. We continue to evaluate multiple attractive opportunities that, if consummated, we believe 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 2016.

   

Off Balance Sheet Arrangements

 

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with GAAP, are not recorded in our consolidated financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage partners’ requests for funding and take the form of loan commitments and lines of credit.

The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the partner defaults and the value of any existing collateral becomes worthless. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Other than $0.8 million potentially payable to the seller of the Cambria® royalty, there are no other earn-out payments contracted to be paid by us to any of our partner companies. We have $6.8 million of unfunded commitments on loan transactions as of June 30, 2016. 

We believe that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.  

ITEM 3.      QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

During the six months ended June 30, 2016, our cash and cash equivalents were deposited in accounts at well capitalized financial institutions. The fair value of our cash and cash equivalents at June 30, 2016, 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.

 27 
 

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 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 SEC rules and forms and that such information is accumulated and communicated to 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 as of the end of the period covered by this report.

Changes in Internal Control over Financial Reporting

 

There have been no changes during the six months ended June 30, 2016 in our internal control over financial reporting that have materially affected, or are 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, 2015, filed with the SEC on March 24, 2016. 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, 2015.

 

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

 

None.

 

ITEM 3.      DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4.      MINE SAFETY DISCLOSURES.

 

Not Applicable.

 

ITEM 5.      OTHER INFORMATION.

 

None.

 

 28 
 

ITEM 6.       Exhibits

 

Number   Exhibit Description   Form   Exhibit  

Filing

Date

 

Filed

Herewith

                     
31.01   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.               X
                     
31.02   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.               X
                     
32.01   Certification of Chief 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 Chief Financial Officer pursuant to 18 U.S.C. Section 1350, adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*               X
                     
99.01   Financial Statements of Holmdel Pharmaceuticals, LP               X
                     
101.INS+   XBRL Instance               X
                     
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.

 

 29 
 

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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, on August 10, 2016. 

 

  SWK Holdings Corporation
   
By:   /s/ Winston L. Black
  Winston L. Black
  Chief Executive Officer
 

(Principal Executive Officer) 

   
   
By:   /s/ Charles M. Jacobson
  Charles M. Jacobson
  Chief Financial Officer
  (Principal Financial Officer)

 

 30