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 September 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 November 8, 2016, there were 13,138,340 shares of the registrant’s Common Stock, $0.001 par value per share, outstanding.

 

SWK Holdings Corporation

Form 10-Q

Quarter Ended September 30, 2016

Table of Contents

 

PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	1
	Unaudited Condensed Consolidated Balance Sheets—September 30, 2016 and December 31, 2015	1
	Unaudited Condensed Consolidated Statements of Income (Loss)—Three and Nine Months Ended September 30, 2016 and 2015	2
	Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)—Three and Nine Months Ended September 30, 2016 and 2015	3
	Unaudited Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 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	26
Item 4	Controls and Procedures	27
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	27
Item 1A.	Risk Factors	27
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 3.	Defaults Upon Senior Securities	27
Item 4.	Mine Safety Disclosures	27
Item 5.	Other Information	27
Item 6.	Exhibits	28
	Signatures	29
	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 ended September 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)

 

		September 30,				December 31,
		2016				2015
ASSETS
Cash and cash equivalents		$	66,438			$	47,287
Accounts receivable			884				1,127
Finance receivables			88,466				99,346
Marketable investments			3,506				5,286
Investment in unconsolidated entities			7,235				7,988
Deferred tax asset			16,833				16,833
Warrant assets			1,334				1,900
Other assets			497				720
Total assets		$	185,193			$	180,487
LIABILITIES AND STOCKHOLDERS’ EQUITY
Accounts payable and accrued liabilities		$	593			$	788
Warrant liability			161				259
Total liabilities			754				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; 13,138,340 and 13,115,909 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively			13				13
Additional paid-in capital			4,433,211				4,432,926
Accumulated deficit			(4,252,627	)			(4,257,798	)
Accumulated other comprehensive loss			(51	)			—
Total SWK Holdings Corporation stockholders’ equity			180,546				175,141
Non-controlling interests in consolidated entities			3,893				4,299
Total stockholders’ equity			184,439				179,440
Total liabilities and stockholders’ equity		$	185,193			$	180,487

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(in thousands, except per share data)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2016				2015				2016				2015
Revenues
Finance receivable interest income, including fees		$	2,783			$	3,987			$	12,710			$	12,098
Marketable investments interest income			—				88				92				265
Income related to investments in unconsolidated entities			1,296				1,621				5,098				4,511
Other			133				11				159				35
Total revenues			4,212				5,707				18,059				16,909
Costs and expenses:
Provision for loan credit losses			—				8,131				1,659				10,725
Impairment expense			314				3,230				7,243				3,230
Interest expense			—				—				—				381
General and administrative			617				460				2,334				2,622
Total costs and expenses			931				11,821				11,236				16,958
Other income (expense), net
Unrealized net gain (loss) on derivatives			496				(1,963	)			936				(3,151	)
Income (loss) before provision for income taxes			3,777				(8,077	)			7,759				(3,200	)
Provision (benefit) for income taxes			—				(3,121	)			—				(1,615	)
Consolidated net income (loss)			3,777				(4,956	)			7,759				(1,585	)
Net income attributable to non-controlling interests			656				822				2,588				2,311
Net income (loss) attributable to SWK Holdings Corporation Stockholders		$	3,121			$	(5,778	)		$	5,171			$	(3,896	)
Net income (loss) per share attributable to SWK Holdings Corporation Stockholders (1):
Basic		$	0.24			$	(0.44	)		$	0.39			$	(0.30	)
Diluted		$	0.24			$	(0.44	)		$	0.39			$	(0.30	)
Weighted Average Shares (1):
Basic			13,132				12,991				13,127				12,986
Diluted			13,135				12,991				13,130				12,986

 

(1) Common stock and per share data for the three and nine months ended September 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.

 

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2016				2015				2016				2015
Consolidated net income (loss)		$	3,777			$	(4,956	)		$	7,759			$	(1,585	)
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on investment in securities
Unrealized holding gain (loss) arising during period			4				(124	)			(51	)			(124	)
Total other comprehensive gain (loss)			4				(124	)			(51	)			(124	)
Comprehensive income (loss)			3,781				(5,080	)			7,708				(1,709	)
Comprehensive income attributable to non-controlling interests			656				822				2,588				2,311
Comprehensive income (loss) attributable to SWK Holdings Corporation Stockholders		$	3,125			$	(5,902	)		$	5,120			$	(4,020	)

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

SWK HOLDINGS CORPORATION

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

		Nine Months Ended September 30,
		2016				2015
Cash flows from operating activities:
Consolidated net income (loss)		$	7,759			$	(1,585	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Income from investments in unconsolidated entities			(5,098	)			(4,511	)
Provision for loan credit losses			1,659				10,725
Impairment expense			7,243				3,230
Change in fair value of warrants			(936	)			3,151
Deferred income tax benefit			—				(1,615	)
Loan discount amortization and fee accretion			(2,551	)			(1,346	)
Interest income in excess of cash collected			—				(759	)
Stock-based compensation			285				495
Debt issuance cost amortization			—				381
Property and equipment depreciation			12				4
Changes in operating assets and liabilities:
Accounts receivable			(293	)			(441	)
Other assets			(253	)			(40	)
Accounts payable and other liabilities			(195	)			(38	)
Net cash provided by operating activities			7,632				7,651
Cash flows from investing activities:
Cash distributions from investments in unconsolidated entities			5,851				5,316
Cash received for settlement of warrants			1,014				—
Net (increase) decrease in finance receivables			7,629				(44,227	)
Marketable investment principal payment			23				80
Other			(4	)			(50	)
Net cash provided by (used in) investing activities			14,513				(38,881	)
Cash flows from financing activities:
Costs of common stock issuance			—				16
Distribution to non-controlling interests			(2,994	)			(2,744	)
Net cash used in financing activities			(2,994	)			(2,728	)
Net increase (decrease) in cash and cash equivalents			19,151				(33,958	)
Cash and cash equivalents at beginning of period			47,287				58,728
Cash and cash equivalents at end of period		$	66,438			$	24,770
Supplemental noncash flow activity:
Common stock received in connection with amendment of finance receivable		$	150			$	—
Consideration (notes and preferred stock) received in connection with loan repayment		$	—			$	8,400
Warrants received in conjunction with the origination of finance receivables		$	—			$	4,539

 

See accompanying notes to the unaudited condensed consolidated financial statements.

 

 

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 September 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 November 8, 2016, the Company and its partners have executed transactions with 22 different parties under its specialty finance strategy, funding $274 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.

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 nine months ended September 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, 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. The Company is currently evaluating the impact this guidance will have on its consolidated financial statements when effective.

 

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 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. The Company is currently evaluating the impact that the adoption of this new standard will have on its 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.

In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230),” which amends ASC 230 to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. The FASB issued this guidance with the intent of reducing diversity in practice with respect to classification of eight types of cash receipts and payments: (1) debt prepayment or debt extinguishment costs, (2) settlement of zero coupon bonds, (3) contingent consideration payments after a business combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance policies and bank-owned life insurance policies, (6) distributions received from equity method investees, (7) beneficial interests in securitization transactions, and (8) separately identifiable cash flows and application of the predominance principle. For public business entities, the guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption will be permitted for all entities and must be applied retrospectively to all periods presented but it may be applied prospectively if retrospective application would be impracticable.

 

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 income (loss) per share for the following (in thousands, except per share amounts):

 

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2016				2015				2016				2015
Numerator:
Net income (loss) attributable to SWK Holdings Corporation Stockholders		$	3,121				(5,778	)		$	5,171				(3,896	)
Denominator:
Weighted-average shares outstanding			13,132				12,991				13,127				12,986
Effect of dilutive securities			3				—				3				—
Weighted-average diluted shares			13,135				12,991				13,130				12,986
Basic income (loss) per share attributable to SWK Holdings Corporation Stockholders		$	0.24				(0.44	)		$	0.39				(0.30	)
Diluted income (loss) per share attributable to SWK Holdings Corporation Stockholders		$	0.24				(0.44	)		$	0.39				(0.30	)

 

For the three months ended September 30, 2016 and 2015, outstanding stock options and warrants to purchase shares of common stock in an aggregate of approximately 403,000 and 464,000 respectively, have been excluded from the calculation of diluted income (loss) per share as all such securities were anti-dilutive. For the nine months ended September 30, 2016 and 2015, outstanding stock options and warrants to purchase shares of common stock in aggregate of approximately 374,000, and 464,000, 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		September 30, 2016				December 31, 2015
Term Loans		$	69,018			$	89,204
Royalty Purchases			21,107				17,224
Total before allowance for credit losses			90,125				106,428
Allowance for credit losses			(1,659	)			(7,082	)
Total carrying value		$	88,466			$	99,346

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 status, 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 finance receivables by portfolio segment, net of credit loss allowance (in thousands):

 

 

		September 30, 2016												December 31, 2015
		Nonaccrual			Performing				Total					Nonaccrual				Performing				Total
Term Loans		$	18,854				48,505			$	67,359			$	20,093			$	62,029			$	82,122
Royalty Purchases			—				21,107				21,107				—				17,224				17,224
Total carrying value		$	18,854				69,612			$	88,466			$	20,093			$	79,253			$	99,346

 

As of September 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. Of the two nonaccrual term loans at September 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 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 nine months ended September 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 and September 12, 2016, the Company entered into additional amendments to the first lien term loan, which provided for an additional $1.0 million of liquidity under the first lien credit agreement. ABT drew down $0.9 million as of September 30, 2016.

 

The collateral for the loan has been individually reviewed, and the Company believes that the fair market value of the loan, less costs to sell, was greater than the recorded investments in the loans as of September 30, 2016. Based on the impairment analysis, the Company has determined that recording a provision for credit losses as of September 30, 2016 is not required. The Company obtained a third party valuation to support such assertion.

 

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 September 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 nonaccrual 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 or third quarters 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 September 30, 2016.

 

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 nine months ended September 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 September 30, 2016, the Company had total unfunded loan commitments as follows (in millions):

 

DxTerity Diagnostics, Inc.		$	2.5
Keystone Dental, Inc.			2.5
Thermedx LLC			1.0
Cambia			0.8
		$	6.8

 

All unfunded loan commitments are contingent upon reaching an established revenue threshold on or before a specified date or period of time per the terms of the credit agreements.

 

Note 4. Marketable Investments

 

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

 

		September 30, 2016				December 31, 2015
Corporate debt securities		$	2,120			$	2,857
Equity securities			1,386				2,429
Total		$	3,506			$	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 September 30, 2016 and December 31, 2015, are as follows (in thousands):

 

September 30, 2016		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Loss				Fair Value
Available for sale securities:
Corporate debt securities		$	2,120			$	—			$	—			$	2,120
Equity securities			1,437				—				(51	)			1,386
		$	3,557			$	—			$	(51	)		$	3,506

 

 

 

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 nine months ended September 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 nine months ended September 30, 2016, the Company recognized an other-than-temporary impairment expense of $0.2 million and $1.1 million, respectively, related to the Cancer Genetics common stock. As of September 30, 2016, the Cancer Genetics and Hooper Holmes equity securities are reflected at fair value of $1.3 million and $0.1 million, respectively, as available-for-sale securities.

 

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 nine months ended September 30, 2016, the Company recorded impairment expenses related to these notes of $0.1 and $0.9 million, respectively. Approximately $0.1 million of these expenses reflect the write off of interest accrued on these notes, with the remainder of the expense taken as an other than temporary impairment. The senior secured notes have been placed on non-accrual status as of September 30, 2016. Total cash collected during the nine months ended September 30, 2016 was $64,000, of which $23,000 was credited to the notes’ carry value. As of September 30, 2016, 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 received a 1x cash on cash return on its interest in Holmdel, SWK HP received 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.

For the three and nine months ended September 30, 2016, the Company recognized $1.3 million and $5.1 million, respectively, of equity method gains. The amount of equity method gains attributable to the non-controlling interests in SWK HP were $0.7 million and $2.6 million, respectively. For the three and nine months ended September 30, 2015, the Company recognized $1.6 million and $4.5 million of equity method gains, respectively. The amount of equity method gains attributable to the non-controlling interests in SWK HP were $0.8 million and $2.3 million for the three and nine months ended September 30, 2015, respectively.

In addition, SWK HP received cash distributions totaling $5.9 million during the nine months ended September 30, 2016, of which $3.0 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 nine months ended September 30, 2016 are as follows (in thousands):  

 

Balance at December 31, 2015		$	7,988
Add: Income from investments in unconsolidated entities			5,098
Less: Cash distribution from investments in unconsolidated entities			(5,851	)
Balance at September 30, 2016		$	7,235

 

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

 

		As of September 30, 2016						Three Months Ended September 30, 2016				Nine Months Ended September 30, 2016
Assets		$	9.9			Revenue		$	2.2			$	8.4
Liabilities		$	2.3			Expenses		$	0.4			$	1.1
Equity		$	7.6			Net income		$	1.8			$	7.3

 

 

		As of December 31, 2015						Three Months Ended September 30, 2015				Nine Months Ended September 30, 2015
Assets		$	11.7			Revenue		$	2.7			$	7.5
Liabilities		$	3.3			Expenses		$	0.4			$	1.1
Equity		$	8.4			Net income		$	2.3			$	6.4

 

Note 6. Related Party Transactions

 

On September 6, 2013, in connection with entering into a new credit facility, the Company issued warrants to an affiliate of a stockholder, Carlson Capital, L.P. (the “Stockholder”), for 100,000 shares of the Company’s common stock at a strike price of $13.88. 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.

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 September 30, 2016 and December 31, 2015, respectively, are reflected as a warrant liability in the unaudited condensed consolidated balance sheets. Unrealized gains of $28,000 and $97,000 were included in other income (expense), net in the unaudited condensed consolidated statements of income (loss) for the three and nine months ended September 30, 2016, respectively. An unrealized gain of $0.1 million and an unrealized loss of $45,000 were included in other income (expense), net in the unaudited condensed consolidated statements of income (loss) for the three and nine months ended September 30, 2015, respectively. The Company determined the fair value using the Black-Scholes option pricing model with the following assumptions:

 

		September 30, 2016				December 31, 2015
Dividend rate			0	%			0	%
Risk-free rate			1.1	%			1.8	%
Expected life (years)			3.9				4.7
Expected volatility			34.4	%			33.3	%

 

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

 

Fair value – December 31, 2015		$	259
Issuances			—
Changes in fair value			(97	)
Fair value – September 30, 2016		$	161

 

During the three and nine months ended September 30, 2015, the Company recognized interest expense totaling $0 and $0.4 million, respectively, consisting of debt issuance cost amortization. The Company did not recognize any interest expense during the three and nine months ended September 30, 2016.

 

Note 7. Stockholders’ Equity

Stock Compensation Plans

 

During the nine months ended September 30, 2015, the Board approved the following grants as compensation for Board services: (i) a grant of 3,366 shares of common stock as the pro-rated director compensation for the non-employee directors appointed on September 6, 2014; (ii) a grant of 3,000 shares to each non-employee director for services as a director for the period January 1, 2015 to September 30, 2015; and (iii) a grant of 9,971 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 $0.1 million and $0.5 million, respectively, during the three and nine months ended September 30, 2015.

 

During the nine months ended September 30, 2016, the Board approved compensation for Board services by granting 18,432 shares of common stock as compensation for the non-employee directors. During the nine months ended September 30, 2016, the Company recorded approximately $185,000 in board compensation expense relating to the quarterly grants. The aggregate stock-based compensation expense, including the board quarterly grants, recognized by the Company for the three and nine months ended September 30, 2016 was $0.1 million and $0.3 million, respectively.

 

The following table summarizes activities under the option plans for the nine months ended September 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			15,000				9.61
Balances, September 30, 2016			190,000			$	11.25				7.1			$	109.5
Options vested and exercisable and expected to be vested and exercisable as of September 30, 2016			190,000			$	11.25				7.1			$	109.5
Options vested and exercisable as of September 30, 2016			31,250			$	10.46				6.5			$	27.4

 

At September 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 2.9 years.

  

The following table summarizes significant ranges of outstanding and exercisable options as of September 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				5.6			$	8.30				18,750			$	8.30
	13.70				100,000				7.9				13.70				12,500				13.70
	9.61				15,000				9.8				9.61				—				—
Total					190,000				7.1			$	11.25				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 nine months ended September 30, 2016, is as follows (in thousands):

 

Balance at December 31, 2015		$	4,299
Add: Income attributable to non-controlling interests			2,588
Less: Cash distribution to non-controlling interests			(2,994	)
Balance at September 30, 2016		$	3,893

 

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 nine months ended September 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 unaudited condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015.

The following information is provided to help readers gain an understanding of the relationship between amounts reported in the accompanying unaudited 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 September 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		$	1,334			$	—			$	—			$	1,334
Marketable investments			3,506				1,386				—				2,120
Financial Liabilities:
Warrant liability		$	161			$	—			$	—			$	161

 

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 nine months ended September 30, 2016 were as follows (in thousands):

 

Fair value – December 31, 2015		$	1,900
Issuance			—
Settlements			(1,405	)
Change in fair value			839
Fair value – September 30, 2016		$	1,334

 

On June 30, 2016, Luminex Corporation acquired Nanosphere, Inc. (“Nanosphere”) 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 nine months ended September 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 $0.081 per share, for a net settlement of $0.4 million, which was recorded as an other receivable in other assets as of September 30, 2016. The Company recognized a $0.4 million gain on the sale of the shares during the nine months ended September 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 unaudited condensed consolidated balance sheets. The fair values for warrants outstanding, which do not 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:

  

		September 30, 2016				December 31, 2015
Dividend rate range			0%				0%
Risk-free rate range			1.1% to 1.4%				1.8% to 2.1%
Expected life (years) range			3.9 to 5.5				4.6 to10.0
Expected volatility range			88.8% to 95.9%				85.6% to 97.2%

 

 The following table presents the financial assets measured at fair value on a nonrecurring basis as of September 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		$	3,466			$	—			$	—			$	3,466

 

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

 

The following table presents the financial assets 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 September 30, 2016 (in thousands):

 

		Carry Value				Fair Value				Level 1				Level 2				Level 3
Financial Assets
Cash and restricted cash		$	66,438			$	66,438			$	66,438			$	—			$	—
Finance receivables			88,466				88,466				—				—				88,466
Marketable investments			3,506				3,506				1,386				—				2,120
Warrant assets			1,334				1,334				—				—				1,334
Financial Liabilities
Warrant liability		$	161			$	161			$	—			$	—			$	161

 

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

  

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 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 treats 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. 

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.

 

As of November 8, 2016, we have executed 22 transactions, deploying approximately $274 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 our outstanding transactions as of September 30, 2016.

  

(In thousands, except share data)
												Income Recognized
Royalty Purchases and Financings	Licensed Technology	Footnote	Funded Amount			GAAP Balance			Rate			YTD			Q3
Besivance®	Ophthalmic antibiotic	(1)	$	6,000		$	3,466		N/A			$	447		$	96
Tissue Regeneration Therapeutics	Umbilical cord banking	(2)		3,250			3,388		N/A				396			178
Cambia®	NSAID migraine treatment	(3)		8,500			8,353		N/A				853			262
Secured Royalty Financing	Women's health	(4)		3,000			2,120			11.5%			92			—
Forfivo XL®	Depressive disorder treatment			6,000			5,901			N/A			291			291

  

													Income Recognized
Term Loans	Type	Footnote	Principal			Maturity Date	GAAP Balance			Rate			YTD			Q3
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)		2,133		06/30/16		2,133			6.5%			49			27
Galil Medical Group	First Lien			12,500		12/09/19		—			13.0%			1,816			—
DxTerity Diagnostics	First Lien			5,000		04/06/21		4,961			13.5%			543			183
Hooper Holmes, Inc.	First Lien	(11)		5,000		04/17/18		2,882			15.0%			1,149			138
Nanosphere, Inc.	First Lien	(12)		10,000		05/14/21		—			12.5%			3,049			—
Soluble Systems, Inc.	First Lien			12,000		05/30/20		12,694			13.3%			1,649			652
Thermedx, LLC	First Lien	(13)		2,500		05/05/21		2,632		N/A				197			123
Keystone Dental, Inc.	First Lien			17,500		05/20/21		17,255			13.0%			877			622
Tenex Health, Inc.	First Lien			6,000		06/30/21		5,947			12.0%			211			211

 

 

									Income Recognized
Other		Footnote	Funded Amount			GAAP Balance			YTD			Q3
Holmdel Pharmaceuticals, LP		(14)	$	6,000		$	7,235		$	5,098		$	1,296
Cancer Genetics (Common Stock)				—			1,288		N/A			N/A
Hooper Holmes (Common Stock)		(11)		—			98		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			Q3
Tribute Pharmaceuticals Canada, Inc.		(5)		1,843,222		Various			$	827		$	(510)		$	311
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			—
DxTerity Diagnostics			161,246			2.33				—			—			—
Hooper Holmes, Inc.		(11)		543,478			1.30			507			307			157
Nanosphere, Inc.		(12)		—			0.01			—			651			—
Soluble Systems, Inc.		(16)		1,209,068			0.99			—			—			—
Keystone Dental, Inc.				694,445			1.26			—			—			—
Tenex Health, Inc.				2,693,878			0.37			—			—			—

 

 

		Assets			YTD Income			Q3
Total Finance Receivables		$	88,466		$	12,710		$	2,783
Total Marketable Securities			3,506			92			—
Total Net Investment in Subsidiary			3,342			5,098			1,296
Fair Value of Warrant Assets			1,334			—			—
Total Assets/Income		$	96,648		$	17,900		$	4,079

 

 

(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 of $713 was recognized in the second quarter of 2016 and $138 of accrued interest was written off in the third quarter of 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, we purchased $15,500 face value for $6,600. Loan sold for $7,200 cash on June 25, 2016. We recognized $5,300 impairment expense during the second quarter of 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 the fourth quarter of 2015.

(8) Received $6,100 principal value with first lien purchase noted above in (7). Placed on nonaccrual 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 first quarter of 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; first lien maturity date has not been extended.

(11) Executed two amendments during the first quarter of 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. We executed one amendment in the second quarter of 2016 as a result of covenant misses and to defer the August 2016 principal payment. In conjunction with the second quarter amendment, we received a significant reduction in outstanding warrant strike price. Hooper also raised $1.8 million new equity to comply with restated covenants.

(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 November 8, 2016.

(14) Holmdel acquired the U.S. marketing authorization rights to a beta blocker pharmaceutical product.  SWK Holdings GP acquired a direct general partnership interest in 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.

(16) Warrant value subject to value caps under certain circumstances.

 

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 in Note (3) above, there are no other earn-out payments contracted to be paid by us to any of our partner companies. As of November 8, 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 our 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 nine months ended September 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 September 30, 2016 and 2015

 

Revenues

 

We generated revenues of $4.2 million for the three months ended September 30, 2016, driven primarily by $2.8 million in interest and fees earned on our finance receivables, and $1.3 million in income related to our investment in an unconsolidated partnership. We generated revenues of $5.7 million for the three months ended September 30, 2015, driven primarily by $4.1 million in interest and fees earned on finance receivables and marketable securities, and $1.6 million in income related to our investment in an unconsolidated partnership. The decrease in revenue is primarily driven by the decrease in interest income resulting from loan payoffs that occurred in the fourth quarter of 2015 through the first half of 2016, totaling $2.1 million. This was offset by revenue of $1.2 million from new loans that were initiated during the nine months ended September 30, 2016.

 

Provision for Loan Credit Losses and Impairment Expense

 

No impairment expense on the fair value of finance receivables was recognized during the three months ended September 30, 2016. We recognized loan credit loss provision expense of $8.1 million on two terms loans, and the carrying value of the secured loans were reduced to their respective fair market values during the three months ended September 30, 2015.

 

We recognized security impairment expense during the three months ended September 30, 2016 on our equity security of $0.2 million to reflect the security at its fair market value as of September 30, 2016. We also recorded an impairment charge of $0.1 million in connection with a write-off of interest receivable associated with our debt security. We recognized impairment expense of $3.2 million on one equity security to reflect the security at its fair market value as of September 30, 2015.

  

Please refer to Item 1. Financial Statements, Note 4 of the Notes to the Unaudited Condensed Consolidated Financial Statements for further information regarding the impairments recognized during the three months ended September 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 increased to $0.6 million for the three months ended September 30, 2016 from $0.5 million for the three months ended September 30, 2015 due to an increase in bonus expense of $0.3 million. This was offset by a decrease of $0.2 million in professional fees and stock-based compensation.

 

Other Income (Expense), Net

 

 Other income (expense), net for the three months ended September 30, 2016, reflected a net fair market value gain of $0.5 million on our warrant derivatives compared to a $2.0 million net fair market value loss for the three months ended September 30, 2015.

 

Comparison of the Nine Months Ended September 30, 2016 and 2015

 

Revenues

 

We generated revenues of $18.1 million for the nine months ended September 30, 2016, driven primarily by $12.8 million in interest and fees earned on our finance receivables and marketable securities, and $5.1 million in income related to our investment in an unconsolidated partnership. We generated revenues of $16.9 million for the nine months ended September 30, 2015, driven primarily by $12.4 million in interest and fees earned on finance receivables and marketable securities, and $4.5 million in income related to our investment in an unconsolidated partnership. The increase in revenue is primarily driven by two loan pay-offs of $3.0 million in the first and second quarters of 2016 and revenue of $1.6 million from new loans that were initiated during the nine months ended September 30, 2016. Income related to our investment in an unconsolidated partnership increased $0.6 million when compared to the nine months ended September 30, 2015. The increase in revenue was offset by the impact of a $3.8 million loan exit payment in the fourth quarter of 2015 and the impact of an impaired loan on nonaccrual status that was paid off in the second quarter of 2016.

 

Provision for Loan Credit Losses and Impairment Expense

 

We recognized loan credit loss provision expense on a royalty purchase of $1.7 million during the nine months ended September 30, 2016. We recognized loan credit loss provision expense of $10.7 million on three terms loans, and the carrying value of the secured loans were reduced to their respective fair market values during the nine months ended September 30, 2015.

  

We recognized security impairment expense during the nine months ended September 30, 2016 on debt and equity securities of $0.7 million and $1.1 million, respectively, to reflect the securities at their fair market values of $2.1 million and $1.4 million, respectively, as of September 30, 2016. We also recorded an impairment charge of $0.1 million related to a write-off of interest receivable associated with our debt security. Also, during the nine months ended September 30, 2016, we recorded an impairment expense for a loan write-off of $5.3 million. We recognized security impairment expense of $3.2 million during the nine months ended September 30, 2015 on one equity security to reflect the security at its fair market value as of September 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 nine months ended September 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 $2.3 million for the nine months ended September 30, 2016 from $2.6 million for the nine months ended September 30, 2015, which was due to a decrease in compensation and stock-based compensation.

 

Interest Expense

 

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

 

Other Income (Expense), Net

 

Other income (expense), net for the nine months ended September 30, 2016, reflected a net fair market value gain of $0.9 million on our warrant derivatives compared to a $3.2 million net fair market value loss for the nine months ended September 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 September 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 September 30, 2016, we had $66.4 million in cash and cash equivalents, compared to $47.3 million in cash and cash equivalents as of December 31, 2015. Other than the impact of cash generated by our operations, the primary driver of the increase in our cash balance was loan payoffs totaling $45.6 million, partially offset by new investments of $31.4 million.

 

Our ability to generate cash in the future depends primarily upon our success in implementing our 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, realizing capital appreciation from equity-related investments in the life science sector.

As of September 30, 2016, our portfolio contains $88.5 million of finance receivables, $3.5 million of marketable investments and a net $3.3 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.

We may borrow funds to make investments to the extent we determine that additional capital would allow us to take advantage of additional investment opportunities. We currently do not have access to a credit facility or other forms of borrowing.

   

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 Cambia® 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 September 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 nine months ended September 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 September 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.

 

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 nine months ended September 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.

 

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
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.

 

 

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 November 8, 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)