See accompanying notes to the unaudited condensed
consolidated financial statements.
(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.
See accompanying notes to the unaudited condensed
consolidated financial statements.
See accompanying notes to the unaudited condensed
consolidated financial statements.
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:
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:
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.
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):
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.
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.
The carrying amounts reported
in the balance sheet for cash and cash equivalents approximate those assets’ fair values.
Certain common equity securities
are reported at fair value utilizing Level 1 inputs (exchange quoted prices).
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.
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.
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):
The following table presents
financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 (in thousands):
The changes on the value
of the warrant assets during the nine months ended September 30, 2016 were as follows (in thousands):
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:
The following table
presents the financial assets measured at fair value on a nonrecurring basis as of September 30, 2016 (in thousands):
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):
There were no liabilities
measured at fair value on a nonrecurring basis as of December 31, 2015.
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.