SWK Holdings Corp 10-Q

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, 2020 (“Annual Report”), as well as our unaudited condensed consolidated financial statements and the accompanying notes included in this report. COVID-19 Considerations We are subject to risks related to public health crises such as the global pandemic associated with COVID-19. Our Pharmaceutical Development segment has seen a reduction in its productivity as well as delays in receiving some of its needed supplies as a direct result of the pandemic and the impact on key vendors. This slow-down is likely to continue in the near term until such time as certain restrictions that have been imposed on us and our suppliers are lifted. Such events may result in business disruption and reduced revenues, any of which could materially affect our business, financial condition and results of operations. Please refer to Part II, Item 1A, Risk Factors, as well as the Risk Factors in our Annual Report, for additional information on risk factors related to the pandemic or other risks that could impact our business and results of operations. Strategic Plan to Focus on Core Specialty Finance Business On May 17, 2021, we issued a press release announcing the formation by our Board of Directors (“Board”) of a Strategic Review Committee (“SRC”) to identify, review and explore strategic alternatives with a view to enhancing stockholder value. With its advisors, the SRC completed a comprehensive review of strategic alternatives for each segment of the Company. On November 1, 2021, we issued a press release announcing that the Board approved a streamlined go-forward business plan and has begun implementing several new measures in light of our current governance structure. The goal of these measures is to improve our strategic focus, growth profile, and capital allocation. The Board believes these measures will allow us to generate long-term value for stockholders. Environmental, Social and Governance As overseers of risk and stewards of long-term enterprise value, our management and Board play a vital role in assessing, identifying and understanding the potential impact and related risks of environmental, social and governance (“ESG”) issues on the organization’s operating model. Our Board and management are committed to identifying those ESG issues most likely to impact business operations and growth by focusing our investment strategy around supporting innovative, growth-oriented companies in the life sciences industry that maximize both social and investment value. Among the ESG issues we support within the Company, we are committed to recruiting, motivating and developing a diversity of talent. We promote and foster a company culture where every voice is welcome, heard and respected, regardless of age, gender, race, religion, sexual orientation, physical conditions, cultural background or country of origin. The nature of our business supports environmental sustainability by being mindful of products we and our partners use in our businesses. We promote recycling to reduce landfill, and we offer our employees a hybrid work model, which allows employees the flexibility to work remotely, thereby reducing the carbon output from commuting in cars or buses. Overview We have organized our operations into two segments: Finance Receivables and Pharmaceutical Development. These segments reflect the way the Company evaluates it business performance and manages its operations. Please refer to Item 1. Financial Statements, Note 10 of the notes to the unaudited condensed consolidated financial statements for further information regarding segment information. Finance Receivables Segment In our Finance Receivables segment, 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”) by tailoring financial solutions to the needs of our business partners. 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. 19 We primarily provide capital in exchange for an interest in an existing revenue stream, which can take several forms, but is most commonly either a royalty derived from the sales of a life science product from the marketing efforts of a third party or from the marketing efforts of a partner company. Our structured debt investments may include warrants or other features, giving us the potential to realize enhanced returns on a portion of our portfolio. Pharmaceutical Development Segment On August 26, 2019, we commenced our Pharmaceutical Development segment with the acquisition of Enteris, which became our wholly-owned subsidiary. Enteris is a clinical stage biopharmaceutical company offering innovative formulation solutions built around its proprietary oral drug delivery technologies, the Peptelligence® platform. Since its founding in 2013, Enteris has advanced multiple internal and external programs leveraging Peptelligence®, which enables the oral delivery of molecules that are typically injected, including peptides and BCS Class II, III, and IV small molecules, in an enteric-coated tablet formulation. Our strategy is to utilize the Peptelligence® platform to create a portfolio of milestone and royalty income, and thus increase our net income and book value, by out-licensing our technology in two ways. First, we intend to out-license our technology to pharmaceutical companies to create novel and important oral therapeutic treatments for a wide variety of indications. Second, we intend to out-license to pharmaceutical companies our internally developed reformulations of approved, off-patent injectable therapeutic treatments where Peptelligence® enables oral delivery, resulting in meaningful improvements for patients and caregivers. We also generate income by providing customers pharmaceutical development, formulation and manufacturing with the ultimate goal of generating new out-license agreements of our technology. 20 Finance Receivables Portfolio Overview The table below provides an overview of our outstanding finance receivables transactions as of, and for the three and nine months ended September 30, 2021 (in thousands, except rate, share and per share data). Royalty Purchases and Other Financings Licensed Technology Footnote Funded Amount GAAP Balance Contract Rate Revenue Recognized YTD Q3 Beleodaq® Oncology treatment $ 7,600 $ 5,059 N/A $ 1,274 $ 456 Besivance® Ophthalmic antibiotic (3) 6,000 — N/A (26 ) (25 ) Best ABT, Inc. Oncology diagnosis (1), (2) 5,784 3,472 N/A — — Coflex®/Kybella®/Zalviso® Spinal stenosis/Submental fullness 4,350 4,160 N/A 465 155 Cambia® NSAID migraine treatment (1) 8,500 2,637 N/A (9 ) (56 ) Forfivo XL® Depressive disorder treatment 6,000 1,490 N/A 982 307 Ideal Implant, Inc. Aesthetics 3,000 3,097 N/A 203 203 Iluvien® Diabetic macular edema 16,501 16,205 N/A 1,813 641 Narcan® Opioid overdose treatment 17,500 539 N/A 2,423 1,030 Ostomy products royalty Ostomy products 3,900 4,443 N/A 450 156 Secured Royalty Financing (Marketable Investment) Women’s health (1), (2) 3,000 198 11.5% — — Tissue Regeneration Therapeutics Umbilical cord banking (2) 3,250 3,491 N/A — — Veru, Inc. Synthetic Royalty (4) 5,166 5,165 N/A 5,914 1,411 Maturity Date GAAP Balance Contract Rate Revenue Recognized Term Loans Type Footnote Principal YTD Q3 4Web, Inc. First Lien 06/03/23 $ 24,929 $ 25,358 12.8 % $ 2,700 $ 983 Acerus Pharmaceuticals, Inc. First Lien 10/11/23 6,550 6,519 12.0 % 968 298 B&D Dental Corporation First Lien (2), (5) 12/10/18 8,365 8,334 14.0 % — — BIOLASE, Inc. First Lien 11/09/23 14,300 14,428 12.3 % 1,645 558 CeloNova BioSciences, Inc. First Lien (6) 12/31/21 2,054 2,058 12.5 % 360 93 DxTerity Diagnostics, Inc. First Lien (7) 11/30/21 2,474 3,217 13.3 % 1,624 340 Epica International, Inc. First Lien 07/23/23 12,000 12,336 13.5 % 1,202 403 eTon Pharmaceuticals, Inc. First Lien 11/13/24 7,000 6,862 12.0 % 761 257 Flowonix Medical, Inc. First Lien 12/23/25 10,000 9,954 11.0 % 961 331 Harrow Health, Inc. First Lien (3) 07/19/23 — — 9.0% - 12.0 % 1,112 — Keystone Dental, Inc. First Lien 11/14/22 15,000 15,455 11.5 % 1,401 473 Misonix, Inc. First Lien (8) 06/30/23 30,096 30,089 10.0% - 12.3 % 2,384 805 Sincerus Pharmaceuticals, Inc. First Lien 03/19/26 9,750 9,765 13.0 % 681 360 Tenex Health, Inc. First Lien (3) 06/30/21 — — 13.0 % 349 — Thermedx, LLC Sub Note (9) 05/20/29 466 466 11.8 % 40 14 Trio Healthcare Ltd. First Lien 07/01/26 5,100 5,033 12.5 % 180 180 21 No of GAAP Change in Fair Value Common Stock Footnote Shares Balance YTD Q3 Misonix, Inc. Common Stock (8) 109,353 $ 2,767 $ 1,557 $ 342 Sincerus Pharmaceuticals, Inc. 26,575 — — — Number of Exercise Price GAAP Change in Fair Value Warrants to Purchase Stock Shares per Share Balance YTD Q3 4Web, Inc. TBD TBD $ — $ — $ — Acerus Pharmaceuticals, Inc. 7,764,004 0.05 CAD 196 (18) (62) B&D Dental Corporation 225 0.01 — — — BIOLASE, Inc. 550,977 0.39 322 94 (35) CeloNova BioSciences, Inc. TBD 0.01 — — — DxTerity Diagnostics, Inc. 2,019,231 2.08 — — — Epica International, Inc. TBD TBD — — — eTon Pharmaceuticals, Inc. 51,239 5.86 126 (175) (55) eTon Pharmaceuticals, Inc. 18,141 6.62 45 (63) (19) EyePoint Pharmaceuticals, Inc. 40,910 11.00 224 99 35 EyePoint Pharmaceuticals, Inc. 7,773 19.30 34 15 5 Flowonix Medical, Inc. 155,561 3.86 — — — Harrow Health, Inc. 373,847 2.08 2,703 726 (83) Income Recognized Assets YTD Q3 2021 Total finance receivables $ 196,141 $ 29,857 $ 9,373 Total marketable investments 2,965 N/A N/A Cost method investment 3,491 N/A N/A Fair value of warrant assets 3,650 N/A N/A Total assets/revenues $ 206,247 $ 29,857 $ 9,373 (1) Investment considered impaired. (2) Investment on nonaccrual. (3) The loan/royalty was paid off during 2021. (4) The return premium pursuant to the credit agreement was reached, and the residual royalty agreement commenced during the third quarter. (5) B&D is evaluating strategic alternatives for the business. The first lien loan is currently in default. (6) Maturity date was amended to December 31, 2021 in July 2021. (7) Maturity date was amended to November 30, 2021 in June 2021. (8) On October 29, 2021, Misonix was acquired by Bioventus. Upon closing of the transaction, the Misonix term loan was paid off. We also tendered our Misonix common stock and received $1.9 million in cash and 71,361 shares of Bioventus common stock. (9) The loan was paid off on October 22, 2021. 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. 22 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. 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, 2021, compared to those discussed in our Annual Report. 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 and their potential impact to our consolidated financial statements. Comparison of the Three Months Ended September 30, 2021 and 2020 ( in millions ) Three Months Ended September 30, 2021 2020 Change Revenues $ 9.6 $ 10.6 $ (1.0 ) Interest expense 0.1 0.1 — Pharmaceutical manufacturing, research and development expense 2.5 1.2 1.3 Change in fair value of acquisition-related contingent consideration — 0.2 (0.2 ) Depreciation and amortization expense 0.8 2.7 (1.9 ) General and administrative expense 3.6 2.5 1.1 Other income (expense), net 0.1 (0.1 ) 0.2 Income tax expense (benefit) 0.5 (0.5 ) 1.0 Consolidated net income 2.2 4.3 (2.1 ) Revenues Revenues decreased to $9.6 million for the three months ended September 30, 2021 from $10.6 million for the three months ended September 30, 2020. The decrease was primarily the result of a $2.6 million decrease in revenues from our Pharmaceutical Development segment, partially offset by a $1.5 million increase in interest and fees earned on our finance receivables. The decrease in Pharmaceutical Development segment revenue was primarily the result of $2.5 million of non-recurring milestone revenue received in 2020 related to Enteris’ license agreement with Cara. The $1.5 million increase in revenue attributable to our Finance Receivables segment primarily consists of a $1.4 million net increase in royalty income and a $1.1 million increase in fees and interest earned on our finance receivables due to funding new and existing loans. The increase in revenue was partially offset by a $1.0 million decrease in interest and fees earned on finance receivables that were paid off or paid down since the third quarter of 2020. Interest Expense Interest expense consists of interest accrued on our revolving line of credit, unused line of credit and maintenance fees, as well as amortization of debt issuance costs. Interest expense for both the three months ended September 30, 2021 and 2020 was $0.1 million, respectively. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense increased from $1.2 million for the three months ended 2020 to $2.5 million for the three months ended September 30, 2021. The $1.3 million increase was primarily due to an increase in manufacturing materials for pipeline projects and clinical trials. Change in Fair Value of Acquisition-Related Contingent Consideration We did not recognize any change in fair value of acquisition-related contingent consideration during the three months ended September 30, 2021, and a $0.2 million remeasurement adjustment was made during the three months ended September 30, 2020. Please refer to Part I, Item I, Financial Statements , Note 7 of the notes to the unaudited condensed consolidated financial statements for further information regarding acquisition-related contingent consideration. 23 Depreciation and Amortization The $1.9 million decrease in depreciation and amortization expense for the three months ended September 30, 2021 primarily consists of a decrease in amortization expense related to the intangible assets of Enteris. Amortization expense is aligned with the expected future cash flows of the intangible assets. General and Administrative General and administrative expenses consist primarily of compensation, stock-based compensation and related costs for management, staff and Board, legal and audit expenses, and corporate governance expenses. General and administrative expenses increased to $3.6 million for the three months ended September 30, 2021 from $2.5 million for the three months ended 2020. The $1.1 million increase was primarily due to a $1.0 million increase in expenses incurred in connection with the SRC’s efforts to identify, review and explore strategic alternatives for the Company; such expenses primarily consist of legal and financial consulting fees, as well as Board compensation. Other Income (expense), Net Other income (expense), net for three months ended September 30, 2021 reflected a net fair market value loss of $0.2 million on our warrant derivatives and a net fair market value gain of $0.3 million on our Misonix common stock. Other income (expense), net for the three months ended September 30, 2020 reflected a net fair market value gain of $0.1 million on our warrant derivatives and a net fair market value loss of $0.2 million on our Misonix common stock. Income Tax Expense (Benefit) During the three months ended September 30, 2021 and 2020, we recognized income tax expense of $0.5 million and income tax benefit of $0.5 million, respectively. The $1.0 million increase in income tax expense is a result of higher taxable income for the three months ended September 30, 2021 when compared to the same period of the prior year. 24 Comparison of the Nine Months Ended September 30, 2021 and 2020 ( in millions ) Nine Months Ended September 30, 2021 2020 Change Revenues $ 41.2 $ 25.8 $ 15.4 Provision for credit losses and impairment expenses — 0.2 (0.2 ) Interest expense 0.3 0.4 (0.1 ) Pharmaceutical manufacturing, research and development expense 5.6 3.3 2.3 Change in fair value of acquisition-related contingent consideration (0.1 ) 2.0 (2.1 ) Depreciation and amortization expense 3.3 9.6 (6.3 ) General and administrative expense 9.8 8.2 1.6 Other income (expense), net 2.2 (1.8 ) 4.0 Income tax expense (benefit) 5.0 (0.2 ) 5.2 Consolidated net income 19.6 0.6 19.0 Revenues We generated revenues of $41.2 million and $25.8 million for the nine months ended September 30, 2021 and 2020, respectively. The $15.4 million increase consisted primarily of a $6.9 million increase in interest and fees earned on our finance receivables and a $8.2 million increase in revenues from our Pharmaceutical Development segment. The increase in Pharmaceutical Development segment revenue included milestone revenue related to Enteris’ license agreement with Cara. The $6.9 million increase in revenue attributable to our Finance Receivables segment was the result of a $5.1 million net increase in royalty income and a $2.8 million increase in fees and interest earned on our finance receivables due to funding new and existing loans. The increase in revenue was partially offset by a $1.0 million decrease in interest and fees earned on finance receivables that were paid off or paid down since the third quarter of 2020. Provision for Credit Losses and Impairment Expense We did not recognize any credit loss provision or impairment expense during the nine months ended September 30, 2021. We recognized impairment expense of $0.2 million on our available-for-sale debt security during the nine months ended September 30, 2020. Interest Expense Interest expense consists of interest accrued on our revolving line of credit, unused line of credit and maintenance fees, as well as amortization of debt issuance costs. Interest expense for the nine months ended September 30, 2021 and 2020 was $0.3 million and $0.4 million, respectively. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense increased from $3.3 million for the nine months ended September 30, 2020 to $5.6 million for nine months ended September 30, 2021. The $2.3 million increase was primarily due to an increase in manufacturing materials for pipeline projects and clinical trials. Change in Fair Value of Acquisition-Related Contingent Consideration We recognized a $0.1 million change in fair value of acquisition-related contingent consideration during the nine months ended September 30, 2021, and a $2.0 million remeasurement adjustment was made during the three months ended September 30, 2020. Please refer to Part I, Item I, Financial Statements , Note 7 of the notes to the unaudited condensed consolidated financial statements for further information regarding acquisition-related contingent consideration. Depreciation and Amortization The $6.3 million decrease in depreciation and amortization expense for the nine months ended September 30, 2021 primarily consists of a decrease in amortization expense related to the intangible assets of Enteris. Amortization expense is aligned with the expected future cash flows of the intangible assets. 25 General and Administrative General and administrative expenses consist primarily of compensation, stock-based compensation and related costs for management, staff and Board, legal and audit expenses, and corporate governance expenses. General and administrative expenses increased to $9.8 million for the nine months ended September 30, 2021 from $8.2 million for the nine months ended September 30, 2020. The $1.6 million increase was primarily due to a $1.4 million increase in expenses incurred in connection with the SRC’s efforts to identify, review and explore strategic alternatives for the Company; such expenses primarily consist of legal and financial consulting fees, as well as Board compensation. The increase also included a $0.2 million increase in salaries and benefits expense, as well as a $0.3 million increase in overall office, insurance and rent expense. The increase was partially offset by a $0.2 million decrease in other professional fees. Other Income (Expense), Net Other income, net for nine months ended September 30, 2021 reflected a net fair market value gain of $0.7 million on our warrant derivatives and a net fair market value gain of $1.6 million on our Misonix common stock. Other expense, net for the nine months ended September 30, 2020 reflected a net fair market value loss of $1.2 million on our warrant derivatives and a net fair market value loss of $0.7 million on our Misonix common stock. Income Tax Expense During the nine months ended September 30, 2021 and 2020, we recognized income tax expense of $5.0 million and tax benefit of $0.2 million, respectively. The $5.2 million increase in income tax expense is a result of higher taxable income for the nine months ended September 30, 2021 when compared to the same period of the prior year. Liquidity and Capital Resources As of September 30, 2021, we had $18.6 million in cash and cash equivalents, compared to $3.0 million in cash and cash equivalents as of December 31, 2020. The primary driver of the $15.6 million increase in our cash balance was $58.3 million of interest, fees, principal and royalty payments received on our finance receivables and a net $5.0 million of payments generated by our Pharmaceutical Development segment (the net $5.0 million includes a $10.0 million payment related to the completion of a milestone under the License Agreement less $6.1 million paid to the seller of Enteris, pursuant to the provisions of the merger agreement). The increase was partially offset by $19.8 million of investment funding, net of deferred fees and origination expenses; $16.0 million of accounts payable, payroll and benefits expense, including $3.2 million for Enteris’ internal pipeline projects; and $11.8 million of net borrowings and repayments on our credit facility. Subsequent to September 30, 2021, we received $35.7 million of interest, fees and principal payments on our finance receivables, including $32.1 million for the payoff of two term loans (please refer to Part I. Financial Information, Item 1. Financial Statements, Note 11 of the notes to the unaudited condensed consolidated financial statements for further details). As of November 8, 2021, we had $56.8 million in cash and cash equivalents. Our ability to generate cash in the future depends primarily upon our success in implementing our Finance Receivables business model of generating income by providing capital to a broad range of life science companies, institutions and inventors, as well as the success of our Pharmaceutical Development segment. We generate income primarily from four 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; 3. Pharmaceutical development, manufacturing, and licensing activities utilizing the Peptelligence® platform; and 4. To a lesser extent, realizing capital appreciation from equity-related investments in the life science sector. As of September 30, 2021, our finance receivables portfolio contains $196.1 million of finance receivables, $3.0 million of marketable investments, and $3.5 million related to our cost method investment. In the aggregate, we expect these assets to generate positive cash flows in 2021. However, the COVID-19 pandemic has created substantial uncertainty in the global markets and economy; therefore, we will continue to monitor the short and long-term impact this may have on our finance receivables portfolio. In addition, the majority of our finance receivables portfolio are debt instruments that carry floating interest rates with a LIBOR-based interest rate floor. Changes in interest rates, including LIBOR rates, may affect the interest income for debt instruments with floating rates. We believe we are well positioned to benefit should market interest rates rise in the future. 26 We expect the Pharmaceutical Development segment to generate positive cash flow above its expenses from proceeds received under its license agreements and customer relationships; however, the timing of the receipt of payments under the license agreements is uncertain and dependent upon the success of our technology licensees’ pharmaceutical development candidates. Also, the COVID-19 pandemic has resulted in disruption and delays to pharmaceutical clinical trials in general and may impact the expected timing of our technology licensees’ ability to achieve milestones upon which we receive income pursuant to our license agreements. Though we expect in the aggregate that the Company will generate positive cash flow in excess of our expenses, given the abrupt decline in global economic activity, and the uncertain recovery from such decline, caused by COVID-19, we cannot predict this with certainty. We entered into a $20.0 million revolving credit facility in June 2018. The credit facility was amended on September 27, 2021 to extend the termination date to September 30, 2022 and to increase the credit facility commitment to $22.0 million. We continue to explore other options with respect to a new credit facility. As of September 30, 2021, approximately $22.0 million was available for borrowing under the credit facility. 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 partner companies’ 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 company 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. Please refer to Item 1. Financial Statements, Note 7 of the notes to the unaudited condensed consolidated financial statements. 27