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, 2021 (“Annual Report”), as well as our unaudited condensed consolidated financial statements and the accompanying notes included in this report. 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. Our commitment to ESG initiatives is an endeavor both the Board and management undertake for the general betterment of those both inside and outside the Company. 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 its business performance and manages its operations. Please refer to Item 1. Financial Statements, Note 9 of the notes to the unaudited condensed consolidated financial statements for further information regarding segment information. 18 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, 2022 (in thousands, except rate, share and per share data). Revenue Recognized Royalty Purchases Licensed Technology Footnote Funded Amount GAAP Balance Q3 YTD Beleodaq® Oncology treatment (1) $ 7,600 $ — $ 27 $ 799 Besivance® Ophthalmic antibiotic (2) 6,000 — 8 21 Best ABT, Inc. Oncology diagnosis (3), (4) 5,784 3,037 — — Coflex®/Kybella® Spinal stenosis/submental fullness 4,350 3,929 105 397 Cambia® NSAID migraine treatment (3) 8,500 1,034 (94 ) (153 ) Forfivo XL® Depressive disorder treatment 6,000 1,408 185 857 Ideal Implant, Inc. Aesthetics 3,000 3,289 134 402 Iluvien® Diabetic macular edema 16,501 15,729 570 1,691 Narcan® Opioid overdose treatment 17,500 487 248 1,908 Ostomy Products Royalty Ostomy products (1) 3,900 — 1,746 1,927 Veru, Inc. Women’s health 10,000 3,509 30 555 Revenue Recognized Term Loans Type Footnote Maturity Date Principal GAAP Balance Rate Q3 YTD 4Web, Inc. First lien 06/03/23 $ 28,808 $ 31,060 15.8 % $ 1,185 $ 3,329 AOTI, Inc. First lien 03/21/27 12,000 11,970 11.0 % 426 840 Acer Therapeutics, Inc. First lien 03/04/24 6,704 6,849 12.0 % 457 1,003 Acerus Pharmaceuticals Corporation First lien (5) 10/11/23 — — 12.0 % — 538 Aziyo Biologics, Inc. First lien 10/08/27 21,000 20,294 11.5 % 265 265 B&D Dental Corporation First lien (5) 12/10/18 — — 14.0 % — 2,401 BIOLASE, Inc. First lien 05/31/25 13,300 13,734 10.5 % 484 1,390 Biotricity, Inc. First lien 12/26/26 12,000 11,845 11.5 % 407 1,193 Epica International, Inc. First lien 07/23/24 12,000 12,374 9.5 % 385 1,097 eTon Pharmaceuticals, Inc. First lien 11/13/24 6,615 6,659 10.0 % 221 666 Exeevo, Inc. First lien 07/01/27 5,010 4,969 12.5 % 187 187 Flowonix Medical, Inc. First lien (4), (6) 12/23/25 10,428 9,789 14.0 % — — Keystone Dental Group First lien (5) 08/01/23 — — 11.5 % — 888 MedMinder Systems, Inc. First lien 07/22/27 20,000 19,831 10.9 % 291 291 MolecuLight, Inc. First lien 12/29/26 10,000 10,007 12.5 % 413 1,036 Sincerus Pharmaceuticals, Inc. First lien 03/19/26 12,820 13,039 13.0 % 534 1,437 Trio Healthcare Ltd. First lien 07/01/26 8,150 8,117 12.5 % 288 780 19 Revenue Recognized Cost Method Investment Licensed Technology Footnote Maturity Date Principal GAAP Balance Rate Q3 YTD Tissue Regeneration Therapeutics, Inc. Umbilical cord banking (4) N/A $ 3,491 $ 3,491 N/A $ — $ — Income (Loss) Recognized Marketable Investments Number of Shares Footnote Funded Amount GAAP Balance Q3 YTD Secured Royalty Financing (Marketable Investment) N/A (4) $ 3,000 $ 88 $ — $ — Bioventus, Inc. Common Stock 71,361 N/A 500 13 (534 ) Epica International, Inc. 25,000 N/A — — — Sincerus Pharmaceuticals, Inc. 26,575 N/A — — — Income (Loss) Recognized Warrants to Purchase Stock Number of Shares Footnote Exercise Price per Share ($) GAAP Balance Q3 YTD 4Web, Inc. TBD $ — $ — $ — $ — AOTI, Inc. 92,490 — — — — Acer Therapeutics, Inc. 150,000 2.46 116 17 (110 ) Acer Therapeutics, Inc. 100,000 1.51 90 (2 ) (2 ) Acerus Pharmaceuticals Corporation 7,764,004 0.053 CAD 20 (33 ) (82 ) Aziyo Biologics 157,895 6.65 895 116 116 BIOLASE, Inc. 22,039 0.39 26 (37 ) (158 ) Biotricity, Inc. 57,536 6.26 21 (39 ) (155 ) CeloNova BioSciences, Inc. TBD (7) — — — — DxTerity Diagnostics, Inc. 2,019,231 (7) — — — — Epica International, Inc. TBD — — — — eTon Pharmaceuticals, Inc. 51,238 5.86 21 (15 ) (74 ) eTon Pharmaceuticals, Inc. 18,141 6.62 8 (5 ) (26 ) Exeevo, Inc. 930 — — — — EyePoint Pharmaceuticals, Inc. 40,910 11.00 129 (4 ) (147 ) EyePoint Pharmaceuticals, Inc. 7,773 19.30 17 (1 ) (24 ) Flowonix Medical, Inc. 155,561 (4), (6) — — — — Harrow Health, Inc. 373,847 (7) 2.08 3,797 1,791 1,285 Total Revenue Assets Q3 YTD Total finance receivables $ 212,959 $ 8,502 $ 25,745 Total marketable investments 588 N/A N/A Cost method investment 3,491 N/A N/A Fair value of warrant assets 5,140 N/A N/A Total assets/revenues $ 222,178 $ 8,502 $ 25,745 (1) Royalty was paid off during the third quarter of 2022. (2) US royalty was paid off during the year ended December 31, 2021. SWK continues to receive insignificant royalties on international sales. (3) Investment considered impaired. (4) Investment on nonaccrual. (5) Loan was paid off during the nine months ended September 30, 2022. (6) Flowonix is evaluating strategic alternatives for the business. (7) Loan was paid off during the year ended December 31, 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. 20 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, 2022, 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, 2022 and 2021 ( in millions ) Three Months Ended September 30, 2022 2021 Change Revenues $ 13.6 $ 9.6 $ 4.0 Interest expense 0.1 0.1 — Pharmaceutical manufacturing, research and development expense 1.8 2.5 (0.7 ) Depreciation and amortization expense 0.6 0.8 (0.2 ) General and administrative 4.3 3.6 0.7 Other income, net 1.8 0.1 1.7 Income tax expense 1.9 0.5 1.4 Net income 6.6 2.2 4.4 Revenues Revenues increased to $13.6 million for the three months ended September 30, 2022 from $9.6 million for the three months ended September 30, 2021. The $4.0 million increase in revenue was due to $5.0 million of milestone revenue related to Enteris’ License Agreement with Cara received during the three months ended September 30, 2022, which did not occur during the three months ended September 30, 2021. The increase in revenue was partially offset by a $0.9 million net decrease in Finance Receivables segment revenues. The decrease in Finance Receivables segment revenue was due to a $1.3 million net decrease in royalty income primarily due to the achievement of return premiums that caused a step down in royalty rates, which was partially offset by a net increase of $0.4 million in interest and fees earned on finance receivables. 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, 2022 and 2021 was $0.1 million, respectively. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense decreased from $2.5 million for the three months ended September 30, 2021 to $1.8 million for the three months ended September 30, 2022. The $0.7 million decrease was primarily due to a decrease in manufacturing materials for pipeline projects and clinical trials. Depreciation and Amortization The $0.2 million decrease in depreciation and amortization expense for the three months ended September 30, 2022 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. 21 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 $4.3 million for the three months ended September 30, 2022 from $3.6 million for the three months ended September 30, 2021. The $0.7 million increase was primarily due to a $1.3 million increase in salaries and benefits expense, of which $1.1 million is related to the former CEO’s severance pay pursuant to the Separation and Release Agreement dated August 31, 2022, and a $0.2 million increase in salaries and benefits expense due to an increase in personnel and the performance-based bonus accrual. The increase in general and administrative expense also included a $0.7 million increase in audit and legal fees related to amending the Company’s Articles of Incorporation and Bylaws and other corporate governance, financing and strategic matters. The increase was partially offset by a $0.9 million decrease in corporate strategic planning and related special committee board fees, as well as a $0.1 million decrease in stock-based compensation expense related to the forfeiture of stock-options held by the former CEO upon his departure on September 30, 2022. Other (Expense) Income, Net Other expense, net for three months ended September 30, 2022 reflected a net aggregate fair market value gain of $1.8 million on our warrant derivatives and Bioventus common stock. Other income, 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, which was tendered in October 2021 in exchange for $1.9 million in cash and 71,361 shares of Bioventus common stock. Income Tax Expense During the three months ended September 30, 2022 and 2021, we recognized income tax expense of $1.9 million and $0.5 million, respectively. The $1.4 million increase in income tax expense is the result of an increase in taxable income for the three months ended September 30, 2022 when compared to the same period of the previous year. Comparison of the Nine Months Ended September 30, 2022 and 2021 ( in millions ) Nine Months Ended September 30, 2022 2021 Change Revenues $ 31.7 $ 41.2 $ (9.5 ) Interest expense 0.2 0.3 (0.1 ) Pharmaceutical manufacturing, research and development expense 5.2 5.6 (0.4 ) Change in fair value of acquisition-related contingent consideration — (0.1 ) 0.1 Depreciation and amortization expense 2.0 3.3 (1.3 ) General and administrative 10.5 9.8 0.7 Other income, net 0.1 2.2 (2.1 ) Income tax expense 3.2 5.0 (1.8 ) Net income 10.7 19.6 (8.9 ) 22 Revenues Revenues decreased to $31.7 million for the nine months ended September 30, 2022 from $41.2 million for the nine months ended September 30, 2021. The $9.5 million decrease in revenue consisted of a $5.4 million decrease in Pharmaceutical Development segment revenue and a $4.1 million decrease in Finance Receivables segment revenue. The decrease in Pharmaceutical Development segment revenue included $5.0 million of milestone revenue related to Enteris’ License Agreement with Cara received during the nine months ended September 30, 2022, compared to $10.0 million of milestone revenue for the same period of 2021. The decrease in Finance Receivables segment revenue was due to a $5.1 million net decrease in royalty income primarily due to the achievement of return premiums that caused a step down in royalty rates, which was partially offset by a net increase of $1.0 million in interest and fees earned on finance receivables. 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, 2022 and 2021 was $0.2 million and $0.3 million, respectively. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense decreased from $5.6 million for the nine months ended September 30, 2021 to $5.2 million for the nine months ended September 30, 2022. The $0.4 million decrease was primarily due to a decrease in manufacturing materials for pipeline projects and clinical trials. Depreciation and Amortization The $1.3 million decrease in depreciation and amortization expense for the nine months ended September 30, 2022 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 $10.5 million for the nine months ended September 30, 2022 from $9.8 million for the nine months ended September 30, 2021. The $0.7 million increase was primarily due to a $1.1 million increase in salaries and benefits expense related to the former CEO’s severance pay pursuant to the Separation and Release Agreement dated August 31, 2022. The increase in general and administrative expense also included a $0.9 million increase in audit and legal fees related to amending the Company’s Articles of Incorporation and Bylaws and other corporate governance, financing and strategic matters. The increase was partially offset by a $1.4 million decrease in corporate strategic planning and related special committee board fees, as well as a $0.1 million decrease in stock-based compensation expense related to the forfeiture of stock-options held by the former CEO upon his departure on September 30, 2022. Other Income, Net Other income, net for the nine months ended September 30, 2022 reflected a net aggregate fair market value gain of $0.1 million on our warrant derivatives and Bioventus common stock. Other income, net for the 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, which was tendered in October 2021 in exchange for $1.9 million in cash and 71,361 shares of Bioventus common stock. 23 Income Tax Expense During the nine months ended September 30, 2022 and 2021, we recognized income tax expense of $3.2 million and $5.0 million, respectively. The $1.8 million decrease in income tax expense is the result of a decrease in taxable income for the nine months ended September 30, 2022 when compared to the same period of the previous year. Liquidity and Capital Resources As of September 30, 2022, we had $19.4 million in cash and cash equivalents, compared to $42.9 million in cash and cash equivalents as of December 31, 2021. The primary driver of the $23.5 million decrease in our cash balance was $71.2 million of investment funding, net of deferred fees and origination expenses; $8.2 million for payments of accounts payable, including $1.9 million for Enteris’s internal pipeline and business development projects; payroll and benefits expense of $8.3 million; $0.6 million to repurchase shares of the Company’s common stock on the open market; and $0.3 million of credit facility interest and other expenses. The decrease in cash and cash equivalents was partially offset by $64.4 million of interest, fees, principal and royalty payments received on our finance receivables and $0.7 million of customer payments generated by our Pharmaceutical Development segment. 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, 2022, our finance receivables portfolio contains $213.0 million of finance receivables, $0.6 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 2022. In addition, the majority of our finance receivables portfolio are debt instruments that carry floating interest rates with a reference rate-based interest rate floor. Changes in interest rates, including the underlying reference 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. We entered into a $20.0 million revolving credit facility in June 2018. The credit facility was amended on September 26, 2022 to extend the termination date to November 29, 2022. We continue to work with our current lender to extend our credit facility. As of September 30, 2022, $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 6 of the notes to the unaudited condensed consolidated financial statements 24