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, 2022 (“Annual Report”), as well as our unaudited condensed consolidated financial statements and the accompanying notes included in this report. 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. 22 Finance Receivables Portfolio Overview The table below provides an overview of our outstanding finance receivables transactions as of, and for the three and six months ended June 30, 2023 (in thousands, except rate, share and per share data). Revenue (Loss) Recognized Royalty Purchases Licensed Technology Footnote Funded Amount GAAP Balance 2Q 2023 Year-to- Date Besivance® Ophthalmic antibiotic (1) $ 6,000 $ — $ 2 $ 14 Best ABT, Inc. Oncology diagnosis (2), (3) 5,784 2,797 — — Coflex®/Kybella® Spinal stenosis/submental fullness 4,350 3,824 87 156 Cambia® NSAID migraine treatment (4) 8,500 — (37 ) (119 ) Duo Royalty Japanese women’s health/cystic fibrosis 15,488 13,789 842 1,373 Forfivo XL® Depressive disorder treatment 6,000 1,366 239 490 Ideal Implant, Inc. Aesthetics (3), (5) 4,314 4,314 — — Iluvien® Diabetic macular edema 16,501 15,164 507 1,051 Veru, Inc. Women’s health 10,000 3,517 132 264 Revenue Recognized Term Loans Type Footnote Maturity Date Principal GAAP Balance Rate 2Q 2023 Year-to- Date 4Web, Inc. First lien 06/03/23 $ 29,411 $ 31,600 12.8 % $ 1,144 $ 2,252 AOTI, Inc. First lien 03/21/27 12,000 12,033 11.0 % 486 966 Acer Therapeutics, Inc. First lien (6) 03/04/24 — — 12.0 % 313 1,560 Aziyo Biologics, Inc. First lien 08/10/27 25,000 25,426 12.0 % 966 1,933 BIOLASE, Inc. First lien 05/31/25 13,300 13,999 10.3 % 559 1,096 Biotricity, Inc. First lien 12/21/26 12,364 12,372 14.5 % 616 1,144 Epica International, Inc. First lien 07/23/24 11,750 12,495 9.5 % 660 1,062 eTon Pharmaceuticals, Inc. First lien 11/13/24 6,230 6,396 10.0 % 250 498 Exeevo, Inc. First lien 07/01/27 5,233 5,194 15.0 % 238 454 Flowonix Medical, Inc. First lien (3), (7) 12/23/25 12,518 11,879 14.0 % — — MedMinder Systems, Inc. First lien 08/18/27 20,000 20,019 12.9 % 711 1,397 MolecuLight, Inc. First lien 12/29/26 10,000 10,142 12.8 % 457 906 NeoLight, LLC First lien 02/17/27 5,000 4,971 13.5 % 206 293 SKNV First lien 05/15/27 13,497 13,629 10.4 % 511 999 Trio Healthcare Ltd. First lien 07/01/26 9,152 9,128 12.5 % 389 749 Revenue Recognized Marketable Investments Number of Shares Footnote Funded Amount GAAP Balance 2Q23 Year-to- Date Secured Royalty Financing (Marketable Investment) N/A (2), (3) $ 3,000 $ 59 $ — $ — Epica International, Inc. 25,000 N/A — — — SKNV 26,575 N/A — — — 23 Other Income (Loss) Recognized Warrants to Purchase Stock Number of Shares Footnote Exercise Price per Share ($) GAAP Balance 2Q 2023 Year-to- Date 4Web, Inc. TBD $ — $ — $ — $ — AOTI, Inc. 92,490 — — — — Acer Therapeutics, Inc. 150,000 2.46 113 19 (184 ) Acer Therapeutics, Inc. 100,000 1.51 79 14 (131 ) Acer Therapeutics, Inc. 250,000 2.39 188 31 (257 ) Acer Therapeutics, Inc. 500,000 1.00 422 45 45 Acerus Pharmaceuticals Corporation — — — — (5 ) Aziyo Biologics, Inc. 157,895 6.65 325 124 (190 ) Aziyo Biologics, Inc. 30,075 6.65 35 (3 ) (63 ) BIOLASE, Inc. 22,039 9.80 1 (1 ) (4 ) Biotricity, Inc. 57,536 6.26 17 5 7 CeloNova BioSciences, Inc. TBD — — — — DxTerity Diagnostics, Inc. 2,019,231 — — — — Epica International, Inc. TBD — — — — eTon Pharmaceuticals, Inc. 51,239 5.86 61 (9 ) 18 eTon Pharmaceuticals, Inc. 18,141 6.62 22 (3 ) 7 Exeevo, Inc. 930 — — — — EyePoint Pharmaceuticals, Inc. 40,910 11.00 170 153 150 EyePoint Pharmaceuticals, Inc. 7,773 19.30 26 24 24 Flowonix Medical, Inc. 155,561 (3), (7) — — — — MedMinder Systems, Inc. 72,324 — — — — MolecuLight, Inc. TBD — — — — Revenue Recognized Assets 2Q 2023 Year-to-Date Total finance receivables, gross $ 234,054 $ 9,278 $ 18,538 Total marketable investments 59 N/A N/A Fair value of warrant assets 1,459 N/A N/A Total assets, gross/revenues $ 235,572 $ 9,278 $ 18,538 (1) US royalty was paid off during the year ended December 31, 2021. SWK continues to receive insignificant royalties on international sales. (2) Investment considered partially impaired. (3) Investment on nonaccrual. (4) Royalty was paid off during the six months ended June 30, 2023. (5) In July 2023, Ideal Implant assets were sold to an aesthetics company. (6) Loan was sold to a third party during the six months ended June 30, 2023. (7) Flowonix Medical assets were sold to Algorithm Sciences, Inc. during the six months ended June 30, 2023. 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. 24 Environmental, Social and Governance As overseers of risk and stewards of long-term enterprise value, our management and Board of Directors (“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. 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 six months ended June 30, 2023, 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 June 30, 2023 and 2022 ( in millions ) Three Months Ended June 30, 2023 2022 Change $ Revenues $ 9.5 $ 6.9 $ 2.6 Provision (benefit) for credit losses (0.7 ) — (0.7 ) Interest expense 0.4 0.1 0.3 Pharmaceutical manufacturing, research and development expense 1.5 1.5 — Depreciation and amortization expense 0.6 0.6 — General and administrative 3.0 3.0 — Other income (expense), net 0.7 (1.0 ) 1.7 Income tax expense 1.5 0.2 1.3 Net income 3.9 0.6 3.3 Revenues Revenues increased to $9.5 million for the three months ended June 30, 2023 from $6.9 million for the three months ended June 30, 2022. The $2.6 million increase in revenue for the three months ended June 30, 2023 consisted of a $2.5 million increase in Finance Receivables segment revenue and a $0.1 million increase in Pharmaceutical Development segment revenue. The $2.5 million increase in Finance Receivables segment revenue was primarily due to $2.5 million increase in interest and fees earned due to funding new and existing loans, a $0.8 million increase in interest income due to an overall increase in reference rates, and a net $0.5 million increase in royalty revenue when compared to the same period of the previous year. The increase was partially offset by a $1.3 million decrease in interest, royalties and fees earned on finance receivables that were paid off in 2022 and 2023. 25 Provision (benefit) for Credit Losses Our allowance for credit losses is established through charges or credits to income in the form of the provision in order to bring our allowance for credit losses for loans and unfunded commitments to a level deemed appropriate by management. Our allowance for credit losses decreased by $0.7 million during the three months ended June 30, 2023 due to an overall decrease in finance receivables. Please refer to Item 1., Financial Statements, Note 3 of the notes to the unaudited condensed consolidated financial statements for further information regarding the provision for credit losses. 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 increased to $0.4 million for three months ended June 30, 2023 from $0.1 million for the three months ended June 30, 2022. The $0.3 million increase in interest expense was due to a higher average outstanding balance under the Prior Credit Agreement with Cadence Bank during the three months ended June 30, 2023 as compared to the three months ended June 30, 2022. On June 28, 2023, we terminated the Prior Credit Agreement with Cadence Bank and entered into a new Credit Agreement with First Horizon Bank. Please refer to Item 1., Financial Statements, Note 5 of the notes to the unaudited condensed consolidated financial statements for further information regarding the Credit Agreement with First Horizon. Pharmaceutical Manufacturing, Research and Development Expense We recognized $1.5 million of pharmaceutical manufacturing, research and development expense for both the three months ended June 30, 2023 and 2022. Depreciation and Amortization We recognized $0.6 million of depreciation and amortization expense during both the three months ended June 30, 2023 and 2022. Depreciation and amortization primarily consists of 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. We recognized $3.0 million of general and administrative expense for both the three months ended June 30, 2023 and 2022. Other Income, Net Other income, net for three months ended June 30, 2023 reflected a net aggregate fair market value gain of $0.4 million on our warrant derivatives and a $0.3 million net gain from the remeasurement of foreign currency transactions into our functional currency, net of changes in fair value of the foreign currency forward contract. Other expense, net for the three months ended June 30, 2022 reflected a net aggregate fair market value loss of $1.0 million on our warrant derivatives and Bioventus common stock. Our Bioventus common stock was sold during the year ended December 31, 2022. Income Tax Expense During the three months ended June 30, 2023 and 2022, we recognized income tax expense of $1.5 million and $0.2 million respectively. The increase in income tax expense is the result of higher taxable income for the three months ended June 30, 2023 when compared to the same period of the prior year. 26 Comparison of the six months ended June 30, 2023 and 2022 ( in millions ) Six Months Ended June 30, 2023 2022 Change $ Revenues $ 18.9 $ 18.1 $ 0.8 Provision (benefit) for credit losses (0.7 ) — (0.7 ) Interest expense 0.5 0.2 0.3 Pharmaceutical manufacturing, research and development expense 2.2 3.4 (1.2 ) Depreciation and amortization expense 1.3 1.3 — General and administrative 5.5 6.2 (0.7 ) Other expense, net (0.1 ) (1.7 ) 1.6 Income tax expense 1.3 1.3 — Net income 8.6 4.0 4.6 Revenues Revenues increased to $18.9 million for the six months ended June 30, 2023 from $18.1 million for the six months ended June 30, 2022. The $0.8 million increase in revenue for the six months ended June 30, 2023 consisted of a $1.3 million increase in Finance Receivables segment revenue and a $0.5 million decrease in Pharmaceutical Development segment revenue. The $1.3 million increase in Finance Receivables segment revenue was due to $4.9 million increase in interest and fees earned due to funding new and existing loans, a $2.4 million increase in interest income due to an overall increase in reference rates, and a net $0.4 million increase in royalty revenue when compared to the same period of the previous year. The increase was partially offset by a $6.4 million decrease in interest, royalties and fees earned on finance receivables that were paid off in 2022 and 2023. Provision (benefit) for Credit Losses Our allowance for credit losses is established through charges or credits to income in the form of the provision in order to bring our allowance for credit losses for loans and unfunded commitments to a level deemed appropriate by management. Our allowance for credit losses decreased by $0.7 million during the six months ended June 30, 2023 due to an overall decrease in finance receivables. Please refer to Item 1., Financial Statements, Note 3 of the notes to the unaudited condensed consolidated financial statements for further information regarding the provision for credit losses. 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 increased to $0.5 million for six months ended June 30, 2023 from $0.2 million for the six months ended June 30, 2022. This $0.3 million increase in interest expense was due to a higher average outstanding balance under the Prior Credit Agreement with Cadence Bank during the six months ended June 30, 2023 as compared to the six months ended June 30, 2022. On June 28, 2023, we terminated the Prior Credit Agreement with Cadence Bank and entered into a new Credit Agreement with First Horizon Bank. Please refer to Item 1., Financial Statements, Note 5 of the notes to the unaudited condensed consolidated financial statements for further information regarding the Credit Agreement with First Horizon. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense decreased from $3.4 million for the six months ended June 30, 2022 to $2.2 million for the six months ended June 30, 2023. The $1.2 million decrease was primarily due to a was primarily due to a reduction in headcount as well as a reduction in R&D and clinical trial expenditures. 27 Depreciation and Amortization We recognized $1.3 million of depreciation and amortization expense during both the six months ended June 30, 2023 and 2022. Depreciation and amortization primarily consists of 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 decreased to $5.5 million for the six months ended June 30, 2023 from $6.2 million for the six months ended June 30, 2022. The $0.7 million decrease included a net $0.6 million decrease in salaries, benefits, general office and maintenance expense mainly due to a reduction in employee headcount in our Pharmaceutical Development segment; and a $0.3 million decrease in corporate strategic planning and related professional fees expense. The decrease was partially offset by $0.2 million increase in Board fees due to a revised Board compensation plan. Other Expense, Net Other expense, net for the six months ended June 30, 2023 reflected a net aggregate fair market value loss of $0.6 million on our warrant derivatives and a $0.5 million gain from the remeasurement of foreign currency transactions into our functional currency, net of changes in fair value of the foreign currency forward contract. Other expense, net for the six months ended June 30, 2022 reflected a net aggregate fair market value loss of $1.7 million on our warrant derivatives and Bioventus common stock. Our Bioventus common stock was sold during the year ended December 31, 2022. Income Tax Expense We recognized income tax expense of $1.3 million for both the six months ended June 30, 2023 and 2022. The nominal increase in income tax expense was the result of an increase in taxable income for the six months ended June 30, 2023 when compared to the same period of the prior year. Liquidity and Capital Resources As of June 30, 2023, we had $6.8 million in cash and cash equivalents, compared to $6.2 million in cash and cash equivalents as of December 31, 2022. The primary driver of the $0.6 million increase in our cash balance was $31.6 million of interest, fees, principal and royalty payments received on our finance receivables. The increase in cash and cash equivalents was partially offset by $13.7 million of investment funding, net of deferred fees and origination expenses; payroll, accounts payable and new credit facility closing costs totaled $9.6 million; $5.1 million to repurchase shares of the Company’s common stock in the open market; and net payments of $2.4 million of credit facility draws, principal, interest and fees paid on our credit facility with Cadence Bank. We entered into a new $45.0 million revolving credit facility in June 2023 with First Horizon Bank. The Credit Agreement provides for one or more incremental increases not to exceed $80.0 million, subject to the consent of the Agent and each Lender, at any time prior to the Commitment Termination Date. As of June 30, 2023, no funds have been borrowed, and $45.0 million was available for borrowing under the new credit facility. Our Prior Credit Agreement with Cadence Bank was terminated in connection with the establishment of the new credit facility. Please refer to Item 1., Financial Statements, Note 5 of the notes to the unaudited condensed consolidated financial statements for further information regarding the Credit Agreement with First Horizon Bank. 28 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 June 30, 2023, our finance receivables portfolio contains $223.0 million of net finance receivables and $0.1 million of marketable investments. We expect these assets to generate positive cash flows in 2023. However, we continuously monitor the short and long-term financial position of our finance receivables portfolio. In addition, the majority of our finance receivables portfolio are debt instruments that carry floating interest rates with a SOFR, Prime, or LIBOR-based interest rate floor. Changes in interest 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 continue to evaluate multiple attractive opportunities that, if consummated, we believe would similarly generate additional income. Since the timing of any investment is difficult to predict, our Finance Receivables segment may not be able to generate positive cash flow above what our existing assets are expected to produce in 2023. We do not assume any near-term repayments from borrowers, and as a result, no assurances can be given that actual results would not differ materially from the statement above. 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. As of June 30, 2023, we had $7.4 million of unfunded commitments. Please refer to Item 1., Financial Statements, Note 6 of the notes to the unaudited condensed consolidated financial statements for further information regarding the Company’s commitments and contingencies. 29