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 Part I. Financial Information, Item 1. Financial Statements, Note 9 of the notes to the unaudited condensed consolidated financial statements for further information regarding segment information. 23 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, 2023 (in thousands, except rate, share and per share data). Revenue (Loss) Recognized Royalty Purchases Licensed Technology Footnote Funded Amount GAAP Balance 3Q 2023 Year-to- Date Besivance® Ophthalmic antibiotic (1) $ 6,000 $ — $ — $ 14 Best ABT, Inc. Oncology diagnosis (2), (3) 5,784 2,677 — — Coflex®/Kybella® Spinal stenosis/submental fullness 4,350 3,749 37 193 Cambia® NSAID migraine treatment (4) 8,500 — 109 (10 ) Duo Royalty Japanese women’s health/cystic fibrosis 15,488 13,155 647 2,020 Flowonix Medical, Inc. Drug delivery device (3), (5) 10,433 10,433 — — Forfivo XL® Depressive disorder treatment 6,000 1,353 408 898 Ideal Implant, Inc. Aesthetics (3), (6) 4,239 4,239 — — Iluvien® Diabetic macular edema 16,501 14,927 519 1,570 Veru, Inc. Women’s health 10,000 3,481 131 395 Revenue Recognized Term Loans Type Footnote Maturity Date Principal GAAP Balance Rate 3Q 2023 Year-to- Date 4Web, Inc. First lien 12/31/24 $ 29,411 $ 31,597 12.8 % $ 1,185 $ 3,437 AOTI, Inc. First lien 03/21/27 12,000 12,067 11.0 % 512 1,478 Acer Therapeutics, Inc. First lien (7) 03/04/24 — — 12.0 % — 1,560 Elutia, Inc. First lien 08/10/27 25,000 25,853 12.0 % 1,035 2,968 BIOLASE, Inc. First lien 05/31/25 13,300 14,085 10.3 % 578 1,674 Biotricity, Inc. First lien 12/21/26 12,364 12,426 14.5 % 565 1,709 CDMO Manufacturer First lien 09/13/27 5,000 4,963 13.3 % 36 36 Epica International, Inc. First lien 07/23/24 9,750 10,432 9.5 % 428 1,490 eTon Pharmaceuticals, Inc. First lien 11/13/24 5,845 6,047 10.0 % 244 742 Exeevo, Inc. First lien 07/01/27 5,452 5,423 15.0 % 230 684 MedMinder Systems, Inc. First lien 08/18/27 20,000 20,037 12.9 % 725 2,122 MolecuLight, Inc. First lien 12/29/26 10,000 10,183 12.8 % 479 1,385 NeoLight, LLC First lien 02/17/27 5,000 4,994 13.5 % 213 506 SKNV First lien 05/15/27 13,497 13,682 10.4 % 527 1,526 Trio Healthcare Ltd. First lien (3) 07/01/26 9,152 9,128 12.5 % — 749 Revenue Recognized Marketable Investments Number of Shares Footnote Funded Amount GAAP Balance 3Q23 Year-to- Date Secured Royalty Financing (Marketable Investment) N/A (2), (3) $ 3,000 $ 50 $ — $ — Epica International, Inc. 25,000 N/A — — — SKNV 26,575 N/A — — — 24 Other Income (Loss) Recognized Warrants to Purchase Stock Number of Shares Footnote Exercise Price per Share ($) GAAP Balance 3Q 2023 Year-to- Date 4Web, Inc. TBD $ — $ — $ — $ — AOTI, Inc. 92,490 — — — — Acer Therapeutics, Inc. 150,000 2.46 110 (3 ) (187 ) Acer Therapeutics, Inc. 100,000 1.51 76 (3 ) (134 ) Acer Therapeutics, Inc. 250,000 2.39 181 (6 ) (263 ) Acer Therapeutics, Inc. 500,000 1.00 392 (30 ) 15 Acerus Pharmaceuticals Corporation — — — — (5 ) Aziyo Biologics, Inc. 157,895 6.65 191 (134 ) (324 ) Aziyo Biologics, Inc. 30,075 6.65 36 1 (62 ) BIOLASE, Inc. 22,039 9.80 1 — (4 ) Biotricity, Inc. 57,536 6.26 8 (10 ) (3 ) CDMO Manufacturer 211,442 1.42 — — — CeloNova BioSciences, Inc. TBD — — — — DxTerity Diagnostics, Inc. 2,019,231 — — — — Epica International, Inc. TBD — — — — eTon Pharmaceuticals, Inc. 51,239 5.86 98 37 55 eTon Pharmaceuticals, Inc. 18,141 6.62 36 14 21 Exeevo, Inc. 930 — — — — EyePoint Pharmaceuticals, Inc. 40,910 11.00 146 (24 ) 126 EyePoint Pharmaceuticals, Inc. 7,773 19.30 22 (4 ) 20 MedMinder Systems, Inc. 72,324 — — — — MolecuLight, Inc. TBD — — — — Revenue Recognized Assets 3Q 2023 Year-to-Date Total finance receivables, gross $ 234,931 $ 8,608 $ 27,146 Total marketable investments 50 N/A N/A Fair value of warrant assets 1,297 N/A N/A Total assets, gross/revenues $ 236,278 $ 8,608 $ 27,146 (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) Investment was paid off during the nine months ended September 30, 2023. (5) Flowonix Medical assets were sold to Algorithm Sciences, Inc. during the nine months ended September 30, 2023. In exchange for releasing its lien, SWK received cash at close and is expected to receive royalties on sales of two products. The finance receivable is now classified as a royalty. (6) In July 2023, Ideal Implant assets were sold to an aesthetics company, which is expected to pay SWK a mid-single digit, capped royalty on implant sales beginning in 2024. (7) Loan was sold to a third party during the nine months ended September 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. 25 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 nine months ended September 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 September 30, 2023 and 2022 ( in millions ) Three Months Ended September 30, 2023 2022 Change $ Revenues $ 9.0 $ 13.6 $ (4.6 ) Provision for credit losses 0.2 — 0.2 Interest expense 0.2 0.1 0.1 Pharmaceutical manufacturing, research and development expense 0.6 1.8 (1.2 ) Depreciation and amortization expense 0.7 0.6 0.1 General and administrative 3.0 4.3 (1.3 ) Other (expense) income, net (0.2 ) 1.8 (2.0 ) Income tax expense (0.4 ) 1.9 (2.3 ) Net income 4.5 6.6 (2.1 ) Revenues Revenues decreased to $9.0 million for the three months ended September 30, 2023 from $13.6 million for the three months ended September 30, 2022. The $4.6 million decrease in revenue for the three months ended September 30, 2023 consisted of a $4.7 million decrease in Pharmaceutical Development segment revenue and a $0.1 million increase in Finance Receivables segment revenue. The $4.7 million decrease in Pharmaceutical Development segment revenue was primarily due to $5.0 million of milestone revenue related to Enteris’ License Agreement with Cara received during the three months ended September 30, 2022, and no similar milestone revenue was recognized during the three months ended September 30, 2023. The $0.1 million increase in Finance Receivables segment revenue was primarily the result of an increase in reference rates. 26 Provision 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 increased by $0.2 million during the three months ended September 30, 2023. The increase in the provision for credit losses resulted from the reclassification of a term loan to a royalty during the three months ended September 30, 2023, as our royalties have slightly higher historic loss rates than our term loans. Please refer to Part I. Financial Information, 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 and the reclassification of the Flowonix term loan to a royalty. 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 $0.2 million for three months ended September 30, 2023 from $0.1 million for the three months ended September 30, 2022. The $0.1 million increase in interest expense was due to an increase in debt issuance costs and unused line fees related to the First Horizon Credit Agreement signed on June 28, 2023, which increased our line of credit from $30.0 million to $45.0 million. 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 Part I. Financial Information, 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 $1.8 million for the three months ended September 30, 2022 to $0.6 million for the three months ended September 30, 2023. The $1.2 million decrease was primarily due to a reduction in headcount, as well as a reduction in research and development and clinical trial expenditures. Depreciation and Amortization Depreciation and amortization expense increased from $0.6 million for the three months ended September 30, 2022 to $0.7 million for the three months ended September 30, 2023. 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 $3.0 million for the three months ended September 30, 2023 from $4.3 million for the three months ended September 30, 2022. The $1.3 million decrease was primarily driven by a one-time severance payment of $1.1 million paid to the former CEO during the three months ended September 30, 2022, as well as a $0.4 million decrease in one-time professional fees expense related to corporate strategic planning. The decrease was partially offset by $0.2 million increase in Board fees and other related expense due to a revised Board compensation plan. Other (Expense) Income, Net Other expense, net for three months ended September 30, 2023 reflected a net aggregate fair market value loss of $0.2 million on our warrant derivatives and a $0.1 million net loss from the remeasurement of foreign currency transactions into our functional currency, net of changes in fair value of the foreign currency forward contract. Other income, net for the three months ended September 30, 2022 reflected a net aggregate fair market value gain of $1.8 million on our warrant derivatives and Bioventus, Inc. (“Bioventus”) common stock. Our Bioventus common stock was sold during the year ended December 31, 2022. 27 Income Tax (Benefit) Expense During the three months ended September 30, 2023 and 2022, we recognized income tax benefit of $0.4 million and $1.9 million of income tax expense, respectively. The decrease in income tax expense is primarily due to a decrease in taxable income for the three months ended September 30, 2023 when compared to the same period of the previous year, as well as the additional release of the valuation allowance on our deferred tax assets resulting from an increase in management's forecasted future taxable income in 2023 when compared to 2022. Comparison of the nine months ended September 30, 2023 and 2022 ( in millions ) Nine Months Ended September 30, 2023 2022 Change $ Revenues $ 27.9 $ 31.7 $ (3.8 ) Benefit from credit losses (0.5 ) — (0.5 ) Interest expense 0.7 0.2 0.5 Pharmaceutical manufacturing, research and development expense 2.8 5.2 (2.4 ) Depreciation and amortization expense 1.9 2.0 (0.1 ) General and administrative 8.5 10.5 (2.0 ) Other (expense) income, net (0.3 ) 0.1 (0.4 ) Income tax expense 1.0 3.2 (2.2 ) Net income 13.0 10.7 2.3 Revenues Revenues decreased to $27.9 million for the nine months ended September 30, 2023 from $31.7 million for the nine months ended September 30, 2022. The $3.8 million decrease in revenue for the nine months ended September 30, 2023 consisted of a $5.3 million decrease in Pharmaceutical Development segment revenue and a $1.5 million increase in Finance Receivables segment revenue. The $5.3 million decrease in Pharmaceutical Development segment revenue was primarily due to $5.0 million of milestone revenue related to Enteris’ License Agreement with Cara received during the nine months ended September 30, 2022, and no similar milestone revenue was recognized during the nine months ended September 30, 2023. The $1.5 million increase in Finance Receivables segment revenue was primarily due to $6.5 million increase in interest and fees earned due to funding new and existing loans and a $4.1 million increase in interest earned on our finance receivables due to an overall increase in reference rates. The increase was partially offset and a net $0.7 million decrease in royalty revenue when compared to the same period of the previous year and an $8.5 million decrease in interest, royalties and fees earned on finance receivables that were paid off in 2022 and 2023. Benefit from 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. We recognized a $0.5 million benefit for credit losses during the nine months ended September 30, 2023. The decrease in the provision for credit losses resulted from an overall decrease in our finance receivables. The decrease was partially offset by the addition of a term loan, as well as the reclassification of a term loan to a royalty during the nine months ended September 30, 2023, as our royalties have slightly higher historic loss rates than our term loans. Please refer to Part I. Financial Information, 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 and the reclassification of the Flowonix term loan to a royalty. 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 $0.7 million for the nine months ended September 30, 2023 from $0.2 million for the nine months ended September 30, 2022. This $0.5 million increase in interest expense was due to the acceleration of debt issuance costs related to the Prior Credit Agreement with Cadence Bank, as well as interest expense incurred on both the Prior Credit Agreement and the new Credit Agreement with First Horizon Bank. 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 Part I. Financial Information, 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. 28 Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense decreased from $5.2 million for the nine months ended September 30, 2022 to $2.8 million for the nine months ended September 30, 2023. The $2.4 million decrease was primarily due to a reduction in headcount, as well as a reduction in research and development and clinical trial expenditures. Depreciation and Amortization We recognized $1.9 million and $2.0 million of depreciation and amortization expense during both the nine months ended September 30, 2023 and 2022, respectively. 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 $8.5 million for the nine months ended September 30, 2023 from $10.5 million for the nine months ended September 30, 2022. The $2.0 million decrease was primarily driven by a one-time severance payment of $1.1 million paid to the former CEO during the three months ended September 30, 2022; a $0.7 million decrease in one-time professional fees and other expense related to corporate strategic planning; and a net $0.4 million decrease in Enteris operational expenses due to a reduction in headcount and business development expense. The decrease was partially offset by $0.2 million increase in Board fees and other related expense due to a revised Board compensation plan. Other (Expense) Income, Net Other expense, net for the nine months ended September 30, 2023 reflected a net aggregate fair market value loss of $0.8 million on our warrant derivatives and a $0.4 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 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, Inc. (“Bioventus”) common stock. Our Bioventus common stock was sold during the year ended December 31, 2022. Income Tax Expense During the nine months ended September 30, 2023 and 2022, we recognized income tax expense of $1.0 million and $3.2 million, respectively. The decrease in income tax expense is primarily due to the additional release of the valuation allowance on our deferred tax assets resulting from an increase in management's forecasted future taxable income in 2023 when compared to 2022. Liquidity and Capital Resources As of September 30, 2023, we had $31.0 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 $24.9 million increase in our cash balance was $43.9 million of interest, fees, principal and royalty payments received on our finance receivables and a $19.6 million net increase on our credit facility. The increase in cash and cash equivalents was partially offset by $18.8 million of investment funding, net of deferred fees and origination expenses; payroll, accounts payable and credit facility closing costs of $14.1 million; and $6.1 million to repurchase shares of the Company’s common stock in the open market. 29 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 September 30, 2023, $22.0 million was outstanding under the new Credit Agreement, and $23.0 million was available for borrowing. On October 10, 2023, the Company entered into a First Amendment to Credit Agreement pursuant to which Woodforest National Bank was added as a lender under the Credit Agreement for an aggregate commitment of $15.0 million, thereby increasing the aggregate commitments under the Credit Agreement from $45.0 million to $60.0 million. Our Prior Credit Agreement with Cadence Bank was terminated in connection with the establishment of the new Credit Agreement (please refer to Part I. Financial Information, Item 1. Financial Statements, Notes 5 and 10 of the notes to the unaudited condensed consolidated financial statements for further information regarding the Credit Agreement with First Horizon Bank). On October 3, 2023, the Company completed a registered underwritten public offering of $30.0 million of the Company’s 9.00 percent Senior Notes due 2027 (the “Notes”). On October 27, 2023, the underwriters exercised their option to purchase an additional $2,9 million in aggregate principal amount of the Notes. The Notes will mature on January 31, 2027, unless earlier redeemed, and will bear interest at a rate of 9.00 percent per annum, payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year and at maturity, commencing on December 31, 2023. The Company received net proceeds after discounts and commissions, but before expenses and fees, of approximately $31.9 million. 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, 2023, our finance receivables portfolio contains $223.6 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 September 30, 2023, we had $7.4 million of unfunded commitments. Please refer to Part I. Financial Information, 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. 30