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, 2023 (“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. 27 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, 2024 (in thousands, except rate, share and per share data): Revenue (Loss) Recognized Royalty Purchases Licensed Technology Funded Amount GAAP Balance Q3 2024 Year-to-Date Besivance® (1) Ophthalmic antibiotic $ 6,000 $ — $ 8 $ 25 Best ABT, Inc. (2), (3) Oncology diagnosis 5,784 2,377 — — Coflex®/Kybella® Spinal stenosis/submental fullness 4,350 3,117 125 207 Cambia® (4) NSAID migraine treatment 8,500 — 108 319 Duo Royalty Japanese Women's health/cystic fibrosis 15,353 12,652 597 1,775 Flowonix Medical, Inc. (3), (5) Drug delivery device 12,455 10,433 — — Forfivo XL® Depressive disorder treatment 6,000 1,285 277 1,002 Ideal Implant, Inc. (3), (6) Aesthetics 4,025 3,552 — — Immune Globuin (8) Immune Globulin Therapeutics 14,100 11,689 414 1,301 Iluvien® (9) Diabetic macular edema 16,501 16,038 598 1,383 Relief Rare Disease Portfolio 7,701 7,839 161 161 Veru, Inc. (9) Women's health 10,000 3,290 (228) 387 Revenue (Loss) Recognized Term Loans Type Maturity Date Principal GAAP Balance Rate Q3 2024 Year-to-Date 4Web, Inc. First lien 12/31/24 $ 23,736 $ 26,329 11.3% $ 1,143 $ 3,655 AOTI, Inc. First lien 03/21/27 8,478 8,580 11.2% 420 1,514 Elutia, Inc. First lien 08/10/27 21,045 23,518 12.0% 950 2,860 BIOLASE, Inc. (3) First lien 05/31/25 14,770 15,846 10.3% (226) 916 Biotricity, Inc. First lien 12/21/26 12,364 12,701 11.5% 606 1,717 CDMO Manufacturer First lien 09/13/27 5,000 5,230 13.3% 206 606 Epica International, Inc. First lien 07/23/24 — — 11.5% 221 957 eTon Pharmaceuticals, Inc. First lien 09/30/27 4,305 3,583 12.1% 203 616 Journey Medical Corporation First lien 12/27/27 20,000 19,894 12.8% 722 1,805 Exeevo, Inc. (2), (3) First lien 07/01/27 4,558 4,538 12.8% — 8 MedMinder Systems, Inc. First lien 08/18/27 20,000 20,293 12.3% 780 2,270 MolecuLight, Inc. First lien 12/29/26 10,881 11,211 12.8% 501 1,438 Nicoya Lifesciences, Inc. First lien 11/30/26 6,000 6,102 12.8% 262 784 NeoLight, LLC First lien 02/17/27 5,000 5,191 13.5% 267 746 Shield Therapeutics, Plc First lien 09/28/28 20,000 19,579 14.3% 833 2,471 SKNV First lien 05/15/27 13,497 13,907 10.4% 550 1,596 Trio Healthcare Ltd. (2), (3) First lien 07/01/26 1,497 1,473 12.5% — — 28 Revenue (Loss) Recognized Marketable Investments Number of Shares Funded Amount GAAP Balance Q3 2024 Year-to-Date Secured Royalty Financing (Marketable Investment) (2), (3) N/A $ 3,000 $ 28 $ — $ — AOTI Common Stock (7) 402,634 N/A $ 727 $ — $ — Change in Fair Value Warrants to Purchase Stock Number of Shares Exercise Price per Share ($) GAAP Balance Q3 2024 Year-to-Date 4Web, Inc. TBD $ — $ — $ — $ — Aziyo Biologics, Inc. 157,895 6.65 348 (188) 65 Aziyo Biologics, Inc. 30,075 6.65 66 (36) 13 BIOLASE, Inc. 22,039 9.80 1 — — Biotricity, Inc. 57,536 6.26 1 (1) (3) CDMO Manufacturer 211,442 1.42 — — — CeloNova BioSciences, Inc. TBD — — — — DxTerity Diagnostics, Inc. 2,019,231 — — — — Epica International, Inc. TBD — — — — eTon Pharmaceuticals, Inc. 1 51,239 5.86 106 56 9 eTon Pharmaceuticals, Inc. 2 18,141 6.62 38 19 2 eTon Pharmaceuticals, Inc. 3 289,736 — 1,072 — — Exeevo, Inc. 930 — — — — EyePoint Pharmaceuticals, Inc. 40,910 11.00 — — 127 EyePoint Pharmaceuticals, Inc. 7,773 19.30 — — 22 Shield Warrant 8,910,540 394 197 (57) MedMinder Systems, Inc. 72,324 — — — — MolecuLight, Inc. TBD — — — — Revenue (Loss) Recognized Assets 3Q 2024 Year-to-Date Total finance receivables, gross $ 270,247 $ 9,498 $ 30,519 Total marketable investments 755 — — Total fair value of warrant assets 2,026 — — Total $ 273,028 $ 9,498 $ 30,519 (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 non-accrual. (4) Investment was paid off during the nine months ended September 30, 2023. SWK continues to receive royalties on actual sales. (5) Flowonix Medical assets were sold to a medical device company 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 in 2024. (7) AOTI warrants exercised and converted to shares. (8) During each of the three months ended June 30, 2024 and September 30, 2024, the Company identified errors relating to prior periods (three months ended March 31, 2024 and June 30, 2024) which were immaterial and corrected in those respective periods. See Note 1 for more details. 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. 29 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, 2024, 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, 2024 and 2023 ( in millions ) Three Months Ended September 30, 2024 2023 Change $ Revenues $ 10.4 $ 9.0 $ 1.4 Provision for credit losses 1.4 0.2 1.2 Interest expense 1.1 0.2 0.9 Pharmaceutical manufacturing, research and development expense 0.6 0.6 — Depreciation and amortization expense 0.2 0.7 (0.5) General and administrative expense 3.0 3.0 — Other income (expense), net 0.3 (0.2) 0.5 Income tax expense (benefit) 0.9 (0.4) 1.3 Net income 3.5 4.5 (1.0) Revenues Revenues increased to $10.4 million for the three months ended September 30, 2024 from $9.0 million for the three months ended September 30, 2023. The $1.4 million increase in revenue for the three months ended September 30, 2024 was primarily due to a $0.9 million increase in Finance Receivables segment revenue and a $0.3 million increase in Pharmaceutical Development segment revenue. The $0.9 million increase in Finance Receivables segment revenue was primarily due to an increase of $2.1 million in interest and fees earned due to funding new and existing loans offset by $1.2 million decrease in interest, fees and royalties earned on finance receivables that were paid off during the period. Provision for Credit Losses Our provision 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 net provision for credit losses of $1.4 million during the three months ended September 30, 2024 and $0.2 million during three months ended September 30, 2023, respectively. See Note 3 to the unaudited condensed consolidated financial statements for further information on the allowance for credit losses. Interest Expense Interest expense consists of interest accrued on our revolving line of credit, 9.00% Senior Notes due 2027, unused line of credit and maintenance fees, as well as amortization of debt issuance costs. Interest expense increased to $1.1 million for the three months ended September 30, 2024 from $0.2 million for the three months ended September 30, 2023. The $0.9 million increase in interest expense was due to issuing approximately $32.9 million of Notes in an underwritten public offering in October of 2023. See Note 5 for further information on the Notes, new Credit Agreement, and Prior Credit Agreement. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense remained consistent for the three months ended September 30, 2024 as compared to the same period in the previous year resulting in an immaterial change in total activity. 30 Depreciation and Amortization Expense The $0.5 million decrease in depreciation and amortization expense for the three months ended September 30, 2024 primarily consisted of a decrease in amortization expense related to no longer amortizing intangible assets related to the Cara license as the intangible assets were fully impaired during the three months ended June 30, 2024. Amortization expense is aligned with the expected future cash flows of the intangible assets. General and Administrative Expense 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 stayed flat at $3.0 million for the three months ended September 30, 2024 and 2023 resulting in an immaterial change in total activity between the periods. Other Income (expense), Net Other income, net increased to $0.3 million for the three months ended September 30, 2024 from other expense, net of $0.2 million for the three months ended September 30, 2023. The $0.5 million increase includes gains on foreign currency transactions and unrealized gains on warrants related to changes in fair value of warrant assets. Income Tax Expense During the three months ended September 30, 2024 we recognized $0.9 million of income tax expense, for the three months ended September 30, 2023 we recognized an income tax benefit of $0.4 million. Income tax expense increased period over period due to the release of valuation allowance on deferred tax assets of $1.1 million during the three months ended September 30, 2023 and an increase in the Company's effective tax rate, which was 22.8% and 13.6% as of September 30, 2024 and 2023, respectively. 31 Comparison of the nine months ended September 30, 2024 and 2023 ( in millions ) Nine Months Ended September 30, 2024 2023 Change $ Revenues $ 32.6 $ 27.9 $ 4.7 Provision (benefit) for credit losses 10.8 (0.5) 11.3 Loss on impairment of intangible assets 5.8 — 5.8 Interest expense 3.5 0.7 2.8 Pharmaceutical manufacturing, research and development expense 1.6 2.8 (1.2) Change in fair value of acquisition-related contingent consideration (4.9) — (4.9) Depreciation and amortization expense 1.2 1.9 (0.7) General and administrative expense 8.6 8.5 0.1 Other income (expense), net 3.7 (0.3) 4.0 Income tax expense 2.2 1.0 1.2 Net income 7.6 13.0 (5.4) Revenues Revenues increased to $32.6 million for the nine months ended September 30, 2024 from $27.9 million for the nine months ended September 30, 2023. The $4.7 million increase in revenue for the nine months ended September 30, 2024 consisted of a $3.7 million increase in Finance Receivables segment revenue and a $1.1 million increase in Pharmaceutical Development segment revenue. The $3.7 million increase in Finance Receivables segment revenue was primarily due to a $6.3 million increase in interest and fees earned due to funding new and existing loans offset by $2.4 million decrease in interest, fees and royalties earned on finance receivables that were paid off during the period. The increase in the Pharmaceutical Development segment was primarily due to the Aptar collaboration agreement. Provision (Benefit) for Credit Losses Our provision 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 net provision for credit losses of $10.8 million during the nine months ended September 30, 2024 and a $0.5 million benefit during nine months ended September 30, 2023, respectively. Most of the change was related to a $8.1 million impairment on the Trio loan and $2.2 million impairment on the Exeevo loan that were included within the provision for credit losses during the nine months ended September 30, 2024. See Note 3 to the unaudited condensed consolidated financial statements for further information on the allowance for credit losses. Interest Expense Interest expense consists of interest accrued on our revolving line of credit, 9.00% Senior Notes due 2027, unused line of credit and maintenance fees, as well as amortization of debt issuance costs. Interest expense increased to $3.5 million for the nine months ended September 30, 2024 from $0.7 million for the nine months ended September 30, 2023. The $2.8 million increase in interest expense was mainly due to issuing approximately $32.9 million of Notes in an underwritten public offering in October of 2023. See Note 5 for further information on the Notes, new Credit Agreement, and Prior Credit Agreement. Pharmaceutical Manufacturing, Research and Development Expense Pharmaceutical manufacturing, research and development expense decreased from $2.8 million for the nine months ended September 30, 2023 to $1.6 million for the nine months ended September 30, 2024. The $1.2 million decrease was primarily due to a reduction in research and development and clinical trial expenditures related to cancelled projects during the period and bonus expense during the previous year. Depreciation and Amortization Expense The $0.7 million decrease in depreciation and amortization expense for the nine months ended September 30, 2024 primarily consists of a decrease in amortization expense related to no longer amortizing intangible assets related to the Cara license as the intangible assets were fully impaired during the three months ended June 30, 2024. Amortization expense is aligned with the expected future cash flows of the intangible assets. See Note 4 for more information on the impairment of the Cara license. 32 General and Administrative Expense 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 $8.6 million for the nine months ended September 30, 2024 from $8.5 million for the nine months ended September 30, 2023 resulting in an immaterial change in total activity between the periods. Other Income (Expense), Net Other income (expense), net increased to $3.7 million for the nine months ended September 30, 2024 from an expense of $0.3 million for the nine months ended September 30, 2023. The $4.0 million increase includes a $2.5 million gain on revaluation related to the Iluvien royalty after a contractual re-negotiation, a $1.0 million gain on unrealized foreign currency transactions, a gain of $0.5 million due to the exercise of warrants. Income Tax Expense During the nine months ended September 30, 2024 and 2023 we recognized $2.2 million and $1.0 million of income tax expense, respectively. Income tax expense increased period over period due to the release of valuation allowance on deferred tax assets of $1.0 million during the nine months ended September 30, 2023 and an increase in the Company's effective tax rate to 22.8% as of September 30, 2024 from 13.6% for the same period in the prior year. 33 Liquidity and Capital Resources As of September 30, 2024, we had $17.2 million in cash and cash equivalents, compared to $5.2 million as of December 31, 2023. The primary driver of the $12.0 million increase in our cash balance was $57.0 million of interest, fees, principal and royalty payments received on our finance receivables and $3.3 million of cash receipts from pharmaceutical development revenues. The increase in cash and cash equivalents was partially offset by $18.6 million of investment funding, net of deferred fees and origination expenses, a net credit facility payment of $12.4 million, a payroll and benefits expense of $4.3 million, $8.0 million of payments on accounts payable, and share repurchases of $5.2 million. We entered into a $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. 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. As of September 30, 2024, there was no outstanding amount under the new Credit Agreement, and $55.0 million was available for borrowing. The $60.0 million Credit Agreement contains a $5.0 million liquidity covenant, bringing the total amount available for borrowing to $55.0 million. Our Prior Credit Agreement with Cadence Bank was terminated in connection with the establishment of the new Credit Agreement (please refer to Part II, Item 8, Financial Statements and Supplementary Data, Note 6 of the notes to the 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 Notes. On October 27, 2023, the underwriters exercised their option to purchase an additional approximately $3.0 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% 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, commissions, expenses and fees, of approximately $30.6 million. See Note 5 for more information. Primary Driver of Cash Flow 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, 2024, our finance receivables portfolio contains $255.9 million of net finance receivables and $0.8 million of marketable investments. We expect these assets to generate positive cash flows in 2024. 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. Changes in interest rates, including the levels of 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 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 2024. 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 34 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, 2024, we had $39.0 million in 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. 35