SWK Holdings Corp annual report, FY2012

SWK Holdings Corporation — 2012 Form 10-K

Reporting period: Fiscal year ended December 31, 2012; this annual filing reports full-year results, not standalone fourth-quarter results. SWK shifted in May 2012 from seeking acquisitions after its 2009 asset sale to a specialty-finance and asset-management strategy focused on life-science businesses, commercial-product royalties, and related financing. The company also provides investment-advisory services.

Financial results and position

Metric	2012	2011
Revenue	$637,000	$0
General and administrative expense	$2.240 million	$1.545 million
Operating loss	$1.603 million	$1.545 million
Net loss	$1.421 million	$1.066 million
Net loss per share, basic and diluted	$0.03	$0.03
Cash used in operating activities	$1.115 million	$1.225 million
Cash and cash equivalents at year-end	$24.584 million	$38.203 million
Working capital	$26.0 million	$38.1 million

• 2012 revenue comprised $337,000 in loan-syndication fees, $160,000 in finance-receivable interest, and $140,000 from acquired advisory-contract interests. Revenue was new under the revised strategy; the filing reports no 2011 revenue.
• G&A rose 45%, primarily reflecting a $497,000 increase in stock-based compensation. Interest and other income fell to $158,000 from $284,000; cash interest income declined to $158,000 from $254,000, and the prior-year warrant fair-value gain did not recur.
• Year-end assets were $45.320 million, liabilities $1.132 million, and total equity $44.188 million, including $7 million of non-controlling interests. The balance sheet shows no debt outstanding; the $6.5 million finance receivable is an investment asset, not company borrowing. Cash includes $1 million of restricted cash for a loan interest reserve.
• Investing activities used $19.504 million, primarily for $6.5 million in finance receivables and a $13 million investment in a partnership. Financing activities provided $7 million from non-controlling investors. Cash declined by $13.619 million overall.
• Operating margin was negative: the $1.603 million operating loss exceeded $637,000 of revenue. The filing does not present a positive operating margin or a standalone fourth-quarter margin.

Material changes and transactions

• In December, SWK arranged a $22.5 million, five-year term loan to a neurology-focused specialty pharmaceutical company. SWK retained $6.5 million and assigned $12.5 million of its commitment to advisory clients. SWK earned a $337,500 arranger fee. The loan has a minimum interest rate of 16%, is secured by substantially all borrower assets, and repays through a tiered revenue-interest mechanism; the lenders are also entitled to an exit fee.
• SWK invested $6 million through a consolidated partnership in a $13 million acquisition of U.S. marketing rights to InnoPran XL; third parties contributed the remaining $7 million. SWK accounts for its partnership interest in the product-rights entity under the equity method.
• SWK paid $150,000, treated as compensation expense, for interests in three revenue-producing client contracts from PBS Capital Management, controlled by the CEO and Managing Director. Additional earn-out payments run through 2016. The seller may repurchase the interest for $1 if either executive’s employment contract is not renewed.
• Common shares outstanding increased to 42,894,894 from 41,647,394. Stock-based compensation expense increased to $586,000 from $81,000.

Outlook, risks, and contingencies

• Management expected the two initial strategy transactions to generate income exceeding operating expenses in 2013 and said future investments could add income with limited additional operating expense. It continued to evaluate opportunities, but acknowledged that investment timing is uncertain and positive cash flow beyond that expected from existing assets was not assured. These are management expectations, not quantified earnings guidance.
• Management estimated liquidity was adequate for operating activities for the 12 months following year-end. It also warned that low rates would keep returns on cash immaterial. No specific forward revenue or earnings targets were provided.
• The business had a limited execution history, only two completed transactions under the new strategy, and a concentrated portfolio. Two customers generated 78% and 11% of 2012 revenue and 81% and 16% of accounts receivable, respectively.
• Principal risks include borrower default and product-sales underperformance; reliance on third parties to market royalty-generating products; life-sciences regulation, competition, patent and product risks; limited information about private companies; and dependence on key executives, co-investors, and access to additional financing.
• SWK reported approximately $448 million in federal and $41 million in state net operating loss carryforwards, but recorded a full valuation allowance against deferred tax assets. Federal NOLs began expiring in 2012, with most expected to expire by 2021; use may be limited by ownership changes under tax law.
• The company stated it was not involved in a legal proceeding expected to have a material effect. The previously disclosed lawsuit naming SWK as a nominal defendant ended after the plaintiff’s voluntary dismissal in June 2012. The filing reports no material off-balance-sheet arrangements.
• SWK’s shares traded on the OTC Bulletin Board, and it reported two full-time employees at year-end. It had not paid cash dividends and did not anticipate doing so in the foreseeable future. The filing’s cover page checked “shell company,” a status investors may wish to reconcile with the operating strategy and transactions described.

Key facts for investors to verify

• Whether the loan borrower and InnoPran XL rights generate the cash flows management expected, and the status of payments, collateral, and the loan’s exit fee.
• The performance, valuation, and cash distributions of SWK’s partnership investment, including the rights and economics of its third-party investors.
• How concentrated 2012 revenue and receivables remain, and whether the advisory-contract earn-out and repurchase terms affect future revenue.
• Cash available for investment after restricted balances and operating needs, and whether additional external capital will be required to execute the strategy.
• The practical usability and remaining expiration schedule of NOLs, including any ownership-change limitations.
• The extent of potential dilution from equity awards: 1.68 million options and 1.648 million restricted shares were reported outstanding at year-end; the restricted shares were not yet included in basic EPS.