SWK Holdings Corporation — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. SWK is a specialty finance and asset-management company focused on lending to life-sciences businesses and acquiring royalties and other product-related revenue interests. Unless noted otherwise, financial amounts below are in millions of dollars.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $5.9 | $5.5 | $19.5 | $26.4 |
| Credit-loss provision and impairment expense | $12.8 | — | $14.0 | — |
| Net income (loss) attributable to SWK | $(5.7) | $2.8 | $1.6 | $11.4 |
| Basic and diluted earnings (loss) per share | $(0.44) | $0.21 | $0.12 | $0.87 |
- Q3 revenue consisted primarily of finance-receivable interest and fees, up $0.4 million year over year as the portfolio grew. Nine-month revenue fell $6.9 million because 2017 included $10.5 million of income from an unconsolidated investment; finance-receivable interest and fees increased $3.7 million.
- Q3 results included $5.3 million of impairment on ABT’s second-lien loan, a $5.0 million credit-loss allowance on ABT’s first-lien loan, and $2.5 million of Hooper impairment. The nine-month credit-loss provision also included $1.2 million on the Cambia royalty investment.
- At September 30, finance receivables were $165.6 million, net of a $7.8 million allowance, versus $152.0 million net and a $1.7 million allowance at December 31, 2017. Nonaccrual term loans were $29.5 million, up from $11.4 million.
- Total assets were $213.1 million; cash and cash equivalents were $19.2 million, down from $30.6 million at year-end 2017. Stockholders’ equity was $209.7 million. The balance sheet reported $3.4 million of liabilities and no drawn debt.
- Nine-month operating cash flow was $15.0 million; investing cash outflow was $25.8 million and financing cash outflow was $0.5 million. Cash declined by $11.3 million over the period.
- A $20 million revolving facility was established in June, maturing in 2021; none was drawn at quarter-end, leaving $20 million available. It bears interest at Daily LIBOR, subject to a 1% floor, plus 3.25%, and includes financial covenants. Unfunded investment commitments totaled $9.8 million.
Material changes, outlook and risks
- Q3 shifted from a $2.8 million profit to a $5.7 million loss, primarily due to the credit provisions and impairments. Nine-month SWK-attributable income fell from $11.4 million to $1.6 million.
- Cash deployment into new and add-on investments was $68.4 million, partly offset by $42.5 million of finance-receivable repayments and receipts, including $13.7 million related to Narcan and $22 million from two payoffs.
- ABT: After quarter-end, a bankruptcy-court-approved asset sale to Best provided for $500,000 in installments over ten years plus a 10% royalty on net sales for ten years. The filing recorded the related Q3 impairments and allowance using estimated values and cash flows; the outcome and realized recovery remain important uncertainties.
- Hooper Holmes: The asset sale closed October 10, 2018. SWK received $15.6 million and expected another $0.2 million; the loan was written down to its realizable value, with a $2.5 million Q3 impairment.
- Other credit exposures: B&D Dental was in default and evaluating strategic alternatives; its loan remained on nonaccrual. Cambia royalty expectations had weakened, resulting in a $1.2 million allowance earlier in 2018. The portfolio’s concentration in life sciences exposes SWK to sector and borrower-specific credit risk.
- In October, SWK funded $9.0 million of an $11.0 million maximum term loan to Acerus, with $2.0 million available subject to conditions; the loan includes a warrant. Management said existing assets were expected to generate positive cash flows in 2018, but cautioned that investment timing could prevent positive cash flow beyond that generated by existing assets. No formal earnings guidance was provided.
- SWK disclosed $377 million of federal NOL carryforwards, mostly expiring by 2021, and said it did not expect its current strategy to generate enough income to use all NOLs before expiration. Management also expects the upcoming CECL accounting standard could result in more upfront portfolio losses.
- Interest-rate changes could affect borrowing costs and investment returns, particularly if the revolving facility is drawn. Management reported disclosure controls were effective, no material changes to internal controls, no material changes to previously disclosed risk factors, and no legal proceedings expected to have a material effect.
Key investor verification points
- Confirm realized recoveries and remaining costs for ABT, including the final transaction consideration, royalty terms, and estimated exit costs.
- Track Hooper’s remaining expected $0.2 million receipt and reconcile the sale proceeds with the Q3 impairment measurement.
- Monitor nonaccrual and impaired exposures, especially B&D, and changes in the allowance for credit losses.
- Assess cash deployment, the $9.8 million of conditional commitments, and any use of the $20 million revolver against its borrowing-base and covenant requirements.
- Evaluate portfolio cash collections, concentration risk, and whether the company can generate taxable income to use its expiring NOL carryforwards.