SWK Holdings Corporation — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. SWK provides specialty financing to life-sciences businesses, primarily through secured loans, royalty purchases and revenue interests. Unless indicated otherwise, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $6.767 | $6.074 | $13.588 | $20.938 |
| Finance receivable interest and fees | $6.764 | $5.734 | $13.581 | $10.390 |
| Credit-loss provision | — | — | $1.179 | — |
| General and administrative expense | $1.178 | $0.951 | $2.399 | $1.612 |
| Consolidated net income | $3.668 | $3.580 | $7.312 | $13.849 |
| Net income attributable to SWK shareholders | $3.668 | $3.409 | $7.312 | $8.645 |
| Diluted EPS | $0.28 | $0.26 | $0.56 | $0.66 |
Revenue increased about 11% in Q2, as the larger finance-receivable portfolio lifted interest and fee income. Six-month revenue fell about 35% because the prior-year period included $10.5 million of equity-method income related to the Holmdel/InnoPran XL transaction, with no comparable 2018 income. Six-month shareholder net income declined about 15%; consolidated net income declined about 47%, partly reflecting the prior-year non-controlling interest. Net income divided by revenue was approximately 54% in Q2 2018 versus 59% in Q2 2017, and 54% for the first half versus 66% in 2017.
Q2 results included $0.8 million of net other expense, mainly unrealized losses of $0.5 million on equity securities and $0.2 million on derivatives. First-half results included a $1.2 million credit-loss provision on a royalty purchase, associated with lower expected Cambia royalty receipts. Management cited higher performance-based bonus accruals as the main reason G&A rose.
Financial position, cash flow and liquidity
- At June 30, cash and cash equivalents were $21.281 million, down from $30.557 million at December 31, 2017. Finance receivables, net, were $170.661 million, up from $151.995 million; total assets were $217.316 million and stockholders’ equity was $215.404 million.
- Finance receivables before allowance were $173.499 million, with a $2.838 million allowance (up from $1.659 million at year-end). Nonaccrual term loans, net of allowance, increased to $32.212 million from $11.402 million. Four loans across three borrowers were on nonaccrual; only one was classified as impaired. Impaired loans measured at fair value were $12.269 million.
- Total liabilities were $1.912 million, including $0.370 million drawn on the new $20 million revolving facility; $19.6 million was available at quarter-end. The facility matures June 29, 2021, carries Daily LIBOR subject to a 1% floor plus 3.25%, and includes asset-coverage and interest-coverage covenants.
- First-half operating cash flow was $9.089 million, versus $6.052 million in 2017. Investing cash flow was an outflow of $18.217 million, compared with an inflow of $7.161 million, primarily reflecting $46.710 million of finance-receivable funding and $28.458 million of repayments. Cash decreased $9.276 million in the period.
- Unfunded commitments totaled $11.9 million at June 30, contingent on specified performance conditions and, for loans, the absence of default.
Changes, outlook and risks
- Portfolio credit concerns warrant attention. ABT Molecular Imaging filed for Chapter 11 in June; SWK agreed to provide up to $1.65 million of debtor-in-possession financing. A sale or restructuring was contemplated, and recovery remained uncertain. B&D Dental was in default and evaluating strategic alternatives. Hooper Holmes was in default, on nonaccrual, and pursuing a sale under a forbearance agreement; its forbearance period ran through August 31, 2018.
- Narcan royalty receipts reached the 1.5-times cash-on-cash cap in Q1, so management expected substantially lower Narcan royalty revenue going forward. Cambia royalty expectations were reduced, prompting the first-half credit-loss provision.
- Management expected the existing portfolio to generate positive cash flows in 2018 and was evaluating new investment opportunities, but said timing was difficult to predict and additional investments might not produce positive cash flow beyond that from existing assets. No quantified earnings or revenue guidance was provided.
- After quarter-end, SWK funded $12.2 million of a maximum $14 million term loan to Epica International on July 25. Parnell Pharmaceuticals repaid its facility on July 30 for approximately $16.4 million, including interest and fees. Hooper’s additional $5 million facility was fully advanced by July 31.
- SWK identified life-sciences borrower concentration, borrower defaults and recoveries, interest-rate exposure, and valuation estimates as risks. It said it expected CECL adoption to result in higher upfront portfolio provisions. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting; no material change to previously disclosed risk factors was reported.
Important facts for investors to verify
- Developments and ultimate recovery prospects in ABT’s bankruptcy, B&D’s default and Hooper’s sale process, including subsequent advances and collateral values.
- Whether elevated nonaccrual balances and the Cambia allowance adequately reflect expected credit losses, and the potential effect of future CECL adoption.
- Post-quarter cash and portfolio effects of the Epica funding, Parnell payoff and Hooper advances, as well as compliance with the revolver’s borrowing-base and financial covenants.
- The sustainability of interest and fee income as Narcan royalties decline, and the extent to which 2017 comparisons are affected by the nonrecurring Holmdel-related income.