SWK Holdings Corporation — Q3 2015 Form 10-Q
Business context and period. SWK is a specialty finance and asset-management company focused on financing life-sciences businesses and acquiring or financing royalty streams. This unaudited filing covers the quarter and nine months ended September 30, 2015; financial figures are in thousands of dollars unless noted. Share and per-share data were retrospectively adjusted for the October 7, 2015 stock splits, which had a net 1-for-10 reverse-split effect for most holders.
Financial results and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $5,707 | $3,718 | $16,909 | $10,749 |
| Net income (loss) attributable to SWK shareholders | $(5,778) | $432 | $(3,896) | $3,281 |
| Basic and diluted earnings (loss) per share | $(0.44) | $0.06 | $(0.30) | $0.65 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $7,651 | $2,608 |
Revenue growth reflected increased finance-receivable interest and fees as SWK deployed more capital. Q3 finance-receivable interest and fees were $3,987, versus $1,850 a year earlier; equity-method income was $1,621 versus $1,769. For the nine months, finance-receivable interest and fees were $12,098, compared with $5,866. No profit-margin measure is reported; substantial credit and investment impairments drove the period’s losses.
Q3 costs included an $8,131 provision for loan credit losses and $3,230 impairment of a SynCardia preferred-stock investment. Nine-month totals were $10,725 and $3,230, respectively. Net loss before tax was $8,077 for Q3 and $3,200 for the nine months; tax benefits of $3,121 and $1,615 reduced the corresponding consolidated net losses to $4,956 and $1,585. The parent-company losses were larger after income attributable to non-controlling interests.
At September 30, cash and cash equivalents were $24,770, down from $58,728 at December 31, 2014. Finance receivables, net of a $10,725 credit-loss allowance, were $122,915, up from $93,347. Total assets were $184,285; total liabilities were $1,293 and stockholders’ equity was $182,992. The balance sheet lists no outstanding loan balance; the related-party credit facility’s draw period had expired, leaving no availability. SWK reported $9,500 of unfunded commitments on closed loans and said it believed funds and alternative sources were sufficient to meet current commitments.
Nine-month investing activities used $38,881, mainly from a $44,227 net increase in finance receivables, partly offset by $5,316 of distributions from an unconsolidated investment. Financing activities used $2,728, primarily distributions to non-controlling interests. Operating cash flow was positive despite the accounting loss, reflecting significant noncash impairment and fair-value adjustments. The filing does not provide a standard liquidity ratio.
Material changes and portfolio developments
- Four term loans to three portfolio companies were on nonaccrual at quarter-end, with $38,860 of gross carrying value; one loan was on nonaccrual at December 31, 2014, with $5,969. Three loans, with $21,098 carrying value net of allowance, were identified as impaired.
- SynCardia loans were placed on nonaccrual in September. SWK recorded a $6,900 credit-loss provision on loans and impaired its Series F preferred-stock investment to zero, recording a $3,230 charge. SynCardia withdrew its planned IPO on October 13; SWK expected a technical loan default in the near future due to anticipated covenant violations.
- Response Genetics filed for Chapter 11 in August. Following an asset sale completed October 9, SWK received cash, Cancer Genetics shares, and accounts receivable as loan recovery. SWK said the $8,646 net loan carrying value at September 30 approximated collateral fair value, but disclosed that Cancer Genetics shares fell a further $4 per share between quarter-end and November 9.
- Cash declined as SWK expanded its finance-receivable portfolio. Revenue increased, but impairment charges and warrant fair-value losses more than offset the growth in revenue.
Outlook, risks and subsequent events
Management expected income from its 18 completed transactions to exceed operating expenses in 2015 and said it expected to continue growing book value, while noting that investment timing is uncertain and positive cash flow above that produced by existing assets was not assured. Management continued to evaluate new opportunities. The company’s strategy and portfolio are concentrated in life sciences, exposing it to borrower credit, collateral valuation, product-sales and sector risks. Warrant valuations rely on models with significant unobservable inputs. Management reported disclosure controls were effective and no material change in internal control; it reported no material change to previously disclosed risk factors.
- CEO Brett Pope gave notice of resignation effective January 12, 2016; the Board named Managing Director Winston Black as his successor.
- PDI agreed to sell its Commercial Services business, subject to stockholder approval. If completed, PDI indicated it intended to repay its SWK loan, including interest and certain prepayment fees.
- SWK reported $421 million of federal net operating loss carryforwards, with most scheduled to expire by 2021; future use may be limited by ownership changes and depends on generating taxable income.
Most important facts for investors to verify
- Whether impaired and nonaccrual loans—especially SynCardia and Response—ultimately recover at or above their reported carrying values, and how subsequent collateral and share-price changes affect recovery.
- Whether PDI’s proposed sale closes and whether the anticipated loan repayment occurs; verify any resulting cash, fees and timing.
- How SWK funds its $9.5 million of unfunded commitments while cash has fallen to $24.8 million and its related-party facility has no remaining availability.
- Whether portfolio income can cover operating costs and credit losses, and whether management’s 2015 outlook and book-value expectations are achieved.
- Whether the $21.7 million net deferred tax asset and substantial NOL carryforwards can be realized, including the effect of potential ownership-change limitations.