SWK Holdings Corporation — Q1 2016 Form 10-Q
Business context and reporting period
For the three months ended March 31, 2016, SWK operated as a specialty finance and asset-management business focused on financing life-science companies and monetizing commercial-product royalties. The company reported unaudited results; financial statement amounts below are in millions unless otherwise noted.
Financial performance and liquidity
- Revenue: $5.236, down 9.7% from $5.801 in Q1 2015. Finance-receivable interest and fees were $3.470 versus $4.145; income from unconsolidated investments was $1.659 versus $1.551.
- Profit: Income before tax was $3.938 versus $4.573. Consolidated net income was $3.938 versus $3.067; net income attributable to SWK shareholders was $3.096 versus $2.256. Basic and diluted EPS were $0.24 versus $0.17. No conventional operating-margin measure is presented.
- Tax: No income-tax provision was recorded in Q1 2016, compared with $1.506 in Q1 2015. SWK cited its assessment that it was more likely than not to realize approximately $16.8 of deferred tax benefits.
- Cash flow: Operating cash flow was $2.329 versus $3.361. Investing activities provided $12.555, mainly from a $10.648 net decrease in finance receivables and $1.910 of investment distributions; investing activities used $1.618 in the prior-year quarter. Financing activities used $0.977, primarily distributions to non-controlling interests.
- Liquidity and balance sheet: Cash increased to $61.194 from $47.287 at December 31, 2015. Total assets were $183.785; total liabilities were $1.264 and stockholders’ equity was $182.521. The filing reports no outstanding balance on the stockholder-affiliate credit facility and no remaining availability under it.
- Portfolio: Finance receivables were $89.455, net of a $7.082 allowance, down from $99.346 at year-end. Marketable investments were $5.111. SWK reported $5.3 of unfunded commitments at quarter-end.
Material changes versus Q1 2015 and year-end
- Revenue declined, primarily because loans were placed on nonaccrual or repaid, partly offset by a larger investment portfolio. Management reported 18 investments in Q1 2016 versus 14 in Q1 2015.
- Shareholder-attributable net income and EPS rose despite lower pretax income, principally reflecting the absence of the prior-year tax provision. General and administrative expense fell to $0.929 from $1.218; interest expense fell to zero from $0.381.
- Security impairment expense was $0.339, related to Cancer Genetics equity securities; none was recorded in Q1 2015. Derivative fair-value results shifted to a $0.030 loss from a $0.371 gain.
- Nonaccrual term loans increased to $31.306 from $20.093 at year-end. Four loans across three portfolio companies were nonaccrual at March 31, versus three loans across three companies at year-end; no cash was collected on nonaccrual loans during the quarter.
Outlook, risks and unusual items
- Management expected existing assets to generate income greater than expenses in 2016, but cautioned that deal timing is uncertain and positive cash flow beyond existing assets was not assured. No formal earnings guidance was provided.
- Credit concerns include SynCardia, which was in default and forbearance; two SynCardia loans were impaired, with a $6.9 provision recorded in 2015 and no additional provision in Q1 2016. B&D Dental was in default and nonaccrual; SWK advanced $0.3 during Q1 to pay critical vendors. ABT Molecular Imaging had existing defaults that SWK said it was working to resolve; no allowance was recorded for its loan at quarter-end.
- SWK’s lending is concentrated in life sciences, exposing it to sector and borrower credit risk. The company reported $405.0 of federal net operating loss carryforwards, most expiring by 2021, and stated it could not assure investors it would find suitable investments or use the NOLs.
- Subsequent events: On May 5, 2016, SWK funded $2.5 of a $3.5 first-lien synthetic-royalty loan to Thermedx, with a further $1.0 draw contingent on benchmarks. Galil Medical announced an agreed acquisition by BTG, subject to closing and potential milestone payments.
- CEO J. Brett Pope resigned effective January 12, 2016. Management reported disclosure controls were effective and no material changes in internal control during the quarter. SWK reported no current legal proceeding expected to materially affect the company.
Important facts for investors to verify
- Progress and recovery prospects for SynCardia, B&D Dental and ABT, including collateral values, defaults, and nonaccrual balances.
- Whether the $7.082 credit-loss allowance and reported impairment assessments remain adequate as portfolio conditions change.
- Cash generation and portfolio income after the Q1 reduction in finance receivables, and the timing and economics of new investments and commitments.
- Realizability and expiration schedule of tax attributes, and the assumptions supporting the $16.8 deferred tax benefit.
- Closing and any resulting portfolio impact of the announced Galil acquisition, and performance milestones for the Thermedx loan.