NOTES TO THE CONSOLIDATED FINANCIAL
STATEMENTS
Note 1. SWK Holdings Corporation and Summary of Significant
Accounting Policies
Nature of Operations
SWK Holdings Corporation
(the “Company”) was incorporated in July 1996 in California and reincorporated in Delaware in September 1999. In July
2012, the Company commenced its strategy of building a specialty finance and asset management business. The Company’s strategy
is to be a leading healthcare capital provider by offering sophisticated, customized financing solutions to a broad range
of life science companies, institutions and inventors. The Company is primarily focused on monetizing cash flow streams derived
from commercial-stage products and related intellectual property through royalty purchases and financings, as well as through the
creation of synthetic revenue interests in commercialized products. The Company has been deploying its assets to earn
interest, fees, and other income pursuant to this strategy, and the Company continues to identify and review financing and similar
opportunities on an ongoing basis. In addition, through the Company’s wholly-owned subsidiary, SWK Advisors LLC, the Company
provides non-discretionary investment advisory services to institutional clients in separately managed accounts to similarly invest
in life science finance. SWK Advisors LLC is registered as an investment advisor with the Texas State Securities Board. The Company
intends to fund transactions through its own working capital, as well as by building its asset management business by raising additional
third party capital to be invested alongside the Company’s capital.
The Company fills
a niche that it believes is underserved in the sub-$50 million transaction size. Since many of its competitors that provide longer
term, non-traditional debt and/or royalty-related financing options have much greater financial resources than the Company, they
tend to not focus on transaction sizes below $50 million as it is generally inefficient for them to do so. In addition, the Company
does not believe that a sufficient number of other companies offer similar types of long-term financing options to fill the demand
of the sub-$50 million market. As such, the Company believes it faces less competition from such investors in transactions that
are less than $50 million.
The Company has
net operating loss carryforwards (“NOLs”) and believes that the ability to utilize these NOLs is an important and substantial
asset. The Company believes that the foregoing business strategies can create value for its stockholders, and produce prospective
taxable income (or the ability to generate capital gains) that might permit the Company to utilize the NOLs. The Company is unable
to assure investors that it will find suitable financing opportunities or that it will be able to utilize its existing NOLs.
As of December 31,
2016, the Company and its partners have executed transactions with 25 different parties under its specialty finance strategy,
funding $319 million in various financial products across the life science sector. The Company’s portfolio includes senior
and subordinated debt backed by royalties and synthetic royalties paid by companies in the life science sector, purchased royalties
generated by sales of life science products and related intellectual property and an unconsolidated equity investment in a company
which retains the marketing authorization rights to a pharmaceutical product.
The Company is headquartered in Dallas,
Texas.
Basis of Presentation and Principles of Consolidation
The Company’s
consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”). The
consolidated financial statements include the accounts of all subsidiaries and affiliates in which the Company holds a controlling
financial interest as of the financial statement date. Normally a controlling financial interest reflects ownership of a majority
of the voting interests. The Company consolidates a variable interest entity (“VIE”) when it possesses both the power
to direct the activities of the VIE that most significantly impact its economic performance and the Company is either obligated
to absorb the losses that could potentially be significant to the VIE or the Company holds the right to receive benefits from the
VIE that could potentially be significant to the VIE, after elimination of intercompany accounts and transactions.
The Company owns
interests in various partnerships and limited liability companies, or LLCs. The Company consolidates its investments in these partnerships
or LLCs, where the Company, as the general partner or managing member, exercises effective control, even though the Company’s
ownership may be less than 50 percent, the related governing agreements provide the Company with broad powers, and the other parties
do not participate in the management of the entities and do not effectively have the ability to remove the Company. The Company
has reviewed each of the underlying agreements to determine if it has effective control. If circumstances change and it is determined
this control does not exist, any such investment would be recorded using the equity method of accounting. Although this would change
individual line items within the Company’s consolidated financial statements, it would have no effect on its operations and/or
total stockholders’ equity attributable to the Company.
On October 7, 2015,
the Company effected a 1-for-100 reverse stock split of its common stock, immediately followed by a 10-for-1 forward stock split
of its common stock. For holders of greater than 100 shares prior to October 7, 2015, the net effect was a 1-for-10 reverse split.
The number of shares of common stock underlying the Company’s options and warrants to acquire shares of common stock were
adjusted accordingly. Share data, per share amounts and related information in the consolidated financial statements and notes
thereto with respect to any date or period prior to October 7, 2015 have been adjusted retroactively to give effect to the stock
splits. See further discussion of stock splits in Note 7.
Variable Interest Entities
An entity is referred
to as a VIE if it possesses one of the following criteria: (i) it is thinly capitalized, (ii) the residual equity holders do not
control the entity, (iii) the equity holders are shielded from the economic losses, (iv) the equity holders do not participate
fully in the entity’s residual economics, or (v) the entity was established with non-substantive voting interests. The Company
consolidates a VIE when it has both the power to direct the activities that most significantly impact the activities of the VIE
and the right to receive benefits or the obligation to absorb losses of the entity that could be potentially significant to the
VIE. Along with the VIEs that are consolidated in accordance with these guidelines, the Company also holds variable interests in
other VIEs that are not consolidated because it is not the primary beneficiary. The Company continually monitors both consolidated
and unconsolidated VIEs to determine if any events have occurred that could cause the primary beneficiary to change. See Note 4
for further discussion of VIEs.
Use of Estimates
The preparation
of the Company’s consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions
that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported
amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are required in the determination
of revenue recognition, stock-based compensation, impairment of financing receivables and long-lived assets, valuation of warrants,
income taxes and contingencies and litigation, among others. Some of these judgments can be subjective and complex,
and consequently, actual results may differ from these estimates. The Company’s estimates often are based on complex judgments,
probabilities and assumptions that it believes to be reasonable but that are inherently uncertain and unpredictable. For any given
individual estimate or assumption made by the Company, there may also be other estimates or assumptions that are reasonable.
The Company regularly
evaluates its estimates and assumptions using historical experience and other factors, including the economic environment. As future
events and their effects cannot be determined with precision, the Company’s estimates and assumptions may prove to be incomplete
or inaccurate, or unanticipated events and circumstances may occur that might cause changes to those estimates and assumptions.
Market conditions, such as illiquid credit markets, volatile equity markets, and economic downturns, can increase the uncertainty
already inherent in the Company’s estimates and assumptions. The Company adjusts its estimates and assumptions when facts
and circumstances indicate the need for change. Those changes generally will be reflected in our consolidated financial statements
on a prospective basis unless they are required to be treated retrospectively under the relevant accounting standard. It is possible
that other professionals, applying reasonable judgment to the same facts and circumstances, could develop and support a range of
alternative estimated amounts.
Equity Method Investment
The Company accounts
for portfolio companies whose results are not consolidated, but over which it exercises significant influence, under the equity
method of accounting. Whether or not the Company exercises significant influence with respect to a partner company depends on
an evaluation of several factors including, among others, representation of the Company on the partner company’s board
of directors and the Company’s ownership level. Under the equity method of accounting, the Company does not reflect
a partner company’s financial statements within the Company’s consolidated financial statements; however, the Company’s
share of the income or loss of such partner company is reflected in the consolidated statements of operations. The Company includes
the carrying value of equity method partner companies as part of the investment in unconsolidated entities on the consolidated
balance sheets.
When the Company’s
carrying value in an equity method partner company is reduced to zero, the Company records no further losses in its consolidated
statements of operations unless the Company has an outstanding guarantee obligation or has committed additional funding to such
equity method partner company. When such equity method partner company subsequently reports income, the Company will not record
its share of such income until it exceeds the amount of the Company’s share of losses not previously recognized.
Finance Receivables
The Company extends
credit to customers through a variety of financing arrangements, including revenue interest term loans. The amounts outstanding
on loans are referred to as finance receivables and are included in Finance Receivables on the consolidated balance sheets. It
is the Company’s expectation that the loans originated will be held for the foreseeable future or until maturity. In certain
situations, for example to manage concentrations and/or credit risk, some or all of certain exposures may be sold. Loans for which
the Company has the intent and ability to hold for the foreseeable future or until maturity are classified as held for investment
(“HFI”). If the Company no longer has the intent or ability to hold loans for the foreseeable future, then the loans
are transferred to held for sale (“HFS”). Loans entered into with the intent to resell are classified as HFS.
If it is determined
that a loan should be transferred from HFI to HFS, then the balance is transferred at the lower of cost or fair value. At the time
of transfer, a write-down of the loan is recorded as a write-off when the carrying amount exceeds fair value and the difference
relates to credit quality. Otherwise the write-down is recorded as a reduction in interest and other income, and any loan loss
reserve is reversed. Once classified as HFS, the amount by which the carrying value exceeds fair value is recorded as a valuation
allowance and is reflected as a reduction to interest and other income.
If it is determined
that a loan should be transferred from HFS to HFI, the loan is transferred at the lower of cost or fair value on the transfer date,
which coincides with the date of change in management’s intent. The difference between the carrying value of the loan and
the fair value, if lower, is reflected as a loan discount at the transfer date, which reduces its carrying value. Subsequent to
the transfer, the discount is accreted into earnings as an increase to finance revenue interest income over the life of the loan
using the effective interest method.
The Company accounts
for its finance receivables at amortized cost, net of unamortized origination fees, if any. Related fees and costs are recorded
net of any amounts reimbursed, and interest is accreted or accrued to interest revenue using the effective interest method. When
and if supplemental payments are received from these long-term receivables, an adjustment to the estimated effective interest rate
is affected prospectively.
The Company evaluates
the collectability of both interest and principal for each loan to determine whether it is impaired. A loan is considered to be
impaired when, based on current information and events, the Company determines it is probable that it will be unable to collect
amounts due according to the existing contractual terms. When a loan is considered to be impaired, the amount of loss is calculated
by comparing the carrying value of the financial asset to the value determined by discounting the expected future cash flows at
the loan’s effective interest rate or to the estimated fair value of the underlying collateral, less costs to sell, if the loan
is collateralized and the Company expects repayment to be provided solely by the collateral. Impairment assessments require significant
judgments and are based on significant assumptions related to the borrower’s credit risk, financial performance, expected sales,
and estimated fair value of the collateral.
Allowance for Credit Losses on Finance Receivables
The allowance for
credit losses is intended to provide for credit losses inherent in the financing receivables portfolio and is periodically reviewed
for adequacy considering credit quality indicators, including expected and historical losses and levels of and trends in past
due loans, non-performing assets and impaired loans, collateral values and economic conditions. The allowance for credit losses
is determined based on specific allowances for loans that are impaired, based upon the value of underlying collateral or projected
cash flows. Changes to the Allowance for Credit Losses are recorded in the Provision for Loan Credit Losses in the consolidated
statement of operations.
Marketable Investments
The Company’s
marketable investment portfolio includes two equity securities and one debt security as of December 31, 2016 and 2015. The
debt security is classified as an available-for-sale security, which is reported at fair value with unrealized gains or losses
recorded in accumulated other comprehensive income (loss), net of applicable income taxes. In any case where fair value
might fall below amortized cost, the Company would consider whether that security is other-than-temporarily impaired using all
available information about the collectability of the security. The Company would not consider that an other-than temporary impairment
for a debt security has occurred if (1) the Company does not intend to sell the debt security, (2) it is not more likely than
not that the Company will be required to sell the debt security before recovery of its amortized cost basis and (3) the present
value of estimated cash flows will fully cover the amortized cost of the security. The Company would consider that an other-than-temporary
impairment has occurred if any of the above mentioned three conditions are not met.
For a debt security
for which an other-than-temporary impairment is considered to have occurred, the Company would recognize the entire difference
between the amortized cost and the fair value in earnings if the Company intends to sell the debt security or it is more likely
than not that the Company will be able to sell the debt security before recovery of its amortized cost basis. If the Company does
not intend to sell the debt security and it is not more likely than not that the Company will be required to sell the debt security
before recovery of its amortized cost basis, the Company would separate the difference between the amortized cost and the fair
value of the debt security into the credit loss component and the non-credit loss component. The credit loss component would be
recognized in earnings and the non-credit loss component would be recognized in other comprehensive income, net of applicable income
taxes.
Derivatives
All derivatives
held by the Company are recognized in the consolidated balance sheets at fair value. The accounting treatment for subsequent changes
in the fair value depends on their use, and whether they qualify as effective “hedges” for accounting purposes. Derivatives
that are not hedges must be adjusted to fair value through the consolidated statements of operations. If a derivative is a hedge,
then depending on its nature, changes in its fair value will be either offset against change in the fair value of hedged assets
or liabilities through the consolidated statements of operations, or recorded in other comprehensive income. The Company had no
derivatives designated as hedges as of December 31, 2016 and 2015. The Company holds warrants issued to the Company in conjunction
with term loan investments discussed in Note 2. These warrants meet the definition of a derivative and are included in warrant
assets in the consolidated balance sheets. The Company issued a warrant on its own common stock as discussed in Note 5. This warrant
meets the definition of a derivative and is reflected as a warrant liability at fair value in the consolidated balance sheets.
Revenue Recognition
The Company records
interest income on an accrual basis based on the effective interest rate method to the extent that it expects to collect such amounts.
The Company recognizes investment management fees as earned over the period the services are rendered. In general, the
majority of investment management fees earned are charged either monthly or quarterly. Incentive fees, if any, are recognized
when earned at the end of the relevant performance period, pursuant to the underlying contract. Other administrative
service revenues are recognized when contractual obligations are fulfilled or as services are provided.
Cash and Cash Equivalents
The Company considers
all highly liquid investments with an original maturity date of three months or less at the date of purchase to be cash equivalents.
There were no such investments at December 31, 2016 or 2015, as all of our cash was held in checking or savings accounts. As
of December 31, 2016, cash equivalents were deposited in financial institutions and consisted of immediately available fund
balances. The Company maintains its cash deposits and cash equivalents with well-known and stable financial institutions.
Interest and Accounts Receivable
The Company records interest
receivable on an accrual basis and recognizes it as earned in accordance with the contractual terms of the loan agreement, to
the extent that such amounts are expected to be collected. When management does not expect that principal, interest, and other
obligations due will be collected in full, the Company will generally place the loan on nonaccrual status and cease recognizing
interest income on that loan until all principal and interest due has been paid or the Company believes the portfolio company
has demonstrated the ability to repay the Company’s current and future contractual obligations. Any uncollected interest
related to prior periods is reversed from income in the period that collection of the interest receivable is determined to be
doubtful. However, the Company may make exceptions to this policy if the investment has sufficient collateral value and is in
the process of collection. For the year ended December 31, 2016 and 2015, the provision for loan credit losses was
$1.7 million and $10.8 million, respectively.
Accounts receivable for
management fees are recorded at the aggregate unpaid amount less any allowance for doubtful accounts. The Company determines an
account receivable’s delinquency status based on its contractual terms. Interest is not charged on outstanding balances.
Accounts are written-off only when all methods of recovery have been exhausted. As of December 31, 2016 and 2015, the allowance
for doubtful accounts was zero.
Certain Risks and Concentrations
Financial instruments
that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents,
accounts receivable, finance receivables and marketable investments. The Company invests its excess cash with major U.S. banks
and financial institutions. The Company has not experienced any losses on its cash and cash equivalents.
The Company performs
ongoing credit evaluations of its partner companies and generally requires collateral. For the year ended December 31,
2016, two partner companies accounted for 41 percent of total revenue. For the year ended December 31, 2015, two partner companies
accounted for 44 percent of total revenue.
The Company does
not expect its current or future credit risk exposures to have a significant impact on its operations. However, there can be no
assurance that its business will not experience any adverse impact from credit risk in the future.
Segment Reporting
The Company operates
in one operating segment with a single management team that reports to the chief executive officer, who is its chief operating
decision maker. Accordingly, the Company does not prepare discrete financial information with respect to separate product line
and does not have separately reportable segments.
Stock-based Compensation
All employee and
director stock-based compensation is measured at the grant date, based on the estimated fair value of the award, and is recognized
as an expense over the requisite service period. Stock-based compensation expense is reduced for estimated future forfeitures.
These estimates are revised in future periods if actual forfeitures differ from the estimates. Changes in forfeiture estimates
impact compensation expense in the period in which the change in estimate occurs.
For restricted stock,
the Company recognizes compensation expense in accordance with the fair value of the Company’s stock as determined on the
grant date, amortized over the applicable service period. When vesting of awards is based wholly or in part upon the future performance
of the stock price, such terms result in adjustments to the grant date fair value of the award and the derivation of a service
period. If service is provided over the derived service period, the adjusted fair value of the awards will be recognized as compensation
expense, regardless of whether or not the awards vest.
Non-controlling Interests
Non-controlling
interests represent third-party equity ownership in certain of the Company’s consolidated subsidiaries, VIEs or investments
and are presented as a component of equity. See Note 4 and Note 7 for further discussion of non-controlling interests.
Income Taxes
Deferred tax assets
and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is recorded to reduce
deferred tax assets to an amount where realization is more likely than not.
If the Company ultimately
determines that the payment of such a liability is not necessary, then the Company reverses the liability and recognizes a tax
benefit during the period in which the determination is made that the liability is no longer necessary. The Company recognizes
accrued interest and penalties related to unrecognized tax benefits as a component of income tax benefit in the statements of operations.
Comprehensive Income (Loss)
Comprehensive income
(loss) and its components attributable to the Company and non-controlling interests have been reported, net of tax, in the consolidated
statements of stockholders’ equity and the consolidated statements of comprehensive income (loss).
Net Income (Loss) per Share
Basic net income
(loss) per share is computed using the weighted average number of outstanding shares of common stock. Diluted net income (loss)
per share is computed using the weighted average number of outstanding shares of common stock and, when dilutive, shares of common
stock issuable upon exercise of options and warrants deemed outstanding using the treasury stock method.
The following table
shows the computation of basic and diluted earnings per share for the following (in thousands, except per share amounts):
|
|
Year Ended
December 31,
|
|
|
2016
|
|
2015
|
Numerator:
|
|
|
|
|
Net income (loss) attributable to SWK Holdings Corporation stockholders
|
|
$
|
28,888
|
|
|
$
|
(7,370
|
)
|
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
|
Weighted-average shares outstanding
|
|
|
13,015
|
|
|
|
12,986
|
|
Effect of dilutive securities
|
|
|
3
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
Weighted-average diluted shares
|
|
|
13,018
|
|
|
|
12,986
|
|
|
|
|
|
|
|
|
|
|
Basic net income (loss) per share
|
|
$
|
2.22
|
|
|
$
|
(0.57
|
)
|
Diluted net income (loss) per share
|
|
$
|
2.22
|
|
|
$
|
(0.57
|
)
|
As of December 31,
2016, and 2015, outstanding stock options and warrants to purchase shares of common stock in an aggregate of approximately 392
thousand and 577 thousand shares, respectively, have been excluded from the calculation of diluted net income (loss)
per share as these securities were anti-dilutive.
Recent Accounting Pronouncements
In January 2016,
the FASB issued ASU No. 2016-01, “Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial
Assets and Financial Liabilities.” This guidance changes how entities measure equity investments that do not result in consolidation
and are not accounted for under the equity method. Entities will be required to measure these investments at fair value at the
end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for
equity investments that do not have readily determinable fair values; however, the exception requires the Company to consider relevant
transactions that can be reasonably known to identify any observable price changes that would impact the fair value. This
guidance also changes certain disclosure requirements and other aspects of current GAAP. This guidance is effective for annual
periods beginning after December 15, 2017, and is applicable to the Company in fiscal 2018. Early adoption is permitted. The Company
is currently evaluating the new guidance and has not determined the impact this standard may have on its consolidated financial
statements nor decided upon the method of adoption.
In March 2016, the
FASB issued ASU 2016-07, “Equity Method and Joint Ventures (Topic 323).” This guidance simplifies the accounting for
equity method investments by eliminating the requirement in Topic 323 that requires an entity to retroactively adopt the equity
method of accounting if an investment qualifies for use of the equity method as a result of an increase in the level of ownership
or degree of influence. The amendments require that the equity method investor add the cost of acquiring the additional interest
in the investee to the current basis of the investor’s previously held interest and adopt the equity method of accounting
as of the date the investment becomes qualified for equity method accounting. ASU 2016-07 is effective for fiscal years and interim
periods within those years beginning after December 15, 2016. The Company believes ASU-2016-07 will not have a material impact
on its consolidated financial statements upon adoption.
In May 2014, the
FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” This guidance requires an entity to recognize
revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which
the entity expects to be entitled in exchange for those goods or services. This guidance also requires an entity to disclose sufficient
information to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash
flows arising from contracts with customers. Qualitative and quantitative information is required about:
|
·
|
Contracts with customers
– including revenue and impairments recognized, disaggregation
of revenue and information about contract balances and performance obligations (including the transaction price allocated to the
remaining performance obligations.
|
|
·
|
Significant judgments and changes in judgments
– determining the timing of satisfaction
of performance obligations (over time or at a point in time), and determining the transaction price and amounts allocated to performance
obligations.
|
|
·
|
Certain assets
– assets recognized from the costs to obtain or fulfill a contract.
|
In May 2016, the
FASB issued ASU No. 2016-12, “Revenue from Contracts with Customers (Topic 606) — Narrow-Scope Improvements and Practical
Expedients,” which clarified guidance on assessing collectability, presenting sales tax, measuring noncash consideration,
and certain transition matters. The new guidance will be effective for fiscal years beginning after December 15, 2017,
including interim periods within those fiscal years. Early adoption would be permitted for fiscal years beginning
after December 15, 2016. The Company has been evaluating the impact of ASU 2014-09 and does not believe it will have a material
impact on the Company’s consolidated financial statements. The Company currently intends to use the modified prospective
approach upon adoption.
In March 2016,
the FASB issued ASU No. 2016-09, “Compensation -Stock Compensation (Topic 718).” The amendments of ASU No.
2016-09 were issued as part of the FASB’s simplification initiative focused on improving areas of GAAP for which cost and
complexity may be reduced while maintaining or improving the usefulness of information disclosed within the financial statements.
The amendments focused on simplification specifically with regard to share-based payment transactions, including income tax consequences,
classification of awards as equity or liabilities and classification on the statement of cash flows. The guidance in ASU No. 2016-09
is effective for fiscal years beginning after December 15, 2016, and interim periods within those annual periods. The Company
believes ASU 2016-09 will not have a material impact on the Company’s consolidated financial statements upon adoption.
In June 2016, the
FASB issued ASU 2016-13, “Financial Instruments –Credit Losses (Topic 326).“The new standard adds an impairment
model, known as current expected credit loss (CECL) model, that is based on expected losses rather than incurred losses. Under
the new guidance, an entity recognizes as an allowance its estimate of expected credit losses, which the FASB believes will result
in more timely recognition of losses. The ASU describes the impairment allowance as a valuation account that is deducted from
the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on
the financial asset. Credit losses relating to available-for-sale debt securities should be measured in a manner similar to current
GAAP; however, the amendments in this update require that credit losses be presented as an allowance rather than as a write-down,
which will allow an entity the ability to record reversals of credit losses in current period net income. The amendments in this
update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years.
An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning
of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). A prospective transition
approach is required for debt securities for which an other-than-temporary impairment has been recognized before the effective
date. The Company is currently evaluating the new guidance but believes it is likely to incur more upfront loan losses under
the new credit loss model.
In August 2016,
the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230),” which amends ASC 230 to add or clarify guidance
on the classification of certain cash receipts and payments in the statement of cash flows. The FASB issued this guidance with
the intent of reducing diversity in practice with respect to classification of eight types of cash receipts and payments: (1) debt
prepayment or debt extinguishment costs, (2) settlement of zero coupon bonds, (3) contingent consideration payments after a business
combination, (4) proceeds from the settlement of insurance claims, (5) proceeds from the settlement of corporate-owned life insurance
policies and bank-owned life insurance policies, (6) distributions received from equity method investees, (7) beneficial interests
in securitization transactions, and (8) separately identifiable cash flows and application of the predominance principle. For the
Company, the guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal
years. Early adoption will be permitted for all entities and must be applied retrospectively to all periods presented but it may
be applied prospectively if retrospective application would be impracticable. The Company believes ASU-2016-15 will not have a
material impact on the Company’s consolidated financial statements upon adoption.
Note 2. Finance Receivables
Finance receivables
are reported at their determined principal balances net of any unearned income, cumulative charge-offs and unamortized deferred
fees and costs. Unearned income and deferred fees and costs are amortized to interest income based on all cash flows expected using
the effective interest method.
The carrying value of finance receivables
at December 31 are as follows (in thousands):
|
|
As of December 31,
|
Portfolio
|
|
2016
|
|
2015
|
Term Loans
|
|
$
|
91,841
|
|
|
$
|
89,204
|
|
Royalty Purchases
|
|
|
36,184
|
|
|
|
17,224
|
|
Total before allowance for credit losses
|
|
|
128,025
|
|
|
|
106,428
|
|
Allowance for credit losses
|
|
|
(1,659
|
)
|
|
|
(7,082
|
)
|
Total carrying value
|
|
$
|
126,366
|
|
|
$
|
99,346
|
|
Credit Quality of Finance Receivables
The Company originates
finance receivables to companies primarily in the life sciences sector. This concentration of credit exposes the Company to a higher
degree of risk associated with this sector.
On a quarterly basis,
the Company evaluates the carrying value of each finance receivable for impairment. A term loan is considered to be impaired when,
based on current information and events, it is determined that the Company will not be able to collect the amounts due according
to the loan contract, including scheduled interest payments. This evaluation is generally based on delinquency information, an
assessment of the borrower’s financial condition and the adequacy of collateral, if any. The Company would generally place
term loans on nonaccrual status when the full and timely collection of interest or principal becomes uncertain and they are 90
days past due for interest or principal, unless the term loan is both well-secured and in the process of collection. When placed
on nonaccrual, the Company would reverse any accrued unpaid interest receivable against interest income and amortization of any
net deferred fees is suspended. Generally, the Company would return a term loan to accrual status when all delinquent interest
and principal become current under the terms of the credit agreement and collectability of remaining principal and interest is
no longer doubtful. In certain circumstances, the Company may place a finance receivable on nonaccrual status but conclude it is
not impaired. The Company may retain independent third-party valuations on such nonaccrual positions to support impairment decisions.
Receivables associated
with royalty stream purchases would be considered to be impaired when it is probable that the Company will be unable to collect
the book value of the remaining investment based upon adverse changes in the estimated underlying royalty stream.
When the Company
identifies a finance receivable as impaired, it measures the impairment based on the present value of expected future cash flows,
discounted at the receivable’s effective interest rate, or the estimated fair value of the collateral, less estimated costs
to sell. If it is determined that the value of an impaired receivable is less than the recorded investment, the Company would recognize
impairment with a charge to the allowance for credit losses. When the value of the impaired receivable is calculated by discounting
expected cash flows, interest income would be recognized using the receivable’s effective interest rate over the remaining
life of the receivable.
The Company individually
develops the allowance for credit losses for any identified impaired loans. In developing the allowance for credit losses, the
Company considers, among other things, the following credit quality indicators:
§
business characteristics and financial conditions of obligors;
§
current economic conditions and trends;
§
actual charge-off experience;
§
current delinquency levels;
§
value of underlying collateral and guarantees;
§
regulatory environment; and
§
any other relevant factors predicting investment recovery.
The following tables
present a summary of the activity in the allowance for credit losses by portfolio segment for the years ended December 31, 2016
and 2015 (in thousands):
|
|
Term Loans
|
|
Royalty Purchases
|
Balance, December 31, 2014
|
|
$
|
—
|
|
|
|
—
|
|
Provisions charged to income
|
|
|
10,848
|
|
|
|
—
|
|
Charge-offs
|
|
|
(3,766
|
)
|
|
|
—
|
|
Recoveries
|
|
|
—
|
|
|
|
—
|
|
Balance, December 31, 2015
|
|
$
|
7,082
|
|
|
$
|
—
|
|
Provisions charged to income
|
|
|
—
|
|
|
|
1,659
|
|
Charge-offs
|
|
|
(7,082
|
)
|
|
|
—
|
|
Recoveries
|
|
|
—
|
|
|
|
—
|
|
Balance, December 31, 2016
|
|
$
|
—
|
|
|
$
|
1,659
|
|
The following table presents nonaccrual
and performing loans by portfolio segment (in thousands):
|
|
December 31, 2016
|
|
December 31, 2015
|
|
|
Nonaccrual
|
|
Performing
|
|
Total
|
|
Nonaccrual
|
|
Performing
|
|
Total
|
Term Loans
|
|
$
|
19,040
|
|
|
|
72,801
|
|
|
|
91,841
|
|
|
$
|
20,093
|
|
|
$
|
62,029
|
|
|
$
|
82,122
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Royalty Purchases
|
|
|
—
|
|
|
|
34,525
|
|
|
|
34,525
|
|
|
|
—
|
|
|
|
17,224
|
|
|
|
17,224
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total carrying value
|
|
$
|
19,040
|
|
|
|
107,326
|
|
|
|
126,366
|
|
|
$
|
20,093
|
|
|
$
|
79,253
|
|
|
$
|
99,346
|
|
As of December 31,
2016, the Company had two term loans associated with two portfolio companies in nonaccrual status with a carrying value, net of
credit loss allowance, of $19.0 million. As of December 31, 2015, the Company had three term loans associated with one portfolio
company in nonaccrual status with a carry value of $20.1 million. No cash on nonaccrual loans was collected during the year ended
December 31, 2016. Of the two nonaccrual term loans at December 31, 2016, neither are deemed to be impaired. (Please see
ABT Molecular Imaging, Inc.
and
B&D Dental
below for further details regarding nonaccrual term loans.)
Of the three nonaccrual
term loans at December 31, 2015, two loans, with a carrying value of $12.5 million, net of credit loss allowance, were identified
as impaired by the Company, as the fair market value of the loans, less costs to sell, were lower than their respective recorded
investments in the loans. During the year ended December 31, 2015, the Company recognized loan impairment expense of $10.8
million.
SynCardia Systems, Inc. (“SynCardia”)
On June 24, 2016,
SWK Funding LLC, a wholly-owned subsidiary of SWK Holdings Corporation, sold 100 percent of its debt and equity interests in SynCardia
to an affiliate of Versa Capital Management for upfront cash consideration of $7.2 million plus additional certain future contingent
payments. The Company’s interests in SynCardia included $22.0 million of a senior secured first lien loan, $13.0 million
of second lien convertible notes, 2,323,649 shares of Series F preferred stock, 4,000 shares of common stock and 34,551 common
stock purchase warrants. The carrying value, as of the date of sale, of the debt and equity interests in SynCardia was approximately
$12.5 million. During the year ended December 31, 2016, the Company recognized $5.3 million of impairment expense related to the
sale of its SynCardia assets.
ABT Molecular Imaging, Inc. (“ABT”)
On October 10, 2014,
the Company entered into a credit agreement pursuant to which the Company provided ABT a second lien term loan in the principal
amount of $10.0 million. The loan matures on October 8, 2021. The synthetic royalty payment due to the Company on December 15,
2015 was blocked by ABT’s first lien lender pursuant to the terms of the intecreditor agreement by and between the Company
and the first lien lender as a result of a forbearance agreement entered into between ABT and the first lien lender. Per the terms
of the forbearance agreement, the first lien lender deferred principal payments until maturity of the first lien in March 2016
and ABT raised additional equity capital.
In February 2016,
ABT violated the terms of the forbearance agreement with the first lien lender. In order to control the work out of the default
under the first lien loan and prevent the equity sponsors from taking control of the first lien term loan, the Company purchased
from an unrelated party the first lien term loan at par for a purchase price of $0.7 million. Since then the equity sponsors funded
cash shortfalls into the second quarter of 2016. The Company continues to work with ABT’s equity sponsors to resolve the
existing defaults.
During the year
ended December 31, 2016, the Company entered into additional amendments to the first lien term loan, which provided for an additional
$1.6 million of liquidity under the first lien credit agreement. ABT has drawn down the full $1.6 million as of March 17, 2017.
The collateral
for the loan has been individually reviewed, and the Company believes that the fair market value of the loan, less costs to sell,
was greater than the recorded investments in the loans as of December 31, 2016. Based on the impairment analysis, the Company
has determined that recording a provision for credit losses as of December 31, 2016 is not required. The Company considered
several factors in this determination, including an independent third-party valuation and developments in the portfolio company’s
business and industry.
B&D Dental (“B&D”)
On December 10,
2013, the Company entered into a five-year credit agreement to provide B&D a senior secured term loan with a principal amount
of $6.0 million funded upon close, net of an arrangement fee of $60 thousand. Subsequently, the terms of the loan have been amended,
and the Company has funded additional amounts to B&D. As of December 31, 2016, the total amount funded was $8.1 million.
B&D is currently
in default under the terms of the credit agreement, and as a result, the Company classified the loan to nonaccrual status as of
September 30, 2015. During the first and fourth quarters of 2016, the Company executed two additional amendments to the loan to
advance an additional $0.5 million in order to directly pay critical vendors and protect the value of the collateral. The Company
believes its collateral position is greater than the unpaid balance; thus, accrued interest has not been reversed nor has an allowance
been recorded as of December 31, 2016. The Company considered several factors in this determination, including an independent
third-party valuation and developments in the portfolio company’s business and industry.
Besivance
On April 2, 2013,
the Company purchased an effective 2.4 percent royalty on sales of Besivance® from InSite Vision for $6.0 million. Besivance
is marketed by Bausch & Lomb, a unit of Valeant Pharmaceuticals. Recently the sales performance of Besivance has weakened due
to substantial increases in sales chargebacks and various rebates (gross sales to net sales deductions) and lower sales volumes,
which has resulted in material reductions in the product’s net sales and associated royalties’ payable to the Company.
During the year ended December 31, 2016, the Company reduced its expectations for future royalty receipts and recognized an allowance
for credit loss on the royalty purchase of $1.7 million.
Note 3. Marketable Investments
Investment in marketable securities at
December 31, 2016 and 2015 consist of the following (in thousands):
|
|
December 31,
|
|
|
2016
|
|
2015
|
Corporate debt securities
|
|
$
|
1,564
|
|
|
$
|
2,857
|
|
Equity securities
|
|
|
1,057
|
|
|
|
2,429
|
|
Total
|
|
$
|
2,621
|
|
|
$
|
5,286
|
|
The amortized cost basis amounts, gross
unrealized holding gains, gross unrealized holding losses and fair values of available-for-sale securities as of December 31,
2016 and 2015, are as follows (in thousands):
|
|
Amortized Cost
|
|
Gross Unrealized Gains
|
|
Gross
Unrealized
Loss
|
|
Fair Value
|
December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
1,564
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
1,564
|
|
Equity securities
|
|
|
1,144
|
|
|
|
—
|
|
|
|
(87
|
)
|
|
|
1,057
|
|
|
|
$
|
2,708
|
|
|
$
|
—
|
|
|
$
|
(87
|
)
|
|
$
|
2,621
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortized Cost
|
|
Gross Unrealized Gains
|
|
Gross Unrealized Loss
|
|
Fair Value
|
December 31, 2015
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale securities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Corporate debt securities
|
|
$
|
2,857
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
2,857
|
|
Equity securities
|
|
|
2,429
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,429
|
|
|
|
$
|
5,286
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
5,286
|
|
During the years ended December 31,
2016, and 2015, the Company had no sales of available-for-sale securities.
Equity Securities
Marketable equity
securities held by the Company include 736,076 shares of Cancer Genetics common stock and 77,922 shares of Hooper Holmes common
stock. During the year ended December 31, 2016, the Company recognized other-than-temporary impairment expense of $1.4 million
related to the Cancer Genetics common stock. As of December 31, 2016, the Cancer Genetics and Hooper Holmes equity securities
are reflected at fair value of $1.0 million and $0.1 million, respectively, as available-for-sale securities.
Debt Securities
On July 9, 2013,
the Company entered into a note purchase agreement to purchase, at par, $3.0 million of a total of $100.0 million aggregate principal
amount of senior secured notes due in November 2026. The agreement allows the first interest payment date to include paid-in-kind
notes for any cash shortfall, of which the Company received $0.1 million on November 15, 2013. The notes are secured only by certain
royalty and milestone payments associated with the sales of pharmaceutical products.
During the year
ended December 31, 2016, the Company recorded an impairment expense of $1.4 million related to these notes, of which approximately
$0.1 million reflects the write off of interest accrued on these notes. The remainder of the expense was taken as an other-than-temporary
impairment. The senior secured notes were placed on nonaccrual status as of June 30, 2016. Total cash of approximately
$41 thousand was collected during the year was and credited to the notes’ carry value. As of December 31, 2016, the notes
are reflected at their estimated fair value of $1.6 million and classified as available-for-sale securities.
Note 4. Variable Interest Entities
The Company consolidates
the activities of VIEs of which it is the primary beneficiary. The primary beneficiary of a VIE is the variable interest holder
possessing a controlling financial interest through (i) its power to direct the activities of the VIE that most significantly
impact the VIE’s economic performance and (ii) its obligation to absorb losses or its right to receive benefits from
the VIE that could potentially be significant to the VIE. In order to determine whether the Company owns a variable interest in
a VIE, the Company performs qualitative analysis of the entity’s design, organizational structure, primary decision makers
and relevant agreements.
Consolidated VIE
SWK HP was formed
in December 2012 to acquire a limited partnership interest in Holmdel Pharmaceuticals LP (“Holmdel”). Holmdel
acquired the U.S. marketing authorization rights to a beta blocker pharmaceutical product indicated for the treatment of hypertension
for a total purchase price of $13.0 million. The Company, through its wholly owned subsidiary SWK Holdings GP LLC (“SWK Holdings
GP”) acquired a direct general partnership interest in SWK HP, which in turn acquired a limited partnership interest in Holmdel.
The total investment in SWK HP of $13.0 million included $6.0 million provided by SWK Holdings GP and $7.0 million provided by
non-controlling interests. Subject to customary limited partner protections afforded the investors by the terms of the
limited partnership agreement, the Company maintains voting and managerial control of SWK HP and therefore includes it in its consolidated
financial statements.
SWK HP has significant
influence over the decisions made by Holmdel. SWK HP receives quarterly distributions of cash flow generated by the pharmaceutical
product according to a tiered scale that is subject to certain cash on cash returns received by SWK HP. SWK HP received approximately
84 percent and 70 percent of the pharmaceutical product’s cash flow until SWK HP received a 1x and 2x, respectively, cash on cash
return on its interest in Holmdel. SWK HP’s current ownership in Holmdel approximates 49 percent. In no instance will SWK HP’s
economic interest decline below 39 percent. Holmdel is considered a VIE because SWK HP’s control over the partnership is disproportionate
to its economic interest. This VIE remains unconsolidated as the power to direct the activities of the partnership is not held
by the Company. The Company is using the equity method to account for this investment. The Company accounts for its interest in
the entity based on the timing of quarterly distributions, which are paid on a quarter lag basis.
Unconsolidated VIE
For the
year ended December 31, 2016, the Company recognized $6.2 million of equity method gains, of which $3.2 million was attributable
to the non-controlling interest in SWK HP. In addition, SWK HP received cash distributions totaling $7.2 million during the year
ended December 31, 2016, of which $3.7 million was subsequently paid to holders of the non-controlling interests in SWK HP.
For the year ended December 31, 2015, the Company recognized $5.9 million of equity method gains, of which $3.0 million was
attributable to the non-controlling interest in SWK HP. In addition, SWK HP received cash distributions totaling $6.9 million
during the year ended December 31, 2015, of which $3.6 million was subsequently paid to holders of the non-controlling interests
in SWK HP. Changes in the carrying amount of the Company’s investment in Holmdel for the years ended December 31, 2016
and 2015, are as follows (in thousands):
Balance at December 31, 2014
|
|
$
|
9,044
|
|
Add: Income from investments in unconsolidated entities
|
|
|
5,884
|
|
Less: Cash distribution on investments in unconsolidated entities
|
|
|
(6,940
|
)
|
Balance at December 31, 2015
|
|
$
|
7,988
|
|
Add: Income from investments in unconsolidated entities
|
|
|
6,219
|
|
Less: Cash distribution on investments in unconsolidated entities
|
|
|
(7,222
|
)
|
Balance at December 31, 2016
|
|
$
|
6,985
|
|
The following table
provides the financial statement information related to Holmdel for the comparative periods during which SWK HP has reflected its
share of Holmdel income in the Company’s consolidated statements of operations:
in millions
|
|
At
December 31, 2016
|
|
|
|
|
Year Ended
December 31, 2016
|
|
Assets
|
|
$
|
8.8
|
|
|
Revenue
|
|
$
|
8.9
|
|
Liabilities
|
|
$
|
1.8
|
|
|
Expenses
|
|
$
|
1.5
|
|
Equity
|
|
$
|
7.0
|
|
|
Net income
|
|
$
|
7.4
|
|
in millions
|
|
At
December 31, 2015
|
|
|
|
|
Year Ended
December 31, 2015
|
|
Assets
|
|
$
|
11.7
|
|
|
Revenue
|
|
$
|
10.9
|
|
Liabilities
|
|
$
|
3.3
|
|
|
Expenses
|
|
$
|
1.4
|
|
Equity
|
|
$
|
8.4
|
|
|
Net income
|
|
$
|
9.5
|
|
Note 5. Related Party Transactions
On September 6,
2013, in connection with entering into a credit facility, the Company issued warrants to an affiliate of a stockholder, Carlson
Capital, L.P. (the “Stockholder”), for 100 thousand shares of the Company’s common stock at a strike price of
$13.88. The warrants have a price anti-dilution mechanism that was triggered by the price that shares were sold by the Company
in a rights offering in 2014, and as a result, the strike price of the warrants was reduced to $13.48.
Due to certain
provisions within the warrant agreement, the warrants meet the definition of a derivative and do not qualify for a scope exception,
as it is not considered indexed to the Company’s stock. As such, the warrants with a value of $0.2 million and $0.3 million
as of December 31, 2016 and 2015, respectively, are reflected as a warrant liability in the consolidated balance sheets.
An unrealized gain of $0.1 million and an unrealized loss of $0.2 million were included in other income (expense), net in the
consolidated statements of operations for the years ended December 31, 2016 and 2015, respectively. The Company determined
the fair value using the Black-Scholes option pricing model with the following assumptions:
|
|
December 31,
|
|
|
2016
|
|
2015
|
Dividend rate
|
|
|
—
|
|
|
|
—
|
|
Risk-free rate
|
|
|
1.9
|
%
|
|
|
1.8
|
%
|
Expected life (years)
|
|
|
3.7
|
|
|
|
4.7
|
|
Expected volatility
|
|
|
34.1
|
%
|
|
|
33.3
|
%
|
The changes on the
value of the warrant liability during the years ended December 31, 2016 and 2015 were as follows (in thousands):
Fair value – December 31, 2014
|
|
$
|
421
|
|
Issuances
|
|
|
—
|
|
Change in fair value
|
|
|
(162
|
)
|
Fair value – December 31, 2015
|
|
|
259
|
|
Issuances
|
|
|
—
|
|
Changes in fair value
|
|
|
(70
|
)
|
Fair value – December 31, 2016
|
|
$
|
189
|
|
During the year
ended December 31, 2015, the Company recognized interest expense totaling $0.4 million, consisting of debt issuance cost amortization.
The Company did not recognize any interest expense during the year ended December 31, 2016.
Other
The Company provides
investment advisory services to an affiliate of a stockholder. During, and as of the end of the years ended, December 31,
2016 and 2015, there was no revenue or accounts receivable from this affiliate.
Note 6. Commitments and Contingencies
Lease Obligations
The Company’s
corporate headquarters is in Dallas, Texas, where it leases approximately 2,400 square feet. Total rent expense recognized
under the lease was $57 thousand and $52 thousand for the years ended December 31, 2016 and 2015, respectively.
The office lease expires in May 2020. Future minimum rent is as follows (in thousands):
|
2017
|
|
|
$
|
58
|
|
|
2018
|
|
|
|
59
|
|
|
2019
|
|
|
|
60
|
|
|
2020
|
|
|
|
26
|
|
|
2021
|
|
|
|
—
|
|
|
Thereafter
|
|
|
|
—
|
|
|
Total future minimum rent with non-cancellable terms of one year or more
|
|
|
$
|
203
|
|
Other Contractual Obligations
As of
December 31, 2016, the Company had unfunded commitments of $10.6 million on the loans and royalty purchases discussed in
Note 2. Of the total $10.6 million, $0.3 million and $3.8 million are potentially payable to the sellers of the
Cambia® and Narcan® royalties, respectively. There are no additional earnout payments contracted to be paid by us to any of
our partner companies. As of December 31, 2016, our unfunded commitments were as follows (in millions):
Cambia®
|
|
$
|
0.3
|
|
Keystone Dental, Inc.
|
|
|
2.5
|
|
Narcan®
|
|
|
3.8
|
|
Tenex Health, Inc.
|
|
|
3.0
|
|
Thermedx, LLC
|
|
|
1.0
|
|
Total Unfunded Commitments
|
|
$
|
10.6
|
|
All unfunded commitments
are contingent upon reaching an established revenue threshold or other performance metrics on or before a specified date or
period of time per the terms of the royalty purchase or credit agreements, and in the case of loan transactions, are only subject
to being advanced as long as an event of default does not exist.
Litigation
The Company is involved
in, or has been involved in, arbitrations or various other legal proceedings that arise from the normal course of its business.
The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative
impact on the Company’s results of operations, balance sheets and cash flows due to defense costs, and divert management
resources. The Company cannot predict the timing or outcome of these claims and other proceedings. Currently, the Company
is not involved in any arbitration and/or other legal proceeding that it expects to have a material effect on its business, financial
condition, results of operations and cash flows.
Indemnification
As permitted by
Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while
the officer or director is, or was, serving in such capacity, or in other capacities at the Company’s request. The term of
the indemnification period is for the officer’s or director’s lifetime. The maximum potential amount of future payments
the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a director
and officer insurance policy that limits its exposure and enables the Company to recover a portion of any such amounts. As a result
of the Company’s insurance policy coverage, the Company believes the estimated fair value of these indemnification agreements
is insignificant. Accordingly, the Company had no liabilities recorded for these agreements as of December 31, 2016 and 2015.
Note 7. Stockholders’ Equity
Common Stock
The total number
of shares of common stock, $0.001 par value, that the Company is authorized to issue is 250,000,000.
Preferred Stock
The Company’s
board of directors (the “Board”) may, without further action by the stockholders, issue a series of preferred
stock and fix the rights and preferences of those shares, including the dividend rights, dividend rates, conversion rights, exchange
rights, voting rights, terms of redemption, redemption price or prices, liquidation preferences, the number of shares constituting
any series and the designation of such series. As of December 31, 2016, no shares of preferred stock have been issued.
Stock Splits
On October 7, 2015,
the Company executed a 1-for-100 reverse stock split of its common stock, followed by a 10-for-1 forward stock split of its common
stock. The stock split was approved at the Company’s 2015 Annual Meeting of Stockholders held on May 20, 2015.
At the effective
time of the reverse stock split, every 100 shares of the Company’s issued and outstanding common stock were automatically
combined into one issued and outstanding share of common stock, with no change in par value per share. Holders with less than 100
shares of common stock had their shares repurchased and retired by the Company in the reverse stock split and received cash in
lieu of such shares. After the reverse stock split, the Company effected a forward stock split pursuant to which stockholders received
10 shares of common stock for each share of common stock held. No fractional shares were issued in connection with the forward
stock split. Stockholders who would otherwise be entitled to receive a fractional share received a cash payment in lieu thereof
at a rate of $1.425 per fractional pre-split share. The Company paid $0.2 million for fractional shares from holders with less
than 100 shares upon the initial 1-for-100 reverse stock split. For stockholders owning greater than 100 shares prior to the reverse
stock split, the net effective ratio was a 1-for-10 reverse split. The number of shares of common stock underlying the Company’s
options, warrants, or other rights to acquire shares of common stock were adjusted accordingly. As a result, each stockholder’s
percentage ownership interest and proportional voting power remains substantially unchanged and the rights and privileges of the
holders of the Company’s common stock are substantially unaffected.
Stock Compensation Plans
The Company’s
1999 Stock Incentive Plan (the “1999 Stock Incentive Plan”), as successor to the 1997 Stock Option Plan (the “1997
Stock Option Plan”), provided for options to purchase shares of the Company’s common stock to be granted to employees,
independent contractors, officers, and directors. The plan expired in July 2009. As a result of the termination of all employees
on December 31, 2009, the stock options held by employees were cancelled on March 31, 2010. No options remain outstanding
under the 1999 Stock Incentive Plan.
The Company’s
2010 Stock Incentive Plan (the “2010 Stock Incentive Plan”) provides for options, restricted stock, and other customary
forms of equity to be granted to the Company’s directors, officers, employees, and independent contractors. All forms of
equity incentive compensation are granted at the discretion of the Board and have a term not greater than 10 years from the
date of grant.
J. Brett Pope resigned
as the Company’s Chief Executive Officer and a member of the Board effective January 12, 2016. Under the terms of Mr. Pope’s
severance agreement, the Company approved the cashless exercise of 18,750 vested stock options and the remaining 156,250 unvested
stock options were forfeited. Of the 18,750 vested stock options, 14,751 options were surrendered to the Company to pay the exercise
price, resulting in a net issuance of 3,999. The surrendered shares were immediately canceled by the Company.
The following table summarizes activities under
the option plans for the indicated periods:
At December 31,
2016, the 1999 Stock Incentive Plan had expired, and the Company had no unrecognized stock-based compensation expense under this
Plan. At December 31, 2016, there were 0.3 million shares reserved for equity awards under the 2010 Stock Incentive
Plan, and the Company had $0.2 million of total unrecognized stock option expense, net of estimated forfeitures, which will be
recognized over the weighted average remaining period of 2 years.
The following table
summarizes significant ranges of outstanding and exercisable options as of December 31, 2016:
Employee stock-based
compensation expense recognized for time-vesting options for the years ended December 31, 2016, and 2015, uses the Black-Scholes
option pricing model for estimating the fair value of options granted under the Company’s equity incentive plans. Risk-free
interest rates for the options were taken from the Daily Federal Yield Curve Rates on the grant dates for the expected life of
the options as published by the Federal Reserve. The expected volatility was based upon historical data and other relevant factors
such as the Company’s changes in historical volatility and its capital structure, in addition to mean reversion. Employee
stock-based compensation expense recognized for market performance-vesting options uses a binomial lattice model for estimating
the fair value of options granted under the Company’s equity incentive plans.
In calculating the expected
life of stock options, the Company determines the amount of time from grant date to exercise date for exercised options and adjusts
this number for the expected time to exercise for unexercised options. The expected time to exercise for unexercised options is
calculated from grant as the midpoint between the expiration date of the option and the later of the measurement date or the vesting
date. In developing the expected life assumption, all amounts of time are weighted by the number of underlying options.
As of December 31, 2016,
the Company had 112,500 shares of restricted stock outstanding with a weighted-average grant date fair value of $3.10. During the
years ended December 2016 and 2015, no restricted shares were canceled, forfeited, granted, or vested. The Company has not recognized
any expense related to restricted stock for the years ended December 31, 2016 and 2015.
The restricted shares
included in the Company’s shares outstanding as of December 31, 2016 and 2015, respectively, but are not included in
the computation of basic income per share as the shares are not yet earned by the recipients. The Company had no unrecognized stock-based
compensation expense, net of estimated forfeitures, related to restricted shares as of December 31, 2016.
In October 2015,
the Board approved a change in the compensation plan for non-employee directors such that each non-employee director shall receive
an annual cash retainer of $45 thousand and an annual grant of 1,000 shares of the Company’s common stock, both payable quarterly
in arrears. In addition, each member of (i) the Audit Committee shall receive an additional fee of $10 thousand payable quarterly
in arrears; (ii) the Compensation Committee shall receive an additional fee of $1,000 payable quarterly in arrears and (iii) the
Governance Committee shall receive an additional fee of $2,000 payable quarterly in arrears. Each non-employee director has the
option to elect to receive up to 100 percent of the annual cash retainer in shares of the Company’s common stock.
During the year
ended December 31, 2015, the Board approved the following grants as compensation for Board services: (i) a grant of 3,366 shares
of common stock as the pro-rated director compensation for the non-employee director appointed on September 6, 2014; (ii) a grant
of 3,000 shares to each non-employee director for services as a director for the period January 1, 2015 to December 31, 2015; and
(iii) a grant of 15,611 shares of common stock in lieu of cash payments to the non-employee directors upon the voluntary election
of such directors.
During the year
ended December 31, 2016, the Board approved compensation for Board services by granting 24,384 shares of common stock as
compensation for the non-employee directors. During the year ended December 31, 2016 the Company recorded approximately $246 thousand
in board compensation expense relating to the quarterly grants. The aggregate stock-based compensation expense, including the
board quarterly grants, recognized by the Company for the years ended December 31, 2016 and 2015 was $0.4 million and $0.6 million,
respectively.
The Company measures
and reports certain financial and non-financial assets and liabilities on a fair value basis. Fair value is the price that would
be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement
date (exit price). GAAP specifies a three-level hierarchy that is used when measuring and disclosing fair value. The fair value
hierarchy gives the highest priority to quoted prices available in active markets (i.e., observable inputs) and the lowest priority
to data lacking transparency (i.e., unobservable inputs). An instrument’s categorization within the fair value hierarchy
is based on the lowest level of significant input to its valuation. The following is a description of the three hierarchy levels.
Transfers into or
out of any hierarchy level are recognized at the end of the reporting period in which the transfers occurred. There were no transfers
between any levels during the years ended December 31, 2016 and 2015.
The fair value of
equity method investments is not readily available nor have we estimated the fair value of these investments and disclosure is
not required. The Company is not aware of any identified events or changes in circumstances that would have a significant adverse
effect on the carrying value of any of its equity method investments included in the consolidated balance sheets as of December 31,
2016 and 2015.
Following are descriptions
of the valuation methodologies used to measure material assets and liabilities at fair value and details of the valuation models,
key inputs to those models and significant assumptions utilized.
The carrying amounts
reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.
Certain common equity securities are
reported at fair value utilizing Level 1 inputs (exchange quoted prices).
The fair values
of finance receivables are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect
the credit and interest rate-risk inherent in the finance receivables. Projected future cash flows are calculated based upon contractual
maturity or call dates, projected repayments and prepayments of principal. These receivables are classified as Level 3. Finance
receivables are not measured at fair value on a recurring basis, but estimates of fair value are reflected below.
If active market prices
are available, fair value measurement is based on quoted active market prices and, accordingly, these securities would be classified
as Level 1. If active market prices are not available, fair value measurement is based on observable inputs other than quoted prices
included within Level 1, such as prices for similar assets or broker quotes utilizing observable inputs, and accordingly these
securities would be classified as Level 2. If market prices are not available and there are no observable inputs, then fair value
would be estimated by using valuation models including discounted cash flow methodologies, commonly used option-pricing models
and broker quotes. Such securities would be classified as Level 3, if the valuation models and broker quotes are based on inputs
that are unobservable in the market. If fair value is based on broker quotes, the Company checks the validity of received prices
based on comparison to prices of other similar assets and market data such as relevant bench mark indices. Available-for-sale securities
are measured at fair value on a recurring basis, while securities with no readily available fair market value are not, but estimates
of fair value are reflected below.
For exchange-traded derivatives, fair
value is based on quoted market prices, and accordingly, would be classified as Level 1. For non-exchange traded derivatives, fair
value is based on option pricing models and are classified as Level 3.
The following table
presents financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2016 (in thousands):
The following table
presents financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2015 (in thousands):
The changes on the value of the warrant
assets during the years ended December 31, 2016 and 2015 were as follows (in thousands):
The Company holds
warrants issued to the Company in conjunction with certain term loan investments. These warrants meet the definition of a derivative
and are included in the consolidated balance sheet. The fair values for warrants outstanding, that have a readily determinable
value, are measured using the Black-Scholes option pricing model. The following weighted average assumptions were used in the models
to determine fair value:
The following table
presents financial assets measured at fair value on a nonrecurring basis as of December 31, 2016 and 2015 (in thousands):
There were no remeasured
liabilities at fair value on a non-recurring basis during the year ended December 31, 2016 or 2015.
The following information
is provided to help readers gain an understanding of the relationship between amounts reported in the accompanying consolidated
financial statements and the related market or fair value. The disclosures include financial instruments and derivative financial
instruments, other than investment in unconsolidated entity.
The components of income (loss) before
income tax (benefit) provision are as follows (in thousands):
During the years ended
December 31, 2016 and 2015, the Company’s (benefit) provision for income taxes was as follows (in thousands):
The components of the income tax provision
(benefit) are as follows (in thousands):
The Company records
deferred tax assets if the realization of such assets is more likely than not to occur in accordance with accounting standards
that address income taxes. Significant management judgment is required in determining whether a valuation allowance against the
Company’s deferred tax assets is required. The Company has considered all available evidence, both positive and negative,
such as historical levels of income and predictability of future forecasts of taxable income from existing investments, in determining
whether a valuation allowance is required. The Company is also required to forecast future taxable income in accordance with accounting
standards that address income taxes to assess the appropriateness of a valuation allowance, which further requires the exercise
of significant management judgment. The Company focuses on forecasting future taxable income for the investment portfolio that
exists as of the balance sheet date. Specifically, the Company evaluated the following criteria when considering a valuation allowance:
As of December
31, 2016, the Company had cumulative net income before tax for the three years then ended. Based on its historical operating performance,
the Company has concluded that it was more likely than not that the Company would not be able to realize the full benefit of the
U.S. federal and state deferred tax assets in the future. However, the Company has concluded that it is more likely than not that
the Company will be able to realize approximately $38.5 million benefit of the U.S. federal and state deferred tax assets
in the future.
The Company will
continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence
that may exist on a quarterly basis. Any adjustment to the deferred tax asset valuation allowance would be recorded in the consolidated
statement of operations for the period that the adjustment is determined to be required. The valuation allowance against deferred
tax assets was $109.6 million and $133.7 million as of December 31, 2016 and 2015, respectively.
The Tax Reform Act
of 1986 limits the use of NOLs and tax credit carryforwards in certain situations where stock ownership changes occur. In the event
the Company has had a change in ownership, the future utilization of the Company’s net operating loss and tax credit carryforwards
could be limited.
The Company is making
an election to early adopt ASU 2015-17 to classify all deferred tax assets and liabilities, along with any related valuation allowance,
as noncurrent on the balance sheet.
A portion of deferred
tax assets relating to NOLs pertains to NOL carryforwards resulting from tax deductions upon the exercise of employee stock options
of $1.9 million. When recognized, the tax benefit of these loss carryforwards will be accounted for as a credit to additional paid-in
capital rather than a reduction of the income tax expense.
As of December 31,
2016, the Company had NOL carryforwards for federal income tax purposes of $404.0 million. The federal NOL carryforwards, if not
offset against future income, will expire by 2032, with the majority of such NOLs expiring by 2021.
The Company also had federal research
carryforwards of $2.7 million. The federal credits will expire by 2029.
The Company records
liabilities, where appropriate, for all uncertain income tax positions. The Company recognizes potential accrued interest and penalties
related to unrecognized tax benefits within operations as income tax expense. The adoption of these provisions did not have an
impact on the Company’s consolidated financial condition, results of operations or cash flows. At December 31, 2016,
the Company did not have any unrecognized tax benefits.
The Company is subject
to taxation in the US and various state jurisdictions. The Company is currently open to audit under the statute of limitations
by the Internal Revenue Service for the years ending December 31, 1998 through December 31, 2015, due to carryforward of unutilized
net operating losses and research and development credits. The Company does not anticipate significant changes to its
uncertain tax positions through December 31, 2016.