SWK Holdings Corp - Annual Report: 2014 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2014

OR

 Commission file number: 000-27163

(Exact Name of Registrant as Specified in its Charter)

(972) 687-7250

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 par value per share

(Title of class)

Indicate by check mark if the Registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.    Yes  o     No  x

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  o     No  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x     No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No  o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    

Yes o      No x

The aggregate market value of the Registrant’s Common Stock held by non-affiliates is $36,300,179 based on the June 30, 2014, closing price of the Registrant’s Common Stock on such date as reported on the Over the Counter Bulletin Board of $1.17.

On March 23, 2015, the Registrant had outstanding approximately 131,091,961 shares of Common Stock, $0.001 par value per share.

SWK Holdings Corporation

Form 10-K

For the Fiscal Year Ended December 31, 2014

TABLE OF CONTENTS

PART I

In addition to historical information, this report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. From time to time, we may also provide oral or written forward-looking statements in other materials we release to the public. Such forward-looking statements are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995. The forward-looking statements are not historical facts but rather are based on current expectations, estimates and projections about our business and industry, and our beliefs and assumptions, and include, but are not limited to, statements under the headings “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Outlook” words such as “anticipate,” “believe,” “estimate,” “expects,” “intend,” “plan,” “will” and variations of these words and similar expressions identify forward-looking statements. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors, many of which are beyond our control, are difficult to predict and could cause actual results to differ materially (both favorable and unfavorably) from those expressed or forecasted in the forward-looking statements.

These risks and uncertainties include, but are not limited to, those described in Item 1A “Risk Factors” and elsewhere in this report. Forward-looking statements that were believed to be true at the time made may ultimately prove to be incorrect or false. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.

Overview

We were incorporated in July 1996 in California and reincorporated in Delaware in September 1999. In July 2012, we commenced our new corporate strategy of building a specialty finance and asset management business. Our 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. Our initial focus is 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. We are deploying our assets to earn interest, fees, and other income pursuant to this strategy, and we continue to identify and review financing and similar opportunities on an ongoing basis. In addition, through our wholly-owned subsidiary, SWK Advisors LLC, we provide 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. We intend to fund transactions through our own working capital, as well as by building our asset management business by raising additional third party capital to be invested alongside our capital.

We intend to fill a niche that we believe is underserved in the sub-$50 million transaction size. Since many of our competitors that provide longer term, royalty-related financing options have much greater financial resources than us, they tend to not focus on transaction sizes below $50 million as it is generally inefficient for them to do so. In addition, we do 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, we believe we face less competition from such longer term, royalty investors in transactions that are less than $50 million.

We will evaluate and invest in a broad range of healthcare related companies and products with innovative intellectual property, including, the biotechnology, medical device, medical diagnostics and related tools, animal health and pharmaceutical industries (together “life science”) and to tailor our financial solutions to the needs of our business partners. Our business partners are primarily engaged in selling products that directly or indirectly cure diseases and/or improve people’s or animals’ wellness, or they receive royalties paid on the sales of such products. For example, our biotechnology and pharmaceutical business partners manufacture medication that directly treat disease states, whereas our life science tools partners sell a wide variety of research instrumentation to help other companies conduct research into disease states.

Our investment objective is to maximize our portfolio total return and thus increase our net income and net operating income by generating income from three sources:

1. primarily owning or financing through debt investments, royalties generated by the sales of life science products and related intellectual property;

2. receiving interest and other income by advancing capital in the form of secured debt to companies in the life science sector; and

3. to a lesser extent, realize capital appreciation from equity-related investments in the life science sector.

In our portfolio we seek to achieve attractive risk-adjusted current yields and opportunities with the potential for equity-like returns.

The majority of our transactions are expected to be structured similarly to factoring transactions whereby we provide capital in exchange for an interest in an existing revenue stream. We do not anticipate providing capital in situations prior to the commercialization of a product. The existing revenue stream can take several forms, but is most commonly either a royalty derived from the sales of a life science product (1) from the marketing efforts of a third party, such as a royalty paid to an inventor on the sales of a medicine or (2) from the marketing efforts of a partner company, such as a medical device company that directly sells its own products. Our structured debt investments may include warrants or other features, giving us the potential to realize enhanced returns on a portion of our portfolio. Capital that we provide directly to our partners is generally used for growth and general working capital purposes, as well as for acquisitions or recapitalizations in select cases. We generally fund the full amount of transactions up to $20 million through our working capital. 

Our investment advisory agreements are currently non-discretionary and each client determines individually if it wants to participate in a transaction. Each account receives its pro rata allocation for a transaction based on which clients opt into a transaction, and each account receives its pro rata allocation of income produced by a transaction in which they participate. Clients pay us management and incentive fees according to a written investment advisory agreement, and we negotiate fees based on each client’s needs and the complexity of the client’s requirements. Fees paid by clients may differ depending upon the terms negotiated with each client and are paid directly by the client upon receipt of an invoice from us. We may seek to raise discretionary capital from similar investors in the future.

In circumstances where a transaction is greater than $20 million, we seek to syndicate amounts in excess of $20 million to our investment advisory clients. In addition, we may participate in transactions in excess of $20 million with investors other than our investment advisory clients. In those instances, we do not expect to earn investment advisory income from the participations of such investors.

We source our investment opportunities through a combination of our senior management’s proprietary relationships within the industry, outbound business development efforts and inbound inquiry from companies, institutions and inventors interested in learning about our capital financing alternatives. Our investment advisory clients generally do not originate investment opportunities for us.

Execution of New Strategy

In the third quarter of 2012, we purchased an interest in three revenue-producing investment advisory client contracts from PBS Capital Management, LLC, a firm that our current chief executive officer, or CEO, and our current Managing Director control, for $150,000 plus earn out payments through 2016. Our interest in these contracts can be repurchased, for one dollar, by PBS Capital Management, LLC, in the event that the employment contracts of our current CEO and current Managing Director are not renewed. We generated approximately $157,000 and $135,000 in 2014 and 2013, respectively, in revenue due to our interest in the advisory contracts. Although revenue generated from these contracts is immaterial to our financials, we expect the investment advisory clients to continue to co-invest with us in future transactions.

On December 5, 2012, we consummated our first transaction under our specialty finance strategy by providing a $22.5 million term loan to Nautilus Neurosciences, Inc. (“Nautilus”). The loan was repaid on December 17, 2013. Prior to repayment, interest and principal under the loan was paid by a tiered revenue interest that is charged on quarterly net sales and royalties of the borrower applied in the following priority (i) first, to the payment of all accrued but unpaid interest until paid in full; and (ii) second to the payment of all principal of the loans. The loan accrued interest at either a base rate or the LIBOR rate, as determined by the borrower, plus an applicable margin; the base rate and LIBOR rate were subject to minimum floor values such that the minimum interest rate was 16%. We syndicated $16 million of the loan to our investment advisory clients and retained the remainder. Upon repayment, we received our proportionate share of a $2,000,000 exit fee which amounted to $578,000 for the year ended December 31, 2013.

As of March 23, 2015, we have executed 14 transactions under our new strategy, deploying approximately $124,000,000 across a variety of opportunities:

In counting our transactions, we generally consider series of transactions with one partner company as a single transaction. In six of the transactions, we participated alongside other investors; our investment advisory clients co-invested in two of these transactions. The other eight transactions were completed solely by SWK. Subsequent to closing on one of the eight transactions, however, we syndicated a portion of the loan to an investment advisory client and then subsequently purchased it back.

The table below provides an overview of the transactions.

Other than the $500,000 payable to seller of Cambia® royalty noted above, there are no other earn-out payments contracted to be paid by SWK to any of our partner companies. SWK has $5,000,000 of unfunded commitments on loan transactions.

For additional information regarding these transactions, see Notes 1 and 2 of the Notes to the Consolidated Financial Statements in Item 8. “Financial Statements and Supplementary Data.”

Rights Offering

On November 26, 2014, we closed our previously announced rights offering to purchase approximately 14,534,884 shares of our common stock. The rights offering was launched on November 3, 2014, to stockholders of record on October 30, 2014, and expired on November 24, 2014.

At closing we issued 14,534,884 shares of common stock as follows: 13,278,664 shares pursuant to the exercise of basic subscription rights and 1,256,218 shares pursuant to the exercise of over-subscription rights. The shares issued pursuant to the over-subscription rights were calculated on a pro-rata basis in accordance with the terms of the offering. We received gross proceeds of approximately $12,500,000. As the rights offering was fully subscribed, no shares were issued in the standby offering.

Rights Agreement

We have viewed our ability to carry forward our net operating losses, or NOLs, as an important and substantial asset. On January 26, 2006, in order to preserve stockholder value by protecting our ability to carry forward our NOLs, we entered into a rights agreement that provided for a dividend distribution of one preferred share purchase right for each outstanding share of our common stock. The purchase rights become exercisable after the acquisition or attempted acquisition of 4.9% or more of our outstanding common stock without the prior approval of our board of directors. On February 2, 2012, we amended and restated the rights agreement to extend the expiration date from February 3, 2012 to February 3, 2015. On August 18, 2014, we amended the Second Amended and Restated Rights Agreement to designate Carlson Capital and its affiliates (“Carlson”) as Exempt Persons (as defined in the Second Amended and Restated Rights Agreement) unless they own more than 76% of the outstanding shares of our common stock in the aggregate.

On August 18, 2014, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with Carlson. Upon initial close, we issued to Double Black Diamond Offshore Ltd. (“Double Black Diamond”) and Black Diamond Offshore Limited (collectively, “Stockholder”), funds associated with Carlson, 55,908,000 shares of our Common Stock for an aggregate purchase price of approximately $76.6 million in cash. Then upon the completion of the Rights Offering, pursuant to the terms of the Purchase Agreement, we issued to the Stockholder, 17,440,525 shares of our Common Stock for an aggregate purchase price of approximately $23.9 million paid in cash, so that Carlson has a voting 69% ownership interest in the Company.

Credit Facility

In order to expand our capital base, we entered into a credit facility with Double Black Diamond, L.P. (“Double Black”), an affiliate of a major stockholder on September 6, 2013. The credit facility provides us financing, primarily for the purchase of eligible investments. The facility works as a delayed draw credit facility where we have the ability to draw down, as necessary, over the next 18 months, or the Draw Period, up to $30 million, based on certain conditions. The credit facility provided for an initial $15 million to be available at closing. On or before the last day of the Draw Period, we could request the loan amount to be increased to $30 million upon us realizing net proceeds of at least $10 million in cash through the issuance of new equity securities. Repayment of the facility was due upon maturity. Double Black, as lender, received a security interest in substantially all of our assets as collateral for the facility. In conjunction with the credit facility, we issued warrants to Double Black, for 1,000,000 shares of our common stock at a strike price of $1.3875. The warrants have a price dilution mechanism that was triggered by the price that shares were sold in the Rights Offering, and as a result, the strike price of the warrants was reduced to $1.348. In connection with the credit agreement, we, Double Black and certain of Double Black’s affiliates, entered into a Voting Rights Agreement restricting Double Black and its affiliates voting rights under certain circumstances and providing Double Black and its affiliates a right of first offer on certain future share issuances. The Draw Period expired on March 6, 2015.  

Competition

Our markets are very competitive. We face competition in the pursuit of outside investors, investment management clients and opportunities to deploy our capital in attractive healthcare related companies. Our primary competitors provide financing to prospective companies and include non-bank financial institutions, federal or state chartered banks, venture debt funds, venture capital funds, private equity funds, investment funds and investment banks. Many of these entities have greater financial and managerial resources than we have. Some of these competitors may also have a lower cost of capital and access to funding sources that are not available to us, which may create a competitive disadvantage for us. As a result, we tend not to compete on price, but instead focus on our industry experience, flexible financing options and speed to evaluating and completing a transaction. In addition, since many of our competitors that provide longer term, royalty-related financing options have much greater financial resources than us, they tend to not focus on transaction sizes below $50 million as it is generally inefficient for them to do so. As such, we believe we face less competition from such longer term, royalty investors in transactions that are less than $50 million.

For additional information concerning the competitive risks we face, see “Item 1A. Risk Factors—Risks Related to our Business and Structure—We operate in a highly competitive market for investment opportunities.”

Employees

As of December 31, 2014, we had three full-time employees and one part-time employee.  We believe that the relationship with our employees is satisfactory.

Additional Information

We file annual, quarterly and current reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended (the “Exchange Act’’), with the Securities and Exchange Commission (“SEC”). Readers may read and copy any document that the Company files at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, D.C. 20549, U.S.A. Please call the SEC at 1-800-SEC-0330 for further information on the Public Reference Room. Our SEC filings are also available to the public from the SEC’s internet site at http://www.sec.gov.

Our internet site is http://www.swkhold.com. We will make available free of charge through our website in the “Investor Relations – SEC Filings” section our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and Forms 3, 4 and 5 filed on behalf of directors and executive officers and any amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Also posted on our website in the ““Investor Relations — Corporate Governance’’ section are charters for the company’s Audit Committee, Compensation Committee and Governance Committee as well as our Code of Ethics and Insider Trading Policy governing our directors, officers and employees. Information on or accessible through, our website is not a part of, and is not incorporated into, this report.

Item 1A.    RISK FACTORS.

An investment in our common stock involves significant risks. You should carefully consider the risks and uncertainties and the risk factors set forth in the documents and reports filed with the SEC and the risks described below before you make an investment decision regarding the common stock. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations.

RISKS RELATED TO OUR BUSINESS AND STRUCTURE

We have a limited operating history executing our new strategy.

While we have been in existence for a number of years, we only commenced implementing the new business strategy in July 2012. As a result, we are subject to many of the business risks and uncertainties associated with any new business, including the risk that we may not achieve our investment objectives and that, as a result, the value of our common stock could decline substantially.

We may suffer losses on our principal invested in credit and royalty transactions.

Most of our assets are expected to be royalty streams or debt backed by royalty streams paid by small- and middle- market businesses, which are highly speculative and involve a high degree of risk of credit loss. In addition, we may own royalties or invest in debt backed by royalties that are derived by products that are early in their commercial launch, face intense competition or are subject to other risks, which similarly involve a high degree of risk of principal loss. These risks are likely to increase during volatile economic periods, such as what the U.S. and many other economies have recently been experiencing.

We operate in a highly competitive market for investment opportunities.

A large number of entities compete with us to advance capital to the companies we target. We compete with non-bank financial institutions, federal or state chartered banks, venture debt funds, venture capital funds, private equity funds, pharmaceutical royalty and other investment funds, business development companies, and investment banks. Additionally, because competition for investment opportunities generally has increased among alternative investment vehicles, particularly those seeking yield investments, such as hedge funds, those entities have begun to invest in areas they have not traditionally invested in, including investments in royalties and debt backed by royalties, which may overlap with our business strategy. As a result of these new entrants, competition for investment opportunities in our target markets has intensified, which is a trend we expect to continue.

Many of our existing and potential competitors are substantially larger and have considerably greater financial, technical and marketing resources than we do. For example, some competitors may have a lower cost of funds and access to funding sources that are not available to us. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and establish more or fuller relationships with potential business partners than us. Furthermore, many of our competitors are not subject to the maintenance of an exception or exemption from regulation as an investment company, which may allow them more flexibility in advancing capital to companies we may also target such as advancing debt capital that is not repaid by royalty streams. We cannot assure you that the competitive pressures we face will not have a materially adverse effect on our business, financial condition and results of operations. Also, as a result of existing and increasing competition and our competitors’ ability to provide a total financing package solution, we may not be able to take advantage of attractive business opportunities from time to time, and we can offer no assurance that we will be able to identify and make investments that are consistent with our business objectives.

We do not seek to compete primarily based on the cost of the capital that we provide, and we believe that some of our competitors provide capital at rates that are comparable to or lower than the rates we offer. We may lose business opportunities if we do not match our competitors’ pricing, terms and structure. If we match our competitors’ pricing, terms and structure, we may experience decreased net interest and royalty income and increased risk of credit loss.

Our financial condition and results of operations will depend on our ability to manage our future growth effectively.

Our ability to achieve our business objectives depends on our ability to grow, which depends, in turn, on our ability to continue to identify, analyze, invest in royalties and/or debt backed by royalties that meet our investment criteria. Accomplishing this result on a cost-effective basis is largely a function of our structuring of transactions and our access to financing on acceptable terms. As we continue to grow, we will need to continue to hire, train, supervise and manage new employees. Failure to manage our future growth effectively could have a materially adverse effect on our business, financial condition and results of operations.

If we are unable to substantially utilize our NOL carryforwards, our future cash tax liability may increase.

As of December 31, 2014, we had NOL carryforwards for U.S. federal income tax purposes of approximately $421,000,000. The U.S. federal NOL carryforwards, if not offset against future income, will expire by 2032, with the majority of such NOLs expiring by 2021. Under Section 382 of the Internal Revenue Code, a corporation that undergoes an “ownership change” may be subject to limitations on its ability to utilize its pre-change NOL carryforward amounts to offset future taxable income. In general, an ownership change occurs if the aggregate stock ownership of certain stockholders (generally 5% stockholders, applying certain look-through and aggregation rules) increases by more than 50% over such stockholders’ lowest percentage ownership during the testing period (generally three years). New issuances of our common stock, which is within our control, and purchases of our common stock in amounts greater than specified levels, which are beyond our control, could create an additional limitation on our ability to utilize our NOL carryforward amounts for tax purposes in the future. Limitations imposed on our ability to utilize NOL carryforward amounts could cause U.S. federal and state income taxes to be paid earlier than would be paid if such limitations were not in effect and could cause such NOL carryforward amounts to expire unused, in each case reducing or eliminating the expected benefit to us. Furthermore, we may not be able to generate sufficient taxable income to utilize our NOL carryforward amounts before they expire. If any of these events occur, we may not derive some or all of the benefits from our NOL carryforward amounts. We do not believe that the purchase of additional shares by funds affiliated with Carlson Capital to maintain their 69% ownership or the rights offering have limited our ability to utilize our NOL carryforward amounts.

We are dependent upon our key management personnel for our future success.

We depend on the diligence, skill and network of business contacts of our senior management and their access to the investment professionals and the information and deal flow generated by these investment professionals in the course of their investment and portfolio management activities. Our senior management team evaluates, negotiates, structures, closes, monitors and services our investments. Our success depends to a significant extent on the continued service of this senior management team, namely Brett Pope and Winston Black. The departure of either of these individuals could have a materially adverse effect on our ability to achieve our business objectives. In addition, we have very few employees.

If we are unable to obtain additional debt or equity financing on commercially reasonable terms our business could be materially adversely affected.

We have limited capital to execute our business strategy and will need to obtain additional debt or equity financing to fund future growth and obtain funds which may be made available for investments.

Once we deploy the proceeds from the Purchase Agreement and the Rights Offering and the expansion of our credit facility, if we are unable to enter into new debt or equity financing arrangements on commercially reasonable terms, our liquidity may be reduced significantly, and as a result, our ability to implement and grow our business strategy could be materially impacted.

Our use of leverage may limit our operational flexibility and increase our overall risk, which may adversely affect our business and results of operations.

Although the use of leverage may create an opportunity for increased returns for us, it also results in additional risks and can magnify the effect of any losses and thus could negatively impact our business and results of operations and have important adverse consequences to our investments. Our current credit facility contains covenants that restrict our operating flexibility, including covenants that, among others, limits our ability to: (i) make distributions in certain circumstances, (ii) incur additional debt, and (iii) engage in certain transactions. In addition, we secured our credit facility through the pledging of substantially all of our assets and if we are unable to generate sufficient cash flow to meet principal and interest payments on such indebtedness, we will be subject to risk that the lender seizes our assets through an acceleration of the credit facility that could require liquidation of pledged collateral at inopportune times or at prices that are not favorable to us and cause significant losses. If the lender seizes and liquidates pledged collateral, such collateral will likely be sold at distressed price levels. We will fail to realize the full value of such asset in a distressed sale. We expect any future debt we incur will contain similar restrictive conditions and protections for the benefit of a lender.

Our credit facility has customary affirmative covenants, negative covenants and default provisions. These provisions may prevent us from entering into transactions which we may otherwise determine are beneficial to us, which could negatively impact our business and results of operations.

Our investments in debt backed by royalty streams paid by our prospective partner companies and the products underlying the royalty streams in which we invest may be risky and we could lose all or part of our investment.

Most of our assets are expected to be royalty streams or debt backed by royalty streams paid by our partner companies. Some of our partner companies to which we advance debt, whether it be backed by royalties or be general obligations of the issuer, have relatively short or no operating histories. These companies are and will be subject to all of the business risk and uncertainties associated with any new business enterprise, including the risk that these companies may not reach their investment objectives and the value of our investment in them may decline substantially or fall to zero.

In addition, the middle-market companies to which we are targeting to advance debt are subject to a number of other significant risks, including:

Similarly, the products underlying royalty streams in which we invest may have relatively short or no sales history, may be established products that face intense competition from newer, more innovative or better marketed products, or may be subject to additional risks. If these products do not achieve commercial success or attain lower sales than we estimate, we may lose value on our investments.

Currently, we have a limited number of assets, which subjects us to a greater risk of significant loss if any of our assets declines in value due to a default on its obligations under any of its debt securities or if any of our royalty investments substantially underperforms our expectations.

A consequence of our currently limited number of assets is that the aggregate returns we realize may be significantly adversely affected if one or more of our significant partner company investments perform poorly or if we need to write down the value of any one significant investment.

We generally do not control our partner companies.

We generally only hold royalties or debt backed by royalties that is issued by our partner companies. As such, we do not, and do not expect to, control any of our partner companies, even though we may have board representation or board observation rights, and the royalty debt agreements may contain certain restrictive covenants that limit the business and operations of our partner companies. As a result, we are subject to the risk that a partner company may make business decisions with which we disagree and the management of such company may take risks or otherwise act in ways that do not serve our interests as debt holders.

If we make investments in unsecured debt backed by royalties, those investments might not generate sufficient cash flow to service our debt obligations.

We may make investments in unsecured debt backed by royalties. Unsecured investments may be subordinated to other obligations of the obligor. Unsecured investments often reflect a greater possibility that adverse changes in the financial condition of the obligor or general economic conditions (including, for example, a substantial period of rising interest rates or declining earnings) or both may impair the ability of the obligor to make payment of principal and interest. If we make an unsecured investment in a partner company, that partner company may be highly leveraged, and its relatively high debt-to-equity ratio may increase the risk that its operations might not generate sufficient cash to service its debt obligations. In such cases we would not have any collateral to help secure repayment of the obligations owed to us.

We may have limited access to information about privately- held royalty streams and companies in which we invest.

We invest primarily in privately-held royalties and debt backed by royalties issued by private companies. Generally, little public information exists about these royalty streams and private companies, and we are required to rely on the ability of our senior management to obtain adequate information to evaluate the potential returns from investing in these assets. If we are unable to uncover all material information about these assets, we may not make a fully informed investment decision, and we may lose money on our investment.

Prepayments of our debt investments by our partner companies could adversely impact our results of operations and reduce our return on equity.

We are subject to the risk that the debt we advance to our partner companies may be repaid prior to maturity. When this occurs, we will generally reinvest these proceeds in temporary investments, pending their future investment in new royalties or debt repaid by royalties issued by partner companies. These temporary investments will typically have substantially lower yields than the debt that was prepaid and we could experience significant delays in reinvesting these amounts. Any future asset may also have lower yields than the debt that was repaid. As a result, our results of operations could be materially adversely affected if one or more of our partner companies elect to prepay amounts owed to us. Additionally, prepayments could negatively impact our return on equity, which could result in a decline in the market price of our common stock.

We may not be able to complete transactions without co-investments from third parties.

We may co-invest with third parties through our registered investment advisory business or otherwise. In certain circumstances, we may not be able to fund transactions without the participations of such third parties. In the event that we are unable to find suitable third parties to co-invest with us or if such third party fails to close, our results of operations may be materially adversely impacted.

Our quarterly and annual operating results are subject to fluctuation as a result of the nature of our business, and if we fail to achieve our investment objective, the market price of our common stock may decline.

We could experience fluctuations in our quarterly and annual operating results due to a number of factors, some of which are beyond our control, including, but not limited to, the interest rate payable on the debt assets that we acquire, the default rate on such assets, the level of our expenses, variations in and the timing of the recognition of realized and unrealized gains or losses, changes in our portfolio composition, the degree to which we encounter competition in our markets, market volatility in our publicly traded securities and the securities of our partner companies, and general economic conditions. As a result of these factors, results for any period should not be relied upon as being indicative of performance in future periods. In addition, any of these factors could negatively impact our ability to achieve our business objectives, which may cause the market price of our common stock to decline.

Our investments in royalty-related transactions depend on third parties to market royalty-generating products.

Royalties generally, and the royalty-related income we expect to receive in the future, will directly or indirectly depend upon the marketing efforts of third parties, particularly large pharmaceutical companies that license the right to manufacture and sell products from technology innovators in exchange for royalty payments from the licensees to the licensors, with whom we may transact. These licensees may be motivated to maximize income by allocating resources to other products and, in the future, may decide to focus less attention on the products that pay royalties in which we have an economic interest. In addition, there can be no assurance that any of the licensees has adequate resources and motivation to continue to produce, market and sell such products in which we have a royalty-related interest. Moreover, the license agreement creating the right to receive royalties may not have specific sales targets and the licensee typically has exclusive or substantial discretion in determining its marketing plans and efforts. As a result, the licensee may not be restricted from abandoning a licensed product or from developing or selling a competitive product. In addition, in the event that a license expires or is terminated, we would be dependent upon the licensor of the license to find another marketing partner. There can be no assurance that another licensee could be found on favorable terms, or at all, or that the licensor will be able to assume marketing, sales and distribution responsibility for its own account. These factors may materially adversely affect any of our future royalty-related assets.

Aside from any limited audit rights relating to the activities of the licensees that we may have in certain circumstances, we do not have the rights or ability to manage the operations of the licensees. Poor management of operations by the licensees could adversely affect the sales of products in which we have a royalty interest, and the payment of royalty-related income to us. In addition, we have limited information on the licensees’ operations. While we may be able to receive certain information relating to sales of the product in which we have a royalty-related interest through the exercise of the audit rights and review of royalty reports, we may not have the right to review or receive certain information relating to the marketed products, including the results of any studies conducted by the licensees or others or complaints from doctors or users of such products, that the licensees may have and that may impact sales levels. The market performance of such products, therefore, may be diminished by any number of factors relating to the licensees that are beyond our control.

Economic recessions or downturns could impair the ability of our partner companies to repay loans, which, in turn, could increase our non-performing assets, decrease the value of our assets, reduce our volume of new loans and have a material adverse effect on our results of operations.

Many of our partner companies may be susceptible to economic slowdowns or recessions in both the U.S. and foreign countries and may be unable to repay our loans during such periods. Adverse economic conditions also may decrease the value of collateral securing some of our loans and the value of our equity investments. Economic slowdowns or recessions could lead to financial losses in our portfolio and a decrease in revenues, net income and assets. Unfavorable economic conditions also could increase our funding costs, limit our access to the capital markets or result in a decision by lenders not to extend credit to us.

A partner company’s failure to satisfy financial or operating covenants imposed by us or other lenders could lead to defaults and, potentially, termination of the partner company’s loans and foreclosure on its secured assets, which could trigger cross-defaults under other agreements and jeopardize the partner company’s ability to meet its obligations under the debt securities that we hold. We may incur expenses to the extent necessary to seek recovery upon default or to negotiate new terms with a defaulting partner company. In addition, if a partner company goes bankrupt, even though we may have structured our investment as senior debt or secured debt, depending on the facts and circumstances, including the extent to which we actually provided significant “managerial assistance,” if any, to that partner company, a bankruptcy court might re-characterize our debt holding and subordinate all or a portion of our claim to that of other creditors. These events could materially adversely affect our financial condition and operating results.

These companies may face intense competition, including competition from companies with greater financial resources, more extensive research and development, manufacturing, marketing and service capabilities and greater number of qualified and experienced managerial and technical personnel. They may need additional financing which they are unable to secure and which we are unable or unwilling to provide, or they may be subject to adverse developments unrelated to the technologies they acquire.

Risks Associated with Investments in the Life Science Industry

Healthcare and life science industries are subject to extensive government regulation, litigation risk and certain other risks particular to that industry.

We have invested and plan to continue investing in cash flow streams produced by life science products that are subject to extensive regulation by the Food and Drug Administration, or the FDA, similar foreign regulatory authorities, and to a lesser extent, other federal and state agencies. If any of these products and the companies which manage such products fails to comply with applicable regulations, they could be subject to significant penalties and claims that could materially and adversely affect their sales levels and operations. Medical devices and drugs are subject to the expense, delay and uncertainty of the regulatory approval process in order to reach the market and, even if approved, these products may not be accepted in the marketplace. In addition, governmental budgetary constraints effecting the regulatory approval process, new laws, regulations or judicial interpretations of existing laws and regulations might adversely affect a partner company or product in this industry.

Companies in the life science industry may also have a limited number of suppliers of necessary components or a limited number of manufacturers for their products, and therefore face a risk of disruption to their manufacturing process if they are unable to find alternative suppliers when needed. Any of these factors could materially and adversely affect the operations of a portfolio company in this industry or the licensee’s operations, which in turn, would impair our ability to timely collect principal and interest payments owed to us or decrease our royalty-related income.

The pharmaceutical industry is subject to numerous risks, including competition, extensive government regulation, product liability, patent exclusivity and commercial difficulties.

Our assets may include royalties and royalty linked debt that are paid on sales of pharmaceutical products, which are subject to numerous risks. The successful and timely implementation of the business model of our specialty pharmaceutical and drug discovery partner companies depends on their ability to adapt to changing technologies and introduce new products. As competitors continue to introduce competitive products, the ability of our partner companies to continue effectively marketing their existing product portfolio, and to develop and acquire innovative products and technologies that improve efficacy, safety, patient’s and clinician’s ease of use and cost-effectiveness is important to the success of such partner companies. The success of new product offerings will depend on many factors, including the ability to properly anticipate and satisfy customer needs, obtain regulatory approvals on a timely basis, develop and manufacture products in an economic and timely manner, obtain or maintain advantageous positions with respect to intellectual property, and differentiate products from competitors. Failure by our partner companies to successfully commercialize existing, planned products or acquire other new products could have a material adverse effect on our business, financial condition and results of operations. In addition, the ability of generic manufactures to invalidate a partner company’s patents protecting its products or to invalidate the patents supporting products in which we receive royalty-related income could have a material adverse effect on our business.

The development of products by life science companies requires significant research and development, clinical trials and regulatory approvals.

The development of products by life science companies requires significant research and development, clinical trials and regulatory approvals. In addition, similar activities and costs may be required to support products that have already been commercialized. The results of product development efforts may be affected by a number of factors, including the ability to innovate, develop and manufacture new products, complete clinical trials, obtain regulatory approvals and reimbursement in the U.S. and abroad, or gain and maintain market approval of products. In addition, regulatory review processes by U.S. and foreign agencies may extend longer than anticipated as a result of decreased funding and tighter fiscal budgets. Further, patents attained by others can preclude or delay the commercialization of a product. There can be no assurance that any products now in development will achieve technological feasibility, obtain regulatory approval, or gain market acceptance. Failure can occur at any point in the development process, including after significant funds have been invested. Products may fail to reach the market or may have only limited commercial success because of efficacy or safety concerns, failure to achieve positive clinical outcomes, inability to obtain necessary regulatory approvals, failure to achieve market adoption, limited scope of approved uses, excessive costs to manufacture, the failure to establish or maintain intellectual property rights, or the infringement of intellectual property rights of others. Failure by our partner companies to successfully commercialize pipeline products in which we have an economic interest could have a material adverse effect on our business, financial condition and results of operations.

Future legislation, and/or regulations and policies adopted by the FDA or other U.S. or foreign regulatory authorities may increase the time and cost required by some of our partner companies to conduct and complete clinical trials for the product candidates that they develop, and there is no assurance that these companies will obtain regulatory approval to market and commercialize their products in the U.S. and in foreign countries.

The FDA and other foreign and U.S. regulatory authorities have established regulations, guidelines and policies to govern the drug development and approval process which affect some of our partner companies. Any change in regulatory requirements due to the adoption by the FDA and/or foreign or other U.S. regulatory authorities of new legislation, regulations, or policies may require some of our partner companies to amend existing clinical trial protocols or add new clinical trials to comply with these changes. Such amendments to existing protocols and/or clinical trial applications or the need for new ones, may significantly impact the cost, timing and completion of the clinical trials.

In addition, increased scrutiny by the U.S. Congress of the FDA’s and other authorities approval processes may significantly delay or prevent regulatory approval, as well as impose more stringent product labeling and post-marketing testing and other requirements. Foreign regulatory authorities may also increase their scrutiny of approval processes resulting in similar delays. Increased scrutiny and approval processes may limit the ability of our partner companies to market and commercialize their products in the U.S. and in foreign countries.

Changes in healthcare laws and other regulations applicable to some of our partner companies’ businesses may constrain their ability to offer their products and services.

Changes in healthcare or other laws and regulations applicable to the businesses of some of our partner companies may occur that could increase their compliance and other costs of doing business, require significant systems enhancements, or render their products or services less profitable or obsolete, any of which could have a material adverse effect on their results of operations. There has also been an increased political and regulatory focus on healthcare laws in recent years, and new legislation could have a material effect on the business and operations of some of our partner companies.

Risks Associated with the Company and our Capital Structure

Our common stock is currently quoted on the Over the Counter Quotation Board, or the OTCQB, and we are subject to additional SEC regulation as a result of our current historical stock price.

Since October 2005, our common stock has been quoted on the OTCQB or its predecessor. The OTCQB is generally considered less efficient than exchanges such as The New York Stock Exchange and The NASDAQ Stock Market. Quotation of our common stock on the OTCQB may reduce the liquidity of our securities, limit the number of investors who trade in our securities, result in a lower stock price and larger spread in the bid and ask prices for shares of our common stock and could have an adverse effect on us. Additionally, we may become subject to the SEC rules that affect “penny stocks,” which are stocks below $5.00 per share that are not quoted on The NASDAQ Stock Market. These SEC rules would make it more difficult for brokers to find buyers for our securities and could lower the net sales prices that our stockholders are able to obtain. If our price of common stock remains low, we may not be able to raise equity capital.

Our listing on the OTCQB and our low stock price may greatly impair our ability to raise any future necessary capital through equity or debt financing and significantly increase the dilution to our current stockholders caused by any issuance of equity in financing or other transactions. The price at which we would issue shares in such transactions is generally based on the market price of our common stock, and a decline in the stock price could result in our need to issue a greater number of shares to raise a given amount of funding.

In addition, because our common stock is not listed on a principal national exchange, we are subject to Rule 15g-9 under the Exchange Act of 1934, as amended, or the Exchange Act, which imposes additional sales practice requirements on broker-dealers that sell low-priced securities to persons other than established customers and institutional accredited investors. For transactions covered by this rule, a broker-dealer must make a special suitability determination for the purchaser and have received the purchaser’s written consent to the transaction prior to sale. Consequently, the rule may affect the ability of broker-dealers to sell our common stock and affect the ability of our stockholders to sell their shares of our common stock in the secondary market. Moreover, investors may be less interested in purchasing low-priced securities because the brokerage commissions, as a percentage of the total transaction value, tend to be higher for such securities, and some investment funds will not invest in low-priced securities (other than those which focus on small-capitalization companies or low-priced securities).

Funds affiliated with Carlson can control or exert significant influence over our management and policies through their ownership of a large amount of our common stock and Double Black’s role as lender under our credit facility.

As of December 31, 2014, funds affiliated with Carlson owned (including the 1,000,000 shares of common stock underlying the Warrant held by Double Black) in the aggregate 69% of our combined issued and outstanding common stock, unvested restricted stock, and common stock underlying the Warrant. In addition, Double Black is a party to a $30 million senior secured credit facility with us. Michael Weinberg, the chairman of our board of directors, and Christopher W. Haga, a director, are employees of Carlson. In view of the large percentage of ownership by funds affiliated with Carlson, and the Double Black’s position as a secured lender to us, Carlson and its affiliates, including Double Black, have the ability to control or exert significant influence over our management and policies, such as the election of our directors, the appointment of new management and the approval of any other action requiring the approval of our stockholders, including any amendments to our certificate of incorporation, a sale of all or substantially all of our assets or a merger or other significant transaction. The investment objectives of Carlson and its affiliates, including the Standby Purchaser, may from time to time be different than or conflict with those of our other stockholders.

In addition, pursuant to the terms of a Stockholders’ Agreement entered into in connection with the initial share issuance on August 18, 2014, funds affiliated with Carlson have the right to approve specific transactions, including the incurrence of indebtedness over specified amounts, the sale of assets over specified amounts, declaration of dividends, loans, capital contributions to or investments in any third party over specified amounts, changes in the size of the board of directors and changes in our chief executive officer.

We have adopted provisions in our certificate of incorporation and bylaws, and a stockholder rights plan that could delay or prevent an acquisition of the Company.

The board of directors has the authority to issue up to 5,000,000 shares of preferred stock. Without any further vote or action on the part of the stockholders, the board of directors has the authority to determine the price, rights, preferences, privileges, and restrictions of the preferred stock. This preferred stock, if issued, might have preference over and harm the rights of the holders of common stock. Although the ability to issue this preferred stock provides us with flexibility in connection with possible acquisitions and other corporate purposes, it can also be used to make it more difficult for a third party to acquire a majority of our outstanding voting stock. We currently have no plans to issue preferred stock.

Additionally, we have a stockholder rights plan that is intended to protect our ability to utilize our NOL carryforwards and which would also make it difficult for a third party to acquire a significant number of shares of our common stock.

Our certificate of incorporation and bylaws include provisions that may deter an unsolicited offer to purchase us. These provisions, coupled with the provisions of the Delaware General Corporation Law, may delay or impede a merger, tender offer or proxy contest. Furthermore, the board of directors is divided into three classes, only one of which is elected each year. In addition, directors are only removable by the affirmative vote of at least two-thirds of all classes of voting stock. These factors may further delay or prevent a change of control of the Company.

If we were deemed an investment company under the Investment Company Act of 1940, applicable restrictions could make it impractical for us to continue our business as contemplated and could have a material adverse effect on our business.

We have not been and do not intend to become registered as an “investment company” under the Investment Company Act of 1940, or the 40 Act, because we believe the nature of our assets and the sources of our income exclude us from the definition of an investment company pursuant to Section (3)(a)(1)(C) under the 40 Act. Accordingly, we are not subject to the provisions of the 40 Act, such as conflict of interest rules, requirements for disinterested directors and other substantive provisions which were enacted to protect investors in “investment companies.”

Generally, a company is an “investment company” if it is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities or owns or proposes to own investment securities having a value exceeding 40% of the value of its total assets (exclusive of U.S. government securities and cash items) on an unconsolidated basis, unless an exception, exemption or safe harbor applies. We refer to this investment company definition test as the “40% Test.”

We monitor our compliance with the 40% Test and seek to conduct our business activities to comply with this test. It is not feasible for us to be regulated as an investment company because the restrictions imposed by the 40 Act rules are inconsistent with our strategy. In order to continue to comply with the 40% Test, we may need to take various actions which we might otherwise not pursue. The actions we may need to take to address these issues while maintaining compliance with the 40% Test (or another exception or exemption from regulation as an investment company), include restructuring or terminating the Company, could adversely affect our ability to create and realize stockholder value.

Because we operate through our subsidiaries, our ability to comply with the 40% Test is dependent on the ability of certain of our subsidiaries to rely on an exclusion or exemption from investment company registration. In this regard, one of our subsidiaries currently relies on the exclusion from investment company registration provided by Section 3(c)(5)(A) under the 1940 Act. Section 3(c)(5)(A), as interpreted by the staff of the SEC, requires us to invest at least 55% of our assets in “notes, drafts, acceptances, open accounts receivable, and other obligations representing part or all of the sales price of merchandise, insurance, and services” (or Qualifying Assets).

In complying with Section 3(c)(5)(A), one of our subsidiaries, SWK Funding LLC, relies on an interpretation that royalty interests that entitle SWK Funding LLC to collect royalty receivables that are directly based on the sales price of specific biopharmaceutical products that use intellectual property covered by specific license agreements are Qualifying Assets under Section 3(c)(5)(A). This interpretation was promulgated by the SEC staff in a no-action letter issued to Royalty Pharma on August 13, 2010. The assets acquired by SWK Funding LLC therefore, are limited by the provisions of the 1940 Act and SEC staff interpretations thereunder. If the SEC or its staff in the future adopts a contrary interpretation or otherwise restricts the conclusions in the staff’s no-action letter such that royalty interests are no longer treated as Qualifying Assets for purposes of Section 3(c)(5)(A), SWK Funding LLC could be required to restructure its activities or sell certain of its assets, potentially negatively affecting our performance. As a result, our business will be materially and adversely affected if SWK Funding LLC fails to qualify for Section 3(c)(5)(A).

The rules and interpretations of the SEC and the courts, relating to the definition of “investment company” are highly complex in numerous respects. While, we intend to conduct our operations so that we will not be deemed an investment company, we can give no assurances that we will not be deemed an “investment company” and be required to register under the 40 Act. If we were to be deemed an “investment company,” restrictions imposed by the 40 Act, including limitations on our capital structure and our ability to transact with affiliates, could make it impractical for us to continue our business as contemplated and would have a material adverse effect on our business and the price of our shares. In addition, we could be subject to legal actions by regulatory authorities and others and could be forced to dissolve. The costs of defending any such actions could constitute a material part of our assets and dissolution could have materially adverse effects on our company and the value of our common stock.

Not applicable.

Our corporate headquarters is located in Dallas, Texas, where we leased approximately 1,300 square feet of space.  The lease expired on January 31, 2015, at which time we moved to a new location in Dallas, where we leased approximately 2,400 square feet of space. We believe these facilities are adequate for our business requirements.

We are involved in, or have been involved in, arbitrations or various other legal proceedings that arise from the normal course of our business. We cannot predict the timing or outcome of these claims and other proceedings. The ultimate outcome of any litigation is uncertain, and either unfavorable or favorable outcomes could have a material negative impact on our results of operations, balance sheets and cash flows due to defense costs, and divert management resources. Currently, we are not involved in any arbitration and/or other legal proceeding that we expect to have a material effect on our business, financial condition, results of operations and cash flows

Not applicable.

PART II

Our common stock trades on the OTCQB Marketplace, under the symbol “SWKH.” The table below sets forth the high and low sale prices of our common stock on the OTCQB Marketplace during the periods indicated:

Holders of Record

There were approximately 598 stockholders of record of our common stock as of March 23, 2015. The actual number of stockholders is greater than this number of record holders, and includes stockholders who are beneficial owners but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities.

Dividend Policy

To date, we have not paid any cash dividends on our capital stock. We intend to retain our cash and, therefore, do not anticipate paying any cash dividends in the foreseeable future.

Recent Sales of Unregistered Securities

In conjunction with the credit facility entered into with Double Black, an affiliate of a major stockholder on September 6, 2013, the Company issued warrants to Double Black for 1,000,000 shares of the Company’s common stock at a strike price of $1.3875. In addition, the Company entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with Double Black, which sets forth their rights to have their shares of common stock owned prior to the closing of the credit facility and shares of common stock issuable upon exercise of the warrants registered with the SEC for public resale upon the request of the holders of at least 50% of the Registrable Securities (as defined in the Registration Rights Agreement). The Registration Rights Agreement terminates at such time as Double Black and its affiliates’ total beneficial ownership of the Company’s common stock is less than 5.0% and Double Black is no longer an affiliate of the Company. The warrants may be exercised at any time upon the election of the holder, beginning on the date of the issuance and ending on the seventh anniversary of the date of issuance. The issuance of the warrants was not registered under the Securities Act as such issuance was exempt from registration under Section 4(2) of the Securities Act. The warrants have a price dilution mechanism that was triggered by the price that shares were sold in the Rights Offering, and as a result, the strike price of the warrants was reduced to $1.348.

On August 18, 2014, we entered into the Purchase Agreement with Carlson. Upon initial close, we issued to the Stockholder 55,908,000 shares of our Common Stock for an aggregate purchase price of approximately $76.6 million in cash. Then upon the completion of the Rights Offering, pursuant to the terms of the Purchase Agreement, we issued to the Stockholder, 17,440,525 shares of our Common Stock for an aggregate purchase price of approximately $23.9 million paid in cash, so that Carlson has a voting 69% ownership interest in the Company. The shares were issued to Stockholder in a transaction exempt from the registration requirements of the Securities Act pursuant Section 4(2) thereunder.

Not Applicable

The following discussion and analysis should be read in conjunction with our financial statements and the related notes. Our discussion includes forward-looking statements based upon current expectations that involve risks and uncertainties, such as our plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set forth under the Risk Factors, Special Note Regarding Forward-Looking Statements and Business sections in this prospectus. We use words such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend,” “may,” “will,” “should,” “could,” and similar expressions to identify forward-looking statements.

Overview

Our 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. We will initially focus 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. We expect to deploy our assets to earn interest, fees, and other income pursuant to this strategy, and we continue to identify and review financing and similar opportunities on an ongoing basis. In addition, through our wholly-owned subsidiary, SWK Advisors LLC, we provide 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. We intend to fund transactions through our own working capital, as well as by building our asset management business by raising additional third party capital to be invested alongside our capital.

We intend to fill a niche that we believe is underserved in the sub-$50 million transaction size. Since many of our competitors that provide longer term, royalty-related financing options have much greater financial resources than us, they tend to not focus on transaction sizes below $50 million as it is generally inefficient for them to do so. In addition, we do 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, we believe we face less competition from such longer term, royalty investors in transactions that are less than $50 million. 

We will evaluate and invest in a broad range of healthcare related companies and products with innovative intellectual property, including the biotechnology, medical device, medical diagnostics and related tools, animal health and pharmaceutical industries (together “life science”) and to tailor our financial solutions to the needs of our business partners. Our business partners are primarily engaged in selling products that directly or indirectly cure diseases and/or improve people’s or animals’ wellness, or they receive royalties paid on the sales of such products. For example, our biotechnology and pharmaceutical business partners manufacture medication that directly treat disease states, whereas our life science tools partners sell a wide variety of research instrumentation to help other companies conduct research into disease states.

Our investment objective is to maximize our portfolio total return and thus increase our net income and net operating income by generating income from three sources:

1. primarily owning or financing through debt investments, royalties generated by the sales of life science products and related intellectual property;

2. receiving interest and other income by advancing capital in the form of secured debt to companies in the life science sector; and

3. to a lesser extent, realize capital appreciation from equity-related investments in the life science sector.

In our portfolio we seek to achieve attractive risk-adjusted current yields and opportunities with the potential for equity-like returns.

The majority of our transactions are expected to be structured similarly to factoring transactions whereby we provide capital in exchange for an interest in an existing revenue stream. We do not anticipate providing capital in situations prior to the commercialization of a product. The existing revenue stream can take several forms, but is most commonly either a royalty derived from the sales of a life science product (1) from the marketing efforts of a third party, such as a royalty paid to an inventor on the sales of a medicine or (2) from the marketing efforts of a partner company, such as a medical device company that directly sells its own products. Our structured debt investments may include warrants or other features, giving us the potential to realize enhanced returns on a portion of our portfolio. Capital that we provide directly to our partners is generally used for growth and general working capital purposes, as well as for acquisitions or recapitalizations in select cases. We generally fund the full amount of transactions up to $20 million through our working capital.

Our investment advisory agreements are currently non-discretionary and each client determines individually if it wants to participate in a transaction. Each account receives its pro rata allocation for a transaction based on which clients opt into a transaction, and each account receives its pro rata allocation of income produced by a transaction in which they participate. Clients pay us management and incentive fees according to a written investment advisory agreement, and we negotiate fees based on each client’s needs and the complexity of the client’s requirements. Fees paid by clients may differ depending upon the terms negotiated with each client and are paid directly by the client upon receipt of an invoice from us. We may seek to raise discretionary capital from similar investors in the future.

In circumstances where a transaction is greater than $20 million, we seek to syndicate amounts in excess of $20 million to our investment advisory clients. In addition, we may participate in transactions in excess of $20 million with investors other than our investment advisory clients. In those instances, we do not expect to earn investment advisory income from the participations of such investors.

We source our investment opportunities through a combination of our senior management’s proprietary relationships within the industry, outbound business development efforts and inbound inquiry from companies, institutions and inventors interested in learning about our capital financing alternatives. Our investment advisory clients generally do not originate investment opportunities for us.

See “Business” section, included in Part I, Item 1 of this report for further discussion of our overall business and strategy.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition, stock-based compensation, impairment of financing receivables and long-lived assets, valuation of warrants, useful lives of property and equipment, income taxes and contingencies and litigation, among others. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The accounting estimates and assumptions discussed in this section are those that we consider to be the most critical to an understanding of our consolidated financial statements because they inherently involve significant judgments and uncertainties.  For a discussion of our significant accounting policies, refer to Note 1 of the Notes to the Consolidated Financial Statements in Item 8, “Financial Statements and Supplementary Data.”

Variable Interest Entities

An entity is referred to as a variable interest entity, or 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. We consolidate a VIE when we have 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, we also hold variable interests in other VIEs that are not consolidated because we are not the primary beneficiary. We continually monitor both consolidated and unconsolidated VIEs to determine if any events have occurred that could cause the primary beneficiary to change.

Finance Receivables

We extend credit to customers through a variety of financing arrangements, including revenue interest term loans.  It is our 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 we have the intent and ability to hold for the foreseeable future or until maturity are classified as held for investment (“HFI”). If we no longer have 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 (expense), net, 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 over the life of the loan using the effective interest method.

Finance receivables are stated at their principal amounts inclusive of deferred loan origination fees.  Interest income is credited as earned based on the effective interest rate method except when a finance receivable becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued. 

Marketable Investments

Available-for-sale securities are 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, we would consider whether that security is other-than-temporarily impaired using all available information about the collectability of the security. We would not consider that an other-than temporary impairment for a debt security has occurred if (i) we do not intend to sell the debt security, (ii) it is not more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis and (iii) the present value of estimated cash flows will fully cover the amortized cost of the security. We 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, we would recognize the entire difference between the amortized cost and the fair value in earnings if we intend to sell the debt security or it is more likely than not that we will be able to sell the debt security before recovery of its amortized cost basis. If we do not intend to sell the debt security and it is not more likely than not that we will be required to sell the debt security before recovery of its amortized cost basis, we 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 (loss), net of applicable income taxes.

Equity securities in privately-held companies that do not have readily determinable fair values are reflected at cost.

Derivatives

All derivatives held by us 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 income. 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 income, or recorded in other comprehensive income (loss). We had no derivatives designated as hedges as of December 31, 2014 and 2013. We hold warrants issued to us in conjunction with term loan investments discussed in Note 2 of the Notes to the Consolidated Financial Statements. These warrants are included in other assets in the consolidated balance sheets. We issued a warrant on our own common stock in conjunction with our credit agreement discussed of Note 7 of the Notes to the Consolidated Financial Statements. This warrant meets the definition of a derivative and is reflected as warrant liability at fair value in the consolidated balance sheets.

Revenue Recognition

We record interest income on an accrual basis based on the effective interest rate method to the extent that we expect to collect such amounts. We recognize investment management fees as earned over the period the services are rendered.  The majority of investment management fees earned is 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.

Fair Value of Financial Instruments

We use fair value measurements to measure, among other items, acquired assets and liabilities in business combinations, leases and derivative contracts. We also use them to assess impairment of intangible assets and goodwill.

Where available, fair value is based on observable market prices or parameters, or is derived from such prices or parameters. Where observable prices or inputs are not available, use of unobservable prices or inputs are used to estimate the current fair value, often using an internal valuation model. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the item being valued.

The carrying values of our financial instruments, including cash and cash equivalents, prepaid expenses, accounts receivable and other current assets, accounts payable and accrued liabilities, approximate their fair values due to their relatively short maturities or payment terms.

Stock-based Compensation

All 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, we recognize compensation expense in accordance with the fair value of such 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.

Equity Method Investments

We account for portfolio companies whose results are not consolidated, but over which it exercises significant influence, under the equity method of accounting. Whether or not we exercise significant influence with respect to a portfolio company depends on an evaluation of several factors including, among others, representation on the portfolio company’s board of directors and our ownership level. Under the equity method of accounting, we do not reflect a portfolio company’s financial statements within our consolidated financial statements; however, our share of the income or loss of such portfolio company is reflected in the consolidated statements of income (loss). We include the carrying value of equity method portfolio companies in ownership interests in and advances to portfolio companies and funds on the consolidated balance sheets.

When our carrying value in an equity method portfolio company is reduced to zero, we record no further losses in our consolidated statements of operations unless we have an outstanding guarantee obligation or have committed additional funding to such equity method portfolio company. When such equity method portfolio company subsequently reports income, we will not record our share of such income until it exceeds the amount of our share of losses not previously recognized.

Non-controlling Interests

Non-controlling interests represent third-party equity ownership in certain of our consolidated subsidiaries, VIEs or our investments and are presented as a component of equity.

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.

We recognize liabilities for uncertain tax positions. If we ultimately determine that the payment of such a liability is not necessary, then we reverse the liability and recognize a tax benefit during the period in which the determination is made that the liability is no longer necessary. We recognize accrued interest and penalties related to unrecognized tax benefits as a component of income tax benefit in the statements of operations.

Earnings per Share

Basic earnings per share, or EPS is computed by dividing net income by the weighted-average number of common shares outstanding for the period. Diluted EPS is computed by dividing net income by the weighted-average number of common shares outstanding increased by the weighted-average potential impact of dilutive securities, including stock options and restricted stock grants. The dilutive effect is computed using the treasury stock method, which assumes the conversion of stock options and restricted stock grants. However, in periods when results are negative, these shares would not be included in the EPS computation as the result would have an anti-dilutive effect.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, (“ASU 2014-09”), “Revenue from Contracts with Customers”. The objective of ASU 2014-09 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle of ASU 2014-09 is that an entity recognizes 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. In applying the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. The new guidance is effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2016 for public companies. Early adoption is not permitted. Entities have the option of using either a full retrospective or modified approach to adopt ASU 2014-09. We are currently evaluating the new guidance and have not determined the impact this standard may have on our consolidated financial statements nor decided upon the method of adoption.

In June 2014, the FASB issued ASU No. 2014-12, Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. We are currently evaluating the impact that the adoption of this guidance will have on our consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which amended the existing accounting standards for consolidation under both the variable interest model and the voting model. Under ASU No. 2015-02, companies will need to reevaluate whether an entity meets the criteria to be considered a VIE, whether companies still meet the definition of primary beneficiaries, and whether an entity needs to be consolidated under the voting model. ASU No. 2015-02 may be applied using a modified retrospective approach or retrospectively, and is effective for reporting periods beginning after December 15, 2015. Early adoption is permitted. We are currently evaluating the potential impact of the pending adoption of this new guidance.

Comparison of the Years Ended December 31, 2014 and 2013

Revenues

We generated revenues of $17.4 million for the year ended December 31, 2014, driven primarily by $11.9 million in interest and fees earned on our finance receivables and marketable securities, and $5.3 million in income related to our investment in an unconsolidated partnership. We generated revenues of $6.4 million for the year ended December 31, 2013, driven primarily by $3.3 million in interest and fees earned on finance receivables and marketable securities, and $2.8 million in income related to our investment in unconsolidated partnership. Our portfolio consisted of 8 investments in 2013 compared to 14 investments in 2014, which is the primary reason for the significant increase in our revenues.

General and Administrative

General and administrative expenses consist primarily of compensation, stock-based compensation and related costs for management, staff, Board of Directors, legal and audit expenses, and corporate governance. General and administrative expenses increased by 87% to $3.3 million for the year ended December 31, 2014 from $1.7 million for the year ended December 31, 2013, due to an increase in income-based incentive expense, professional fees and stock-based compensation expense.

Interest and Other Expense, net

Interest and other expense, net was $0.8 million for the year ended December 31, 2014, which included interest expense of $0.6 million and fair market value adjustments on derivative warrants of $0.2 million. During the year ended December 31, 2013, interest and other expense, net was $0.2 million which included $0.2 million fair market value adjustments on derivative warrants. The increase in interest expense related to a higher average balance outstanding on the loan credit agreement during the year ended December 31, 2014, compared to 2013.

Income Tax Benefit

We have incurred net operating losses on a consolidated basis for all years from inception through 2012. Accordingly, we have historically recorded a valuation for the full amount of gross deferred tax assets, as the future realization of the tax benefit was not “currently more likely than not.” As of December 31, 2014, we concluded that it is more likely than not that the Company will be able to realize a portion of the benefit of the U.S. federal and state deferred tax assets in the future. As a result, we released $10.0 million and $10.9 million of the valuation allowance against our net deferred tax assets during the years ended December 31, 2014 and 2013, respectively.

During the year ended December 31, 2014 and 2013, our valuation allowance against deferred tax assets decreased by approximately $10.0 million, due to the partial release of our valuation allowance and $21.0 million, due to the write-off of expired deferred tax assets and partial release of our valuation allowance, respectively.

As of December 31, 2014, we had net operating loss carryforwards for federal income tax purposes of approximately $421.0 million. The federal net operating loss carry forwards if not offset against future income, will expire by 2032, with the majority expiring by 2021.

Liquidity and Capital Resources

As of December 31, 2014, we had $58.7 million in cash and cash equivalents, compared to $7.7 million in cash and cash equivalents as of December 31, 2013. As of December 31, 2014, we had working capital of $70.2 million, compared to working capital of $8.7 million as of December 31, 2013. The increase in our cash and resulting working capital is primarily attributable to the net proceeds from the Carlson Purchase Agreement and the Rights Offering closed in the second half of 2014.

On August 18, 2014, we entered into a Purchase Agreement with Carlson. Upon initial close, we issued to the Stockholder, 55,908,000 shares of our Common Stock for an aggregate purchase price of approximately $76.6 million in cash. Then upon completion of the Rights Offering, pursuant to terms of the Purchase Agreement, we issued to the Stockholder 17,440,525 shares of our Common Stock for an aggregate purchase price of $23.9 million paid in cash, so that Carlson has a voting 69% interest in the Company.

As of December 31, 2014, we had $19 million of available borrowings under our credit facility and no amounts outstanding. We estimate our liquidity and capital resources are adequate to fund our operating activities for the twelve months from the balance sheet date. The Draw Period under the credit facility expired on March 6, 2015.

Primary Driver of Cash Flow

Our ability to generate cash in the future depends primarily upon our success in implementing our revised business model of generating income by providing capital to a broad range of life science companies, institutions and inventors. We generate income primarily from three sources:

1. primarily owning or financing through debt investments, royalties generated by the sales of life science products and related intellectual property;

2. receiving interest and other income by advancing capital in the form of secured debt to companies in the life science sector; and,

3. to a lesser extent, realize capital appreciation from equity-related investments in the life science sector.

As of March 23, 2015, we have consummated 14 transactions under our new strategy and expect these assets to generate income greater than our expenses in 2015. We continue to evaluate multiple attractive opportunities that, if consummated, would similarly generate additional income. Since the timing of any investment is difficult to predict, we may not be able to generate positive cash flow above what our existing assets will produce in 2015.

Operating Cash Flow

Net cash provided by operating activities was $5.1 million for year ended December 31, 2014 and consisted primarily of net income of $23.6 million partially offset by noncash adjustments of $18.4 million. The noncash adjustments were primarily attributable to a $10.3 million deferred tax benefit, $5.3 million from equity income on an investment in an unconsolidated entity and $4.0 million in loan discount amortization, fee accretion and interest income in excess of cash collected, offset partially by $0.8 million stock compensation expense and $0.2 million net fair value market losses on warrants. We had positive cash flow from operating activities of $1.3 million for the year ended December 31, 2013 driven by total net income of $14.3 million reduced by $12.9 million non-cash income, which primarily included a deferred tax asset allowance release of $9.8 million and $2.8 million equity income on an investment in an unconsolidated entity.

Investing Cash Flow

The Company’s investing activities had negative cash flow of $55.6 million during the year ended December 31, 2014, driven by net issuances of $60.6 million in finance receivables and a $1.7 million investment in marketable securities. These were partially offset by $6.7 million in cash distributions received from an investment in an unconsolidated entity. During the year ended December 31, 2013, the Company’s investing activities provided negative cash flow of $20.1 million, which primarily related to our issuance of $22.4 million in net issuances of finance receivables and $3.0 million purchase of marketable securities, partially offset by $5.4 million in cash distributions received from an investment in an unconsolidated entity.    

Financing Cash Flow

The Company’s financing activities had positive cash flow of $101.6 million for the year ended December 31, 2014, driven by the Carlson Purchase Agreement and Rights Offering discussed previously, partially offset by a net repayment of $5 million on the Company’s credit facility and $3.6 million in cash distributions to non-controlling interests. The Company’s financing activities had positive cash flow of $1.8 million for the year ended December 31, 2013, which consisted of $4.7 million in loan proceeds from our credit agreement, partially offset by $2.9 million in cash distributions to non-controlling interests.   

Outlook

As of March 23, 2015, we have consummated 14 transactions under our revised strategy, two of which have been repaid. We believe the income generated by our current portfolio will be more than our operational expenses, and we will begin to grow our book value going forward. We continue to evaluate multiple attractive opportunities that, if consummated, would similarly generate additional income. We expect that the income generated by such future investments would be earned with minimal additional operational expenses.

Off-Balance Sheet Arrangements

In the normal course of operations, we engage in a variety of financial transactions that, in accordance with GAAP, are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit.

 The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults and the value of any existing collateral becomes worthless. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Other than the $500,000 payable to seller of Cambria® royalty, there are no other earn-out payments contracted to be paid by us to any of our partner companies. We have approximately $5 million of unfunded commitments on loan transactions. 

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.  

During the year ended December 31, 2014, our cash and cash equivalents were deposited in accounts at well capitalized financial institutions. The fair value of our cash and cash equivalents at December 31, 2014, approximated its carrying value.

Investment and Interest Rate Risk

We are subject to financial market risks, including changes in interest rates. As we seek to provide capital to a broad range of life science companies, institutions and investors, our net investment income is dependent, in part, upon the difference between the rate at which we earn on our cash and cash equivalents and the rate at which we lend those funds to third parties. As a result, we would be subject to risks relating to changes in market interest rates. We may use interest rate risk management techniques in an effort to limit our exposure to interest rate fluctuations by providing capital at variable interest rates.  We constantly monitor our portfolio and position our portfolio to respond appropriately to a reduction in credit rating of any portfolio of products.

Inflation

We do not believe that inflation has had a significant impact on our revenues or operations.

SWK HOLDINGS CORPORATION

INDEX TO FINANCIAL STATEMENTS

Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

SWK Holdings Corporation


We have audited the accompanying consolidated balance sheets of SWK Holdings Corporation and its subsidiaries (the “Company”) as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SWK Holdings Corporation and its subsidiaries as of December 31, 2014 and 2013, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.


/s/ Burr Pilger Mayer, Inc.
San Jose, California
March 27, 2015 

SWK HOLDINGS CORPORATION

CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

See accompanying notes to the consolidated financial statements.

SWK HOLDINGS CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(In thousands, except per share data)

See accompanying notes to the consolidated financial statements.

SWK HOLDINGS CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands, except per share data)

See accompanying notes to the consolidated financial statements.

SWK HOLDINGS CORPORATION

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands, except share data)

See accompanying notes to the consolidated financial statements.

SWK HOLDINGS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

Noncash activity:

During 2014, the Company received a warrant for 347,222 common shares for Tribute Pharmaceuticals at an exercise price of $0.43 per share in conjunction with the additional draw on a term loan. The fair value of the warrant at time of receipt was $99,000. The Company received a warrant for 681,090 common shares for Response Genetics at an exercise price of $0.94 per share in conjunction with a new term loan in July 2014. The fair value of the warrant at the time of receipt was $379,000. In September 2014, the Company assigned rights under the warrant to 200,321 common shares to an investment management client as part of a Loan Assignment. The fair value of the assigned rights at time of transfer was $115,000. The warrants, net of any portion assigned, are reflected in other assets in the consolidated balance sheet. In September 2014, the Company was issued 165,374 shares of Series F Preferred Stock of SynCardia, Inc. in lieu of cash payment of $230,000 on the SynCardia Second Lien Credit Agreement.

During 2013, the Company issued a warrant for one million shares of common stock in conjunction with the execution of its Loan Facility. The initial fair value of the warrant of $232,000 was deferred and is reflected as warrant liability in the consolidated balance sheet.

See accompanying notes to the consolidated financial statements.

SWK HOLDINGS CORPORATION

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 has initially 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 their own working capital, as well as by building their asset management business by raising additional third party capital to be invested alongside the Company’s capital.

The Company fills a niche that they believe is underserved in the sub-$50 million transaction size. Since many of its competitors that provide longer term, 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 they face less competition from such longer term, royalty 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, 2014, the Company has executed 14 transactions under its new specialty finance strategy, funding approximately $124,000,000 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%. The related governing agreements provide the Company with broad powers, and the other parties do not participate in the management of the entity and do not have the substantial ability to remove the Company. The Company has reviewed each of the underlying agreements to determine if it has effective control. If circumstances changed and it was determined this control did not exist, this 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 our operations and/or total stockholders’ equity attributable to the Company. The Company operates in one operating segment with a single management team that reports to the chief executive officer, who is the Company’s chief operating decision maker.

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, useful lives of property and equipment, 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 change those estimates and assumptions. Market conditions, such as illiquid credit markets, volatile equity markets, and economic downturn, 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 income. 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 income 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.

Finance receivables are stated at their principal amounts inclusive of deferred loan origination fees.  Interest income is credited as earned based on the effective interest rate method except when a finance receivable becomes past due 90 days or more and doubt exists as to the ultimate collection of interest or principal; in those cases the recognition of income is discontinued and any outstanding receivable for interest due is reversed.

Marketable Investments

The Company’s marketable investment portfolio includes two equity securities and one debt security as of December 31, 2014, and one equity security and one debt security as of December 31, 2013. 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, 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.

The Company’s equity securities as of December 31, 2014, represent shares in privately-held companies and do not have a readily determinable fair value. As such, they are currently reflected at cost. As of December 31, 2014, there are no indicators of impairment for these securities.

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 income. 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 income, or recorded in other comprehensive income. The Company had no derivatives designated as hedges as of December 31, 2014 and 2013. 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 other assets in the consolidated balance sheets. The Company issued a warrant on its own common stock in conjunction with its credit agreement discussed in Note 7. 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, 2014 or 2013, as all of our cash was held in checking or savings accounts.  At December 31, 2014, 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.

Accounts Receivable

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, 2014 and 2013, 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 customers and generally requires collateral.  For the year ended December 31, 2014, two partner companies accounted for 61 percent of total revenue. For the year ended December 31, 2013, three partner companies accounted for 78 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.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are three years for computer equipment, software and furniture and fixtures. Upon retirement or sale, the cost and related accumulated depreciation are removed from the accounts, and any related gain or loss is reflected in operations. Improvements that extend the life of a specific asset are capitalized, while normal maintenance and repairs are charged to operations as incurred.

Segment Reporting

The Company operates in one operating segment with a single management team that reports to the chief executive officer, who is our 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 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 income.

Comprehensive Income

Comprehensive income 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.

Net Income per Share

Basic net income per share is computed using the weighted average number of outstanding shares of common stock. Diluted net income 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):

As of December 31, 2014, and 2013, outstanding stock options and warrants to purchase shares of common stock in an aggregate of approximately 4.8 million and 6.2 million shares, respectively, have been excluded from the calculation of diluted net income per share as these securities were anti-dilutive.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, (“ASU 2014-09”), “Revenue from Contracts with Customers”. The objective of ASU 2014-09 is to establish a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most of the existing revenue recognition guidance, including industry-specific guidance. The core principle of ASU 2014-09 is that an entity recognizes 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. In applying the new guidance, an entity will (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the contract’s performance obligations; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 applies to all contracts with customers except those that are within the scope of other topics in the FASB Accounting Standards Codification. The new guidance is effective for annual reporting periods (including interim periods within those periods) beginning after December 15, 2016 for public companies. Early adoption is not permitted. Entities have the option of using either a full retrospective or modified approach to adopt ASU 2014-09. We are currently evaluating the new guidance and have not determined the impact this standard may have on our consolidated financial statements nor decided upon the method of adoption.

In June 2014, the FASB issued ASU No. 2014-12, Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period. This ASU is effective for annual periods and interim periods within those annual periods, beginning after December 15, 2015. We are currently evaluating the impact that the adoption of this guidance will have on our consolidated financial statements.

In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which amended the existing accounting standards for consolidation under both the variable interest model and the voting model. Under ASU No. 2015-02, companies will need to reevaluate whether an entity meets the criteria to be considered a VIE, whether companies still meet the definition of primary beneficiaries, and whether an entity needs to be consolidated under the voting model. ASU No. 2015-02 may be applied using a modified retrospective approach or retrospectively, and is effective for reporting periods beginning after December 15, 2015. Early adoption is permitted. We are currently evaluating the potential impact of the pending adoption of this new guidance.

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):

Term Loans

Nautilus Neurosciences, Inc.

On December 5, 2012, the Company entered into a credit agreement pursuant to which the lenders party thereto provided to Nautilus Neurosciences, Inc., a neurology-focused specialty pharmaceutical company, a term loan in the principal amount of $22,500,000. The loan was repaid on December 17, 2013. The Company initially provided $19,000,000 and a client of the Company provided the remaining $3,500,000 of the loan. The Company subsequently assigned $12,500,000 of the loan to its clients and retained the remaining $6,500,000. The loan was managed by the Company on behalf of its clients pursuant to the terms of each client’s investment management agreement.

Prior to repayment, interest and principal under the loan was paid by a tiered revenue interest that is charged on quarterly net sales and royalties of the borrower applied in the following priority (i) first, to the payment of all accrued but unpaid interest until paid in full; and (ii) second to the payment of all principal of the loans. The loan accrued interest at either a base rate or the LIBOR rate, as determined by the borrower, plus an applicable margin; the base rate and LIBOR rate are subject to minimum floor values such that that minimum interest rate is 16%.  In addition, the Company received its proportionate share of a $2,000,000 exit fee, which was accreted to interest income over the term of the loan.  The Company recognized $1,591,000 in interest income, of which $578,000 related to the accretion of the exit fee, recorded as revenue in the consolidated statements of income for the year ended December 31, 2013.

Tribute

On August 8, 2013, the Company entered into a credit agreement pursuant to which the Company provided to Tribute Pharmaceuticals Canada Inc. (“Tribute”) a secured term loan in the principal amount of $8,000,000. The loan matures on August 8, 2018. The Company provided $6,000,000 at closing and an additional $2,000,000 on February 4, 2014. On October 1, 2014, the credit agreement was amended to increase the secured term loan total commitment to $17,000,000, with $6,000,000 funded at the time of the amendment. The unfunded commitment under the loan is currently $3,000,000.

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales and royalties of Tribute applied in the following priority first, to the payment of all accrued but unpaid interest until paid in full; second to the payment of all principal of the loans.

The loan shall accrue interest at the LIBOR rate, plus an applicable margin, subject to a 13.5% minimum. In addition, the Company earned an origination fee at closing, and the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized $1,352,000 and $366,000 in interest income recorded as revenue in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively.

In connection with the loan and at closing, Tribute also issued the Company a warrant to purchase 755,794 common shares an exercise price of $0.60 per share that may be exercised at any time prior to August 8, 2020 with an initial fair value of $334,000.   In conjunction with the additional draw on February 4, 2014, Tribute issued an additional warrant to purchase 347,222 common shares at an exercise price of $0.432 per share that may be exercised at any time prior to February 4, 2021, with an initial fair value of $99,000. In conjunction with the credit agreement amendment on October 1, 2014, Tribute issued an additional warrant to purchase 740,000 common shares at an exercise price of $0.70 per share that may be exercised at any time prior to October 1, 2019, with an initial fair value of $228,000. The fair market value of the warrants was $594,000 and $204,000 at December 31, 2014 and 2013, respectively, and is included in other assets in the consolidated balance sheet. A net unrealized holdings gain of $62,000 was included in interest and other expense, net, in the consolidated statements of income for the year ended December 31, 2014. An unrealized holdings loss of $131,000 was included in interest and other expense, net, in the consolidated statements of income for the year ended December 31, 2013. The Company determined the fair value of the warrants outstanding at December 31, 2014 and 2013, using the Black-Scholes option pricing model with the following assumptions:

In the event of a change of control, a merger or a sale of all or substantially all of Tribute’s assets, the loan shall be due and payable. The Company will be entitled to certain additional payments in connection with repayments of the Loan, both on maturity and in connection with a prepayment or partial prepayment. Pursuant to the terms of the credit agreement, Tribute entered into a guaranty and collateral agreement granting the Company a security interest in substantially all of Tribute’s assets. The credit agreement contains certain affirmative and negative covenants. The obligations under the credit agreement to repay the loan may be accelerated upon the occurrence of an event of default under the credit agreement.

SynCardia Credit Agreement

First Lien Credit Agreement

On December 13, 2013, the Company entered into a credit agreement pursuant to which the Company provided to SynCardia Systems, Inc. (“SynCardia”), a privately-held manufacturer of the world’s first and only FDA, Health Canada and CE (Europe) approved Total Artificial Heart, a secured term loan in the principal amount of $4,000,000. The loan was an expansion of the SynCardia’s existing credit facility, resulting in a total outstanding amount under the existing credit facility of $16,000,000 at closing. At the lenders’ option, the lenders can increase the term loan to $22,000,000; the Company has the right but not the obligation to advance $1,500,000 of any potential increase. The Company funded the $4,000,000, net of an original issue discount of $60,000 and an arrangement fee of $40,000 at closing.

The loan matures on March 5, 2018, with principal due upon maturity. The loan bears interest at a rate of 13.5%.

Pursuant to the terms of the credit agreement and subject to a security agreement, SynCardia granted the lenders a first priority security interest in substantially all of its assets. The security agreement contains certain affirmative and negative covenants.

In the event of a change of control, a merger or a sale of all or substantially all of SynCardia’s assets, the loan shall be due and payable. The lenders will be entitled to certain additional payments in connection with repayments of the loan, both on maturity and in connection with a prepayment or partial prepayment. The obligations to repay the loan may be accelerated upon the occurrence of an event of default under the credit agreement.

In addition to the discount and arrangement fee, the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized $672,000 and $32,000 in interest income recorded as revenue in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively.

Second Lien Credit Agreement

On December 13, 2013, the Company also entered into a second lien credit agreement, pursuant to which the Company and other lender parties thereto provided to SynCardia, a term loan in the principal amount of $10,000,000 (the “Second Lien Loan”). The Company provided $6,000,000 principal amount of the Second Lien Loan, funded at closing net of an origination fee of $90,000. The Second Lien Loan matured on December 13, 2021. The Second Lien Loan was contracted be repaid by a tiered revenue interest that is charged on quarterly net sales and royalties of, and any other income and revenue actually received by SynCardia. Pursuant to the terms of the Second Lien Loan, SynCardia granted the lenders a second priority security interest in its assets subject to a security agreement which contains certain affirmative and negative covenants.

On February 13, 2015 the Second Lien Loan was repaid for total consideration of $17,000,000 comprised of $3,000,000 of cash, $11,500,000 million of senior secured second lien convertible notes (the “Convertible Notes”) and 1,798,563 shares of Series F Preferred Stock. The Company received its pro-rata share of the repayment consideration which included $1,800,000 million of cash, $6,900,000 of Convertible Notes and 1,079,138 shares of Series F Preferred Stock. The Convertible Notes accrue interest at 10% per annum and interest paid in kind. The Convertible Notes are convertible into shares of SynCardia common stock at a 25% discount to the price of an initial public offering.

In the event of a Change of Control prior to conversion into shares of SynCardia common stock, the Convertible Notes shall be due, with the total amount payable to the lenders equal to a specified premium defined by the terms of the Convertible Notes. The obligations to repay the Convertible Notes may be accelerated upon the occurrence of an event of default under the terms of the Convertible Notes.

The Company recognized $4,601,000 and $79,000 in interest income recorded as revenue in the consolidated statement of income for the years ended December 31, 2014 and 2013, respectively. The Company was issued 165,374 shares of Series F Preferred Stock of SynCardia, Inc. in lieu of one cash payment of $230,000 during the year ended December 31, 2014.

Private Dental Products Company

On December 10, 2013, the Company entered into a credit agreement to provide a private dental products company (“Dental Products Company”) a senior secured term loan with a principal amount of $6,000,000 funded upon close net of an arrangement fee of $60,000. The Loan matures on December 10, 2018.

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales and royalties of the Dental Products Company. Pursuant to the terms of the agreement, the Company was granted a first priority security interest in substantially all of the Dental Products Company’s assets. The loan accrues interest at the Libor Rate, plus an applicable margin; the Libor Rate is subject to minimum floor values such that that minimum interest rate is 14%.

In the event of a change of control, a merger or a sale of all or substantially all of the Dental Products Company’s assets, the loan shall be due and payable. The Company will be entitled to certain additional payments in connection with repayments, both on maturity and in connection with prepayments.

The Company also received a warrant to purchase up to 225 shares of the Dental Products Company’s common stock, which if exercised, is equivalent to approximately four percent ownership on a fully diluted basis. The warrant expires December 10, 2020. The warrant is currently valued at zero at December 31, 2014 and 2013 in the consolidated balance sheets.

In addition to the arrangement fee, the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized $618,000 and $51,000 in interest income recorded as revenue in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively.

The Dental Products Company is currently under default under the terms of the credit agreement and the loan has been classified as non-accrual. On January 8, 2015, the Company executed an amendment to the loan to advance an additional $650,000 to the Dental Products Company. For further discussion refer to “Non-Accrual Loan” later in this Note.

Parnell Pharmaceuticals Holdings Pty Ltd

On January 23, 2014, the Company entered into a credit agreement pursuant to which the lenders party thereto provided to Parnell Pharmaceuticals Holdings Pty Ltd, a leading global veterinary pharmaceutical business (“Parnell”), a term loan in the principal amount of $25,000,000. The Company provided $10,000,000 and the Company’s investment advisory clients provided the remaining $15,000,000 of the loan. The Company serves as the Agent, Sole Lead Arranger and Sole Bookrunner under the credit agreement. The loan was repaid on June 27, 2014.

Parnell was obligated to make payments calculated on its quarterly net sales and royalties until such time as the lenders received a 2.0x cash on cash return. The revenue based payment was subject to certain quarterly and annual caps. Pursuant to the terms of the credit agreement, Parnell granted the lenders a first priority security interest in substantially all of Parnell’s assets.

The Company recognized a syndication fee of $375,000 upon execution of the credit agreement and interest income of $834,000 as revenue in the consolidated statement of income for the year ended December 31, 2014, respectively.

Response Genetics

On July 30, 2014, the Company entered into a credit agreement pursuant to which the Company provided to Response Genetics, Inc. (“Response”) a term loan in the principal amount of $12,000,000. The loan matures on July 30, 2020. The Company provided $8,500,000 at closing and an additional $1,500,000 upon an amendment to the loan on February 2, 2015. Response can draw down the remaining $2,000,000 of the credit facility at any time until December 31, 2015, if Response achieves certain revenue thresholds, and as long as it is in compliance with all covenants under the credit agreement.

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales and royalties of Response applied in the following priority: first, to the payment of all accrued but unpaid interest until paid in full; and second to the payment of all principal of the loans.

In connection with the loan and at the time of close, Response also issued the Company a warrant to purchase 681,090 common shares at an exercise price of $0.94 per share, at any time prior to July 30, 2020 with an initial fair value of $379,000, which is included in other assets on the consolidated balance sheet as of December 31, 2014.

On September 9, 2014, the Company assigned to an investment management client approximately $3,500,000 of the total term loan commitment at par. The assignment included $2,500,000 previously funded to Response, and an unfunded commitment of approximately $1,000,000. In addition the Company assigned rights under the warrant to 200,321 common shares. The fair value of the transferred warrant rights at time of the assignment was $115,000. On February 2, 2015, to facilitate the amendment to the loan with Response, the Company purchased the previous syndication.

The loan shall accrue interest at the LIBOR rate, plus an applicable margin, subject to a 13.5% minimum. In addition, the Company earned an origination fee at closing, and the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized approximately $421,000 in interest income recorded as revenue in the consolidated statement of income for the year ended December 31, 2014.

The fair market value of the warrant held by the Company at December 31, 2014 was $86,000, and is included in other assets in the consolidated balance sheet. An unrealized holding loss of $178,000 was included in interest and other expense, net in the consolidated statement of income for the year ended December 31, 2014. The Company determined the fair value of the warrant outstanding at December 31, 2014, using the Black-Scholes option pricing model with the following assumptions:

 ABT Molecular Imaging, Inc.

On October 10, 2014, the Company entered into a credit agreement pursuant to which the Company provided to ABT Molecular Imaging, Inc. (“ABT”) a second lien term loan in the principal amount of $10,000,000. The loan matures on October 8, 2021.

ABT is obligated to make payments calculated on its quarterly net sales and royalties until such time as the lenders receive a 2.0x cash on cash return. The revenue-based payment is subject to certain quarterly and annual caps. The total amount payable is subject to adjustment under certain events including qualified partial payments, a change of control or full prepayment of the loan. The revenue-based payment is made quarterly. The Company recognized $382,000 in interest income recorded as revenue in the consolidated statement of income for the year ended December, 31, 2014.

Pursuant to the terms of the credit agreement, ABT granted the lenders a second priority security interest in substantially all of its assets. The credit agreement contains certain affirmative and negative covenants. The obligations to repay the loan may be accelerated upon the occurrence of an event of default under the terms of the credit agreement.

In connection with the loan, ABT also issued the Company 5,000,000 common share purchase warrants with each warrant entitling the Company to acquire one common share in the capital of ABT at an exercise price of $0.20, at any time prior to October 10, 2034. The warrant is currently valued at zero at December 31, 2014 in the consolidated balance sheet.

PDI, Inc.

On October 31, 2014, the Company entered into a credit agreement among pursuant to which the Company provided to PDI, Inc. (“PDI”) a term loan in the principal amount of $20,000,000. The loan matures on October 31, 2020.

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales and royalties of PDI applied in the following priority first, to the payment of all accrued but unpaid interest until paid in full; second to the payment of all principal of the loans. Beginning in January 2017, PDI will be required to make principal payments on the loan. Additionally, beginning in January 2017 and ending on October 31, 2020, subject to a quarter cap, the Company will be entitled to receive quarterly revenue-based payments from PDI equal to 1.25% of revenue derived from net sales of molecular diagnostics products.

The loan shall accrue interest at the LIBOR rate, plus an applicable margin, subject to a 13.5% minimum. In addition, the Company earned a $300,000 origination fee at closing, and the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized approximately $536,000 in interest income recorded as revenue in the consolidated statement of income for the year ended December 31, 2014.

Pursuant to the terms of the credit agreement, PDI entered into a guarantee granting the Company a senior security interest in substantially all of their respective assets. The credit agreement contains certain affirmative and negative covenants. The obligations under the credit agreement to repay the loan may be accelerated upon the occurrence of an event of default under the credit agreement.

Galil Medical, Inc.

On December 9, 2014, the Company entered into a credit agreement pursuant to which the Company provided to Galil Medical, Inc. (“Galil”) a term loan in the principal amount of $12,500,000. The loan matures on December 9, 2019.

Interest and principal under the loan will be paid by a tiered revenue interest that is charged on quarterly net sales of Galil, subject to certain quarterly and annual caps, applied in the following priority first, to the payment of all accrued but unpaid interest until paid in full; second to the payment of all principal of the loans. The first principal payment will occur February 17, 2015.

The loan shall accrue interest at the LIBOR rate, plus an applicable margin, subject to a 13.0% minimum. In addition, the Company earned a $156,000 origination fee at closing, and the Company is entitled to an exit fee upon the maturity of the loan, both of which will be accreted to interest income over the term of the loan. The Company recognized approximately $103,000 in interest income recorded as revenue in the consolidated statement of income for the year ended December 31, 2014.

Pursuant to the terms of the credit agreement, Galil granted the Company a senior security interest in substantially all of their respective assets. The credit agreement contains certain affirmative and negative covenants. The obligations under the credit agreement to repay the loan may be accelerated upon the occurrence of an event of default under the credit agreement.

Royalty Purchases

Bess Royalty Purchase

On April 2, 2013, the Company, along with Bess Royalty, LP (“Bess”), purchased a royalty stream paid on the net sales of Besivance®, an ophthalmic antibiotic, from InSite Vision, Inc. Besivance is marketed globally by Bausch & Lomb. The initial purchase price totaled $15,000,000; the Company funded $6,000,000 of the purchase price at closing to own 40.3125% of the royalty stream. Additional contingent consideration includes (i) $1,000,000 to be paid by Bess upon certain net sales milestones achieved by Bausch & Lomb and (ii) annual payments to be remitted to InSite Vision, Inc. once aggregate royalty payments received by the Company and Bess exceed certain thresholds. Bess paid the $1,000,000 contingent consideration in February 2014, which did not result in a change in the Company’s interest in the royalty. The purchased royalty stream does not include any further amounts once the aggregate royalty payments received by the Company and Bess reach a certain threshold as defined in the underlying agreement. As the purchased royalty stream has been capped by the defined threshold amount, in effect limiting the Company’s implicit rate of return, the Company’s share of the purchase price has been reflected as a Finance Receivable in the consolidated financial statements. The Company recognized approximately $1,032,000 and $795,000 in interest income in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively, representing our pro rata portion of royalties paid.

Tissue Regeneration Therapeutics Royalty Purchase

On June 12, 2013, the Company purchased from Tissue Regeneration Therapeutics, Inc. (“TRT”) two royalty streams derived from the licensed use of TRT’s technology in the family cord banking services sector. The initial purchase totaled $2,000,000 paid upon closing. On October 20, 2014, additional consideration of $1,250,000 was paid upon aggregate royalty payments reaching a certain threshold. Additional contingent consideration includes annual sharing payments due to TRT once aggregate royalty payments received by the Company exceed the purchase price paid by the Company. The purchased royalty stream does not include any further amounts once the aggregate royalty payments received by the Company reach a certain threshold as defined in the underlying agreement. The purchase has been reflected as a Finance Receivable in the unaudited condensed consolidated financial statements. The Company recognized approximately $362,000 and $176,000 in interest income recorded as revenue in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively.

Cambia^® Royalty Purchase

On July 31, 2014, the Company purchased 25% of a royalty stream paid on the net sales of Cambia^®, an NSAID pharmaceutical product indicated for the treatment of migraine. Cambia^® is marketed in the United States by Depomed, Inc. and in Canada by Tribute. The initial purchase price totaled $4,000,000. Additional contingent consideration includes (i) $500,000 to be paid by the Company to the seller upon Cambia^® reaching certain net sales and (ii) annual sharing payments to be remitted to the seller once aggregate royalty payments received by the Company exceed certain thresholds. The purchased royalty stream does not include any further amounts once the aggregate royalty payments received by the Company reach a certain threshold as defined in the purchase agreement. The Company recognized approximately $308,000 in interest income recorded as revenue in the consolidated statement of income for the year ended December 31, 2014.

Credit Quality of Finance Receivables 

On a quarterly basis, the Company evaluates the carrying value of each finance receivable for impairment. Currently there are no finance receivables considered impaired and no corresponding allowance for credit losses for impaired loans.

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 all 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.

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. 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 would individually develop the allowance for credit losses for any identified impaired loans if any existed. In developing the allowance for credit losses, the Company would consider, 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.

Non-Accrual Loan

The Company had one non-accrual loan at December 31, 2014 for approximately $6,000,000. The Company measured the loan for impairment as of December 31, 2014 by comparing the outstanding loan balance to the fair market value of the collateral and determined that the fair value of the collateral exceeded the outstanding balance. As a result, the Company was not required to record any impairment charge on this loan as of December 31, 2014. As of December 31, 2013, the Company did not have any non-performing assets.

Note 3. Marketable Investments

Investment in securities at December 31, 2014 and 2013 consist of the following:

Debt Security

Senior Secured Note

On July 9, 2013, the Company entered into a note purchase agreement to purchase, at par, $3,000,000 of a total $100,000,000 aggregate principal amount offering of a Senior Secured notes due in November 2026.  The notes pay interest quarterly at a rate of 11.5% per annum. The agreement allows the first interest payment date to include paid-in-kind notes for any cash shortfall, of which the Company received $119,000 on November 15, 2013.  Subsequent interest payments from February 15, 2014, through May 15, 2015, are supported by a cash interest reserve account funded at close of $4,500,000.  The notes are subject to redemption on or after July 10, 2015, at a price at or above par, as defined.  The notes are secured only by certain royalty and milestone payments associated with the sales of pharmaceutical products. The notes are reflected at fair value as available-for-sale securities. The Company recognized approximately $360,000 and $166,000 in interest income recorded as revenue in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively.

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, 2014 and 2013, are as follows (in thousands):

Equity Securities

SynCardia Series F Preferred Stock

On September 15, 2014, the Company purchased a total of 1,244,511 shares of Series F Preferred Shares of SynCardia at a price of $1.39 per share, including 165,374 shares which were received in lieu of cash payment for $230,000 in interest income on the second lien loan. The Company’s total investment in SynCardia at December 31, 2014 was $1,730,000. The holders of the preferred shares are entitled to vote on all matters upon which holders of common shares have the right to vote and have representation on SynCardia’s Board of Directors. The preferred shares can be converted into common shares at any time after the date of issuance, and are automatically converted into common shares upon the closing of a public offering. The preferred shares will entitle the holder to receive a dividend at annual rate of ten percent and will accrue whether or not declared by SynCardia’s Board of Directors, and whether or not actually paid. No dividend will be declared or paid on any common shares unless simultaneously there also is declared or paid, a dividend on the preferred shares. Dividends accrued will be payable in cash or stock as determined, (i) upon the voluntary or involuntary conversion of the preferred shares, (ii) upon redemption thereof, or (iii) upon the occurrence of the liquidation or dissolution of the affairs of SynCardia. As described in Note 2, as part of the repayment of the SynCardia Second Lien Loan, on February 13, 2015 SWK received 1,079,138 shares of Series F Preferred Shares of SynCardia at a price of $1.39 per share.

SynCarida Common Stock

In conjunction with the first lien secured term loan with SynCardia, the Company received from SynCardia an aggregate of 40,000 shares of SynCardia’s Common Stock, in consideration for the mutual covenants and agreements set forth in the credit agreement. The shares purchased by the Company reflect an ownership percentage in SynCardia of less than 0.05%. The Company deems the shares to not have a readily determinable fair value. SynCardia is privately held and in development stage. The Company has reflected the shares at a zero cost basis as of December 31, 2014 and 2013. 

During the years ended December 31, 2014 and 2013, the Company had no sales of available-for-sale securities and no securities have been considered impaired.

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 Holdings LP (“SWK HP”)

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 $13,000,000. 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 $13,000,000 included $6,000,000 provided by SWK Holdings GP and $7,000,000 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 is considered a VIE due to the lack of voting or similar decision-making rights by its equity holders regarding activities that have a significant effect on the economic success of the partnership. The Company’s ownership in SWK HP constitutes variable interests. The Company has determined that it is the primary beneficiary of the SWK HP as (i) the Company has the power to direct the activities that most significantly impact the economic performance of SWK HP via its obligations to perform under the partnership agreement, and (ii) the Company has the right to receive residual returns that could potentially be significant to SWK HP. As a result, the Company consolidates SWK HP in its financial statements and the limited partner interests of SWK HP owned by third parties are reflected as a non-controlling interest in the Company’s consolidated balance sheet.

Unconsolidated VIEs

Holmdel

SWK HP has significant influence over the decisions made by Holmdel. SWK HP will receive 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. Until SWK HP receives a 1x cash on cash return on its interest in Holmdel, SWK HP will receive approximately 84% of the pharmaceutical product’s cash flow. As the cash on cash multiple received by SWK HP Holdings LP increases, SWK HP’s interest in the cash flow generated by the pharmaceutical product decreases, but in no instance will it decline below 39%. 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.  SWK HP’s current ownership in Holmdel approximates 84%.  The Company accounts for its interest in the entity based on the timing of quarterly distributions, which are paid on a quarter lag basis.

For the year ended December 31, 2014, the Company recognized $5,341,000 of equity method gains, of which $2,839,000 was attributable to the non-controlling interest in SWK HP. In addition, SWK HP received cash distributions totaling $6,722,000 during the year ended December 31, 2014, of which $3,585,000 was subsequently paid to holders of the non-controlling interests in SWK HP. For the year ended December 31, 2013, the Company recognized $2,779,000 of equity method gains, of which $1,470,000 was attributable to the non-controlling interest in SWK HP. In addition, SWK HP received cash distributions totaling $5,354,000 during the year ended December 31, 2013, of which $2,857,000 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, 2014 and 2013, are as follows (in thousands):  

The following table provides the financial statement information related to Holmdel for the comparative periods which SWK HP has reflected its share of Holmdel income in the Company’s consolidated statements of income:

Note 5.  Accounts Payable and Accrued Liabilities

Accounts payable and accrued liabilities are comprised of the following as of December 31 (in thousands):

Note 6.  Interest and Other Expense

Interest and other expense is comprised of the following for each of the years ended December 31 (in thousands):

Note 7. Loan Credit Agreement with Related Party

The Company entered into a credit facility with an affiliate of a stockholder, Carlson Capital, L.P. (“Carlson”), (collectively, the “Stockholder”) on September 6, 2013. The credit facility provides financing for the Company, primarily for the purchase of eligible investments. The facility matures on September 6, 2017, and provides that the loan shall accrue interest at the LIBOR rate plus a 6.50% margin. The average interest rate for the period the facility was outstanding during the years ended December 31, 2014 and 2013, was 6.73% and 6.75%, respectively. The principal is repayable in full at maturity. The facility works as a delayed draw credit facility with the Company having the ability to drawdown, as necessary, over the first 18 months (the “Draw Period”) up to $30,000,000, based on certain conditions. The credit facility provided for an initial $15,000,000 to be available at closing. The Company executed a draw of $5,000,000 on December 9, 2013. During the year ended December 31, 2014, the Company executed additional draws totaling $6,000,000 and then utilized net proceeds received from the Shareholder Equity Investment discussed in Note 9, to pay down the $11,000,000 outstanding balance of the credit facility. The outstanding balance of $5,000,000 was reflected as Loan credit agreement in the consolidated balance sheet as of December 31, 2013. There is no outstanding balance under the loan credit agreement as of December 31, 2014. On or before the last day of the Draw Period, the Company can request the loan amount to be increased to $30 million upon the Company realizing net proceeds of at least $10 million in cash through the issuance of new equity securities discussed in Note 9 fulfilled this requirement and as a result the Company had $19,000,000 of availability remaining on the facility as of December 31, 2014. The Draw Period expired on March 6, 2015. The Stockholder, as lender, has received a security interest in basically all assets of the Company as collateral for the facility. In conjunction with the credit facility, the Company issued warrants to the Stockholder for 1,000,000 shares of the Company’s common stock at a strike price of $1.3875. The warrants have a price dilution mechanism that was triggered by the price that shares were sold in the Rights Offering, and as a result, the strike price of the warrants was reduced to $1.348. In connection with the credit agreement, the Company and the Stockholder and certain of the Stockholder’s affiliates, including the lender entered into a Voting Rights Agreement restricting the Stockholder’s and such affiliates’ voting rights under certain circumstances and providing the Stockholder and such affiliates a right of first offer on certain future share issuances.

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 in the Company’s stock. As such, the warrants with a value of $421,000 and $292,000 at December 31, 2014 and 2013, respectively, are reflected as a warrant liability in the consolidated balance sheets. Unrealized losses of $129,000 and $60,000 were included in interest and other expense in the consolidated statements of income for the years ended December 31, 2014 and 2013, respectively. The Company determined the fair value using the Black-Scholes option pricing model with the following assumptions:

During the years ended December 31, 2014 and 2013, the Company recognized interest expense totaling $589,000 and $68,000, respectively. Interest expense included $143,000 and $47,000 of debt issuance cost amortization for the years ended December 31, 2014 and 2013, respectively.

Note 8. Commitments and Contingencies

(a)  Lease Obligations

 In 2012, the Company relocated its corporate headquarters to Dallas, Texas, where it leases approximately 1,300 square feet.  Total rent expense recognized under this lease was approximately $21,000 and $22,000 for the years ended December 31, 2014 and 2013, respectively. The office lease expired January 31, 2015. On November 21, 2014, the Company entered into a lease for approximately 2,400 square feet at another location in Dallas, Texas, beginning in 2015 with a lease term ending May 2020. Future minimum rent is as follows:

(b) Other Contractual Obligations

As of December 31, 2014, the Company had unfunded commitments of approximately $5,471,000 on the Tribute and Response Genetics loans discussed in Note 2.  In addition, as of December 31, 2014, the Company had unfunded contingent consideration payable to seller of Cambia^® discussed in Note 2 of $500,000 contingent upon aggregate net sales levels achieving certain thresholds.

(c) Litigation

The Company is involved in, or has been involved in, arbitrations or various other legal proceedings that arise from the normal course of our 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. 

(d) 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 is, or was, serving at the Company’s request in such capacity. 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, 2014 and 2013.

Note 9. Stockholders’ Equity

(a) 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.

The Company entered into a Securities Purchase Agreement with a Stockholder on August 18, 2014 (Initial Closing Date). Pursuant to the terms of the Securities Purchase Agreement, the Stockholder acquired, through a series of transactions, 73,348,525 newly issued shares of the Company’s common stock, for a purchase price of $1.37 per share or an aggregate purchase price of approximately $100,488,000. The Company incurred issuance costs of $2,159,000 in relation to this transaction.

The Securities Purchase Agreement provides that the Company would conduct a rights offering as promptly as reasonably practical after the closing of the Securities Purchase Agreement. The rights offering was closed on November 26, 2014, with 14,534,884 newly issued common shares for a purchase price of $0.86 per share or an aggregate purchase price of $12,500,000. The Company incurred issuance costs of $675,000 in conjunction with the rights offering.

In connection with the Securities Purchase Agreement, the Company and the Stockholder entered into a stockholders’ agreement, pursuant to which, among other things, the Company granted the Stockholder approval rights with respect to certain transactions including with respect to the incurrence of indebtedness over specified amounts, the sale of assets over specified amounts, declaration of dividends, loans, capital contributions to or investments in any third party over specified amounts, changes in the size of the board of directors or changes in the Company’s CEO. In addition, the Stockholder agreed that until the earlier of the fifth anniversary of the Initial Closing Date or the date it owns less than 40% of the outstanding shares of the Company’s common stock it will not increase its voting percentage to greater than 76% or cause the Company to engage in any buybacks in excess of 3% of the then outstanding shares of common stock without offering to acquire all of the then-outstanding common stock at the same price and on the same terms and conditions. The Stockholder further agreed that, until the earlier of the fifth anniversary of the Initial Closing Date or the date it owns less than 40% of the outstanding shares of common stock, it will not sell shares of common stock to any purchaser that would result in such purchaser having a voting percentage of common stock in excess of 40% unless the purchaser contemporaneously makes a binding offer to acquire all of the then-outstanding common stock of the Company, at the same price and on the same terms and conditions as the purchase of shares from the Stockholder. The Stockholder also agreed that, until the earlier of the eighth anniversary of the Initial Closing Date or the date it owns less than 40% of the outstanding shares of common stock, the Stockholder will not engage in a transaction as described in Rule 13e-3 under the Securities Exchange Act of 1934, as amended, without offering to acquire all of the then-outstanding common stock at the same price and on the same terms and conditions. Additionally, until the earlier of the eighth anniversary of the Initial Closing Date or the date it owns less than 40% of the outstanding shares of common stock, the Stockholder agrees to maintain at least two directors who are not affiliates of the Stockholder or the Company (the “Non-Affiliated Directors”), and agrees that any related party transaction or deregistration of the Common Stock from SEC reporting requirements requires the approval of the Non-Affiliated Directors. The stockholders’ agreement also contains a right for the Stockholder to serve as the exclusive standby purchaser for any additional rights offerings prior to September 6, 2016, and a pre-emptive right to purchase its pro rata share of any additional offerings other than such rights offerings by the Company prior to such date.

The stockholders agreement also provides that, until the second anniversary of the Initial Closing Date, the Company will not seek, negotiate or consummate any sale of common stock, except through one or more rights offerings substantially on the same structural terms as the rights offering. In addition, the Stockholder agreed that until the earlier of the fifth anniversary of the Initial Closing Date or the date it owns less than 40% of the outstanding shares of common stock, it would provide support to the Company in various ways, including with respect to sourcing financing and other business opportunities.

In connection with the transactions described above, the Company amended its Second Amended and Restated Rights Agreement to designate the Stockholder and its affiliates as Exempt Persons (as defined in the rights agreement) unless they own more than 76% of the outstanding shares of common stock.

In connection with the transactions, the Voting Agreement by and among the Stockholder and the Company dated September 6, 2013 was terminated.

(b) Preferred Stock

The Board of Directors 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, 2014, no shares of preferred stock have been issued.

(c) 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.  The only remaining options outstanding as of December 31, 2014 under the 1999 Stock Incentive Plan are those held by some of the Company’s current directors.

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 Company’s Board of Directors (the “Board”) and have a term not greater than 10 years from the date of grant.

On August 18, 2014, the Company entered into new employment agreements with J. Brett Pope and Winston L. Black. In conjunction with the new employment agreements, each received an option grant for 1,000,000 shares with an exercise price of $1.37 per share. Fifty percent of the options vest annually over 4 years beginning December 31, 2015 and fifty percent vest if the 30-day average closing stock price exceeds $2.06 prior to December 31, 2018. In addition, the options granted to Messrs. Pope and Black on May 14, 2012 were modified to extend the termination date of the options from May 14, 2017 to December 31, 2018. As a result, the Company remeasured these grants as of August 18, 2014. The modification resulted in incremental value of $151,500, with $50,000 being expensed during the year ended December 31, 2014  There were no stock options granted in 2013.  There were no options exercised in 2014 or 2013.

The following table summarizes activities under the option plans for the indicated periods:

At December 31, 2014, there were no options available for grant under the 1999 Stock Incentive Plan, and the Company had no total unrecognized stock-based compensation expense under this Plan.  At December 31, 2014, there were 2.7 million shares reserved for equity awards under the 2010 Stock Incentive Plan and the Company had approximately $0.6 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, 2014:

Employee stock-based compensation expense recognized for time-vesting options for the year ended December 31, 2014, and 2013, 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.

On January 31, 2012, the Board of Directors (the “Board”) approved a change in the compensation plan for non-employee directors. In lieu of cash payments to our Board members historically paid for Board service, the Board approved an annual grant of 35,000 shares of restricted common stock for each of our non-executive Board members on January 31 of each year, starting with 2012. The restricted shares fully vest on the first anniversary of the grant and are forfeited if the Board member does not complete the full year of service.

The following table summarizes restricted stock activities under the equity incentive plans for the indicated periods:

For restricted stock granted in 2014 and 2013 under the 2010 Stock Incentive Plan, the Company recognizes compensation expense in accordance with the fair value of such stock as determined on the grant date, amortized over the applicable derived service period using the graded amortization method. The fair value and derived service period of awards with market performance vesting was calculated using a lattice model and included adjustments to the fair value of the Company’s common stock resulting from the vesting conditions being based on the underlying stock price. . As a result of the Initial Closing, 540,000 shares of restricted stock vested pursuant to the terms of the Company’s 2010 Stock Incentive Plan. As a result, the Company recognized $545,000 of expense during the year ended December 31, 2014. The remaining 1,125,000 restricted shares are included in the Company’s shares outstanding as of December 31, 2014, 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, 2014.

The stock-based compensation expense recognized by the Company for the years ended December 31, 2014, and 2013 was $844,000 and $254,000, respectively.

(d) Non-controlling Interests

As discussed in Note 4, SWK HP has a limited partnership interest in Holmdel.    The total investment by SWK HP was $13,000,000, of which SWK Holdings GP provided $6,000,000.  The remaining $7,000,000 is reflected as non-controlling interest in the consolidated balance sheets and the consolidated statements of stockholders’ equity.   Changes in the carrying amount of the non-controlling interest in the consolidated balance sheet for the year ended December 31, 2014, is as follows:  

Note 10. Fair Value Measurements

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, 2014 and 2013.

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 our equity method investments included in the consolidated balance sheets as of December 31, 2014 and 2013.

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.

Cash and cash equivalents

The carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets’ fair values.

Securities available for sale

Certain common equity securities are reported at fair value utilizing Level 1 inputs (exchange quoted prices).

Finance Receivables

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.

Marketable Investments and Warrants

Marketable Investments 

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.

Derivative securities 

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, 2014 (in thousands):

The following table presents financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2013 (in thousands):

The changes on the value of the warrant assets during the years ended December 31, 2014 and 2013 were as follows (in thousands):

The changes on the value of the warrant liability during the years ended December 31, 2014 and 2013 were as follows (in thousands):

For assets and liabilities measured on a non-recurring basis during the year, accounting guidance requires quantitative disclosures about the fair value measurements separately for each major category. There were no remeasured assets or liabilities at fair value on a non-recurring basis during the years ended December 31, 2014 and 2013.

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 affiliates.

Off-balance sheet financial instruments

Fair values for off-balance sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.

For the year ended December 31, 2014:

For the year ended December 31, 2013: 

Note 11.  Income Taxes

The components of income before income tax benefit are as follows (in thousands):

During the years ended December 31, 2014 and 2013, the Company’s benefit for income taxes was as follows:

The components of the income tax 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, 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. Specifically, the Company evaluated the following criteria when considering a valuation allowance:

     • the history of tax net operating losses in recent years;

     • predictability of operating results

     • profitability for a sustained period of time; and

     • level of profitability on a quarterly basis.

As of December 31, 2014, 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 $20,106,000 benefit of the U.S. federal and state deferred tax assets in the future.

As of December 31, 2014 and 2013, the Company’s valuation allowance against deferred tax assets decreased by approximately $10,032,000 and $20,960,000, respectively, due to write off of expired deferred tax assets and partial release of the Company’s valuation allowance.

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 income for the period that the adjustment is determined to be required. The valuation allowance against deferred tax assets was $129,808,000 and $139,840,000 as of December 31, 2014 and 2013, respectively.

Deferred tax assets consist of the following (in thousands):

The Tax Reform Act of 1986 limits the use of net operating loss 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.

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 approximately $1,900,000. 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, 2014, the Company had net operating loss carryforwards for federal income tax purposes of approximately $421,000,000. The federal net operating loss 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 approximately $2,700,000. 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, 2014, the Company did not have any unrecognized tax benefits.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

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, 2014, 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, 2014.

Note 12. Related Party Transactions

 The Company provides investment advisory services to an affiliate of a stockholder. During the years ended December 31, 2014 and 2013, the Company recognized approximately $100,000 and $120,000, respectively in revenue. Accounts receivable from the affiliate were approximately $0 and $75,000 as of December 31, 2014 and 2013.

As disclosed in Note 7, on September 6, 2013, the Company entered into a credit facility with an affiliate of a stockholder. As of December 31, 2014 and 2013, the Company had $0 and $5,000,000, respectively, outstanding under the credit facility.

Note 13. Subsequent Events

SynCardia

On February 13, 2015 the Second Lien Loan was repaid for total consideration of $17,000,000 comprised of $3,000,000 of cash, $11,500,000 million of senior secured second lien convertible notes (the “Convertible Notes”) and 1,798,563 shares of Series F Preferred Stock. The Company received its pro-rata share of the repayment consideration which included $1,800,000 million of cash, $6,900,000 of Convertible Notes and 1,079,138 shares of Series F Preferred Stock. The Convertible Notes accrue interest at 10% per annum and interest paid in kind. The Convertible Notes are convertible into shares of SynCardia common stock at a 25% discount to the price of an initial public offering.

None.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) are designed to ensure that information required to be disclosed in reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures.

In connection with the preparation of this report, our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.

Management’s Report on Internal Control over Financial Reporting

Our management, under the supervision of the Chief Executive Officer and the Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting (as defined in Rules 13a-15(f) and 15d(f) under the Exchange Act) is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted  in the United States of America (“GAAP”). Internal control over financial reporting includes those policies and procedures which (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of assets, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, (iii) provide reasonable assurance that receipts and expenditures are being made only in accordance with appropriate authorization of management and the board of directors, and (iv) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of assets that could have a material effect on the financial statements.

In connection with the preparation of this report, our management, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, conducted an evaluation of the effectiveness of our internal control over financial reporting as of the end of the period covered by this report based on the criteria established in Internal Control—Integrated Framework issued in 2013, issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). As a result of that evaluation, management concluded that as of December 31, 2014, our internal control over financial reporting was effective based on the criteria set forth in the COSO framework.

This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

Inherent Limitations over Internal Controls

Our system of controls is designed to provide reasonable, not absolute, assurance regarding the reliability and integrity of accounting and financial reporting. Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent or detect all errors and fraud. A control system, no matter how well-designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system will be met. These inherent limitations include the following: