SWK Holdings Corp Q3 FY2022 Earnings Call

Good morning, and welcome to the SWK Holdings Third Quarter 2022 Financial Results Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note today’s event is being recorded. I would now like to turn the conference over to Jason Rando, Tiberend Strategic Advisors. Please go ahead.

Good morning, everyone, and thank you for joining SWK Holdings third quarter 2022 financial and corporate results call. Yesterday evening, SWK Holdings issued a press release detailing its financial results for the three months ended September 30, 2022. The press release can be found in the Investor Relations section of swkhold.com under News Releases. Before beginning today's call, I would like to make the following statement regarding forward-looking statements. Today, we'll be making certain forward-looking statements about future expectations, plans, events, and circumstances, including statements about our strategy, future operations and the development of our consumer and drug product candidates, plans for future potential product candidates and studies, and our expectations regarding our capital allocation and cash resources. These statements are based on our current expectations, and you should not place undue reliance on these statements. Actual results may differ materially due to our risks and uncertainties, including those detailed in the Risk Factors section of SWK Holdings 10-K filed with the SEC and other filings we make with the SEC from time to time. SWK Holdings disclaims any obligation to update information contained in these forward-looking statements, whether as a result of new information, future events or otherwise. Joining on today's call from SWK Holdings is Jody Staggs, President, Interim CEO; and Yvette Heinrichson, Chief Financial Officer. They will provide an update on SWK's third quarter and year-to-date corporate and financial results. Jody, go ahead.

Thanks, Jason, and thanks, everyone for joining our third quarter conference call. I'm excited to be speaking to you in my new role with SWK. This has been a productive past few months for the SWK team, and I look forward to sharing our progress. However, before doing so, I want to thank our Board for helping to ensure a successful leadership transition. And I also want to thank my predecessor, Winston Black, who has left SWK in a strong position. Winston is a longtime friend and mentor. I'm grateful for this opportunity to build on the foundation he's left. I'd like to start with an overview of how I see the current business as well as a vision of where we are going. SWK's mission is to be the partner of choice for small to mid-sized life science companies seeking non-dilutive financing to fuel the development and commercialization of important life-saving technologies. Since 2012, SWK has completed transactions with nearly 50 parties, funding almost $700 million. We think the results and the numbers produced over the past decade demonstrate that we are fishing in an attractive pond. Our focus is financing in the $5 billion to $25 million range, and we have created a niche in non-name-brand sponsored situations, a highly competitive field. We also focus on smaller off-the-road royalties, while most larger competitors gravitate towards Tier 1 high-profile royalties. We believe and think the numbers demonstrate that the returns in this segment are highly attractive. SWK targets a low to mid-teens return on our financings. During the third quarter, our effective yield was 14.3%, while our realized yield was 17.5%. We believe these returns are at the high end of our comp group. Our sweet spot has been and remains financings in the $7.5 million to $15 million range. However, in the third quarter, we closed $225 million financings with larger borrowers, demonstrating that our platform is valuable to companies on the larger end of our target range. I think about the value of SWK in two buckets. The first bucket is our financial and balance sheet assets, and the second bucket is our intangible assets. I think our financial assets are somewhat obvious to all, and you can certainly review these in the press release and the marketing deck. The first is our existing portfolio of yielding finance receivables and other tangible book value assets, and this is about $19.14 a share. The second is our deferred tax asset, which is on our books for $1.45 a share. And the third is our insurance assets, which are on our books for just over $1 a share. What may not be as apparent to everyone is the intangible assets that SWK has built over the past decade. The first of these is a highly motivated and skilled team. Our corporate team currently is six, which will increase to seven next week, and we anticipate adding a couple of additional investment professionals in 2023. While the team isn't large, the team does possess the skill set specific to succeed in our market vertical. The second intangible asset is our reputation as a trusted partner. More partners and real sources know SWK will do what we say we will do and sell in a timely fashion. They also know that we'll treat our partners with respect, and this hasn't taken years to build. It is an asset that we protect. The third intangible asset is an extensive proprietary deal sourcing via our network of executives, Board members, intermediaries, co-lenders, and former deal partners. This network can also provide references for potential borrowers. And fourth, we have a strong underlying track record with a 20% IRR and 1.4 times MOIC on 30 exits. Looking ahead, our leadership team is energized to build upon these valuable assets as we seek to scale our platform and drive per-share value. We will do this while maintaining underwriting discipline and always with an eye to protecting and growing our shareholders' capital. The good news is, we don't have to reinvent the wheel and can utilize a tried and true path. In the near term, we need to scale the platform. To facilitate this, we are evaluating added leverage to our balance sheet, and we will do this in a responsible fashion while being mindful of our particular financing assets. While we are flexible and will consider various structures, the path of least resistance to add leverage will have two steps. The first is we need to upsize our existing ABL. Our current $22 million ABL is too small for SWK, and we're working with our existing lender to address this, and we hope to have an update on this by year-end. The second step would be to explore unsecured bonds. As a reminder, earlier this year, we filed an S3 in anticipation of exploring this path. The bond market has clearly softened since we made that filing, but based on recent specialty finance bond offerings and considering our asset yields, we continue to think this is an attractive alternative. We will need to receive our secured lenders' approval to issue a bond. Adding an appropriate amount of leverage has multiple benefits. First, we will improve our return on equity, which is a metric closely linked to how financial equities trade as a percent of both value. And secondly, the additional capital allows us to pursue more financings, which helps develop the SWK team and our ecosystem. So, in the near term, we aim to bring on leverage, deploy it, and increase our ROE. In the medium term, we're also exploring a third-party asset management strategy. Many allocators and generalist credit funds find our life science niche attractive, and they like the means of allocating capital to the space. SWK has a platform, know-how, and track record that is valued. We are in the early stages of exploring what might be possible here, and anything we do will require finding the right partner, and of course, we will need to benefit our shareholders. We have taken initial concrete steps in this strategy by hiring a firm to audit our full investment track record. These initiatives are focused on driving SWK's value per share, which is our North Star. One way we can augment this metric is through more capital allocation, and in particular, repurchasing stock at attractive valuations. During the third quarter, we repurchased over 34,000 shares at a $17.49 average cost via our 10b5 program. We've also been buying back stock post the quarter close. It’s important that our shareholders know we have a sophisticated board which balances the return that can be achieved by buying back stock with the return from making additional loans and royalties. We don't focus on the stock price on a day-to-day basis, but over a reasonable period, the Board and Management Team want the stock price to reflect the value of our assets and platforms. Given SWK's strong foundation as well as a clear path to scaling the platform and driving shareholder returns, you can understand why the team is energized by the opportunity presented to us. While our portfolio companies are not immune to the current economic and capital market challenges, our outlook for the remainder of 2022 and into 2023 is optimistic. We are in communication with our existing portfolio companies to ensure they have adequate liquidity and are not in denial about the challenging environment. However, we are also playing offense and targeting several financing opportunities, as the ongoing market volatility makes our non-dilutive structures attractive to companies in need of capital. With that, I would like to turn the call to our new CFO, Yvette Heinrichson, for an update on our financial performance for the quarter. I've worked closely with Yvette for several years and I'm excited to see her promoted to CFO. It’s a well-deserved promotion and I'm confident our financial and accounting functions are in great hands. SWK and our shareholders will benefit from initiatives that Yvette is spearheading, including optimizing our capital structure and streamlining processes required to support financial receivables growth. With that, I'll turn the call over to you.

Thank you, Jody. I appreciate the kind words, and I'm very happy to be here. I'd also like to thank you all for joining us this morning. SWK had a solid third quarter that was in line with expectations. As of September 30, 2022, SWK’s total investment assets grew by 8% to $222.2 million from $206.3 million for the third quarter of the previous year. Please note that the quarter-end figure does not include portfolio movement post-quarter end. At the end of the quarter, the weighted average projected effective yield of our finance receivables portfolio, including non-accrual positions, was 14.3%. As Jody mentioned earlier, this is above SWK’s historical range and represents an increase from 13.8% from a year ago. The third quarter realized yield on finance receivables was 17.5% compared to 18.8% one year ago. SWK reported non-GAAP tangible financing book value per share at $19.14 as of September 30, 2022. That's a 9.4% increase from $17.50 as of September 30, 2021. This figure excludes the deferred tax assets, intangible assets, goodwill, and contingent consideration payable. Management uses tangible financing book value per share as a relevant metric to value the company's core finance receivables segment. The finance receivables segment's adjusted return on tangible book value was 11.1% as of September 30, 2022. For the third quarter of 2022, SWK reported total revenues of $13.6 million. This is an increase from $9.6 million for the third quarter of 2021. The increase in revenue included recognition of $5 million of milestone revenue from Cara Therapeutics. Finance receivables segment revenue decreased to $8.5 million from $9.4 million from the previous year. The decrease in finance receivables segment revenue was primarily due to a $1.3 million net decrease in royalty income, which was primarily due to the achievement of return premium that caused a step down in royalty rates. That decrease in revenue was partially offset by a net increase of $0.4 million in interest and fees earned on our finance receivables. GAAP net income for the third quarter of 2022 totaled $6.6 million or $0.51 per diluted share, compared to $2.2 million or $0.17 per diluted share for the third quarter of 2021. The 2022 third quarter's net income reflected $1.1 million of severance payable to the former CEO. For the third quarter of 2022, adjusted non-GAAP net income generated by our finance receivables segment was $6 million compared to $7.7 million for the third quarter of 2021. Back to you, Jody.

Thanks, Yvette. In conclusion, SWK’s fundamentals are strong and the current market conditions are ideal for our custom financing solutions. We are working with our existing portfolio of companies to ensure they understand and are prepared for the challenging environment we face. We are urgently pursuing opportunities to scale the platform while thoughtfully deploying the capital. We are well positioned to capitalize on our reputation as a financing partner of choice for small and mid-sized life science companies. With that, I'll open the call for questions.

Thank you. We will now begin the question-and-answer session. Today's first question comes from Kyle Bauser with Lake Street Capital Markets. Please go ahead.

Hey, guys. This is Jake on here for Kyle. Thanks for the updates and taking the question. I just have a couple of them for you guys today.

Thanks Jake.

So to get started, I was just wondering about the update on timing for adding leverage to the balance sheet. I know you talked about it being in the short term, what is that looking into Q4, Q1 early?

Yes. Okay. If it was up to me, I would make it happen now. I think the first step, I expect us to have an update very soon with the term on the ABL in the fourth quarter. The second step, which we think could be the unsecured debt, I think it could happen relatively soon. There are a few challenges there. Number one is we do have to have our unsecured lenders' approval to do a bond. And so that's a focus right now. And the second is the market conditions. It looks like today we're back in the bull market, so that's great. The 10-year is down, and it's potentially opening up a window here. Six weeks ago, folks couldn't get financing. So, if the market is open and we can get kind of the paperwork lined up, it's something that I think we can get done in a reasonable period. I don't want to say an exact date; the fourth quarter would be aggressive, but the watchword I want to convey is there's a sense of urgency to get these things done.

Yes. Thanks for elaborating on that. And my next one talks about headcount. You mentioned you are currently at 6 and looking to be at 7, I believe. Is there a potential need to keep adding more, or is the team all set in place?

Yes. We have an investment professional starting Monday, which will increase our investment team to four, including myself, and our finance and accounting team to three. I believe we have a solid baseline. We are considering hiring an experienced mid-level investment professional and a business development person in 2023. If we can make those two hires, and they are not immediate necessities, I believe it will significantly strengthen the team and enhance our ability to scale the platform. Currently, I think we have a decent foundation, and if we can add those two positions, we'll be in great shape; we just need to find the right candidates. We are focused on ensuring that every new hire is better than our existing team, so we are being selective.

Yes, that's a good process for that, and that makes a lot of sense. And I just got one more for you guys today. So, what changes are you seeing in the level of deal activity out there compared to earlier this year? Thanks.

Yes. There have been some fits and starts. Our portfolio is very healthy. If you had capital right now, I think we would have several deals that we would be pushing towards closing. I think what we're trying to do is really upgrade the situations we're looking at. So, the rates may be roughly the same as the things we've looked at, but we're looking to finance better assets, higher quality assets, more equity, and better lender terms. There are numerous life science companies that are in need of capital and are reaching out and sort of presenting themselves for second lien or quasi-equity situations. And the returns on those, of course, are attractive, but we're really not focused there right now. So, the pipeline is strong, with lots of flow, and we're really just trying to sift through the things that make sense for SWK.

Awesome. Thank you.

Okay. Thank you. I appreciate the question.

Our next question comes from Scott Jensen of Private Investor. Please go ahead.

Good morning and congratulations, Jody, on your new position. I too want to thank Winston for good stewardship of the capital over the years. I guess my first is thank you on the buyback and keep going. I'm glad that you still are. I think that's a good use of capital at these price levels. The second is you've answered most of them as far as capital and deal flow. So, thank you. As you talk about going into the asset management space, are there regulatory costs that come from that? And does that then determine the size that you need to make it a worthwhile venture?

Thank you for the question. To echo Winston, we are still experiencing benefits from successes that were planned under his leadership in previous quarters and years. The asset management concept is still in its early stages but aligns well with our business model. Regarding regulatory costs, we already have an OIA in place for SWK. A lot depends on the specifics of the situation. This is more of a brainstorming session than a finalized plan. If we were to consider a GP LP fund, it would be quite challenging, especially as first-time fund sponsors. You’re correct that the costs would likely be higher, including regulatory expenses and the need for investor outreach, along with finding suitable LPs. Conversely, if we consider a fund of funds or a general credit group that aims to invest in the cost space, the costs and regulatory requirements would be significantly lower. However, it's important to note that fees would scale accordingly as well. Does that address your question?

Yes. Yeah, that helps. Thank you. And I guess my next one since most have been expanded upon already is obviously, you've shown great progress at Cara and got another milestone, and you just presented your data for Ovarest in I think last month. And I'm just wondering what might be the next step there, both from a regulatory standpoint. This is a small Phase 2, but it was with an approved drug already. So that changes the need to prove that it's safe and effective. Are you thinking about partnering? Do you launch it on your own, which obviously that goes to a Phase 3 would be a higher cost structure. Are there any thoughts about the next step for that drug?

Yeah. Let me make a general statement and then a more specific statement. So, given the leadership change and considering we've owned Enteris for three years, I feel like it made sense to evaluate where we are and where we're going with Enteris. I am working with the Enteris team and an adviser to really assess value, evaluate the assets, and also the cost structure. This is a process that just kicked off, and I don't have anything further than that, but we'll be able to tell you more in the fourth quarter. So, just as a general comment, I think that's important to note. In terms of Ovarest, I was actually speaking to the CMO a couple of days ago, and there are some interesting findings there in terms of full suppression of Estradiol in some of the samples. Gary went out and did a paper on this, so it's out there. In terms of what exactly that means, we're going to understand more as we conduct this evaluation and work with the team. SWK's not funding the base story, just to be very clear.

Okay. Good.

It seems like there are interesting prospects.

Yes.

Let me conclude by saying that SWK is not funding a Phase 3. So, it's an interesting asset, but SWK is not in the drug development business, full stop. So hopefully, that answers your question.

Yeah. Yeah. Great. I mean, there's been so much interest in that space, the French government coming out and making it a priority to work on endometriosis. I mean, there's just a lot of good interest. I would think somebody might have interest in the product. So thank you. That's great.

I think that could be right.

Okay. Great. I'll go back in line. Thanks, and congratulations again.

Okay. Thank you, Scott.

And ladies and gentlemen, this concludes the question-and-answer session. I'd like to turn the conference back over to Jody Staggs for closing remarks.

Thank you, and thanks, everyone, for joining the call. We appreciate your time and continued attention towards SWK. Please reach out to myself, Yvette, or Tiberend with any follow-up questions. Have a great day.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.