SWK Holdings Corp Q1 FY2023 Earnings Call

Good morning, and welcome to the SWK Holdings Corporation First Quarter 2023 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Jason Rando with Tiberend Strategic Advisors. Please go ahead.

Good morning, everyone, and thank you for joining SWK Holdings First Quarter 2023 Financial and Corporate Results Call. Earlier this morning, SWK Holdings issued a press release detailing its financial results for the 3 months ended March 31, 2023. 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're 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, financial future potential of product candidates and studies, and expectations regarding our capital allocation and cash resources. These statements are based on current expectations and 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 those forward-looking statements whether as a result of new information, future events, or otherwise. Joining me from SWK Holdings on today's call are Jody Staggs, President and CEO; and Yvette Heinrichson, Chief Financial Officer, who will provide an update on SWK's first quarter 2023 corporate and financial results. Jody, go ahead.

Thank you, Jason, and thanks, everyone, for joining our first-quarter conference call. First-quarter results were in line with our expectations as Financial segment non-GAAP net income totaled $7.3 million, representing a 12% annualized return on tangible finance book value. This is a solid baseline return for our lending strategy, although we believe we can improve on this figure to continue diligent underwriting combined with appropriate balance sheet leverage. Our gross total investment assets reached an all-time high of $250 million, which is an increase from $238 million at the end of 2022 and $196 million at March 31, 2022. This quarter, we implemented the current expected credit losses model, better known as CECL. CECL implementation resulted in an $11.8 million allowance for credit losses, which bridges to the $238 million net total investment assets reported at period end. The CECL allowance is not allocated to a specific finance receivable nor is driven by a view on any specific finance receivable. SWK has worked with a consultant to calculate an appropriate CECL reserve using our historical loss rates as well as competitor loss rates. Through this analysis, we concluded that an approximately 4% reserve against our funded and unfunded finance receivables is appropriate at this time. Based on our typical 5-year loan maturity, this translates to a roughly 80 basis point per year loss rate. This allowance was charged to our accumulated deficit and after adjusting for a change in our deferred tax asset, resulted in a $9.7 million reduction in book value. Our portfolio effective yield was 15.5%, up from 13.9% in the first quarter of 2022 and around an all-time high. Our tailored financing solutions are well suited for the current market environment, and we're issuing new term sheets with a mid- to high-teens cost of capital. Turning to the portfolio of credit quality, you will see in our 10-Q, we disclosed our internal credit scores for the first time. We score our loans 1 through 5, with 5 being the highest score. With the extension of the $11.8 million Flowonix nonaccrual position, all SWK loans are rated 3 or better as of the first quarter of 2023. We continue to work with Flowonix to achieve a resolution. We are also in regular communication with Boards that will require additional funding during 2023. We score royalties green, yellow, and red. For the first quarter of 2023, 84% of our royalties were scored green. The $4.2 million ideal royalty and the legacy $2.9 million best royalty are the majority of the non-green royalty positions. We are in regular communications with Ideal and working to achieve a resolution. The turnaround at our Enteris subsidiary continues with total Enteris operating expenses declining from $2.6 million in the fourth quarter of 2022 to $1.4 million as of the first quarter of 2023. While there will be one-time charges in the second quarter from former employee severance, current employee retention payments, some final R&D program costs, and strategic review costs, the first quarter 2023 OpEx run rate is a reasonable normalized operating expense level for Enteris. Additionally, we are excited with the $7 million of CDMO proposals Enteris has bid on year-to-date. A material portion of these bids were driven by our relationship with a large pharma services organization. While it's too early to forecast our close rate, these are warm leads, and we expect the strong pipeline to drive revenue growth in the second half of 2023. As previously discussed, we are working with an adviser to evaluate strategic alternatives for Enteris and we'll provide an update when appropriate. During the quarter, we repurchased 28,766 shares through our 10b5-1 program. And year-to-date, we have repurchased nearly 50,000 shares. Minor correction from the press release, post-quarter close, we have repurchased over 18,000 shares for approximately $318,000 or $17.57 a share. I think the press release said $400,000. Our current program expires May 15, and I expect our Board will approve a new 10b5 program that we believe will have benefits over the old program, ideally allowing us to repurchase a greater number of shares. To summarize, the first quarter of 2023 was a solid quarter for our financial segment with $7.3 million of segment adjusted net income, a very strong 12% return on book, and a 15.5% effective yield. We are working with our 2 nonaccrual borrowers to seek a positive resolution and are in regular communications with borrowers that need access to capital markets near term. The new loan environment is attractive, and we're pursuing balance sheet capital to deploy into this opportunity. With that, I would like to turn the call to our CFO, Yvette Heinrichson, for an update on our financial performance for the quarter. Yvette, the call is yours.

Thank you, Jody, and good morning, everyone. As we mentioned earlier this morning, we reported earnings for the first quarter of 2023. We reported GAAP pretax net income of $4.5 million or $0.35 per diluted share. Our reported Q1 2023 net income of $4.6 million after income tax benefit of $0.1 million included a $1.7 million decrease in finance receivables segment revenue and a $0.6 million decrease in our Pharmaceutical Development segment revenue. The decrease in year-over-year revenue included a $5.3 million decrease from Finance Receivables that were paid off in 2022. That included $2.4 million of revenue from the resolution of the B&D Dental loan in Q1 of 2022 as well as $1.4 million of royalties received on sales of Narcan, which was sold in the fourth quarter of 2022. The decrease was partially offset by a $4.4 million increase in revenues received from new investments initiated over the past 12 months or additional funding extended to existing borrowers. Absent any material unforeseen payoffs, we anticipate that Finance Receivables revenue over the next 3 quarters of the year to be comparable to revenue reported in Q1 2023. Overall operating expenses during Q1 2023 decreased to $3.4 million from $5.1 million in Q1 of 2022. As Jody mentioned earlier, Enteris' operating expenses decreased to $1.4 million in Q1 2023 from $2.6 million in Q1 of 2022. And Finance Receivables segment operating expenses decreased to $2 million in Q1 2023 from $2.2 million in Q1 2022. Again, as Jody mentioned, effective January 1, 2023, SWK adopted the Accounting Standards Update 2016-13, which requires companies to develop an expected credit loss methodology based on historical data combined with both current conditions and future developments. Upon the adoption of the new accounting standard, we wrote off the full $11.8 million previously reported allowance for credit losses on specific finance receivables. Those receivables are now presented net of those previously reported allowances. We estimated expected credit losses using a loss rate model that utilizes publicly available data sources, current conditions and qualitative forecasts that are reasonable and supportable as inputs. We've identified our loss rate model to our 2 portfolio segments to arrive at our current allowance for credit losses of coincidentally $11.8 million, which is presented as a reduction to Finance Receivables. We also recorded a $0.4 million liability for the unfunded commitments described in Footnote 6 of our Q1 10-Q. The cumulative impact from the adoption of the accounting standard was recorded as a $9.7 million reduction, net of applicable deferred tax assets of $2.5 million to the accumulated deficit. Although the adoption of this accounting standard had a material impact on prior earnings, utilizing the expected credit loss model will allow for smoother financial reporting as it incrementally predicts nonperforming loans and future write-offs that create volatility in financial reporting. With that, I will conclude by echoing Jody's remarks that the environment is as attractive as ever for high-quality, well-priced deployment, and we are working hard to take advantage of that. I will now turn the call back over to Jody.

Thanks, Yvette. In summary, the first quarter of 2023 was in line with our expectations, and we are pursuing our 2023 goals to position SWK for long-term shareholder value creation. Operator, let's open the call for questions.

The first question comes from Mark Argento with Lake Street.

Just a couple of quick questions. First off, I know you walked through the implementation of CECL. Just wanted to clarify how are you doing kind of low loss reserves previously where you were haircutting specific loans? Or is there a different way that you're accomplishing the same thing?

Yes. Let me give you sort of the high level, and I'll let Yvette speak to kind of the specific accounting treatment. But historically, we've been either impairing or reserving against specific loans or royalties once a loss is anticipated. So it was specific. So we have not historically had an unallocated sort of general loss bucket. So that's really what the difference is here. Yvette, do you want to comment or elaborate on that?

Under the previous model for recognizing credit losses, it was necessary to identify something that was likely to happen. This was specifically applied to an asset that we knew would not pay according to the contractual terms. Now, we have a general reserve that is applied to the entire portfolio.

All right. That's helpful. Jody...

Just one other comment. I know it can be a bit confusing, but the key point is that this is an accounting measure we are required to implement. It does not reflect our views on the portfolio or anticipated losses in any way. We needed to establish this general reserve. Many finance companies have been doing this over the past three years, and it was time for us to adopt it.

Yes, that makes sense. Turning to the general opportunity out there, there is clearly a need for capital, especially in the areas you focus on. It appears that you made one new loan in the quarter and extended additional capital to some existing customers. What is the current dynamic in terms of the opportunity to deploy more capital? Additionally, I know you have been working hard to source additional capital and add leverage to the balance sheet. Could you provide an update on both of these areas?

Yes, the opportunity set is quite interesting, and we have a good pipeline. The challenge is that we are fairly deployed at the moment. We can potentially engage in a small deal or two, but it's difficult at that level since our business requires a range of opportunities from initial discussions to term sheets. When our capital is limited, it becomes a matter of selecting which opportunities to commit to, and if those do not progress, we need to revert to the mid-level of our pipeline. We won’t commit to situations without sufficient capital. However, we are currently building more capital, which gives us some options regardless of our balance sheet status for future deals. I’m personally frustrated that we haven't made any announcements yet. Answering this question is a bit tricky because we have been active and explored various options, but regional bank challenges have been significant. I believe we will overcome this, and I'm confident we will finalize something soon. We are collaborating with multiple parties, some of whom have their own internal issues. Overall, I feel positive about our progress, as we are focused on a specific project to move forward. However, I don’t want to make any over-promises. We will get this done; it's just a matter of timing. Ideally, we will enhance our ABL capacity, which is the most cost-effective and structurally advantageous capital for us. We will also consider other options, like unsecured bonds. The timing remains to be determined, but once we secure additional capital, I expect we will be able to close more loans and operate our business development efforts more efficiently.

The next question comes from Scott Jensen, a private investor.

So I have a question, just how do you kind of view or prepare for the possible new regime in the market for companies raising capital since it often appears that your kind of that bridge until they get that next set of financing? How do you kind of protect yourself or view that development?

Yes. Let me address that question. We identify unique life science product companies and provide them with capital to enhance their value. Eventually, all of our companies will need to secure additional funding or consider some form of exit. That has always been the core of our business. The capital we invest is intended to help them approach cash flow breakeven. The current market conditions for raising capital are challenging, as everyone is aware. In response to your question, we aim to anticipate situations where there is an immediate need for funding, especially in more pressing scenarios. This may involve amendments, and with those amendments, we might require certain actions, such as more frequent communications. We are becoming more diligent and strategic in managing these situations. For new investments, we are focusing on opportunities that our capital can help transition into cash flow-positive positions, ensuring there is equity investment coming in. We are also looking for longer runways than we have historically, targeting 18 months or more, whereas in the past, we have been more comfortable with shorter time frames.

Okay. Great. And then my last question is just you had mentioned a possible increase in cost just for the second quarter for Enteris. Do you have like an approximate range about what that might be? Like it's $0.5 million, $4 million, $2 million, $1...

No, it won't be that much. We're talking about hundreds of thousands of dollars here. I don't have that number in front of me. There are a few things going on. We mentioned some one-time costs, some former severance expenses, and a few retention payments. We're also running the strategic process, which incurs costs. However, I think you'll see a slight adjustment in the second quarter. Once we move past all of that, I believe this $1.4 million to $1.5 million OpEx number, which includes everything related to Enteris, will hold steady. We feel confident about it. The only way I would expect it to change is if they continue to perform strongly on the revenue side, which might necessitate additional support.

Understood. And then just one more would be a statement rather than a question, and that is just I would keep advising more aggressive buying back the stock, and I'm glad that you're thinking about expanding the program in that fashion.

Yes, I appreciate that. We believe this is a strong use of capital at this level. It hasn't been as straightforward as we all would have preferred. We think our rule 10b5-1 could have been better and that there is room for improvement. I can't share specifics, but we have consulted with new legal counsel. Our first step is to optimize that program and observe the outcomes. I believe you agree with that sentiment.

This concludes our question-and-answer session. I would like to turn the conference back over to Jody Staggs for any closing remarks.

Thank you, operator. Thank you, Jason. Thank you, Yvette. I appreciate everyone dialing in and the questions that I will be around today, tomorrow. Feel free to reach out if you would like to discuss or have any questions on the results. Thanks, everyone. Have a great day. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.