Earnings Call Transcript - SWKHL Q3 2023

Operator, Operator

Good morning, and welcome to the SWK Holdings Third Quarter 2023 Corporate and Financial Results Conference Call. I would now like to turn the conference over to Jason Rando at Tiberend Strategic Advisors. Please proceed.

Jason Rando, Presenter

Good morning, everyone, and thank you for joining SWK Holdings' Third 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 September 30, 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 consumer and drug product candidates, plans for future potential product candidates and studies and expectations regarding 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 me from SWK Holdings on today's call are Jody Staggs, President and CEO; and Yvette Heinrichson, Chief Financial Officer. They will provide an update on SWK's third quarter 2023 corporate and financial results. Jody, go ahead.

Jody Staggs, President and CEO

Thank you, Jason, and thanks, everyone, for joining our third quarter conference call. During the third quarter, our core finance business generated healthy returns, while our Enteris subsidiary grew revenue, reduced costs and moved closer to profitability. We achieved a key 2023 strategic goal of improving our balance sheet via the issuance of a $33 million senior note as well as a $15 million increase in our credit facility to $60 million. We appreciate our underwriters' work to complete the bond offering in a challenging environment. We are also thrilled to partner with our new bank group member, Woodforest, and appreciate the work the Woodforest team undertook to evaluate our business. With the added capital, we have over $60 million of liquidity to deploy into an attractive opportunity set. We believe raising this capital has several benefits. First, we were able to play offense at a time when other funding sources have pulled back. Second, we believe a larger and more diversified portfolio may lead to a lower cost of capital for SWK. Finally, during our prior strategic review process, we learned that interested parties value a larger and more diversified portfolio, which this financing will allow. Our gross finance receivables totaled $235 million at quarter's end, a 10% increase from the prior year. We closed on one $5 million transaction during the quarter, and after quarter end, we closed 2 term loans totaling $26 million. The new deal pipeline remains strong with multiple royalty and loan opportunities, and we anticipate closing additional financing in the coming months. We are issuing new proposals at a 15% plus IRR while targeting the best risk/reward opportunities. Our portfolio effective yield was 14%, a 30 basis points decrease compared to the third quarter of 2022. Our realized yield in the quarter was 14.7%, a decline from 17.5% in the third quarter of 2022. There were no early prepayments during this quarter. Looking at credit quality, we rate our loans from 1 to 5, with 5 being the highest score. During the quarter, we had 2 loans scored as a 2, and the remaining loans were rated 3 or better. One of the 2-rated loans is our financing to Trio Healthcare, which was placed on nonaccrual at quarter's end. We are working with management to achieve a satisfactory resolution. Our core business is financing pre-profitability commercial stage life science companies. We are regularly speaking with our borrowers to ensure they appreciate the challenging macro and capital markets conditions. We believe our borrower partners understand this dynamic and have taken steps to reduce costs and raise capital to weather the challenging conditions. We rate our royalties green, yellow and red. The 3 nonaccrual royalties, best, ideal and Poloniex are rated as reds. 2 royalties are rated yellow, with the remaining royalties rated green, and green-rated royalties account for 55% of the royalty portfolio. Tangible book value per share increased to $19.35 per share, a 6% year-over-year increase after adjusting for the implementation of CECL. Results in Enteris continue to improve, driven by the hard work of the team and support from our strategic partner. Revenue increased 72% sequentially to $0.3 million, and we expect strong revenue growth in the fourth quarter. Year-to-date, we have booked $2.7 million of CDMO projects and are bidding on an additional $5 million of projects. The headline bid number is down from the prior quarter as we removed 2 large legacy opportunities. Neither came from our strategic partner. Both remain possibilities but have been delayed, and we thought it prudent to remove them from the count. Through our strategic partnership, we are currently working on approximately 18 projects from a variety of underlying customers. Third quarter 2023 Enteris operating expense totaled $1.2 million compared with $2.6 million in the third quarter of 2022. We view the third quarter 2023 Enteris quarterly operating expense as a reasonable quarterly run rate. Third quarter 2023 Enteris EBITDA loss was $900,000, an improvement from a $2.5 million loss in the third quarter of 2022 after adjusting for a $5 million care milestone payment in the year-ago quarter. We are deepening our relationship with our strategic partner and are working together to improve Enteris' profitability and increase subsidiary value. During the quarter, we repurchased 60,335 shares of stock for approximately $1 million. Year-to-date, we have repurchased 361,593 shares for a total cost of $6.1 million. We'll be repurchasing shares at the current discount to book value as an attractive use of capital. To summarize, during the third quarter of 2023, we added capital to our balance sheet at a time when deployment yields are attractive. Our Enteris segment reduced burn and continues to improve its value proposition to our strategic partner, and our financial segment generated healthy returns while closing additional loans. We are focused on prudently deploying the recently raised capital in attractive loans and royalties while working with our current portfolio partners to navigate the challenging business environment. 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.

Yvette Heinrichson, Chief Financial Officer

Thank you, Jody, and good morning, everyone. Thank you for joining our quarterly conference call. Earlier this morning, we reported earnings for the third quarter of 2023. We reported GAAP pretax net income of $4.1 million or $0.36 per diluted share. Our reported net income for Q3 2023 was $4.5 million after an income tax benefit of $0.4 million, which included a $0.1 million increase in finance receivables segment revenue primarily due to an overall increase in reference rates, offset by a $4.7 million decrease in our Pharmaceutical Development segment revenue compared to Q3 2022. The decrease in our Pharmaceutical Development segment revenue was mainly due to receiving a $5 million milestone revenue related to Enteris' license agreement with Cara Therapeutics in Q2 2022, with no similar milestones occurring in Q3 2023. Absent any significant unforeseen payoffs, we expect finance receivables revenue to slightly increase in Q4 2023 due to one new term loan added during the quarter and two additional term loans added after the quarter ended. Overall operating expenses, which include interest, pharmaceutical manufacturing research and development expense, as well as general and administrative expenses, were $3.8 million during Q3 2023, down from $6.2 million in Q3 2022. Enteris operating expenses for Q3 2023 were $1.2 million, compared to $2.6 million in Q2 2022, while Finance Receivables segment operating expenses were $2.6 million in Q3 2023, compared to $3.6 million in Q3 2022. The $1.3 million decrease in our operating expenses was mainly driven by a one-time severance payment of $1.1 million to the former CEO in Q3 of 2022 and a $0.4 million decrease in one-time professional fees related to corporate strategic planning that took place in 2022. This decrease was partially offset by a $0.2 million increase in board fees and other related expenses due to a revised board compensation plan in 2023. Our gross Finance Receivables portfolio decreased by $13.9 million from the first quarter of 2023, primarily because of the payoff of one term loan in Q2. However, the addition of a $5 million term loan during the third quarter resulted in a provision for credit loss expense of $0.2 million. As a reminder, in Q1 of this year, we adopted the CECL accounting standard. Going forward, changes in the size of our finance receivables will lead to corresponding percentage changes in our allowance for credit losses, as was the case in Q3 of 2023. Each quarter, management evaluates the underlying assumptions used to establish estimated loss rates, including whether the current finance receivable pools remain appropriate. Any changes in these assumptions may also lead to changes in our allowance for credit losses. We did not have any changes to these assumptions during the third quarter of 2023 but plan to reassess them at year-end, and any future changes to our allowance for credit losses will impact the income statement. I'll now turn the call back over to Jody.

Jody Staggs, President and CEO

Thank you, Yvette. The highlights of positives from the quarter. Our portfolio generated a 14.7% realized yield. We have liquidity to deploy into an attractive opportunity set. We are buying back stock at a discount to tangible book, and our Enteris subsidiary has reduced its operating burn and is forming a deep relationship with our strategic partner. Operator, let's open the call for questions.

Operator, Operator

At this time, we will take our first question from Mark Argento with Lake Street.

Mark Argento, Analyst

Jody, Yvette, just a quick question. With all the updates, the new maybe bond debt issuance and then the new facilities, can you just walk us through where you sit right now in terms of kind of lending capacity, the ability to fund loans? And how aggressive are you guys going to be in terms of starting to deploy more capital? It looks like you already leaned in pretty good to start off the quarter.

Jody Staggs, President and CEO

Thank you, Mark. We currently have over $60 million available for deployment, after accounting for all reserves and unfunded commitments, giving us ample capital at this time. We recently secured a significant financing shortly after completing our bond and increasing our ABL. We're actively working on several deals and have a few term sheets in circulation along with multiple proposals, with the expectation that some proposals will convert into term sheets. We're optimistic about the opportunities in our market segment. We're looking to deploy this capital but want to do so with discipline. There are many companies in need of funding, and we're focused on identifying the highest quality opportunities at favorable rates. I'll stop here and see if that addresses your question.

Mark Argento, Analyst

No, that's helpful. So the $60 million, does that include the $26 million you've already deployed? Or is that on top of the $26 million?

Jody Staggs, President and CEO

No, that's afterwards. As of today, the $60 million is probably closer to $65 million in deployable liquidity.

Mark Argento, Analyst

Got it. All right. No, that's helpful. And then in terms of your current lending portfolio, I know a decent number of the companies are publicly traded or small publicly traded. When you guys are thinking about the conditions of the equity markets right now, kind of how imperative is it for the equity markets to open back up for some of these companies to continue to fund their businesses? Meaning, is that something you guys are spending a lot of time on? Are you guys concerned about the condition of the equity markets at this point within your portfolio companies? Or just kind of walk us through your thinking around that.

Jody Staggs, President and CEO

Yes, we are actively discussing this with all borrowers. Our message has been clear: the ability to raise capital may be limited in the near future, so it's important not to rely on that. Instead, it's crucial to explore other avenues to achieve cash flow breakeven as soon as possible. This will involve cost reductions and possibly forming revenue partnerships. On the cost side, it's essential for everyone to recognize the need to act decisively without cutting to the bone, focusing on discretionary expenses. In our portfolio, this approach has been a common strategy, and most have implemented it. It's a case-by-case situation; if capital markets were to close permanently, that would pose a significant challenge. However, the management teams we are in contact with have successfully found innovative ways to secure some capital along the way.

Mark Argento, Analyst

Helpful. And then just, again, talking about the markets, your guys' stocks trading '15, '16 book values, '19 and change. And so you were active with the buyback. Where are you in terms of the buyback? And is there ability to get bigger or more aggressive with that if there's still such a significant disconnect?

Jody Staggs, President and CEO

Yes. So yes, I agree with all of that. The ability to repurchase shares through our 10b5 program is limited by trailing volume, trailing 20-day volume. So there's not a whole lot we can do on that front. Now the one change to our program this year is we do have the ability to buy back one block a week. So if any block of shares comes up, we have the ability now to purchase those. That occurred earlier this year where we were able to buy 3 decently-sized blocks. Our primary goal would be to source more of those blocks. If we're doing it through 10b5, we are somewhat limited just via the 10b5 trailing volume and policies.

Mark Argento, Analyst

Got it. How much more do you have authorized under your current buyback program, if you have that information readily available?

Jody Staggs, President and CEO

Yvette, do you know that number off the top of your head? Mark, I have a ballpark idea, but I want to give you the right number. I might need to follow up with you on that unless that has...

Operator, Operator

Our next question will come from Scott Jensen, a private investor.

Unknown Attendee, Private Investor

So a few of the questions were already answered on kind of returning capital to shareholders and your restrictions sometimes on the buyback. Have you thought about other ways such as dividends, which would obviously open up to more investors as well?

Jody Staggs, President and CEO

Yes. Yes. The Board is always considering. I think every quarter, we have a discussion about dividends. Of course, there are other ways to repurchase stock. Yes, yes, they're always considering other ways to return capital.

Unknown Attendee, Private Investor

And then I guess another one is with the Enteris pipeline, you don't seem to report any of the deals that you get. How will we gauge the progress of that? Is that restricted in the same way with some of your borrowers? The only way I can find information is by searching the web for your name. Are you precluded from releasing those loans?

Jody Staggs, President and CEO

So on Enteris, we have a couple of things. We're going to do a better job of giving you the bookings on a periodic basis. I think we detailed $2.7 million of bookings year-to-date. The last time, we said it was $2 million. I would say that's the number to track. Hopefully, we can continue to accelerate the bookings, but that would be the number one metric you should track. Bookings should turn into revenue over a 4- to 12-month basis. That should be helpful. In terms of the underlying customers, I don't think that's something we can or really should be disclosing. We have our one strategic partner who sends us referrals. We then have to win the business. They do not give us business; they provide us with referrals. The Enteris team goes and makes bids, proposals and pitches their services. The underlying customers, these biotechs may select Enteris for Phase I and Phase II CDMO services. We will continue to look at what we can disclose and try to clarify what the trends and trajectory are.

Unknown Attendee, Private Investor

Yes. And my last one is, when you go to buy a royalty today, with all the generic competition constantly coming into markets as well as new drugs coming to market, which could affect us relatively, how do you price that risk? Or how do you think about that risk?

Jody Staggs, President and CEO

Yes, that's a good question. I don't think that dynamic has necessarily changed. What's probably changed over the past 10 years is pricing. You used to be able to assume 3% to 8% price increases. Now, of course, you can't assume that; you probably should be assuming maybe a couple of percent increase in the early years and then down in the out years. I don't know that that has changed. For us, really the key on the royalties is when we have to find unique setups where there's something a little bit off the run, it's smaller. There are multiple sellers. Maybe it's not a standard royalty. The larger $30 million plus royalties in Tier A assets are very competitive. We don't want to be the last option for those people. So the initial focus is the deal dynamic looking really attractive. If that checks out, and we think the product has value and usability, then what we're trying to do is make a conservative underwriting case and price that to mid-teens. If you look at our two largest royalties, that's what we did, and we have been able to do mid-teens plus. Both are trending well versus our underwriting case. We try to be conservative in pricing mid-teens plus with a really good setup that's somewhat off the run. We have also done deals in the past where you buy these royalties from experienced parties. The bid ask may be quite wide. One way we've narrowed that bid ask is by saying, we're not going to buy this outright; we're going to give you $10 million, and when we get a 2x return, you get the royalty back. That can be a really interesting way to see if these parties believe in the asset and want to keep a residual. If they keep a residual, they have skin in the game. So those are a few things we think about.

Unknown Attendee, Private Investor

I thought of one more question, and that is on the buyback. If there's somebody out there that wants to sell those blocks, do they know how or who to call?

Jody Staggs, President and CEO

Yes. I would tell them to call me, and I can put them in touch with our broker. We work through Jones, and I can connect them.

Operator, Operator

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

Jody Staggs, President and CEO

Thank you. Thanks, everyone, for joining the call. Thanks to the team at SWK and our shareholders, and I hope everyone has a great day.

Operator, Operator

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