SWK Holdings Corporation (SWKH) Earnings Call Transcript & Summary

Good morning. Welcome to SWK Holdings Second Quarter 2020 Financial Results Conference Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Jason Rando from Tiberend Strategic Advisors. Please go ahead.

Good morning, everyone, and thank you for joining SWK Holdings Second Quarter 2020 Financial and Corporate Results Call. This morning, SWK Holdings issued a press release detailing its financial results for the 3 months ended June 30, 2020. The press release can be found in the Investor Relations section of swkwhold.com under News Releases. Before beginning today's call, I would like to make the following statements 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 me on today's call is Winston Black, Chairman and CEO of SWK Holdings. Winston will provide an update on SWK's second quarter 2020 corporate and financial results. Winston, go ahead.

Thank you, Jason, and everyone, for joining our second quarter conference call. Second quarter 2020 continue -- it has been a significant progress year for SWK, high by an improved quarter-over-quarter performance, those driven by strong returns from our specialty finance business. We believe this is reflective of the growth potential of SWK's business model and our ability to capitalize on attractive financing opportunities within the small to midsized commercial-stage life sciences sector. Looking ahead, we believe that current industry and general economic dynamics, inclusive of the strong underlying demand for health care products and services, despite the current COVID-19 conditions, should remain favorable throughout the remainder of 2020. We anticipate these conditions and the credit quality of our portfolio will not only enable us to continue to produce strong results from our current specialty finance portfolio, but also to provide new differentiated opportunities for us to deploy capital in a compelling industry-asset efficient manner to support innovative companies, help them achieve their growth opportunities. SWK initiated our growth -- our strategic growth plan in 2019. We viewed the expansion of our investor base as central to the planned success. Recent addition of SWK to the Russell indexes marks an important step toward achieving this goal. Russell indexes are a widely used benchmark for active investment strategies that should enable SWK to broaden its visibility within investment community and increase the liquidity of our stock as we continue to explore additional avenues to attract new investors to increase shareholder value. This achievement demonstrates both the determination of SWK team, with high potential we offer the investment. Before I discuss our second quarter results and achievements, I'd like to provide a brief update on the COVID-19 situation and how we are positioned in our subsidiary, Enteris BioPharma. As we cased previously, SBK as a business has been minimally impacted by the COVID-19 outbreak. We remain in regular contact with imaginable management team in our portfolio of companies and are pleased to report that our portfolio on a whole keeps the whole firm against the challenges impacting the broader U.S. economy and the health care industry, which we believe is illustrated by no new nonaccrual positions year-to-date. We also believe this is due to SWK's focus on investing in differentiated companies with strong intellectual property, producing commercial products that fill demand and important needs within the health care system. Also benefiting SWK, we remain reasonably well capitalized with approximately $32 million of cash and revolver availability to execute share repurchases to support our partner companies and execute on potential investment opportunities. Unlike BDCs and some similar investment funds, SWK's balance sheet is not highly leveraged. Regarding our subsidiary, Enteris BioPharma. It was approximately a year ago that SWK completed the acquisition. We remain excited -- as excited about the opportunities in front of Enteris as we were when we closed the acquisition. Ensuring 12 months since closing, SWK has worked closely with Enteris to strengthen its operations, advance the expansion of its manufacturing capabilities and enhance its management team. A critical step in this process occurred during the second quarter with the appointment of Dr. Rajiv Khosla as the company's new Chief Executive Officer. Dr. Khosla has already made substantial impact on Enteris' business, instituting several measures that should enable the company to capture more value creating opportunities and maximize the potential of our Peptelligence platform. We continue to believe that our core thesis at Enteris' Peptelligence technology in commercial platform have yet to realize their full economic potential remains valid. For example, Cara Therapeutics, which utilizes the Peptelligence platform and a license for its Oral KORSUVA program announced in the second quarter 2020 update that expects to initiate the safety portion of its Phase III program that Oral KORSUVA as a treatment for pruritus in patients with moderate to severe chronic kidney disease in the fourth quarter of 2020. This would occur in advance at the end of Phase II meeting with the FDA, which are now forecast for the first quarter of 2021. Additionally, Cara now expects to report top line results in the first half of 2021 from its 2 Phase II clinical trials of Oral KORSUVA in atopic dermatitis and pruritus in patients with hepatic impairment due to primary biliary cholangitis. In closing, while the coronavirus outbreak continues to have an influence in all aspects of life and business for foreseeable future, we believe that SWK's structure and focus allow us to withstand these challenges and potentially position us for growth in near term, and certainly once the situation subsides. As of June 30, '20, SWK's yielding portfolio of royalties and structured credit backed by royalties total approximate $178.7 million across 23 partners. That compares favorably to $178.3 million as at the end of the first quarter of 2020 and $173.3 million as of the year-end 2019. During the second quarter of 2020, the company deployed $0.6 million to existing borrower, Harrow Health, and we deployed an additional $2 million to another existing borrower, Eton Pharmaceuticals, first quarter. At the end of the second quarter of 2020, the weighted average effective yield of the finance receivable portfolio was 13.2%, inclusive of nonaccrual positions versus 13.9% as of the end of second quarter in the previous year. SWK reported a book value per share of $18.09 as of June 30, 2020, which includes an aggregate $0.40 per share of noncash charge during the quarter, which was comprised of 26% -- sorry, $0.26 per share of negative impact from the amortization of Enteris intangibles and $0.14 per share loss due to the increase in the fair value estimate of the Enteris acquisition-related contingent consideration liability. These items were offset by an approximate $0.08 per share positive impact from the mark-to-market changes on warrant and equity securities. This compares to our book value per share of $18.31 as of December 31, 2019, and $17.31 as of June 30, 2019. The tangible specialty financing book value per share, which includes the deferred tax assets, intangible assets, goodwill and contingent consideration payable totaled $16.08 at the end of the quarter. Management views of the tangible financing book value per share as a relevant metric to value of the company's core specialty finance business. For the second quarter of 2020, SWK reported total revenue of $7.9 million compared to $5.7 million for the second quarter of 2019, which was driven by an increase of $1.8 million in our royalty income and then that $300,000 increase in fees and interest earned on our finance receivables portfolio. Revenue primarily consisted of interest and fees earned on the portfolio and the royalty payments generated by portfolio companies as well as pharmaceutical development revenue generated by Enteris. Focusing on the second quarter financial results, I want to highlight that the increase in the royalty payments during the second quarter was higher than we originally expected. As revenue stream, royalty payments can be a bit irregular or lumpy which can result in fluctuations from quarter-to-quarter. Income before tax for the second quarter of 2020 totaled $1.3 million compared to $4.3 million for the same period the previous year. The decline was driven by a $3.4 million expense for Enteris intangibles amortization, a $1.8 million loss due to increase in the fair value estimate of the Enteris acquisition-related contingent consideration, a $1.7 million operating loss for Enteris and these were partially offset by $1 million gain as a result of the fair market value increase of our equity-related positions. A quick reminder about the Enteris acquisition accounting, we are amortizing the purchase price value ascribed to intangible assets, which resulted in a $2.2 million charge in nonexpense cash during the quarter. Additionally, the $1.8 million loss in the quarter related to the increase in the fair value of the contingent consideration was caused by our increased expectation for the value of that consideration. Unfortunately, even though we have greater expectations for the value of potential cash payments under existing license agreements GAAP doesn't allow for an offsetting increase in the assets. GAAP net income for the second quarter ended June 30, 2020, totaled $0.9 million or $0.07 per diluted share compared to $4.3 million or $0.34 per diluted share for the same quarter of 2019. For the second quarter of 2020, the non-GAAP adjusted net income was $4 million, and the specialty finance segment reported an increase in non-GAAP earnings to $5.7 million versus $4.3 million for the second quarter of 2019. From a portfolio perspective, our income-producing assets, which includes our finance receivables and corporate debt securities, reached an all-time high during the quarter to $178.7 million as of June 30, 2020. This increase compares to $169.7 million as of June 30, 2019. As evidenced by these results, our specialty finance business continues to perform well, and we're working hard to target new transactions that leverage our areas of expertise and the growing need among small to mid-life -- midsized life science companies to access capital. We're well capitalized to meet the continued demand and what we expect to be increasing as well for our financial products. At Enteris, our focus continues to be on supporting our license partners, building the business development function generally, which includes evaluating our own asset opportunities for future development and potential out-licensing, and expanding our manufacturing capabilities. All these activities are focused on crystallizing overall future growth strategy. To that end, we have added personnel to Enteris team this year, including a new CEO and CMO, are working to expand the company's manufacturing facilities, which continues according to plan. Further, regarding our overall business development strategy, the hiring of Dr. Khosla, as Enteris' new CEO, marks a key development at a critical time for Enteris. He brings through his new role a wealth of experience of the industry executive as a consultant advising biopharmaceutical companies on the monetization and financial property as well as their development experience and the deep knowledge of all of the great technologies are highly critical to Enteris as the company targets multiple growth opportunities to maximize the value of Peptelligence. Through his arrival, Enteris' management team now possesses an executive team with substantial experience, ingenuity, and look forward to being an active and supportive partner as Enteris seeks to advance its external and internal development programs as well as development of new licensing and partnership opportunities that leverage the Peptelligence platform. We anticipate providing a more thorough update regarding Enteris in early 2021. In conclusion, the second quarter has been a sustained period of growth for SWK. Also made possible our diligent efforts of our SWK Holdings team, I'd once again like to thank our employees for their dedication and loyalty and our stakeholders for their continued support as we evolve our model into robust SWK. With that, I will now open the call to your questions.

[Operator Instructions] Our first question is from Kyle Bauser from Colliers Securities.

Winston, thanks for all the updates here. Maybe -- can you talk a little bit about upcoming catalysts we should keep an eye out for within the Enteris business? I know you walked through a couple of them, but I didn't quite catch them. I just want to make sure we know what to look out for over the next 12 months.

Sure. So as we -- we really don't like giving much forward guidance, but the things that we are looking for to demonstrate the advancement of the business will be because, first off, the manufacturing side, just continued their build-out and completion of that expansion project. And then, of course, any public announcements that are made by our various licensees of our Peptelligence technology, including Cara. And yes, of course, we'll be watching to see how they continue to hit their milestones. And then any updates regarding kind of numbers of feasibility studies and then potential new licenses regarding the business. So that's really the things that we're going to be looking at demonstrating advancements there.

Okay. And I think you mentioned Q4 of this year and then first half of next year. And what milestones or -- I think it was with Cara and clinical trial activity.

Sure. So they -- yes, so I'm not telling you things they haven't announced publicly. So our second quarter update a week or so ago, announced that they intend to begin the safety portion of their Phase III trials in the fourth quarter of this year, and they expect to have the FDA end of Phase II meeting during the first quarter of 2021. And then they expect to have additional Phase II results in the first half of 2021 for their other 2 Phase II trials in atopic dermatitis and then pruritus in patients with hepatic impairment due to primary biliary cholangitis.

Got it. Perfect. And as we think about deployment of cash, do you have a preference for share repurchases or to make it through COVID and conserve cash to support the current portfolio? Or do you think you have enough fresh capital to deploy for new investments? Just kind of trying to understand how you're prioritizing deploying cash through COVID here.

Sure. Well, I guess, first, I point out that thankfully, the portfolio continues to perform well. So the capital that we have today is not a static pool for those continue to generate healthy cash flow. So as we think about deploying both the portfolio of cash flow that we'll be getting over the coming quarters and years, plus the liquidity we have today, I've mentioned at the end of last quarter, it really is a bit of a balancing game. And as we seek to invest our capital kind of the highest return areas because we're -- a lot of ways for companies to build shareholder value. And so we're always evaluating share repurchases. And then we're, of course, looking at new transactions and we, of course, wanted to make sure that there's enough liquidity to support portfolio companies as circumstances change because as everyone knows, these are uncertain times. And while we feel great about generally, there may and will be surprises that we may have to help the companies with. And of course, as we look at opportunities with Enteris too, as we kind of further understand, for example, our opportunities on some of our own asset development potential and maybe that we decide that, that actually will be great prices deployed on corporate resources. So yes, I think as we think about building the book and building Enteris and returning value to shareholders, we'd like to allocate the capital in the most judicious way that we believe is possible.

Got it. And certainly, a lot of fresh capital that you can deploy for each of those, and including Enteris, which I didn't mention. So I appreciate that. And as it relates to the specialty finance side of the business, is it a competitive market out there? I mean, what's the activity like as you evaluate new deals? Is there less activity from other competitors bidding on deals? Is it a little bit easier maybe to avoid those types of situations where it comes down to competitive front and you're going up against some other people? Or is it still pretty active and there's still other companies that are looking to deploy capital to some of these high-quality names?

Sure. Yes, I think the first part of the answer to that question is exactly what you asked. I think that the first thing that I ask is there -- we continue to see a multi-suite of really attractive opportunities. And so, yes, I think we're a little bit lucky in that we can be picky in evaluating different deals. And so we're thankful for that and a testament to the platform we built. But regarding kind of the competition itself, it really kind of depends on what segments you're looking at. In some places, it's getting fairly competitive, in other places that deals where there are any other potential vendors around. And so another thing that's interesting is, I think, from our perspective, the level of competition doesn't necessarily indicate the credit quality of an asset from our perspective. And so I don't know that -- in my perspective, be any sort of increase in competition in certain segments is we're producing the credit quality of opportunities, and we're still able to raise in the deals that we've been working hard on and achieve our kind of our typical returns that we may have in the past. So it's a little bit of a mix. And so I don't know that, that's really all that different from prior periods where certain segments are competitive and that kind of goes away and other segments going to be competitive.

Our next question is from Nat Stewart from N.A.S. Capital.

Winston, great job to see the credit portfolio hold up so well. Honestly, better than I expected, given all the crazy stuff that's gone on. I just had a few questions. I noticed the very synthetic royalty performed very well. If I remember, it has a step down on the royalty rate once some targeted return is met. I was just curious where that synthetic royalty is and if there's any detail just on how the strong performance has had?

Sure. Yes. I guess first on its strong performance, the team there has just done a great job in growing the product. And so we're obviously benefiting from that, and we're very thankful for their strong execution. And so that's going quite well. You recall correctly, that the way that deal works is until we receive a, I guess, a 1.7625x the cash-on-cash return from the initial $10 million invested, until we hit that, we continue to receive the higher royalty rate. And then once that multiple has been achieved, then it steps down to 5%. And the royalty can be terminated by -- the residual royalty there can be terminated by buying it out on a change of control type transaction. In terms of how much further we have to go until we hit that multiple, I don't have that number at the top of my top of my head, but it's -- I think it's worth of well north of $5 million. But I can get back to you afterwards. All the cash flow we received are obviously public. So it can be figured out from the public document. I'll look it up and get it to you there.

Yes. It looks -- I mean, it looks like -- I mean, it shows the quality of these different royalties and the credit agreements you've had that I can look at them and a number of them I can determine, I think they're really worth more than the book value. But my second question was on the contingent consideration. I think it's probably a little confusing for many people how the Enteris deal was accounted for with the amortization and has caused the divergence and kind of accounting values because I think you're actually building value there. But for the time being, the short term, that's -- it's kind of hidden by the funny accounting treatment. But I was just curious about the contingent consideration because that stepped up, that's actually a good thing.

That's right.

It's a liability increasing. And I was just curious what was the cause of that. If I understand correctly, that's just based on the potential milestone payments. So it sounds like, if I'm remembering correctly, the milestone payments went up a bit, which is a good thing. Is there any more detail you can provide on that?

Sure. So I guess, first on the accounting itself, GAAP requires us to book the value of any payments that would have been made to the seller as part of the deal. So as a reminder, we did have sharing of the proceeds of our license agreements as well as any sort of proceeds on the initial pre-owned assets that the company had owned product candidates. And so for us, we have to book the full value of that as an asset, meaning the full 100% that will be paid out on a risk-adjusted basis. And then the amount that would be paid out to the seller is the contingent liability. So you're exactly right that our general expectation based on kind of developments of our -- of the license, in particular, have increased. And as a result, that liability results in a loss in the P&L and an increase to the liability, even though with no kind of offsetting amount on the asset side. So you're exactly right. Yes, it's really -- they're really counterintuitive. I mean, the contract, we had lower expectations in the marketing asset down, effectively, we get a gain, which on the P&L, it's -- yes. It's -- I agree.

That will be a bad sign.

It's funky. Yes, I agree it's funky, but it is indeed a good thing and you are right in that the value of the purchase price that was described to existing licenses because we do expect as we've noted during the initial conference call that we expect a lot of cash proceeds in the near to medium term that have resulted in those assets being amortized over that period, which is, if you look at it, I agree. I think the business has increased in value but yet here we are, it's a trick in the balance sheet. But that's the way it's accounted.

It's going to be a discrepancy for a period of time, but I think it will resolve itself over a period of years or as things further develop on the revenue side. So I just wanted to clarify that.

Yes, I think that's right. I appreciate that. Yes. Thank you for that.

[Operator Instructions] At this time, we have no more questions. This concludes the question-and-answer session. I would like to turn the conference back over to Winston Black for closing remarks.

In closing, thanks, everyone. I really appreciate your time and attention and look forward to future updates as we continue to advance SWK Holdings. I'd like to also extend my sincere wishes and good health to all.

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