Safeguard Scientifics, Inc.
Q3 2019 Earnings Call Transcript

Published: 11 Nov 2019

[Operator:]

Good morning and welcome to Safeguard Scientifics Third Quarter 2019 Financial Results Conference Call. Please note this event is being recorded. I would now like to turn the conference over to John Shave, Safeguard Investor Relations. Please go ahead.

[John Shave:]

Good morning and thank you for joining us for this update. Joining me on today’s call and webcast are

[Brian Sisko:]

Good morning and thank you for joining us. We have continued to do in 2019 what we started to pursue early in 2018. We have returned an aggregate of over $184 million back to our balance sheet since we began pursuing this strategy, by being patient and opportunistic.We have now reached a meaningful milestone in the execution of this strategy. We have repaid our debt and currently we have cash of approximately $45.5 million on hand. As a result, the Safeguard Board of Directors has declared a special cash dividend of $1 per share, payable on December 30, 2019 to shareholders of record as of the close of business on December 23, 2019.We expect the dividends to be characterized as a return of capital for federal tax purposes. Mark will provide some further information on that determination later in the call.To reiterate something we have said previously, whenever we have cash and cash equivalents on our balance sheet that exceed the amount, we believe is then prudent to keep on hand to operate the business and continue to support our partner companies, our Board of Directors will authorize share repurchases and/or dividends.Currently, we believe $25 million is the appropriate amount to retain on our balance sheet. In addition to the determination regarding the dividend and then to further align interests with shareholders, the Safeguard Board of Directors also decided to reduce the size of our Board of Directors from 6 to 4 as of the next annual meeting and to pay all Board compensation in Safeguard equity.We continue the pursuit of individual partner company exits while considering all alternatives as circumstances dictate, including among others, the sale of individual partner companies, the sale of certain partner company interests in secondary market transactions, or a combination thereof, as well as the sale of the entire company. We will also continue to consider financing transactions which could expedite the return of value to shareholders.We remain bullish regarding our portfolio of partner companies and continue to believe that the current value of our portfolio interests, and our cash and equivalents significantly exceed our current share prices.Let me highlight some recent partner company occurrences. Recently, Syapse signed a collaboration agreement with the FDA, which will help to solidify their approach to real-world evidence collection as the industry standard. This announcement is anticipated to accelerate discussions with current and future pharma partners.As previously announced, Syapse also entered into a deal with Pfizer to develop a precision medicine solution for oncology. This marks the third major biopharma company to partner with Syapse. Most recently, the company announced that Fletcher Payne has been appointed as the company’s Chief Financial Officer.Mr. Payne joined Syapse, as it is experiencing tremendous momentum driven by its new life sciences and health system partnerships, and its collaboration with the FDA. Safeguard has deployed $20.6 million into Syapse since 2014 and we own 20.1% of the company.During the quarter, Safeguard partner company MediaMath introduced SOURCE by MediaMath to the global marketplace. SOURCE by MediaMath is a new ecosystem that addresses fundamental challenges like fraud, single view of the customer and commercial term transparency to name a few.The reception by external audiences has been strong and the company is looking forward to seeing this momentum continue. Furthermore, MediaMath was recently named as a leader in the 2019 Gartner Magic Quadrant for Ad Tech. Notably, MediaMath in that quadrant is ranked ahead of Google in its ability to execute.The company also is ranked ahead of Amazon, The Trade Desk and Verizon for market vision. Overall, MediaMath attained the highest upper right composite score for market leadership and vision.As the company continues to roll out SOURCE, this Gartner Magic Quadrant assessment should provide an extra tailwind, as it transforms the digital advertising ecosystem. Safeguard has deployed $15.5 million in MediaMath, and we own 13.4% of the company.We have accomplished a lot under our new strategy, including streamlining our internal operations to reduce costs, repaying our debt and moving forward with strategic transactions involving our partner companies that have returned significant capital back to Safeguard, which has also allowed us to retire our debt and implement our return of capital program.We are pleased with what we have accomplished, but much work is left to be done. We continue to work with other partner companies on potential exits and hope to have more news to share in the coming months.On our last quarterly call we indicated that we were highly confident of additional exit activity in 2019. We were recently informed that the exit we were referring to is going to take longer than previously anticipated and the contemplated transaction will likely not occur by the end of the year. The delay was not due to company performance as the company is performing above plan and we hope to be in a position to provide further information in the near future.As I described above as additional equity from additional exits is returned to our balance sheet, we will return the excess to our shareholders as soon as practical in the form of repurchase and/or dividends. We believe that our partner company interests will continue to mature and attract strategic and financial buyer attention as we continue to explore the exit alternatives we referenced above.Now, I’ll turn the call over to Mark for a review of the quarter’s financial results.

[Mark Herndon:]

Thank you, Brian. Our third quarter resulted in a net loss of $2.5 million, or $0.12 per share on a basic and fully diluted basis as compared with net income of $32.1 million, or $1.56 per share for the same quarter of 2018. Our year-to-date results are net income of $55.3 million, or $2.68 per share on a basic and fully diluted basis as compared with net income of $1 million, or $0.05 per share for the same 9 month period in 2018.Our third quarter results were highlighted by continued reductions in general and administrative costs as compared to prior periods the full repayment of our prior credit facility and non-cash gains resulting from certain equity holdings. Our year-to-date results also benefited from the second quarter’s $50 million gain from the transaction as well as the first quarter’s $34.9 million gain from the Propeller transaction.Safeguard’s cash, cash equivalents, restricted cash and securities at September 30, 2019, totaled $45.6 million compared to $46.2 million at 2018’s year-end. In July, we made a final principal and interest repayment of $49.5 million to repay our debt facility in full, which relieves us of our prior restriction from repurchasing shares or declaring dividends. As we indicated the board has now declared a $1 per share special dividend for shareholders of record at December 23, 2019.In regards to the taxability of this special dividend, we have recently completed an analysis of the cumulative and year-to-date earnings and profits. As a result of that analysis we believe that the special dividend will be characterized as a return of capital for federal tax purposes. However, I should emphasize that the final determination of this characterization can only be made once the calendar year is complete. There remains the possibility of additional transactions including possible transactions involving our partner companies that could impact this determination.Our third quarter’s general and administrative expenses were $2.3 million compared to $3.5 million for the same quarter of 2018. This lower level of general and administrative expenses is primarily the result of the absence of the $1 million severance charge in the prior third quarter as well as the lower overall level of staffing, lower office rent costs and lower professional fees.Our general and administrative expenses for the 9 months ended September 30, 2019, were $7.9 million as compared to $14.3 million for the comparable 2018 period. Similarly the lower level of year-to-date general and administrative expenses is primarily the result of the absence in 2019 of the $3.8 million severance charge that was taken in 2018 as well as the lower professional fees incurred in 2019.Corporate expenses, which exclude interest, depreciation, severance stock-based compensation and other non-recurring items were $1.9 million for the 3 months ended September 30, 2019, and $6 million for the 2019 year-to-date period. These amounts are lower than the $2.2 million and $8 million in the 3 and 9 months ended September 30, 2018 due primarily to the lower level of staffing and related office costs. We continue to believe that corporate costs for 2019 will be at or below the low end of the previously stated $8 million to $9 million target that was announced in early 2018. We are pleased about the reduced level of spending in 2019 and we will continue to work towards continuing to decrease costs where possible.With respect to our partner company holdings, we have 15 partner companies representing an aggregate cost of $206.1 million and having a carrying value of $62.8 million at September 30, 2019. During the third quarter, we deployed $3.8 million of capital to 4 existing partner companies. The most individually significant being a $2 million deployment to Syapse and a $1.5 million deployment to Aktana. Subsequent to the quarter, we also deployed an additional $1.75 million to Moxe.As a result, our year-to-date deployments aggregate to $16.3 million. While we may make a couple of small follow-ons during the remainder of Q4, we do not expect any further material deployments during 2019. Going forward, we continue to expect our level of annual follow-on deployments will diminish and we will look to selectively deploy relatively small additional amounts into certain of our partner companies to maintain our position of influence if we continue to believe in their long-term prospects.For the 3 months ended September 30, 2019, other income or loss improved $9.9 million as compared to the comparable 2018 quarter. 2019 included $4.1 million of income related to the decrease in the fair value of the credit facility repayment feature liability and an aggregate of $4.3 million gain for the increase in the value of 3 non-partner company equity securities based on observable price changes.I should also note that each of these other income items were non-cash. Interest expense increased $2.5 million during the quarter primarily due to [Maycol] [ph] interest payments related to the credit facility. As we’ve previously disclosed the last payment included a $4.1 million [Maycol] [ph] interest and $0.9 million of accrued interest. Additionally for the 3 months ended September 30, 2019, we realized $1.8 million of equity income gains on proceeds received from the amounts – from amounts held – previously withheld from prior exit transactions.And finally, for the 3 months ended September 30, 2019, our share of the losses of our equity method partner companies was $6.3 million as compared to $11.2 million for the comparable prior period in 2018. Our share of the losses from equity method partner companies for the 9 month period ended September 30, 2019, were $21.9 million as compared to $37.9 million for the comparable prior period.These reductions are the result of less companies in the portfolio and more companies reducing their burn rate and trending toward cash flow breakeven. In terms of revenue guidance, we have lowered our projected range of aggregate partner company revenue for 2019 to between $355 million and $370 million for the 15 remaining partner companies. That would represent a growth rate of between 7% and 12% for the same partner companies in 2018. Excluding our digital media companies, the revenue of Safeguard’s portfolio of partner companies is growing at more than 50% in aggregate year-over-year.I should also remind everyone that Safeguard reports the revenue of its equity and cost method partner companies on a 1-quarter-lag basis.Now, we’re back to Brian.

[Brian Sisko:]

Thank you. Operator, why don’t we open up the lines for any questions.

[Operator:]

[Operator Instructions] Your first question comes from the line of Bob Labick with CJS Securities. Your line is open.

[Brian Sisko:]

Good morning, Bob.

[Peter Lukas:]

Hi, good morning. Hi, good morning. It’s Pete Lukas again for Bob. How are you?

[Brian Sisko:]

Good.

[Peter Lukas:]

Just a question on how you decided on the dividend versus repurchase, looking at your stock saying that the company value and cash are – exceed the share price, how you make that decision, then how you think about that decision going forward?

[Brian Sisko:]

Yeah, so, Pete, look, I think it’s fair to – it’s fairly obvious that whenever we’re making these decisions and when we have excess capital, it’s a combination of a lot of different factors that we take into account. I think what drove the decision here was the opportunity that we had to make this a return of capital dividend to be as straightforward as I can about it.

[Peter Lukas:]

Got you. And then, I guess, you pretty much answered everything. The only other one is in your overall timeline on the wind down, everything is still as you’ve talked about in the past there?

[Brian Sisko:]

Yeah, no changes. We’re still within the timeframes that we believe it will apply and we continue to proceed along that path. So, yeah, I think that’s the correct assessment.

[Peter Lukas:]

And then, last one for me, in terms of funding for the partner companies, you said you expected that to be down next year. Any sense on the – or diminished next year – any sense on the magnitude of that reduction?

[Mark Herndon:]

Sure. Yeah, in terms of funding for next year, we would expect it to diminish significantly from 2019 and 2018’s levels.

[Brian Sisko:]

We’ll be hopefully providing a little bit better guidance when we get into the 2020 first quarter assessment and earnings call, Pete.

[Peter Lukas:]

Great. Thank you.

[Operator:]

Your next question comes from the line of Jim MacDonald from First Analysis. Your line is open.

[James MacDonald:]

Good morning, guys.

[Brian Sisko:]

Hi, Jim.

[James MacDonald:]

On the exit activity, you say you expect something in the next couple months, but you are not highly confident anymore. Maybe a little more color on that?

[Brian Sisko:]

We’re confident of continuing exit activity, obviously. But I just wanted to make sure that we clarified the expectation that we had set last quarter, because the specific transaction that we were highly confident of occurring in this timeframe is pushed off a little bit. But we would certainly expect that transaction to occur. So I’m not concerned about the situation. I’m just cognizant of the fact that we had said in the second – or in the fourth quarter, the year we expected it to occur.

[James MacDonald:]

We also have the MediaMath option coming up here, so any thoughts on that? And I assume MediaMath’s been affected by the softness in the digital marketing area. Any thoughts on how that might affect exit at MediaMath?

[Brian Sisko:]

Well, the MediaMath option expired. They did not exercise it. And I think that what I’d propose is important to remind everyone of regarding MediaMath is now they are one of only two scaled independent demand-side platforms left in the marketplace. dataxu got bought by Roku in a transaction.They were like the third player arguably and were probably considered sub-scale. They were attractive at some level, because of their OTT and video. But they were not a complete package like a MediaMath or a Trade Desk. So I think that only means good things for MediaMath. And I know that there has been whisper in the market as to what the multiples were in that dataxu transaction and I heard 4X to 5X.If that is correct, and I’m not in possession of any particular information regarding that transaction that anyone else isn’t. But if that is the right number that is a number that would not be inappropriate to apply to figure out what MediaMath value is.

[James MacDonald:]

Okay. And maybe talk a little bit about how you determine $25 million as the cash you need to have on hand. It was a little bit lower than we had expected you would’ve picked.

[Brian Sisko:]

Well, I’m glad we didn’t disappoint you in that regard. We certainly don’t want to keep excess capital when we don’t need it. There’s no point to that. But we’re also trying to be careful and make sure that we don’t get ourselves in some sort of cash bind that we don’t need to get ourselves into.So it’s just some aggregate operating expenses plus some expected follow-on is really how you get there. I mean, there is – it’s not magic. And we would expect that to go down over time, as we continue on through the strategy obviously. But at the moment the Board is comfortable with that kind of number, that kind of range, to keep available to us.

[James MacDonald:]

And just sort of two somewhat technical ones. Do you expect the partner losses to remain? Do you think the $6.3 million for this quarter is approximately where that will remain or hopefully maybe diminish over time as the companies progress?And the second quick one is, what’s your view on further escrow prospects? Do you see any order of magnitude of how much escrow you might achieve from previous transactions?

[Mark Herndon:]

Sure, I can address those for you. In regards to the equity method losses across 15 different companies, as you might expect, there is some level of volatility in seeing their results. But we would expect some level of consistency, as we continue to decline, as we continue to shrink the size of the portfolio.So again, so to the extent that there are less companies in it, then that would be a factor. And if we continue to see companies trending closer to a breakeven for their own results, as they mature and develop, that would also be a factor toward reducing it. So it is a difficult number to predict going forward, but I do see a favorable trend line in that so far.In regards to escrows, there are a variety of companies of prior transactions that have escrows outstanding. And so, we may see some relatively small activity coming through the next few quarters related to that, but it would not be dramatic results to our financial statements.

[Brian Sisko:]

The trend in most of these transactions we’re doing these days, it seems that – escrows are going down in the amounts. So the amounts reserved – or the amounts held back in transactions that was typically larger back in the day. Things are being dealt with through rep and warranty insurance and things like that. So those numbers will tend to be small going forward, I think.

[James MacDonald:]

Okay. Thanks a lot guys.

[Operator:]

Your next question comes from the line of Joshua Horowitz with Palm Global. Your line is open.

[Brian Sisko:]

Hey, Josh.

[Joshua Horowitz:]

Hi, Brian. Hi, Mark. Hope you’re both well. Couple of questions, back in August, when you announced earnings, you said that you continue to believe the current value of the portfolio interest and cash exceed the current share price. At that time the share price was around $11.50. Do you still feel the same way today?

[Brian Sisko:]

Yeah, I think we said that in the scripted comments, but I’ll repeat myself that. Yeah, no matter how we look at it we believe that’s the case.

[Joshua Horowitz:]

Great. Any color on which of the board members might be stepping down and why that’s going to happen at the next annual meeting versus end of the year or just any color around that?

[Brian Sisko:]

Well, the board will go through the normal formal corporate governance process to name those people. And I’m told I need to be careful, because of the proxy solicitation rules that we need to be cognizant of, and that mentioning names is jumping the gun insofar as proxy solicitation. So I can’t say specifically. But you can probably think through how that will play out. But formal decisions will be made in the normal course of our preparation for that meeting.

[Joshua Horowitz:]

That’s fair. On SG&A going forward as we shed assets is there any way to think about additional SG&A cuts? We have 15 companies today. If we have – I’m making up a number – 9 by this time next year what is our SG&A?

[Mark Herndon:]

Right. So it wouldn’t necessarily be linear based on the number of companies. But we do expect that cost reductions will continue and, in particular, as the overall size of the portfolio decreases and exits occur, we will continue to reduce costs.

[Joshua Horowitz:]

Great. Thank you both. I appreciate your time.

[Brian Sisko:]

Thanks, Joshua.

[Mark Herndon:]

Thank you.

[Operator:]

[Operator Instructions] Your next question comes from the line of Ron Mass with Almitas Capital. Your line is open.

[Brian Sisko:]

Good morning.

[Ronald Mass:]

Yes. Good morning. You talked about the cash distribution versus buying shares back. And I appreciate that the dividend will be a return of capital versus taxable. But can you tell us whether you feel like you could have been buying shares in the open market? Given potential transactions in place would you have been restricted from buying shares back? Or could you have if you wanted to could you have made the decision to buy back shares in lieu of paying this dividend?

[Brian Sisko:]

I think that the right answer there is we’re always at risk of being limited in what we can do because of material non-public information that we have. So read into that what you will. The other part of that answer is probably that open market purchases for us are difficult, because we don’t have a lot of volume in the stock too. So it’s not necessarily the most efficient way to do that. But those things as well as tender offers for stock, et cetera, will always be something that we’re considering as we have that excess capital bucket to deliver out to you guys.

[Ronald Mass:]

Can you give us a sense for to do – be able to do tender offers, what position you would need to be in, in a sales process of a company not to be in kind of a blackout period with material non-public information? I mean, if could you have done a tender during this current period? Or do you feel that that would have been giving you of a sale? We’ve been talking about this in progress. Would that have impeded your ability to do a tender offer?

[Brian Sisko:]

I really have to be careful here, Ron, with what I say about what we could have or should have done and how it relates to what material non-public information we have, because by saying something I sort of can give away the cat. So I have to punt on that.

[Ronald Mass:]

And can you give us a sense of the company that you’re in the sales process of, can you give us any general sense of the type of size of realization whether this would be a relatively small one or a larger one in the context of the market value of the company?

[Brian Sisko:]

Let me answer more generically that the specific reference that we made did have to do with one company. But at any given time, we’ve got any number of companies that are either quote/unquote in process or having some level of dialogue with potential interested acquirers. This just happened to be a situation that was staring us in the face that circumstances changed a bit. But I’d be remiss, if I tried to put this into a bucket of size. So I can’t really answer with any level of certainty or granularity for you there.

[Ronald Mass:]

Okay. And also can you comment on when you said, you believe that the current stock price is substantially below your estimate of value, can you shed any additional light on how you look at the value or any type of metrics or numbers or any approximation of what where you see the intrinsic value of the company?

[Brian Sisko:]

Well, we’re not at – we’re not able to put dollars and cents to that to give you an answer. But what I would tell you that the way we look at value is in a number of different ways. We can look at the current value of each of the enterprises as evidenced by their most recent funding round by applying comparables to their performance metrics and coming up with a specific number. And we also look at our expected exit values for these companies and what the discounted value would be at present of those anticipated exit values. And that’s what I meant when I said no matter how we look at it, we believe that there is a significant delta. I think, if you look at the information that was included at the back of the press release, you’ll also get some further idea of the things you’re asking about.

[Ronald Mass:]

Okay. Great. Thank you very much.

[Mark Herndon:]

Yeah, I’ll just add that the back of that press release that referenced the cost that the company has invested in the partner companies is approximately $206 million, and then you add on top of that where we stand today with the cash of the $45 million. So that alone is a substantial value when you look us as the company with 0 debt.

[Ronald Mass:]

Okay. Thank you.

[Operator:]

Your next question comes from the line of Jim MacDonald with First Analysis. Your line is open.

[James MacDonald:]

Yeah. I thought, I’d just follow-up with a question about the 3 most recent financings. Could you characterize at all the sort of type of financing for Syapse, Aktana and Moxe Health? I mean, are they just support growth or cover losses? What are your thoughts on those?

[Brian Sisko:]

Those are all absolutely growth support transactions, full stop, yeah.

[James MacDonald:]

Okay. And any update on Prognos? I hear they’re progressing well.

[Brian Sisko:]

Prognos is doing very well. Yeah, their commercial traction and their partnership development continues to be very pleasing to us. Sundeep is doing a – has been doing and continues to do a fabulous job there. Yeah, nothing but good things to say about Prognos.

[James MacDonald:]

Okay. Thanks very much.

[Operator:]

There are no further questions at this time. I’ll now turn the call back over to the presenters.

[Brian Sisko:]

Well, thank you very much. We have a lot of work ahead of us to bring this strategy to conclusion. We’ll keep you all apprised of our progress as best we can on an ongoing basis. In the meantime, thank you very much for your continued interest and support, and your confidence in us here at Safeguard.

[Operator:]

This concludes today’s conference call. You may now disconnect.