Safeguard Scientifics, Inc.
Q3 2017 Earnings Call Transcript

Published: 26 Oct 2017

[Operator:]

Good morning, and welcome to Safeguard Scientifics' Third Quarter 2017 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to John Shave, Senior Vice President, Investor Relations and Corporate Communications. Please go ahead.

[John Shave:]

Good morning, and thank you for joining us for this update on Safeguard Scientifics' third quarter 2017 financial results. Joining me on today's call and webcast are Steve Zarrilli, Safeguard's President and CEO; and Jeff McGroarty, Safeguard's Senior Vice President and CFO. During today's call, Steve will review highlights of the quarter, as well as other developments at Safeguard and our partner companies. Then Jeff will discuss Safeguard's financial results and strategies. After that, we will open the lines to take your questions. As always, today's presentation includes forward-looking statements. Reliance on forward-looking statements involves certain risks and uncertainties, including, but not limited to, the uncertainty of future performance of our partner companies, the risks associated with our acquisition or disposition of interest in partner companies, risks associated with our decisions about the deployment of capital and the effect of regulatory and economic conditions generally and other uncertainties that are described in our SEC filings. During the course of today's call, words such as expect, anticipate, expect, believe and intend will be used in our discussion of goals or events in the future. Management cannot provide any assurance that future results will be as described in our forward-looking statements. We encourage you to read Safeguard's filings with the SEC, including our Form 10-K, which describe in detail the risks and uncertainties associated with managing our business. The company does not assume any obligation to update any forward-looking statements made today. Now here is Safeguard's President and CEO, Steve Zarrilli.

[Steve Zarrilli:]

Thanks, John, and good morning everyone, and thank you for joining us today for an update on Safeguard and our partner companies. Recently we held an Investor Luncheon in New York City during which we provided an update on Safeguard and our companies. Three of our partner companies, Clutch Holdings, Transactis and Trice Medical also presented. A replay of this meeting is available on our website at IR.safeguard.com. The information in our presentation today is comparable to the information we shared two weeks ago. However it's now updated through September 30, 2017. Our partner companies achievements continue to support Safeguard's primary strategic objectives of executing exit transactions and driving shareholder value. The majority of Safeguard's 26 partner companies remain on track to meet or exceed their developmental goals for the year. In turn, we now expect aggregate partner company revenue for 2017 to increase approximately 25% to between 360 million and 370 million. However the company's pace of exit transactions in 2017 has not as of yet met our expectations. During the nine months ended September 30, we realized $19.8 million from the sale of Safeguard's ownership interest in Nexxt, Inc., formerly known as Beyond.com and Good Start Genetics. The challenges of executing asset transactions are not exclusive to Safeguard. According to data compiled by PitchBook, the venture capital sector in 2017 is on track to experience the lowest exit levels since 2010. PitchBook analysis shows that privately held companies are seeing private longer and raising more funds rather than moving toward exit transactions or IPOs. Based upon the most current data available, the average time to exit stands at about six years and the median time to IPO now exceeds eight years. The number of U.S.-based exits have decline annually since 2004 according to PitchBook. Safeguard's outreach over the past 18 months to larger strategic and financial investors continues to elicit substantial interest in our portfolio. A significant number of our partner companies are actively exploring potential exit opportunities that we believe will generate meaningful returns to Safeguard. We remain energized by these prospects and confident in the abilities by our talented Safeguard team to execute. We also remain committed to achieve as soon as possible a partial or full monetization of our interest in MediaMath and an appropriate value. A variety of activities are underway in assessing potential alternative structures for such an exit. We regard these quarterly presentations as opportunities to remind our investors and ourselves what differentiates Safeguard from other publicly traded companies. Chief among our key differentiators is our disciplined execution of our business model, our strategic focus on promising growth stage businesses in select vertical markets and our strong alignment of management and shareholder interest. Safeguard's business model is to target growth stage technology driven enterprises that are developing business-to-business solutions in the healthcare, financial services, and digital media sectors where market opportunities are large and expanding. Technology drivers for us are always evolving as is the broad definition of technology itself. Presently these drivers include the Internet of Everything, enhanced security, and predictive analytics. We prefer significant minority equity positions in companies with among other features recurring revenue, minimal regulatory risk, and management teams who themselves hold significant but not controlling ownership positions. We generally deploy about $6 million initially with potentially an equal amount of follow-on capital as milestones are achieved. We deliberately limit total capital to anyone company to know more than approximately 25 million of capital. We believe that we can capture more value by focusing on developments of this size and are at a relatively early stage in a targets development. As these partner companies mature, we also deploy other forms of support personified by Safeguard's team members and their deep domain expertise and operating experience. Our capital and expertise help companies sharpen their business plans, commercialize their products and services and drive growth in operating earnings and revenue. Our goal is to realize value at the well-timed exit transactions that deliver aggregate cash-on-cash returns of at least two times. As I explained earlier, increasing the pace of portfolio monetizations and other accretive transactions is an important and essential goal of the Safeguard team. We believe our business model offers patient investors many reasons to put their capital to work in the company. Our strong stable of tech enabled partner companies is focused on dynamic, growing markets in healthcare financial services and digital media involving technology themes such as the Internet-of-Things, security and artificial intelligence. Our team brings to bear deep domain expertise and operating experience to support the growth of the portfolio. In addition the team is incentivized by appropriate compensation features that align our interest with shareholders to drive value. The accounting for our interest in our partner companies under the equity method of accounting results in a carrying value that does not necessarily reflect fair value. Carrying value of our aggregate partner company holdings is currently less than 50% of the original cost. Safeguard's balance sheet demonstrates financial strength and flexibility, our corporate structure is lean and not constrained by the typical limited partner fund structure. Our evergreen funding model is flexible, scalable and allows us to deploy capital across multiple stages of an enterprise's development. In short, we believe that Safeguard is well positioned to grow and deliver improved performance that enhances shareholder value. So with that, I'll turn the call over to Jeff for a review of the quarters financial results.

[Jeff McGroarty:]

Thanks Steve. At September 30, 2017 we had 26 partner companies. At the end of the third quarter the cost of our interest in these companies was $323.1 million and the carrying value was $133.9 million. Average capital deployed in our partner companies at September 30 was $12.4 million and the weighted average length of time that Safeguard has been a shareholder in those companies is 4.3 years. 11 of the 26 companies have been a Safeguard partner company for three years or less. This next slide takes the cost and carrying value of our partner companies and shows the pro forma value of those companies under two different assumptions. Our stated objective is to achieve a minimum two times aggregate cash on cash return on our deployments, that's inclusive of successful exits as well as write-offs. If we can achieve our target that $323 million that's been deployed in our 26 companies today could be worth $646 million compared to a carrying value of approximately $134 million. Alternatively our track record for new deployments since the beginning of 2006 for which we have exited in an aggregate cash and cash return of 1.55 times. At that return level, the $323 million currently deployed could be worth $485 million. This next slide provides the same data in graphical form. You can see the carrying value and cost compared to the pro forma values of our partner companies based on the historical track record and our goal of two times cash-on-cash returns. During the third quarter we [sort] our ownership interests in Good Start Genetics to Invitae Corporation in exchange for Invitae common stock. Based on the market price as of September 30, 2017 the initial stock received is valued at $3.9 million and additional shares held an escrow valued at $1.3 million. In other third quarter transactions, we deployed $7.1 million of capital in seven existing partner companies. Months ended September 30 we deployed $27.7 million in follow-on capital to 15 partner companies. We expect to deploy $10 million to $14 million in additional follow-on capital to our partner companies during the remainder of 2017. Safeguard's cash, cash equivalents and marketable securities at September 30 totaled $39.7 million compared to $37.7 million at year end 2016. The carrying value of our outstanding debt was $85.1 million at September 30, 2017. During the three months ended September 30, corporate expenses excluding depreciation and stock based compensation expense were $3.1 million versus $4 million in the same quarter forward 2016. For the nine months those expenses totaled $12.1 million compared to $12.6 million for the same period of 2016. We expect corporate expenses for 2017 will be approximately $16 million. Aggregate partner company revenue for 2017 has been revised to reflect the exit of Nexxt and Good Start Genetics and the write-off of Pneuron. We now project aggregate partner company revenue to be between $360 million and $370 million for 2017. Aggregate revenue for the same partner companies was $292 million for 2016 and $265 million for 2015. Aggregate revenue for all years reflects revenue on a net basis. Revenue data for certain partner companies pertain to periods prior to Safeguard's involvement with those companies and are based solely on information provided to Safeguard by those companies. Safeguard reports the revenue of its equity and cost method partner companies on a one quarter lag basis. Now here's Steve to lead us through the Q&A segment of the call.

[Steve Zarrilli:]

Thanks Jeff. Operator, let's open the phone lines for any questions.

[Operator:]

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

[Bob Labick:]

I just wanted to start - could we talk a little about - and you’re talking about the strong revenue growth from your partner companies, could you talk about the key drivers and the key contributors to that and then without penning you down to a specific number, talk about the outlook for next year if you expect those drivers and contributors to continue to show strong growth, please.

[Steve Zarrilli:]

So Bob as you would expect, this number generally is strong when the vast majority of the companies are performing well, and that's what we're seeing this year some of the smaller companies are growing at rates in excess of 50% of growth, but it's not lost and I saw also that this growth rate for 2017 is also reflective of the strong performance that MediaMath is having in the market. Last year it was a bit of an aberration in a number of ways and growth for these companies was less in the aggregate - less than 10% but I think if you look at 2018 and beyond, I think it's going to normalize back to what you should have expected to see historically from us which is on a regular basis we were seeing on an aggregate basis 20% to 30% revenue growth on an annual basis and I think we were able to sustain that going into 2018. Could it be a little bit stronger maybe, as some of these younger companies continue to mature and reach a point in their maturation which allows for some accelerated growth that could come into play. A lot will also be determined as to how well they transition in the next quarter or two from '17 into '18 but all indications thus far would lead us to believe that the '18 guidance that we would provide when we do so in March of 2018 should be as strong as the guidance that we’re providing today.

[Operator:]

[Operator Instructions] And your next question comes from the line of Jim MacDonald with First Analysis. Your line is open.

[Jim MacDonald:]

I hate to try to pen you down but any idea on timing of MediaMath's exit, is it possible it could still be in this year?

[Steve Zarrilli:]

Anything is possible and I got to tell you Jim, we are working very diligently to find a opportunity to monetize a part or all of our interest. I know that MediaMath is very cognizant of that fact as well, and as they continue to think about their future and growth needs and growth capital needs, they are clearly mindful of our desire to potentially exit this investment. And so there's a partnering that goes on in that process and we continue to explore other ways in which we might be able to unlock that value. We have probably no less than three or four different initiatives at any given time being considered as it relates to the MediaMath asset but we want to make sure that whatever we do, we’re not minimizing the ultimate result and we want to provide the value in that asset that the shareholders have expected.

[Jim MacDonald:]

Can you make any further comments on other exit kind of what level of activity you expect?

[Steve Zarrilli:]

I think the way we’re starting to build - about a third of our businesses are in some form of an active process and those processes can take some time as you know. I'll remind everyone on this call who may have been around about 18 months ago, it took a few more extra months for Patni to ultimately find an exit, but it ultimately resulted in a much better outcome and a stronger outcome for us. So we very diligently Jim are looking to help these management teams and their advisors position these assets for an exit with the third of the businesses in our portfolio actively looking to see what the market could offer them and that when I say actively meaning engage with advisors so they are working with them on their behalf. We are confident that 2018 is going to provide for a number of different opportunities for us to take advantage of. And so we still have two months on the clock here in 2017 and we even have a few months before we report in March of next year. So there's a fair amount that could happen between now and late February as we continue to work with these businesses.

[Jim MacDonald:]

I had a couple of technical ones so could you talk about your plans to monetize the Invitae stock that you got and also you mentioned sort of what I would consider a high level of follow-on activity for the fourth quarter of $10 million to $14 million maybe talk a little about that?

[Jeff McGroarty:]

Yes, let’s take both - so with regard to Invitae the investment policy that we have is that those assets when the lockup expires, we want to take advantage of monetizing our interest. So if you count six months from the date of that transaction in August, you’ll get a pretty good approximation of when that monetization will occur. I'm sorry the second question was with regard to?

[Jim MacDonald:]

Yes, the $10 million to $14 million follow-on that you expect?

[Jeff McGroarty:]

Yes, so the $10 million to $14 million of additional follow-on, the good news is most of these companies are now getting to a point of having what we consider to be fully funded business models. When we look at what's required in Q4 and then and as we provide guidance in March as to what we think is going to be required in 2018, you’re going to see that the tail is coming quickly and that it's pretty - it's fairly rational reasonable and small. So the amount of additional capital these companies need over the next 12 to 18 months is what we believe to be manageable, realistic and it keeps us generally within the construct of what we have been experiencing which is that the average deploy capital into anyone of these companies is somewhere between - call it $12 million and $15 million. And with the follow-ons that we’re pursuing today coupled with what we may have to provide in 2018, the vast majority of those companies will be within that range. There is a few outliers some of which have been around for a while obviously MediaMath we have about $25 million deployed into NovaSom and InfoBionic are at or closing in on $20 million, but the vast majority of the portfolio is at that midpoint of that range that I described or even a little bit less. So what that should tell you is if all of our attention right now is focused on exits and we’ll continue to be as we get into 2018 and you may have also inferred from the data that we’re also trying to manage our expense structure in a way that’s providing probably even some greater efficiency and you may see even better numbers in 2018. It really does kind of create the scenario that if we can start this wave of exits that the net inflow of cash into the business as we go forward will be pretty substantial in relationship to the required net outflow associated with this group of companies. Keep in mind, we set forth on this path about four years ago of enlarging the stable of partner companies, we went a little earlier in their lifecycles but we also went with a smaller initial checks and we're just now starting to see that maturation point come to grips and find the routine of that strategy beginning to reflect what we think will be the next evolution of its process which means let's get into the monetization mode.

[Operator:]

And your next question comes from the line of Sam Rebotsky from SER Asset Management. Your line is open.

[Sam Rebotsky:]

It was very positive the corporate luncheon that you put together, it was very helpful in knowing where you're going. As far as the corporate the convertibles that are due in May of 2018 do we believe that we will have a monetization transaction so that we don't have to raise additional funds to pay this off what's our thoughts on that event?

[Jeff McGroarty:]

Yes Sam our goal as Steve mentioned we’re working on a number of fronts to generate some exits including MediaMath and some of our other companies. So our goal would be to generate the proceeds from exits to pay up the converts, we do have the flexibility that if we had to refinance the portion of the convert out beyond our current credit facility that we could do that so that is always an option as well.

[Sam Rebotsky:]

But do you think that - something will happen before the amounts of money is due or we may have - I mean do we expect the transaction before that May period or is it too difficult to sort of predict at this moment?

[Jeff McGroarty:]

Exits are always difficult to predict with certainty but as we said that's been - our focus is generating some exits from our current portfolio.

[Steve Zarrilli:]

I just want to emphasize what Jeff has just that, we’re working very diligently to try to create some opportunity to generate monetizations that should give us the cash necessary to ultimately avoid having to reissue any convertible debt instruments.

[Operator:]

And your next question comes from the line of [Anthony Seaman] from Corporate Financial Advisors. Your line is open.

[Unidentified Analyst:]

I was wondering especially in the case of MediaMath how much in research and development hiring credits have you recouped from the federal and state governments?

[Jeff McGroarty:]

Yes, that's not something that we as a minority investor in MediaMath have the ability to get any credit in that way.

[Operator:]

And there no further questions at this time. I'll now turn the call back over to Steve Zarrilli for closing remarks.

[Steve Zarrilli:]

I just want to thank everyone for participating in today's call and just to repeat what we've shared with you today. All of our efforts focus and activities are revolving around our ability to get these companies to a state of maturity and position of exits so that we can begin to demonstrate the value that we have built into these companies and to realize that value for our shareholders. So thank you very much.

[Operator:]

And this concludes today's conference call. You may now disconnect.