Safeguard Scientifics, Inc.
Q4 2017 Earnings Call Transcript

Published: 1 Mar 2018

[Operator:]

Good morning, and welcome to Safeguard Scientifics' Fourth Quarter and Full Year 2017 Financial Results Conference Call. 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'. Joining me on today on the conference 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 recent highlights, 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. Our forward-looking statements are subject to risks and uncertainties. The risks and uncertainties that could cause actual results to differ materially include, among others, our ability to make good decisions about the monetization of our partner companies for maximum value or at all and distributions to our shareholders, the ongoing support of our existing partners companies, the fact that our partner companies may vary from period to period, challenges to achieving liquidity from our partner company holdings, fluctuations in the market prices of our publicly traded partner company holdings, competition, our ability to attract and retain qualified employees, market valuations in sectors in which our partner companies operate, our inability to control our partner companies, our need to manage our assets to avoid registration under the Investment Company Act of 1940, and risks associated with our partner companies, including the fact that most of our partner companies have a limited history and a history of operating losses, face intense competition and may never be profitable, the effect of economic conditions in the business sectors in which Safeguard's partner companies operate, and other uncertainties described in our filings with the SEC. Many of these factors are beyond the company's ability to predict or control. As a result of these and other factors, the company's past financial performance should not be relied on as an indication of future performance. During the course of today's call, words such as expect, anticipate, 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 and thank you for joining us. As you know, we have been busy over the past month communicating Safeguard's new strategy following the Board's approval of a go forward plan to operate the business and pursue opportunities to enhance shareholder value, which Safeguard embarked on at the beginning of this year. I intend to spend much of my portion of the call discussing this new strategy. I'll then turn the call over to Jeff, who will discuss our fiscal Q4 performance. Finally, we will then open the call for questions, during which time, I'm happy to reflect further on the fourth quarter and full 2017 financial results. Safeguard began 2018 by opening a new chapter in the company's 65-year history. After an extensive review of strategic options with financial and legal advisors, the Safeguard board authorized to shifting its business strategy and operations. Under this new strategy, Safeguard will not deploy any capital into new partner company opportunities and will focus on

[Jeff McGroarty:]

Thanks, Steve. At December 31, 2017 we had 25 partnered companies. The cost of our interest from those companies was $320.5 million and the carrying value was a $129.8 million. Average capital deployed in our partner companies at December 31, 2017 was $12.8 million. The weighted average length of time that Safeguard has been a shareholder in those companies is 4.6 years. 10 of the 25 companies have been a Safeguard partner company for three years or less. During the fourth quarter, we deployed $9.1 million of capital into 9 existing partner companies. For the year we deployed $36.8 million in follow-on capital to 18 partner companies. We expect to deploy $15 million to $20 million in additional follow-on capital to partner companies in 2018. As Steve mentioned earlier, we will no longer deploy capital into new companies. As of December 31, 2017, [indiscernible] Safeguard's position and initial revenues stage the partner company full measure recognizing a $7 million impairment charge. This was based on Safeguard's decision not to continue to deploy follow-on capital into the company in the absence of significant capital being raised from new investors. During the year, we sold our interest in Nexxt, Inc., formerly known as Beyond.com for $26 million. We received an initial $15.5 million of cash along with a three-year $10.5 million term loan which is in fully reserved on a balance sheet. Subsequent to year-end, Nexxt repaid the term loan in full resulting in an aggregate cash on cash return of 1.9 times. We will recognize a gain in the first quarter on this repayment. Subsequent to the close of the year, digital advertising partner companies Spongecell merged into privately held Flashtalking in which Safeguard now holds a 10% equity interest. As of December 31, 2017, our NOL balance was $253 million. We plan to use these NOL carry forward to offset taxes on expected capital gains on exit transactions. Under the new tax reform, all NOL's generated in 2017 and prior maybe utilize to offset 100% of federal taxable income with no alternative minimum tax. These NOL's retain their 20 year carry forward period. The earliest any of our existing NOL's expire is 2021. NOL's generated in 2018 and forward will be limited to 80% of federal taxable income and we have an indefinite carry forward period. Safeguard cash, cash equivalents and marketable securities at December 31st, total $25.2 million compare to $37.7 million at year-end 2016. The carrying value of outstanding debt was $85.8 million at December 31, 2017. Safeguard has $41 million of convertible notes, which come due in May of this year. We expect to refinance or repay the converts utilizing available cash, proceeds from exits and availability under the $75 million senior secured credit facility. Continued compliance with the covenants under our senior secured credit facility will be depended upon the achievement of profit generating exits in the near-term. During the fourth quarter, corporate expenses excluding interest depreciation severance and stock-based compensation expense where $3.3 million. For the year, those expenses totaled $15.1 million compared to $15.2 million in 2016. As a result of the company's recently announced strategy shift, it includes initiatives to reduce any ISE [ph] expenses by $5 million to $6 million, we expect corporate expenses excluding interest depreciation severance, stock-based compensation expense and unusual items for 2018 will range from $10 million to $11 million. Staff reductions associated with these initiatives are expected to result in severance expense of $1.3 million which will be recognized in the first quarter of 2018 and paid over approximately 12 months. Aggregate partner company revenue for 2018 is projected to be between $475 million and $500 million, which includes revenue for all partner companies in which Safeguard had an interest at January 1, 2018. Aggregate revenue for the same partnered companies was $410 million for 2017, and $344 million for 2016. Aggregate revenue or all years reflects the pro forma combined revenue of Flashtalking and Spongecell due to the recent merger. Aggregate revenue for all years reflects revenue on a net basis. Revenue data for certain partnered companies pretend the 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 across its partnered companies on a one quarter lag basis. Now, here Steve to lead to 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] Your first question comes from the line of Bob Labick from CJS Securities. Your line is open.

[Bob Labick:]

Good morning.

[Steve Zarrilli:]

Good morning, Bob.

[Bob Labick:]

Hi, I just wanted to start kind of where you just finished off in terms of getting an update on the convert and refinancing for that. Do you have enough liquidity in hand now to be able to refinance or do you, will this require an exit reasonably sized exit before May? And just kind of the plans you have in place and to play that out?

[Steve Zarrilli:]

Sure, Bob. Our plans are that the we should have enough liquidity between cash available today, the cash we received just recently from the repayment of the next note receivable in conjunction with the few other transactions that we expect will take place between now and May 15. And we do have $25 million available under the credit facility. So, our goal is to repay that. And it might require some additional borrowing under the HPS facility.

[Bob Labick:]

Okay, great. Got it. And then, can you talk about the embedded value of the holdings. I know when the HPS facility was put in place or I believe when it was put in place that you had a third party go out and compute the value of your holdings. Can you talk a little about maybe what is changed since then, and how it's played out versus your original expectations?

[Steve Zarrilli:]

Sure. Yeah, we have kind of a roll forward of that valuation, we haven't gone out and had another party valuation done. But we've had some exits like Beyond now Nexxt since that time. We've had a few impairments, but we've also had some additional deployments and we've had as Steve alluded to in his prepared comments, we had a few companies that raise capital at up rounds that give us further indication that the value of those companies has increased. So, when we add all that activity together and roll that forward, the net is we're still well above the covenant that was set.

[Bob Labick:]

Okay, great. And then maybe last for me. Just if you could give and you talked about it obviously little bit, but an update on MediaMath and how they're doing operationally looking at their I guess closest peers that are public. But you just done the stocks have been performing very well recently. So just wondering to see how their operations are going and what more you can tell us about them. And then potentially if you know if they're looking to raise financing this year that you could participate in?

[Steve Zarrilli:]

So, two important points related to MediaMath. As you alluded to Bob, their public competitors have announced very strong results for 2017 and are bullish for 2018. And the trade that can particularly had a substantial rise in its shared value in the last couple of weeks because of that guidance. MediaMath have seen the same thing, they are bullish and confident. They are continuing to grow revenues at a substantial pace, they're producing profits on a cash flow basis, they are considering ways in which to further capitalize the company for further growth that may also include acquired growth that they find the right opportunities. They've recognized that we would like to have an opportunity to exit. We have been in contact with them very frequently as you can imagine, since we announced our new strategy and are working collaboratively with them in a manner to hopefully find that type of exit that we are looking for and have been talking about for quite some time. But as we are waiting and orchestrating some of those activities the good news is MediaMath continues to grow in value and that’s been a good thing for our shareholders and I don’t expect anything different in 2018.

[Bob Labick:]

Okay, super. Thank you very much.

[Operator:]

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

[Jim MacDonald:]

Hi, good morning, guys. You talked about, so you have three people managing investments now, how about director’s seats which were spread amongst a number of people of those change over or will some of your former partners continue in those roles?

[Steve Zarrilli:]

No Bob -- I mean Jim, good morning. No, those changes have already been made, so take 25 company divided by three, its roughly eight companies per single executive that is that’s involved here, so that’s pretty rational number and obviously that number will decrease as companies are monetized. So, the Board changes have been made and the three executes are squarely engaged in those companies, the transition was seamless, our departing colleagues were very instrumental in having time and working with us to make sure that those transitions happened appropriately.

[Jim MacDonald:]

Right. And moving on to Flashtalking, could you tell us a little bit more about that transaction, it sounds like you just took stock, no other consideration, but I am not sure about that and it seems like Flashtalking might have been about double the size or Spongecell, is that, about right?

[Steve Zarrilli:]

So, we're really excited about that transaction. Flashtalking was probably about three times the size of Spongecell to be honest, and maybe even a little bit larger, it’s a company that's majority owned by TA, a private equity firm. It is company that has been growing substantially itself. This merger puts the assets of Spongecell into a platform that I think when combined will give Flashtalking a really legitimate opportunity to find some strategic alternatives for itself over the next 18 months or so. So, we have a legitimate opportunity in stock here to have a substantial return on our Spongecell investment and we think that the leadership of Flashtalking, which now includes some of the management personnel of Spongecell has the right game plan and DNA in order to really achieve some terrific results in the market.

[Jim MacDonald:]

Great, and I have several technical questions. So, you wrote off full measure, was that done in the quarter I mean because your partner losses didn't seem to be that much higher to include the $7 million loss

[Steve Zarrilli:]

Yeah, Jim that was a decision that was made in conjunction with the year-end results being closed and there were some transactions that offset that. As I mentioned, we had a couple companies that raised money at up rounds and in those transactions we put in a little bit less than our pro rata and the accounting for those transactions is that you'll recognize a gain or loss on your change in interest when that happens and because these were up rounds we had gains on Prognose, Syapse that combined offset the impact of the loss that you referred to with full measure.

[Jim MacDonald:]

Thanks for that explanations. And then, by my calculation, so you said that 2017 partner revenue grew 23%, so under the old list of companies that mean it was about $360 million, so in the range maybe at the low end of the range you had projected?

[Steve Zarrilli:]

Yes, exactly $360 million right at the lower end of the range.

[Jim MacDonald:]

Okay. And then one more for me, so NovaSom you have been it looks like spoon-feeding every quarter, can you give us an update on that investment?

[Steve Zarrilli:]

Company that still continues to grow, but is still looking for a longer-term capital solution, leadership is intact and has actually been strengthened recently with some additions and we’re continuing to work with our fellow capital partners to find the right capital for NovaSom and then ultimately the right opportunity for an exit of our interest.

[Jim MacDonald:]

And I guess, the slip in one market, congratulations by the way on having five companies sort of promoted this quarter. Any others you expect to be promoted maybe in 2018?

[Steve Zarrilli:]

Sure. And for others on the call, when we talk about the company being promoted or graduating from one stage to another, remember we categorize our companies in three different stages, initial revenue which is up to $5 million, expansion which are companies doing $5 million to $20 million in revenue and high traction companies which are doing $20 million and greater. Those companies that moved into a higher stage in 2017 included a Aktana, Quantic Mine, Syapse, Lumesis and Flashtalking, via the Spongecell merger is now high traction company. The ones that I, keep an eye on for 2018 that we think could move from the initial revenue stage to the expansion stage are three healthcare companies, meQuilibrium, Trice Medical and Propeller, I think those are the most likely and you will see there could be others that could move up, but those are the ones I would highlight today.

[Jim MacDonald:]

Great, thanks.

[Operator:]

[Operator Instructions] Your next question comes from the line of Joe [ph] from Stifel. Your line is open.

[Unidentified Analyst:]

Hi, Steve, good morning. You enacted the 382 and I wondered what your calculation was of over the past three years what percentage of your 5% holders had raise their holdings.

[Steve Zarrilli:]

I’ll let Jeff, to answer that question.

[Jeff McGroarty:]

Yeah, this is something we have, we continue to monitor for many years we have been analysis updated and look at that ownership change, we don't disclose what the amount is, but it is something that we monitor and particularly in light of the change in our strategy in the potential for shareholder and ownership changes.

[Unidentified Analyst:]

Okay, because, I mean you don’t really need it, if you're getting close to 50% because in effect it is a poison pill on 5% holders accumulating in lighting more, correct?

[Steve Zarrilli:]

Obviously there is always a risk and the board made the right decision to approve that preservation plan and as we pointed out we have almost bought a little over $250 million of tax NOLs and for the shareholders to get the returns that we think we’re going to be able to deliver, it’s important that the entirety of that NOL is utilized to remove the vast majority of any double taxation that would occur in the ultimate monetization and distribution of these proceeds to shareholders.

[Unidentified Analyst:]

But your 5% holders are your big holders are almost the most they are obviously big institutions, the other ones, mostly likely to buy substantial amounts of new stock and now because of this mood they had been precluded, am I correct on that.

[Steve Zarrilli:]

Yes.

[Unidentified Analyst:]

Thank you for answering the questions.

[Steve Zarrilli:]

You’re welcome.

[Operator:]

[Operator Instructions] Your next question comes from Lee [ph] from Baird. Your line is open.

[Unidentified Analyst:]

Hi, Steve.

[Steve Zarrilli:]

Good morning.

[Unidentified Analyst:]

In relations of the [indiscernible], I would hope that you could change it or not put it in a way that it precludes people from buying more than 5% but preserves the tax loss carryforward?

[Steve Zarrilli:]

Well, Lee - the plan does provide management, I mean not management the board with the ability to provide exemptions as appropriate. So, there’s -- so as and as documented in the plan so there's opportunity if it presents itself in those opportunities are presented to the company for consideration.

[Unidentified Analyst:]

It doesn't seem like it's in my shareholder interest. I appreciate that you guys are liquidating. The market is not treating you fairly. But I do think that that was not my shareholder interest. And I want to make sure you guys know that.

[Steve Zarrilli:]

Thank you.

[Unidentified Analyst:]

Bye-bye.

[Operator:]

There are no further questions. I now turn the call back over to Mr. Zarrilli.

[Steve Zarrilli:]

Thank you. So, much work lies ahead for the Safeguard team as we execute a new transforming strategy designed to maximize shareholder value. I think we've been able to give you some sense of where that value is currently being built and the progress that we're making. We will keep you apprised of our progress. And in the meantime, thank you for your continued interest, confidence and support on Safeguard.

[Operator:]

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