Safeguard Scientifics, Inc.
Q1 2018 Earnings Call Transcript

Published: 26 Apr 2018

[Operator:]

Good morning. And welcome to Safeguard Scientifics' First Quarter 2018 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' first quarter 2018 financial results. Joining me on today's call and webcast are Steve Zarrilli, Safeguard's President and CEO; Brian Sisko, Safeguard’s Executive Vice President, Managing Director and COO; and Jeff McGroarty, Safeguard's Senior Vice President and CFO. During today's call, Steve will provide an update on the strategy, developments in the business, and Brian will review recent highlights, as well as other developments at Safeguard and our partner companies. And Jeff will discuss Safeguard's financial results and strategies. After that, we will open it up to 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 any 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 SEC filings. 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. With that here is Steve.

[Steve Zarrilli:]

Thanks, John. Good morning, and thank you for joining us. I’d like to begin by addressing our recently announced management changes, which were made to further align the Company with its new strategy and to reduce operating costs. As announced on April 6, 2018, I will be stepping down as President and CEO, effective July 1, and will retire from the Company on September 30th. I will also not stand for reelection to the Board of Directors at our 2018 Annual Meeting of shareholders. The Company's EVP, Managing Director and Chief Operating Officer, Brian Sisko, who many of you have interacted with over the years at our various investor Day events, has been selected to succeed me as Safeguards next President and CEO. The Board and I believe Brian is the right leader for the Company as we continue to execute on our new strategy. He has an intimate knowledge of our partner companies and possesses the appropriate merger and acquisitions, corporate finance, general management and operational skills to lead the Company through a successful completion of the new strategy. Brian and I worked together for nearly a decade at Safeguard and together we developed the current roster of partner companies. This will be a seamless transition for our partner companies, employees, shareholders and other stakeholders. Also, as previously announced, Dave Kille, our Corporate Controller will become CFO on June 1st. Dave will succeed Jeff McGroarty, who has served Safeguard effectively for 12 years. Dave has the experience and skills necessary to fulfill the responsibilities of CFO for the Company. These organizational changes were contemplated as a part of the original construct of our current strategy. We have been aggressively looking for ways to continue to reduce cost, while ensuring appropriate resources are in place to execute on the strategy. Jeff and I purposely removed ourselves from this organization, recognizing that a leaner and more cost efficient organizational structure and management team are critical to the Company's plan to maximize the amount of distributions to our shareholders. We are confident the reconfigured management team is in the best interest of the Company and all of its shareholders. Now, turning to our business. Over the past three months, the Safeguard team has made significant progress transforming the Company into a leaner and more agile organization, and continuing to provide meaningful support to our partner companies. Their success will be our success. Though, we are in the early stages of implementing our new strategy, we believe that our focus and efforts will continue to deliver results as we work towards the following core strategic objectives; creating value in each of Safeguard’s current 25 growth stage partner companies; and seeking meaningful well-timed risk-adjusted exit for our interest in these businesses to allow for the distribution of net proceeds to our shareholders. We have committed to distributing the proceeds from these monetizations, net of debt obligations and working capital needs, to Safeguard’s shareholders through a process that could involve special dividend payments and other distribution methods. Now, let me turn it over to Brian to provide you with some more specifics regarding activities related to our partner companies.

[Brian Sisko:]

Thanks Steve. I appreciate the confidence you and the board have placed in me to execute the strategy we announced in January. The rest of the go forward management team and I are committed to successfully delivering against the strategy. Our partner companies continue to grow, gain market share and create value. You’ll recall that Safeguard categorizes partner companies in the three revenue stages; initial revenue stage, where companies expecting to generate annualized revenue up to $5 million; expansion stage, where companies with expected annualized revenues ranging between $5 million to $20 million; and high traction stage, for companies with anticipated annualized revenues of $20 million or more. During the 2017 calendar year, five partner companies increased their revenues and mature their operations enough to advance to new revenue stages in our classification system. We believe that at least three additional partner companies are on track to advance from initial two expansion stage during 2018. This allocates consistent with Safeguard’s guidance for annual aggregate partner company revenue, which is projected to be between $475 million and $500 million compared to revenue of $410 million in 2017. These figures include revenues for all partner companies in which Safeguard had an interest at January 1, 2018. I would note that the aggregate revenue figure referenced for all years reflect the pro forma combined revenue of Flashtalking and Spongecell due to their recent merger. We are at a point with our current group of partner companies where we anticipate relatively small amount of required follow-on support capital from Safeguard. Our partner companies will continue to become more self-reliant going forward. Most of our partner companies are not expected to meet substantial amounts of follow-on capital from Safeguard between now and their projected exit. Regarding our plans for pursuing monetizations. As we've done in the past and we’ll continue to continue to do moving forward, we will always be actively considering our options to monetize our stakes in our partner companies, whether through secondary sales of those interests or M&A transactions concerning the partner companies themselves. The management teams of many of our partner companies are working with us to identify and pursue possible transactions to allow us to exit our ownership interests in those companies based on current valuations of those businesses even though the businesses may not be pursuing outright exit transactions. These efforts and initiatives will continue to benefit us as we pursue the basic tenants of the new strategy. We are committed to continuing to support our partner companies’ needs and we will continue to work to leverage our capital and relevant operating expertise to help them achieve additional market penetration, revenue growth, cash flow improvement and increased value. While we estimate that the timetable for completion of the monetization and distribution processes could take three to five years, we remain encouraged today by the market interest in the Safeguard portfolio. We are and will remain mindful of the benefits we can achieve if our efforts can facilitate quicker exit results at fair valuations. With respect to our largest partner company, MediaMath, we continue to work to find meaningful pathway to a partial or full monetization of our interest. We are working with the management team of MediaMath to find such alternatives. We are open to all potential alternative structures, but we will only proceed with a transaction that provides our shareholders with a fair value for our interest in MediaMath. As you know, MediaMath is an advertising and marketing technology leader with revenues growing substantially year-over-year at rates greater than 20%. Found in 2007, MediaMath is cash flow positive and is expanding its domestic and international operations, both organically and through acquisitions. Safeguard has deployed $25.5 million in capital to MediaMath since 2009 and we hold 20.5% primary ownership position in that company. At March 31, 2018, our carrying value for MediaMath was $3.5 million. MediaMath is operating in an attractive and growing space, and its publicly traded competitors are reporting and projecting solid growth and profitability. The Trade Desk is the largest competitor in MediaMath peer group with a market capitalization of more than $2 billion. Equity Analyst estimate Trade Desk revenue will grow more than 20% per year through 2019 with operating margins in excess of 30%. Enterprise value in relation to revenue for the Trade Desk range from about 3.0x to 4.0x. Clearly, monetization efforts related to our equity holdings are the principal significant focal points for our new strategy. But cost and operational efficiency, including the streamlining of our organizational structure, is also a critical element to ensure the successful execution of the plan. As we announced in January, our initial staff cuts and expense cuts were expected to reduce annual operating expenses to approximately $10 million to $11 million. The latest expense reduction initiatives, including the management changes that Steve referred to earlier, are expected to trim Safeguard’s annual operating expenses to approximately $8 million to $9 million, excluding interest, depreciation, severance and stock-based compensation. For both 2016 and 2017, annual operating expenses were slightly more than $15 million. Going forward, as assets are monetized, we do expect some additional reductions in this annual operating cost structure. Now, I’ll turn the call over to Jeff for a review of the quarter's financial results.

[Jeff McGroarty:]

Thanks, Brian. At March 31, 2018, we had 25 partner companies with an aggregate cost of $324.7 million and a carrying value of $127.6 million. Average capital deployed in our partner companies was $13 million as of March 31. The weighted average length of time that Safeguard has been a shareholder in those companies is 4.9 years. Eight of the 25 companies have been a Safeguard partner companies for three years or less. During the first quarter, we deployed $4 million of capital in seven existing partner companies. We expect to deploy $10 million to $15 million in additional follow-on capital to partner companies during the remainder of 2018. In 2017, we sold our interest in Next Inc., formerly known as Beyond.com for $26 million. We received an initial cash payment of $15.5 million dollars, as well as a three year $10.5 million term note, which had been fully reserved on our balance sheet. In the first quarter, Next repaid the principal balance in full resulting in an aggregate cash on cash return of 1.9 times. For the three months ended March 31st, our net loss was $6.2 million or $0.30 per share compared with a net loss of $22.1 million or $1.08 per share for the same period of 2017. Results for the quarter reflect $9.5 million gain on the Next note repayment and $4 million gain on the merger of Spongecell into Flashtalking. During the first quarter, corporate expenses were $4.1 million, excluding interest, depreciation, severance and stock-based compensation compared with $4.8 million in the same period last year. As result of the Company's recently announced strategy shift and management changes, we expect to reduce annualized corporate expenses to a range of $8 million to $9 million. Staff reductions announced in January resulted in a severance charge of $1.3 million, which was recognized in the first quarter. Additional severance charges totaling $2.5 million are expected to be recognized during the second quarter and third quarter. Safeguard’s cash, cash equivalents and marketable securities at March 31, 2018 totaled $34.3 million compared to $25.2 million at year end 2017. The carrying value of outstanding debt was $86.6 million at March 31st. Safeguard has $41 million of convertible notes that mature in May. We expect to repay the converts utilizing cash on hand and availability under our senior secured credit facility. Now, here is Steve to lead us through the Q&A segment of the call.

[Steve Zarrilli:]

Thanks, Jeff. Before we open the call to questions and answer portion of the call, I would like to briefly address the agreement we reached with Sierra Capital earlier this week. As you may have seen, we announced the addition of two new independent directors Russell Glass and Ira Lubert to the Safeguard board, the settlement agreement is a constructive step forward for the Company, and one that demonstrate Safeguard's willingness and desire to engage with the shareholders for the benefit of all of our stakeholders. The Board looks forward to welcoming Russell and Ira to the Safeguard Board and drawing from their valuable expertise as we continue to execute on a transformative strategy. The new board consisting of five independent directors expected to be elected at our Annual Meeting also illustrates yet another step forward in the overall cost reduction of our business. This conference call will be the last for Jeff and me, as we move forward, we both do so with the belief that the foundation has been laid for success in the next chapter in Safeguard's history. While adopting this strategy was truly one of the toughest recommendations and decisions we have ever made due to the impacts on Safeguard’s employees and Safeguard’s standing in the entrepreneurial ecosystem, I firmly believe that the strategic shift, we are executing is in the best interest of the Company shareholders and that it will maximize shareholder value. Until I leave the Company, I intend to work every day to deliver on that promise of this new transforming strategy. Thank you for the honor and privilege of leading this organization. I have thoroughly enjoyed working with the Board of Safeguard, the Company's talented and dedicated staff, our partner companies and with all of our shareholders and covering analysts. Before opening the call to your questions, I want to remind you that the purpose of today's conference call is to discuss our first quarter results and current strategy. I do not intend to answer any questions related to the recently announced settlement with Sierra. Our public disclosures on this matter, I believe are sufficient at this time. So with that operator, let's open the phones for any questions.

[Operator:]

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

[Charles Strauzer:]

It’s Charles Strauzer for Bob. Couple of things, I mean you talked about the timeline to exit the landscape now. What has changed since the last call to your optimism on that front?

[Steve Zarrilli:]

Charlie, this Steve and I’ll let Brian also speak to this in a moment. I think we’re continuing to see A, the growth in these companies so they are continuing to evolve in a way that we would hope. The market is very strong today. Companies are looking for strategic opportunities to grow their businesses. And I think our companies, as I have said in the past, are interesting targets for many of these other growing enterprises. So as you may recall, strategic acquisition or the acquiring of these businesses by a strategic partner is our most ideal exit pathway. And with those factors, I think that there is a real opportunity to continue to see movement and momentum as it relates to the monetization of these businesses. Brian, would you like to add anything?

[Brian Sisko:]

I guess, I would just add that the portfolio in the overall has reached a stage where these companies are past the one or zero stage in large part. And they’re all growing healthy businesses, not necessarily ones that we can push out the door immediately but ones that are tracking along the path that you want your companies to be tracking along to an eventual exit opportunity.

[Charles Strauzer:]

And then on MediaMath, you talked about that the cash flow positive. Do they have the additional capital that would allow for the next round of financing as an exit for you guys?

[Steve Zarrilli:]

The capital that MediaMath might seek in the marketplace is really to recap part of the business to allow for certain shareholders to exit like Safeguard, and to continue the scale of business. They are producing substantial cash flow today, but they also have ambitions to grow the business on a consistent basis as they have in the past to remain competitive in the marketplace. And I believe that as they continue to mature, as you would expect of a company of their size that they are going to look for alternate ways in which to capitalize that business in order to take advantage of market opportunities. I believe if you were to ask management at this time of MediaMath, they would also suggest that there is potentially some consolidation opportunities in the market that they may want to take advantage of if they were to have more capital in order to do so.

[Charles Strauzer:]

And then switching gears to the financing and with that to next month, you talked about using cash on hand for the credit facility. What are the other options that you may have available for you?

[Jeff McGroarty:]

We’ve been talking to some of the existing convert holders, as well as our senior lenders, about the options available to us to repay the existing convert. Those discussions have been ongoing for a while and continue. So we can't really say much more at this point in time. And as always, we’re always looking for the potential for exit to provide additional cash to take down that debt balance.

[Charles Strauzer:]

And then lastly just when you look at the total overhead expense and factoring in the interest expense once you do some refi or anything associated with that. What would total overhead might look like?

[Steve Zarrilli:]

Well, as we have said, the corporate expense, excluding depreciation, severance and non-cash items, will be going from about $15 million to the $8 million to $9 million range just based on the current changes that we've made. And then looking forward, I would expect that there wouldn’t be a significant change in the interest costs unless we were to have exit that allowed us to pay down that debt. But right now, we’re looking at about $90 million of debt that we have. We don’t expect that that would necessarily change as we look to refinance and repay these obligations.

[Operator:]

Your next question comes from [Joe Pratt] from Stifel. Your line is open.

[Unidentified Analyst:]

Most of my questions have been answered, just a quick question. How much is available on the line that you referred to?

[Jeff McGroarty:]

25 million.

[Operator:]

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

[Steve Zarrilli:]

Thank you all for joining us today. We look forward to continuing to update you on the progress against this strategy. And as we look to transfer responsibilities over to the new management team, they will continue to practice good transparency with our shareholders as it relates to keeping them apprised of our success and progress. Thank you.

[Operator:]

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