Safeguard Scientifics, Inc.
Q2 2018 Earnings Call Transcript

Published: 26 Jul 2018

[Operator:]

Good morning, and welcome to Safeguard Scientifics Second Quarter 2018 Financial Results Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to 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' second quarter 2018 financial results. Joining me on today's call and webcast are Brian Sisko, Safeguard's President and CEO, and Dave Kille, Senior Vice President and CFO. During today's call, Brian will provide a corporate strategic update and review recent highlights including developments of Safeguard and our partner companies, and Dave will discuss Safeguard's financial strategies and results. 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 distribution to our shareholders, the ongoing support of our existing partner companies, the fact that our partner companies may vary from period-to-period, challenges to achieving liquidity from our partner company holdings, fluctuations in market prices of any other publicly traded 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 Act of 1940 and risks associated with our partner companies including the fact that most of our companies have a limited history and the history of operating losses, face intense competition, may never be profitable, the effect of economic conditions in the business sectors in which they operate and other uncertainties described in our filings with the SEC. Many of these factors are both beyond the company's ability to predict or control. As a result of these 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 our filings with the SEC, including our Form 10-K, which describe in detail the risks and uncertainties associated with our business. The company does not assume any obligation to update forward-looking statements made today. With that, here is Brian.

[Brian Sisko:]

Thanks, John. Good morning, and thank you for joining us. As my first quarterly call as CEO of safeguard, I've contributed to our reporting this goes over my 11-year tenure here and I am excited by the opportunity to lead Safeguard at such a pivotal point for the company and to speak to you on behalf of the company for the first time. Since we announced our new strategy in January, we've made substantial intangible progress, executing against our new strategy. Since the end of the first quarter, we realized proceeds of $66.5 million for monetization events involving three partner companies

[Dave Kille:]

Thanks, Brian. For today's call, I will provide an update on our partner company holdings, highlights of our second quarter results and a summary of our cash and debt balances. First our partner company holdings. At June 30, we had 23 partner companies with an aggregate cost of $293 million and a carrying value of $106 million. Average capital deployed in our partner companies at June 30 was $12.7 million, and the weighted length of time that Safeguard has been a shareholder in those companies is 5 years. During the second quarter, we deployed $4.2 million of capital in 7 existing partner companies bringing the year-to-date total of follow-on funding through June 30 to $8.2 million. We expect to deploy an additional $10 million to $14 million of follow-on capital to existing companies during the remainder of 2018. Financial results for the second quarter reflect a $4.2 million gain from the exit of Cask. Results for the 6 months ended June 30 include a $9.5 million gain related to the Nexxt prepayment of their note and a $3.8 million gain on the merger of Spongecell and the Flashtalking, both of which were recognized during the first quarter. Gains related to the partial exit of MediaMath and the exit of AHS will be recognized in our third quarter results. Results for the second quarter also include a $6.6 million impairment charge related to the full write-off of the carrying value of partner company Apprenda. Apprenda recently decided to wind down its operations. Safeguard had deployed $22.1 million in growth capital in Apprenda since 2013, and we held a 29% primary ownership stake. For the second quarter, corporate expenses excluding interest, depreciation, severance and stock-based compensation were $3 million compared with $3.9 million in the second quarter of 2017. For the 6 months ended June 30, these same expenses were $7.2 million compared with $8.8 million in 2017. As a result of the company's recently announced strategic shift and management changes, we expect to reduce annualized expenses, excluding severance, interest and stock-based compensation, to a range of $8 million to $9 million. Staff reductions announced in January and April resulted in an aggregate severance charge of $3.6 million, of which $1.1 million was recognized in the first quarter and $1.7 million was recognized in the second quarter. The remaining severance charge will be recognized during the second half of the year. Safeguard's cash, cash equivalents and marketable securities at June 30, 2018, totaled $26.7 million, compared to $25.2 million at year-end 2017. Subsequent to the end of the second quarter, we received aggregate proceeds of $55 million from the partial exit of MediaMath and the exit of AHS. In May 2018, we amended the terms and borrowing limit of our credit facility with HPS Investment Partners. The borrowing capacity of our secured credit facility was increased from $75 million to $100 million. On the amendment date, we borrowed an incremental $35 million in addition to the $50 million that was previously outstanding, resulting and $85 million outstanding as of June 30, 2018. Available borrowing capacity under the credit facility stands at $50 million as a revolver that expires on December 30, 2018. Proceeds from the incremental borrowing and cash on hand were used to repay in full $41 million of convertible senior debentures under maturity date of May 15, 2018. For the first time in over 20 years, Safeguard has no convertible debentures outstanding. The amendments to the credit facility did not change the interest rate or the maturity date of May 2020. Early repayment terms under the amended credit facility include a make-whole interest provision equal to the interest that would have been payable had the principal amount subject to repayment, been outstanding through the maturity date of the amended credit facility. If the aggregate amount of the company is cash, cash equivalents and marketable securities at any quarter end date exceeds $50 million, the company will be required to repay outstanding principal amounts under the credit facility, plus any accrued or make-whole interest in an amount equal to 100% of such excess. With the $55 million of proceeds received in the third quarter from the transactions involving MediaMath and AHS, we anticipate repaying a portion of our outstanding debt during the fourth quarter. Certain debt covenants were modified in connection with amending the credit facility. The company is no longer required to maintain a specific net worth or any diversification or concentration requirements with respect to capital deployments to its partner companies. New debt covenants were added that established limits on follow-on funding and adjusted annual operating expenses. The company is currently in compliance with all of its debt covenants. Additionally, the company is restricted from repurchasing shares of its outstanding stock and/or issuing dividends until such time as the amended credit facility is repaid in full. Now, here's Brian to lead us through the Q&A segment of the call.

[David Langsam:]

Thanks, Dave. Operator, you can open the lines for any questions, please.

[Operator:]

[Operator Instructions]. And your first question here comes from Robert Labick from CJS Securities.

[Peter Lukas:]

It's actually Pete Lukas for Bob. Just a couple of questions for you. One for AHS. You've owned that for a while, just wondering what changed in terms of having you sell it now. And for Cask, were you guys involved in the decision to sell to a strategic buyer? Or was that decision made by management?

[Brian Sisko:]

Let me -- I'll answer your first -- your last question first just because -- in every case, Pete, we're on the board of all these companies, so no decisions are made by the management teams in a vacuum. The Cask sale to a strategic buyer was a collective decision made. It was a decision between do we re-up and everybody contribute a bunch more capital and go out and raise some third-party capital and continue to plow forward, or do we run a process and try to find a buyer for the business at its present state. And the collective wisdom was to sell the company, and we were able to structure that in a fashion through continuing support through that sale process in a fashion that results have been us getting -- returning our capital, which is the right decision to do there. Great team, great technology, but it was going to need a lot more capital, and that was the right decision to make there for everybody around the table, I think.

[Dave Kille:]

And on AHS question, nothing really changed, Pete. And I have to have to make some decision. We have to make some decisions going forward to manage this portfolio as a whole. And I have to -- sometimes, you have to sacrifice something to bring some cash back to the balance sheet. I had an opportunity to close a transaction that was a friendly transaction with our existing investors around the table, provided us a clear pathway to returning our capital there. In a perfect world, I might not have wanted to do it right now, but the opportunity was there, and it was a transaction that got structured in a fashion that'll allow me to be very comfortable with that decision.

[Peter Lukas:]

And can you expand a little bit on how you came up with the valuation for MediaMath assuming that was probably tied into their financing that they did and your expectations on them exercising the option on the other 10.9%?

[Brian Sisko:]

So regarding the money that we took off the table with MediaMath, it wasn't linked at all to their financing. What was linked to their financing was the availability of capital for them to be able to undertake a transaction. And as you well know and everybody else on the phone all knows, there are multitude of factors that play into the pricing of a transaction including but not limited to liquidity discounts et cetera, et cetera. So it would be fair to say that our board with the help of outside advisors reached a conclusion regarding the appropriateness of the value that we got back for that initial stake when we took that into account in connection with our overall needs to run the company and manage our cash. Doing that transaction has a lot of ancillary benefits for us. If I compare that to when I -- maybe could've gotten it if I went out and sold that interest in the secondary market, I came outright in the same place, and we ultimately did not have to pay bankrupt fees, et cetera. So that's how we approach that. Your other question...

[Peter Lukas:]

The expectation on them exercising the option on the other 10.9%.

[Brian Sisko:]

Well, I'd hate to put any words in their mouth, but I've -- They're going through a cash management exercise. So they have availability from their financing that, that board has to manage through. When are they going to use their capital to do so they have pipeline of acquisition opportunities, which were -- they're analyzing and negotiating. So the availability of $12.5 million to either repurchase our stake or enter into another transaction, maybe that's the math that they'll do, and I do expect them because it is a good transaction for MediaMath to reacquire the rest of that stake if you take a long-term view of that company. But I can't guarantee it. And it really is all about them allocating their available capital to either buy companies or buy our interest back.

[Peter Lukas:]

Great. Just two more quick ones for me. Anything you can say to update us on the numbers of companies in the portfolio currently in the sale process. I know you did update us as to them changing categories and that maybe you can say on a number of exits, where you are in the sale process and exits you would anticipate for the remainder of the year?

[Brian Sisko:]

So what I would point out to you, Bob, I'd start by pointing out that what we've done so far under this new strategy and characterize those, how those events whether they were in process or out of process. There was no process for AHS. There was a process for Cask. There wasn't a process for MediaMath. So by me trying to characterize what's in process, what's not in process, probably doesn't lead you to any better understanding about what your expectation should be. I would tell you that if you look at the revenue stages of our companies, you've got such a significant number of companies that are in that $5 million above category. And probably, if John and I sat down, John, Dave and I sat down and rejiggered that -- those categories to include a $10 million up category, you'd have a significant amount in the $10 million up category which is probably in the M&A market, the real relevant number to be looking at. And when companies hit that point, whether you're running a process or not, there's dialogues being had with these -- by these companies with potential acquirers who reach out either through bankers or directly, sometimes their customers, sometimes their competitors, and sometimes they're just strategics that through Safeguard's work, through the companies management work, bankers had become -- those companies should become visible to bankers, because they've achieve such a significant level of market penetration. And so I think rather than saying who's in sales process, I would point you to that the category of revenue stage, because conversations are always ongoing. That being said, there are a couple of companies that are in a more formal process, but I've learned not to try to predict timing. Remember Putney, we were in a process with that company for over a year, by own results in great sales but everybody kept asking about what's the status of the process, which made it sound like it was failing. But it takes a while sometimes and I think it's fair to predict that's what's going to happen across the board here.

[Peter Lukas:]

Thanks. And last one for me. Assuming the sale of MediaMath, can you just remind us of how much NOL value you would have left and need to -- what you need to do to preserve that?

[Brian Sisko:]

I'm going to pass it to Dave to talk about that.

[Dave Kille:]

Sure. So as of December 31, 2017, we had approximately $250 million of NOLs. And I estimate that after the MediaMath transaction, with some other offsetting transaction for this year, we are about that same level currently. We do have an NOL Poison, our best tax benefit plan in place that protects the NOLs against any -- so that they can be utilized against any taxable income as we monetized the portfolio moving forward. That plan thus allow shareholders to submit some waiver request if they're interested in doing that, and our board can consider that at the time.

[Operator:]

[Operator Instructions]. Your next question comes from Jim MacDonald with First Analysis.

[James MacDonald:]

Can someone talk a little bit more about Apprenda. I mean that was a promising company in the expansion stage, so maybe a little bit more on why they decided to shut down?

[Brian Sisko:]

Yes. We are in the venture business. We have to always acknowledge that. And I'm -- I think it's fair to say that we're just as disappointed as you are that we ultimately weren't successful with Apprenda. It is pretty unusual for a company to gain the level of traction that Apprenda did, and they'll ultimately not successfully market itself for exit. One point, there were some very significant players who were more than sniffing around the process that was being run around Apprenda. But ultimately, I think, and I'm not a technologist, I'm not going to get into the kind of level of detail that others might be able to regarding whether the market has the technology, but I think there were some of that going on here. I think Sinclair Schuller did a great job, but he didn't ultimately get the company to a sale point. So I don't know else to say other than the decision around the table around between ignition partner and NEA and us. It was the right decision because this company would have needed to develop -- to continue to develop technology and try to catch back up, I guess, was significant. The collective view around the table that it wasn't appropriate to plow more capital into this opportunity. I hope that's at least as helpful as possible in what is acknowledged by us as a disappointing outcome there.

[James MacDonald:]

Yes. Just maybe just one follow-up and that's the -- is there any chance that someone buys the pieces at some point? Or is it -- there's no chance of that now?

[Brian Sisko:]

No, no. The reality of the situation is that there's $6 million of debt financing that was in place and we -- I can't imagine a circumstance for the technology ends up getting sold for a number that it would be anything materially above that. Now I could be completely wrong, but it's not going to be material to us given that we don't own the whole remainder. So I'm not going to set expectations. There is a possibility of some amount, but nothing that I would suggest anybody pay any time trying to figure out.

[James MacDonald:]

Okay. Then moving on, so you've obviously pared down the portfolio a little bit here. What is sort of -- just can you give us any overall view of your targeted return for the remaining portfolio? I mean, as you put capital into these companies, what kind of return you expect to achieve all that kind of stuff?

[Brian Sisko:]

I'm going to punt in some part to future conversation, Jim, but I will say that we continue to standby what we said in the past, that our aggregate expectations are what they have there. Nothing's changed. When we put capital work in these new companies, we're going through the same rigor that we went through previously. Obviously over time, as things go -- fall out of the portfolio or sold out the portfolio, I should say, ultimately, there's a different math that gets done than the math that applies when we were building a portfolio. But we're going to -- John and Dave and I acknowledge that we need to spend time figuring out how best to communicate expectations going forward, but we're not there yet. So I'm going to punt that through a future date.

[James MacDonald:]

Okay. And then just a couple technical things. I appreciate the update on the debt and all that stuff that they went through. But I think I heard at the end that you can't buy back any shares or pay any dividends until the debt is repaid, so maybe you could talk a little bit about your -- please confirm whether that's true and if you could talk about when you think -- what's going to be our use of proceeds and maybe when you'll be able to repay the debt?

[Brian Sisko:]

Well, we tied to our overall hesitancy ever try to predict the timing of outcomes, et cetera, that obviously impacts that question. We do have, as I think Dave stated in his portion of the scripted stage of this call, we have a requirement under the debt facility to repay when at any quarter end we have over $50 million. So we'll be repaying debt starting in the fourth quarter -- I mean, repaying principal, okay? That process will continue as more capital is brought back to the balance sheet and at any other subsequent quarter end where we once again about $50 million will be paying that debt down. As you would expect in a situation like we're in where we have an existing portfolio that's securing the debt and that the debt is on the top of the capital stock, one of the things that we asked to when we amended the debt facility was to agree that weren't -- we couldn't go take capital and start paying -- or start repurchasing shares or dividend out cash, and so we paid the debt off. I mean that's pretty standard operating procedure especially in a circumstance like we find ourselves. So we'll continue to try to be as transparent as we can regarding what that timing is. But don't -- I wouldn't expect from us some grand disclosure next quarter or the following one that on such a day, we expect to be able to start delivering cash out. We do have an ultimate repayment obligation date on the debt, which we expect to honor and be able to live up to, and obviously at that time, we will be free to do what we want with our excess cash.

[Operator:]

And your next question comes of the line of Joe from Stifel.

[Joseph Pratt:]

Question on the status of the NOL pill. Any chance we could see that go away that would facilitate existing 5% owners to accumulate more and encourage new buyers to come in for whom a 5% position would be way too small?

[Dave Kille:]

Well, Joe, I think as we responded to your question at the annual meeting, I'll respond the same way that our board can do -- can change things at any time in real-time. There's no current conversation being had nor does there seem to be any color of conversation that would lead me to conclude that anyone on this phone should expect that NOL pill to be eradicated. It was put in place for a very important reason and while it can be argued as to how far away from a trigger point we might be and whether there's the need for it, the pill is going to remain in place I think is the assumption that everyone that's around the table should make. That being said as I think Dave reference in his earlier comments, there is a provision that allows for companies to request waivers, and our board has indicated, in my conversations with them, a willingness to engage in those conversations as long as it doesn't put the company in a position where it's risking NOL off. So since there is room, I'm not looking to create an open invitation of any sort other the one that already exist, which is there is provision for people to reach out to us and have a discussion about their desires and intentions.

[Operator:]

[Operator Instructions]. Your next question comes from [indiscernible].

[Unidentified Analyst:]

Congrats on the monetizations. Just a quick one on the debt covenants. I believe there was a debt covenant that had -- you had to have at least $350 million in cash plus, I guess, appraised value. Are you still above that threshold? And do you anticipate after paying some of the debt down that you're still be above that threshold?

[Dave Kille:]

Absolutely. Just to put that in context. You got $350 million minimum value and you can picture that you don't set a covenant in a fashion on either side of the transaction that is close to the line. So there is a significant buffer built into any covenant including, but not limited to that covenant obviously. So to state the obvious, the covenant is set at a level that we're extremely comfortable with. Number two, you take into account the nature of the beast here, and when HPS does its analysis it's a very conservative analysis. So the numbers that they're using to create what we'll call that minimum value is an extremely conservative view of the value of the portfolio. So we have no qualms at all, and we obviously didn't have any qualms about keeping that into the mix as one of the covenants -- or one of the only covenants that's left under the facility. So if there's anything that keeps Dave and I up at night it's certainly not worrying about that.

[Operator:]

And there are no further questions at this time. I will turn the call back over to Mr. Brian Sisko for closing remarks.

[Brian Sisko:]

I appreciate it. Thank you all for joining us for the quarterly update. I look forward to future calls. Before we do sign off, I do want to remind you that during the quarter, the Safeguard Board of Directors added two independent directors, Russell Glass and Ira Lubert. They were recommended by institutional investor Sierra Group. Mr. Glass and Mr. Lubert join Maureen Morrison, John Roberts and Bob Rosenthal on our board. Now the Safeguard board is comprised exclusively of independent members and has been reduced to five members from seven in prior years. We do want to thank the former directors Julie Dobson, Steve Fisher, George MacKenzie, and Steve Zarrilli for their years and years of service. We look forward to working with the new board as we continue to execute this new strategy designed to maximize shareholder value. We will keep you all apprise of our progress and in the meantime, thank you for your continued interest, confidence and support. Thank you very much.

[Operator:]

And ladies and gentlemen, this concludes today's conference call. You may now disconnect.