Safeguard Scientifics, Inc.
Q2 2016 Earnings Call Transcript

Published: 30 Jul 2016

[Operator:]

Good morning, and welcome to Safeguard Scientifics' Second Quarter 2016 Financial Results Conference Call. All participants will be in a listen-only mode. After the speaker’s remarks, there will be a question-and-answer session. [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 Safeguard Scientifics’ second quarter 2016 conference call and webcast. Joining me on today’s call 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 from the second 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 involve 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, as well as the development of the healthcare and technology markets, and other uncertainties that are described in our SEC filings. 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 described 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’s Safeguard’s President and CEO, Steve Zarrilli.

[Steve Zarrilli:]

Thanks, John, and good morning and thank you all for joining us for an update on Safeguard and our partner companies. We had a solid second quarter in 2016 and as we enter the second half of 2016, Safeguard's 27 partner companies are well positioned for growth and value creation. We remain sharply focused on our core value creating strategies to deploy capital and operational support services to early- and growth-stage partner companies in targeted vertical markets, and to realize aggregate cash on cash returns of at least 2x on the 301 million of capital deployed in our 27 partner companies. We are not deterred by the ongoing political and economic uncertainties that have roiled global capital markets in 2016. Instead, we believe that the year's turbulence may generate opportunities for Safeguard as we work to expand our roster of partner companies, improve the pace of exit transactions, and evaluate potential new segments of the technology markets to deploy growth capital. However, we must also stay disciplined to the fundamentals of appropriate values and transaction structures. Based on signed term sheets and deal flow activity, we are working to increase Safeguard's current stable of 27 partner companies to between 30 and 32 by the end of 2016, inclusive of exits. During the second quarter, we led a $17.5 million financing of Aktana with a Safeguard commitment of 8.25 million and hold 23% primary ownership position. Aktana provides data-driven support for global life science sales teams and joins our roster of HealthTech partner companies. We continue to focus on mechanisms to drive profitable exits. Proceeds from exits replenish the company's cash balance, driving our evergreen business model. Safeguard realized a 3.9x cash on cash return during the second quarter from the sale of our 28% stake in Putney resulting in a gain of $55 million recorded in the second quarter. During the second quarter, we brought on new executive talent with Tina Aufiero who joined our deal team as Senior Vice President and Managing Director. Tina will be spending much of her time focused on financial service technology opportunities. We view this area as growing and substantial opportunity. Tina's 20-plus years of experience in principal investing, M&A and strategy will be an invaluable asset to Safeguard, as well as our current and prospective partner companies. Before joining safeguard, Tina was Managing Director and Head of Corporate Development for New York-based financial technology firm Tradeweb where she led several key acquisitions and inorganic growth initiatives. Previously, she served as Vice President of Principal Strategic Investing at Goldman Sachs where she led numerous investments in the financial technology sector as part of $1 billion portfolio. Earlier, Tina led M&A for Moneyline Telerate, which itself was acquired by Reuters in 2014. She is a CPA and earned a B.S. degree in economics from The Wharton School of the University of Pennsylvania and an M.B.A from UCLA Anderson School of Management. We are excited to have Tina on the Safeguard team and look forward to working with her to identify new opportunities and to advance our current partner companies towards successful exits to drive value for Safeguard shareholders. We are also selectively pursuing certain other potential new hires to augment our capabilities. I believe Tina's arrival reinforces our belief that our opportunities in our business model are attracted to highly qualified professionals. I’d like to turn the spotlight now onto one of our partner companies, Syapse, an initial revenue-stage HealthTech company in which Safeguard deployed 13.3 million of capital since 2014. Safeguard holds a 29% primary ownership position in Syapse. Syapse is driving healthcare transformation through precision medicine. The Syapse precision medicine platform is a comprehensive software suite designed for leading health systems to improve clinical outcomes, to streamline operations, and to shift to new payment models. Syapse client base is expanding rapidly, having added two major health systems, Catholic Health Initiatives and Henry Ford Health System during the second quarter. Syapse platform is drawing increasing national awareness through its launch of the Oncology Precision Network, a consortium of major healthcare providers in 11 states. OPeN is working to advance cancer care through data sharing and increased access to clinical trials for as many as 50,000 new patients per year when fully implemented. The network is an important facet of the White House Cancer Moonshot led by Vice President Joe Biden who has highlighted Syapse’s technology and leadership role in cancer data sharing in his remarks at a Cancer Moonshot Summit which was held last month in Washington, D.C. Syapse continues to make critical progress towards improving the treatment of cancer through precision medicine. Another partner company that I'd like to re-highlight this quarter is Transactis, a leading provider of electronic billing and payment solutions. There is a major transformation that's taking place in billings and payments and we believe Transactis is paving the way. During the second quarter, Transactis closed on a $30 million Series E financing. The valuation for Transactis in this Series E financing was three times that of the Series D financing with a post money valuation of 130 million. To-date, Transactis has raised $70 million. Safeguard along with five of the largest U.S. commercial banks; Capital One, Fifth Third, PNC, TD and Wells Fargo each deployed an equal amount into the company as part of this latest financing. Safeguard has deployed 14.5 million into Transactis since August of 2014 and maintains a 24% primary ownership position. Over the coming quarters, we expect to execute more transactions with improved consistency. Safeguard has realized 201.4 million in proceeds from seven profitable exits since late 2013. We continue to focus on ways to increase the frequency of exit transactions. We are energized by our progress to date in 2016, and enthusiastic about our prospects going forward. Safeguard remains well positioned in 2016 to grow our valuable portfolio of partner companies and to realize significant gains from an increased pace of exit transactions. Now, here is Jeff with an update on financial performance and metrics in the quarter.

[Jeff McGroarty:]

Thank you, Steve. At June 30, 2016, we had 27 partner companies. The cost of our interest in those companies was $301.2 million and the carrying value was $171.9 million. Early in the second quarter, we closed the previously announced sale of Putney to Dechra Pharmaceuticals for $200 million. As a result of the transaction, Safeguard realized $58.2 million in cash which represents 3.9 times cash on cash return and generated a book gain of $55 million. Quarterly results also reflect an impairment charge of $1.7 million related to AppFirst, a former partner company in which Safeguard had deployed $12.8 million since December 2012, and had a 34% primary ownership position. During the second quarter, AppFirst ceased operations and sold its technology returning $0.9 million of cash to Safeguard. We also sold our ownership interest in Bridgevine to existing investors and others for $5 million. Safeguard deployed $10 million in Bridgevine since 2007. The disposition of our Bridgevine holdings reflects our continuing emphasis on finding exit opportunities for our legacy partner companies. During the second quarter ended June 30, 2016, we deployed $8.8 million of capital in six existing partner companies, which includes $5 million into Transactis, as Steve referenced earlier. Corporate expenses, excluding interest, depreciation and stock-based compensation expense, were $4.3 million compared to $4 million for the same quarter of 2015. For the six months ended June 30, 2016 and 2015, corporate expenses were $8.6 million. We expect corporate expenses for 2016 to range between $16.5 million and $18 million. Safeguard's cash, cash equivalents and marketable securities at June 30 totaled $91.4 million and the carrying value of outstanding debt was $51.7 million. Our aggregate partner company revenue guidance for 2016 was revised during the second quarter to reflect the sales of Putney and Bridgevine and AppFirst cessation of operations. For 2016, aggregate partner company revenue is projected to be between $380 million and $400 million which includes revenue for all partner companies in which Safeguard had an interest at January 1, 2016 except for those three companies. Our aggregate revenue guidance represents 7% to 13% growth over 2015. Aggregate revenue for the same partner companies was $354 million for 2015 and $301 million for 2014. Aggregate revenue for all years reflects revenue on a net basis. Revenue data for certain partner companies pertains 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 companies on a one-quarter lag basis. Safeguard’s overall financial strength, flexibility and liquidity are evident in the company's balance sheet at June 30. 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]. Your first question comes from the line of Bob Labick with CJS Securities. Your line is now open.

[Bob Labick:]

Good morning.

[Steve Zarrilli:]

Good morning, Bob.

[Bob Labick:]

Hi. So just wanted to start, obviously Putney was a very successful exit and I was hoping maybe you can compare and contrast that with Bridgevine and AppFirst discussed in this quarter as well, and maybe talk a little bit about the lessons learnt from all three of those recent transactions?

[Steve Zarrilli:]

Sure, and it’s also important to keep in mind that as we talk about Putney and Bridgevine and AppFirst, we’ve actually had 12 exits over the last three and a half years since 2013. And of those, AppFirst is by far the largest loss that we had of $13 million or approximately thereabout. And Bridgevine was a recovery of capital for a company that predates all of us, but we felt that given its pending potential cash needs in the future, the ability to recover the capital that the carrying value which existed on our balance sheet was probably the most appropriate thing to do. From an AppFirst perspective, we had a company that had a relevant technology, it was just having substantial difficulty getting market traction of the rate that we expected. In fact, when we ultimately made the decision to begin the shutdown process of AppFirst, they still had a pipeline of opportunity that was being considered but we weren’t seeing it materialize quickly enough for us to feel as if we should be putting additional capital to work there. And when I look at the body of work and the body of exits over this last three and a half period of time, in addition to AppFirst and Bridgevine that we’ve talked about, we did have one other smaller write-off in [indiscernible] back in 2014 of 2 million. But we’ve also had eight other exits that have produced sizable returns, three of which you may recall were equal to or north of 4x. They were Putney, Crescendo and ThingWorx and the others being at least 2x or better. So on average, we’re still well within the guidelines that we consider to be appropriate. Write-offs are trending much below the averages that you would see in most venture platforms. We have tangible evidence that we’re able to produce more so than not exists that equal or exceed a 2x return, which gives us confidence in looking at the current portfolio of 27 companies and knowing that those partner companies have significant opportunity to produce returns for Safeguard shareholders. The other piece of good news is when we look across the complement of companies that we currently have today, there is nothing that is giving us significant heartburn or that is requiring substantial impairment charges to reduce carrying values to a lesser amount. But it was unfortunate with AppFirst. And the lesson learned there to answer your question, and I’m sorry for the longwinded answer, but the answer was that we probably needed to take away from that example the fact that if we don’t see the materialization of revenue as quickly as we originally anticipate, that we should not be afraid to step in and ultimately make some tough decisions, which we ultimately did with AppFirst.

[Bob Labick:]

Got it, that’s great. And you touched on kind of my follow up there too. And obviously you’ve discussed the goals of the two times aggregate returns and you’ve demonstrated it as well. And we can see from this in general, it’s not linear. So looking at your portfolio now and not naming names, obviously, do you think you have a handful of four-baggers and a handful of zero to one times in there? And if so, how do you – what’s the strategy with each and how do you think about fostering the four-baggers, selling them or riding them? And then the zero to ones, how long can you hold on, just your thought process around that on the portfolio?

[Steve Zarrilli:]

Well, I think we’ve been pretty consistent over a fairly long period of time of speaking to the fact that we believe in well-timed risk-adjusted returns and activities to produce those returns. So we don’t want to put ourselves in a position where we think we’re going to ride something longer than we need to in order to squeeze out some incremental additional profit. And we also realized that at times there’s going to be a need to recognize that you’re going to have to work through some challenging situations to get to the other side. We’ve had examples of both where we’ve been able to maximize returns for our shareholders. I know that memories tend to become short in these quarterly cycles that a lot of us live within, but we do think that the complement of companies that we have today, more than half of which have come onboard in less than three years’ time. If you think about it, back in late 2012 when I assumed the role of CEO, we had about 16 companies as part of the roster. Today, we’re north of 27. We’ve had exits of one form or another of 12 and we’ve added a number of companies. So the body of work would suggest that there’s still proof in the pudding here to be had that we need to demonstrate that the Putney return of 4x is not an anomaly and that we can continue to produce those. But just again as a reminder, we’ve had 4x exists in the last three and a half years, and I think that that’s a demonstration of our ability to continue to have those types of returns, which then gives us confidence that our aggregate cash on cash return target for this stable of companies is legitimate when we speak to a 2x number.

[Bob Labick:]

Great, all right. Thanks, Steve.

[Operator:]

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

[Jim Macdonald:]

Hi. Good morning, guys. Speaking of returns, can you give us an update on MediaMath? I see it was listed as a promising pre-IPO company. Any thoughts on what it takes to get there?

[Steve Zarrilli:]

MediaMath continues to execute against its business plan. It actually took some proactive steps during 2016 to tighten up its operating cost structure. They expect to be EBITDA profitable this year and expect to accelerate on profit growth in 2017. We continue to be very active in our involvement with MediaMath. We are its second largest shareholder and we have been very deliberate and specific with MediaMath and with you all that we desire to see if we can have a partial or a full exit of MediaMath sooner rather than later. So that is top of mind for everyone, Jim, not just this management team at Safeguard but also with the management team at MediaMath.

[Jim Macdonald:]

Great. And then as a follow up, you talked about watching your companies get traction. You got a lot of companies on the initial revenue space. Can you talk about getting some of those into the expansion stage?

[Steve Zarrilli:]

Sure. As you know that that’s a process of the evolution of those companies. We, every year, expect that companies are going to continue to evolve and move from one stage of growth to another. And in doing so, we want to ensure that we’re giving them the right capital to do that, that they have the right ability to do that with regard to their own operations. And while we’re not predictive at any point in the process, I think we’ve had a track record of demonstrating that we have been able to move these companies from left to right on the chart that you’re most familiar with.

[Jim Macdonald:]

Okay, great. Thanks.

[Operator:]

[Operator Instructions]. Your next question comes from the line of Bruce Collins with Ciara Partners [ph]. Your line is now open.

[Unidentified Analyst:]

Hi, guys. Thanks for taking my questions.

[Steve Zarrilli:]

Good morning.

[Unidentified Analyst:]

I have a question regarding MediaMath. I know that you made your initial investment many years back and obviously that one looks really good. But you’ve made some follow-ons and most recently I think the valuation was around $600 million when you made your last follow on. And you always targeted 2x return on your investments. Are you still happy with that investment? Do you think you’ll make it 2x on that or a little less because it’s less time? How do you feel about I guess the follow-ons? And I guess another question is we’ve noticed lately a lot of – more follow-on money going into companies as opposed to new companies. Just want to hear your thoughts on that.

[Steve Zarrilli:]

So with regard to MediaMath, we obviously continue to feel very confident with its ability to execute and produce value. As I mentioned to the previous question, the company continues to perform in both the revenue growth line as well as taking prudent steps in order to manage its expenses to produce profits. And I think those two elements themselves will continue to drive value in MediaMath. And again to not to be redundant but we are working diligently to see if we can have a partial or a full exit of MediaMath in a reasonable period of time and that reasonable would be any time from now until we can accomplish that goal. With regard to follow-on capital, you may notice that we’ve been over the course of the last couple of years, we have at times gone a little earlier into some of these companies in order to get a meaningful ownership stake, which we think is important to influencing the outcome of the results of the companies over the long term. And while we don’t control, we like to take an active role. And the average entry point for us is much lower over the last 24 to 36 months than it has been in previous years. We average about $6 million going in. We have an internally developed threshold that we don’t want any more than $25 million of capital deployed in any one given opportunity. We recognize that if we’re going in at a little earlier stage with a bit of a smaller entry level of deployment amount that we’re going to have probably a greater number of follow-on fundings into these companies. But when we look at the aggregate dollars, they’re still very much in line with what we would anticipate over the lifecycle of any one of these companies.

[Unidentified Analyst:]

All right. Thank you.

[Operator:]

Your next question comes from the line of Alex Paris with Barrington Research. Your line is now open.

[Chris Howe:]

Good morning. This is Chris Howe sitting in for Alex Paris.

[Steve Zarrilli:]

Good morning.

[Jeff McGroarty:]

Good morning.

[Chris Howe:]

Good morning. Just wanted to see if you would be able to provide any general overview or insight on some key companies or highlights that have shown an acceleration of growth beyond your internal expectations across the four stages of development?

[Steve Zarrilli:]

There is a number of companies that continue to show great promise and are probably going to be the next generation of winners for Safeguard. For those who have been associated with Safeguard over an extended period of time, you come to the realization that it’s almost like generational change as one generation matures, the next generation of companies then ultimately begin to show their capabilities. We have a number that we’re extraordinarily excited about and at the risk of picking some of my children and not all of them, but I will point out a few that I think you should – we pointed out two today, Syapse and Transactis. I’ve been pretty specific in sharing thoughts in the past as it relates to keeping your eye on the ball with regard to Propeller and Apprenda and WebLinc and QuanticMind as companies that we think are substantially growing and will provide really interesting opportunity. Keep in mind more than half of the stable of companies that we have today are growing at rates in excess of 20% annually. So if you just take simple math and take the 27 companies, 14 of them are at growth rates that are in excess of 20% and a great percentage of those are starting to knock on the door of being in that 40% to 50% range. So there’s a lot of opportunity here in this portfolio of companies that we are proud to call partner companies and we’ll continue to update you as to their progress as they make progress with regard to their growth initiatives.

[Chris Howe:]

Thank you for the additional color. And one follow up, if I may. Has there been any change in the composition of the High Traction Stage since the corporate presentation?

[Steve Zarrilli:]

The only change would be the sale of Bridgevine.

[Chris Howe:]

Okay.

[Steve Zarrilli:]

Other than that, the companies are the same.

[Chris Howe:]

Thank you.

[Operator:]

With no further questions at this time, I’ll turn the call back over to Mr. Zarrilli.

[Steve Zarrilli:]

Thank you all for your continued interest, your confidence and your support in Safeguard. We are here to drive value and we look forward to keeping you apprised as to our progress against those broad goals as we’ve outlined today. Thank you.

[Operator:]

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