Safeguard Scientifics, Inc.
Q3 2016 Earnings Call Transcript

Published: 27 Oct 2016

[Operator:]

Good morning, and welcome to Safeguard Scientifics’ Third 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 that this event is being recorded. I would now like to turn the conference call 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’ third 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 third quarter of 2016 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, the effect of regulatory and economic conditions generally, and other uncertainties that are described in our SEC filings. During the course of today’s call, words such as expect, anticipate, 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, which describes 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’s Safeguard’s President and CEO, Steve Zarrilli.

[Steve Zarrilli:]

Thanks, John, good morning and thank you all for joining us for an update on Safeguard and our partner companies. Recently, Safeguard conducted a strategic assessment to evaluate where the company is today against our core objectives. And to identify any actions, we believe we need to implement in order to propel us towards our shared division and primary objective to build and enhance shareholder value. We evaluated what’s working, what isn’t and what’s changed as it pertains to the macroeconomic environment and how that may impact Safeguard. This review included objective assessments of Safeguard’s strengths, weaknesses, opportunities and challenges. We believe that this process sets the stage for the coming year influencing our strategic focus in resource allocation. At this juncture in late 2016, I want to outline some key findings and review why we believe Safeguard is properly positioned to realize our long-term goals. We remain confident that Safeguard’s current core business model is the appropriate foundation on which to build the company’s future. We intend to continue to drive value creation by providing growth capital for significant minority stakes in business-to-business companies in opportunity ridged focus areas where technology is the key driver for business evolution and growth. We believe that our initial capital deployments should remain in the range of $5 million to $15 million with a targeted overall cap of $25 million and any one particular partner company. Deployments in these ranges mean that Safeguard will focus on Series A and Series B financing, occasionally funding C-Stage companies might prove fruitful if the company and market opportunity are specially promising. Funding in late stage companies could also be rewarding, however we have determined that valuations for later stage businesses tend to be out of reach given our disciplined capital deployment and ownership preferences. We will continue to seek ownership stakes between 20% and 50% with board representation. We also recognize that attractive opportunities may arise where we could exceed that ownership limit. Our goal remains to realize value to well-timed exit transactions that deliver aggregate cash-on-cash returns of at least 2x. Since 2006, we have allocated capital to growth-stage businesses in two distinct segments, healthcare and technology. This strategy was designed to provide Safeguard a platform of ownership stakes in companies within areas of the market that we’re considered to be counter-cyclical. A review of our current recent successful exits in our existing partner companies reveals that technology is a common thread amongst our most promising companies. Moreover, technology oriented businesses tend to require less capital, involve lower levels of regulatory oversight, compared with traditional healthcare ventures and enjoy faster adoption rates. Going forward, we intend to focus more sharply on technology enabled businesses that address cyber security, ubiquitous connectivity of devices which we referred to as the Internet-of-Everything and artificial intelligence, which for Safeguard predominantly focuses around the areas of predictive analytics and machine learning. We will marry these technology drivers to healthcare, financial services and digital media. Within healthcare, this refinement focus, is more on health-tech and digital health opportunities and eliminate certain focus areas including diagnostics, therapeutics and medical devices, although medical device companies had integrate care delivery with data analytics will still be of interest. While these changes may not seem all that dramatic on the surface, it significantly impacts our capital deployment objectives, our market strategy and our allocation of resources. We think this further refined narrative will allow us to go deeper in key areas within healthcare, financial services and digital media, while focusing on key technology drivers. It’s important to note that this change will not affect our current partner companies as we will continue to work with them in order to achieve their target growth objectives. At September 30, 2016, Safeguard’s roster of partner companies totaled 28. More than one third of those companies have been a partner company for at least three years. Over the previous 10 years, Safeguard has exited companies with an average holding period of 3.7 years. Yesterday, we announced our 29th partner company Brickwork, a software platform that bridges the gap between consumer e-commerce and brick and mortar retail experiences. Safeguard deployed $4.2 million leading the $5 million Series A financing. Proceeds will be used to expand sales and marketing and strengthen the platform with deeper data science and analytics. As of September 30, 2016, most of our partner companies have achieved meaningful scale from proven technologies. Each company is generating revenue. In the case of certain of our more mature partner companies, annual revenue exceeds $20 million. A significant number of Safeguard’s partnered companies have reached the point in their development where they are attracting serious interest from strategic investors, in pursuit of growth and proven innovative technology. We are confident that we can continue to build partnered company value and in-turn, achieve exit transactions to drive shareholder value. An increased pace of exit transactions will, not only drive Safeguard’s profitability but will also allow us to increase the size of our partnered company portfolio. As such we will continue to focus on increasing the number of partnered companies under management and the number of exits per year. We expect to conclude 2016 with about 30 partnered companies. We have also taken steps internally to realign certain resources to address monetization opportunities both with respect to initiation and execution. We completely understand the relationship of profit producing activities related to monetization and the impact to increasing shareholder value. Longer term Safeguard is still targeting meaningful ownership stakes in 40 to 50 partnered companies, we believe that this goal is a significant underpinning to our strategy. A larger portfolio should lead to a more realistic flow of steady monetization and the organic growth of assets under management. Our emphasis on technology is also the driver for our most recent executive hire, Scott Snyder. Scott joined Safeguard as the Company’s first Chief Technology and Innovation Officer in more than 20 years. Scott is charged with helping the management team to shape the company’s long-term technology strategy, evaluate potential opportunities and further establish Safeguard’s point of view on technology matters in the market. He will also be a key resource and advisor to our partner companies to assist them in their technology evolution and to coordinate complimentary activities amongst them. Scott brings more than 25 years of experience in business leadership, strategic planning and technology management to, Safeguard. He is an entrepreneur having started several business ventures and has held execution positions at GE, Martin Marietta, and Lockheed Martin. He is also a distinguished technology thought leader and author. He is a Senior Fellow in the Management Department at the Wharton School and earned an, undergraduate and doctoral degrees in systems engineering from the University of Pennsylvania. We look forward to Scott’s counsel and contributions for years to come. Our strategic assessment process is an essential activity for determining Safeguard’s trajectory toward value creation. After the 2016 installment of our strategic review, we believe the company is well positioned to realize a promising future in 2017 and beyond. Now here is Jeff with an update on financial performance and metrics in the quarter.

[Jeff McGroarty:]

Thanks Steve. At September 30, 2016, we had 28 partner companies. The cost of our interest in those companies was $314.6 million and the carrying value was $168.3 million. During the third quarter, we deployed $4.5 million in one new partner company, Moxe Health, as part of a $5.5 million Series A financing. Moxe software platform integrates electronic medical records, accelerating information exchanges between payers and providers. Moxe intends to use proceeds from the funding to expand product development and hire engineers and sales staff. Safeguard has a 33% primary ownership position in Moxe Health. During the quarter, we also deployed $9 million of capital in five existing partner companies. For the nine months, follow-on financings totaled $41.2 million for 12 existing partner companies. Corporate expenses excluding interest, depreciation and stock-based comp expenses were $4 million compared to $3.8 million for the same quarter of 2015. For the nine-months ended September 30, 2016 and ‘15, corporate expenses were $12.6 million and $12.3 million respectively. We expect the corporate expenses for 2016 will range between $16 million to $17 million. Safeguard’s cash, cash equivalents and marketable securities at September 30, totaled $76.6 million and the carrying value of outstanding debt was $52.1 million. The company has in excess of $200 million in tax-loss carry-forwards available to offset future taxable income from profitable exits. None of these carry-forwards begin to expire until 2021 at the earliest. Our aggregate partner company revenue guidance for 2016 was revised during the second quarter to reflect the sales of Putney and Bridgevine in the closure of AppFirst. 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 partner companies on a one-quarter lag basis. Safeguard’s overall financial strength, flexibility and liquidity are evident in the company’s balance sheet at September 30. Now here is Steve to lead us through the Q&A segment of the call.

[Steve Zarrilli:]

Thanks Jeff. Operator, let’s open the phones for any questions.

[Operator:]

[Operator Instructions]. And our 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, Steve, could you discuss the Adtech sector please some of the public peers to MediaMath are doing well and others not as well depending on where they stand. So I was wondering I was hoping you could give us an update on the space and the prospects for MediaMath and the opportunity for a fuller partial exit for Safeguard from MediaMath over the reasonably near-term?

[Steve Zarrilli:]

Yes, happy to do so Bob. And as you know, MediaMath as well as some other companies are, key to some of our market focus. And with respect to your question regarding MediaMath, we do recognize that valuations in the Adtech industry have softened. Based on the peer group we consider comparable to MediaMath from a market comps perspective. It would suggest a multiple in the range of say 2.6 to 3.7 times 2016 revenue. And this is somewhat down from the beginning of the year. We don’t believe that this is a long-term phenomenon and long-term in nature. And we continue to be bullish on the overall market opportunities associated with Adtech or in some part, market or MarTech. And we do have a number of companies that operate in this area who are utilizing their technologies to deliver unique and meaningful solutions to their customers. These technologies include the unique and growing capabilities of artificial intelligence and we look at it more specifically from a data analytics perspective. We think MediaMath is operating right in the heart of this market opportunity with bit sophisticated technology platform. We do acknowledge that MediaMath’s growth rate has slowed a bit. As we discussed earlier this month at our Investor Day lunch and MediaMath had shed some lower margin revenue to focus on its higher-margin technology platform revenue. We think that that’s a really important element to their business evolution. The business strategy has resulted in a lower growth rate in ‘16 when compared to some historical growth rates. But we think it’s going to set a solid foundation for enhanced growth in 2017 and beyond. But I would leave you with some other thoughts as it relates to MediaMath that I think are important attributes and should be considered when assessing the value of MediaMath. One; I think their geographic footprint continues to expand in key market areas and along with this their technology platform offering continues to gain great market penetration and has become an even more sophisticated. Gross margins remain very strong. Organizational changes during 2016 were intended to position MediaMath for accelerated profit growth in future periods and I think we’re going to see some evidence of that in the back-half of 2016. So, when we put it all together, finally, when we mentioned public aim in previous communications that under the right circumstances, we would be open to a partial or a complete monetization of our interest in MediaMath. So that hasn’t changed. We will continue to seek a well-timed risk adjusted return on our interest in MediaMath. But until then we’re very supportive of management’s direction and strategic plan with respect to the business. So, I hope that helps in putting MediaMath in the Adtech sector into perspective.

[Bob Labick:]

Absolutely, very helpful. And then just sticking with the not MediaMath specific but the exit part of the question, can you just, remind us and talk about the investment process at Safeguard versus the operating process. And what percent of your effort is spent on exits versus spent on new investments and has that changed over the last few years or how do you view that?

[Steve Zarrilli:]

Well, I can tell you that we all come to work every day recognizing that there are two key attributes to our business, putting money to work and recovering that money at a profit from these exits that we pursue. And the team is actively involved in those activities across the board. However, having stated that, over the last year, we continued to introduce new ways in which certain key members of our team can be introduced into certain situations to work with the investment deal team professionals to further augment the process that we see as possibilities with regard to exits. So, it’s not lost on us that exits are important. We have at times engaged our professionals in different activities of that exit process to increase the activity associated with things necessary to get these companies postured for exit. But again, we’re subject to certain market conditions and just certain timing elements of the evolution of these businesses as well.

[Bob Labick:]

Great. Thanks so much.

[Operator:]

Our next question comes from the line of Colin Gillis from BGC Financials. Your line is open.

[Colin Gillis:]

Hi Steve, it’s Colin.

[Steve Zarrilli:]

Good morning, Colin.

[Colin Gillis:]

Good morning. So, regarding MediaMath, could you just elaborate whether a partial exit would be something that you would consider so you would still retain a stake and have a piece of some upside or what are the scenarios out there that you’re considering?

[Steve Zarrilli:]

Yes, it’s a great question and it kind of reaffirms what we’ve said in the past. We look for opportunities to either have a partial or a full-exit from MediaMath. If it’s a partial, say half of our interest that would be fine with us. We think that there is a lot of opportunity for MediaMath in the future that we could take part of. And we would love to be a part of that future value creation. So that actually would be a win-win for us in a lot of respects. And we’ve been open in our discussions with management to see if that could be made a true possibility for us. So, we continue to dialog with certain parties with the help of MediaMath to determine whether or not we can find the right partner in that equation. We do believe in MediaMath’s long-term value opportunity. What we’re trying to do is manage certain expectations of our shareholders as well as some risk management associated with the portfolio and that’s why we tend to look at MediaMath from that perspective and realize that at least a partial monetization would be a good thing for our shareholders and for Safeguard.

[Colin Gillis:]

Yes, that makes a lot of sense. And then switching to new capital deployment; is it fair to say that you’re focusing in on areas that have less regulatory hurdles?

[Steve Zarrilli:]

Absolutely. In fact, you probably could notice a bit of a trend this year and from the last half of last year. We’ve been really focused much more - we’ve been focusing much more of our attention on Health-Tech and that does have far lesser regulatory hurdles to deal with as the company is growing and evolve.

[Colin Gillis:]

Perfect. And would you say there is less, overall capital requirements for that tranche of companies?

[Steve Zarrilli:]

We expected that will be the case. You’re seeing that our average entry-point is generally somewhere between $4 million to $6 million. We’re generally looking at something that’s probably double that initial amount as follow-on capital over the course of 18 to 24 month period of time. So, that, if you just follow the line on that trend, that would suggest that the capital required for any particular company would probably be on the lower end of that range for us of $15 million to $25 million over the life of their existence.

[Colin Gillis:]

That’s perfect. Thank you.

[Operator:]

Our next question comes from the line of Paul Knight from Janney Montgomery. Your line is open.

[Paul Knight:]

Hi Steve. Regarding the operating expenses of $4,687,000 versus $3,962,000, could you put color around that and obviously the concern would be as that line grows, we need to see an increase in AUMs. So, what are the increases behind it, what are your thoughts around the cost structure?

[Steve Zarrilli:]

Yes, let me have Jeff answer that for you Paul.

[Jeff McGroarty:]

Good morning, Paul. Yes, the expense line that includes stock based compensation. So that’s the main driver, is the performance oriented investing of our long-term equity awards. So, when our expectations for exits improve, we recognize that expense based on the probabilities and our expectations for when and how much of those exits will be. So, we also had some achievement of some of the earlier performance based awards based on the exit that we had from Putney earlier in the year. So, the main driver of that expense is non-cash stock-based compensation. When we really look at the cash based expenses of the business, we’re right in line with last year, just ticking slightly ahead. So I don’t think you’re going to see a significant increase by the end of the year and what our cash expenses are.

[Paul Knight:]

Okay. And then specifically on, last one portfolio company question. It looks like you have new pricing strategy, good start that does seem to be the trend in the industry, any sense on customer response with that pricing strategy at this point?

[Jeff McGroarty:]

Paul, I don’t have any specific information that I could offer you with regard to up-tick. We do acknowledge and reaffirm your point that it’s part of a strategy that the new CEO has put into place. We have started to see a number of green shoots as it relates to good start and its ability to get back onto a growth trajectory with regard to its business. They have introduced some other tests as well into the marketplace. So, we don’t have a specific answer to your question but we can follow-up supplemental in some kind of public forum at some point to introduce that information.

[Paul Knight:]

I’ll ask one last one Steve, this acquisition of healthcare IT company in Madison, I’m here in Madison visiting Epic which is kind of the core firm in Healthcare IT, it’s a red-hot growth vehicle. What are the dynamics you’re seeing in Healthcare IT based on the macro I’m getting, it seems like this is one of the more deftly placed deals you’ve done in a while. Can you talk about your level of interest, level of deal-flow on the healthcare IT side?

[Steve Zarrilli:]

Yes, well, we began to see a trend about 18 months ago that really solidified for us a belief that healthcare technology, digital health as used by some in the industry is going to be an area that is going to be the recipient of a fair amount of capital as we go forward. And we’re working really hard to make sure that we’re a competitor in that space from the standpoint of provisioning capital into business models that we think are going to have some real longevity. One of the keys that we think to our future success in this area will be this emphasis on technology, the addition of Scott Snyder as an executive to help us coordinate some of the activities amongst a variety of these companies as well. So, it’s not only the individual opportunity that we think can provide value to the Safeguard shareholder one-by-one, company-by-company but we’re actually trying to create an ecosystem here internally that will allow them to leverage their collective strengths to not only build their business models but to potentially introduce us to other opportunities that we think are going to be attractive.

[Paul Knight:]

Okay, thanks.

[Operator:]

There are no further questions in queue at this. I’ll turn the call back over to management for any closing remarks.

[Steve Zarrilli:]

We just like to thank you all for participating in today’s call. And we look forward to speaking with you in the future. Thank you.

[Operator:]

And ladies and gentlemen, this does conclude today’s conference call. Thank you for joining us. You may now disconnect your lines.