Safeguard Scientifics, Inc.
Q1 2010 Earnings Call Transcript

Published: 27 Apr 2011

[Operator:]

Good day ladies and gentlemen and welcome to Safeguard Scientifics’ first quarter 2011 results conference call. At this time all participants are in a listen only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instruction). I would now like to introduce Mr. John Shave, Vice President of Business Development and Corporate Communications. You may begin.

[John Shave:]

Good morning and thank you for joining us for our first quarter financial results conference call and update. Joining me on today’s call are Peter Boni, Safeguard’s President and Chief Executive Officer, and Steve Zarrilli, Senior Vice President and Chief Financial Officer. During today’s call Peter will review highlights first quarter 2011 highlights and other developments. Then Steve will discuss Safeguards’ financial results and strategies. After that we’ll open the line for your questions. Before we begin I must remind you that today’s presentation includes forward-looking statements. Reliance on forward-looking statements involve certain risks and uncertainties, including future performance of our partner companies, the risks of acquisition or disposition of interests in our partner companies, capital spending by customers, regulatory and economic conditions generally, as well as the development of the life sciences and technology markets and other uncertainties that are described in our SEC filings. During the course of today’s call words such as except, anticipate, believe and intend will be used in our discussion of goals or events in the future. Management cannot be certain that final outcomes will be as described today. We encourage you to read Safeguard’s financial filings with the SEC, including our Form 10-K. The company does not assume any obligations to update any forward-looking statements made today. Now here is Safeguard’s President and CEO, Peter Boni.

[Peter Boni:]

Thanks John and thank you all for joining us today for updates on Safeguard Scientifics and our partner companies. The results for the first quarter ending March 31st were distributed early today. We are encouraged by advances across several fronts of our strategic game plan. First, we continue to drive aggressive growth and milestone achievements in our partner companies. Specifically, we provided $9 million of follow-on funding to technology company, MediaMath in part to expand global sales and marketing initiatives and then to fuel technology development. Next, we deployed $5 million of equity capital into ThingWorx, an innovative, technology partner company that is addressing a growing market at managing data from connected devices. And then subsequent to the quarter, we deployed $25 million of equity capital in to PixelOptics; a medical technology company that’s developed and will soon be commercializing the world’s first and only electronically focusing prescription eyewear. I will talk more about MediaMath and PixelOptics a bit later. Lastly, we took our first substantial step towards our strategic initiative of augmenting Safeguards’ existing resources with alternative sources of capital. Safeguard reached an agreement in principle to acquire a significant equity interest in an operating and management enterprise of a mezzanine lending company, and to commit a total of $30 million of capital to such venture over several years. The strategic partnership will be formed with the private company which provides subordinated debt and structured equity financing. Our capital will be deployed alongside private capital committed to funds managed by the company. It’s anticipated that initially the fund will have in excess of $60 million available for lending and operations, including our capital and committed capital from a few limited partners. This entity will deploy capital principally in subordinated debt financing for a lower and middle market enterprises operating generally in the mid-Atlantic region, as well as other geographies strategic to Safeguard. This initiative not only allows us to directly augment our available capital, but also it squarely positions Safeguard with an advantage to address both equity and debt capital needs of enterprises. The mezzanine company will be managed by an experienced team of subordinated debt lenders, and together, we will be able ramp up operations quickly. For sometime now, we’ve stated that we’ve been working to develop an approach to leverage alternative pools of capital. We see a gaping opportunities to provide capital to both private and public enterprises in small to mid markets. This initiative will augment what we already do; provide meaningful and flexible capital, plus operational support services to growth stage businesses. As an equity partner in this [mezzanine] of lending enterprise will have expanded our platform and created a framework which we intend to replicate to take advantage of other opportunities to leverage other sources of capital, and external management expertise in a fashion that produces income and profit participation for the company. This initiative further Safeguard’s capability and enhances our strategy to seek equity or debt positions via significant minority or majority stakes in public or private companies with our own capital and manage capital from strategic and financial sources. Steve will provide some further detail later on in the call, and then we’ll the name under which the joint venture will operate and other details of the transaction at a future date. In the mean time, looking more broadly at external US factors; the US economy continues a slow recovery after the 2008 nosedive, but more over positive momentum and global capital markets continues despite any instability in the Middle East and Northern Africa and despite any natural disasters in Japan. First quarter M&A and IPO headlines were mixed, while proceeds from 32 IPO transactions totaling over $12 billion, the highest first quarter value since 2008 according to data compiled by PWC. They couldn’t pace with activity in Q4, 2010, but were ahead of a year ago. Excluding the Visa IPO in 2008, the largest IPO in US history, 2011 first quarter proceeds overall were the biggest since 2000. The US IPO market is [thonned] to be on pace to generate more than $39 billion in 2011, while eclipsing the 2011 annual total. Trends in deal volume and value are encouraging for entrepreneurs and financial sponsors alike, signaling improved access to capital for businesses and good liquidity for investors. Included in the current IPO pipeline are 44 venture backed firms; and one of those 44 is Safeguard Life Sciences partner company, Advanced BioHealing. Today, Safeguard’s growth stage life science and technology partner company has remained well positioned for a continued growth and improved profitability. Our deal things continue to evaluate promising, high-potential businesses in our target protocols and our optimism is really high for creating additional value for not only 2010, but beyond. The components stems from Safeguard’s discipline focus on specific segments within the life sciences and technology industries that exploit five strategic themes that drive growth; maturity, migration, convergence, compliance and cost containment. We typically deploy up to $25 million in growth capital per company and then time our exits from ownership positions in these companies to achieve aggregated target risk adjusted returns of capital of three to five times. Excellent opportunities may arise at any time and in different forms including privately negotiated sale of securities or assets, public offering of securities or in the case of a publicly traded partner company, the sale of securities on the open market. If an opportunity clears our strategic growth and return [heralds], we’ll respond appropriately. We will not deploy capital or pursue exits simply for activity sake. We’ve said this often and we can’t say it enough; discipline is the hallmark of the Safeguard strategy. In the meantime we’ll continue to work to build value in Safeguard’s partner companies, drive their growth and keep their spending plans in line. The addition of PixelOptics to the Safeguard’s roster of life sciences partner companies is especially exciting. Subsequent to the first quarter’s close, we announced our lead role in $45 million equity and debt financing round for PixelOptics. Safeguard deployed $25 million of the $35 million equity raise for a 25% ownership stake. Now the syndicate partners for the equity financing included Delphi Ventures, The Carlyle Group, Longitude Capital, and Stark Investments, while Horizon Technology finance provided the $10 million of venture debt. Now Pixel was a medical technology company that has developed and will soon be commercializing the world’s first and only electronically focused prescription eyewear called emPower! This innovative company is changing the standard of eyecare for eyeglass wearer. PixelOptics novel approach to vision correction is really revolutionizing how eyeglass wearers will be able to transition between nearer and far distances. The company’s product emPower! represents the most significant technological advance in prescription eyewear in the last 50 years, featuring the most advanced electronic innovations. emPower! substantially reduces or eliminates the perceived distortion and other limitations associated with multi-focused lens. It will be addressing a really large growing $13 billion global market with a highly differentiated and innovative product. We will welcome PixelOptics to the Safeguard, and are looking forward to providing you with updates on our next call. Now, let’s review some specific recent developments at some of our partner companies that underscore the power of Safeguard’s business model. As noted the life sciences partner company Advanced BioHealing has filed a registration statement on Form S-1 with the SEC in preparation for its IPO. Safeguard deployed $10.8 million of capital in to ABH since February of 2007, and we have a 28% ownership stake. Because of the pending transaction, I can’t add much more, but please refer to the ABH filings with the SEC. Our progress continues at NuPathe, which is specialty pharmaceuticals vertical. NuPathe recently gained FDA acceptance of its new drug application for its lead product candidate Zelrix, a single-use transdermal patch for the treatment of acute migraine. The company expects the FDA to complete its review of the NDA in the third quarter of this year. Zelrix is the first ever submission to the FDA of a transdermal patch for migraine treatment. The commercial launch of Zelrix is forecast by the company to occur in the first half of next year. In late 2010, NuPathe raised $43 million of net proceeds from its IPO boosting its cash reserves. Safeguard has deployed $18.3 million of capital in NuPathe since September of 2006, and we own 18% of its outstanding common shares. Our healthcare IT company, AdvantEdge Healthcare Solutions and Portico Systems achieved continued growth during the quarter. The sector also continues to be a hotbed of acquisition activity for strategic and financial buyers alike. AHS is now one of the nation’s top 10 providers of medical billing and practice management services for physicians, ambulatory surgical centers and other healthcare providers. The company’s state-of-the-art technology efficiently collects financial information and then accelerates the reimbursement of (inaudible) patient payments enabling hospital physician groups to maximize revenue and decrease their billing and practice management costs. AHS is achieving profitable growth. 2010 revenue was up almost 115% from 2009. With the completion of another acquisition late last year, AHS expects continued growth in 2011. Safeguard deployed $15 million of capital in AHS since November of 2006 for a 40% ownership stake. Portico assistance offer provider management software and services to the health insurance industry that enables them to design, build, service manage and reimburse their provider networks. Portico has 39 healthcare insurance companies today, including CIGNA, The Principal Financial Group and many of the big blues who served more than 42 million members. During the fourth quarter of last year Safeguard provided Portico with a $5 million mezzanine debt financing, while the company also increased its credit facilities with Comerica Bank. Portico is using this financing to fuel the next level of market penetration. Company revenues have grown at double-digit rates over the past five years. [Horizon], a follower of the field previously named the firm in its on-demand 100 for its innovation, market potential, commercialization, stakeholder value and its media buzz. Based on Q1 performance, Portico has advanced from our expansion stage to our high traction stage. Safeguard deployed a little over $14 million in Portico since August 2006, and we have a 45% stake in the company. Within the Internet/New Media companies growth at MediaMath has been especially impressive. 2010 revenues was up 150% from the previous year and it’s demand continues to build for MediaMath its enterprise-class, digital media buying and reporting platform that enables advertising agencies and advertisers to analyze billions of daily impressions. In 2010, MediaMath made a key strategic hires, and it acquired a joint interactive. Its continued momentum reflects the environment for digital display advertising. The Interactive Advertising Bureau featured in an annual report prepared by TWC that for the first time ever in 2010, display ad spend exceeded newspaper advertising spending. Web ad revenues rose 15% to $26 billion, and that growth was led by a 24% gain in display advertising; like online banner ad, digital video ads, all-in a sign that major brands are growing more comfortable with the [media] as a place to invest their marketing dollars. This supports one of our major themes; migration, demonstrating that consumers and businesses are migrating from offline to online for news, advertising and other forms of media. The company has been aggressively growing its domestic and international operations, opening offices in LA, Chicago, Boston and DC in the US and then in Ontario, Canada and in London. Additional offices are slated to launch this year in Latin America and then in Asia As a result of this momentum, MediaMath was recognized by AlwaysOn for the third consecutive year as one of the hardest companies in the digital ad space, and it’s now ranked among the world’s top 100 privately held firms. In total, Safeguard’s deployed 15.7 million in MediaMath since 2009 for a 22% primary ownership position. Now there’s no shortage of progress throughout Safeguard’s other partner companies, but in the interest of time I’ll stop there, and I’ll turn the call over to our CFO, Steve Zarrilli for an update on Safeguard’s financial strategies and our performance. Go ahead Steve.

[Steve Zarrilli:]

Thanks Peter. I can elaborate on details of our financial or strategic initiatives during the Q&A period, until then I want to outline big picture trends and our performance and strategic objectives. The past two quarters at Safeguard have been period of exceptional financial activity and achievement. Consider the following

[Peter Boni:]

Thanks Steve. Mary, let’s open the phone for any questions.

[Operator:]

(Operator Instruction). Our first question comes from Greg Mason from Stifel Nicolaus.

[Greg Mason:]

My first question is about the fund. I know you’ll announce the team and everything later, but can you give us a sense of how long this team has been doing mezzanine type of investments; and given it’s a $60 million fund, what’s kind of the target hold size for you investments in that fund.

[Peter Boni:]

Steve would you take that.

[Steve Zarrilli:]

Greg the team itself has well over 15 years of experience, much of that working together as a team.

[Peter Boni:]

15 each.

[Steve Zarrilli:]

15 each right. And obviously having spent a fair amount of time in this segment of the market. So we very, very pleased with the opportunity to be able to partner with this dedicated and experienced team. With respect to the second question, we are still at a point where we can’t say a whole lot about the specifics of the company until we get to our definitive agreement. The target size of the investment will be somewhere in the $4 million to $6 million range.

[Greg Mason:]

Just to clarify, are they doing venture capital lending or is this private equity middle market debt?

[Steve Zarrilli:]

This is more along the lines of typical mezzanine lower medical market subordinated debt.

[Greg Mason:]

Moving on, you gave us guidance for the technology revenues, and this is may be the first time that they have broken out or that I remember. Can you give us some kind of historical track record of may be what those numbers were in the last three years, so we can get a sense for the growth in the tech revenue guidance.

[Peter Boni:]

We have broken this out, we have given aggregate guidance and we’ve also given it by sector, life sciences and technology; and in 2007 on an apples-to-apples basis, those companies did $46 million, and in 2008 63, and in 2009 87 million, and the last year 2010, it did a $139 million. So the $180 million to $190 million guidance for 2011 is off of a $139 million from 2010.

[Greg Mason:]

On the new investment PixelOptics you said they are approaching commercialization. What is your expectations for timing of when that business starts generating revenues? How close are we to that?

[Steve Zarrilli:]

I would think that the summer of 2011 provides the right opportunity for a launch for Pixel.

[Greg Mason:]

Could you also talk about Molecular Biometrics? In your press release it says that it’s been pulled from the market and will take substantial new funding. Are you providing that or looking at that? What should we think about your investment in that business?

[Peter Boni:]

Greg we are evaluating the situation at Molecular Biometrics and have made no determination to date.

[Greg Mason:]

Can you give us any information about just that what happened with the product?

[Steve Zarrilli:]

That was a technological issue that needed to be addressed in order to redeploy the product in the market place.

[Greg Mason:]

One final question, you talked about the pipeline, it is robust, but can you may be give us a little more guidance about what you are seeing, is it life science, is it technology? Where are the more attractive opportunities you are seeing today for future investments?

[Peter Boni:]

Greg across the board we are seeing some very attractive opportunities and substantial numbers. Remember, we have been evaluating some 1000 opportunities per year. We are definitely on track within that pace or may be even excess of that pace to date. During the financial melt down of the last couple of years, a number of companies just took to the bunkers and they sequestered them selves and said man it’s hostile out there, we are going to just try to make it on our own for now. And what we see as the economy is improving and the global markets are improving, they are taking their head out of the bunkers and saying, my gosh, now we really need to grow capital in order to execute a strategic game plan. So we are seeing a lot of activity across the board.

[Operator:]

(Operator Instruction). Our next question comes Matt Dolan from ROTH Capital Partners.

[Matt Dolan:]

First question, a follow-up on the mezzanine fund and you’ve touched on some of this. But Steve could you just, may be give us a little more on Safeguard’s role in the management and operations of the fund, how much are you dedicating from a spend perspective to this fund. Secondly, I heard you say cash-on-cash return of two to three times, is that your target across the board for the fund or is that for certain situations and may be calibrate us on returned expectations within this initiative.

[Steve Zarrilli:]

I think there were three questions there. From an oversight and involvement perspective, like everything else that we do with our partner companies we don’t intend to be a passive participant in this platform. We actually anticipate being active in its governance. There will be a dedicated team of experienced professionals who will be responsible for sourcing, evaluating and determining whether or not to go or no go on a particular opportunity. Most of those opportunities given their anticipated size will ultimately require some level of Board approval as well and that has been baked in to the review and approval process for that entity. So it’s an active versus passive relationship. With regard to cash-on-cash return targets jumping to point number three; actually the way we are looking at this is from a mezzanine lending type of environment. Our cash-on-cash return expectations will probably be somewhere in the two timed cash-on-cash return range, but with a targeted IRR of some thing north of 20%. Matt I apologize; there is a middle question in there that you would asked.

[Matt Dolan:]

It was relative to your involvement and how much you spend, if you could quantify that as you raise you operating expenditure.

[Steve Zarrilli:]

Well it will not in any way impact our operating expense. The capital that we are deploying into the fund along with any other management fee is that it may earn in connection with other private funds that are brought to bear. We will be more than sufficient to pay for the ongoing operations of that entity. Where appropriate, we will leverage certain attributes and infrastructure elements of Safeguard to augment the funds activities. But we don’t expect that to be of any significant nature, nor should it have any substantial or significant impact on the projected operating expenses of Safeguard in and of itself.

[Matt Dolan:]

The second topic, in terms of deployment this year, by our math you are already closing in on a $120 million in allocations. Should we think about things slowing down for Safeguard in terms of deployments for the remainder of 2011?

[Steve Zarrilli:]

Well also look at the mezzanine fund. I would encourage you to look at that as a multi-year deployment of capital for one. So when you start to think about deployment of capital, we tend to look at that not as 30 million necessarily in one year but over two to three year period of time. Again, we are very determined to put capital to work in the right opportunities that meet our criteria, and we are currently on pace to stay within the guidance that we had provided before. Those two factor combined would suggest that we still have a fair amount of gun powder or dry powder to be used in 2011, and we also expect that the capital that we have is more than sufficient to allow us to pursue the strategies outlined in our game plan for 2011.

[Matt Dolan:]

May be one for Peter. [Accidentally] you touched on the IPO market and we saw a big medical device acquisition last night announced. Can you give you outlook for excellent opportunities within your own portfolio? Are there in the near term that we should start thinking about.

[Peter Boni:]

I can’t be predictive to that Matt except the environment is more attractive than its been over the last few years, and we have a group of companies that continue to mature in their value creation. (inaudible) one of your questions. We still seek a three to five times cash-on-cash return at a minimum, when we are seeking opportunities in those selected areas of technology and life sciences. What Steve mentioned is that the mezz (mezzanine) debt opportunity might be more along the lines of 2x, and on occasion we might find a later stage, lower middle market firm where we could put some capital to work and potentially look at two-three times as a target at a minimum. So we have three to five or two and then potentially a deal or two at later stage it might two to three.

[Steve Zarrilli:]

One point in clarity on the mezz (mezzanine) fund, the return of capital may be shorter as well. We in many cases will not have to wait for a five year period of time to transpire before that cash is recycled back in to a newer opportunity.

[Matt Dolan:]

If I could just [speak] one more follow-up Pixel. Sounds like a summer of 2011 launch. Anything beyond that in terms of the aggressiveness of that launch and how we should start thinking about revenue contributions from that opportunity, thanks a lot for the time.

[Steve Zarrilli:]

Matt I would encourage you to just continue to monitor that which is out in the public domain as it relates to the marketing activity that Pixel underway. It has done some very credible following in the market place as it relates to its technology and its appeal to the consumer market place, and the company is hoping to properly time the launch of its commercialization activities to ride the wave of excitement that’s being build through its marketing and public relation activities.

[Peter Boni:]

Also Matt Pixel will be penetrating a rollout regionally, giving it an opportunity to scale up its production. So that’s a regional rollout not a global rollout, but it beings in the summer of this year, and we are really excited about that. That’s a $13 billion market opportunity; there were some 50 million progressive lenses global that have penetrated the market place. This is clearly a highly innovative product offering in that market place.

[Operator:]

I am not showing any other questions at this time. I would now like to turn it back to the speakers for any additional remarks.

[Peter Boni:]

Okay, if there are no more questions, we will continue to give you outlines as to our capabilities, as we’ve enhanced our strategy to seek equity or debt positions. We are a significant minority or majority stakes and private or public companies with our own capital or managed capital from financial and strategic sources. We are excited about what we’ve done, we hope you are too and we’ll continue to keep you posted on our progress. Thanks very much.

[Operator:]

Ladies and gentlemen, this does conclude today’s program. You may now disconnect and have a wonderful day.