Safeguard Scientifics, Inc.
Q3 2015 Earnings Call Transcript

Published: 23 Oct 2015

[Operator:]

Good morning and welcome to Safeguard Scientifics' Third Quarter 2015 Financial Results Conference Call. All participants will be in a listen-only mode. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Please note, this event is being recorded. I’d 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' third quarter 2015 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 and 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 involves 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 Safeguard's filings with the SEC, including our Form 10-K, which describe in detail the risks and uncertainties associated with managing our business. The Company does not assume any obligation to update any forward-looking statements made today. Now, here is Safeguard's President and CEO, Steve Zarrilli.

[Stephen Zarrilli:]

Thank you, John. Good morning and thank you all for joining us today for an update on Safeguard and our partner companies. Safeguard’s successful Investor Day in New York City just two weeks ago, I encourage you to review the video webcast archived on our Web site along with the transcript for insight into our business model of deploying growth capital into targeted healthcare and technology companies in select markets with the goal of realizing on a consistent basis above the average cash on cash returns at exit. We believe our corporate strategy aligns our interest with those of our shareholders. While the public markets have suffered from substantial volatility throughout the year, especially during the third quarter, Safeguard’s partner companies continue to grow revenue on an aggregate basis and achieved significant development milestones. In addition, Safeguard remains on track to achieve our corporate goals and objectives for 2015. First, increasing our partner company total to approximately 30, next deploying $35 million to $50 million in new partner companies and $30 million to $50 million in follow on funding for current partner companies. Third, generating continued growth in partner company aggregate revenue to a range of $430 million to $450 million and lastly, realizing a minimum of two profitable exits with a minimum aggregate cash value of $50 million, with the drive factor exit in the second quarter at a 2x cash on cash return, we’re diligently working towards achieving this objective before year-end. While our business activities remain in line with our overall objectives for the year, market volatility in the third quarter and year-to-date has been exceptional and Safeguard do not escape this market upheaval. Our stock was down 22% for the first nine months ended September 30, 2015. Correspondingly, major U.S equity indices have also weathered significant declines. Thus far two-thirds of small cap stocks fell from their 2015 highs by 20% or more. Most of the downward pressure has stemmed from worries about global economic growth, especially in China. Other factors have included speculation about whether or not the U.S Federal Reserve Board will increase interest rates, as well as the ongoing quantitative leasing in Europe. Small cap stocks represented by the Russell 2000 Index were down more than 9% and just as importantly from a comparison perspective, our proxy peer group was down in the aggregate by similar percentages. The silver lining to this market volatility has been a further balancing of valuation ranges for potential new capital deployment opportunities for Safeguard. Despite the volatility, we continue to receive interest from potential acquirers for a number of our partner companies. Top tier organizations continue to recognize that their future growth will hinge in part on strategic acquisition opportunities, and in turn seem willing to pay a premium for assets that are critical to their growth. We believe that these market dynamics support our ability to produce meaningful, profitable exits over the next several years. Our business model is highly dependent on maintaining a steady stream of new opportunities that will ultimately, which is a result in a steady stream of consistent, meaningful, profitable exits. The Safeguard team continues to focus on developing the methods to achieve a more predictable and consistent stream of capital inflows through well timed exits of our holdings in current partner companies. If we achieve these goals, then we ultimately achieve our longer term vision of being a nationally recognized, innovative growth capital provider capable of delivering consistent superior returns. Our business focus involves supporting growth of businesses in the five markets within the broader segments of healthcare and technology. In healthcare, those markets are principally -- in those market areas principally include medical technology. In other words, the diagnostics and devices and healthcare information technology. We also have one current partner company in the category of specialty pharmaceuticals. For technology, our focus is principally in the areas of digital media, which primarily includes business models related to advertising technology or ad tech. Enterprise applications and infrastructure which we also define as enterprise 3.0 and finally financial services technology. At our recent Investor Day, we spend time defining our strategy within the category of advertising technology. This strategic focus now comprises approximately 25% of our total capital deployed, representing six of our 27 current partner companies. Our ad tech partner company line up includes Clutch, MediaMath, QuanticMind, Sonobi, Spongecell, and WebLinc. We are highlighting this category today due to its potential to create significant value as the general digital media and ad tech industries continue to grow, mature and consolidate. We believe that the current market dynamics related to ad tech will produce positive outcomes for Safeguard over the next 36 months. We also believe that this is a market that will continue to present new opportunities for new capital deployment. Digital advertising represents a $160 billion market. Our ad stack of partner companies are among Safeguard’s fastest growing deployment. More specifically with respect to the companies in the category of advertising technology, we believe that Safeguard has a unique integrated platform of companies representing best-in-class operations related to customer loyalty and e-commerce development tools and services, as well as programmatic digital advertising platforms. A few examples include Clutch, which delivers customer engagement and retention services to premium retailers through a point of sale e-commerce platforms, mobile applications and social networks. WebLinc, which specializes in another facet of retail e-commerce for B2B and B2C clients who need responsive, scalable, feature rich Web sites. E-commerce is growing at solid double-digit annual rates compared to offline retail sales growth rates in low single-digits according to comScore data. Our other partner companies in this category provides distinct and valuable data driven tools and services for managing integrated advertising and marketing in today’s digital world. Our continued focus is to find, capitalize and support unique businesses in all stages of growth early the high traction within our defined markets. To accomplish this goal, we anticipate out in six to eight partner companies in any given rolling 12-month period, we also expect that certain modest additions to our deal teams will be made to ensure that we have the right level of personnel to pursue, evaluate, manage and ultimately seek an exit for the partner companies under management. We plan on continuing our methods of applying financial, operational, and governance oversight with respect to our involvement with these companies. Our focus is to deploy no more than $25 million in any particular opportunity, generally through a series of capital tranches over the course of our involvement with that company. We also generally seek a significant minority interest. We do not want to control these enterprises, but we do want to stay actively involved with respect to their development and having meaningful ownership stake to influence outcomes. Ultimately the goal is to exit our relationship with a partner company, generally through the sale of the business to a strategic acquirer within three to five years from the date of initial capital deployment. Since 2016, Safeguard has generated approximately $790 million from exit transactions and has deployed $534 million in new opportunities. We believe that this evergreen business model is capable of creating long-term shareholder value. Since the beginning of 2013, we’ve increased by 50% the number of our partner companies from 18% to 27%. Our initiatives have also resulted in a balanced distribution of holdings as measured by annual revenue. These activities have served to diversify the risk attributes of our collective holdings, while developing a larger stable of companies that can produce a more regular stream of profitable exits. Now hear Safeguard CFO, Jeff McGroarty for an update on our financial performance for the third quarter of 2015.

[Jeffrey McGroarty:]

Thanks, Steve. As of September 30, we had 27 partner companies. The cost of our interests in those companies was $278.9 million. The carrying value of these partner companies at September 30 was $158.7 million. Safeguard's reputation for building high potential growth stage businesses in targeted markets within technology and healthcare, means our pipeline is always full with prospects. Year-to-date our deal teams have screened more than 700 companies, resulting in 60 qualified prospects, eight issued term sheets, and six closed deals. During the third quarter, we received initial proceeds of $7.8 million on the sale of Quantia, excluding $1.2 million which will be held in escrow until July 2016. We also received proceeds related to prior year’s exit transactions, including amounts released from escrow of $1.7 million for Alverix and $0.9 million for Crescendo Bioscience, plus $3.3 million from the achievement of performance milestone by ThingWorx. For the nine months ended September 30, we received aggregate proceeds of $24.8 million on the sales of DriveFactor and Quantia, and various escrow and milestone payments. By the end of 2015, we may receive up to an additional $3.2 million in performance milestone payments and $4.1 million from escrow related to ThingWorx. During the third quarter, we deployed follow on funding of $10 million into Apprenda, and $1.5 million into InfoBionic. Corporate expenses for the nine months ended September 30, were $12 million and are tracking slightly lower than our previous annual guidance of $17.5 million to $18 million. Among the quarter’s developments was use of progress at former partner company NuPathe. In September, NuPathe corporate parent Teva Pharmaceutical Industries launched ZECUITY, its migraine, headache treatment that is delivered via a patch. This commercialization is significant to Safeguard, because it could lead to additional cash payments of up to $24.2 million, if certain revenue milestones are achieved over the long-term. NuPathe was sold to Teva in early 2014 for $144 million. Safeguard’s initial cash proceeds were $23.1 million, representing a one-time cash-on-cash return. Our cash-on-cash return could reach 2x, if the revenue milestones are achieved. We expect continued growth in aggregate revenue of our partner companies. Aggregate revenue for 2015 is projected to be at the upper end of the range of our previously announced guidance of between $430 million and $450 million, excluding DriveFactor and Quantia, which were sold earlier this year. Aggregate revenue for the same partner companies was $359 million for 2014 and $290 million for 2013. Safeguard’s financial strength, flexibility, and liquidity are evident on this slide showing the companies balance sheet at September 30. The balance sheet also reflects the effects of our current share repurchase authorization for up to $25 million that was initiated during the third quarter. Through September 30, we repurchased approximately $99,000 shares of common stock for an aggregate cost of $1.7 million. At September 30, Safeguard’s share is outstanding total $20.7 million. Safeguard’s cash, cash equivalents and marketable securities totaled $104.2 million at September. The carrying value of outstanding debt was $51.4 million resulting in net cash, cash equivalents and marketable securities of approximately $52.8 million. Now here's Steve, to lead us through the Q&A segment of the call.

[Stephen Zarrilli:]

Thank you, Jeff. Operator, we will open up the lines for questions.

[Operator:]

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

[Bob Labick:]

Good morning, everyone.

[Stephen Zarrilli:]

Good morning, Bob.

[Jeffrey McGroarty:]

Good morning, Bob.

[Bob Labick:]

Hi. You obviously have some very exciting companies in the high traction bucket, which typically means you held them a while. You’ve also demonstrated that exits can come from basically any of the stages of development that you have. I know timing is difficult, you touched on this briefly, but could you elaborate on where you stand in terms of timings and be specific as you can please?

[Stephen Zarrilli:]

So with regard to some of those companies that are in the high traction stage, I think there are three that we considered to be legacy companies. Companies that are continuing to grow, require very little capital, but have business models that probably aren’t as -- aren’t significantly in line with our current strategy as they may have been in years passed. Now we’re looking for ways in which we can ultimately find a strategic acquirer for those businesses. I’m not a point today to give you any refined timing of that. We do have it high on our list, Bob. So this management team is making sure that we’re not loosing side of trying to find a home for those three legacy companies. Also in that category are three other companies that, one is Good Start Genetics. And I think as I mentioned in last quarter’s call, Good Start has been going through a bit of a pivot with its business. It actually had some important milestones this quarter, including getting approval on a variety of different reimbursement fronts with insurers that should help with regard to revenue and revenue recognized. It’s looking to bring some new products and capabilities to the market. It’s potentially going to require a bit more capital, nothing that’s significant in our mind, but it’s probably a story that’s going to have to play out over the course of 2016. And then that leaves MediaMath and Putney to that we believe have demonstrated not only the ability to develop businesses that are attracted to the market, their revenues are growing substantially. There’s a lot of interest in those two companies and we recognize that that interest could actually be very beneficial to the Safeguard shareholders soon or rather than later as we get into the final throws of this year and into next year.

[Bob Labick:]

Okay, terrific. I appreciate that.

[Operator:]

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

[Stephen Zarrilli:]

Good morning, Jim.

[Operator:]

Jim Macdonald your line is now open. Please un-mute your line sir.

[James Macdonald:]

Yes. Sorry about that. Good morning.

[Stephen Zarrilli:]

Good morning.

[James Macdonald:]

A technical question, the escrow in milestone payments, we’re they the reason for the better than expected kind of earnings in lower loss this quarter?

[Jeffrey McGroarty:]

Yes, Jim within the healthcare segment had the impact of Alverix and Crescendo, because those escrows and earn-outs were not previously reflected on our balance sheet. So the cash received resulted in gains equal to the amount of the proceeds, and for ThingWorx it shows up in the technology segment.

[James Macdonald:]

Okay. So they had zero-basis basically?

[Jeffrey McGroarty:]

Correct.

[James Macdonald:]

You obviously put more money in the Apprenda, it’s getting up close to your sort of theoretical limit of $25 million per company, maybe you could talk about why you’re so excited about Apprenda?

[Jeffrey McGroarty:]

Yes, Apprenda continues to demonstrate an ability to develop capabilities in the market that are not only state of the art but actually ahead of the curve and we’re finding that there are some very large enterprises that are finding real meaningful solutions within the Apprenda service offering. There’s a lot of interest in Apprenda. It not only competes in a segment of the enterprise application market that I think is going to continue to grow like some fairly significant rates, but we had the opportunity to get ahead of the curve here Jim, put some capital to work, probably a little bit before they actually needed the size of capital round that they wanted but they wanted to secure their balance sheet and by us leaving that round, we were able to even further enhance our ownership position in Apprenda. So Apprenda is in that category that I would encourage you to stay focused on as we talk about the next wave of companies that could create real value for Safeguard, those are number of them but Apprenda is high -- is top of that list. We also showcased a few others a couple of weeks ago that should also be viewed as potential -- the next wave, if you will, if you recall we had Transactis some of our ad tech companies were in attendance. So we actually think Apprenda has got some real opportunity in the market and that’s why we’ve placed a fairly large amount of capital into play there.

[Operator:]

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

[Paul Knight:]

Hi, Steve could you talk about your share buyback program. Is it going to be in the market daily or how are you making those decisions? And how are you running quarter-to-date versus the September quarter?

[Stephen Zarrilli:]

So, if you recall Paul the program that we currently have in place was recently approved during the summer and we at that time shared with our shareholders and other interested parties that’s the reason why we’re putting that authorization in place was because we felt that the value of the share is currently traded, we’re below -- significantly below intrinsic value and intrinsic value as we defined it and probably intrinsic value as many of the covering analyst define it. And so we are going to use that program opportunistically and in a particular way to take advantage of periods of time where we think that, that delta exists. We have not disclosed the specifics, we won't continue to disclose on a quarterly basis the amount utilized. It will probably get utilized a little differently than the authorization in 2014 and that it’s probably going to be used over a longer period of time.

[Operator:]

Your next question comes from the line of Greg Mason from KBW. Your line is open.

[Greg Mason:]

Great. Thank you, guys. I just wondered if you could talk a little bit about the significant weakness we have been seeing in the biotech public markets and how is that impacting your ability to potentially exit some of these healthcares investments or add new to the portfolio?

[Stephen Zarrilli:]

Well interestingly enough, the way we look at it is, we have really no exposure to biotech. I think the thing that would come close is from a diagnostics play is good start genetics. Everything else in our healthcare portfolio is really focused on devices or healthcare information technology. So we really don’t believe that we’re exposed to the headwinds that biotech is now currently feeling and I know last year if we had this conversation the range was all about biotech. You’re not going to see us lean into that area of the market Greg and we also had one outlier from a standpoint of focus and that’s Putney in a specialty pharmaceutical play which probably would, you could argue comes to closest to biotech but that’s a story that has matured fairly rapidly gaining a lot of market traction and providing real opportunity for, an interesting outcome for Safeguard.

[Greg Mason:]

Okay. And then one kind of additional question, with your goal of at least two profitable exits for a minimum aggregate cash value of $50 million, if we look at drive factor I believe you got $9 million Quantia, I think $8 million so you’re at $17 million with those two exits. It sounds like you’re implying that there is one more this year that could be pretty big to get to that $50 million dollar mark or am I missing something there?

[Jeffrey McGroarty:]

I don’t think you’re missing anything. We’re working really hard to try to achieve that objective. Timing is always going to be a little interesting, is it -- does it slip because of market conditions and do you find yourself two or three weeks later than what you expected or -- but we’re working really hard to make sure that we come as close to possible in achieving that objective and that’s why we haven’t tried to suggest differently.

[Operator:]

Your next question comes from the line of Bob Labick from CJS Securities. Your line is now open.

[Robert Labick:]

Thank you. You touched on this earlier in your remarks, I was just hoping you could expand a little bit. I know you put a lot of work in building the portfolio from I think maybe 15 or 16 companies Steve when you took over CEO that’s closer to 30. How do you feel now, you’re up there in terms of the timing of getting closer to that steady state of exits -- multiple exits per year, I know that was a lot of the goal behind growing to 30. When do you think that can be achieved, just elaborate on that goal, please?

[Stephen Zarrilli:]

So the goal -- the goal still very much exit and its very much part of the focus of this management team and you’re right Bob we’ve almost doubled the number of partner companies over that 36 month period of time if you looked at ’15 to ’16 when I became CEO in November of 2012 and what we expect will end up near the end -- at the end of this year. So the goal -- we do want to continue to build that base. I think I feel even that much more comfortable if we had on a steady state basis something north of 30. You could argue is that number 35 or 40, but I think its going to take a couple of years to build into that just given the fact that we will be deploying capital generally into about six to eight new names a year and we hope that we’re going to continue to -- we’re going to produce two or three exits a year. So when you start to add those numbers together you got two steps forward one step back. So the goal very much is to get into a steady state and I think we’re getting closer to determining and demonstrating that, that can be achieved. When I look at those companies that are now populated within the base of 30 and I know that there are two prominent ones that will probably be nearer than further from a monetization perspective. We’re starting to build a stable of companies in that expansion and high track -- I mean initial revenue in expansion stage that should give us the ability to begin demonstrating that pathway that you just referred to. So the goal is still the same. We’ve actually been working really hard to make sure that we’ve got the underpinnings in place and now it’s a matter of determining how we can best execute on that objective.

[Robert Labick:]

That’s terrific. Thank you.

[Operator:]

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

[James Macdonald:]

Yes, just following up on that question, you have a lot of companies in the initial revenue stage. You want to highlight any thoughts on maybe having a goal of how many will graduate next [technical difficulty]?

[Stephen Zarrilli:]

Yes. Our current estimate right now Jim is about a third of those have a real legitimate shot of moving from initial into expansion stage from this year to next. It could be a few more than that maybe, but we’re going to see some pretty credible substantial meaningful movement from initial to expansion stage over the course as we report into 2016, and we’ll have that data finalized and ready for our discussion with you all as we report yearend results in March.

[James Macdonald:]

Great. Thanks a lot.

[Operator:]

And we have no further questions at this time.

[Stephen Zarrilli:]

Great, thank you all for your continued interest, confidence and support of Safeguard and we look forward to keeping you apprised of developments here at Safeguard.

[Operator:]

And this concludes today's conference. You may now disconnect.