Safeguard Scientifics Inc (SFE) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Safeguard Scientifics second-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 instructions.) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. John Shave, Vice President of Business Development and Corporate Communications.

Good morning. Thank you for joining us for Safeguard Scientifics' second-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 second-quarter 2011 highlights and other developments. Then Steve will discuss Safeguard's financial results and strategies. After that, we will open up the lines for your questions.

Before we begin, I must remind you that 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 and the risks of acquisition or disposition of interest in partner companies, capital spending by customers, and the effect of 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 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 be certain that final outcomes will be as described today. 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, Peter Boni.

Thanks, John, and thank you all for joining us today for updates on Safeguard Scientifics and our partner companies.

Results for the second quarter ending June 30 were distributed earlier today. Our progress quarter over quarter and over the past 6 months has not only been significant, but we're really pleased with our progress. The strategic game plan is firing on all cylinders. More hard work lies ahead, but we believe Safeguard is well positioned, with a talented team, for continued growth and we really couldn't be more optimistic about Safeguard's prospects.

Value creation has been the driver behind Safeguard's exceptional financial activity and achievements over the past quarter. Consider the following. We deployed $45.8 million of capital in new and existing partner companies, including NovaSom, PixelOptics, and Alverix. We formally announced that we will acquire a 36% interest in Penn Mezzanine, the management company and general partner. Penn Mezzanine is a lending firm that will provide subordinated debt and structured equity financing to lower middle market businesses in the middle Atlantic and adjacent regions. We committed $3.7 million of initial capital, with the potential to deploy an additional $26.3 million over a several year period. We believe this strategic partnership is an important diversification for the Safeguard business platform. And it will generate solid opportunities for fee income and profit participation for us. This transaction is also expected to close by the end of August.

We announced two great acquisitions of our partner companies by prominent top tier multinational firms, Shire's acquisition of Advanced BioHealing and McKesson's acquisition of Portico Systems. Portico officially closed yesterday for which Safeguard expects to receive $38.1 million in aggregate cash proceeds. That represents a 4x cash-on-cash return and a 36% IRR. Now that's on the heels of GE Healthcare and Eli Lilly's acquisition of Clarient and Avid Radiopharmaceuticals, respectively, that occurred in December of 2010.

As a result of all this activity, Safeguard enjoys improved financial strength and flexibility, with excellent liquidity and access to capital. In March we repurchased substantially all of Safeguard's convertible notes due in 2024. Our debt-to-equity ratio improved to 1 to 8 at June 30. That's from 1 to 3 at year end 2010 and 1 to 2 at year end 2009. Now in 2006, as we embarked upon this current strategy, that ratio stood at 1 to 1. So as you can see, we've improved the match of our long-term obligations with exit expectations and cash deployment plans.

Value creation is both the objective and the motivation behind Safeguard's progress. Our life sciences and technology partner companies remain well positioned for continued growth and improved profitability. Our deal teams continue to evaluate promising high potential businesses in our targeted verticals. Now, our optimism is really high for creating additional value in 2011 and beyond. That confidence stems from Safeguard's disciplined focus on specific segments of life sciences and technology industries that exploit five strategic growth-driving themes -- maturity, migration, convergence, compliance, and cost containment.

In life sciences we target opportunities in the areas of lower relative technological and regulatory risk, namely in molecular and point-of-care diagnostics, medical devices, regenerative medicine, specialty pharmaceuticals and selected healthcare services. In technology, we pursue companies developing transaction-enabling applications with a recurring revenue business model in internet and new media, financial technology, IT, healthcare, and some selected business services. Our deal teams continually evaluate near-term, high potential capital deployment opportunities, reviewing over 1,000 proposals annually.

We also may find an opportunity or two in a later-stage firm, generally defined as lower middle market opportunities. The aggregate cash-on-cash return target for those later-stage deals might be 2 to 3 times cash on cash versus the current 3 to 5, but the anticipated time horizon may be shorter as well.

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 targeted risk-adjusted returns on capital of 3x to 5x. Exit opportunities may arise at any time and in different forms, including privately negotiated sale of securities or assets, public offerings 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 hurdles, we'll respond appropriately. We'll not deploy capital or pursue exits simply for activity's sake. Now we've said this often and we can't really say it enough -- discipline is the hallmark of our strategy. In the meantime, we'll continue to work to build value in the Safeguard partner companies, drive their growth, and keep their spending plans in line.

Safeguard's new partnership with NovaSom illustrates an important strategic themes in our deployment of growth capital. In June we led a $35 million Series E financing of NovaSom, a pioneer and a leader at the at-home diagnostics for obstructive sleep apnea. Safeguard provided $20 million in equity financing. Existing investors provided an additional $15 million. Proceeds are being used to increase NovaSom's penetration of the healthcare payor and provider markets and to improve the Company's proprietary diagnostic medical device and cloud-based patient management portals. Safeguard now holds a 34% primary ownership position in NovaSom.

Why NovaSom? Our life sciences team identified an established leader in a fast growing, $4 billion domestic market. NovaSom's home sleep test is portable, FDA-approved instrument that's approved for reimbursement through Medicare and can detect obstructive sleep apnea at home for patients' convenience and enhanced accuracy. NovaSom's innovative home service delivery model, combined with a pioneering cloud-based portal technology, connects NovaSom with physicians, therapy providers, and payors to achieve alignment in patient preference, cost, and quality objectives.

Currently only about 5% of the 3 million sleep tests conducted annually in the US are done at home. By 2015 home testing is projected to comprise nearly 50% of sleep tests. NovaSom competes in a market with small regional distributors of home test devices and larger national providers. Recent strategic acquisitions in this sector have been completed at attractive multiples.

Focus, discipline, and execution characterize Safeguard's capital deployment in NovaSom, an established leader with regulatory and reimbursement clearance for its fully commercialized product in a fast growing, multibillion dollar market. Safeguard can add value with capital and then management support as NovaSom works to expand its distribution channels. NovaSom is already at the expansion stage.

In Q2 we also deployed $25 million of a $45 million equity and debt financing round for PixelOptics, a medical technology company that's commercializing the world's first and only electronically processing prescription eyewear. This innovative company is changing the standard of care for eyeglass wearers. PixelOptics' novel approach to vision correction is revolutionizing how eyeglass wearers will be able to transition between near and far distances. The company's product and power 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-focus lenses.

Public comps are trading on the average of 2.2 enterprise value, according to a March 21 research note published by Stephens. Safeguard has a 25% primary ownership in PixelOptics.

Now let's just review some specific recent developments in a few of our other partner companies that underscore the power of the Safeguard business model. Within the internet new media companies, MediaMath is benefiting from the rapidly rising tide of digital advertising growth. Market research firm eMarketer recently forecasted that online advertising spending is set to increase 20% in 2011 to more than $31 billion. By 2015 online advertising is expected to represent 28% of US ad spending.

MediaMath's revenue continues to grow at double-digit rates in 2011, building on 2010's performance where revenue was up over 150% from the previous year. The company's enterprise-class digital media buying and reporting platform was first to market in 2007 and enabled advertising agencies and advertisers to analyze billions of daily impressions. Last year MediaMath launched its enhanced media buying platform called TerminalOne, with a user interface that allows marketers to directly manage campaigns according to specific objectives.

MediaMath is also growing its domestic and international operations, opening offices in LA; Chicago; Boston; DC; Ontario, Canada; and London. Additional offices are planned for later this year in both Latin America and Asia. MediaMath is recognized as one of the hottest companies in digital advertising and it's now ranked by Online Media, Silicon Valley Insider, and Ernst & Young among the top 100 private companies globally. In addition, Safeguard has deployed $15.7 in MediaMath since 2009 for a 23% primary ownership position.

Progress continues at NuPathe, a specialty pharma company that develops and is commercializing branded therapeutics for diseases of the central nervous system. Earlier this year the FDA accepted NuPathe's NDA for its lead product candidate, Zelrix, a single-use, transdermal patch being used to treat migraine. Zelrix is the first-ever submission to the FDA of a transdermal patch for the treatment of migraine. If approved, the patch should provide an attractive option for the millions of underserved migraine patients who would benefit from a treatment that consistently addresses both headache pain and migraine-related nausea. Migraine-related nausea, also referred to as MRN, is a common symptom of migraine that is underreported. It's debilitating. And more debilitating than the headache, it can cause patients to delay taking their medication or avoid treatment altogether.

The company is preparing for the commercial launch of Zelrix early next year. During the second quarter the company presented long-term data that supports the headache relief and nausea improvement in patients using Zelrix.

NuPathe was also granted a patent for its migraine patch, added seasoned sales and marketing executives to its commercial team, and received a $10 million term loan under its secured credit facility. NuPathe has two additional proprietary product candidates, one for the continuous symptomatic treatment of Parkinson's disease, and the other for the long-term treatment of schizophrenia and bipolar disorder. Both are in preclinical development.

NuPathe's IPO of common stock in August 2010 raised $43 million (sic - see Press Release) in gross proceeds. Safeguard has deployed $18.3 million in NuPathe since September 2006 and we own 18% of its outstanding common shares.

So in the interest of time I'll stop there, but I encourage you to look at our press release that was issued earlier this morning and learn more about the progress of Safeguard's other partner companies.

Let me turn it over now to Steve Zarrilli, our Chief Financial Officer, and Steve will give you an update on Safeguard's financial strategies and our performance. Go ahead, Steve.

Thanks, Peter.

I'd like to outline some trends in Safeguard's financial performance and remind today's listeners of this management team's strategic focus. Over the past 5 years, the Safeguard team has delivered meaningful and measurable results for shareholders, despite unprecedented volatility in the capital markets. Our success has been driven by a disciplined focus on making the right deployment decisions in areas of the market for which we have deployed a substantial amount of industry expertise. The Company's cash and marketable securities balance has grown to more than $260 million. What is as impressive is the strength and the depth of our deal pipeline. This pipeline continues to remain very strong, with high potential opportunities in the targeted sectors of life sciences and technology. This disciplined focus is at the heart of Safeguard's success in deploying growth capital, building value in partner companies, realizing that value, and then communicating our progress concisely, consistently, and credibly.

Focusing on these fundamentals is what has allowed Safeguard to report cash-on-cash return multiples ranging from 3x to 13x on our most recent exit transactions involving large, multinational companies interested in the commercial success of our partner companies. We remain committed to these core disciplines in driving our future capital deployment activities.

We also believe that participation in activities related to the co-management of various fund platforms will further augment our capital deployment strategy and value creation for our shareholders. Penn Mezzanine is an example of a co-managed fund where we will leverage our capital, alongside experienced fund managers.

In addition, we continued to explore ways to raise other pools of capital, which we will be responsible for managing. Referring to these pools of capital as co-participation funds, these pools of capital would augment our existing capital resources and leverage our industry expertise. These funds strategies serve to produce management fee income and carried interest for Safeguard.

Some key financial metrics for the second quarter include -- at June 30 we had $263 million in cash, cash equivalents, and marketable securities, excluding cash held in escrow of $6.4 million and restricted cash equivalents of $14.5 million. During the quarter primary uses of cash were -- one, the deployment of $20 million and $25 million, respectively, into two new life science partner companies, as Peter mentioned, NovaSom in June and PixelOptics in April, along with about $800,000 in follow-on funding for Alverix.

Cash operating expenses were $3.1 million. This total excludes interest, noncash stock-based compensation, and depreciation expense. For 2011 we continue to project cash operating expenses in the range of $17 million to $18 million. That range reflects the addition of experienced deal team professionals, as well as certain anticipated corporate development expenses.

We also reiterate our expected use of cash of between $100 million and $150 million in 2011 for these major initiatives -- repayment of debt, corporate expenses, capital deployment into new partner companies, follow-on funding for current partner companies, and the expansion of our platform. Year to date we have deployed approximately $50 million into new partner companies, provided $10 million in follow-on funding to existing partner companies, and used $31 million to repurchase debt.

We believe that Safeguard and its partner companies remain well-positioned for continued revenue traction and value creation in 2011 and beyond. For 2011, Safeguard projects aggregate partner company revenue for its technology group to be in the range of $180 million to $190 million, representing 29% to 36% growth year over year, and unchanged since the beginning of the year.

Following the sales of Clarient and Advanced BioHealing, our remaining life science partner companies are either in the pre-revenue or early commercialization stages. Accordingly, we do not expect significant revenue to be generated by these companies until they are further along in their development, nor do we consider revenue a significant indicator of their near-term progress.

For 2011, Safeguard projects aggregate partner company revenue for its life sciences group to be approximately $12 million. As a reminder, Safeguard reports the revenue of its partner companies on a one-quarter lag basis.

Our partner companies continue to execute aggressively. They are using their cash to grow and, in certain situations, generating cash and making strategic and opportunistic acquisitions. We work with the management teams of each partner company to evaluate levels of existing and required capital, strength of personnel resources, and unique opportunities for growth. Our focus on these ongoing processes allow Safeguard to assist partner company management teams in unique ways to drive value creation and maturity.

Now with that I'll turn it back over to Peter.

Thanks, Steve. Shannon, could I ask you to open up the phones for any questions?

(Operator instructions.) Greg Mason; Stifel Nicolaus.

The revenue guidance that you gave for the technology and life sciences businesses --obviously historical numbers have changed, given the exits. Could you give us some back-year data of kind of the same-company revenues so we can get a sense for how those revenues have grown over the past 3 to 4 years?

Hi, Greg. The one to really look at are the technology firms on an apples-to-apples basis. In 2007 they did in the aggregate $46 million. In 2008 they did $63 million; in 2009, $87 million; and 2010 $139 million. So you can see the forecasted growth is off of a $139 million 2010.

Okay, great. And could you talk a little bit about the diluted share count? Last quarter I believe it was 20.7 million and this quarter jumped to 24 million. Could you talk about what is included this quarter in the diluted shares?

Steve, can I ask you to take that?

Yes. The principal change there is how in a prior quarter there would have been an antidilutive effect of certain equity instruments. Because we had substantial gains in this current quarter, those shares are then added to the calculation because they are no longer antidilutive.

Could you give us what has been kind of the change -- assuming there was no antidilutive impact, has there been a jump in the potential option shares or the diluted number if you take out that antidilutive impact last quarter?

That is by far the most significant portion of the change and there is nothing else of any significant magnitude or of real substance that would have caused that number to change otherwise.

Okay, great. And could we talk a little bit about the potential new Penn Mezzanine investment? Are you guys investing in owning the management contract or are you investing in an actual fund that will be making the loans and getting a return off of that?

We have provided capital into a management company which today is managing roughly $64 million of capital, of which we have provided $26.7 million, or $26.3 million, of additional capital over and above the $3.7 million that we used to capitalize the management company. Our ownership will apply to the platform that's created. So if this experienced group of fund managers is capable of going out with our help and raising subsequent pools of capital in what is traditionally referred to as funds, we will benefit from those future activities as well as the current pool of capital that exists today. So we own 36% of the management company.

Right. And can you talk about, of the portion that's going to be invested in the pool of capital that's going to be making loans, what is your expectations for the coupons off of those loans? And what's been the historical track record of this team?

So this team has a historical track record that ranges between 18% and 22% on a IRR basis. Our expectation is that the average size of deployments from this fund in the form of subordinated or junior debt or mezzanine debt, will be somewhere between $2 million to $5 million on average, that the expected coupon on these instruments would be similar to what you would expect in the marketplace today for mezzanine loans, which would average between 12% and 14%.

There may be some additional warrant coverage associated with these transactions -- in fact, there would be most likely additional warrant coverage -- that would hopefully target a return on any particular deployment of somewhere between 18% and 22%. In certain cases we will also be able to potentially acquire some equity alongside of providing debt into these target companies. And we will look at those situations as a way to further increase our level of opportunity within a particular situation.

Okay, great. Then one last question and then I'll hop off. You said NovaSom is in the expansion stage. Can you remind us again what levels of revenues the expansion stage implies?

Expansion is the range of $5 million to $20 million.

Great. Thank you.

Matt Dolan; ROTH Capital Partners.

Just, Peter, considering all the exits you've had in recent quarters and I think you mentioned later-stage deals in your prepared remarks, can you give us an update on the deployment strategy? Do you expect to get more aggressive now that the portfolio has some room? And secondly, how much -- how mature should we think about these companies being?

We've given guidance of $150 million for 2011 and we should consider that guidance. And the guidance was for not only deployment of capital into new partner companies, but the repayment of debt, corporate expenses, follow-on funding for our current partner companies and then expansion of the platform. We're consistent with that, Matt. We have a rich pipeline and we continue to be selective and disciplined in the execution of our game plan and the deployment of capital. But the strategy remains the same.

Okay. And then, Steve, you covered the debt fund well, but you've spoken about other alternative pools of capital. Is Penn Mezzanine where you're sticking today or are you still evaluating other opportunities that might be out there?

We are consistently evaluating other opportunities that are being presented to us. So we think Penn Mezzanine represents a good first example of where we can potentially take some of our strategy thoughts. The trick will be -- and Peter used the word "discipline." The trick will be to use that discipline as well in the formation of those opportunities to make sure that we're partnering with the right types of fund managers, those that actually can truly augment what we're doing here at Safeguard and provide for not only an extension of our existing strategy, but the right level of diversification.

In addition to that, we refer to co-managed opportunities, which is what Penn Mezz represents. We are still very actively looking for an opportunity to create a co-participation fund, basically a scenario of which we will apply a certain amount of capital alongside of externally-raised capital for which we will manage 100% and have full benefit of the management fee and the carried interest associated with that capital.

Okay, great. And then two more quick ones -- on Penn Mezzanine, $30 million over several years, can you give us any feel for the cadence of deployments there? Is that something that will be fully invested in a couple years' time? Just trying to gauge how the interest off of those deals should play into our model.

Yes, the short answer is, think about somewhere between $8 million and $10 million a year. The longer answer is, the pace of deployment will be factored along two lines. One, it will be the initial capital that's deployed in any particular situation. And there will be a little bit of capital that's held behind and if in the event that there's some follow-on opportunity within a particular opportunity that we've already provided that funding for. But generally speaking, I think you're safe in thinking about $8 million to $10 million over the next 30 to 36 months. And the expectation is if we're successful in deploying that capital and beginning to build that track record that already augments the fund manager's existing track record, that that team would then be out in the marketplace to raise the next pool of capital, which would be targeted in the $75 million to $100 million range.

Paul Knight; CLSA.

Peter, with the dozen or so diagnostics acquisitions I've seen in the market here in the last 6 months, where is it -- is that affecting the deal flow you're seeing on that side, on the life science area? And where do you think values are in your portfolio? Up/down I guess is the general answer on that.

Sure. Hi, Paul. The diagnostics sector has been an active one and we have been active in the diagnostics sector. It is an area that we have targeted. It's a remaining target. And we continue to see very pronounced deal flow there.

The exit values are really based upon the value that the ownership has been able to produce. And we have been fortunate thus far to be able to realize some significant valuation metrics based upon the performance of those firms. And we expect that to continue as long as we continue to groom our organizations, groom our companies, and then position them for a well-timed exit.

Do you want to have more assets a year from now on the life science side or are you happy with the balance we have now?

Our life sciences and technology teams are both competing with one another for access to the Company war chest. And those that bring the very best deals forward, with the very best prospects for cash-on-cash return, will be the ones where we unlock the treasury chest. What we've seen to date is that there's been a fairly decent balance, maybe with a tilt towards healthcare.

And is there any new color on PixelOptics, I think a recent transaction of yours?

Steve, I'll let you comment on Pixel.

A soft launch occurred in the early part of the summer. Going well. Hard launch in the Southeast begins in earnest next week.

Okay. Thank you.

(Operator instructions.) Nick Halen; Sidoti.

First question I had was just getting back to the ABH acquisition. I was wondering if you could give us a little insight into what exactly the rationale was behind why they agreed to be acquired instead of going public. And what kind of a role did you guys have in that decision, if any?

Well, ABH, as everyone knows, was near the end of their road show and ready to price their IPO. And they had a good deal of activity going on during that period of time. Shire came in and essentially made an offer that was a 25% premium for that midpoint of pricing that was announced at the outset of the IPO. Risk-adjusted return, so valuation analysis -- the Board, where Safeguard had a prominent position, made that decision. Safeguard did not singularly make that decision. But that was a significant return for all shareholders and would-be shareholders, terrific for the opportunity to expand Shire's platform and really great to give the ABH personnel a platform from which to continue to grow their business.

Okay. And then, lastly, just kind of a housekeeping question -- where do we stand right now in terms of NOLs that you guys have on the books?

Yes. So Nick, we start with $266 million. We expect that we will use about $150 million of that number to net down to about $103 million when all is said and done.

So $103 million and that's after all the exits from this year?

That's the exits including the impact of the receipt of escrow.

Okay. All right, perfect. All right. Thanks, guys.

Thank you. I'm showing no further questions at this time. I would now like to turn the conference back over to Safeguard for closing remarks.

Thanks, Shannon. Well, once again, we appreciate the interest of our shareholders. Safeguard seeks both significant minority and majority positions, the equity supplemented by debt, in not only private but public companies with our own capital and managed capital from strategic financial sources. We look forward to keeping you posted about our progress. Thanks again.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.