Safeguard Scientifics Inc (SFE) 2012 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Safeguard Scientifics first quarter 2012 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 follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would like to introduce your host for today's conference, Mr. John Shave, Vice President of Business Development and Corporate Communications. Sir, you may begin.

Good morning, and thank you for joining us for the Safeguard Scientifics first quarter 2012 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 first quarter 2012 highlights, as well as other developments; then, Steve will discuss Safeguard's financial results and strategies. After that, we will open lines 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 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 SEC filings.

During the course of today's call, words such as accept, 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 first quarter ending March 31 were distributed earlier today. Now, as a whole, we're especially encouraged by the steady growth and development of our 16 partner companies during the quarter. And the phase of some macroeconomic headwinds and wobbly capital markets, Safeguard's performance validates our strategic focus on growth-stage life science and technology businesses.

Today's prepared remarks will be brief, since not much time has passed since our 2011 year-end update that was laid in February. Nevertheless, there's solid progress to discuss. During the quarter, we added two new technology partner companies and deployed follow-on financing for a few of our current partner companies. Four of Safeguard's 16 partner companies have achieved sustained positive EBITDA status. Moreover, our platform expansion initiative is gaining traction.

Safeguard's partnership with Penn Mezzanine is generating interest income and planning is underway for a continued evolution of that vehicle as a long-term activity for us. In short, our team is executing a focused and disciplined strategy that enhances Safeguard's brand as the preferred catalyst to build great companies, ultimately boosting the Company's financial strength and flexibility and driving value for our shareholders. Safeguard's continued progress underscores that substance trumps even the macroeconomic environment, where global capital markets are volatile and domestic economy remains fragile and politically charged.

Now, year-to-date M&A and IPO activity remains curiously subdued, despite current low interest grades and corporation's large cash balances. A survey by investment bank ThinkEquity concluded that the technology IPO window may be reopening. Recent pricing may signal an upturn in demand for tech offerings. Through March, 13 tech IPOs raised an aggregate $1.8 billion with 22 deals in the wings targeting an additional $7 billion of capital. And the passing of the JOBS Act may only add to this upturn. Now, we'll keep an eye on all of these macroeconomic trends and then the potential trickle-down effect for our partner companies.

In the meantime, Safeguard is disciplined and focused, are unwavering. We're augmenting companies for expansion and growth, and ultimately an exit transaction remains our path to continued financial strength and flexibility, as well as improved shareholder value.

Now, for those of you who are new to the Safeguard story, I'll review the hallmarks of our strategy, which are built on three pillars; focus, discipline, and execution. Focus is the first pillar of Safeguard's strategic foundation. We deploy capitals for high-potential businesses and 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. Not in new therapeutics, but rather in molecular and point-of-care diagnostics, medical devices, specialty pharmaceuticals, and some selected healthcare services. In technology, we pursue transaction-enabling applications with a recurring revenue business model in Internet new media, financial technology, healthcare IT and other selected business services.

Safeguard's discipline complements our focus. We will not deploy capital or pursue exits simply for activities sake. Now, if an opportunity clears our strategic growth and return hurdles, we respond appropriately. Our deal team evaluates more than 1,000 proposals each year. 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 an aggregate targeted risk-adjusted return on capital of two to five times over three to five years. For all non-legacy capital deployments since January of 2006 that have been realized or written off, Safeguard has thus far realized gross aggregate cash-on-cash returns of two times.

Exit opportunities may arise at any time and in different forms, including privately negotiated sales of stock or assets, public offerings. But now, in the case of publicly traded partner companies, exits can involve the sale of stock on the open market.

Execution is how focus and discipline are tested, and it's also how Safeguard has distinguished itself. Focus, discipline and execution have served Safeguard and its shareholders well. By any measure, the Company is fundamentally stronger today and better positioned for continued growth and value creation, this year and we believe beyond.

Now, let's review some recent developments that illustrate how we are expanding Safeguard's business model.

Safeguard's partnership with Penn Mezzanine, formed last year, represents our first initiative to augment our capabilities as a growth capital provider and participate in the management of external sources of capital. This platform expansion initiative is producing current interest and loan fee income, and we expected to produce management fee income as well as profit participation as this initiative grows and then matures.

Managed by a team of experienced mezzanine lenders, this platform enables Safeguard to provide flexible financing strategies to our current and prospective partner companies, as well as other potential lower middle-market borrowers to build value in their businesses and ultimately realize that value through a well-timed exit.

Penn Mezzanine closed its first fund in 2011 after raising more than $64 million. That was including $30 million of capital from Safeguard. As of March 31 this year, Penn Mezzanine has deployed an aggregate of $26.4 million in seven companies, yielding 12.8%. Safeguard's deployed $3.9 million in Penn Mezzanine in August 2011 and has a 36% ownership position. In addition, as of March 31, Safeguard has deployed $12.2 million in connection with Penn Mezzanine's lending activities, of which $9.8 million remains outstanding at this date.

Now, in the interest of time, I'll stop and turn the call over to our Chief Financial Officer, Steve Zarrilli, for an update on our financial strategies and the performance. So, go ahead, Steve.

Thanks, Peter. Good morning. At March 31, Safeguard's interest in its 16 partner companies represented an aggregate of $174.5 million in capital deployed. As of the same date, our cash, cash equivalents, and marketable securities totaled $234.4 million. Net cash equaled $188.5 million, after subtracting the total carrying value of debt outstanding of $45.9 million.

Over the past five years, the Safeguard team has delivered meaningful and measurable results for shareholders. Despite unprecedented volatility in capital markets, we've remained focused on building value in partner companies, realizing that value and then communicating our progress concisely, consistently and credibly.

Disciplined focus on enhancing Safeguard's financial strength and flexibility also helps position the Company for continued success. We repaid and restructured corporate debt, continue to control our holding company expenses and have developed alternative sources of capital and income.

Today, Safeguard is stronger, leaner and better positioned to execute our game plan than in any other time of the past 10 years. This team's focus on value creation is keen and we remain optimistic about prospective opportunities.

Further, our interests are closely aligned with Safeguard's shareholders by virtue of our long-term compensation incentives. Our management team remains focused on building and realizing value for shareholders. So let's move on to some key financial metrics for the quarter.

At period end, we had $234.4 million in cash, cash equivalents, and marketable securities. This amount does not include an aggregate $16.4 million of restricted cash and cash held in escrow. The total carrying value of outstanding debt was $45.9 million, resulting in net cash of $188.5 million.

During the quarter, primary uses of cash were cash operating expenses of $6.7 million, or $0.32 per share versus $0.35 per share in the same period of 2011.

During the first quarter of 2012, Safeguard deployed $12.2 million into new partner companies, Lumesis and Spongecell, $2.5 million into Penn Mezzanine loan participations, and follow-on deployments of [$37.] million in Good Start Genetics, and $800,000 in Alverix.

In 2012, we project uses of cash between $100 million and $150 million in the areas of capital deployment into new partner companies, follow-on funding for current partner companies and Penn Mezzanine participations, corporate expenses and the expansion of our platform.

During the first quarter, we received $300,000 in cash interest and fees related to our Penn Mezzanine participation. We expect to receive an aggregate of between $1.4 million and $1.6 million in interest and fees in 2012 from such participations. This cash return directly offsets our cash expenses. We also received $2.4 million in the first quarter from the repayment of a loan participation with respect to Penn Mezzanine.

Safeguard's partner companies remain well positioned for continued revenue traction and value creation. For 2012, Safeguard projects aggregate partner company revenue in the range of $160 million to $165 million. Results for Safeguard partner companies are reported on a one-quarter-lag basis. For Q1, aggregate revenue of our partner companies grew 26%, in line with our guidance.

Our partner companies continue to execute aggressively, are using their cash to grow, and in some cases, 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 to lead us through the Q&A session of the call.

Thanks, Steve. Chuck, let's open the phone lines for any questions there might be.

Thank you, sir. (Operator Instructions) Greg Mason, Stifel Nicolaus.

Great, thank you. Good morning, gentlemen. Peter, could you talk about Abbott a little bit? You received your first payout as an earnout from the sale of Abbott to Eli Lilly. What are the kind of milestones or how is it measured to get potential future payouts? And what should we think about potential future payouts from Abbott?

Hi, Greg. I'm going to ask Steve to comment on that, okay?

So, good morning, Greg. We, as you noted, just received our first milestone payment in April as we disclosed. The clock is now ticking on a three-year period for commercialization activities by Lilly. And throughout that period, as they hit certain milestones as defined in the original agreement, we will potentially have the opportunity for enhanced earnings from that transaction in the form of earn-out payments.

As we get more clarity, we'll begin to share with the Street what we think those numbers might look like. But we're going to be having to pull the information from Lilly on somewhat of a regular basis as they begin this process. So more to come. We don't have much visibility at this moment in time. We're only about two weeks away from when FDA approval is provided.

To quantify that, Greg, we could get up to $54 million based upon primarily the revenue on commercial milestones over the next couple of years -- few years.

Okay, great. And then, could you talk about how the PixelOptics rollout is going? I know you started with a few states in the Southeast. What's demand looked like? What challenges are you facing? How is the prospects for Pixel looking with this rollout?

Sure. Greg, Steve sits on the Pixel Board. So, once again, I'm going to ask him to make commentary.

So, Greg, we are somewhere between six and 12 months behind schedule, as it relates to the rollout. Now, having said that, we are in the market, we are producing glasses and we are selling them to consumers. And principally in the Southeast, as you know, we've recently grown on a new CEO, by the name of Brett Craig, and Brett has a lot of experience, including being part of the management team that took Transitions Optical from about $100 million in revenue to $1 billion in revenue.

So, Brett has kind of reset the table, has been doing some things operationally to enhance the supply chain processes, principally related to one of our largest suppliers, Panasonic. Those efforts have actually begun to bear fruit in that we're going to see lower cost, higher gross margins, but it also delayed some of our activity in a more aggressive rollout of Pixel through the eyecare professional network that we've established. We have over 2,000 eyecare professional organizations targeted. We have rolled out kiosks, if you will, that have the ability to demonstrate the technology as well as having the complete selection of frames to well over 500 of these ECPs. We are working through a very targeted program with 60 of them to ensure not only our -- that sales are occurring, but that the any kings in the process in getting lenses to the optician, to the lab for grinding and precision, and back to the consumer that they're worked out in a way that will ultimately provide the acceleration path that we're planning for as we get into the second half of the year.

So, a little bit of two steps forward, one step back, but management is managing through it very efficiently. We did provide some additional capital in the form of a bridge. We will probably provide some additional capital as we get into the summer. All of the existing investors are very much engaged and we expect that to continue as we pursue this rollout.

What are you seeing on the demand side from the consumer? Is there any bark at the price, or is -- what's the consumer demand looked like beyond the supply chain --?

[We'll do it right now].

Yes, the marketing has -- it has stirred consumer demand. So there is a lot of pent-up demand, if you will. There are people who are literally looking for this product to arrive to their market. We haven't seen any real pushback on price. Our revenue assumptions are actually fairly conservative in that we're looking for just a certain number -- a very few number of pairs of glasses to be sold by each ECP. And early indications suggested that's actually going to be ahead of original projections.

So demand is there. It's just the matter of making sure that when we get the product into the hands of the consumer, that they're actually getting the product that they have come to expect and we're wanting to make sure that those quality measures are really nailed very substantially. There were a few hiccups in the beginning that we've been able to correct very quickly, but you really do want to minimize those types of things, especially with a high-profile consumer product like PixelOptics is producing.

Anecdotally, Greg, this comes with a $1,200 suggested retail price. There is no evidence of bark on that. And actually, one eyecare professional told us that he thought that he was getting $1,400 as opposed to $1,200, and had no bark at that. So he's been selling his for above the suggested retail price.

Thank you. Matt Dolan, ROTH Capital Partners.

Hey, guys. Good morning.

Good morning, Matt.

Hi, Matt.

First question on deployment, I know you said the funnel is as full as it's ever been, but it looks like deployments are about a third of the way through the year here or below that type of run rate in terms of your guidance of $100 million to $150 million. And I did hear you say that you won't deploy capital for the sake of activity. So should we anticipate deployments to be closer to the low end or should we look for a big wave of deployments here going into the summer months, maybe you can just help frame that number to what we've seen so far?

No, we're at the term sheet stage in a number of things. We've given guidance and we've reaffirmed that guidance and we believe we'll achieve within that range, but it's hard to be predictive, but we have given you a good range. And there is two-thirds of the time left on the clock here, Matt. I wouldn't get too predictive at this point in time as to suggesting that we're at the lower end of that range. We are being discipline through. The valuation marketplace is kind of [squarely] right now, and you know from having kind of followed us now for a bit of time, we actually win bigger when we can actually manage the dollar amount that -- or the valuation that we go in at. So we're being extraordinarily disciplined in having very substantial conversations around valuation and valuation expectations.

We're also trying to make sure that for a couple of the ones that we have in our queue that we've got the right partners joining us in those opportunities, especially for some of the life science opportunities. Having the right partner is extraordinarily beneficial to us, because it gives us the confidence to move forward that if any event or hiccup occurs, we've got some others that can stand tall with us and actually that played out with Pixel in a very nice way. So those types of things are sometimes not necessarily as fluid as you would expect, but it takes some time just to work through some of the nuances in order to get to the end result, which is a deployment of cash into a new opportunity.

Okay, that's helpful. Then, in terms of just the aggregate growth rate for the year, I think it's kind of a mid, maybe slightly upper-teens number that's implied. And I think you said that you're -- you grew 26% on an aggregate basis. So, are you remaining conservative on the guidance front in terms of aggregate revenue, or what would maybe cause a slowdown throughout the year looking at those numbers?

Again, one quarter into the game, we're playing -- we're making sure that we manage the clock here. So stepping away from that basketball analogy for a moment, I think as we get further into Q2, we'll have a better perspective as to what the end of the year looks like for many of these companies. And we'll -- when it's appropriate, we will make whatever adjustments to our guidance as we think is necessary.

Okay. And then, last one is on Penn Mezz, and maybe more generally other alternative pools of capital, it sounds like that's going at least as well as you had hoped. Why not accelerate that program or comparable programs to help offset your core operating spend?

We're executing on our strategy, Matt, which includes platform expansion and when we have something to announce, we'll announce it.

(multiple speakers).

And just to tag on to that, I think one of the things that we're trying to do with our platform expansion is not be redundant. So to go long and deep say in mezzanine, which I'm not necessarily sure you were suggesting, that would probably begin to create some concentrations that may not ultimately provide the long-term returns that our shareholders are looking for. What Peter and I are also focused on along with the rest of the management team are finding opportunities either in these co-managed opportunities, where not only is there a good, solid revenue flow for Safeguard, much like Penn Mezz, but we're moving into other areas of the market that we think are synergistic to what we -- our core business is focused on. So it could be other areas of technology or in the areas of -- other areas of healthcare services. Geography might come into play. We've recognized we've got to touch a lot of rocks in this process in order to see what opportunities truly exist. We're looking for credible teams with proven results that we can be highly confident that they're going to be able to execute in a way that we're executing. So we're spending a lot of time and energy, pursuing and evaluating opportunities. But as we get closer to getting a couple that we think are real, we'll begin to share with the Street what we think those could be like.

Or re-emphasize that, Matt. We are executing in the platform expansion. We just don't have anything to announce, but we're -- there's plenty of activity in the sidelines there.

Thank you. Paul Knight, CLSA.

Good morning, Peter and Steve. Starting with the revenue guidance of $160 million to $165 million in FY 2012, was the pro forma in 2011 $131 million, or is my math off?

Hi, Paul. I'm going to ask Steve to make some commentary there.

The pro forma was -- last year was $140 million.

Okay, great.

And then, to keep in mind, Paul, we're on a one-quarter-lag basis as well with these companies.

Okay. And then, you were saying that Q1 or Q4 was up 26%?

Year-over-year, Q1 was up 26% in aggregate.

Okay.

And because that's on a quarter-lag basis, that actually represents the Q4 activity for these partner companies.

Okay.

So, hopefully, we haven't confused you. We speak about it just like Peter says as Q1, because we have historically and consistently accounted for these or represented these on a quarter-lag basis.

Correct. And then, Alverix and Good Start Genetics, both have begun commercial launch early this year. Could you comment on each of those two diagnostics firms?

Yes, well, Good Start Genetics did receive $3.7 million of follow-on capital from us to really move to commercialization. They have moved to commercialization according to plan and they are up and running. Alverix is now at the initial revenue stage through some OEM activity with Becton Dickinson for a flu-related handheld device, not only here, but also abroad. And once again, they continue to produce, producing revenue in the initial revenue stages. That for us is a $1 million to $5 million range.

This year?

This year.

At Alverix?

Both Alverix and Good Start Genetics are in the initial revenue stages today. As they produce revenue in the annualized rate of over $5 million, they had moved to what we would call the expansion stage. Today, they are both in the initial revenue stages.

Okay. And then, on Penn Mezzanine, how do you recognize the yield on these investments? Is it an accrual? What's the accounting treatment on the returns you mentioned in the press release?

On a current basis, it's an accrual of the interest to be earned for that period of time. The accrual interest could lag actual cash receipts, but we're accounting for it on an accrual basis of accounting.

And then, last on Putney, could you talk to -- a bit about the business development there?

Putney is doing actually extremely well, not only with their current handful of generic drugs that are selling to the veterinary community, but they have, gosh, not quite two dozen and varying stages through the dog and cat version of the FDA. Their CEO has been extremely bullish that these products will get through the FDA process and give her a very strong revenue stream of growth through new products as we enter the New Year and beyond.

(multiple speakers).

And just to further augment, three currently -- three primary products currently being sold in the marketplace with the potential three to four that could be launched over the next 12 months.

Okay. And then, deal flow on the healthcare side, how is it looking, how do you like valuations right now?

Our deal flow has actually been exceptionally strong and actually in both areas of technology as well as life sciences. Jim Datin and his team have been looking at a variety of things. And as I mentioned, we were in varying stages of a term sheet in a number of opportunities.

Thanks.

Thank you. Nick Halen, Sidoti & Company.

Good morning, guys. I just had one quick follow-up question for you. A lot of what I had was actually asked. Just in terms of the anticipated demand for tech IPOs going forward, I mean is that going to affect how you guys deploy capital? I mean, is it going to -- are you guys going to adjust your strategy hurdle or is it going to be pretty similar to what we've seen in the past?

I think it will be similar to what we have seen in the past. Our teams are really in competition for one another -- with one another for the Company treasury chest. And we will deploy capital on the very best opportunities that we see. And both groups, tech and life sciences, both have brought forward a number of very interesting looking opportunities.

Just a word on our strategy and why we think it's paying dividends for us. We are multiple stage in addition to multiple domain. Tech and life sciences tend to be countercyclical. If that's the driver of our economic engine, why be positioned in any one area, if we can have some balance? Also as multiple stage, that's somewhat cyclical as well. We do some selective things in developmental-stage companies and initial revenue-stage companies and expansion-stage companies and high-traction companies. We can enter and we can exit at any stage.

Now, given that that's somewhat cyclical, today, we see that some later-stage technology firms are getting the enthusiasm with LinkedIn, Facebook and Xingomania. And that's impacted some of the expected valuations there. If we were single domain or single stage, we have the risk of buying high and selling low, but we have the luxury of being able to buy low with the opportunity to sell high and that's the essence of our strategy.

Thank you. (Operator Instructions) Greg Mason, Stifel Nicolaus.

Great, thank you. Steve, I believe you gave guidance of $17 million in cash operating expenses for 2012. Yet, this quarter looked pretty high at $6.7 million, so that's kind of a $27 million run rate. Is there just some lumpy items this quarter? What do we think about that $17 million 2012 operating cash number?

Yes. Remember, Q1 always has the payment of bonuses that relate to the prior year.

So there were no expected change in that $17 million target?

None.

Okay. And then, on MediaMath, how quickly will the joint venture with PubliGroupe impact MediaMath? And is there going to be any need for additional capital to expand there in Europe?

MediaMath is really executing on a variety of cylinders. They have evaluated whether an additional capital would be of use to them, but they are actually on a positive cash flow business run rate right now. So we don't have any guidance to give on that.

Okay, great. Thank you, guys.

Greg, just to comment on Q1, Q1 expense was actually down year-over-year. And also on Q1, you've got all the audit stuff for year-end that is in there as well.

Great. Thank you.

Thank you. At this time, I'm showing no further questions. I'd like to turn the call over to Mr. Peter Boni for closing remarks.

Well, thanks very much, ladies and gentlemen, for your interest in Safeguard. And as the year progresses, we'll continue to give you updates and guidance. Thanks, again, for your interest.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Have a great day.