Safeguard Scientifics Inc (SFE) 2013 Q3 法說會逐字稿

Good morning and welcome to the Safeguard Scientific's third-quarter 2013 financial results conference call. All participants will be in listen-only mode. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to John Shave, Vice President Business Development and Corporate Medications. Please go ahead.

Good morning, and thank you for joining us for our third-quarter 2013 conference call and update. Joining me on today's call are Stephen Zarrilli, Safeguard's President and Chief Executive Officer, and Jeff McGroarty, Safeguard's Senior Vice President and Chief Financial Officer.

During today's call, Steve will review highlights of the quarter as well as other developments at Safeguard and our partner companies. Jeff will then discuss Safeguard's financial results and strategies. Then we will open the lines to take your questions.

As always, 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, the risks associated with our acquisition or disposition of interest in partner companies, risk 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 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, Steve Zarrilli.

Thank you, John, and thank you all for joining us today for the update on Safeguard Scientifics and our partner companies. For some of you it will be somewhat of a redundancy since you were at our investor day, but we do want to provide an update where possible on our partner company activity.

Safeguard and our partner companies achieved real progress and measurable growth during the third quarter, and remain on track to achieve and or exceed operating, financial, and strategic milestones. Focus and consistent execution are vital to the success of our business, and we remain encouraged by our partner companies' progress in the aggregate and the gradual improvement of the M&A environment.

As a result, subsequent to the quarter we increased 2013 aggregate partner company revenue guidance to a range of $285 million to $295 million, up from our initial revenue guidance of $250 million to $270 million. This range represents a 44% to 49% increase as compared to the $197 million in 2012.

We maintain a disciplined focus on our core business as the key driver for shareholder value. We strive for greater consistency in the amount of capital deployed and capital realized, and we will continue to target aggregate cash on cash returns at a minimum of 2 times cost. We believe that this combination will push our capital under management into a range of $550 million to $700 million by the end of 2015. The continued growth and success of our partner companies will help us to achieve this capital under the management target.

As of today we have not achieved one of our goals for 2013, related to an exit or two regarding our partner companies. The team is still working diligently to potentially achieve this goal before year-end.

As a reminder, we categorize our partner companies by revenue stage. It is important to note that a company does not need to move all of the way from the left to the right in order to be an attractive acquisition target. We have had partner companies acquired who were initial revenue companies, as well as expansion stage companies. The evolution of our partner companies through these stages can make them attractive targets for strategic acquirers.

So let's quickly review the stages. Development stages for pre-revenue businesses that may be proving their technology through prototype development or beta product versions. Safeguard has one development stage company, NuPathe, which is also our only publicly-traded partner company today. As of September 30, this stage represented 9% of our total capital deployed in our current partner companies.

Initial revenue stage represents 10 of our 22 partner companies. Businesses in this stage are building corporate infrastructure and management teams; they are beginning to penetrate target markets; and have revenues of $5 million or less. As of September 30, we had 35% of our deployed capital in this stage.

Expansion stage currently has six partner companies with the characteristics of commercial grade solutions, growing market penetration, complete infrastructure and management teams, and revenue in the range of $5 million to $20 million. As of September 30, we had 28% of deployed capital in this stage.

And finally, high traction stage represents companies with revenues of more than $20 million and which are experiencing rapid growth and significant commercial success. This stage includes five of our partner companies. Most recently added was Good Start Genetics. As of September 30, we had 28% of our deployed capital in this category.

With that, let me take a few minutes to highlight a few of our companies. Crescendo Bioscience is a molecular diagnostics company dedicated to developing and commercializing blood tests for rheumatoid arthritis and other diseases, so physicians can make more informed treatment decisions. Safeguard has deployed $11 million of capital in Crescendo since December 2012, and has a 13% primary ownership position.

During the third quarter, Crescendo continued to grow revenue, increase lab test volume, and expand penetration of its target market. Testing volume in 2013 has more than doubled to an annual rate of 90,000, and the Company is projecting $30 million of revenue in 2013.

Next up, Putney, a rapidly growing specialty pharmaceutical company developing high-quality, cost-effective generic medicines for pets. Putney now has four FDA approved veterinary generic products with a pipeline of more than 20 products in various stages of development and CVM review.

Putney expects to be a high-traction company before year-end 2013, and by year-end 2018, Putney projects revenue of more than $190 million and EBITDA in excess of $40 million. Safeguard deployed $10 million in Putney in September 2011, and has a 28% primary ownership position.

A couple of interesting additional facts. 91% of drugs approved for dogs and cats do not have an equivalent generic, whereas 84% of all human prescriptions in the US are filled with a generic. And today in the US, there are more dogs and cats than there are children. We see that Putney has a significant opportunity in front of them.

Good Start Genetics is the newest member of our high traction stage group, expecting to generate more than $30 million in net revenue in 2013, achieve profitability, and be operating cash flow breakeven. Good Start Genetics is an innovative molecular diagnostic company that has developed more accurate and comprehensive pre-pregnancy genetic tests.

During the third quarter, Good Start Genetics' laboratory test volume increased to an annual run rate of more than 250,000. Earlier, the Company received approval to conduct genetic screening in New York, making the company the first laboratory to offer extensively validated next-generation DNA sequence-based carrier screening in New York, where nearly 25% of all reproductive health carrier screening is performed each year. Safeguard has deployed $12 million of capital in Good Start Genetics since September 2010, and has a 30% primary ownership position.

The last company I'd like to highlight is MediaMath. MediaMath is the high traction partner company that is attracting the most speculation about a potential exit, due to its few successful IPOs in the digital media space. As you know, MediaMath is a pioneer in digital marketing technology.

From a network of 12 locations worldwide, MediaMath serves more than 3500 clients and many of the top ad agencies. International operations are now responsible for approximately 35% of MediaMath's annual revenue. Safeguard has deployed $18.5 million of capital in MediaMath since July 2009, and has a 23% primary ownership position.

Of note, the September IPO of Rocket Fuel, which now trades on the NASDAQ under the ticker symbol FUEL, was viewed as an important indicator of the growing value of sophisticated technologies to improve the performance of digital advertising. Rocket Fuel raised $116 million of new equity capital through the offering and now has a market valuation of approximately $2 billion on trailing 12-month revenue of approximately $160 million. At market close yesterday, shares of Rocket Fuel closed at $61.08, up from its IPO price of $29 per share.

With that, I'm going to turn it over to Jeff so that he can provide you with some information on our financial performance and ongoing goals.

Thanks, Steve. I'll lead off with a review of key financial metrics for the quarter and nine months ended September 30. At period end, we had $166.1 million in cash, cash equivalents, and marketable securities. The total carrying value of outstanding debt was $49.7 million, resulting in net cash of $116.4 million.

During the quarter, primary uses of cash were capital deployment of $12.5 million in new partner companies Clutch and Quantia, follow-on capital deployments of $2.3 million in three current partner companies, and cash used in operations of $4.8 million.

For the nine months, primary uses of cash were capital deployments of $20.5 million in our four new partner companies -- Clutch, Pneuron, Quantia, and Sotera Wireless, follow-on deployments of $15.1 million in seven current partner companies, cash used in operations of $16.3 million, and deployments in Penn Mezzanine loan participations of $2.3 million.

Our priorities for uses of cash remain unchanged. Capital deployment into new partner companies, follow-on funding for current partner companies, corporate expenses, and expansion of our platform. At September 30, our roster of partner companies totaled 22, and the carrying value of those 22 partner companies was $137 million. The cost of our interest in these companies totaled $249 million.

Safeguard's financial strength, flexibility, and liquidity are evident from the Company's balance sheet at September 30, 2013. Now it's time for Steve to lead us through the question-and-answer segment of the call.

Thanks, Jeff. Operator, if you wouldn't mind, let's open the phones for any questions.

(Operator Instructions) Troy Ward, KBW.

Thanks. Jeff, real quick, on the other income loss of $14 million, I assume the $1.3 million impairment of Pixel is in that, but can you speak to what else is in that number?

You're looking at the third quarter, Troy?

Yes.

And the other income loss, net interest and equity income line on the financial statements?

That's right, negative $14.595 million.

Yes, that includes really everything from our partner companies. It includes the $1.3 million Pixel impairment, it includes the $4.8 million unrealized loss on the mark to market of our holdings in NuPathe. And that also includes the net equity loss that we've picked up for our pro rata share of our equity method partner companies.

, Okay, all right, great. Steve, can you speak to a minute; you talked about the Crescendo. Can you speak to the relationship with their financing and the optionality that one of the previous lenders has there?

Previous lenders? You mean capital providers?

Capital providers, I'm sorry, yes.

Well, actually, I think which you may even be more specifically thinking about is Myriad?

Correct.

Yes, so there is a contractual opportunity for Myriad to take advantage of the opportunity to acquire Crescendo at some predetermined values within a prescribed period of time once certain financial metrics have been achieved, which are anticipated to occur before the end of the year.

Then the question becomes whether or not that option is pursued by Myriad. We don't have any specific insight, other than we know that publicly Myriad has spoken about Crescendo and has indicated that it could be important to their future platform. Crescendo clearly would view that as an opportunity.

They would also look at other potential ways to unlock shareholder value. I think they haven't lost sight of the fact that Foundation Medicine went out through an IPO recently. So I think Crescendo is actually in the catbird seat from the standpoint of having a number of different paths that they can potentially pursue, and management and the board of the Company and the investor group is looking at all of those opportunities in determining the best way to create shareholder value.

Okay, great. I'll hop back in the queue. Thanks.

Robert Labick, CJS Securities.

Hi, good morning. You actually have Arnie Ursaner backing up Bob this morning. My first question relates to a comment Eli Lilly made yesterday in their earnings release and on their conference call where they said they continue to look for acquisitions in the animal health space.

Do you need any help finding their phone number as it relates to Putney?

I don't believe we do, Arnie, but thank you for that offer.

Do you care to comment more generally about the likelihood of larger companies looking for companies like Putney for acquisitions?

Oh, I sure can; I thought you were asking about the phone number. I think Putney recognizes that they are pursuing a market opportunity that is big, probably bigger than many anticipate. They have some terrific ways in which they go about their business in bringing product to the market.

Their CEO was at our investor day. I think she tried to size up the opportunity for Putney in the next couple of years, and she's put some numbers out there in the marketplace that we have actually again highlighted this morning.

We are building a great company, and obviously at some point in the future, there might be an opportunity for someone else to have a stake in that company. And I think the comments that Lilly made with regard to the market are just further evidence that this is going to be a very important market going forward.

Any other questions, Arnie?

Jim MacDonald, First Analysis.

Yes, good morning guys. Steve, you mentioned that you are still working toward your goal of getting a couple exits this year. Can you talk a little bit more about that and if anything in particular has held back your progress toward that goal?

As I mentioned, and have over the course of a couple of quarters, we continue to strived to find appropriate exits for a number of our companies, assuming that the terms and conditions of those exits represent proper value to our shareholders.

We had at times found ourselves in situations where we may have a particular interest expressed in one of our partner companies, and that interest may actually be formalized through a formal discussion and maybe even some exchange of paperwork. But we found that the values have fallen short to where we think it's appropriate.

We're not looking to take the last nickel off the table. We look for well-timed risk-adjusted exits. And having said, that we still think that there's a number of dialogues that are occurring as we speak that could ultimately result in one of those goals being -- that goal being achieved by the end of the quarter.

I'm fond of saying football is a four-quarter game. We are in the fourth quarter of our game. We have about 70 days left on the clock, and we are taking advantage of every one of those days as we work through those opportunities.

Thanks. And just a follow-up related to MediaMath. I know the decision's not yours specifically, but what are your feelings on what MediaMath should do now that some other companies have taken a lot of money in the space and gone public?

Yes, MediaMath is a phenomenal company that has demonstrated an ability to grow profitably. So I think you've got to start with that as the backdrop to any discussion.

Joe and his team are focused on ensuring that they have an operating infrastructure and a platform that can continue to grow over a long period of time. He has shown in the past an ability to find opportunistic ways in which to acquire other technologies to expand that platform.

Joe and his board continually evaluate the market for what is right for MediaMath as it relates to either capital development or fundraising for the future growth of that business, and other ways in which they may be able to begin the process of unlocking value for shareholders.

We do have a seat at that table. We are not a controlling shareholder in MediaMath, as I know you know, but we do have the opportunity to express our views and opinions to Joe and to the rest of the board as that collective group evaluates the opportunities that MediaMath is faced with.

They are great opportunities. Rocket Fuel is just one example. I believe that there are some other companies including a French-based company that is contemplating or is in the process of an IPO, and I think will add further validation to the space and will continue to influence the way MediaMath looks at its near and long-term future.

Right. And just one more maybe if you could on Penn Mezzanine. You didn't mention anything specific about it on the call. It seemed to kind of just be plugging away during the quarter. Any other comments there?

You know, I'll let Jeff answer that since he actually sits on the board with Brian Sisko on Penn Mezzanine.

There were no new deployments and no follow-on deployments in Penn Mezz in the quarter, and the activity there as far as finding new opportunities to make mezzanine loans have been less than what we had hoped a couple of years ago when we started this.

So they are continuing -- just like we do, they are continuing to look for the right opportunities to deploy capital to have the right return profile, and those have been fewer and further between to find. So it's not been an emphasis of ours from a management time standpoint.

So we wouldn't expect necessarily that there will be any additional deployments before the end of the year. But that being said, we've got several participating interests in these loans that are generating interest income, and some companies that are doing well and a few of them that are positioning themselves for potential exit in the near term.

Thanks, Jeff.

(Operator Instructions) Robert Labick, CJS Securities.

Hi, it Arnie Ursaner again for Bob. Your analyst day covered a lot of the elements related to the Company. So I wanted to shift gears, Steve, and talk a little about capital allocation. You have a lot of great companies that are reaching maturity or approaching exits, and it sounds like you have more than enough cash on your balance sheet to support these investments you plan to make.

Can you talk a little bit more about, I'll be pretty specific here, why not buy stock back now before these exits occur and before the value is realized in the market? And maybe you could highlight the board's approach or your approach, or the decision-making process about repurchases.

Yes, so the board actively discusses capital allocation. They look at concepts related to share repurchase, repayment of debt and other elements, including potentially dividends. During the third quarter we did not execute any share repurchases. However, subsequent to the quarter end, we made some modest share repurchases when the stock showed some short-term weakness, and we purchased less than 10,000 shares since October 1.

Again, not to pin you down, but can you be more specific about the criteria you use for share repurchase?

We generally don't disclose that, Arnie, and it's actually something that the board continues to dialogue about and will continue to evaluate on a very regular basis. So management and the board continually have that discussion, and it's a very fluid discussion and one that I think the shareholders will -- that they should take comfort in the thought that we are actively discussing it quite frequently.

In the same spirit, when you've had exits in the past you've reinvested immediately in other businesses. Could you care to comment, is there a thought process that maybe at some point a more formulaic approach to dividends will return capital to your shareholders make some sense?

Well, again, one of the primary goals that I have is to show consistency in our operating model. I think I've been pretty consistent in that strategic element in describing that. And what that really means is that I am looking to ensure that we not only can put capital to work in a very consistent fashion -- and hold that thought for a second because I want to touch on something else there -- but that we are also bringing capital back into the organization through monetization.

And as the model matures and solidifies around those two cornerstones, the dialogue that can transpire in the board room then becomes much different, as you can imagine. Unfortunately, we are sitting here today having waited thus far a little over two years since our last exit. And we recognize that, we understand that it's important that we get back on the monetization trail, if you will, and we are working very diligently to get that in place.

And it's not just that I want one or two by the end of the year. It's a much broader discussion about how do we continue to keep that engine running so that, yes, we are putting new capital to work, but we are also returning capital to the business.

And as those two elements begin to flow with each other in a much more consistent fashion, the dialogue that the board is able to engage in can be much different as well, as you can well imagine. If there's consistency, predictability, a greater level of comfort, then your capital allocation discussions begin to take on different tones and different elements.

Having said that, two other points. One, we're not here just to build a big platform. So we're not into empire building. We want to make sure that the shareholders are getting the value that they anticipate, but we also recognize that we are doing a pretty good job of being a capital provider in the marketplace.

We have some great companies that we've referred to today, and that we do need a certain amount of capital in order to be continually successful in the market. And we continually challenge ourselves to understand what that number is, how much do we need, and how much might we not necessarily need for purposes of deployment.

I also believe that you need to understand that as we evolve, we want a greater number of companies in play at any given time. So this year we are trying to get to a number of 25 or 26, net of a couple of exits. Next year in 2014, you would probably see a similar number of deployments in quantity, meaning 6 to 8 with an average deployment size of probably somewhere between 5 to 10, maybe sometimes a little north of 10.

So that's all being factored into a lot of the thought process that we go through in determining capital allocation and how we think we should be using our capital to best benefit the shareholders. I hope that that long-winded answer gives you some further clarity.

It was very thorough. Thank you very much.

Paul Knight, Janney Capital Markets.

Hi, Steve. With this market starting to get very active for diagnostics, IPOs and other liquidity events, are you seeing more active deal flow on the private side on this diagnostic space?

The deal teams are seeing definitely a quality deal flow for us to consider. I think some of our higher profile companies demonstrate that we are pretty astute and intelligent investors. So we are starting to have dialogue in a number of different areas that I think will provide future value as well in this segment for us.

Management goes off-site for a day in November to talk about 2014, and then we bring that to the board in the first two weeks of January. So we are going to be talking about that particular subject quite thoroughly as it relates to capital allocation in that segment in 2014.

Are you seeing more pre-IPO transactions, not uncertain IPO windows, but it seems like -- I hear of that occurring. Are you seeing pre-IPO rounds occurring at this point?

I can't say, Paul, that I'm seeing that specifically. What I do know is that the space is getting a lot of attention. Obviously, a couple of ideas that have been recently completed have rehighlighted the market environment for these types of companies.

We clearly have two that we are very proud of being a part of, and we think they have a lot of future value for Safeguard and its shareholders. And I think we're able to take advantage of that.

Back to the first point that you were trying to convey or understand, we are seeing other opportunities to potentially put capital to work in.

And then lastly, I don't know if you can comment on this or it's a Don Hardison question, and that is the nature of Good Start Genetics tests versus the tests at Verinata at Illumina. Can you talk to that, or should I talk to Don?

You would be better served talking to Don. I would not do justice to that question.

Okay. Thank you.

Ed Woo, Ascendiant Capital.

Great. Good morning. Touching upon some of the investment opportunities out there, have you seen any big changes in valuations or potential investments?

There are certain segments that tend to have some value parameters that are a little frothy, and we are doing our best to ensure that we don't get ourselves in a situation where the value of a company that we may be pursuing to deploy capital in is way outside of a range that we are comfortable with.

Because as you recall, Ed, and I think you and I have had some conversations about this in the past as I have with others, a lot of our success on the backend comes from the success of the dollar amount, the value that we get in at the beginning. So we are very cognizant of what's maybe transpiring out there with regard to valuations potentially getting a little frothy.

Now, it's a double-edged sword because on one end if we're in the market wanted to potentially help a partner company reach a monetization event, that's a good thing. And then on the other side of the equation as we are looking to deploy new capital, we want to make sure that we are not, in our way of looking at the world, overpaying as we enter into the relationship.

So there's a lot of work that goes into evaluating companies based upon not only operating capability and scalability and management strength, but also valuation and valuation expectations. There are areas that are starting to get a little ahead of themselves, and we've seen this cycle play out before.

And I think part of the volume of the Safeguard model is having this multipronged segment approach, because if one gets a little ahead of itself, we can pool our resources into a little bit of a different direction and still be able to hit our deployment goals.

Do you think that will present any challenge to try to get to that 25 companies invested by the end of the year?

No.

Okay, great. Well, thank you, and good luck.

Thanks.

Troy Ward, KBW.

Thank you. Steve, just a quick follow-up. Can you speak to Sotera for a minute? I saw in the release where subsequent to the third quarter, there was a positive FDA approval. And can you give us a little bit of color on that?

And I know they're still in the initial revenue stage, but what path are they on? And then also can you speak to their capital needs and your ownership position? I know a 7% is kind of less than most of your other companies.

Yes, Sotera did get some good FDA news close to the end of the quarter. Actually, Tom Watlington mentioned that he was actually waiting for it when he was up on the podium at our investor day. And that really just allows him to be back in market with the product, the product that is starting to get some real good market traction.

We are also -- we are working with Tom and the rest of the investor group there to understand the capital needs of the business as they go into 2014. Our original intent was to be a part of that discussion; hence, the reason for the deployment of capital earlier this year into Sotera, or late last year, one or the other.

And what we are going to be doing over the next four or five months is assessing what those capital needs are and how Safeguard might participate. And through that process as you would hopefully expect, we will get a better sense as to where the real market opportunities lie for Sotera. And not only for their current principal product but some of the other ambitions that the management team has in the marketplace.

Okay, great. Thank you.

This concludes our question-and-answer session. I would like to turn the conference back over to Steve Zarrilli for any closing remarks.

We'd just like to thank everyone for joining us today and we will continue to report on progress. Thank you.