Safeguard Scientifics Inc (SFE) 2015 Q3 法說會逐字稿

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 would now like to turn the conference over to John Shave, Senior Vice President, Investor Relations and Corporate Communications. Please go ahead.

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 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, 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 the 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.

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 website along with the transcript for insights 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-average cash-on-cash returns at exit. We believe our corporate strategy aligns our interests 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 achieve 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 DriveFactor exit in the second quarter at a 2X cash-on-cash return, we are 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 did not escape this market upheaval. Our stock was down 22% for the first nine months ended September 30, 2015. Correspondingly, major US 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 US Federal Reserve Board will increase interest rates, as well as the ongoing quantitative easing 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 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 defined 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, 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 spent 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 lineup 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 deployments. 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 eCommerce 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 point-of-sale eCommerce platforms, mobile applications, and social networks. WebLinc, which specializes in another facet of retail eCommerce for B2B and B2C clients who need responsive, scalable, feature-rich websites. eCommerce is growing at solid double-digit annual rates compared to off-line retail sales growth rates in low single digits, according to comScore data.

Our other partner companies in this category provide 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 at all stages of growth, early to high traction within our defined markets. To accomplish this goal, we anticipate adding 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 have increased by 50% the number of our partner companies from 18 to 27. Our initiatives has 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, here is Safeguard's CFO, Jeff McGroarty, for an update on our financial performance for the third quarter of 2015.

Thanks, Steve. As of September 30, we had 27 partner companies. The cost of our interest 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 milestones 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 news of progress at former partner company NuPathe. In September, NuPathe's 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 two times 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 Company's 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 shares outstanding totaled 20.7 million. Safeguard's cash, cash equivalents, and marketable securities totaled $104.2 million at September 30. 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 is Steve to lead us through the Q&A segment of the call.

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

(Operator Instructions) Bob Labick, CJS Securities.

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

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 significantly in line with our current strategy as they may have been in years past.

Now, we are looking for ways in which we can ultimately find a strategic acquirer for those businesses. I'm not at 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 losing sight 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 leads MediaMath and Putney, two that we believe have demonstrated not only the ability to develop businesses that are attractive 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 sooner rather than later, as we get into the final throes of this year and into next year.

Okay, terrific. I appreciate that. And --

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

Good morning, Jim.

Jim Macdonald, your line is now open. Please unmute your line, Sir.

Yes, sorry about that. A technical question. The escrow and milestone payments, were they the reason for the better-than-expected kind of earnings and -- or lower loss this quarter?

Yes, Jim. Within the healthcare segment, you had the impact of Alverix and Crescendo, because those escrows and earnouts were not previously reflected on our balance sheets. So, the cash received resulted in gains equal to the amount of the proceeds. And for ThingWorx, it shows up in the technology segment.

Okay. So they had zero basis, basically?

Correct.

Okay. You obviously put more money in Apprenda. It's getting up close to your sort of theoretical limit of $25 million per company. Maybe you could talk about why you are so excited about Apprenda.

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 at some fairly significant rates, but we had the opportunity to get ahead of the curve here, Jim, and 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 leading 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, there is a 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 presenting; 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.

Paul Knight, Janney Montgomery.

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?

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 the reason why we were putting in place was because we thought that the value of the shares currently traded were significantly below intrinsic value; intrinsic value as we defined it, and probably intrinsic value as many of the covering analysts 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 will continue to disclose, on a quarterly basis, the amount utilized. It will probably get utilized a little differently than the authorization in 2014, in that it's probably going to be used over a longer period of time.

Greg Mason, KBW.

I just wondered if you could talk a little bit about the significant weakness we've been seeing in the biotech public markets? And how is that impacting your ability to potentially exit some of these healthcare's investments or add new to the portfolio?

Well, interestingly enough, the way we look at it is we have really no exposure to biotech. I think the thing that would come closest 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 are exposed to the headwinds that biotech is now currently feeling. And I know last year if we had this conversation, the rage 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 the 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.

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 DriveFactor, I believe you've got $9 million; Quantia, I think $8 million. So you are at $17 million with those two exits. It sounds like you are implying that there is one more this year that could be pretty big to get to that $50 million mark. Or am I missing something there?

I don't think you are missing anything. We are working really hard to try to achieve that objective. Timing is always going to be a little interesting, as 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 are 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.

Bob Labick, CJS Securities.

You touched on this earlier in your kind of remarks, so I was just hoping you could expand a little bit. I know you've put a lot of work in building the portfolio from, I think, maybe 15 or 16 companies, Steve, when you took over as CEO, to closer to 30.

How do you feel now that you are up there in terms of the timing of getting closer to that steady-state of exits, you know, of multiple exits per year? I know that was a lot of the goal behind growing to 30. Just -- when do you think that can be achieved? Just elaborate on that goal, please.

So, the goal still very much exists, and it's very much part of the focus of this management team. And you are right, Bob. We've almost doubled the number of partner companies over that 36-month period of time, if you looked at 2015 to 2016 when I became CEO in November of 2012, and what we expect we'll 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'd 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 it's 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've got two steps forward, one step back. So the goal very much is to get into that steady-state. And I think we are 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 are starting to build a stable of companies in that expansion and high-traction -- I mean, initial revenue and expansion stage, that should give us the ability to begin demonstrating that pathway that you just referred to.

So, 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.

That's terrific. Thank you.

Jim Macdonald, First Analysis.

Just following up on that question. You have a lot of companies in the initial revenue stage. Do you want to highlight any thoughts on maybe having a goal of how many will graduate next year?

You know, 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. Could it be a few more than that? Maybe. But we are 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 year-end results in March.

Great. Thanks a lot.

And we have no further questions at this time.

Well, 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.

This concludes today's conference. You may now disconnect.