Safeguard Scientifics Inc (SFE) 2017 Q4 法說會逐字稿

Good morning, and welcome to Safeguard Scientifics' Fourth Quarter and Full Year 2017 Financial Results Conference Call. 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 this update on Safeguard Scientifics'.

Joining me today on the conference call and webcast 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 recent highlights as well as 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. Our forward-looking statements are subject to risks and uncertainties. The risks and uncertainties that could cause actual results to differ materially include, among others, our ability to make good decisions about the monetization of our partner companies for maximum value or (inaudible) all and distributions to our shareholders, the ongoing support of our existing partner companies, the fact that our partner companies may vary from period-to-period, challenges to achieving liquidity from our partner company holdings, fluctuations in the market prices of any publically traded partner company holdings, competition, our ability to attract and retain qualified employees, market valuations in sectors in which our partner companies operate, our inability to control our partner companies, our need to manage our assets to avoid registration under the Investment Act of 1940, and risks associated with our partner companies, including the fact that most of our partner companies have a limited history and a history of operating losses, faced intense competition and may never be profitable.

The effective economic conditions in the business sectors in which Safeguard's partner companies operate and other uncertainties described in our filings with the SEC. Many of these factors are beyond the company's ability to predict or control. As a result of these, and other factors, the company's past financial performance should not be relied on as an indication of future performance.

During the course of today's call, words such as expect, anticipate, believe and intend will be used in our discussion of goals or events in the future. Management cannot provide any assurance that future results will be as described in our forward-looking statements. We encourage you to read Safeguard's filings with the SEC, including our Form 10-K, which describe in detail the risks and uncertainties associated with managing our business. Company does not assume any obligation to update any forward-looking statements made today.

Now here is Safeguard's President and CEO, Steve Zarrilli.

Thanks, John, and good morning, and thank you for joining us. As you know, we have been busy over the past month communicating Safeguard's new strategy following the board's approval of a go-forward plan to operate the business and pursue opportunities to enhance shareholder value which Safeguard embarked on at the beginning of this year. I intend to spend much of my portion of the call discussing this new strategy. I'll then turn the call over to Jeff, who will discuss our fiscal Q4 performance. Finally, we will then open the call for questions during which time I'm happy to reflect further on the fourth quarter and full 2017 financial results.

Safeguard began 2018 by opening a new chapter in the company's 65-year history. After an extensive review of strategic options with financial and legal advisors, the Safeguard board authorized a shift in its business strategy and operations. Under this new strategy, Safeguard will not deploy any capital into new partner company opportunities, and will focus on: first, supporting its existing partner companies to monetization opportunities that maximize our risk-adjusted returns; and secondly, return the net proceeds of such efforts to shareholders.

The company will consider initiatives including, among others, the sale of individual partner companies, the sale of certain partner company interest in secondary market transactions or a combination thereof as well as other opportunities to maximize shareholder value. We expect to return net proceeds from the sale of partner companies, or partner company interest to our shareholders after satisfying the company's debt obligations and working capital needs.

We will no longer deploy growth capital in new companies. I want to emphasize that we are committed to supporting the needs of our existing partner companies. We will continue to leverage our capital and relevant operating expertise to help Safeguard's 25 existing partner companies, achieve additional market penetration, revenue growth, cash flow improvement and growth and long-term value. This is a bold shift in strategy for Safeguard, and much work lies ahead to identify the right exit opportunities for each of these companies in order to maximize the value of our partner company interest for the benefit of our shareholders. These ultimate monetization efforts will take place in tandem with the management teams and other financial partners of these partner companies. As you may recall, while we maintain significant minority stakes in these companies, we do not, in any scenario, control the enterprises or solely dictate exit strategy and timing.

At this time, we cannot set a timetable for the completion of the monetization and distribution processes, as these matters could take as long as 3 to 5 years. In the interim, we intend to explore the potential size, timing, number and method of distributions to shareholders once exits are achieved for these companies. We also expect to shield most of our projected profits on such exits from federal taxation, given the size and remaining life of our existing net operating loss carry-forwards. As you can imagine, this shift in strategy was difficult given the legacy of Safeguard, the value of our relationships with current and past employees, and the true pleasure we have had in working with innovative and dynamic entrepreneurs and management teams of our partner companies. However, we are confident that this is the right direction to provide the greatest value to our shareholders.

As a part of this change in strategy, we've substantially reduced our ongoing operating expenses. We currently expect that such operating costs will range between $10 million and $11 million in 2018, absent any unusual expenses that may arise. Further, we believe that there may be additional opportunities to refine this cost structure during the year. Going forward, as assets are monetized, we anticipate and expect further reductions in this annual operating cost structure. Our full-time staff now is comprised of 16 individuals, representing approximately 1/2 the number a year ago. This group is a combination of 6 management professionals and 10 support staff. Partner company oversight is now the responsibility of myself; our EVP, Chief Operating Officer and Managing Director Brian Sisko; and our Senior VP Managing Director Dr. Gary Kurtzman. Administrative functions involving finance, accounting, investor relations and other communication requirements are overseen by our CFO, Jeff McGroarty; and our SVP of Communications, John Shave. We believe this new organizational structure is not only cost-effective but retains the necessary skills and experience needed to execute on our refined strategy. This team has the requisite experience and knowledge of the current portfolio to ensure the most effective process of growth and monetization.

Compensation and retention programs are currently being finalized by our board. These programs will be designed to ensure an alignment of actions and results with compensation both short and long term in nature. Details of such refinements will be disclosed as they are finalized and implemented.

Our confidence in the potential of our partner companies stems from one simple point. They continue to demonstrate strong growth and development. Our partner companies are maturing, growth and revenue in operations are accelerating, partnerships are being signed and customer accounts are ramping. Market interest in and opportunities for our partner companies has continued to be strong. Safeguard's partner companies are achieving strong growth and financial results. Importantly, some of these growth achievements were rewarded in 2017 by virtue of new rounds of capital at valuations reflecting an increase in enterprise value. We believe that our partner companies are well positioned to realize their full potential over reasonable periods of time. We believe that many of our partner companies are reaching a point of meaningful maturation, which begins to position them for exits at attractive valuations. While it is still early in the process, we believe that we can achieve our target, aggregate return up 2x our invested capital.

One important metric in demonstrating our partner companies’ momentum is captured by their aggregate revenue growth, which amounted to 23% in 2017, and is initially projected to be between 16% and 22% in 2018. 10 of our 25 current partner companies have annual revenues between $5 million and $20 million, while another 4 companies have annual revenues that exceed $20 million. MediaMath, as an example of Safeguard's largest asset within the digital marketing arena. Safeguard has deployed a total of $25.5 million of growth capital in the company since 2009, resulting in a primary ownership position of slightly more than 20%.

Under the leadership of founder and CEO, Joe Zawadzki, MediaMath has grown into a global leader in digital advertising and marketing technology that enables marketers to reach the audiences that they want at the scale they need. Today, MediaMath has a substantial revenue base, continues to grow significantly and operates in 42 countries. As MediaMath continues to grow and attract attention from strategic investors, Safeguard is fully committed to a partial or a full monetization of our equity stake assuming the valuation is appropriate. We believe such a transaction would not only benefit Safeguard shareholders but would also attract the kind of long-term capital MediaMath wants to achieve its own goals.

Transactis, one of our promising financial technology companies is a fast-growing leader in electronic billing and payment solutions. We have deployed $14.5 million in Transactis beginning in 2014, and hold a 24% primary equity stake that we carry on our balance sheet at $9.1 million. Transactis has attracted strategic investment from 5 of the largest commercial banks in the world. Today, the transaction client roster includes 12 of the top 25 largest financial institutions. Founder and CEO, Joe Proto, is projecting continued market share growth, and is targeting more than the -- and is targeting more of the financial sector. He is exploring ways to serve healthcare providers and other industries that generate large volumes of billing and payment transactions that can be made more efficient through its electronic platform.

Syapse is a fast-growing health technology company. The company continued its growth in 2017, and closed a $30 million round of capital in a Series D financing involving certain new strategic investors including Amgen, Merck, Roche, and Medidata. Safeguard contributed $2.3 million to this round and maintains a 20% primary ownership position. Certain of these new investors have subsequently announced significant collaboration agreements with Syapse for market and revenue development. Syapse is characterized as an expansion stage enterprise for 2018.

In the interest of time, I'll stop now. But I want to leave you with this key takeaway. Safeguard initiated a new strategy to maximize value that coincides with the ongoing growth of maturation of our increasingly value -- valuable partner companies. Through this strategy, we believe that Safeguard shareholders will be rewarded over the next 3 to 5 years.

With that, I'll turn the call over to Jeff for a review of the quarter's financial results.

Thanks, Steve. At December 31, 2017, we had 25 partner companies. The cost of our interest in those companies was $320.5 million, and the carrying value was $129.8 million. Average capital deployed in our partner companies at December 31, 2017, was $12.8 million. The weighted average length of time that Safeguard has been a shareholder in those companies is 4.6 years. 10 of the 25 companies have been a Safeguard partner company for 3 years or less.

During the fourth quarter, we deployed $9.1 million of capital into 9 existing partner companies. For the year, we deployed $36.8 million in follow-on capital to 18 partner companies. We expect to deploy $15 million to $20 million in additional follow-on capital to partner companies in 2018. As Steve mentioned earlier, we will no longer deploy capital into new companies. As of December 31, 2017, we wrote off Safeguard's position in initial revenue stage partner company, Full Measure, recognizing a $7 million impairment charge.

This was based on Safeguard's decision not to continue to deploy follow-on capital into the company in the absence of significant capital being raised from new investors.

During the year, we sold our interest in Nexxt, Inc., formally known as Beyond.com, for $26 million. We received an initial $15.5 million of cash along with a 3-year $10.5 million term loan, which has been fully reserved on our balance sheet. Subsequent to year-end, Nexxt repaid the term loan in full, resulting in an aggregate cash-on-cash return of 1.9x. We will recognize a gain in the first quarter on this repayment. Subsequent to the close of the year, digital advertising partner company Spongecell merged into privately held Flashtalking, in which Safeguard now holds a 10% equity interest.

As of December 31, 2017, our NOL balance was $253 million. We plan to use these NOL carryforwards to offset taxes on expected capital gains on exit transactions. Under the new tax reform, all NOLs generated in 2017 and prior may be utilized to offset 100% of federal taxable income with no alternative minimum tax. These NOLs retain their 20-year carryforward period. The earliest any of our existing NOLs expire is 2021. NOLs generated in 2018 and forward will be limited to 80% of federal taxable income, and will have an indefinite carryforward period.

Safeguard's cash, cash equivalents and marketable securities at December 31, totaled $25.2 million compared to $37.7 million at year-end 2016. The carrying value of outstanding debt was $85.8 million at December 31, 2017. Safeguard has $41 million of convertible notes, which come due in May of this year. We expect to refinance or repay the converts utilizing available cash, proceeds from exits, and availability under the $75 million senior secured credit facility. Continued compliance with the covenants under our senior secured credit facility, we'll be dependent upon the achievement of profit generating exits in the near term.

During the fourth quarter, corporate expenses, excluding interest, depreciation, severance and stock-based compensation expense, were $3.3 million. For the year, those expenses totaled $15.1 million compared to $15.5 million in 2016. As a result of the company's recently announced strategy shift, that includes initiatives to reduce annualized expenses by $5 million to $6 million, we expect corporate expenses, excluding interest, depreciation, severance, stock-based compensation expense, and unusual items for 2018 will range from $10 million to $11 million. Staff reductions associated with these initiatives are expected to result in severance expenses of $1.3 million, which will be recognized in the first quarter of 2018 and paid over approximately 12 months.

Aggregate partner company revenue for 2018 is projected to be between $475 million and $500 million, which includes revenue for all partner companies in which Safeguard had an interest at January 1, 2018. Aggregate revenue for the same partner companies was $410 million for 2017 and $344 million for 2016. Aggregate revenue for all years reflects the pro forma combined revenue of Flashtalking and Spongecell due to the recent merger. Aggregate revenue for all years reflects revenue on a net basis. Revenue data for certain partner companies pertain to periods prior to Safeguard's involvement with those companies and are based solely on information provided to Safeguard by those companies. Safeguard reports the revenue of its equity and cost method partner companies on a 1-quarter lag basis.

Now here's Steve to lead us through the Q&A segment of the call.

Thanks, Jeff. Operator, let's open the phone lines for any questions.

(Operator Instructions) Your first question comes from the line of Bob Labick with CJS Securities.

Just wanted to start kind of where you just finished off in terms of getting an update on the convert and the refinancing for that. Do you have enough liquidity in hand now to be able to refinance? Or do you -- will you -- will this require an exit, a reasonably sized exit before May? And just kind of plans you have in place to play that out?

Sure, Bob. Our plans are that we should have enough liquidity between cash available today. The cash we received just recently from the repayment of the Nexxt note receivable in conjunction with a few other transactions that we expect will take place between now and May 15, and we do have the $25 million available under the credit facility. So our goal is to repay that. And it might require some additional borrowing under the HPS facility.

Okay, great. Got it. And then, can you talk about the embedded value of the holdings. I know when the HPS facility was put in place -- or I believe when it was put in place that you had a third-party go out and compute the value of your holdings. Can you talk a little about maybe what has changed since then? And how it's played out versus your original expectations?

Sure. Yes, we have done a roll-forward of that valuation. We haven't gone out and had another third-party valuation done. But we've had some exits like Beyond, now Nexxt. Since that time, we've had a few impairments, but we've also had some additional deployments, and we've had, as Steve alluded to in his prepared comments, we had a few companies that raised capital at up-rounds that give us further indication that the value of those companies has increased. So when we add all that activity together and roll that forward, the net is, we're still well above the covenant that was set.

Okay, great. And then maybe last for me. Just if you could give an -- you talked about it obviously a little bit, but an update on MediaMath and how they're doing operationally? Looking at their, I guess, closest peers that are public, but each has done -- the stocks have been performing pretty well recently. So just wanted to see how their operations are going, and what more you can tell us about them? And then potentially, if you know if they're looking to raise financing this year that you could participate in?

So two important points related to MediaMath. As you alluded to, Bob, their public competitors have announced very strong results for 2017 and are bullish for 2018. And the Trade Desk, in particular, had a substantial rise in its share value in the last couple of weeks because of that guidance. MediaMath has seen the same thing. They are bullish and confident. They are continuing to grow revenues at a substantial pace. They're producing profits on a cash-flow basis. They are considering ways in which to further capitalize the company for further growth that may also include acquired growth, if they find the right opportunities. They recognize that we would like to have an opportunity to exit. We've been in contact with them very frequently as you can imagine since we announced our new strategy, and are working collaboratively with them in a manner to hopefully find that type of exit that we're looking for, and have been talking about for quite some time. But as we're waiting, and orchestrating some of those activities, the good news is MediaMath continues to grow in value. And that's been a good thing for our shareholders. And I don't expect anything different in 2018.

Your next question comes from the line of Jim MacDonald from First Analysis.

Could you talk about -- so you have 3 people managing investments now. How about director seats which were spread amongst a number of people, are those change over or will some of your former partners continue in those roles?

No, Bob -- I mean Jim. No, those changes have already been made. So take 25 companies divided by 3, it's roughly 8 companies per senior executive that is -- that's involved here. So that's pretty -- a pretty rational number. And obviously, that number will decrease as companies are monetized. So those -- the board changes have been made. The 3 execs are squarely engaged in those companies. The transition was seamless. The -- our departing colleagues were very instrumental in having time and working with us to make sure that those transitions happened appropriately.

Great. And moving on to Flashtalking. Could you tell us a little bit more about that transaction? It sounds like you just took stock, no other consideration, but I'm not sure about that. And it seems like Flashtalking might been about double the size of Spongecell? Is that about right?

So we're really excited about that transaction. Flashtalking was probably about 3x the size of Spongecell, to be honest, and maybe even a little bit larger. It's a company that's majority owned by TA, a private equity firm. It is a company that has been growing substantially itself. This merger puts the assets of Spongecell into a platform that, I think, when combined, will give Flashtalking a really legitimate opportunity to find some strategic alternatives for itself over the next 18 months or so. So we have a legitimate opportunity and shot here to have a substantial return on our Spongecell investment. And we think that the leadership of Flashtalking, which now includes some of the management personnel of Spongecell, has the right game plan and DNA in order to really achieve some terrific results in the market.

Okay, great. And I've several technical questions. So you wrote-off Full Measure. Was that done in the quarter? I mean because it's -- your partner losses didn't seem to be that much higher to include the $7 million loss?

Yes, Jim. That's -- that was a decision that was made in conjunction with the year-end results being closed. And there were some transactions that offset that. As I mentioned, we had a couple of companies that raised money at up-rounds. And in those transactions, we put in a little bit less than our pro rata. And the accounting for those transactions is that you've recognized a gain or a loss on your change in interest when that happens. And because these were up-rounds, we had gains on Prognos and Syapse, that combines, offset the impact of the loss that you referred to with Full Measure.

Thanks for that explanation. And then by my calculation -- so you said that 2017 partner revenue grew 23%. So under the old list of companies, does that mean it was about $360 million. So in the range -- maybe at the low-end of the range you had projected?

Yes, exactly. $360 million, right at the lower-end of the range.

Okay. And then one more for me. So NovaSom, you've been -- it looks like spoonfeeding every quarter. Can you give us an update on that investment?

A company that still continues to grow, but is still looking for a longer-term capital solution. Leadership is intact and has actually been strengthened recently with some additions. And we're continuing to work with our fellow capital partners to find the right capital for NovaSom, and then ultimately the right opportunity for an exit of our interest.

And I guess, I'll slip in one more. Congratulations by the way on having 5 companies sort of promoted this quarter. Any others you expect to be promoted maybe in 2018?

Sure. And for those others on the call, when we talk about a company being promoted or graduated from one stage to another, remember we categorize our companies on 3 different stages: initial revenue, which is up to $5 million; expansion, which our company is doing $5 million to $20 million in revenue; and high traction companies, which are doing $20 million and greater. Those companies that moved into higher stages in 2017 included Atona, QuanticMind, Syapse, Lumesis and Flashtalking, the other Spongecell merger is now a high traction company. The ones that I'd keep an eye on for 2018, that we think could move from the initial revenue stage to the expansion stage, are 3 healthcare companies: meQuilibrium, Trice Medical and Propeller. I think those are the most likely. And we'll see there could be others that could move up, but those are the ones I would highlight today.

(Operator Instructions) Your next question comes from the line of Joe Pratt from Stifel.

Just -- you enacted the 382. And I wondered what your calculation was of over the past 3 years. What percentage of your 5% holders had raised their holdings?

I'll let Jeff answer that question.

Yes, this is something we have -- we continue to monitor for many years. We have an analysis updated, and look at that ownership change. We don't disclose what the amount is, but it is something that we monitor, and particularly in light of the change in our strategy and the potential for shareholder ownership changes.

Okay. Because -- I mean you'd only need it if you're getting close to 50% because in effect, it's a poison pill on 5% holders accumulating more, correct?

Obviously, there's always a risk. And the board made the right decision to approve that preservation plan. And as you -- as we've pointed out, we have almost a little over $250 million of tax NOLs, and for the shareholders to get the returns that we think we're going to be able to deliver, it's important that, that entire -- the entirety of that NOL is utilized to remove the vast majority of any double taxation that would occur in the ultimate monetization and distribution of these proceeds to shareholders.

But look, your 5% holders are your big holders. You're almost -- the most -- they're obviously big institutions, the others ones most likely to buy substantial amounts in new stock. And now because of this move they've been precluded. Am I correct on that?

Yes.

(Operator Instructions) Your next question comes from Lee Zimmerman with Baird.

In relation to the poison pill, I would hope that you could change it or -- and not put it in, in a way that it precludes people from buying more than 5%, but preserves the tax loss carryforward.

Look, Lee -- the plan does provide management -- I mean not management, the board with the ability to provide exemptions as appropriate. So there's -- so as -- and as documented in the plan. So there's opportunity if it represent itself and those opportunities are presented to the company for consideration.

Well, it doesn't seem like it's in my shareholder interest. I appreciate that you guys are liquidating, the market is not treating you fairly, but I do think that, that was not in my shareholder interest, and I want to make sure that you guys know that.

Thank you. We do.

There are no further questions. I'll now turn the call back over to Mr. Zarrilli.

Thank you. So much work lies ahead for the Safeguard team as we execute a new transforming strategy designed to maximize shareholder value. I think we've been able to give you some sense of where that value is currently being built, and the progress that we're making. We will keep you apprised of our progress. And in the meantime, thank you for your continued interest, confidence and support in Safeguard.

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