Safeguard Scientific's (SFE) Steve Zarrilli on Q1 2016 Results - Earnings Call Transcript

| About: Safeguard Scientifics, (SFE)

Safeguard Scientifics, Inc. (NYSE:SFE)

Q1 2016 Earnings Conference Call

April 28, 2016, 09:00 AM ET

Executives

John Shave - SVP, Investor Relations and Corporate Communications

Steve Zarrilli - President and CEO

Jeff McGroarty - SVP and CFO

Analysts

Lee Jagoda - CJS Securities

Arnold Estaner - Private Investor

Operator

Good morning and welcome to Safeguard Scientific’s First Quarter 2016 Financial Results Conference Call. All participants will be in 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.

John Shave

Good morning and thank you for joining us for Safeguard Scientific's first quarter 2016 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 first quarter of 2016 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. 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 markets that are – where we put capital to work and other uncertainties 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 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 the 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.

Steve Zarrilli

Thanks, John. Good morning and thank you all for joining us for an update on Safeguard and our partner companies. In the week since our year end results conference call, partner company Putney, a specialty pharmaceuticals company was acquired by Dechra Holdings, U.S. a subsidiary of UK based Dechra Pharmaceuticals for $200 million in cash. We announced the deal in mid-March and the transaction closed last week. During this transaction Safeguard realized proceeds of $58.2 million for a cash-on-cash return of 3.9 times. In the second quarter of 2016 we will recognize a book gain of approximately $55 million, which will positively impact our book value by nearly $3 per share. Safeguard has deployed $14.9 million in Putney since September of 2011 and had a 28% primary ownership position at the time of the acquisition.

By many metrics, the Putney exit is a significant transaction for Safeguard. The cash-on-cash return multiples above our target aggregate return of two times, moreover at four times trailing 12-month revenue, the purchase price exceeds the average acquisition multiple of 3.5 times in nearly 50 transactions in the generic pharma sector since 2008. In the four and a half years since Safeguard deployed capital onto the company, Putney developed and launched 11 FDA approved veterinary products, increased revenue by 374% to $49.6 million in 2015, and built a robust pipeline of promising new generics. I know I speak on behalf of our entire team here at Safeguard when I say that we enjoyed working with Putney's founder and CEO, Jean Hoffman along with our entire team throughout Safeguard's involvement with the company. We wish them the best of luck as they embark on the next chapter in Putney's success.

Over the coming quarters we expect to execute more transactions with improved consistency. To date Safeguard has realized $201 million in proceeds from seven profitable exits since 2013. Yet the pace of exit transactions has been uneven and below our expectations. Realistically, market dynamics often expand transaction timelines and temporarily delay our objectives. In the Putney deal, initial discussions on an exit began more than a year ago. We worked with Putney's advisors Jefferies to review M&A proposals for more than 20 strategic and financial prospects.

At this point in 2016, the climate for meaningful near term exits has improved. Our yield seems to remain very active and Safeguard's partner companies are attracting interest from potential acquirers as these parties seek additional capabilities to grow their businesses. We are working diligently to create more profitable turnover in Safeguard's portfolio over the next 12 months. A high growth pioneer in advertising, technology and analytics, MediaMath has been in the Safeguard portfolio since 2009, and now serves advertisers and publishers from 16 locations around the globe. We hold a 21% primary ownership position in the company, and have deployed a total of $25.5 million in growth capital. As we discussed during our March conference call, it is precisely MediaMath's rapid growth and access to other sources of debt and equity capital that worked in multiple enquiries regarding Safeguard’s ownership position in MediaMath. We continue to evaluate opportunities on an ongoing basis, and whether or not we should sell a portion or all of our stake in MediaMath.

This depends of course on the consideration of underlying market condition, company prospects et cetera. With the Putney sale, Safeguard is no longer in the specialty pharmacies market. Today Safeguard is focused on growth based businesses in select technology in healthcare markets including enterprise, digital media and healthcare technology. We target total capital deployments between $5 million to $25 million over the course of our partnership with the company for significant minority ownership stakes. Today our roster of partner companies stands at 28. We expect to increase that total to at least 32 to 34 in 2016, with all partner companies operating and growing in our core strategic segments within technology and healthcare.

Another partner company that I'd like to highlight is Transactis, a leading provider of electronic billing and payment solutions. Subsequent to the first quarter of 2016, Transactis announced a $30 million Series E financing. Safeguard along with five of the largest U.S. commercial banks, Capital One, Fifth Third, PNC, TD and Wells Fargo, each deployed an amount into the company as a part of this latest financing. To date Transactis has raised $70 million. Safeguard initially deployed $9.5 million into Transactis in August of 2014 as part of an $11 million series E financing. The valuation for Transactis in this series E financing was three times that of the series B financing with the post money valuation of $130 million. This latest financing bring Safeguard's total capital deployed to $14.5 million for 24% primary ownership position. There is a major transformation that's taking place in billings and payments and Transactis is taking away. We're proud of with Transactis's chairman and CEO Joe Proto and his team have achieved, and look forward to supporting the company as it extends its leadership position in the billings and payments industry. We are also energized by our progress to date in 2016, and enthusiastic about our prospects going forward. Safeguard remains well positioned in 2016 to grow our valuable portfolio of partner companies, and to realize significant gains from an increased pace of exit transactions.

Now here is Jeff with an update on financial performance and metrics in the quarter.

Jeff McGroarty

Thanks Steve. At March 31st 2016 we had 29 partner companies. The cost of our interest in those companies was $324.6 million, and the carrying value was $178.2. As Steve mentioned the closing of the Putney exit, subsequent to the quarter's close has reduced our partner company total to 28 for the time being. During the first quarter, we deployed $23.4 million of capital in nine existing partner companies, and achieved the final $3.3 million performance milestone related to the sale of ThingWorx in December 2013, bringing our total cash-on-cash return on ThingWorx to 4.7 times.

Corporate expenses excluding interest, depreciation and stock-based compensation expense were $4.3 million, compared to $4.6 million for the same quarter of 2015. We expect corporate expenses for 2016 to range between $16.5 million to $18 million. At March 31st, 2016, Safeguard’s cash, cash equivalents and marketable securities totaled $42.3 million. Inclusive of recent proceeds realized from the Putney sale, Safeguard's cash, cash equivalents and marketable securities on a pro forma basis at March 31st were $100.5 million, and the carrying value of outstanding debt at that date was $51.3 million.

Due to the sale of Putney, we have adjusted our aggregate partner company revenue guidance for 2016 and actual revenue for prior years. For 2016, aggregate partner company revenue is projected to be between $435 million and $450 million, which includes revenue for all partner companies in which Safeguard has an interest at January 1st, 2016 except for Putney. Aggregate revenue for the same partner companies was $420 million for 2015, and $338 million for 2014. Aggregate revenue for all years reflects revenue on a net basis. Revenue data for certain partner companies pertains to periods prior to Safeguards 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 one quarter lag basis.

Our aggregate revenue guidance represents 4% to 7% growth over the prior year. When you exclude a few of our larger, longer tenured companies, the rate would be approximately 15% to 17%. Additionally, our partner companies experienced some softness in the fourth quarter of 2015. Due to quarter lag, this impacts our 2016 aggregate revenue. Our partner companies were somewhere conservative when developing their 2016 budgets, particularly the first half of the year due to concerns about the macroeconomic environment. Safeguard’s financial strength, flexibility and liquidity are evidenced in the Company’s balance sheet at March 31.

During the third quarter of 2015 our Board authorized share repurchases for up to $25 million. During the first quarter of 2016, we purchased approximately 420,000 shares for an aggregate cost of $0.4 million, bringing the total repurchases since inception of the authorization to $10.4 million. Currently we are not actively buying shares under the existing board level authorization. Instead we intend to utilize our cash to fund new partner company opportunities and to ensure that our current roster of partner companies is adequately funded. However, the remaining $14.6 million of the original authorization remains in place, and we may reenter the market at any time. Now we have Steve to lead us through the Q&A segment of the call.

Steve Zarrilli

Thanks Jeff, Operator lets open the phones for any questions.

Question-and-Answer Session

Operator

[Operator Instruction]. And your first question comes from the line of Bob Labick with CJS Securities. Your line is open.

Lee Jagoda

This is actually Lee Jagoda for Bob. So you had mentioned earlier that, you would like to get to the point where you've got to study your cadence of exits but we're not really there yet. How do you think about -- what are the things you need to do to be able to achieve that goal of getting to the more steadier exits?

Steve Zarrilli

Yes, I think the way you that you need to look at it Lee, is that, just in a little over three years since we began on this process, when I became CEO, we’ve been building the stable of partner companies over that time. We’ve actually almost doubled the number of companies under management since that time and we expected that it would take as you might expect somewhere between 3.5 to 5 years for that cadence to begin to develop in a more significant way, because that’s generally the timeline of what we try to target for an exit for our partner company. So I think we’re in the beginning throws of that and I think as you heard in the comments that we had earlier, we're expecting and working very diligently on trying to increase the pace even here in 2016. So stay tuned, it's top of mind here at Safeguard and it's something that we're actively working on a month by month basis, but it is embedded within the overall strategy that we laid out three years ago.

Lee Jagoda

And if I think about the cadence of potential sales over the next few quarters, are we thinking more legacy holdings or co-holding and I guess what would come first?

Steve Zarrilli

What I clearly regard [indiscernible] for legacy companies that in an ideal situation, we would like to have someone else owning our stake in those companies, and there might be some opportunity for that in 2016. But then you need to just look at the broader set of companies that we have and recognize that any one of them at any different time could potentially it. And so I think we’ve had a pretty interesting track record of exits whereby some companies have been with us for relatively short periods of time and others have been here for a bit longer. And I wouldn’t necessarily get fixed stated with actual numbers of companies, potentially exiting. I would get more focused on levels of dollars. So when we think about exits in 12 month periods of time, what we’re trying to do is get into a steady state of somewhere between -- at least somewhere between a $100 million to $150 million of proceeds coming back each year, because that would be outpacing the deployment pace that we have, really covering the operating expense and then producing profits on a more consistent basis. So for us, when we look at our business, exits really means profits, profits will build value, obviously increases book value, but builds value over, you know a sustained period of time. So it’s all about producing net profits in any particular calendar year, that we're reporting. And that’s the focus that we have.

Operator

Your next question comes from Arnold Estaner a Private Investor. Your line is open.

Arnold Estaner

I just want to try to follow up on your math if I can. You meant, you have 28 companies now I think in prepared remarks. You expect to be somewhere between 32 to 34 at the end of the year and you've talked about possibly three to four exits of the legacy business, if that’s double in the course of the year. Wouldn’t this be one of the most active years for you in terms of new investments and am I thinking about this right?

Steve Zarrilli

Well actually, Arnie, that number would suggest probably two more exits this year and eight total deployments. That would actually be pretty much in line with what we did last year from a deployment prospective into new companies. And the year before that was six. So if we do -- if you target eight this year, '14 was six, '15 was eight, '16 was eight. So we're basically targeting somewhere between six to eight this year as well.

Arnold Estaner

And obviously you've talked about in response to Lee's question, a more consistent return and steadier results. To the extent you may add eight this year, how many of these are essentially in the pipeline in some form already?

Steve Zarrilli

Actually two of the eight are in -- under term sheet and the pipeline is, as you would expect is very solid and on pace with the data that we've seen in prior periods, with regards of number of opportunities being presented.

Arnold Estaner

My final question relates to the legacy businesses, which you spoke about on your last conference call. They haven't been showing very much growth. Can you give us a sense of the performance of the three of -- the three legacy business in total and perhaps give us a sense of what percent of your total revenues and total EBITDA they account for?

Steve Zarrilli

Yes, so, on average those companies have been growing fairly slowly, comes in that 1% to 5%. There is one of those four that we tend to focus on as legacy that is actually starting to accelerate its growth. It had a little bit of a pivot in the marketplace and it's beginning to accelerate on revenue growth, and that's beyond. When I look at the total revenue, actually Jeff has the number here, he can share with you, but with regard to the other parts of your questions, let me turn it over to Jeff so at he can give you some guidance.

Jeff McGroarty

Of course, thanks Steve. Those three companies and our guidance for 2016 in aggregate, we're talking about a $124 million.

Arnold Estaner

So, excluding the roughly one third or so -- one quarter, one third of your total revenues, what is the growth rate embedded in the remaining companies in your portfolio?

Steve Zarrilli

As we alluded to in the previous remarks we're looking at about 15% to 17% in aggregate for the remainder of the companies.

Arnold Estaner

Since John Shave's letting me ask more than my one question and a follow-up, as you look at the growth rate expected on some of your targeted companies, would you expect that the overall growth rate for Safeguard to accelerate to the extent you can add these to your portfolio, are they fast or growing?

Steve Zarrilli

You're talking about the new companies that we're looking at, that are say under term sheet or in our business line?

Arnold Estaner

Yes.

Steve Zarrilli

The typical companies we're looking at tend to be in the -- what we call the initial revenue space, which is doing anything up to $5 million and typically they're growing quite nicely and taking our capital to invest it in sales and marketing and continued product development to continue and accelerate even if there's sales growth.

Arnold Estaner

So, to sum this up Steve, to the extent you can actually complete these acquisitions, as investors look to 2017, your growth rate should accelerate from the current levels. Even though it's pretty good now, it should accelerate nicely in the next year. Is that a fair way to think of this?

Jeff McGroarty

Yes, before Steve comes in, I'll just answer to say that the only thing that works against that math that you could imagine, because we're talking about relatively small companies, even if they're growing at a high percentage, when we've got three very large companies comparatively that aren't growing at that nearly the same rate, when we look at it in the aggregate those smaller companies, even if they're growing quite nicely aren't going to move the aggregate amount as much as you might like.

Steve Zarrilli

Unless we're able to successfully get our ownership in those companies into the hands of others. And that's also why it's important that we begin to move very deliberately on trying to find exit opportunities for these more mature legacy businesses that we have.

Operator

Your next question comes from Bob Labick with CJS Securities. Your line is open.

Lee Jagoda

I didn't want Arnie to dominate the Q&A, so I figured I'd hope in for one more. As you look at Transactis, given you had the decision to either invest or likely exit in the recent round, you chose to double down. Can you talk about the future prospects there and what gets you excited about that holding?

Steve Zarrilli

Well, Transactis, as we alluded to in our prepared remarks and in some of the other information that we've share publicly, it's in a sector of the marketplace right now that we think is very interesting and attractive segment. There's still presentment and payment, capabilities that they have which is basically provided as a white label solution to large financial institutions and other players in the market. They're setting the foundation for what I think is going to be a phenomenally successful business and we at no time wanted to exit this opportunity. In fact, I think this transaction just goes to further demonstrate Lee, that we were able to not only put some additional capital to work, $5 million on our part; but we got five large money share financial institutions to participate, who as you can imagine are going to help drive revenue growth with this business, because now as shareholders, they have a vested interest in making sure that this company succeeds in some very grand way. So for us, this is actually a perfect example of what we think is -- what we could do and do well. And we're less than three years into this relationship with Transactis. So we're within the guidelines of what we consider to be a reasonable period of time to continue to support and develop a company like Transactis for some greater growth.

Operator

There are no further questions at this time. I will now turn the call back over to the presenters.

Steve Zarrilli

Thank you and thank you for being with us today. We look forward to keeping you apprised as to our progress throughout the year.

Operator

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

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