Safeguard Scientifics, Inc. (NYSE:SFE) Q4 2010 Earnings Call March 3, 2011 9:00 AM ET
John Shave - Vice President of Business Development and Corporate Communications
Peter Boni - President & Chief Executive Officer
Steve Zarrilli - Senior Vice President and Chief Financial Officer
Bob Labick - CJS Securities
Matthew Pommer - ROTH Capital
Bill Sutherland - Boenning & Scattergood
Sam Rebotsky - SER Asset Management
Good day ladies and gentlemen and welcome to Safeguard Scientifics’ fourth quarter and year end 2010 results conference call. At this time all participants are in a listen only mode. Later we will conduct a question and answer session and instructions will be given at that time. If anyone should require assistance during the conference please press star then 0 on your touchtone telephone. And as a reminder this is being recorded. I would now like to introduce Mr. John Shave, Vice President of Business Development and Corporate Communications. You may begin.
Good morning. Thank you Mary and thank you for joining us for Safeguard Scientifics conference call and update. Joining me on today’s call are Peter Boni, Safeguard’s President and Chief Executive Officer, and Steve Zarrilli, Senior Vice President and Chief Financial Officer. During today’s call Peter will review highlights of 2010 and provide an outlook for 2011. Then Steve will discuss financial results and strategy. After that we’ll open the line for your questions.
Before we begin I must remind you that today’s presentation includes forward-looking statements. Reliance on forward-looking statements involve certain risks and uncertainties including but not limited to the uncertainty of future performance of our partner companies and the risks of acquisition or disposition of interests in partner companies, capital spending by customers and the effect of regulatory and economic conditions generally as well as the development of the life sciences and technology markets and other uncertainties that are described in our SEC filings.
During the course of today’s call words such as 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 financial 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 obligations to update forward-looking statements made today. Now here is Safeguard’s President and CEO Peter Boni.
Thanks John and thank you all for joining us today for this quarterly and year end update on Safeguard Scientifics and our partner companies. Results for the fourth quarter and then for the year ended December 31st were distributed earlier today. On many levels 2010 was a very rewarding year for Safeguard. We clearly demonstrated the power of our business model through the well timed exits of Safeguard’s stakes in Clarient and Abbott Radio Pharmaceuticals for a combined net proceeds of more than $180 million.
Aggregate partner company revenue growth was also strong, growing from $662 million in 2009 to 403 million in 2010 inclusive of Clarient and Clinova Pharmaceuticals, both sold in late 2010. The Clarient and Abbott deals demonstrate the quality of Safeguard’s network of highly credible, properly capitalized and well positioned companies. GE Healthcare acquired Clarient for $587 million and that provided us three times cash on cash return to Safeguard.
But it represented a five times increase in market cap from the time that Clarient was repositioned from its original ChromaVision Medical Systems heritage. Eli Lily bought Abbott for an initial payment of $300 million inclusive of amounts in escrow and that represented a three times cash on cash return to Safeguard. Now Safeguard could ultimately see its cash on cash return approach eight times based upon Abbott’s achievement of some typical regulatory and revenue milestones.
Not only were the gains from those deals absorbed by Safeguard’s tax loss carry forwards, but the proceeds also bolstered Safeguard’s financial strength and flexibility. We ended the year with $225 million in cash, cash equivalents and marketable securities on our balance sheet. That’s up from 106 million at year end 2009. In addition, in the spring of 2010 we refinanced the majority of our senior convertible debentures to match our expectations for cash sources and uses.
So today Safeguard’s growth stage life science and technology partner companies are well positioned for continued growth and improved profitability. With a good deal of confidence, we expect additional value to be created in 2011 and again in 2012. We believe that Safeguard’s current achievements can be credited to our steadfast diligence and our focus on several specific segments within the life sciences and technology industries that exploit five strategic themes that are driving growth: maturity, migration, conversions, compliance and cost containment.
We typically deploy up to $25 million in growth capital per company and then time our exits from ownership positions in these companies to achieve aggregate, targeted, risk adjusted returns of capital from three to five times. Exit opportunities may arise at any time and in many different forms including privately negotiated sales of securities or assets, public offerings of securities or in the case of a publicly traded partner company, the sale of securities in the open market.
If an opportunity clears our strategic growth and return hurdles we’ll respond appropriately. We’ll not deploy capital or pursue exits simply for activity’s sake. In the meantime we’ll continue to work to build value in our partner companies, drive their growth and keep their spending plans in line. Now we have said this often but we really can’t say it enough. Discipline is the hallmark of our strategy.
As we begin 2011 we’ll also continue to explore ways to augment our capital and evaluate other models, which complement our current activities. Despite the momentum generated with our 2010 exits, we’re not resting. We have an expansive pipeline, which we are constantly evaluating for new opportunities to deploy capital.
Recently we announced the deployment of $5 million into ThingWorx, a company with disruptive technology designed to accelerate the development of applications connecting people, systems and devices. ThingWorx extends the key functionality of Web 2.0, social media and the semantic Web of the worldwide of things, creating a platform that amplifies the productivity of people through collective intelligence and user driven information.
ThingWorx will use its proceeds from this Series B financing to ramp product development as well as sales and marketing to launch its initial release. We welcome ThingWorx to the Safeguard family. 2010 life sciences and technology teams sourced and evaluated a large number of growth stage companies. From those pipelines we intend to augment Safeguard’s holdings with more winners. Additionally, as needed we intend to continue to build further expertise within our deal teams.
The US economy and global capital markets are recovering and evolving. However, they haven’t regained all of the lost ground. US economic growth resumed late last year despite still high unemployment and a weak housing industry. Regulatory uncertainty dampened the recovery in some financial and healthcare markets. Capital markets staged a decent comeback in 2010 with activity in the M&A and IPO surging actually at year end last year.
Now activity for the beginning of 2011 is also encouraging although global and regulatory uncertainty remain factors. Throughout the growth and evolution of 2010 we remained focused on one principle objective and that’s value creation. We can report solid progress on that front too and Safeguard’s market cap increased nearly 70% in 2010. That’s on top of 150% increase in 2009.
Now every day this management team works to build value in Safeguard’s partner companies and then ultimately for Safeguard’s shareholders. Now let’s review some specific recent developments in some of our companies that underscore the power of Safeguard’s business model. Life sciences partner company Advanced Bio Healing or ABH filed a registration statement of an S1 statement with the SEC in preparation for an IPO.
Safeguard deployed $10.8 million of capital in ABH since 2007 - actually February of 2007. We have a 28% ownership position. Now because of their pending transaction I’m restricted in what I can further say about ABH. Our newest life sciences partner company is Good Start Genetics. They’re developing a comprehensive pre-pregnancy test for multiple genetic disorders. In late 2010 we deployed $6.8 million of capital and have a 26% primary ownership position in Good Start.
The company plans to move into a new permanent lab facility soon and remains on track to launch its product in Q4 of this year. Good Start may also develop other applications for its proprietary technology including oncology, cardiovascular and adult genetic disorders. We’re excited about the progress at NuPathe - that’s PATH on the NASDAQ and that is a specialty pharmaceuticals segment.
NuPathe recently gained FDA acceptance for its new drug application for its lead product Zelrix. This is a single use transdermal patch for the treatment of acute migraines. The company expects the FDA to complete its review of the NDA in the third quarter of this year and Zelrix is the first ever submission to the FDA of a transdermal patch for migraine treatment. The commercial launch of Zelrix is forecasted by the company to occur in the first half of next year.
In late 2010 NuPathe raised $43 million of net proceeds from an IPO, boosting its cash reserves. And Safeguard deployed $18.3 million of capital in NuPathe since September of 2006 and we own 18% of NuPathe’s outstanding common shares. A healthcare IT company, Advantage Healthcare Solutions and Protocol Systems, reported continued growth during the quarter and the year.
This sector also continues to be a hotbed of acquisition activity for strategic and financial buyers. AHS is now one of the nation’s top 10 providers of medical billing and practice management services for physicians, ambulatory surgical centers and healthcare providers. The company’s state of the art technology efficiently collects financial information and then accelerates the reimbursement of third party claims and patient payments enabling hospital physician groups to maximize revenue and decrease their billing and practice management costs.
AHS is achieving profitable growth. Their revenues were up approximately 115% from 2009 revenues. With the completion of another acquisition last year AHS expects continued growth in 2011. Safeguard deployed $15.3 million of capital in AHS since November of 2006 and have a 40% ownership stake. Portico Systems offers provider management software services to the health insurance industry that enables them to design, build, service, manage and reimburse their provider networks.
Portico has 39 healthcare customers today including Sigma, the Principle Financial Group and many of the big blues, all of whom serve more than 42 million members. During the fourth quarter of 2010 Safeguard provided Portico with a $5 million subordinated debt financing while the company also increased its credit facilities with Comerica Bank. Portico will use this financing to fuel the next level of market penetration.
Company revenues have grown at double digit rates over the last five years and in 2011 Portico may very well advance from our expansion stage to our high traction stage. Safeguard deployed $14.3 million in Portico since August of 2006 and have a 45% stake in the company. Within our Internet and new media companies growth at MediaMath is especially impressive. 2010 revenue was up over 150% from the previous year.
Demand continues to build for MediaMath’s enterprise class digital media buying and reporting services that enable advertising agencies and advertisers to analyze billions of daily impressions. In 2010 MediaMath made key strategic hires and acquired Adroit Interactive. Its continued momentum is reflected in the environment for digital display advertising. Wall Street Journal reported that for the first time ever in 2010 display ad spend exceeded newspaper advertising spend.
This supports one of our major themes - migration, demonstrating that consumers and businesses are migrating from offline to online for news, advertising and other forms of media. As a result of this continued momentum, Safeguard provided $9 million of follow on funding to MediaMath within the last couple of weeks in part to expand global sales and marketing initiatives as well as fuel further technology growth.
The company has been aggressively growing its domestic and its international operations opening offices in LA, Chicago, Boston, DC in the US and then Ontario, Canada and now London. Additional offices are slated to launch in 2011 in Latin America and Asia. In total, Safeguard has deployed 15.7 million in MediaMath since 2009 and we have a 23% primary ownership position.
There is no shortage of progress throughout Safeguard’s other partner companies but in the interest of time I’ll stop now and turn the call over to our CFO Steve Zarrilli. Steve will give you an update on our financial strategies and our performance. Go ahead Steve.
Thanks Peter. Good morning. I can elaborate on the details of any aspect of our financial or strategic initiatives during the Q&A period. Until then I want to discuss some big picture trends in our performance and strategic objectives. During 2010 we accomplished a series of objectives relating to increasing deployable capital, restructuring corporate debt and managing operating expenses.
Without question Safeguard is stronger, leaner and better positioned to execute our game plan than at any time over the last five years. And now and for the foreseeable future our strategic financial emphasis remains on further enhancing Safeguard’s strength and flexibility. We are also committed to exploring ways to further evolve our capital platform. At December 31, 2010 we had $225 million in cash, cash equivalents and marketable securities excluding cash held in escrow of 6.4 million and restricted cash equivalents of 16.8 million.
For comparison’s sake, the cash balance at December 31, 2009 was 106 million excluding 6.9 million held in escrow. Interestingly, our debt to equity ratio is now 1.3 or one to three. A year ago that ratio was one to one. After March 21st following an expected put to us of our 2.625% debentures totaling 31.3 million, we expected Safeguard’s debt to equity ratio will be one to five. During 2010 Safeguard restructured a large portion of the company’s remaining senior convertible debentures.
We negotiated with institutional investors to exchange 46.9 million of the company’s 2.625% senior convertible debentures due March of 2024 for a like amount of 10.125% debentures due in 2014. The new debentures have an effective conversion price of $16.50 subject to certain restrictions. We have thus improved the match of our long-term debt obligation with exit expectations and cash deployment plans.
Safeguard’s debt balance at December 31st was 78.2 million at face value, 31.3 million in the 2.625% senior convertible debentures due at March of 2024, which we anticipate paying off in March of 2011, and 46.9 million in the 10.125% senior debentures due in March of 2014. In the fourth quarter primary uses of cash were operating expenses of 3.9 million. This total excludes interest, non-cash stock-based compensation and depreciation expense.
For the year cash operating expenses totaled 15.3 million. It also included the use of our cash, deployment of 7.4 million to support the capital needs of existing partner companies. In 2011 we intend to continue our disciplined evaluation and pursuit of growth opportunities and to further augment existing capital with well timed exits and alternative pools of capital. We have also budgeted an approximate 19% increase in cash operating expenses for 2011 to provide for the cost of additional experienced deal team professionals as well as certain anticipated corporate development expenses.
Our pipeline is flush with interesting opportunities. We continue to focus on life sciences opportunities in the areas of diagnostics, devices, specialty pharmaceuticals and healthcare services. In technology we still pursue Internet and new media, financial tech, healthcare IT, transaction services and other technology enabled services. Our deal teams are actively evaluating the potential for several new capital deployments over the near term.
We may also fund an opportunity or two in a later stage firm generally defined as lower middle market private equity opportunity. The cash on cash return target for these later stage deals may be two times to three times versus our current three times to five times cash on cash expectation but the anticipated time horizon may also be shorter.
For 2011 we see between 100-150 million in cash to be put to use for five primary purposes - repayment of our senior convertible debentures, corporate expenses, capital deployment in new companies, follow on funding for partner companies and potential platform expansion initiatives. We believe that Safeguard and its partner companies remain well positioned for continued revenue traction and value creation in 2011 and beyond.
In 2010 our partner companies inclusive of Clarient and Clinova, each of which were sold in late 2010, grew revenue in the aggregate by 54% year over year. For 2011 Safeguard projects aggregate partner company revenue for its technology group to be in the range of 180-190 million, up between 29-36% from 2010. For the life sciences group due to Advanced Bio Healing’s registration statement on Form S1 filed on February 25th of this year, we are unable to provide aggregate partner company guidance for our life sciences group at this time.
Safeguard reported aggregate partner company revenue inclusive of Clarient and Clinova of $403 million for 2010, $262 million for 2009, $179 million for 2008 and 100 million for 2007. As a reminder, Safeguard reports the revenue of its equity method and cost method partner companies on a one-quarter lag basis.
Our partner companies continue to execute aggressively, are conserving cash or in some cases generating cash and making strategic and opportunistic acquisitions. Our partner companies closed multiple acquisitions in 2010 and remain opportunistic to make additional acquisitions either strategically or tactically in 2011. We work with the management teams of each of our partner companies to evaluate levels of existing and required capital, strength of personnel resources and unique opportunities for growth.
These ongoing processes allow us to assist management in unique ways to continually drive value creation and maturity. And with that I’ll turn it back to Peter.
Thanks Steve. Mary, let’s open the phone up for any questions.
Question and Answer Session
Thank you. Ladies and gentlemen, if you do have a question please press star then 1 on your touchtone telephone. If your question has been answered and you wish to remove yourself from the queue you may press the pound key. Our first question comes from Bob Labick from CJS Securities.
Good morning. Congratulations on a nice quarter and year.
A couple questions - first I wanted to touch on MediaMath. Obviously you just announced that you made follow on funding in there so I guess that means you’re pretty excited about the prospects. I was hoping you could tell us a little bit more about the funding, the use of those funds and where they stand in their business plan, if this brings them to a breakeven point or what will this do for them and where do you see them in three years?
MediaMath is obviously something we’re very excited about Bob. They’re recognized to be a leader in their space by a variety of indices pundits. They’ve been growing very rapidly and continue to gain traction. The global expansion is an important piece of this business plan on a going forward basis as well as continual enhancement of their product technology.
MediaMath could make money today if the board allowed them to but we have continued to encourage them to make investments for growth.
Okay. Great. And then part of your cash deployment goals, you mentioned five points, the last one being platform expansion. Without giving away too many secrets could you elaborate on a few opportunities that might be encompassed in platform expansion?
Bob, one of the things that we continue to evaluate is our ability to potentially access alternative pools of capital where we could end up either being the direct manager for that pool of capital or no less than a co-manager of that capital. And we will continue to explore those opportunities. The pace at which we’re presented with opportunities to look at has actually increased somewhat substantially over the last six months.
So we do have a real set of initiatives in 2011 to critically evaluate some of these opportunities and to determine which ones could actually work for Safeguard and Safeguard shareholders.
Okay. Great. And then just sticking with the uses of cash, you highlighted the cash operating expense increase but you went through it quickly. Could you just - obviously this is from a position in strength in planning. Could you tell us what the goals are with the I assume new personnel and if it’ll be for new areas of research or for augmenting your teams and how you see that coming into this year?
Bob, we intend to augment our team somewhat in both the technology and life sciences area. Actually the team downsized a little during the disruption we had over the last few years and we’re just backfilling now.
Okay. Great. I’ll let others ask questions. Thanks again.
Ladies and gentlemen, if you do have a question please press star then 1. Our next question comes from Matthew Pommer from ROTH Capital Partners.
Good morning everyone. Thanks for taking the questions. Let’s see - so first I wanted to ask on AHS what the company generated in revenue for 2010. How much of that was including the acquisition of AMS Plus and also what’s the annual revenue contribution you expect from AMS separate from the organic revenue in 2011?
Matt, I believe the CEO of AHS went on record that his 2010 was exceeding a $30 million run rate when we met in October. And the acquisition was actually concluded on New Year’s Eve and it was a $10 million plus company and that was not included in David’s forecast of $30 million plus run rate.
Fair enough. Thank you. And going back to the previous question line around MediaMath, I was wondering if you could help us with the gross margin of that business, whatever you’re willing to talk about. Is that - and where that might be trending? And secondly on that one, what the revenue contribution is from the new media buying platform Terminal 1.
The new platform is exactly that - it’s new. So they haven’t disclosed any traction thus far although they continue to grow and their growth is coming from all different sources of all the new product and all the new locations and all the new customers, number one. I don’t believe they have disclosed anything regarding their gross margins either so I’m not able to do that.
I can tell you that as they continue to grow and gain more size they continue to gain all of the metrics that you would hope from an efficiency standpoint.
Okay. Thanks for the questions.
Our next question comes from Bill Sutherland from Boenning and Scattergood.
Thanks for taking the question. Were you all the sole investor in this MediaMath raise?
Hi Bill. Yes we were in this last $9 million round. We were the sole investor.
Okay. And Peter and Steve, as you look at your pipeline of opportunities for investment are you leaning or potentially going to lean towards investments with a shorter return period as you all have discussed including in the mix? Or do you think your primary goal will remain more the three plus time return over three to five plus years kind of investment?
I’m going to ask Steve to take that.
Bill, we’re trying to actually achieve a really healthy balance of a diversified set of assets. So you’re going to see as many opportunities being evaluated by this team and potentially being acted upon that relate to earlier stage entities where we may be the largest and potentially the sole investor where the opportunity for an outsized return in that three to five or even greater range could be the expectation.
As well as putting some capital to work in opportunities that may be a little bit later stage - it’s more aligned with growth capital initiatives that the company may have. We think that that balance actually benefits our shareholders and those later stage deals may come with a little bit less risk and a little bit lower of a return from a cash on cash perspective. But we’re not abandoning what we’ve been doing over the last five years from an early stage perspective.
Really what we want to do is have just a nicer mix of opportunity within our categories of partner companies that really balance the investment profile of Safeguard.
Bill, we evaluate the returns of the industry, one thing really smacks and that is firms that have a singular discipline or a singular stage don’t have as good of returns as companies with multiple stages and multiple disciplines. So to Steve’s point of diversity that’s what we’re striving for.
This doesn’t force us to buy high and sell low.
The other thing I’ll leave you with Bill is that we’re not afraid to put capital to work either in an equity fashion or in a debt fashion. And you’ve seen us do that in the past and I think we’ve done it successfully.
Right. And Steve, would it be a potential strategy to move any investments internally if you were to go to some focuses later stage or does that not make sense for you all?
I’m not sure if I understand when you say move assets internally.
I guess I’m sort of thinking of this as just three pools of capital and I guess that’s not the way to think of it. You’re just going to be tilting your investments just based on the characteristics of them without putting them into specific pools. So that just answered my own question.
The last one is on Advantage Health. I was looking back at the companies that you initially invested in 2006 and I know you’re focused in a disciplined way on executing well timed exits. And I’m just curious as you think about Advantage or help us think about the potential exit there, the type, since much of its strategy has been consolidation and acquisition growth. Is there a natural buyer or is there a different kind of exit?
Well, in these situations it 80-90% will be a strategic buyer and 10-20% could ultimately be an IPO. We have stated that AHS from the get go was a consolidation vehicle that could grow organically. But in a $4 billion industry with lots of moms and pops, somewhat of a cottage industry, we viewed them as a consolidation vehicle.
Fundamentally they have been acquiring at four to five times EBITDA with all of the efficiencies that they gain. They significantly reduce the multiple on an EBITDA basis and we believe we have the opportunity to grow a $100 million business with a very strong EBITDA multiple as an exit whether it be through IPO or a strategic acquisition by a strategic.
And those strategic buyers Bill may be what you would typically call a BPO, a business process outsourcer - someone who is in the business of aggregating operations where they are providing these types of outsourced services like AHS does. So we actually think that to Peter’s point, once we can get to a certain level of revenue achievement this becomes a very interesting target for a number of different parties.
And I think you’re seeing the rapid evolution and maturation of AHS’ business, which has been accelerating over the last 24 months.
Great. Good work guys. Thanks a lot.
If you do have a question please press star then 1. Our next question comes from Sam Rebotsky from SER Asset Management.
Thanks for taking my questions. Congratulations Peter on exceeding mine, I’m sure most other investors’ expectations.
Thanks a lot Sam.
And as far as your tax loss carry forward, can you quantify the capital and the NOL and what your ability is to reflect it on the balance sheet, what is required and do you expect to do that in the near future?
Go ahead Steve.
The balance of the NOLs is approximately $260 million. Actually I think the real number is 266. Sam, we are not in a position right now to book any portion of that as a benefit or as an asset on the balance sheet of Safeguard. One of the principle hurdles that we need to achieve is whether it’s more likely than not that we’ll be able to utilize these benefits within some prescribed period of time.
And as you know with our business even though we have proper expectations and excitement around these monetization opportunities, we don’t have enough precision that would allow us from a GAAP perspective to get not only ourselves but our auditors satisfied with the realization of those tax attributes or benefits. So they are there for us to shelter wins and gains if you will. But they aren’t necessarily going to be showing up on our balance sheet any time soon as a tax benefit.
Okay. I guess I just have to consider that. One other consideration - you expect to raise 150 million and possibly 50 million. Is there any type of timeframe for this? Is there any (unintelligible) - that may occur?
Sam, I don’t think we said we were going to raise it. I thought we said we were looking at those sources or those five areas to consume that much cash.
Okay. So you don’t expect - did you have a shelf registration or no? Am I mistaken?
Sam, we do have a shelf. We completed that in 2010. So we could to your point, we are in a position if we thought it was appropriate for the business and for our shareholders, we could go out and raise additional capital using those shelf registrations. But right now our primary focus is to properly put to work the capital that we currently have today. And that’s the primary focus for 2011.
Well, wonderful. Good luck.
I am not showing any further questions. I would now like to turn it back for any additional remarks.
Thanks Mary. Well, once again we’re very pleased with our performance that we just outlined to you and optimistic that we’ll continue to build value going forward. And we continually look forward to giving you more progress reports on how well we’re doing. Thanks so much.
Ladies and gentlemen, this does conclude today’s program. You may now disconnect and have a wonderful day.
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