Safeguard Scientifics, Inc. (NYSE:SFE) Q2 2023 Earnings Call Transcript

Safeguard Scientifics, Inc. (NYSE:SFE) Q2 2023 Earnings Call Transcript August 10, 2023

Matt Barnard: Good afternoon, and thank you for joining us for this presentation of Safeguard Scientifics’ Second Quarter 2023 Financial Results. Joining me on today’s call and webcast are Eric Salzman, Safeguard’s Chief Executive Officer; and Mark Herndon, Safeguard’s Chief Financial Officer. Following our prepared remarks, we will open up the call to 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 the outcomes of corporate strategic transactions, if any; the uncertainty of the future performance of our companies; our ability to make good decisions about the monetization of our companies; the ongoing support of our companies; our inability to adequately control our companies; fluctuations in the market prices of any of our companies that are publicly traded; and the effect of regulatory and economic conditions generally; and other uncertainties described in our filings with the SEC.

Many of these factors are beyond our ability to predict or control. As a result of these and other factors, our 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 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-Q, which describes 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. With that, I would now like to introduce Eric.

Eric Salzman: Thanks Matt. Thanks for joining us this afternoon for our Q2 2023 earnings call. Today, we will review the following topics. We’ll discuss today’s announcement regarding our strategic process, our plan to return excess cash to shareholders, and our efforts to materially reduce our ongoing operating expenses. We’ll review the portfolio and exit activities of our companies. Next, Mark will run us through the financials, and then we’ll open up the call for questions. I’ll start with the strategic process. As we announced in our press release, Safeguard is no longer in discussions with a single counterparty on a potential strategic transaction. After spending considerable time and effort, we could not reach an agreement on deal terms due in part to valuation, tax, and structural elements that were critical for us to do the — we also explored alternative structures with this counterparty, but were unable to reach agreement on a deal.

While other strategic transactions could still be considered, we are now working diligently on a plan to return excess cash to our shareholders, materially reduce our operating costs, and exit the assets over the next two years. First, we intend to return excess cash to shareholders in Q4 2023. We define excess cash as cash on hand, less amounts needed to be retained to support the operations of the company, satisfy liabilities, and pay one-time costs incurred as a result of pursuing this strategy. Based on our current estimates, which are being further refined and assuming a substantial reduction in our operating costs, which I will discuss in a couple of minutes, we estimate that approximately half of our Q4 2023 balance sheet cash could be returned to shareholders in a dividend.

Second, to substantially reduce our ongoing operating costs, safeguard is exploring delisting from NASDAQ in becoming a non-reporting [Technical Difficulty] company. To do this, we would file a proxy and seek a shareholder vote. Over the past few years, we have worked diligently to reduce our corporate expenses. These have come down from $7.1 million in 2019 to our current $3 million corporate expense run rate. However, at this time, we do not believe there is room to cut this much further. By delisting from NASDAQ and becoming a nonreporting company, we expect we can reduce our annual cash corporate expenses by up to 50% or $1.5 million. Assuming it takes the next two years to exit the remaining portfolio of companies, this would amount to $3 million in total savings, which represents a sizable benefit to Safeguard shareholders.

Third, we estimate the exit values from the remaining portfolio of companies, assuming normal conditions and course exits would range from $25 million to $45 million over the next two years. We expect the vast majority of these proceeds to come from companies that we categorize as Bucket 1, a concept we introduced last quarter and which I will expand upon a little later in my remarks. We are excited about this path as it reflects our commitment to maximizing value for shareholders and returning cash in a timely manner. I’ll next talk about the portfolio. Last quarter, we divided the portfolio of companies into two categories, Bucket 1 and Bucket 2. We would like to further refine this categorization and provide greater detail to help you better understand how we are thinking about the company’s and their expected exit values.

Redefine Bucket 1 companies as those that are well-capitalized, executing on their business plans, while navigating their share of risks and opportunities, which is typical of VC-backed companies at this size and stage. We believe that the vast majority of exit proceeds from Safeguard’s portfolio positions will come from Bucket 1 companies. Bucket 1 companies consists of Moxe, meQuilibrium, Prognos, and Clutch, the same companies we described last quarter. Now, let me provide a few highlights from Q2 on each of these companies. Note that these are not exhaustive, do not reflect all the risks inherent in these venture-stage companies. I’ll start with Moxe. Moxe posted first half 2023 revenue growth of 20% year-on-year. It signed another — with a top five electronic medical health record vendor, spanning its network coverage, and its bidirectional convergence product is gaining traction in the market with two leading health care providers using it.

meQuilibrium posted first half 2023 revenue growth of over 20% year-on-year. The company exceeded its budgeted revenue and EBITDA targets for the first half and it was operating cash flow positive in Q2. Clutch posted first half 2022 — excuse me, first half 2023 revenue growth of 35% year-on-year. It closed 10 new logos in the quarter and it began beta-testing embedded AI tools with select customers, allowing the customers the ability to generate content and improve their product and engagement recommendations. Prognos exceeded its revenue and EBITDA plan for the first half of 2023. The company announced a strategic partnership with GeneDx to help rare disease patients more rapidly gain access to potential treatment options and the company is adding Travis May, the Founder and former CEO of Datavant to Prognos’ Board.

Bucket 2 companies are those where we expect an outcome that returns a de minimis amount of capital to Safeguard. The expected outcomes for Bucket 2 companies are disappointing and results from any number of the following factors; an inability to attract additional equity capital due to business model, financial profile, or risk appetite in the current market; too high debt load and an inability to refinance the debt in the current market; the company’s path to breakeven is too distant to attract capital in the current environment. We have three companies in Bucket 2. While we haven’t directly identified them by name, the transactions announced in our earnings release for Aktana and Trice Medical would confirm that they are Bucket 2 companies.

For Aktana, we exited our investment in June as part of a senior lender-led restructuring and recapitalization that left investors with a de minimis ownership stake in the company. As part of that transaction, Safeguard was cashed out of its subordinated promissory note for a cash payment of $0.4 million. We have no further economic interest in the company post this transaction. For Trice Medical, we exited our position in July as part of a similar senior lender-led restructuring and recapitalization. In the Trice case, Safeguard retained a small, subordinated debt position in the recapitalized company, representing the value of our subordinated line of credit that we funded in December 2022 and January 2023. In addition, we [Technical Difficulty] small consent fee payable at maturity and retained a sub-2% ownership stake in the recap company.

We also have an eighth company, which is in an in-between category. This company is in the process of recapitalizing and raising third-party capital. Should this transaction come to pass, we expect the company to move to Bucket 1. Should this transaction not be completed, then this would move to Bucket 2. We expect resolution of the situation in the next 60 to 90 days. On an overall portfolio basis, I will note that we do not expect to deploy additional capital to any of our remaining companies. Sales processes. We have worked closely with our portfolio of companies to pursue M&A. And over the past 18 months, five of our eight companies launched M&A processes with reputable investment banks. Unfortunately, the outcomes of these processes have been disappointing and to-date, none of these M&A efforts have resulted in transactions.

On our Q1 call, we said that there were two companies in active M&A processes, one for an outright sale and the other for a merger. Neither deal move forward. A combination of company, business model, balance sheet, and the market environment have led to these outcomes. On a macro level, the late-stage VC market continues to experience headwinds amid a challenging financing and public exit environment. This is driven by a weak IPO market, reduced risk appetite from VCs, higher debt costs, and a pullback in investing by non-traditional investors. Having said that, there are signs of stabilization as evidenced by the fact that median valuations for most VC stage companies ticked up in Q2, and anecdotally, we are seeing some improvement in the overall M&A market.

I will now hand the call over to our CFO, Mark Herndon, to take you through the numbers in more detail.

Mark Herndon: Thanks Eric. Safeguard’s net loss for the quarter ended June 30th, 2023 was $2.9 million or $0.18 per share as compared to net income for the comparable 2022 second quarter at $0.5 million or $0.03 a share. The year-to-date period ended June 30th, 2023, was a net loss of $6.3 million or $0.39 per share as compared to $6.2 million or $0.38 per share for 2022. Safeguard ended the quarter with $15.1 million of cash, cash equivalents, restricted cash and marketable securities and continue to have no debt obligations. Our general and administrative expenses were $1.2 million for the second quarter of 2023 versus $1.1 million for 2022 on rounded basis, up slightly 3.5%. Similarly, our general administrative expenses were $2.4 million for both of the year-to-date periods.

The uptick in expenses was primarily the result of certain professional fees associated with our project [indiscernible]. Corporate expenses for the quarter, which represent general and administrative expenses, excluding stock-based compensation, severance expenses, and non-recurring and other items, were $0.7 million and $0.8 million on rounded basis for each of the second quarters of 2023 and 2022, respectively. The year-over-year decline was 12.2%. The corporate expenses for the six months ended June 30th, 2023 were $1.5 million as compared to the $1.7 million for the comparable 2022 period. The declines in corporate expenses were across a variety of expenses, but included lower employee costs, related taxes, and professional fees. We expect the quarterly level of corporate expenses have stabilized at this approximate level before we implement any cost structure changes referred to earlier.

With respect to our ownership interest, we have an aggregate carrying value at June 30th, 2023 of $13 million as compared to $15.4 million at December 31st, 2022. This quarter’s activity was limited to the $3 million deployment to Prognos that increased our carrying value and the application of the equity method of accounting, which reduced our carrying value based on our share of the losses of our companies. We also recorded a $0.2 million impairment this quarter related to one of our remaining other ownership ventures. Our reported share of the losses of our equity method ownership interest for the 3 months ended June 30th, 2023, was $2.8 million as compared to $3.9 million for the comparable period in 2022. This change is largely the result of several contracts reaching [Indiscernible] carrying value during late 2022 or even during 2023.

At that point, we generally ceased recording losses from that entity. I would also like to remind everyone that we report our share losses on the equity method company is on a one quarter lag. So, this quarter’s share of losses reflect the first quarter of 2023. Also with respect to our ownership interest, the third-party debt at this group of six remaining companies was approximately $135 million versus $134 million last quarter, essentially unchanged. And I’ll just note that the six companies remaining that we’re referring to are InfoBionic, meQuilibrium, Moxe, Prognos, Syapse, and Clutch. This group excludes Aktana and Trice who were in this disclosure last year where we no longer have an ownership interest. Cash at the same group of six companies was unchanged at $51 million.

However, you may recall that Prognos raised equity during the quarter. So, after considering their equity raise, there continue to be a decrease in the group’s cash, primarily related to the quarterly burn at three companies. In terms of revenue performance, we reported an 11.7% increase at this group of six companies for the trailing 12-month period ended March 31st, 2023 due to the one quarter lag. We continue to see consistent strong growth from Moxe and meQuilibrium. And this quarter, both Clutch and Syapse also showed improved revenue growth for this trailing 12-month period. Now, it is time for us to turn to the Q&A segment of the call. So, I’ll ask our operator to open the phone lines for questions.

Q&A Session

Operator: Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jason Stankowski with Clayton. Please go ahead.

Jason Stankowski: Hey guys. Can you hear me?

Eric Salzman: Yes, we can.

Jason Stankowski: Do you know if the return of capital, at least the first one, potentially in Q4, if it all goes that way, will be a return of capital similar to our dividend a few years ago?

Mark Herndon: Yes. And just for those that are on the phone, as a quick recap, in December of 2019, the company paid a $1 dividend per share, and that was a return of capital. So, effectively a nontaxable distributions to shareholders at that time. And that is based on a taxable analysis for the year and that was circa 2019. We were similarly — in a similar situation this year, we expect that we’ll be in that position. I’ll caveat it that everything can change if we have a transaction that flips us to a, — to use technical term, an accumulated profit position.

Jason Stankowski: That’d be a good problem to have, right?

Mark Herndon: Yes that would be okay. But we’ll address that if that occurs. But our expectation is that we will be in a similar circumstance.

Jason Stankowski: And then I don’t know when the decision will be made or how far along, but can you give us — assuming you continue to slow down the cost reduction path and prepare a proxy you have a thumbnail of what that timeline would look like? Is that a week process or like a three-month process? Or are you kind of ready to go?

Eric Salzman: Well, I would say we indicated a Q4 return of capital and that would correspond with the delisting process also. So, that’s good — that we’re planning for.

Jason Stankowski: Right. They’re not inextricably linked, right? You could do a dividend if you want, but I guess you’re saying they kind of are because you need that reduction in overhead to plan how much cash you actually want to keep. So, you need that approval to figure that out.

Eric Salzman: Exactly. One does not require the other, but input from one will determine what amount of money needs to be retained.

Jason Stankowski: Got it. Okay. I think that’s all I had. Thanks.

Eric Salzman: Thank you.

Operator: Thank you. [Operator Instructions] Matt, There are no questions on the audio bridge. You can take over.

Matt Barnard: We do not have any questions on the webcast either.

Eric Salzman: Okay. Well, thank you for joining us on the call today. And as always, please contact us if you have any follow-up questions. Thanks and have a good evening.