Safeguard Scientifics Inc

Good afternoon, and thank you for joining us for this presentation of Safeguard Scientific's third quarter 2022 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 involves 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 unilaterally control our companies, fluctuations in the market prices of any of our companies that are publicly traded, any 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 other factors, our past financial performance should not be relied on as an indication of future performance. During the course of today's call, we're to just expect, anticipate, believe, and intend. We'll be using our discussion of goals or events in the future. Management cannot provide any assurance that future results will be as described in our forelooking statements. We encourage you to read safeguards filings with the SEC, including our Form 10-Q, which describe in detail the risks and uncertainties associated with managing our business. The company does not assume any obligation to update any forward-looking statements made today. With that, I would now like to introduce Eric.

Thanks, Matt. Thanks for joining us on our third quarter 2022 earnings call. This afternoon, we'd like to cover the following topics. We'll provide an overview of the state of the portfolio and the broader market environment, provide an update on M&A activities, capital raising efforts, and follow-on deployments in the portfolio, share the latest public market peer multiples that we use, among other tools, to value the portfolio, provide some recent highlights on each company, and lastly, we will provide an update on the Houlihan-Loki process. After my remarks, I will hand the call over to Mark Herndon, our CFO, to walk you through the financials for the quarter. We will then open up the call for questions. I'll start with the state of the portfolio. As you know, we are focused on maximizing the value of our companies, monetizing our positions, and returning value to shareholders, while at the same time reducing ongoing operating expenses. When I joined Safeguard in Q2 2020, we had 17 portfolio companies. As of Q3 2022, we had eight companies left, and three of them are currently pursuing sales processes. Over the past two and a half years, We have generated $74 million in proceeds and returned $43 million in capital to safeguard shareholders. While we recognize the progress we've made over the past two and a half years, we are also cognizant of the volatile economic and capital markets environment in which we operate. These conditions impact how we manage the portfolio and influence our expectations of the value and timing of exits. Many of our comments today will be directed towards how we operate in the current market environment and how this environment affects our companies and strategy. Over the past quarter, the economy, the business environment, and the capital markets have deteriorated. This impacts our portfolio in several ways. First, for a few of our companies, the sales cycle for their products and services has lengthened, making it more difficult to meet revenue targets and determine future demand and revenue growth. We attribute this muted demand to pressure on corporate budgets, disruptions and delays caused by reductions in headcount occurring at many of our company's customers, and an otherwise more cautious stance towards making financial commitments. Interestingly, we have yet to see this impact on our companies that sell to healthcare or pharma customers, which constitutes the majority of our portfolio. but we are seeing some slowdown among Fortune 500 companies and small and medium-sized businesses. Second, raising equity or debt has become more challenging. Over the past few months, there has been a pullback in the pace of investing and lending by venture capitalists and debt providers. This has no impact on our companies which have recently secured capital, Moxie and Syapps, for example, but does impact those companies which are currently raising debt or equity. Third, the M&A environment has slowed considerably for both strategic as well as financial buyers. While deals are still getting done, for example, the Loomis sale, the bar for acquiring a company has gone up. The cost of capital has increased, and determining asset values has become more difficult. This could negatively impact the three safeguard companies that are currently pursuing sales processes. Regardless of the business and market environment, we are working very closely with our companies, pushing management teams and boards to take tough decisions that are necessary for the long-term health of each business. Fourth, nearly all of our companies have venture debt, which is typical for late-stage tech companies. Leverage introduces risks to each company and can also reduce the degrees of freedom that a company has to operate. Senior loans generally have financial covenants tied to the company's budgets. In situations where a company is out of compliance with its covenants, where the debt is amortizing, addressing the needs of the lender becomes one of the factors that the company must take into consideration. This could be done through providing additional capital to the company, restructuring or refinancing the loans, and or pursuing a more rapid exit. We are working closely with our companies to address situations where this could come into play, and our goal is to maintain as much operating and strategic flexibility as possible. Fifth relates to revenue growth. Each quarter, we report the aggregate revenue growth for the portfolio to provide some insight to our investors on the state of our companies. We do this on an aggregate basis to avoid sharing any one company-specific revenue or revenue growth which could impact its competitive positioning. For Q3, which is reported on a one-quarter lag basis, the aggregate trailing 12-month revenue growth was 11%. Note that not all of our companies are growing at this average rate. Some are growing at substantially higher rates, some lower, and a couple are not growing while they implement changes to their business model. For some of our companies, Booking's growth is a better leading indicator of future performance than revenue because what is booked in the current quarter is recognized as revenue in future periods. Where possible, we try to share Booking's information in the company-specific highlights. In summary, while we are operating in a difficult economy and facing uncertain capital markets, there's a lot to be excited about in the portfolio. One strategy in particular that we've begun to explore is to use Safeguard's resources, its cash and management oversight, to take a more aggressive role with one or two of our companies. In essence, we would play offense with one or two of our portfolio companies that have sound business models but are victims of the difficult current capital markets. This could come in the form of making more concentrated deployments in one or two names, setting the deal terms, in leading key strategic and operational initiatives at the company, all with a goal of generating substantially enhanced returns for Safeguard. This is still early, but we have direct experience and a track record taking advantage of dislocations in markets to deploy capital and down cycles to generate outsized returns. We'll update you on progress with this approach on our Q4 call. M&A. As described in our press release last month, Loomisys was acquired by Solve Advisors. Safeguard received $5.3 million in proceeds with additional proceeds to be released from escrows over the next 12 plus months. To connect the dots from our comments on the Q2 call, Loomisys was the company that we said received inbound interest from a strategic buyer and the parties had made significant progress towards the transaction. As mentioned at the outset of this call, we currently have three companies pursuing M&A processes. This includes the two that we mentioned on our Q2 call. As you recall, one had hired Piper and the other RBC as their bankers, and each was preparing to launch its process after Labor Day. Those two processes are in flight. A third company hired a banker, also Piper, and is kicking off a process this month. While each of these companies offers both financial and strategic value to several potential buyers, this is a tough time to be selling companies. So it is difficult to predict the outcome. And while parties are actively engaged with each opportunity, it is unclear how the broader slowdown in M&A will impact these situations. I'll now provide an update on capital raises. At a macro level, deal activity across all stages of venture capital showing signs of weakness. In fact, there's been three consecutive quarterly declines in the number of completed deals. Fewer potential investors seeking to deploy capital, combined with a shift in investment criteria towards more profitability, a development that we highlighted on our Q2 call, can impact the capital raise processes of our companies. With that said, four of our companies are currently seeking to raise capital. Two were mentioned on our Q2 call, where we stated that two companies were exploring capital raises ahead of launching M&A processes. Also on the Q2 call, we mentioned a third company that was launching a process to raise growth capital. Those three companies continue to have conversations with financing parties, but no LOIs have been signed. In addition, fourth company has had recent conversations with parties about raising capital, but those efforts are at an early stage. In parallel, we are working with each of these companies on alternative plans should capital not be available or not be available on terms that are satisfactory. Against that backdrop, we were pleased with the SIAPS announcement in July of their $35 million raise, which came from Innovata's capital with a concurrent investment by existing investors. Safeguard deployed $1.6 million in the inside convertible note as part of that round. Update on follow-on deployments. While our follow-on deployments in the portfolio have declined over the past two years, the current business environment could impact the capital we set aside to support each company going forward. The outcome of the four companies that are raising money could also impact how much capital we expect to require for the portfolio. Also, pursuing a more concentrated strategy that I highlighted earlier in my remarks could have an impact on the quantum on follow-on capital required. In every case, we have set a high bar for deploying more capital in the portfolio, so the returns and rationale need to be extremely compelling, and we discussed these criteria on our Q2 call. With that in mind, we have decided to maintain the maximum cash threshold at $18 million. To remind investors, this is the amount above which we would look to return cash to shareholders. In addition to the $1.6 million we deployed in SIAPS, subsequent to the quarter, Safeguard funded $500,000 to MeQilibrium as part of an inside convertible note round together with other MeQilibrium investors and We also made a $375,000 subordinated debt commitment to Trice alongside other Trice investors. Public market peer multiples. As we do each quarter, we provide the EV enterprise value to revenue multiples and consensus revenue growth rates of our public peers to help investors triangulate around potential valuations. Please keep in mind that this is only one of several valuation methodologies used and should not be relied upon exclusively. Differences in company size, growth rates, margins, net debt, capital structures, and liquidity discounts all come into play. Note that the following data is as of October 26th. For our tech-enabled healthcare companies, The EV to 2022 revenue multiples for our publicly traded peers were 3.4 times down from 3.8 times on our Q2 earnings call. Consensus revenue growth for 2022 for tech-enabled healthcare companies is 10%. Given we're in the last quarter of 2022, it is appropriate that we also consider 2023 EV to revenue multiples and expected revenue growth rates. Our tech-enabled healthcare multiples were 3.2 times 2023 consensus revenue estimates, with 12% expected revenue growth for 2023. For Clutch, our single marketing technology position, EV to 2022 revenue multiples for the peer group were 2.7 times, down from 3.3 times in our last call, Consensus revenue growth for 2022 was 16%. 2023 EV multiples in revenue growth for the MarTech peers were 2.4 times 2023 consensus with 2023 revenue growth pegged at 14%. Please remember that from the implied enterprise values that are calculated using revenue multiples, we subtract out net debt for each of our portfolio companies and then run the remaining proceeds through a waterfall for each company that reflects its specific capital stack, options, management carve-outs, if any, deal fees, et cetera, to arrive at what Safeguard's stake could be worth. Companies with more net debt will, by definition, have less available proceeds for the equity holders, and companies with more complicated preferred capital structures can also impact safeguards proceeds depending on where we sit in the capital stack. From an equity perspective, while the month of October posted gains, since our Q2 call, markets have sold off, with the S&P down 8%, the Russell 2000 down 6%, our healthcare peers down 14%, and our MarTech peers down 35%. Year to date, S&P, and Russell 2000 are both down around 20%. Healthcare peers are down 25% and MarTech peers are down 62%. I will now go through the name by name highlights for the portfolio. Note that these are selected highlights for the quarter and do not reflect the risks inherent in each company. Octana met its product bookings through Q3 of this year. The company added new logos, including Novo, Nordisk, and Nestle. It reduced roughly $10 million in annual operating expenses and expects to achieve operating cash flow in 2023. For SIAPS, we mentioned their $35 million financing led by Innovata's capital earlier. Also of note are key collaboration and partnership announcements with Science 37, Genesis, and Merck. Prognos completed its business transition to a marketplace model. This should position the company for rapid growth with both data providers and customers. The company signed three new marketplace data partner contracts in Q3, bringing the year-to-date total to 10 new agreements. Prognos also sold its non-core underwriting business to Gradient AI. Trice experienced Q3 year-on-year revenue growth of over 30%. The company was EBITDA positive in August for the first time and expects to be consistently EBITDA positive later next year. Its new MyEye 25-degree camera release led to over 50% growth in disposable carpal tunnel systems. Infobionic posted continued year-on-year growth in ARR, annualized recurring revenue, with a 70% increase year-on-year in deployed devices. Its sales pipeline continues to build momentum, especially with large health systems, and the Mayo relationship remains strong, with recent IDTF deals in addition to Mayo Clinic deployments. From equilibrium, its contracted ARR was up 18% year-on-year in Q3, and its revenues were up 20% year-on-year. At the company's recent annual resilience conference, Paychex, PepsiCo, Marriott, Florida Blue, Ford Motor Company, and Xcel Energy were all honored for their achievements in supporting employee resilience, a strong endorsement of Mequilibrium's value proposition by these hallmark companies. Moxie implemented 56 new connections in Q3 and each quarter of 2022 has seen a record number of connections. The company has 24 new providers in its network as of Q3, and the fourth quarter provider sales pipeline is strong. For Clutch, September was the company's highest recurring revenue month in its history, achieving over 20% growth for the nine months through September. It also had its strongest sales quarter in company history, adding over $1 million in ARR in Q3 2022. I'll now provide an update on our strategic process with Houlihan Loki. Let me start by reminding investors that our base case plan is to run off the portfolio in the ordinary course and return capital to shareholders. We retained Houlihan Loki in Q1 2021 to see if we could enhance shareholder value over and above this base case plan. This enhanced value could come from, among other things, monetizing our net operating losses, or NOLs, the public shell, or other aspects of safeguards infrastructure and operating footprint. Anything we consider on this front must be superior to the risk-adjusted returns of the base case runoff plan. Having said that, we are in discussions with a number of parties and wanted to provide you with an update. First, based on the feedback we have received from parties, we do not anticipate selling the portfolio in bulk or in packages. Put simply, this portfolio does not fit well as a secondary sale, and that approach would not be in the shareholders' best interests. An approach that we have been exploring is to design a structure that ring fences our portfolio interests and allows the exits to occur in the ordinary course, similar to our base case plan, with proceeds returned to safeguards current shareholders. We would then use the public shell that would have the NOLs and some cash left behind, and with this shell, we would acquire another entity, assets, or a company, thereby preserving the NOLs in building an additional potential source of value to safeguard shareholders. In this way, shareholders would receive the vast majority of the proceeds from the legacy portfolio as it run off, while maintaining an ownership interest and the upside in a new go-forward business. There are a variety of regulatory and economic complexities defining a structure that meets our objectives. but we've worked with outside tax and legal advisors and have come up with an approach that we believe achieves these goals. The next requirement is finding a target that we believe would create meaningful value as a public company and enhance returns to safeguard shareholders. Working with Houlihan Loki, we've examined a number of potential targets, including operating companies, portfolios of assets, and asset managers, to name a few, each of whom could be viable as a public company. We've also considered whether any of our existing portfolio companies would be an appealing merger partner and if it made sense for that company to effectively go public through safeguard. We continue to spend time on this and are in discussions with several parties. There's no assurance that we'll be able to settle on a specific structure and or find a specific target that meets our objectives. We will keep you updated on the progress with these efforts. At this time, I'd like to hand the call over to our CFO, Mark Herndon.

Thanks, Eric.