Safeguard Scientific

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SAFEGUARD SCIENTIFICS : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-Q)

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08/09/2019 | 07:34 pm


Cautionary Note Concerning Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that are
based on current expectations, estimates, forecasts and projections about
Safeguard Scientifics, Inc. ("Safeguard" or "we"), the industries in which we
operate and other matters, as well as management's beliefs and assumptions and
other statements regarding matters that are not historical facts. These
statements include, in particular, statements about our plans, strategies and
prospects. For example, when we use words such as "projects," "expects,"
"anticipates," "intends," "plans," "believes," "seeks," "estimates," "should,"
"would," "could," "will," "opportunity," "potential" or "may," variations of
such words or other words that convey uncertainty of future events or outcomes,
we are making forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. Our forward-looking statements are subject to risks and uncertainties.
Factors that could cause actual results to differ materially, include, among
others, our ability to make good decisions about the deployment of capital, the
fact that our partner companies may vary from period to period, our substantial
capital requirements and absence of liquidity from our partner company holdings,
fluctuations in the market prices of our publicly traded partner company
holdings, competition, our inability to obtain maximum value for our partner
company holdings, our ability to attract and retain qualified employees, our
ability to execute our strategy, 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 Company Act
of 1940, and risks associated with our partner companies and their performance,
including the fact that most of our partner companies have a limited history and
a history of operating losses, face intense competition and may never be
profitable, the effect of economic conditions in the business sectors in which
Safeguard's

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partner companies operate, compliance with government regulation and legal
liabilities, all of which are discussed in Item 1A. "Risk Factors" in
Safeguard's Annual Report on Form 10-K and updated, as applicable, in "Factors
that May Affect Future Results" and Item 1A. "Risk Factors" below. Many of these
factors are beyond our ability to predict or control. In addition, as a result
of these and other factors, our past financial performance should not be relied
on as an indication of future performance. All forward-looking statements
attributable to us, or to persons acting on our behalf, are expressly qualified
in their entirety by this cautionary statement. We undertake no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise, except as required by law. In light
of these risks and uncertainties, the forward-looking events and circumstances
discussed in this report might not occur.
Business Overview
Over the recent past, Safeguard has provided capital and relevant expertise to
fuel the growth of technology-driven businesses in healthcare, financial
services and digital media. Throughout this document, we use the term "partner
company" to generally refer to those companies in which we have a significant
equity interest. In many, but not all cases, we will also be actively involved,
influencing development through board representation and management support, in
addition to the influence we exert through our equity ownership. From time to
time, in addition to these partner companies, we also hold relatively small
equity interests in other enterprises where we do not exert significant
influence and do not participate in management activities. In some cases, these
interests relate to former partner companies.

In January 2018, Safeguard announced that we will not deploy any capital into
new partner company opportunities and will focus on supporting our existing
partner companies and maximizing monetization opportunities to enable returning
value to shareholders. In that context, we have, are and will consider
initiatives including, among others: the sale of individual partner companies,
the sale of certain or all partner company interests in secondary market
transactions, or a combination thereof, as well as other opportunities to
maximize shareholder value. As a result of the debt repayment, we anticipate
returning value to shareholders in the form of stock repurchases and/or
dividends, based on prevailing market conditions and other factors.

Safeguard's existing group of partner companies consists principally of
technology-driven businesses in healthcare, financial services and digital media
that are capitalizing on the next wave of enabling technologies including
business intelligence and predictive analytics. We strive to create long-term
value for our shareholders by helping our partner companies to increase their
market penetration, grow revenue and improve cash flow. Safeguard typically
deploys up to $25 million in a company.

Results of Operations
We operate as one operating segment based upon the similar nature of our
technology-driven partner companies, the functional alignment of the
organizational structure, and the reports that are regularly reviewed by the
chief operating decision maker for the purpose of assessing performance and
allocating resources.
There is intense competition in the markets in which our partner companies
operate. Additionally, the markets in which these companies operate are
characterized by rapidly changing technology, evolving industry standards,
frequent introduction of new products and services, shifting distribution
channels, evolving government regulation, frequently changing intellectual
property landscapes and changing customer demands. Their future success depends
on each company's ability to execute its business plan and to adapt to its
respective rapidly changing market.
As previously stated, throughout this document, we use the term "partner
company" to generally refer to those companies in which we have an economic
interest and in which we, generally, but not all cases, are actively involved
influencing development, usually through board representation in addition to our
equity ownership. During 2019 we ceased using the equity method of accounting
for Hoopla Software, Inc. and T-REX Group, Inc. as a result of other new
investors diluting our interest. We have retained our equity interests under the
Other accounting method.
The following listing of our partner companies includes only entities which were
considered partner companies as of June 30, 2019. Certain entities which may
have been partner companies in previous periods are omitted if, as of June 30,
2019
, they had been sold or are no longer considered a partner company as a
result of a reduction in our ownership interest and value

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ascribed to the entity.



Safeguard Primary Ownership as of June 30,
Partner Company 2019 2018 Accounting Method
Aktana, Inc. 18.8% 24.5% Equity
Clutch Holdings, Inc. 41.2% 41.2% Equity
Flashtalking 10.1% 10.3% Other
InfoBionic, Inc. 25.4% 39.5% Equity
Lumesis, Inc. 43.6% 43.8% Equity
MediaMath, Inc. 13.4% 20.5% Other
meQuilibrium 32.7% 36.2% Equity
Moxe Health Corporation 32.4% 32.4% Equity
NovaSom, Inc. 31.7% 31.7% Equity
Prognos Health Inc. 28.7% 28.7% Equity
QuanticMind, Inc. 24.2% 24.7% Equity
Sonobi, Inc. 21.6% 21.6% Equity
Syapse, Inc. 19.4% 20.0% Equity
Trice Medical, Inc. 16.7% 24.8% Equity
WebLinc, Inc. 38.5% 38.0% Equity
Zipnosis, Inc. 37.7% 25.4% Equity







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Three months ended June 30, 2019 versus the three months ended June 30, 2018



Three months ended June 30,
2019 2018 Variance
(In thousands)
General and administrative expense $ (2,603 ) $ (5,148 ) $ 2,545
Other income (loss), net 3,118 (2,452 ) 5,570
Interest income 763 666 97
Interest expense (5,682 ) (3,422 ) (2,260 )
Equity income (loss), net 40,497 (14,540 ) 55,037
$ 36,093 $ (24,896 ) $ 60,989


General and Administrative Expense. General and administrative expense decreased
$2.5 million million for the three months ended June 30, 2019 compared to the
prior year period primarily due to the lower overall level of staffing, the
absence of the $1.7 million severance charge for employees who were terminated
in connection with our change in strategy in 2018, and $0.9 million of lower
professional fees, primarily due to costs associated with activist shareholder
matters in the prior year. The three months ended June 30, 2019 also includes an
increase of $0.3 million for depreciation of our leasehold improvements as a
result of our exit from our prior facility in June 2019.
Other Income (Loss). Other Income (loss) improved $5.6 million for the three
months ended June 30, 2019 compared to the prior year period. Other income for
three months ended June 30, 2019 included a $3.0 million of income related to
the decrease in the fair value of the amended credit facility repayment feature
liability as compared to a $2.5 million loss related to an increase in the same
liability in the prior comparable period.
Interest Income. Interest income increased $0.1 million for the three months
ended June 30, 2019 compared to the prior year period was primarily attributable
to higher investment income resulting from our marketable securities resulting
from a higher daily average investment balances, partially offset by lower
average notes receivable from our partner companies.
Interest Expense. Interest expense increased $2.3 million for the three months
ended June 30, 2019 compared to the prior year period primarily due to a $2.9
million
make-whole interest payment related to the credit facility, net of the
absence of any borrowings under the convertible debentures that were outstanding
in 2018.
Equity Income (loss), net. Equity income (loss), net increased $55.0 million for
the three months ended June 30, 2019 compared to the prior year period. The
components of equity income (loss), net for the three months ended June 30, 2019
and 2018 were as follows:
Three months ended June 30,
2019 2018 Variance
(In thousands)
Gains on sales of partner interests $ 50,441 $ 4,153 $ 46,288
Unrealized dilution gains on the decrease of our
percentage ownership in partner companies 1,290 3,515 (2,225 )
Loss on impairment of partner companies (2,965 ) (6,567 ) 3,602
Share of loss of our equity method partner
companies (8,269 ) (15,641 ) 7,372
$ 40,497 $ (14,540 ) $ 55,037


The gains on sale of partner interests for the three months ended June 30, 2019
is comprised of Transactis of $50.4 million. The gain on the sale of partner
company interests for the three months ended June 30, 2018 is comprised of the
sale of Cask Data.
The unrealized dilution gains for the three months ended June 30, 2019 was the
result of meQuilibrium, T-Rex and Syapse, who each raised additional equity
capital that diluted the Company's interest in those entities.
The loss on impairment of partner companies for the three months ended June 30,
2019
is comprised of NovaSom, Inc.'s August 2019 bankruptcy filing. For the
three months ended June 30, 2018, the loss on impairment of partner companies is
comprised of Apprenda, which ceased operations.

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The change in our share of equity loss of our equity method partner companies
for the three months ended June 30, 2019 compared to the prior year period was
due to a decrease in the number of partner companies and a decrease in losses
associated with the remaining partner companies.


Six months ended June 30, 2019 versus the six months ended June 30, 2018



Six months ended June 30,
2019 2018 Variance
(In thousands)
General and administrative expense $ (5,660 ) $ (10,738 ) $ 5,078
Other income (loss), net 1,233 (3,887 ) 5,120
Interest income 1,636 1,465 171
Interest expense (8,217 ) (6,112 ) (2,105 )
Equity income (loss), net 68,764 (11,794 ) 80,558
$ 57,756 $ (31,066 ) $ 88,822


General and Administrative Expense. General and administrative expense decreased
$5.1 million for the six months ended June 30, 2019 compared to the prior year
period primarily due to the lower overall level of staffing, the absence of the
$2.8 million severance charge for employees who were terminated in connection
with our change in strategy in 2018, and $1.9 million of lower professional
fees, primarily due to costs associated with activist shareholder matters in the
prior year. The six months ended June 30, 2019 also includes an increase of $0.7
million
for depreciation of our leasehold improvements as a result of our exit
from our prior facility in June 2019.
Other Income (Loss). Other Income (loss) improved $5.1 million for the six
months ended June 30, 2019 compared to the prior year period. Other income for
the six months ended June 30, 2019 included $1.0 million of income related to
the decrease in the fair value of the amended credit facility repayment feature
liability as compared to a $2.5 million loss related to an increase in the same
liability in the prior comparable period. Other loss for the six months ended
June 30, 2018 also reflected a $1.2 million decrease in the fair value of shares
of Invitae Corporation common stock obtained in connection with the sale of Good
Start Genetics
in August 2017.
Interest Income. Interest income increased $0.2 million for the six months ended
June 30, 2019 compared to the prior year period primarily attributable to higher
investment income resulting from our marketable securities resulting from a
higher daily average investment balances, which was partially offset by lower
average notes receivable from our partner companies.
Interest Expense. Interest expense increased $2.1 million for the six months
ended June 30, 2019 compared to the prior year period primarily due to a $2.9
million
make-whole interest payment related to the credit facility, net of the
absence of any borrowings under the convertible debentures in 2019 that were
outstanding in 2018.
Equity Income (loss), net. Equity income (loss), net increased $80.6 million for
the six months ended June 30, 2019 compared to the prior year period. The
components of equity income (loss), net for the six months ended June 30, 2019
and 2018 were as follows:
Six months ended June 30,
2019 2018 Variance
(In thousands)
Gains on sales of partner interests $ 85,573 $ 18,176 $ 67,397
Unrealized dilution gains on the decrease of our
percentage ownership in partner companies 1,760 3,081 (1,321 )
Loss on impairment of partner companies (2,965 ) (6,567 ) 3,602
Share of loss of our equity method partner
companies (15,604 ) (26,484 ) 10,880
$ 68,764 $ (11,794 ) $ 80,558


The gains on sales of partner interests for the six months ended June 30, 2019
is comprised primarily of Propeller of $34.9 million and Transactis of $50.4
million
. The gains on sales of partner company interests for the six months
ended June 30, 2018 is comprised of Spongecell's merger with Flashtalking, the
repayment of the note from Nexxt (fka Beyond.com), and the sale of Cask Data.

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The unrealized dilution gains for the six months ended June 30, 2019 was the
result of meQuilibrium, Syapse, Trice, and T-Rex, who each raised additional
equity capital that diluted the Company's interest in those entities.
The loss on impairment of partner companies for the six months ended June 30,
2019
is comprised of NovaSom, Inc., which was unable to service its debt
obligations. For the six months ended June 30, 2018, the loss on impairment of
partner companies is comprised of Apprenda, which ceased operations.
The change in our share of equity loss of our equity method partner companies
for the six months ended June 30, 2019 compared to the prior year period was due
to a decrease in the number of partner companies and a net decrease in losses
associated with the remaining partner companies.
Income Tax Benefit (Expense)
Income tax benefit (expense) was $0.0 million for the three and six months ended
June 30, 2019 and 2018. We have recorded a valuation allowance to reduce our net
deferred tax asset to an amount that is more likely than not to be realized in
future years. Accordingly, the income tax provision that would have been
recognized in the six months ended June 30, 2019 and 2018 was offset by changes
in the valuation allowance.
Liquidity and Capital Resources
As of June 30, 2019, we had $72.9 million of cash and cash equivalents and $25.0
million
of marketable securities and trading securities for a total of $97.9
million
. As of June 30, 2019, we had $44.5 million of principal outstanding on
our Credit Facility, which was repaid in full in July 2019.
In January 2018, Safeguard announced that, from that date forward, we will not
deploy any capital into new partner company opportunities and will focus on
supporting our existing partner companies and maximizing monetization
opportunities to return value to shareholders. In that context, we have, are and
will consider initiatives including, among others: the sale of individual
partner companies, the sale of certain partner company interests in secondary
market transactions, or a combination thereof, as well as other opportunities to
maximize shareholder value. As a result of the debt repayment, we anticipate
returning value to shareholders in the form of stock repurchases and/or
dividends, based on prevailing market conditions and other factors.
The Company was subject to a Credit Facility consisting of a term loan.
Repayment terms under the Credit Facility included a make-whole interest
provision equal to the interest that would have been payable had the principal
amount subject to repayment been outstanding through the maturity date of the
Credit Facility. If the aggregate amount of our qualified cash at any quarter
end date exceeded $50.0 million, we were required to prepay outstanding
principal amounts under the Credit Facility, plus any applicable interest and
prepayment fees, in an amount equal to such excess. Based on this requirement,
the Company made a principal payment of $24.0 million and a make-whole interest
payment of $2.9 million on April 15, 2019 based on the Company's qualified cash
at March 31, 2019. Further, the Company repaid the remaining obligation,
including $49.5 million of principal, $4.1 million of make-whole interest and
$0.9 million of accrued interest, in July 2019.
The Credit Facility required us to (i) maintain a liquidity threshold of at
least $20 million of unrestricted cash; (ii) maintain a minimum aggregate
appraised value of our ownership interests in our partner companies, plus
unrestricted cash in excess of the liquidity threshold, of at least $350 million
less the aggregate amount of all prepayments; (iii) limit deployments to only
existing partner companies and such deployments may not exceed, when combined
with deployments after January 1, 2018, to $40.0 million in the aggregate
through the maturity date; and (iv) limit certain expenses (which excluded
severance payments, interest expense, depreciation and stock-based compensation)
incurred or paid to no more than $11.5 million in any twelve-month period after
the date of the amendment (or such shorter period as has elapsed since the date
of the amendment). Additionally, the Company was restricted from repurchasing
shares of its outstanding common stock and/or issuing dividends until such time
as the Credit Facility is repaid in full. As of June 30, 2019 and the date the
loan was repaid, we were in compliance with all applicable covenants.
In 2015, the Company's Board of Directors authorized us, from time to time and
depending on market conditions, to repurchase up to $25.0 million of the
Company's outstanding common stock. During the year ended December 31, 2018 and
the six months ended June 30, 2019, we did not repurchase any shares under this
authorization.
We are required to return a portion or all the distributions we received as a
general partner of a private equity fund for further distribution to such fund's
limited partners ("clawback"). Our ownership in the fund is 19%. The clawback
liability is joint and several, such that we may be required to fund the
clawback for other general partners should they default. In 2017, we were
notified by the fund's manager that the fund was being dissolved and $1.0
million
of our clawback liability was paid. The maximum additional clawback
liability is $0.3 million which was reflected in Other long-term liabilities on
the Consolidated Balance Sheet at June 30, 2019.

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Our ability to generate liquidity from sales of partner companies, sales of
marketable securities and from equity and debt issuances has been adversely
affected from time to time by adverse circumstances in the U.S. capital markets
and other factors. The transactions we enter into in pursuit of our strategy
could increase or decrease our liquidity at any point in time. As we seek to
provide additional funding to existing partner companies or commit capital to
other initiatives, we may be required to expend our cash or incur debt, which
will decrease our liquidity. Conversely, as we dispose of our interests in
partner companies from time to time, we may receive proceeds from such sales,
which could increase our liquidity. From time to time, we are engaged in
discussions concerning acquisitions and dispositions which, if consummated,
could impact our liquidity, perhaps significantly. The Company believes that its
cash, cash equivalents and marketable securities at June 30, 2019 will be
sufficient to fund operations past one year from the issuance of these financial
statements.
Analysis of Consolidated Cash Flows
Cash flow activity was as follows:

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