Safeguard Scientifics Inc (SFE) 2002 Q2 法說會逐字稿

Good morning. Thank you for joining us for Safeguard's second quarter 2002 conference call. Joining he is our president and chief executive officer, Tony Craig and Chris Davis, managing director and chief financial officer. The format will include both Tony and Chris making brief presentations, followed by a question-and-answer session. As we move to slide two, let me remind all participants during this conference call, the statements contained in this call and in the presentation that are not historical facts are forward-looking statements, which involve risks and uncertainties, including, but not limited to risks associate wide uncertainty of future performance of partner companies, acquisitions of additional partner companies and dispositions of partner companies, additional financial requirements, the effect of economic conditions in the business segment our partners operate, our ability to execute our strategy and other uncertainties described in the company's filings with the Securities and Exchange Commission. The company does not assume any obligation to update forward-looking statements or other information contained in this conference call and presentation. I will now introduce Tony Craig, president and chief executive officer of Safeguard.

Good morning. I am very happy to say that our (inaudible) continue on a downward trend. In this last quarter, we have been successful in making $44 million in funding and our cash balance remains strong at $190 million. I will share with you, as we go through this discussion, where we are in the strategy and perhaps observations on markets influencing our directions. Chris will give details on the financial results, the status of our partner companies and equity funds. He will share goodwill related disclosure, certification plans, information regarding our (inaudible) of stock options and then we will have a chance to take questions that you may have. In our last call I told you we had a mark for developing a (inaudible). My first three months were spent (inaudible). The next three months were devoted to developing strategic direction. This resulted in assembling of a team of individuals, including previous CEOs and COOs who (inaudible) IT services and software areas. We created a talent bank of experienced executives who can provide on demand CEO, CIO, marketing and business acquisition expertise to our companies on a project basis. Since then Tony Ibarguen have developed acquisition criteria and a strong pipeline. They are actively providing management and guidance to existing companies. Bob Crowley joined us in May as managing director of software practice. He has undertaken assessment of current operations and future needs of our partner companies. He is now (inaudible) vision for growth in software packages. During the first quarter we did $38 million in funding related to strategic companies. Cash balances remain strong at $190 million, as of August 6. As we make acquisitions, we will continue our critical assessment of existing holdings as normal business process. (inaudible). For those of who you are new to our conference call, (inaudible) provides clear articulation of our strategy (inaudible). For those who have been on the call before, you will recall our strategy builds on three values, as outlined on slide six. We focus on business and IT services. Our goal is self-sustainability to generate cash flow. We intend to build or acquire majority-owned software companies, where we will drive growth and accelerate value. Once we achieve (inaudible) continue to support entrepreneurs in creating new technology. Let me give detail of our progress in IT, business services and software. We plan to acquire full ownership for 80% control in the business IT service companies to generate solid cash flow and enable tax consolidation (inaudible) operating cash flow. We expect to see modest recovery in the demand for IT services by the beginning of the third quarter of this year. We have yet to see encouraging signs. Bad news is IT services sector has yet to recover. Good news, this is an excellent environment for acquisitions. We are not alone in this observation, as evidenced by deals, such as IBM's acquisition of (inaudible). We firmly believe demand for IT will rebound, the current climate has two implications. First, it reenforces our plan to acquire high-quality companies with long-term viability. We continue to be patient waiting for the right fit. We are encouraged by what we see. Second, the climate impacts IT service business. We are managing the operation of expenditures of our current companies (inaudible). These companies have good market presence and active pipelines. Slide eight provides a description of solutions in a line strategy. Our two service companies (inaudible). We have organized Lever 8 Solutions in specialized practices. This week Lever 8 Solutions announced we adds sap practice group, including unit of Arthur Anderson SAP practice and his team. A line strategy continues as separate business providing IT strategy solutions. Both Aligne and (inaudible) as it becomes available. On the IT service market place is challenging, we were pleased to see Compucom reported net revenues up 30% over the first quarter of 2002, net income of $4.7 million, 78% increase over the first quarter of this year. That includes the effect of the - I'm sorry, excludes the effect of the accounting principles. (inaudible) provider of outsourcing and systems invasion services. On slide nine, another goal is to fuel the growth of existing and to the acquired software companies. Our intention is to (inaudible) leaders in the markets and at or best approaching the acceleration point in the growth market strategies for expansion capital and know-how is critical. Our intent for majority ownership, we noted in the last call, we provided funding for (inaudible) and SOTAS and now the majority holder in each company, 63%, 70% and 75% respectively. Since then, we entered into agreements to purchase $10 million in stock from ChromaVision and provided $6 million to medical systems to fund operations. ChromaVision continues to accelerate in sales and marketing activities. Pursuing shareholders approval, the transaction later this month, this will result in increase in ownership position from 28% to 56%. ChromaVision has created a versatile digital microscope with automated cellular imaging system that uses software called ACIS. This system has the ability to automatically detect, count and classify cells of clinical interest based on color, size and shape. Capabilities assist pathologist in making cancer and other diagnosis, traditionally done by analyzing slides under microscope. ChromaVision reported last week quarterly revenues had doubled over the prior year's quarter and losses were sharply reduced quarter over quarter. It has a relationship with more than 200 U.S. customers who have adopted their technology. Customers have expanded the use of ACIS beyond breast cancer testing. One of the major customers, US Labs, major laboratory, recently a-announced (inaudible) 9 to 19, an excellent example of the (inaudible) lab setting. ChromaVision's ability to respond positively and rapidly to request new tests is a result of the capabilities designed into the various software and ChromaVision's broad FDA clearance. The companies in which we have acquired or expect to acquire majority interest later this month, Agari Mediaware, ChromaVision, Mantas and SOTAS have several characteristics in common. Each has proven technology in solving business problems, each have major customers that (inaudible) solutions. Yet, each company needs broader expansion. That is where Safeguard comes into play and we can help. Let me give you a couple of quick updates. Agari, earlier stage middleware company was highlighted in July report on contact integration which provided independent validation of Agari's technology in the rich data management area. During the quarter, SOTAS continues to deliver their flood prevention product to a number of major carriers and recently signed a significant contract with a large telecommunication carrier for fraud prevention product. You may have seen Mantas in the news recently, including Wall Street and Technology Investor. News Week and the Washington Post. (inaudible) firms to detect and (inaudible) fraud and suspicious activity. Software users use data binding and recognition techniques to track suspicious financial transactions. To further software initiatives, we opened a Boston area office in the heart of the Route 128 corridor. This places us in major center for software development and will facilitate our plan (inaudible). Moving to slide 11, as we implement our strategy, we are seeing market forces that are having influence on our direction, as you can see on slide 11. Following the dot-com bust, companies have shifted buying habits to more established channels of distribution, as opposed to early-stage companies. Promising start-ups are (inaudible) more established enterprises to take advantage of established brands, distribution channels and work (inaudible) trend. We are seeing the extension of Legacy Systems, the availability of web-based service tools and applications to stand the private and public Internet. This creates a clear need to manage security, audit functions and liability exposures. In addition, manic declines in net storage costs are providing significant images to developers of applications (inaudible) to stand both the public and private Internet. We are also seeing significant regulatory and compliance initiatives which will require software applications that address all of these forces. For instance, both the New York Stock Exchange and the NASD have adopted rule changes to ensure compliance with the secrecy act and the USA Patriot Act. USA Patriot Act requires certain financial institutions (inaudible) programs to protect against money laundering. The act requires organizations disclose suspicious communications and records under certain circumstances. These new regulations require that the financial services industry increase its ability to protect these behaviors in a timely manner. Finally, the heightened importance of the communication assistance for law enforcement act, will drive software development and behavior detection in telecommunication and services. (inaudible) between these trends and capabilities of our current companies. These market forces are also influencing our evaluation of acquisition candidates. Our frequent discussions with industry analysts and the investment community are validating our view of these trends. Let me turn over to Chris Davis, our chief financial officer, who will give you specifics on the financials.

Thank you and good morning. As you will see on slide 12, we want to update you today on Safeguard's continued strong cash and security position, cash activities during the second quarter through August 6th, our second quarter results, brief update on public and private companies and private equity funds, including companies and disclosure of (inaudible). Brief outlook for the balance of 2002 and a discussion of the new CEO and CFO certification of financial statements and our accounting for stock options. Turning to slide 13, I am pleased to report Safeguard cash balances remain very strong, cash of $192 million. (inaudible), decrease from $220 from our last call reflects (inaudible) of several software companies. Let me also note cash balances include $135 (inaudible) cash balance of our consolidated subsidiaries. The value of our public partner company (inaudible) Securities, as of June 30, was $220 million dollars and $219 million as of August 6. Our cash (inaudible) securities therefore total $412 million and (inaudible) as of August 6. My comments below will follow the format we used last quarter to update the drivers of the cash flow upward. Slide 14 shows changes in cash for the second quarter. During the second quarter, we received $63 million in a tax refund, $7 million in activity on distributions. (inaudible) included $3 million e leased from escrow for a previously sold partner company and $3 million in fund distributions. During the second quarter, we completed $38 million in funding relating to existing partner companies, including $16 million related to ChromaVision and $15 million to Mantas. We completed $6 million against existing (inaudible) for private equity funds. In June, we paid semiannual interest payment of $5 million on 5% subordinated debentures due in 2006. Our cash g and a expended was $3 million. Our forecast for corporate g and a remains $22 million, including professional fees, DNO insurance and (inaudible). The forecast contribution from our existing wholly owned companies was expected to be $2 million for 2002. Due to reduced demand for IT services and continued market softness in 2002, the forecast contribution will be minimal. However, we are actively managing the expenses for the services companies, while being well positioned to take advantage of the recovery when it occurs. There have been minimal changes in our cash balance since June 30, as you can see on slide 15. Let me turn to our second quarter financial results, which are shown on slide 16 and should help you understand the components of our operating results. For the second quarter, we reported net loss of $34 million, improvement over first quarter 2002 loss of $41 million before the cumulative effect of the change in accounting principle. It is also a significant improvement over second quarter 2001 loss of $110 million. A majority of partner companies are currently investing in new products and services and as a result are realizing operating losses related to the activities. The improvement over the first quarter of 2002 was primarily the result of improved results and certain consolidated subsidiaries and lower impairment charges. For the six months ended June 30, 2002, we reported net loss of $75 million, excluding the $21 million charge for the cumulative effect of the adopting of accounting principles. This is improvement from the same period in 2001 of $260 million. As required, we adopted the provisions of SFAS 142, goodwill and other intangible assets in 2002. We reported the cumulative effect of change in accounting principle as of January 1, 2002, of $21 million, relating to the following provisions of SFAS 142. First, negative goodwill existing as of January 1, 2002, should be included in income. Our first quarter results including $425,000 of income from Compucom, as a result of this provision. Second, SFAS 142 changed the method under which goodwill and other intangible assets of consolidated companies are tested for impairment. It changed from cash flow approach to fair value approach. Safeguard reported $22 million charge as of January 1, 2002, related to business and IT services reporting unit as result of this transition. Going forward, we are required to test goodwill and intangible assets of our consolidated companies for impairment annually or on interim basis if an event or circumstances exist, indicating it was more likely than not impairment loss has occurred. (inaudible) SFAS 142, please refer to second quarter 10-Q, filed by August 14th. As we have discussed in prior calls, to better understand our operating results, it is important to remember that our business model calls for acquiring interest and funding software and merging growth companies during a period in which they are reporting operating losses. Generally accepted accounting principles require us to (inaudible) our share of their income or losses. As a result, certain companies have (inaudible) values of zero, including ICG, even though fair market value is higher. When we have monetization of that, we report gain or loss based on the difference of the proceeds received and carrying value at that time. I would like to turn now to providing an update for public and private companies and our private equity funds. We currently have 14 companies in our private company portfolio as seen on slide 17, with aggregate carrying value of $62 million at June 30, 2002. We currently have 9 public company [W-S] market value of $219 million as of August 6th, as seen on slide 18. The decrease in number of public companies relates to bankruptcy filing for LifeFX. We will continue to assess our partner companies and take appropriate action for those no longer fitting our strategic objectives or investment return. With respect to private equity funds, we currently hold general partner, limited partner interest in 12 (inaudible) on our campus. These twelve private equity funds have excess of $2.6 million of funds committed (inaudible) $128 million. 88 million dollars of which has already been funded. We expect the remaining $40 million, to be funded over the next several years. In addition to our on-campus funds, Safeguard has investment in other private equity funds. The size of these funds is $900 million and Safeguard's commitment is $116 million, of which $100 million has already been funded. The carrying value of all funds as of June 30 was $54 million. We are examining our current commitments and participation in off-campus private equity funds to evaluate their strategy, as we previously noted, we recently reduced commitment to (inaudible) 6.3 million. We continue to work on providing additional insight into the financials of our partner companies as we begin to implement our new operating model. Beginning with our first quarter 10-Q, we have expanded our other operations of segment into three separate segments to correspond with the implementation of our strategic direction. Additionally, as more private companies are consolidated because of majority ownership, key financial results for business segments should begin more visible to shareholders. Turning to our cash outlook on slide 19, remember our cash balances from period to period are significantly impacted by the pace of monetization activities, the pace and size of acquisitions, our follow-on fundings to corporate companies and private equity funds and our net G and A cash expenditures. For these reasons and the sequencing of the implementation of our strategy, it is difficult to predict cash flow forecast for the remainder of 2002 and for 2003 at this time. However, we begin the rest of the year with yesterday's cash balances of approximately $190 million. We anticipate funding $8 million to partner companies and private equity funds during the remainder of 2002, based on today's commitment. G and A cash expend side estimated at $11 million for the remainder of the year. Interest paid in the second half of the year will include $5 million interest payment on the 5% subordinated debentures due in 2006. I will note, we have no plans to retire any debts. We can predict the pace of monetization cash distributions and acquisition activity. I would like to remind you that later this month, we will settle the remaining $86 million liability related to hedge of our (inaudible) Holdings by delivering 1.4 million shares of (inaudible) stock. This settlement will have no impact on cash and little impact on (inaudible). As a result of settlement, total current liabilities will decrease by approximately $86 million. Based on our 2001 consolidated revenues, Safeguard has been selected by SEC to provide CEO and CFO certifications of our financial statements. Within the next week, we will certify the SEC filings made by the company in 2002, including Safeguard's 10-K from 2001, 10-Qs for the first and second quarter of 2002 and 2002 proxy statement. Additionally, compliance with the (Saroxly) act signed by president Bush on (inaudible) statements to be included in second quarter 10-Q and each 10-Q and 10-K filed thereafter. Finally, a few comments on accounting for stock options. As you know, under current accounting rules, companies are not required to count the cost of stock options as expense, but may choose to do so. There has been a great deal of discussion about the expensing of stock options and related valuation of the dollar. We will continue to monitor these discussions and comply with new accounting pronouncements in this area. At this time, there are 2001 10-K included pro forma disclosure regarding the expensing of stock options, granted through December 31, 2001, using existing GAAP methodology. We want to report as a result of the option exchange program slated by the company in 2002, in January of 2002, we expect that the pro forma expense relating to existing options will decrease significantly in 2002 (inaudible) to prior years. Tony and I will take questions that you may have. 00:44:04

At this time, I would like to remind everyone in order to ask a question, please press * and 1 on your telephone keypad. Please hold for the first question. Our first question is from Rick Lumer of Value Line.

You have recommended we look at the value of your portfolio holdings in determining Safeguard's value. It looks now like earnings are becoming more of an important yardstick. I was wondering when earnings becomes a primary yardstick for value in Safeguard?

That is an interesting observation. As we take majority ownerships, obviously that begins to come more to the floor. As we increase exposure associate wide private companies and get more transparent, obviously there will be more interest in that. I can't tell you what method you should use to do the evaluations, but I think the strategy and focus is on operations and has entered a level of how successful we will be in those operations.

Thank you.

Your next question comes from Charlie Park.

Yes. Good morning. Couple of questions. The first question is just so I understand, you are not thinking of swapping out Compucom to buy new IT companies, are you?

Could you restate the question. I missed it because of the static.

The question is, I am unclear. Are you thinking of swapping Aligne or Compucom (inaudible) or a question of buying additional IT service companies to uncover the cost of the cash burn at the moment?

The best answer, it is our strategy to acquire service companies that have predictable revenues and solid cash flow as one of the planks to put more strength into Safeguard. Our existing companies do that. We will, however, continue to evaluate at all times, relevancy of existing asset to potential return and ability to meet that objective. We do intend to complete to continue to acquire company that is show revenue and for cash flow production.

And on the - second question, has there been any signs that you are able to sell off any of the other private equity fund interests, as you did in the fourth quarter of last year?

This is Chris. We continue to work on that, the secondary market for interest and private equity funds is a busy one right now. We are continuing to work on it. It would be premature to report we have a disposition under contract or anything at this point.

Thank you.

Once again, I would like to remind everyone in order to ask a question, please press * and the number 1 on your telephone keypad. Your next - at this time, there are no further questions.

Well, everybody, thank you for your interest in Safeguard this morning. We are making a lot of progress in our strategy, (inaudible) market conditions, we remain optimistic about our ability to execute it. We have a lot of cash and are committed to finding the right opportunities to invest in. We are looking at those patiently and will continue to pursue every monetization avenue that makes sense to provide additional capital to fund our growth. As I said before, execution takes time and we are patient owners. I continue to believe that Safeguard is undervalued, with a solid strategy, solid management, 400 million in cash and public securities, promising business in software services group, trends that seem to be going in the right direction and approximately a 160 million market cap, I think Safeguard has great value generation potential. Thank you very much.

Thank you for participating in today's conference. You may now disconnect.