Safeguard Scientifics Inc (SFE) 2002 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to Safeguard Scientific's third quarter 2002 conference call. At this time, all participants are in a listen-only mode. Later we will conduct an question-and-answer, and instructions will follow at that time. If anyone should acquire assistance during the call, please press star then zero on your touch-tone telephone. As a reminder this, call is being recorded. This call is also being web cast with slides for your viewing Safeguard's website at www.safeguard.com.

Two hours after the conclusion of the call, a replay will be available from Safeguard's website or by dialing 1-800-642-1687 and entering identification number 617-1750 until midnight on November 10th. The company has asked that we give you the following reminder: The statements contained in this call and in the presentation that are not historical facts are forward-looking statements which involve certain risks and uncertainties, including but not limited to, the risks associated with the uncertainty of future performance of our partner companies, acquisitions of additional partner companies, and disposition of partner companies.

Additional finance requirements, the effect of economic conditions in the business sectors in which our partner companies operate, our ability to execute our strategy, and other uncertainties described in the company's filings with the SEC. The company does not assume any obligation to update any forward-looking statements or other information contained in this conference call and presentation. I would now like to introduce your host for today's conference, Mr. Anthony Craig, President and CEO of Safeguard Scientifics. Mr. Craig, you may begin.

Good morning. Today I will share with you an overview of our strategy, which some of you have heard on previous calls and our [INAUDIBLE] progress to date. Chris will then provide details on Safeguard's financial results and the status of our partner companies and private equity funds. Then we'll take any questions you may have.

I have been here for 12 months now and it would be useful perhaps to provide you with a brief recap of what I found, what we set out to do, and where we are today. When I arrived last October, I found a company with a strong brand, SSH and financial resources that also that many underperforming assets. It was clear that Safeguard business model at the time was overly dependent on capital markets for cash to fund its own operations. I saw a need to stabilize both the organization and its assets in order to improve cash flow and growth opportunities. To that, Safeguard needed a well defined strategy and the right team to implement it.

After the first --during the first year, we have developed, articulated and begun to implement a new strategy. We have generated $50 million in cash, 2 million of notes receivable, 3 million of preferred securities and 13 million of liability reduction, by disposing of nonstrategic or slow-growth assets. We have increased our ownership in five of our strategic companies through $53 million in new and follow-on acquisitions.

We have collected a $63 million tax refund and reduced other tax liability by a further $61 million by utilizing capital losses, and we have reorganized Safeguard and recruited world class talent to lead the business IT services and our software areas. We're also building a strong bench of external extended enterprise talent, which operates to assist our partner companies on an as needed basis.

As a result of our collective efforts, we have reduced our private company holdings from 20 to 14 companies, of which seven are majority owned. We now have eight public companies within our group as well, of which three are majority owned. [INAUDIBLE]. This is a very different group than the year ago. We are much more focussed and are operationally applying our expertise to these businesses. Cash balances remain strong at $185 million as of November the 5th. Recently, we closed on the sale of our corporate campus, and the lease back of our corporate offices.

Mr. Davis will provide you with additional details on this sale in his remarks. We still have some cleanup work to do, but we are focussed and ready to act on our strategy of adding to our base of business in our IT services and software companies through thoughtful acquisitions. Turning to slide five, for those of you who are new to our conference call, slide 5 provides a clear articulation of our strategy, managing, operating and applying our expertise to develop superior companies. Our business strategy builds on three specific paths to value creation, which you see outlined on slide 6.

We have a significant focus on business in IT services, for our goal is to achieve self-sustainability, internally generate the cash flow by acquiring and building a group of companies where we own a minimum of 80 percent interest. We intend to acquire or build majority owned software companies with compelling technology where we will drive growth and accelerate value creation. While we have seen significant progress in the first two areas, we intend to acquire [INAUDIBLE] in earlier stage companies, and we continue to support entrepreneurs in creating new technology and applications. Turning to slide 7, let me give a little more detail about progress in the business and IT areas.

As we mentioned in our last call, we had expected to see a modest recovery in demand for IT services by the beginning of the third quarter of this year. Our market intelligence now indicates that a recovery is more likely to occur in early to mid-2003. As a result, we are being extremely discriminating in our review of acquisition candidates. We are also actively managing the operating expenditures of our current service companies, Lever8, and Align Strategy.[PHONETIC].

In this declining market, we were pleased to see that CompuCom reported a slightly increase in net revenues for the third quarter of 2002, and through very effective cross management, CompuCom reported net income of $5.5 million, which represents a 370% increase over the third quarter of 2001. Safeguard holds a 59 percent voting interest in CompuCom. and provides outsourcing and systems integration sources.

Slide 8, another goal is to fuel the growth of our existing and to be acquired software companies. We have refined our software acquisition focus to acquire controlling interest in companies that have firstly, a commercially viable product in the revenue growth phase. Secondly, a strong, experienced management team. Third, real customers and established market presence. Finally, software utilizing open architecture and industry standards. We are attracted to companies in the real near time or realtime business analytics area, as exemplified by two of our current software companies, Mantas and Sotas.

Slide 9 provides with you a brief description of our software-related companies. Since our last calls, several of these have announced positive milestones which I will share with you. Mantas, our 63 percent-owned provider of the behavior detection technology for the financial services industry, announced this week that Merrill Lynch will deploy its money laundering monitor and broker surveillance monitor applications to guard against efforts to launder money through Merrill Lynch accounts. The Mantas platform works by analyzing every transaction that occurs within an organization and is capable of processing hundreds of millions of transactions daily.

Software looks for behavior, including single occurrences and patterns within an account or among various accounts that may indicate illegal or unethical behavior, such as money laundering and insider trading. This significant contract with Merrill Lynch is an extension of the close relationship between the company that is began in 1998. Mantas began building Merrill Lynch's best execution analysis and monitoring system, known as BEAMS, which monitors execution quality with an electronic order of trades executed at Merrill Lynch and order flow sent to other broker dealers.

The BEAM system has helped Merrill Lynch lead the industry in best execution valuation. Additionally, Mantas has opened offices in the UK and is beginning to make progress in the European market. At 75 percent owned Sotas, a leading provider of telecommunications network management solutions, the company announced earlier that Thomas Greely [PHONETIC] has been hired as President and CEO. He will be responsible for the overall direction and advancement of the company. We welcome him to the team.

He comes to Sotas with a background both in entrepreneurial and large company environments, having held senior positions at Xerox, IBM, Broad Street and E Tunnels. In addition, Sotas has recently close the several contracts worth in excess of several million dollars with well known telecommunication customers in the last month. Regarding Mediaware, an industry innovator in content application integration, in which we have a 70 percent interest, recently announced it was selected by IBM to be its partner to deliver digital media applications to the media and entertainment industry. [INAUDIBLE] integration will provide the application foundation for IBMs world class middle wear, including Web Sphere, Application Server, and Web Sphere MQ. This relationship will be integral to IBM's digital media technology architecture.

Moving to 56 percent owned ChromaVision Medical Systems, Inc., the company recently announced that the U.S. food and drug administration approved the use of its automated cellular imaging system, known as ACIS, to perform two tests that help physicians determine an appropriate course of treatment for breast cancer patients. ChromaVision's ACIS Systems provides physicians with a more precise and quantitative understanding of the specific trends of individual cancer tumors. With over 200,000 new cases of breast cancer diagnosed each year in the U.S., ChromaVision's technology should provide health care professionals with a tool in their battle to effectively treat cancer, while saving millions of dollars by avoiding inappropriate testing.

This F.D.A. approval enables ChromaVision to make specific claims as to the prognostic and therapeutic value of ACIS. [INAUDIBLE] market estimated to be up to 8 million dollars per year. In addition, ChromaVision recently announced a joint marketing agreement with Santana Medical Systems to market an automated staining and imaging system of the testing of the HPV. In the U.S. alone, the company estimates the testing opportunity of between 3.5 and 7 million tests per year. As you may know, the company is paid on a per-test basis. Combining ChromaVision's ACIS technology with the added expertise of instruments that automatically prepare and obtain tissue samples in infectious disease and treatment to provide physicians with a compelling new tool for early cervical cancer detects.

It also provides ChromaVision entry into the infectious disease diagnostics market which is estimated at $500 million per year. I'm also pleased to report that the stockholders of ChromaVision gave final approval to our $10 million stock purchase we discussed in our last call, making our ownership in ChromaVision from 28 percent to 56 percent. As mentioned before, we believe these companies have several characteristics in common. Each has proven technology that is solving decision [INAUDIBLE] business problems. Each has major customers that have embraced these solutions.

In each of these companies broader expansion is needed and that is where Safeguard is helping. A year ago, our business had over 51 companies engaged in a variety of activities. Today, we are actively focussed on eight strategic companies for growth. This represents a dramatic change in focus and activity at Safeguard. That change significantly improves our ability to assist our majority-owned companies in their growth process. Let me now turn the call over to Chris Davis, our Chief Financial Officer, who will give you some specifics on the financials.

Thanks Tony and good morning. As you'll see on slide 10, I'm going to update you today on Safeguard's continued strong cash and marketable securities position, our cash activity during the third quarter, and through November 5th, our third quarter operating results, a brief update on the public and private companies, and private equity fund, a brief outlook for the balance of 2002, and a discussion of the CEO and CFO certifications of our financial statements.

Turning to slide 11, I'm pleased to report that Safeguard's cash balances remain very strong, cash of $183 million as of September 30th, an $185 million as of November 5th. The decrease from $192 million from our last call on August 8th reflects primarily our follow-on funding from several companies. Let me also note that these cash balances exclude $146 million of additional cash balances of our less than wholly owned subsidiaries. The value of our public partner company Marketable Securities was $247 million at September 30th, and at November 5th. Our cash and public company securities, therefore, total $430 million as of September 30th, and $432 million as of November 5th. My comments below will follow the format we did last quarter, which updates you on the key drivers of our cash flow and operating results.

Slide 12 shows the changes in cash for the third quarter. During the third quarter, we received $2 million of cash from [INAUDIBLE]. During the third quarter, we also completed $4 million in fundings relating to existing partner companies, including $3 million related to ChromaVision and Agari Mediaware. We also completed $5 million of fundings against existing commitments for our private equity funds. Our GNA cash expended was $6 million. Our forecast for annual corporate G and A remains at a $22 million rate, which includes our personnel-related costs, professional fees, DL insurance, and [INAUDIBLE] costs.

In November 2002, we completed the sale of a corporate campus and the lease back of the portion of the campus that we occupy. This sale generated $5 million in cash proceeds, reduced the debt on our balance sheet by $13 million, and reduced our future annual operating costs.

Let me now turn to our third quarter financial results, which are shown on slide 14, and should help you understand the components of our operating result. For the third quarter, we reported a net loss of $23.3 million, which is a reduction over our second quarter 2002 loss of $33.9 million. It is also a significant reduction over third quarter 2001 loss of $76.1 million. As you can see on slide 15, this is the sixth consecutive quarter that we have reported reduced losses over the respective prior quarter.

Our third quarter operating results also include ChromaVision's results for the first time for a full quarter, now that we are consolidating ChromaVision after increasing our ownership position. The improvement over the second quarter of 2002 was primarily the result of a reduction in market value of our marketable securities and lower [INAUDIBLE]. For the nine months ended September 30th, we reported a net loss of 98 million dollars, excluding the $21 million charge for the cumulative effect in the change of accounting principles related to the accounting for goodwill, as we discussed in our second quarter call.

This is a significant reduction over our loss for the same period in 2001 of $436 million. As we've discussed in prior calls, to better understand our operating results, it is important to remember that the majority of our partner companies are currently investing in the development of their products and services, and as a result, are recognizing operating losses related to those activities. Generally accepted accounting principles requires us to reflect in our operating results, our share of their losses.

In addition, certain companies have carried [INAUDIBLE] zero including our 13 percent interest in IGE and our 16 percent interest in eMerge, even though their fair market value is somewhat higher. When we have an [INAUDIBLE] event, the difference between proceeds received and the [INAUDIBLE] value at that time. I'd like to turn now to provide a brief update for both our public and private companies and our private [INAUDIBLE] funds.

We currently have 14 companies in our private company portfolio, as seen on slide 16, with an aggregate carrying value of $55 million as of September 30th. We have eight public companies with market value of $247 million as of November 5th, as seen on slide 17. The decrease in the number of public companies relates to the sale of our interest in U.S. data in October. We will continue to assess our partner companies and take appropriate action for those that no longer fit our strategic objectives or our internal return objectives.

Where's our private equity funds, we currently hold general partner and limited partner interests in 11 funds on our campus. These 11 private equity funds have in excess of $2.6 billion of funds committed and Safeguard's commitment to these fund is a total of $126 million, 90 million of which we have already funded. We expect the remaining $36 million will be funded over the next several years. In addition to our on-campus funds, Safeguard has investments in four other private equity funds. The aggregate size of these funds is approximately $800 million and Safeguard's commitment to them is $106 million, of which 93 million has already been funded. The aggregate carrying value of all funds as of September 30th was $51 million.

We are examining our current commitments and participation in our off campus private equity funds to evaluate their fit with our business strategy. On a year to date basis, we have reduced our commitment to two funds by an aggregate of $7.3 million and are in the process of liquidating two other funds. Turning to our cash outlook on slide 18, please remember our cash from period to period is significantly impacted by the pace of our monitoring activities, the pace and size of our acquisitions, follow-on fundings to our partner companies, and private equity funds, and our net GNA cash usage. [INAUDIBLE], as well as the [INAUDIBLE] of the implementation of our strategy, it is difficult to predict a cash flow forecast for the remainder of 2002, or for 2003 at this time.

However, we begin the rest of the year with cash balances of approximately $185 million. We anticipate funding $4 million through existing partner companies, and private equity funds during the balance of 2003. Based on today's legal commitments. Cash GNA expended is estimated at $5 million for the remainder of the year. Interest paid in the second half of the year will include a $5 million interest payment on the 5 percent [INAUDIBLE] that are due in 2006. I would note at this time that we have no plans to retire that debt. What we can predict is the pace of monitorization, cash distribution, and acquisition activity.

In late August, we settled the remaining $87 million liability related to the second hedge of our [INAUDIBLE] by delivering 1.4 million shares of stock. This settlement had no impact on cash and minimal impact on our operating results. As a result of the settlement, total current assets and total current liabilities increased by $87 million. Including the settlement of the first hedge in margin of 2002, total current assets and total current liabilities increased by $172 million compared to year-end 2001.

In compliance with the [INAUDIBLE] Act, we will sign personal certifications under sections 302 and 906 of the Act, to be included in our third quarter 10-Q and each 10-Q and 10-K filed thereafter. Complementing our existing controls, we have expanded our internal [INAUDIBLE] at Safeguard and our majority of our companies to better ensure compliance with the [INAUDIBLE] Act. Tony and I now will take any questions that you may have.

If you would like to ask a question at this time, simply press star, then the number 1 on your telephone key pad. If you would like to withdraw your question, press star, then the number 2 on your telephone key pad. We'll pause for just a moment to compile the question-and-answer roster. The first question comes from Eric Swergold of Grubberman.

[INAUDIBLE] Good morning, good quarter in terms of cash presentation in a difficult environment. My basic question is what's your rationale for not going into the market and having bought back stock when it was trading at a 30 percent discount to net cash on your books? Thanks.

Thanks, Eric. It's a question we received quite frequently a few weeks ago when our stock was trading at a lower level. It's a subject that we look at very carefully and the conclusion we have reached in this marketplace is that cash conservation, capital scarf vision in our number 1 priority. We were pleased to see that the stock rebounded very nicely without any need for Safeguard to intervene in the market.

Okay.

But my basic question is, when you have the opportunity to reduce your share count dramatically at a price that's below net cash, you can benefit all your public shareholders in the future when earnings in the environment do, in fact, at some point recover, without necessarily spending a large amount of your cash flow at that time.

Our capital allocate model is one that allows us to compare opportunities in the marketplace to build value through new acquisitions versus spending it in other ways, such as buying back the stock. And we're comfortable that in the long run, the shareholders will benefit by our continued acquisition activities rather than by buying in the stock.

Okay. And in terms of your investment activities, should we view this as the trough in terms of number of companies in the portfolio? Have you kind of rationalized what you want to rationalize at this point and are you looking to make additional investments at this time and increasing from this level in terms of the number of investments?

I think you could see from our report, we made some progress, and we've also indicated a focus on eight companies we're actively providing operational support cards. I've also indicated we are constantly evaluating potential future returns in every one of the others. I think you should view us as being extremely objective about what should remain for growth assistance versus what might make a more appropriate [INAUDIBLE].

Thank you.

At this time, I would like to remind everyone if you would like to ask a question, please press star, then the number 1 on your telephone key pad. At this time there are no further questions. I would now like to turn the call back over to management for closing comments.

Well, thank you all for your interest in Safeguard this morning. We made quite a bit of progress in our strategy in what has to be described as a very difficult and deteriorating general market conditions.

With a solid strategy, now in execution phase, management on board focussed on achieving our strategy, over 430 million in cash and public securities, we believe very promising businesses in our software and service groups, I continue to think that we have a lot of value generation potential. This is a very different company than it was a year ago. We are an operationally focused company with a clear strategy for growth in quite well-defined areas. Thank you again for your interest in Safeguard.

Thank you for participating in Safeguard Scientific's third quarter 2002 conference call. You may now disconnect.