Safeguard Scientifics Inc (SFE) 2002 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to Safeguard Scientifics, Inc. 2002 Q4 conference call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. And instructions will be given at that time. If you should require assistance during the call, please press star and zero on your phone. As a reminder, this call is being recorded. This call is also being webcast with slides for your viewing on 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 identify case number 8431940 until midnight on March 1st. The company has asked that we give you the following reminder.

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 risks associated with the uncertainty of future performance of our partner and companies, acquisitions of additional partner companies, and disposition of partner companies, additional finances requirements, the effect of economic condition 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 Securities and Exchange Commission. The company does not assume any obligations 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, CEO of Safeguard Scientifics. You may begin.

Thank you. Good morning, everybody. We started off on the slide while watching the web cast. I will share with you a summary of our accomplishments in 2002. An update of our business and IT services and majority owned businesses and current outlook for 2003. Before I do that I am pleased to announce three new independent members were elected to Safeguard's Board of Directors this week. Julie Dobson, former Chief Operating Officer as well as one of the founding principals of TeleCorp EPS. George MacKenzie the recently retired Vice Chairman of the Board and Chief Financial Officer of Hercules Incorporated and John Roberts is a former global managing partner and member of the leadership team of PriceWaterhouseCoopers. We issued a press release with more information regarding these new independent board members. After our remarks, Chris Davis will provide details on Safeguard's financial results and the status of our partner companies and private equity funds. Then we will have the traditional question-and-answer session.

On slide 4, at the outset of 2002, we outlined certain priorities on which Safeguard management would focus through the year. They include stabilizing the organization and its assets, lessening Safeguard's dependence on capital markets by obtaining sources of cash flow to fund operations, and strengthening Safeguard's existing service and software company base. I can report that during 2002, we have developed, articulated and commenced implementing a new strategy for Safeguard. We have generated $37 million of cash proceeds, $2 million of notes receivable, $3 million of preferred security, and $33 million of liability reduction by disposing of nonstrategic or slow growth assets including our sale of Safeguard corporate campus and a reduction of our commitments to certain private equity funds.

We have acquired Alliance Consulting Group Associates, a business that designs and implements digital enterprise strategies for its clients by integrating information technology solutions across every line of business for $55 million and the assumption of $5 million in liabilities. Alliance adds approximately $82 million of annualized revenue. We have also increased ownership in five of our operating companies through $45 million in new and follow-on activity. Collected a $63 million tax refund and reduced other potential tax liabilities by an additional $61 million by utilizing capital losses. We have reorganized Safeguard, added world-class talent to lead our business areas, added talent to our controlled subsidiaries and built a strong bench of external extended enterprise talent which assists our companies on an as needed basis.

As a result of our collective efforts in 2002, we have focused our private company holdings from 16 to a net of 13 companies, of which eight are now majority owned. At eight public companies within our group as well, of which three are majority owned. This is a remarkably different Safeguard than a year ago. We are much more focused. We are operationally applying our expertise to this much smaller but more promising group of businesses. We find that our past has positioned us well for our future. This year is Safeguard's 50th anniversary. And for 50 years, Safeguard has excelled in understanding the technology market and trends and building superior companies as a result. We are positioning Safeguard to continue this legacy.

Slide 5, as we look at the world today, we can see several significant trends. Probably the most important is the continuing freefall in the pricing and margins associated with infrastructure elements of technology like processing, power, storage, and communication costs. This changes the fundamental economic applications. Massive amounts of data are now digitally available to users. They need to be synthesized, managed, potentially reused in order to be useful to management. There is a growing need for deep domain knowledge in vertical markets to deliver information and solutions that matter. And there is a continuing trend of a blurring between software services and business process outsourcing companies driven by a customer's increasing preference to obtain comprehensive solutions from providers as opposed to piece parts to address the critical points. As we mentioned before, we see a growing market for companies that in this environment can offer business analytic tools and solutions, needing complex software systems and services that deliver specialized information which is the basis for decisions by the main experts in their businesses. As we will discuss today, we see many of our majority-owned companies fall into this category. Other categories will emerge as our companies grow, but we expect certain characteristics to remain constant.

During the course of 2002, we discussed our strategy to acquire companies in the business and IT services area. As you can see on slide 6, we achieved significant part of this goal through our December 2002 acquisition of 100% of Alliance Consulting. It provides us with a platform upon which we are integrating our existing services businesses, aligned and leveraging solutions, to meet the stage for growth and consolidation of operating cash flow. Alliance has a unique business model that leverages its talent base efficiently by being directly responsible to its customers' complex needs. Furthermore, Alliance's high value digital intelligence capability enhances our existing and targeted software companies. We are confident the timing of this major acquisition is good. Despite the slowdown in IT spending during the last year and a half, the market remains large, is very fragmented with thousands of participants. This offers us an opportunity to build our business and IT services strategy. Valuation companies for IT companies have declined to a historical low point matching 1990 levels. We believe the acquisition of Alliance for approximately .7 times 2002 revenue, timely, with below historical levels and in the middle of the range of recent comparable transactions such as the 2002 acquisition of Great Lakes and CMG by LOJICA of NAVIGANT [INAUDIBLE] Group. As we noted in our November release we acquired a hundred percent of the equity for approximately $55 million in cash plus the assumption of $5 million in [INAUDIBLE].

You will see the mix of Alliance services on slide 7, including business intelligence, data warehousing, solutions, application development and integration in managed services. They have a proven track record in architect and building and delivering solutions for the fortune 2000 market using advanced project methodology designed to ensure the highest quality of deliverance for their clients. Over its 10-year history, Alliance has developed deep knowledge of their customer's applications and businesses. They have deep domain expertise in pharmaceutical, financial services, and manufacturing retail distribution industry. Alliance's unique assemble to order delivery model provides clients with highly specialized engagement teams able to build IT solutions tailored to specific business requirements. They maintain a full-time core staff complement of a flexible combination of hourly and salaried employees and highly qualified independent contractors. This allows the engagement team to focus on meeting or exceeding their clients' requirements and contrast to consultancies with full-time employee delivery models, which worry about applying the people on their payroll and utilization of existing staff regardless of their ability to provide necessarily the best skill match to clients' precise needs.

2002, Safeguard reported revenues of $27 million from the line on Lever8. Alliance's 2002 revenue was $82 million at December 31 resulting in a pro forma total for a starting point, if you like, about $109 million. Our integration efforts at bringing these companies together are proceeding in accordance with our plans. We are creating here a wholly owned service company with the necessary scale and breadth of services and domain expertise to provide improved profitability for us and become one of the top players in the IT services market. In addition, and importantly, Alliance's consultants continued focus on digital intelligence solutions, positions us to create higher value in partnering with our software companies. Sotas and Mantas, for example, require a combination of industry specific expertise and technical skills from their systems integration partners. Mantas and Alliance have begun working together and are focused on individual projects today.

Throughout 2002, slide 8, we articulated our strategy to obtain and maintain an ownership position in each of our operating companies of at least 51%. We implemented this part of the strategy by making additional investments in five companies, including Sotas, Mantas and ChromaVision Medical Systems. Slide 8 shows you the highlights relating to each company, Mantas, ChromaVision and CompuCom. ChromaVision's microscope imaging system provides an integrated analytic software solution based on complex [INAUDIBLE]. This aids pathologists in diagnosis of various diseases and conditions through ChromaVision's proprietary systems. The company announced U.S. Labs has renewed its agreement with them to support the continued growth of ChromaVision's access to [INAUDIBLE] pathology program.

U.S. Labs is the largest of the accredited laboratory center of excellence servicing the access remote pathology network. By utilizing ChromaVision's cellular imaging system, the company enhances laboratory standardization to the network's remote pathology customers. The access program has broadened the marketing reach of both companies and allows community-based pathologists to offer the features of the analysis technology to patients and physicians. Through the access program, launched in 2001, U.S. Labs and ChromaVision jointly serviced more than 75 pathology customer sites throughout the United States. In addition, last year, ChromaVision joined a medical systems home marketing and [INAUDIBLE] imaging methods for testing for the human papaloma virus, the primary cause of cervical cancer. ChromaVision's year end revenues were $9.3 million, an 89% increase from the previous year, 2001. In the Q4 of 2002, they reported $2.7 million in revenues, which was a 52% increase from the same period in 2001. The company reported more than doubling the number of instruments in the field, generating revenues over the prior year. If you would like more information on this business, ChromaVision's earning call regarding its Q4 results is scheduled today, this morning at 11:30 a.m. eastern time. We are pleased to report we have increased our holdings in ChromaVision by approximately 5% to roughly 62% through our purchase yesterday of $5 million of additional shares of ChromaVision's common stock acquired from the company.

Moving to Mantas, the company recently announced it intends to introduce a next release of its brokers surveillance monitor product, which will address mutual fund breakpoints, an issue in the news quite a bit lately. Mantas behavior technology, detection technology, is currently used by banks, brokerage firms and other financial service firms to detect potentially suspicious behavior. This new feature can help ensure clients are being charged the correct amount for a mutual fund purchases is expected to roll out later this year. This product and all Mantas products are based upon Mantas' behavior detection platform. This encompasses proprietary techniques such as link analysis which can find hidden relationships, sequence matching which evalues actions in a sequence to detect potentialing troubling actions. The Mantas platform is designed to analyze billions of accounts and transactions all in the context of each other to identify suspicious activities which may require further review for management action. In case of mutual fund breakpoints, the ability to augment this process can protect investors ensuring they pay the correct price for fund purchases and protect firms ensuring they are in compliance with the regulatory requirement and also able to monitor the practices of their employees. While the nature of Mantas's solution, and its contracts preclude listing its customers by name, the company did report a new deal with one client, Merrill Lynch, late last year. Its current client base includes many of the best known names in the financial services industry.

Turning to CompuCom in an extremely difficult market and excluding the effects of a change in accounting principles, the company reported 2002 net earnings of $18.3 million, and that was 175% increase over 2001. 13.5% decline this overall revenue. Looking at the Q4, 2002 performance, CompuCom reported $403.9 million in net revenues a 9.8% increase compared to the Q4 of 2001 due to increases in product and services revenue. CompuCom's fourth quarter net earnings of $5.5 million represent a 230% increase over the same period of 2001. Safeguard holds a 59% voting interest in CompuCom. They are a leading provider of IT outsourcing technology procurement and systems integration services.

So, at the end of 2002, slide 9, we have generated $106 million in cash, including $63 million refund, tax refund. We put $37 million of it to work to achieve majority positions in growing operating companies and used $55 million to acquire Alliance Consulting.

As we continue to refine our strategy, we see our companies falling into three categories which you will see on slide 10. First, companies in which we are strategically and operationally engaged share certain characteristics that bear repeating. These are businesses that provide software or service solutions, primarily based on complex, comprehensive business intelligence and analytics. A variety of vertical markets, and these are targeted to the cash flow positive in 12 months. We will maintain or acquire controlling interest. The second category comprises our Legacy companies. This can be characterized as those in which we have less than a controlling interest or which don't fall in our strategic initiatives including public and private companies, as well as our interests in venture capital funds.

With regard to our Legacy private equity funds, we are examining our current commitments and participation in both on and off campus funds to evaluate their fit within our strategy. At this time we do not anticipate making any new investments in any private equities funds. Similarly, we do not intend to make any additional minority acquisitions, or acquisition of any early-stage technology companies in 2003. Other than those which are complementary to our existing holdings. Let me now turn the call over to Christopher Davis, CFO, Managing Director, who will discuss specifics on the financials.

Thank you, Tony. Good morning. As you see on slide number 11, I'm going to update you today on cash and marketable securities, cash activities during the Q4 and through February 27th. Q4 and year end results for 2002, brief status report on public and private companies and our private equity funds and a brief outlook for 2003.

Turning to slide 12, I'm pleased to report that Safeguard's cash balances were $125 million as of December 31, 2002. $114 million as of February 25. Decreased from $185 million from our last earnings call on November 7, primarily reflects our acquisition of Alliance Consulting for approximately $55 million. Let me note that these cash balances at December 31, exclude $143 million of additional cash balances of our less than wholly owned but consolidated subsidiaries. The value of our public company marketable securities was $236 million at December 31, and $187 million at February 25. Significant decline from year-end is attributable for the most part to the decline in the value of CompuCom's stock from $5.61 per share to $3.08 per share. Our cash in public company securities therefore totalled $361 million as of December 31, $301 million as of February 27. My comments below will follow the format we used the last several quarters, and we will update you on the [INAUDIBLE] of our cash flow and operating revenues.

Slide 13 shows changes in cash for the Q4. During the quarter, we received $11 million in cash from modernization activities, including $800,000 from our pension fund distribution, $3 million on the sale of our interest in private equities. Also included in these is the sale of our corporate campus and lease back a portion of the campus we currently occupy. This was completed November of 2002. This sale generated $6 million in cash proceeds, reduced net on our balance sheet by 13%, will reduce our future annual operating costs. We also completed sales of three other interests in the Q4, including [INAUDIBLE] and U.S. Data. During the Q4, in addition to the acquisition of Alliance Consulting, we completed $3.7 million of fundings relating to other existing companies. We also completed $1 million in funding against existing commitments for private equity.

Our G&A cash expended was $3 million for the Q4 and $23 million for the full year. Since December 31, we have realized $4 million for the collection of [INAUDIBLE] and modernization. Our cash since December 31 did $6 million for acquisition fundings, $3 million of cash paid for our [INAUDIBLE] insurance premiums, $5 million of other operating expenses and accruals, which include the seasonal impact of certain annual expenses made throughout the year. As Tony mentioned, we have acquired $5 million of additional equity in ChromaVision [INAUDIBLE] 2003. This investment is not reflected in the $114 million cash balance reported as of February 25.

Let me now turn to our Q4 financial results, which are on slide 14. For the Q4, we reported a net loss of $31.2 million versus our Q3 2001, $23.3 million loss as shown on slide number 15. This is a significant reduction over our Q4 2001 loss. Included in our Q4 2002 net loss of $31.2 million is an $11.4 million [INAUDIBLE] charge related to Safeguard's loan receivable from Keith Mucher, our former Chairman and CEO. We are pursuing all available legal avenues to collect the amounts under this loan. However, generally accepted accounting principles require we compare any loans based on current information and events and we determined we may not be able to collect all amounts. As of December 31, 2002, value of collateral pledged by Mr. Mucher through the loan had an approximate value of $14.5 million. Compared to the loan's carrying value of $25.9 million. We have concluded that the decline in collateral value was other than temporary. In addition, based on the information available to us, we concluded that Mr. Mucher may not have sufficient personal assets to satisfy the outstanding balance due under the loan when the loan becomes in full recourse against him in April of 2006. Finally, the loan became payable on a limited basis on January 1, 2003. Safeguard sent him a demand notice. When no payment was received, a default notice. The loan is effectively in default now. Based on this information acquired by generally accepted accounting principles, impaired the loan by $11.4 million, the value of the collateral we presently hold. We will continue to view the loan for further impairment on a quarterly basis. Again, it is important to note that while financial reporting rules dictate we take a term charge at this time, but not modify the loan given any amounts due under the loan. We are fully committed to enforcing the contract and maximizing our collection efforts from him. For the year-ended December 31, 2002, reported a net loss of $160.5 million, including the $21.4 million charge for the effects of the accounting principles relating to the accounting for goodwill, as we discussed in our Q2 call. The 2002 results are significant reduction over these 2001 loss.

I would like to turn now to providing an update for both our public and private companies and our private equity funds. At the end of 2002, we had 13 companies in our private company portfolio as seen on slide number 16. These companies had aggregate sharing value of $107 million at December 31, 2002.

We currently have eight public companies with market value of $187 million as of February 27 as seen on slide number 17. We disposed of several of these Legacy companies during the Q4 of 2002, and will continue to assess them in 2003, for balance sheet and liquidity contributions on an ongoing basis. We move towards supporting our strategic initiatives. With respect to 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. Safeguard's commitment to these funds totals $126 million. $91 million of which has already been funded. We expect the remaining $35 million will be funded over the next several years. In addition to our on-campus funds, Safeguard has investments in three other private equity funds. The aggregate size of these funds is approximately $365 million and Safeguard's commitment to them is $86 million, of which a $5 million has already been funded. The aggregate carrying value of these funds was $36 million at December 31. We continue to reduce our commitments to and participation in the off-campus private equity fund.

During the Q4 of 2002, we sold our interest in the Green Hills fund, the total cash proceeds generated by the sale were $3 million. Released from our remaining commitment a fund of $12 million. On a year-to-date basis, we reduced our commitment to three funds by an aggregate of $19.7 million and are in the process of liquidating one other fund.

Returning to our cash outlook on slide 18, remember that our cash balances for the periods are significantly impacted by the pace of our modernization activities. The pace and size of our acquisition activities, follow-on fundings to our companies and private equity funds and our net G&A. For these reasons, as well as the sequencing of the implementation of our strategy, it is difficult to predict a meaningful cash flow forecast for the remainder of 2003. However, we begin the rest of the year with cash balances of approximately $114 million. We anticipate funding $26 million to existing partner companies and private equity funds during 2003 based on today's commitments. And these commitments include the $5 million which we invested in ChromaVision just yesterday.

Interest paid during 2003 will include two $5 million interest payments in June and December on our 5% debentures in 2006. We continue to evaluate the capital we have available and the best means of supporting such capital. This evaluation includes considering debt retirement stock repurchases and future acquisitions on other uses. However, we can't predict the pace of modernization, cash distribution, or acquisition. In compliance with the Surveillance [INAUDIBLE] Act, Tony and I will sign personal certification statements under section 302 and 906 of the act and these will be included in our 10-K which will be filed in March. Tony and I will take any questions you may have.

At this time, if you would like to ask a question, please press star, and the number 1 on your telephone key pad. We will pause for a moment to compile the Q&A roster. Again, if you would like to ask a question, please press star, then the number 1 on your telephone keypad. Your first question comes from Will Brockenbank of Finley Park.

I just had one quick question about the ChromaVision investment. Was that part of your funding commitments and if so, could you just lay out the timing of future funding commitments in 2003 if you can? And did the funding commitment, if that was what it was in ChromaVision, demand a $5 million investment for 5%, is the valuation locked in? Thank you very much.

Good morning, Will. The investment we made yesterday in ChromaVision was not part of a preexisting commitment to the company. You recall we had a transaction last year, and as part of that transaction, we had agreed to provide a $3 million guarantee to support a new debt facility for ChromaVision. That guarantee has now been put in place as the company announced just recently. Yesterday's investment was a new investment for us, and was based on current market conditions in terms of its valuation. It had not previously been locked in in any way. And we have no remaining commitments to the company for either debt or equity commitments.

Thank you very much.

Your next question comes from Paul Patrick with First Manhattan.

Good morning.

Good morning, Paul.

On the last comment you made in your presentation was the priorities for your use of cash and you listed debt retirement, stock repurchase and future acquisitions. Can you talk about that? Has that changed? Is the potentially buying the convertible notes increased in priority? Or is that just the way you listed them?

The way we listed them was not an attempt to put priorities to them. We continued to evaluate all of those options, because of the volatility in the marketplace and how frequently opportunities are changing, we really need to continue to set priorities as the marketplace changes. So we evaluate each of the different investment opportunities from time to time and have not preestablished any priorities.

I guess just to follow up, can you discuss specifically your views today on purchasing the convertible notes?

We continue to view it as one opportunity to deploy capital. Maturity is in June of 06. We continue to watch the value of the bond in the marketplace, mindful of the maturity base and include in all of our discussions about the new capital [INAUDIBLE].

Thank you. At this time there are no further questions. Mr. Craig, do you have closing remarks?

Thank you. 2002 was a very challenging year. We made a lot of progress implementing the first stages of our strategy. And other than the necessary accounting impairment charge related to the loan for the former CEO which we intend to pursue in its entirety, our losses declined for the seventh quarter. Safeguard is a different company than it was a year ago. We are moving rapidly towards becoming an operationally-focused company with a clear strategy for growth in defined areas. There are few companies in the technology sector that can boast a 50-year history. The reason in the past, Safeguard focused on developing its minority interest in early stage companies, companies in the time to market stage of their life cycle and achieved considerable success. Now Safeguard is focusing on driving operational excellence at majority-owned companies in the time-to-volume stage. These companies tend to share certain characteristics that we have discussed with you today. Our strategic initiatives are to operationally expand our reach in the business intelligence and analytic solutions area, in companies that are in the time-to-volume stage of their life cycle. We intend to manage these companies for revenues and profit growth. For our Legacy companies we intend to manage them to contribute to our balance sheet strength and liquidity. If you look at this as the second stage of a three-stage program. Moving from what could be characterized as an early-stage portfolio company towards a softer and solutions-based operating company. The first stage was turnaround initiation, strategy formulation, and is largely complete. We are currently in the second stage. We are continuing the turnaround process, strategy refinement while actively supporting operational excellence in a stable base of companies, including providing the necessary funding and developing the right measurements of supporting them operationally, by which we will be able to review results. We will arrive at the third stage when we have evolved to a point where we can share the measurements we feel drive our business, and when we are evaluated against traditional operating company parameters. This is not a static model. We will continue to evolve as our business matures and face the market challenges. We will keep you informed as to our direction and progress as we move through the year. Thank you very much for your interest in Safeguard today.

This concludes today's conference. You may now disconnect.