Safeguard Scientifics Inc (SFE) 2008 Q2 法說會逐字稿

Good morning. At this time I would like to welcome everyone to the Safeguard Scientifics second quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (OPERATOR INSTRUCTIONS) Thank you. I would like now turn the call over to John Shave, Vice President of Investor Relations and Corporate Communications.

Good morning and thank you for joining us today for our second quarter 2008 earnings conference call. I'm John Shave, Vice President of Investor Relations and Corporate Communications; and joining me on today's call are Peter Boni, President and Chief Executive Officer; and Stephen Zarrilli, Senior Vice President and Chief Financial Officer at Safeguard. During today's call, Peter will review Safeguard's second quarter 2008 highlights. Steve will then review financial results for Safeguard and our partner companies. We will follow that with a question-and-answer session. Also please note supporting slides are being used and available for you to view at www.safeguard.com/earnings.

Before we begin, we would like to remind you that we would be making forward-looking statements during this presentation. Safeguard would like to caution you concerning reliance on forward-looking statements since they involve certain risks and uncertainties including but not limited to risks associated with the uncertainty of future performance of our partner companies, acquisitions or deposition of interest in partner companies, the effect of economic conditions generally, capital spending by customers, development of the technology and life science market in which we focus and other uncertainties. Also during the course of today's call words such as accept, anticipate, believe, and intend will be used when referring to goals or events in the future. The Company cannot be certain that the final outcomes would be as described today. Our filings with the SEC including our Form 10-K described in detail the risks and uncertainties associated with managing our business. You are encouraged to read the language in those filings. The Company does not assume any obligation to update any forward-looking statements made today. With that I'll turn the call over to CEO, Peter Boni.

Thanks John. And thank you for joining us on Safeguard Q2, 2008 conference call. Before reviewing our results and business highlights for the second quarter, let me remind you that on May 7, 2008 we completed the bundled sale of five partner companies including three former majority held partners Acsis, Alliance and Laureate Pharma as well as two minority owned partner companies, Neuronyx and ProModel. The transaction resulted in gross proceeds of approximately $74.5 million as well as the elimination of $31.5 million of debt guarantees. As we previously reported, $6.4 million of the cash proceeds will be held in escrow through April 2009.

On consolidated revenue for the second quarter reflects the result of Clarient our one majority held partner. Clarient and our 13 minority held partner companies are well aligned with our strategy to focus on high growth segments in the life sciences and technology arenas. Today we'll provide you with on update on our business, the progress of these partners, and the aggregate partner Company revenue expectations for the year. Consolidated revenue for the second quarter, that's Clarient's revenue was $16.9 million. That's up 71% year-over-year adjusted for discontinued operations. The Clarient team continues to generate very robust top-line growth while remaining simultaneously focused on earnings. This allowed Clarient to achieve positive adjusted EBITDA for the second quarter in a row. Adjusted EBITDA is defined by Clarient as income or loss from continuing operations before interest expense, tax expense, depreciation and amortization expense and also stock-based compensation expense. The Company delivered these results due to the growing demand for diagnostic services, new service offerings and an eye towards managing expenses.

As you know during the second quarter, Safeguard's former CFO Ray Land joined Clarient as CFO. We believe Ray's prior experience to Clarient as well as his skills as an experienced financial executive in the medical or life sciences industry will be highly advantageous for Clarient as they move toward the next phase in their development as the leading player in a field of cancer diagnostics. We thank Ray for his services to Safeguard and we welcome Steve Zarrilli to the position of Safeguard CFO. You'll remember that Steve served as our interim CFO prior to Ray's tenure and we're really happy to have Steve back as part of the executive team..

Our game plan remains the same. We are deploying capital and interesting high growth partners in life sciences and technology. We've identified five strategic themes that we believe are present in both technology and life sciences that somewhat guide our placement of capital, maturity, migration, convergence, compliance, and cost containment. For instance the population is maturing. Medicines have their patents expiring. The IT infrastructure is maturing and that sector is consolidating. There's a migration of business models and technologies from one place to the other. The perpetual licensing model giving way to the on demand delivery model, analog to digital and so on.

Technology and life sciences are converging. Regulatory compliance is driving buying behavior and cost containment is the watch word everywhere, spiraling healthcare costs, spiraling maintenance costs and the IT infrastructure. Major strategic themes like this attract entrepreneurial businesses. That's Safeguard's business. Find it, provide it growth capital, as well as some operational support services, strategic guidance, partner with the entrepreneur and build a great business. We realize value with selective well timed exits. That's the driver of our economic engine and we'll continue to provide more tools and transparency to better understand the underlying value of our partner companies.

Cash received through the recent bundled sale has provided us with ample resources to fund new partner opportunities as well as continue supporting our current partners. At the end of Q1 we reported that the pipeline was strong in number and quality and this continues to be the case. Additionally, private company valuation expectations are catching up with the broader markets. As you may have heard, exits for venture backed companies continue to decline in Q2 with no IPOs for venture backed companies according to the National Venture Capital Association exit poll and this is the first time this has occurred since 1978. The M&A market for venture backed companies has also softened but remains active with 120 exits for the first half of 2008. The combination of lower valuations and tighter VC investing puts Safeguard in a particularly strong position to find opportunities in which to deploy capital and then partner with some top quality high growth companies. We are evaluating a number of exciting opportunities in both life sciences and the technology spaces and we expect to announce a couple of new deployments before the end of September.

For Safeguard, today's dynamic business environment also means that our focus on building value on our partner companies needs to remain very sharp since high growth, strategically positioned companies stand out particularly in a challenging economic environment. They will also be the most strongly positioned as the markets improve, by helping our partner companies grow we will later be able to better realize value through exits as they reach new stages in their development. This builds value for Safeguard and our shareholders.

As we described last quarter, we view our partner companies as being one of four stages of development. First are the development stage companies. These companies are proving out technology concepts, developing prototypes, refining their go to market strategies, and forming early partnerships. Avid Radiopharmaceuticals, NuPathe and our stealth technology company fit into the development stage category. Avid is the leader in the development of molecular imaging products for neurodegenerative diseases. In Q2, Avid initiated phase 2 clinical trials on schedule for its Alzheimer's imaging compounds and is developing a potential groundbreaking test for the early detection of Alzheimer's. The Company is also in further development of their novel Parkinson's disease imaging products and it's developing a third product line to target diabetes. Avid also rounded out its management team by adding an accomplished CFO, Richard Baron and CEO Dan Skovronsky was chosen as a finalist in the life sciences category for Ernst & Young's Entrepreneur of the Year.

NuPathe, our life sciences partner that specializes in the development of therapeutics for the treatment of neurological and psychiatric disorders including migraines and Parkinson's Disease anticipates beginning Phase III studies for its transdermal patch for the relief of migraines, a condition suffered by an estimated 36 million people annually in the United States alone. Preclinical proof of concept studies for the application of NuPathe's sustained relief approach for Parkinson's also continues to progress. NuPathe CEO Jane Hollingsworth was recognized by Pharma Voice 100 as one of the most inspiring people in the life sciences industry in 2008 and on July 8, the Company completed a $30 million Series B financing which included new investors SR1. That is GlaxoSmithKline's independent corporate healthcare venture capital fund as well as Quaker Bioventures.

And our Stealth Technology company, which is being the world's first social information management system is currently in beta and expects to unveil its product at a major industry event in September where we expect to garner a good deal of attention. That will move the Company to the second group. The second group of partner companies, the initial revenue stage companies. These companies are developing initial customer relationships, gaining a foothold, penetrating their target markets and they're rounding out their management teams, their organization and their infrastructures. Safeguard Life Science partner companies Alverix, Cellumen and Rubicor Medical fall into this category of initial stage revenue companies. Alverix is an electronic company that is developing a portable medical diagnostic instrument in cooperation with leading point of care diagnostic companies. Alverix' devices enable the central laboratory quality results to be achieved in the physician's office, laboratory outreach locations, retail clinics and homes where test information is critical to patient care. As a point of care diagnostics technology provider, Alverix has launched its first product while the development of new products continue. Alverix also welcome James Merselis, the Company's new CEO onboard in early July. Mr. Merselis is an accomplished CEO with domain expertise in this space.

Cellumen, a cellular system biology company that delivers propriety services and products to support drug discovery and development, continues to pursue several new opportunities and partnerships. While the sales cycle has lengthened, a growing number of referencable customers are driving new partnerships and they are supporting a robust sales pipeline. Most recently the Company announced the initiation of a research collaboration with the National Center of Toxicology Research. That is a research center of the FDA. And Cellumen is at the forefront of drug safety profile services to aid in predicting drug toxicity early in the discovery and development process.

Rubicor Medical is a medical devices company focused on the development and commercialization of minimally invasive breast biopsy and tissue removal technologies. Acceptance and product demand for its minimally invasive technology continues to remain strong.

The third partner company category is expansion stage companies. These are companies with commercial grade solutions that are focused on expanding their market position. These companies are managing a rapid revenue growth, they have a solid management team and we have four partner companies in Safeguard's technology portfolio in the expansion stage category. Advantage Healthcare Solutions, Authentium, beyond.com and Portico Systems. Advantage Healthcare is a technology based hospital physician billing practice that is experiencing improvements in both revenue growth and productivity. The Company is also seeking acquisitions to complement this growth. In Q2 Safeguard completed our previous commitments from the Series A financing round through Advantage Healthcare Solutions by deploying an additional $3 million that would help Advantage toward their growth objectives.

Authentium, the leading developer of security software as a service for financial institutions has already signed its first customer FirstPay for its SafeCentral active desk-top agent that protects consumer data for financial transactions and is pursuing a number of growth initiatives. This security software is also receiving favorable reviews from such notable outfits as PC Magazine.

Beyond.com one of the largest networks for online niche career communities, despite a dampening economy Beyond continues to grow revenues while maintaining its position as the leading career network site on the Internet. Beyond did report an industry drop in online ads in this sluggish economy but they are gaining market share in this sluggish economy.

Portico Systems, the software solution provider to health insurance plans again delivered results according to their plan through the first half of 2008, continued strong bookings growth has Portico on track while the shift to recurring revenue model is improving revenue visibility. Portico expects to see continued broadening of its pipeline and a stronger market position with additional focus on sales and marketing.

And finally, there are our high traction stage partner companies including technology partner companies Bridgevine and NextPoint networks and life sciences partner companies Advance BioHealings and Clarient. These companies are experiencing solid growth or close to break even, are already profitable and they've demonstrated clear commercial traction. Bridgevine, the online shopping engine for digital services including digital TV, broadband Internet access and Voice over IP services continues to see revenue growth. This is especially significant in an environment where the number of household moves is decreasing in a softer real estate market and overall economic environment and we are impressed with Bridgevine's ability to deliver growth results.

NextPoint is our Internet protocol based solutions provider to telco operators. NextPoint continues their growth in Q2 and also driving cost containment opportunities such as leveraging resellers and offshoring some R&D functions.

On the life sciences side, Advanced BioHealings, or ABH is the leader in the science of regenerative medicine. ABHs FDA approved Dermograft for diabetic foot ulcers is seeking strong demand and should benefit from additional growth with an expanding sales team. And finally, as I mentioned our only majority held partner, publicly traded Clarient, a cancer diagnostic company, continues to show robust year-over-year growth. Clarient just reported its 16th quarter of sequential revenue growth and reported positive adjusted EBITDA for the second quarter in a row as cost reduction measures made in late 2007 continue to show impact, improving gross margins as well as operating margins in both of the three and six month periods as compared with the prior year. For the full year, Clarient remains on track to hit its strong revenue growth targets. Actually they just increased their guidance. Let me turn the call over to Steve and Steve will provide you with more details on our financial performance and some tools and transparency to allow you to better analyze and interpret the value of Safeguard. Go ahead, Steve.

Thanks Peter, and I'm excited to be back to help Safeguard carry on its tradition of identifying high growth life science and technology companies, growing them to build value and then realizing that value with strategic exits.

As Peter mentioned we finished the second quarter with one majority partner company publicly held Clarient and 13 other partner companies accounted for using the equity or cost method of accounting. Therefore for Q2 of 2008, our consolidated revenue reflects only the revenue related to Clarient when discontinued operations are excluded. For the second quarter of 2008 Safeguard reported consolidated revenue of $16.9 million, up 71% from the second quarter of 2007. We reported a net loss of $7.4 million compared to a net loss of $9.6 million in the second quarter of 2007. Again excluding discontinued operations.

Clarient's revenue increase in Q2 of $7 million was driven by growing demand for diagnostic services and new service offerings. Clarient also continues to make headway managing expenses with gross margins now at 59% compared to 44% a year ago. Clarient reported an operating loss of $1.7 million compared with an operating loss of $2.8 million in the second quarter of 2007. With the improvement reflecting higher revenue and effective cost management. As a reminder, Safeguard accounts for its interest in its partner companies using three methods, consolidation, equity or cost. As mentioned, Clarient is the only partner company today accounted for under the consolidation method.

For partner companies accounted for under the equity method where we maintain an ownership position of 20 to 50%, our share of the income or loss of each company is reflected in equity loss in our financial statements. For partnership companies where ownership is less than 20%, our share of income or loss is not included in our consolidated income or loss. Equity losses for our minority owned partner companies in the second quarter were higher than in 2007 mainly due to the change in our partner company mix which included more equity method partner companies in 2008 than in 2007. For the calendar year 2008 we expect aggregate revenue for our consolidated and nonconsolidated partner companies as of June 30, 2008, to be between 175 and $200 million reflecting the continuing strength in the operations of our partner companies despite general economic conditions. Among our life science partners, we expect 2008 life science aggregate revenue to be between 85 million and $100 million modestly above the previous guidance of 75 million to $82 million. Among our technology partners, we anticipate 2008 aggregate revenue to be between 90 million to $100 million modestly below previous guidance of 100 million to $118 million. Keep in mind that we account for our interest in the results of our minority companies on a quarter lag reporting basis consistent with prior periods.

From a corporate expense perspective, we have continued our efforts to refine our cost structure and eliminate unnecessary cost from a corporate operating perspective. For the second quarter of 2008, operating expenses including stock-based compensation and depreciation expense approximated 4.1 million versus $5.5 million for the same period in 2007 representing a 25% reduction. A similar reduction of approximately 20% existed for the six month period ended June 30, 2008, compared to the comparable period in 2007. We expect to achieve some additional cost efficiencies in Q3 and Q4 for 2008. These changes however will not minimize our ability to leverage our administrative, legal, financial, marketing and operational capabilities in supporting our partner companies.

From a parent only balance sheet perspective, we ended the second quarter with $152.7 million in cash, cash equivalents and marketable securities excluding restrictive security of $3.9 million and cash held in escrow of $6.4 million. Cash increase from the end of the first quarter, principally as a result of the proceeds received of $74.5 million inclusive of $6.4 million of escrow funds from the bundled sale. This transaction has also eliminated $21.3 million of cash collateral requirements related to the consolidated companies sold. Also on a year-to-date basis through the current date, we have deployed $12 million in existing partner companies to further support their business initiatives. After June 30, 2008, we received a payment of $4.9 million from Clarient against a portion of the outstanding balance of our credit facility to them. This payment resulted from their ability to secure an independent credit facility for $8 million with [Gemino] Healthcare finance.

We also renewed our credit facility on June 29, 2008, to provide for total borrowings of up to $30 million. As of June 30, 2008, approximately $11 million was available for borrowing after deducting Clarient's borrowings under their credit facility and other letters of credit. We announced on May 7, our Board has authorized a share repurchase program of up to $10 million. We began our stock repurchase program during the second week of June 2008 resulting in the repurchase of 161,600 shares of the Company's stock during the second quarter. We intend to continue with this program as Management deems it appropriate.

In May we also announced our intention to seek shareholder authorization for a reverse stock split at our annual meeting. That shareholder proposal was overwhelmingly approved. Approval authorizes the Board to effect a reverse stock split at an exchange ratio of no less than 1 for 4 and not more than 1 for 8 at any time prior to our 2009 annual meeting of shareholders. No decision has been made by our Board regarding the timing or terms of any such reverse split. With that let me turn it back to Peter for some closing thoughts before we open the call for your questions.

Thanks Steve. Well, the overall economic and stock market environment is certainly disconcerting but business cycles come and go, we believe the best thing for Safeguard is to remain focused on our strategy by deploying new capital and promising high growth companies at favorable valuations, building value on our partner companies through additional funding, technical and managerial counsel and finally, seeking strategic well timed exits for those partners that have gotten to an appropriate stage in their development. I look forward to sharing additional successes with you as time goes on. Please reference our press release for upcoming events where Safeguard will be presenting. And Chris let's open the call up now for any questions that anyone might have.

(OPERATOR INSTRUCTIONS) Your first question comes from Robert Labick with CJS Securities.

Good morning.

Hi Bob.

Hi, Peter, and welcome back Steve.

Thanks Bob.

A couple of questions. First, obviously you have a large cash position now and I was hoping maybe you could give us a little insight on your internal debate and understanding your use of cash going forward, how you are evaluating stock repurchase, debt retirement and then, obviously deployments to grow the business. If you could just walk us through the thought process there that would be helpful and what we might expect over the next 12 to 18 months.

I'll let Steve take that and I might do a footnote on it.

So Bob, as you would hope and as we are -- have expected, we are actively evaluating a number of different options for the use of our cash. The four primary categories as you can expect would be cash deployment for new opportunities, cash deployment for existing partner companies, the repayment of debt or the buyback of shares. We still have authorization from our Board to buyback debt when appropriate. We have been actively reacquiring or acquiring or repurchasing our stock I should say, and we are anticipating being able to deploy some capital into some new opportunities in Q3 as well as some existing partner companies in Q3. So it's a balance act right now. And in that balancing act we are taking a look at all of the opportunities that we have. We are having active dialogue internally and at the Board level and with some outside parties to determine what is the best application and use of this cash. I will tell you that we are on a internal savings plan, if you will to make sure that we have sufficient cash to pay down that debt as we go through the next two and a half years. So we will be actively working to reduce that debt as we go forward. But we are also going to be opportunistic with regard to the purchase of stock when it is appropriate.

Great. And part of that answer certainly does help with my next question which is given the broader economic environment can you discuss the deal pipeline, what is out there, what are people looking for, and how it impacts you? It sounds like you have some opportunities in Q3 to deploy some cash.

Bob, the pipeline continues to be very strong for some very interesting companies, and frankly we think we are at an advantage at this stage of the game, recognizing that the valuations of private companies tend to lag the valuations of public companies and we see now a trend for these private company valuations to catch up with the broader markets. Recognizing that we like to buy low, build value and sell high, this is working to our advantage. So we do anticipate the announcement of some closed deals before the end of Q3 and our pipeline remains strong with some very interesting firms.

And as a footnote to that there are some great trends and valuations that will benefit us as we go to making these investments in the next couple of quarters, Bob.

And you gave us some additional detail obviously, on the expected revenue of the partner companies, could you maybe discuss a little bit of the best performers and maybe some of the people that are a little behind based on the economy or whatever? Obviously, it sounds like life science is a little ahead of expectation on revenues and tech is a little behind consolidated growth is still very strong. Can you elaborate on those trends?

I think we stated that one of the benefits for us to have the technology and the life sciences trust is that the areas tend to be counter cyclical. We have seen some softening of growth in our technology partner companies while we've seen some acceleration for growth in our life sciences companies. In the aggregate our revenue expectations that we have set remain in the same range, but there's a little bit of a change in shift, if you will. The good news is that our technology companies have the benefit of being positioned with five strategic themes that are really propelling their growth. So in a softening economy while others are actually contracting, we've seen growth but perhaps a little slower growth than what's being seen earlier on.

In addition, Bob, in any set of circumstances you are going to at any given time going to have few that are going to be exceeding expectations, some that re going to be hitting their plan and some that may be behind plan, and we have that situation today. And it doesn't surprise us, and it does confirm what Peter continues to try to remind shareholders of and that is we have a, what we consider to be a very nicely balanced grouping of partner companies so that when one segment or one sector or one grouping of these companies tend to be doing well, it will help us from the standpoint of allowing us to divert some resources and time and energy to the ones that may need some additional help to get over a particular hill or through a difficult market scenario.

Great. One last question and I'll get back in the queue. You discussed positive trend in reigning in your corporate expenses, a 25% reduction year-over-year. Could you just talk more about your expectations on corporate going forward and how does it fit the current size of your portfolio and what should we expect in relation to corporate expenses to the portfolio of partner holdings over the next several years?

So you'll be happy to know that cost management is high on the priority list here, and we continue to make some tremendous and terrific improvements around the way we are managing and deploying cash as it relates to our corporate infrastructure. I do expect to see some continued improvement, some nips and tucks if you will to some of our corporate spending. There won't be any wholesale changes. We have look at our corporate infrastructure and have concluded that we can move in one of two directions. We can either continue to shrink corporate expenses to anticipate a lower or smaller amount of asset to be managed but there are opportunities going forward to increase the size of asset under management, and leverage this corporate infrastructure in ways which we may not have tried to in the past. So when we sit down as a management team, we are actually very bullish about opportunity that is we are seeing in the marketplace and it even relates to how we might be able to leverage our corporate infrastructure going forward in future periods around other activities that we may have an opportunity to pursue.

Great. Well, thank you very much. I will get back in queue and let others ask questions.

Thanks Bob.

(OPERATOR INSTRUCTIONS) Your next question comes from Bill Sutherland with Boenning & Scattergood.

Thank you. Good morning.

Hi Bill.

Steve, would you mind repeating what you said about the Q2 investment, the total that you made in the companies?

Q2 I believe was $12 million.

That was how many separate investments?

It was approximately four or five follow-on investment and exiting partner companies and we can get you that information specifically.

Okay. Good. On the stock repurchase, have you done anything since the end of Q2?

We continue to execute under our plan that has been put into place, and we'll continue to address that. It's a 12-B-15 plan, and we will continue to address the methodology that we are using under that plan going forward into Q3. So the short answer to your question is yes.

I understand. Thanks. Peter, since John Loftus left, I wasn't sure if there was any additional plans for the executive group inside tech.

We have a strong bench inside tech. Kevin Kemmerer has stepped up as the Managing Director of the Technology Group, and he continues to have a group that is appropriately sized to execute both supporting the existing companies as well as deploying new capital.

Okay. That's right. And then finally, just one thing I wanted to follow-up on on one of the partner companies, that is Cellumen. Just curious what is happening with the sale cycle there as far as stretching out.

Are they closing business. It's taking longer. Welcome to the new service offering, our new product offering in the marketplace. They continue to get testimonials from the customers that have signed on and that's helping them qualify that pipeline, but the closure of new deals in a new environment is taking a little longer than their plan.

Okay. Sounds good. Thanks guys.

Thanks Bill.

Your next question comes from Scott Nussbaum with [Broadlawn Capital].

Guys, could you tell me the current level of net operating loss carried forwards you have?

Yes. Scott, the total is $450 million in NOL carry forwards.

Okay. Thank you very much.

Your welcome.

(OPERATOR INSTRUCTIONS)

Well, on that note folks, thanks for your continued interest in Safeguard and we look forward to keeping you updated as to our progress.

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