Safeguard Scientifics Inc (SFE) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Safeguard Scientific 2009 year end results 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 follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, John Shave, Vice President of Development and Corporate Communications.

Good morning, and thank you for joining Safeguard Scientific's conference call and update. Joining me on today's call are Peter Boni, Safeguard's President and Chief Executive Officer and Steve Zarrilli, Senior Vice President and Chief Financial Officer. During today's call, Peter will review highlights of 2009 and our outlook for 2010, and Steve will discuss financial results and strategies for Safeguard. After that, we will open the line for your questions.

Before we begin, I will remind you that today's presentation contains forward-looking statements. Reliance on forward-looking statements involves certain risks and uncertainties including, but not limited to, the uncertainty of future performance of our partner companies and the risks of acquisition or disposition of interests in partner companies, capital spending of customers and the effect of the economic conditions generally, as well as the development of the life sciences and technology markets on which Safeguard focuses.

During the course of today's call, words such as accept, expect, anticipate, believe and intend will be used in our discussion of goals or events in the future. Management cannot be certain final outcomes will be as of today. We encourage you to read our filings with the SEC. The Company does not assume any obligations to update forward-looking statements made today. Now here is Safeguard's President and CEO, Peter Boni.

Thanks, John, and thank you all for joining us today at the recap of 2009 and an update of developments in 2010 at Safeguard and our partner companies. For newcomers on today's call, let me review Safeguard's business model. We target high potential life sciences and technology businesses with capital requirements of up to $25 million that exploit five strategic trends: maturity, migration, convergence, compliance and cost containment. Now currently, Safeguard's portfolio of partner companies is comprised of 17 companies, 10 life sciences partners and seven technology partners. Our ownership position in them range from now a low of 4.5% to a high of 59%. We are generally, but not always, the largest shareholder with specific influence. Exits from our partner companies may be realized through private land negotiated sales of securities or assets, public offerings of partner company securities, or in the case of a publicly traded partner company, the sale of securities on the open market.

Now, discipline is the hallmark of our strategy. We've said this often, but it bears repeating. We remain disciplined and focused on enhancing value of our partner companies rather than deploying capital or pursuing exit simply for activity's sake. Our deal teams evaluate hundreds of opportunities throughout the year. On the other side of the equation, exit opportunities may arise at any time and in different forms. However, in last year's general business climate, many of these opportunities didn't clear our strategic growth or return hurdles. We work every day to build value in our partner companies, drive their growth and keep their execution in line. In 2009, the power and soundness of Safeguard's strategy was readily apparent. Despite prolonged turbulence in capital markets an the US economy, we ended the year stronger and leaner than we began it and are well positioned to continue our progress in 2010. We executed strategic and financial transactions in 2009 that enhanced the Company's appeal to investors, reduced corporate expenses and debt and positioned our partner companies for additional growth and value creation.

So here's a list of some key developments in 2009. In March and again in May, partner company Clarient completed a private placement of $40 million in convertible preferred stock with Oak Investment Partners. With $40 million in new capital from Oak, Clarient extinguished all of its outstanding set except for receivable financing. The deal provided additional working capital to support Clarient's growth and its geographic expansion. These transactions allowed Safeguard to recapture $19.5 million in cash from Clarient's borrowings under a $30 million mezzanine debt facility, extinguishing that facility. The replacement also released $12.3 million in cash collateral supporting our guarantees of Clarient debt with third parties and eliminated any contractual commitment to provide more capital to Clarient. As a result of this private placement transaction, Safeguard's ownership declined from 60% to 47%.

In August, we completed a one for six reverse split of our common stock, reducing the shares outstanding from 122.3 million to 20.4 million and broadening Safeguard's appeal to investors. Our stock price at year end was $10.31 per share, and that was up nearly 150% from the $4.14 per share on a split adjusted basis at December 31, 2008. 2010 year to date, we were up an additional 28%. Now the Russell 2000 was up 25% during 2009, and it's up 8% year-to-date. We repurchased an additional $7.8 million in Safeguard's 2.625 convertible senior debentures at a discount to face value. reducing the outstanding ambulance to $78.2 million, and that's down from $150 million at the -- by Q4 of 2005. We deployed $24.9 million in additional capital to support growth at 10 existing partner companies.

In addition, Safeguard deployed just under $12 million in two new promising partners, Quinova Pharmaceuticals and MediaMath. During 2009, our partner companies grew aggregate revenue to $262 million. That's up from $179 million in 2008, as adjusted to reflect the inclusion of our new partner companies. Terrific growth during a year that many deemed quite difficult. We accomplished these milestones and more despite a rocky stock market, a lingering credit crunch that squeezed all businesses and perhaps the tightest market for venture-backed IPOs and M&A since the 1970s. While uncertainty remains remains an adjective for financial markets worldwide, there are signs that the macro level of resumed growth and stability are returning and in that context, we're excited about safeguard's prospects for 2010 for more growth throughout our holdings of life sciences and technology businesses and for the continued value creation for our shareholders. Now, let's take a look at some of our partner companies that illustrate the power of Safeguard's business model and the value of our holdings.

Clarient, Safeguard's only publicly traded company, is approaching $100 million in annual revenue from its cancer diagnostic testing services. Clarient's top line has grown rapidly since 2005 when it generated only $11.4 million in revenue. The company has since built its menu to more than 200 advanced molecular tests for tumors of the breast, prostate, lung, cervix and colon as well as for leukemia and lymphoma. Clarient's test volume increased approximately 20% year-over-year, and its customer base of oncology and pathology practices in the US exceeded 1,100, and that reflects a better than 98% customer retention rate. In addition, Clarient Laboratories continued to operate at efficiency levels well above industry averages. Yesterday, Clarient reported a revenue increase of 6% and 24% for the fourth quarter and for the full year 2009, respectively. Clarient's guidance for 2010 projects revenue in the $108 million to $115 million range with improved DSOs and cash collections.

During the fourth quarter, Clarient acquired Applied Genomics in an all stock transaction valued at up to $17.6 million. The AGI acquisition broadens Clarient's product pipeline and expands its geographic footprint throughout AGI's lab facilities in Alabama. In addition, Clarient implemented tighter controls throughout the organization, which improved billing and collection metrics as new accounting assumptions and systems began to take hold. In addition, bad debt expense declined 18% as a percentage of revenue, DSOs declined by 17 days from 103 to 86 days, and cash collections were recorded at $23.3 million, and cash flow from operations were $3.4 million.

Now heading into 2010, Clarient's management is focused on attaining sustainable profitability and continuing to improve Company billing and collection processes. As I mentioned earlier, Safeguard's position in Clarient was valued at $75.5 million at the close of trading yesterday. Avid Radiopharmaceuticals is a leader in the development of molecular imaging products to enable early diagnosis and prognosis of neurodegenerative diseases. Later this year, Avid anticipates completion of Phase III clinical trials and an MDA submission for its lead compound of imaging amyloid plaque in the brain related to Alzheimer's disease. The addressable population for the imaging of Alzheimer's disease pathology is estimated at more than 9 million annually by 2020 in the US alone. Furthermore, Avid has a robust pipeline, including imaging of patients to confirm the rule -- or rule out pathology related to Parkinson's disease and dementia with Lewy bodies, which is in Phase II, and to identify pathology in diabetes, which is currently in proof of concept Phase I clinical trials.

In 2009, Avid hired a GE Healthcare veteran as VP of marketing and sales to foster the company's next phase of growth, specifically through the commercialization of its lead compound for Alzheimer's. Advanced biohealing is at the forefront of regenerative medicine with a growing lineup of engineered tissue products that use living cells to repair or replace body tissue damaged by injury, disease or aging. AVH had revenues approximating $85 million in 2005, up almost 100% year-over-year and is profitable, driven by its surging demand for its FDA approved Dermagraft for diabetic foot users. Annual incidents of diabetic foot users in the US more than 800,000, representing an addressable market of more than $1 billion. AVH is aggressively expanding its US commercial sales force and exploring new applications for its products for domestic and international markets. Going forward, the company expects growth to continue by increasing US sales as well as indications and geography for its products.

Advantage Health Care Solutions, AHS, is among the industry's largest medical billing firms using proven and proprietary software to deliver outsource billing solutions to hospital physician groups. On our watch, the company has tripled in size, was cash flow positive in Q4 2009. The company has completed four accretive acquisitions since 2007 and is exploring multiple acquisition prospects in targeted specialties. We believe that AHS's growth prospects very, very bright. The company competes in a highly fragmented US market estimated at $4.5 billion in size in 2008.

Fewer than 20% of physician practices currently outsource billing in practice management. Beyond.com is the largest internet career network comprised of thousands of local industry and niche communities. The company monetizes its go local model via job posting and career services and online lead generation and advertising. The Beyond network of websites accounts for more than 5 million resumes and powers portals for some of the internet's best known and well established career brands and publishes. Despite a challenging job market, beyond.com continued to expand its strategy and its positioning from a pure community of job boards to a career network. This transformation has allowed the company to satisfy both employers and advertiser's increasing needs for performance and flexibility while simultaneously diversifying its revenue base. Additionally, employers spend more than $5.9 billion on online job recruitment in 2006, which is projected to surpass $12 billion by 2012. We believe that Beyond is well positioned to continue its growth in the US as the US economy recovers.

The most recently added Safeguard partner companies, MediaMath and Quinova are also making significant progress. Recently, Media Math was named to the AlwaysOn OnMedia Top 100 list and won the advertising networks and exchanges category. AlwaysOn is an annual listing of the hottest emerging companies in digital advertising. Inclusion in the AlwaysOn OnMedia Top 100 list signifies leadership amongst its peers and game-changing approaching and technologies that are likely to disrupt existing markets and the entrenched players . Quinova has several markets on the market and generated revenues of more than $10 million in 2009, up 78% from 2008. With the proceeds from the Series B financing, Quinova plans to start a Phase III clinical trial for an NDA product which recently completed Phase II trial, expand the company's sales and marketing capabilities, facilitate the company's other NDA and medical device clinical trials and then support R&D initiatives.

So there you have it. Summaries of seven of Safeguard's 17 partner companies representing a part of the value that we're working to develop on behalf of our shareholders. now let me turn this over to Steve Zarrilli, our CFO, and Steve will review Safeguard's financial strategies and our performance. Go ahead, Steve.

Thanks, Peter. Our earnings news release and financial statements were distributed earlier this morning. I would be happy to elaborate on any aspect of our fourth quarter in 2009 performance during the Q&A period. This morning, I'd like to provide to you some information with respect to several of our key strategic financial objectives and aggregate partner company revenue guidance for 2010. But first, let's establish the framework for our strategic financial outlook.

Safeguard continued to improve its financial strength and flexibility through 2009, largely due to increases in our cash balance and reductions of debt. This focus on the continual strengthening of our balance sheet will not change in 2010. At 12/31/2009, we had $106 million in cash, cash equivalents and marketable securities, excluding $6.9 million of cash held in escrow. For comparison purposes, our comparable balance at 12/31/2008 was $88 million.

Some detail with respect to cash resources are as follows. Cash operating expenses were $14.7 million for the year, cash expenditures, excluding interest payments on the convertible debentures, were down 4% when compared to 2008 and 19% in comparison to 2007. These totals exclude non-cash stock based compensation and depreciation expense. For the quarter ended December 31, 2009, cash expenses were $3.6 million. We deployed in the aggregate $24.9 million to support the capital needs of 10 existing partner companies, including deployments of $8.3 million during the fourth quarter and reflecting the exercise of certain warrants for additional Clarient shares. And we deployed an aggregate $11.7 million for equity interest of 18% and 26% respectively in the two new partner companies, MediaMath and Quinova Pharmaceuticals. For 2010, we anticipate Safeguard's cash operating expenses to be within the range of $14.5 million to $15 million.

During 2009, in connection with the transactions involving Clarient with respect to the investment by Oak and the secondary offering of Safeguard's Clarient shares, we recorded a net gain of $118.2 million, which was comprised of $106 million gain recognized in connection with the deconsolidation of Clarient in May 2009 and a $12 million valuation increase related to the net fair value adjustments for the period 2009 through December 31, 2009 -- for the period May through December of 2009. Our debt to equity ratio was approximately 1 to 1 on December 31, 2008 and today is approximately 1 to 2. Safeguard's debt balance of $78.2 million related to the convertible debentures has declined steadily under current management because of our ongoing campaign to purchase the original 150 million issue at discounts to face value when possible. As previously noted, our goal is to repurchase, refinance and/or restructure our convertible debt on or before March 2011 which represents the first put date available to the holders of these instruments.

This morning, we also announced that we entered into privately negotiated agreements with certain institutional holders of an aggregate of approximately $47 million in face value of our 2.625% senior convertible debentures due in 2024 to exchange the debentures held by such holders for an equal amount of newly issued senior convertible debentures due in March of 2014. The remaining amount of approximately $31 million would remain outstanding with an initial put date of March of 2011. The new instruments have the following features: Annual interest coupon of 10.125%, a conversion price equal to $0.1650 per share and if the debentures are converted, Safeguard has the right to settle the conversion in stock, cash or a combination thereof. We believe that this transaction gives us enhanced financial flexibility as we approach the first put date of our longstanding debentures, and we are better matching our long-term debt obligations with our exit expectations and capital deployment plans. We also feel that the flexibility to settle all or a part of these obligations using stock, cash or a combination thereof in the event of a conversion is advantageous to our shareholders in managing potential dilution. Under certain circumstances, the Company also has the right to force the conversion of these instruments after the second anniversary, should it be advantageous to us. The forced conversion would require that the Company compensate the holders for any interest due through maturity.

With respect to 2010, we intend to continue to evaluate and pursue opportunities to, A, reduce operating expenses where possible, B, manage cash deployments appropriately in support of our partner companies, C, selectively deploy capital in new and existing -- new and exciting growth companies and D, augment existing capital with well timed exits and alternative sources of capital. Our guidance on aggregate partner revenue for 2010 is $300 million to $325 million. That is up from a reported revenue of $262 million in 2009 and $170 million in 2008 and a $100 million in 2007. These historical amounts have been recasted to address the impact of the addition of our two new partner companies, Quinova and MediaMath, in order to ensure proper comparison between periods. For our life science partner companies, 2010 aggregate revenue is projected to be between $200 million and $218 million. For the technology group, we anticipating aggregate partner company revenue to be between $100 million and $107 million.

Over the last 12 months, we have advised Safeguard parter companies to conserve their cash, use aggressive competitive tactics and be opportunistic regarding potential M&A activities. They heeded that advice well. In addition rapid revenue growth, our partner companies completed three acquisitions. We see no reason to retreat from the mindset and believe that Safeguard and its partner companies are positioned for continued revenue and value creation in 2010. And now with that, I'll turn it over to Peter for the Q&A session.

Thanks, Steve. Givan, we're ready to take questions.

(Operator Instructions)

Operator, I'm showing two people in the queue.

Our first question comes from Bob Labick from CJS Securities.

Good morning.

Hello, Bob.

Hi. A couple of questions. You gave us a lot of information. For Steve first, you just went through the converts. I wanted to -- could you just verify the option of that conversion for cash or stock? Is it at your option or at the convert holder's option?

It is at Safeguard's option.

Okay, terrific. And then you also discussed forced conversions. Is that similar to a type of fallback, or is there any type of fallback provision? Or if you were to get a lot of cash from an exit early, could you exit or call back some of this debt before the 2014?

Correct. So after the second anniversary, when the stock has traded at a certain amount for a certain period of time, so the premium over current share value, over the 16.50 conversion price we could force a conversion and then settle that conversion in either stock or cash.

Okay. And then I think you discussed cash operating expenses to be basically flat with this year? Is that, despite probably higher interest expense, what actions have you taken there? I just wanted to verify that as well.

Bob, so the question with regard to our operating expense, we do expect operating expenses to be flat in relationship to 2009. We're always looking for ways in which to manage that number down, obviously, in addition some of the initiatives we're considering as to how to generate certain other forms of revenue potentially, such as management fees from co-participation funds and the like that would further reduce that number. So that operating expense number that I was trying to put forth is trying to compare apples to apples between 2010 and 2009.

Great. And then can you give us a sense -- as much as you know right now about the approximate amount you expect to deploy in your existing companies over the next 12 months?

Well, as you know, that's always a moving target for us. And the first priority is to ensure that our existing partner companies have that they capital they need. We want to be continually prudent with the use of our cash, recognizing that there are some opportunities that may present themselves over the next 12 to 24 months where we may be increasing our cash balances due to some well-timed exits. So we're going to continually balance the needs of our existing partner companies with the opportunities that we're seeing, an we're going to look to deploy capital at a pace that will continue to provide for the ongoing replenishment of the inventory, but I don't have a specific number to give you, but you can probably look at 2009 as an initial proxy of what we may be looking to do.

Terrific, and that leads to my next question and I'll jump back in queue. But you mentioned potential well timed exits expected to impact your cash balance. Can you give us an update on expectations for 2010 in terms of in your portfolio, what you see that might be potential exits and what are the milestones we should look for as outsiders as to when these might take place?

We began deployment of capital under this management team and this strategy in 2006 with a 3 to 5 year expectation of realizing exits. One might take a look at the calendar and say, okay, it's getting near that time, 2010, 2011. We should begin to see some exits. This is hard to predict, and we are not going to be predictive of many exits in many of our companies. We continue to position our businesses well, build value, and we'll just see where we stand regarding exits. But I just can't be predictive.

Okay. Understood. Thank you very much.

Thanks, Bob.

Our next question comes from Greg Mason from Stifel Nicolaus.

Good morning, gentlemen. This is Jonathan. Just a quick question. Peter, on the investor day, I think ABH, or it was stated that they were on pace to do about $120 million in revenue for 2010. Can you give us an update on that number and just the business in general?

I believe ABH has stated, most recently at a conference last week that they attended, that they achieved some $85 million in growth for 2009 and do have a $120 million forecast as a target for 2010. They continue to gain penetration in the diabetic foot ulcers application of their product offering. Many of the healthcare community are embracing their product Dermagraft earlier in the treatment of diabetic foot users, which is enhancing their penetration. They also are intending to gain approval in international markets to sell that product line in 2010, and they're going through the approval process now to enable that product line to have application for venous leg ulcers, which by itself will double the market potential of the Dermagraft product. So they're really clicking on many cylinders, and the management team there has been doing a fine job of penetrating the market and managing their growth with tight controls.

I appreciate that. And the timeline, I believe Dermagraft or the VLU indications are in later stage trials. Do you maybe have a timeline for when that's expected to be done and when that indication could be approved and Dermagraft could be used for VLUs?

Venous leg ulcer is likely to be a 2012 penetration, and internationalization or globalization of the Dermagraft product for diabetic foot ulcers is likely to take place later this year. I think that's their target.

Okay, great, thank you. And then also an update on the timeline for Avid's AV-45. You mentioned an NDA filing will be coming down the pike here. When would you expect after that's done AV-45 to come to the market?

Avid is targeting an NDA for the back half of 2010 and a 2011 market release .

And then one question, more broader market, are you starting to see the IPO market really opening up and becoming available to you, and how would that impact your ability to look at exits going forward this year and next?

Well, the IPO market is opening up a crack as compared to several years back. An IPO all by itself all by itself is not necessarily an exit. It's a valuation exercise and perhaps a financing exercise. It's a little trickier from an exit standpoint. But most venture-backed, if you will, or the finance companies find an exit 90% of the time via the M&A route as opposed to the IPO route.

And the M&A market, in your perspective, how is that at this time in time?

We are seeing more activity by strategic companies that have significant cash on their balance sheet to take a look now at the prospect of expanding their business via the M&A route. They have really pulled in their horns in 2009. The business climate is seemingly a little bit more positive, and we're seeing more activity in that area in terms of people kicking the tires. I think M&A activity is up as well as IPO activity up, but I can't say it's off the charts at the moment. But we are seeing a lot of folks circling on a variety of different properties.

Okay, great. Thank you. And, Steve, I apologize if I missed it. Would you be able to tell me if there are any prepayment penalties or no call provisions in the newly extended $47 million of convertible debt out?

There are no specific call provisions, but there is the ability to force conversion after the second anniversary.

So you could, if this was made available, be able take that debt out at any time in 2014?

Correct. And we can always be in the market acquiring debt in the way that we have in the past. I wouldn't necessarily believe that it could be at a discount in what we've seen. But you always have the opportunity to reach out to the holders of that debt to see if they would want to sell their interest in that instrument.

Okay, great. Thank you, guys.

Our next question comes from the line of Sam Rebotsky from SER Asset Management.

Good morning, Peter and Steve. You did a great job, and I guess it's a pleasure both to see the stock trade where it is and the opportunities. Could you talk about the opportunities for investing your money in new situations and what the values are today compared to, say, a year ago?

Hi, Sam. Thanks for the attaboy. We have a very rich pipeline of opportunities in both technology and life sciences today. We believe the climate, however, is still such that only the very best companies will gain financing, and those financings should come at pretty attractive price points.

So you see a valuation similar to what you've had before? There's no substantial increase on the -- what you have to pay for a situation to get involved?

I think valuations are holding accordingly from 2009 to today.

(Operator Instructions) Sir, I'm showing no more questions in the queue.

On that note, ladies and gentlemen, thanks very much for your continued interest in Safeguard, and we'll continue to keep you abreast of our progress as we execute in 2010.

Ladies and gentlemen, thank you for your participation the today's conference. This concludes the program. You may all disconnect. Everyone have a great day.