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Executives

John Shave - VP, IR & Corporate Communications

Peter Boni - President & CEO

Steve Zarrilli - CFO

Analysts

Bob Labick - CJS Securities

Scott Nussbaum - Broadlawn

Bill Sutherland - Boenning & Scattergood

Sam Robosky - SER Asset Management

Chris Cook - Zazove Associates

Safeguard Scientifics, Inc., (SFE) Q3 2008 Earnings Call Transcript October 31, 2008 9:00 AM ET

Operator

Greetings and welcome to the Safeguard Scientifics 2008 Third Quarter Earnings Call. At this time all participants are in a listen-only mode. A question-and-answer session will follow with formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, John Shave, Vice President of Investor Relations and Corporate Communications with Safeguard Scientifics. Thank you, Mr. Shave. You may begin.

John Shave

Good morning. Thank you for joining us for Safeguard's third quarter 2008 earnings conference call. Joining me on today's call are Peter Boni, President and Chief Executive Officer, and Steve Zarrilli, Senior Vice President and Chief Financial Officer at Safeguard. During today's call, Peter will review highlights from the third quarter. Afterwards, Steve will review financial results for Safeguard and our partner companies. Then we will open up the phone for your questions. You can also find supporting slides for today's webcast at www.safeguard.com/earnings.

Before we begin, I must remind you that today's presentation includes forward-looking statements. As you know, 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 interest in our partners companies, capital spending by customers, and the effect of economic conditions generally, as well as the development of technology and life sciences markets on which Safeguard focuses. During the course of today's call, words such as accept, anticipate, believe, and intend, will be used in our discussion of goals or events in the future. The Company cannot be certain that the final outcomes will be as described today. Our filings with the SEC, including our Form 10-K, describe in detail the risks and uncertainties associated with managing our business. You are encouraged to read those filings. The Company does not assume any obligations to update any forward-looking statements made today.

With that, I will turn the call over to Safeguard's CEO, Peter Boni.

Peter Boni

Thanks, John. And thank you all for joining us on Safeguard's third quarter 2008 conference call. Today, we will provide you with a progress report on Safeguard and our partner companies as well as some revenue expectations for this year. Despite this extreme volatility that has punched global financial markets, Safeguard and our partner companies continue to execute solidly against our game plan. During the third quarter, our partner companies grew revenues, and with strategic guidance from us, improved their corporate infrastructures, enhanced their competitiveness, and they built value. While many around us are retrenching, Safeguard is forging ahead.

At the holding company level, we strengthened our balance sheet during the quarter, took position in an exciting new technology partner company, and maintained a strong position to deploy capital in more growth stage businesses and targeted niches in the life sciences and technology sectors. Safeguard and our partner companies continued to build momentum in the third quarter despite the macroeconomic landscape that has deteriorated considerably since the last quarterly call.

Our three-prong strategy is number one to deploy capital in high-growth life sciences and technology companies. Number two to build value in these companies, and number three to realize this value through well-timed exits. As many of you know, our target cash on cash return is 3 to 5 XR capital within a three to five year period of time. Since 2005, this management team has deployed $120 million in capital into our current partner companies, and at the same time we and our partner companies have realized some $274.5 million in cash value.

The five long-term trends that comprise our strategy are intact. These themes of maturity, migration, convergence, compliance, and cost containment, remain forceful drivers in business today. The population is maturing. Patents have their -- medicines have their patents expiring. The IT infrastructure is maturing, and the industry is consolidating. There is a migration of business models and technologies. Technology companies are moving to on-demand service models from wired to wireless and from stand-alone to integrated.

Technology and life sciences are converging. Regulatory compliance is driving new requirements for companies and industries, and cost containment has never been more important considerations for management teams everywhere in this climate. You can see these themes manifested in our business plans of Safeguard's portfolio companies. We partner with entrepreneurs who are capitalizing on these themes in novel ways.

As a public company valuations have compressed in the current economic climate, valuations for private companies are also now under pressure. However, for Safeguard, this represents opportunity. Our pipeline is strong, and has particularly high quality and depth at this time. We have a strong healthy balance sheet that will enable us to take advantage of these opportunities at compelling valuations. However, because public and private company valuations are currently compressed, this is not a particularly good time to sell. We are more focused on enhancing value in our partners than in pursuing exits. Exit opportunities may arise at any time, but in these challenging business climates, we are working to improve value in our partner companies, driving growth and keeping their cash position and spending in line.

Now, let us review the progress that our partner companies during the third quarter. Clarient is Safeguard's majority health partner. We own 58% of Clarient shares, and we carry on our books of value of $17.3 million as of September 30th. As many of you know, Clarient is publicly traded on the NASDAQ.

Clarient generated strong top-line growth, posting its 17th consecutive quarter of increased revenue for the period ending September 30th. There is no question about the robust demand for Clarient's cancer diagnostic products and its services. Management's challenge has been to translate that revenue growth into earnings, and I can report great progress on this front. Operating margins continue to improve. Clarient has reported its third quarter of positive adjusted EBITDA and its first quarter of positive EBIT. Expense control initiatives have gained traction. While Clarient recognizes the traditional seasonality of the fourth quarter based upon their outstanding performance in the third quarter and the first nine months, their management raised guidance for the full year of 2008 revenue growth from a range of 45% to 55%, to a range of 55% to 60% over revenue of 2007.

In other developments during the third quarter, Clarient launched two important partnerships, a consulting and training agreement with the University of Pennsylvania School of Medicine and a five-year strategic partnership with [Finnegan] under which the two companies will collaborate to develop and commercialize tools that evaluate quantitative fire markers that indicate cancer treatment response to targeted therapies.

Let us move now to the highlights of Safeguard's minority-held partners. During the third quarter, we deployed $3.4 million in capital for a 29% stake in Swaptree. This is a web-based start-up with an innovative software platform that finds bartering opportunities for individuals to trade books, CDs, DVDs and video games. Currently, members pay only for shipping which averages $2.50 per item. This unique model leverages their patented technology at a time when individuals and households are tightening their belts and controlling discretionary spending, but they still want to enjoy the latest books, CDs, DVDs and video games.

As a result of this trend. Swaptree's unique visitors have grown over 300% since capital deployment, and the company is preparing to move to the next stage, revenue generation. We also deployed $3 million in a yet-to-be-announced life sciences partner company. Now Swaptree joins our existing development stage companies, Avid Radiopharmaceuticals, Kadoo, and NuPathe. These companies are proven out their technologies, developing prototypes, refining their business models, and building partnerships.

Avid is the leader in the development of molecular imagine products for neurodegenerative diseases. Avid's amyloid imaging compound is now in Phase II of the FDA trials, and is well-positioned to rapidly enter late stage development based upon the FDA advisory committee's recommendations. It was the first compound to enter multi-center Phase II clinical studies, and Avid anticipates initiating Phase III trials in early 2009. In addition, there is a Phase III trial sponsored by Eli Lilly for the Alzheimer's therapeutic that Avid is a part of. Avid continues to makes progress with their Parkinson's Disease imaging product which is now in clinical trials and is anticipating entering Phase II trials shortly. Safeguard has a 14% stake in Avid.

Now Kadoo, which has been in stealth mode, launched in September at a trade show called Demo 2008 and is a leading conference showcase for emerging technology companies. Kadoo is building the world’s first social information management system, a suite of software that aggregates and intelligently integrates web applications with content management and social networking capabilities. Safeguard has a 14% ownership with Kadoo.

NuPathe is a life sciences partner company that specializes in therapeutic for the treatment of neurological and psychiatric disorders including migraine and Parkinson's Disease. NuPathe anticipates initiating its Phase III trials in the FDA for its Smart Relief transdermal patch for the relief of migraines. NuPathe development of this product is a novel approach in the treatment of Parkinson's Disease, and it is making progress with pre-clinical proof of concept studies. Our stake in NuPathe is 23%.

Now Safeguard's initial revenue stage companies are Alverix, Cellumin, and Rubicor Medical. These partners are developing customer relationships, starting to penetrate their target markets, and rounding out their management teams, organizations and infrastructures. Alverix is an opto-electronics company developing portable medical diagnostic instruments in cooperation with leading point of care diagnostic companies. They enable central laboratory quality results to be achieved where test information is critical to patient care in the physicians' offices, laboratory outreach locations, retail clinics, and at home. Safeguard currently maintains an ownership position in Alverix of 50%.

Cellumen is a discovery toxology company that provides the most accurate prediction of drug efficacies and safety. Cellumen is leading the way in drug safety profiling services to help indicate drug toxicity early in the discovery and development process. In the third quarter, they started penetrating the market with their cellular level tool to facilitate drug trials within the pharmaceutical industry. Although revenue development is progressing slower than originally anticipated, they have built a large backlog of Big Pharma and leading biotech customers. We hold a 41% ownership position in Cellumen.

Rubicor Medical is a medical devices company developing and commercializing minimally invasive breast biopsy and tissue removal technologies. The Company is currently undertaking its search for a new CEO. Further, the Company is exploring the possibilities of raising additional funding, and operating activities have been suspended until this additional capital is secured. Safeguard currently owns a 36% position in Rubicor.

Now Safeguard's expansion partner companies are Advantage Healthcare Solutions, Authentium, Beyond.com, and Portico Systems. They are managing rapid revenue growth with solid management teams in place. Advantage Healthcare is a technology-based provider of medical billing solutions to physician groups. AHS continues to grow while making productivity improvements. They are also negotiating to enhance their growth through acquisition and that would scale their business even more rapidly. As growth alternatives are being explored, management is tightening its managing operating expenses. Our ownership position there is 38%.

Authentium is the leading developer of security software as a service for financial institutions. They recently introduced a new product, Safecentral active desktop agent. Authentium's core security business continues to be stable. Management is in the process of developing new relationships to spur channel revenue opportunities with this new product offering. Safeguard has a 20% ownership position in Authentium.

Beyond.com, one of the largest networks for on-line niche career communities. Beyond is increasing its market penetration with a differentiating positioning in the market in spite of a currently compressed job market. As old media turns to new media to advertise and promote, Beyond.com is very well-positioned with good margins. Current market dynamics will create some near-term headwinds for Beyond's business, however, and the company anticipates remaining substantially on plan. Safeguard has a 37% ownership position here.

Portico provides software solutions to help insurance plans. Portico is on track for a roughly 30% organic growth this year, and they announced they acquired Ethidium Health Systems. The deal positions Portico at the forefront of emerging medical, home, and paper performance initiatives, and they significantly expanded their industry leading integrated provider management platform. Our ownership stake in Portico is 47%.

Safeguard's high traction stage partners, Advance BioHealings, Bridgevine, GENBAND, and Clarient are all reporting terrific growth, nearing break-even or driving further bottom line results, and they are gaining additional commercial traction. I summarized Clarient's progress earlier. ABH is a leader in regenerative medicine, increasing revenue 62% year-over-year. Demand remains brisk for their FDA-approved dermagraph product for diabetic foot ulcers. In addition, the company is expanding its market by developing other effective wound care protocols and leveraging its technology in new market segments and geographies. Revenue growth is exceeding initial internal expectations. We have a 28% ownership in ABH.

Bridgevine is an Internet advertising platform for digital services including digital TV, Broadband, Internet access, and Voice-over-IP services. They are performing well and growing revenue despite fewer household moves due to contracting home prices and tight mortgage markets. Bridgevine is benefiting from a widely expanded set of offerings from more than 100 merchants in the entertainment, financial, security, and mobile sectors. Our Bridgevine ownership position stands at 21%. They are experiencing some near-term slowing of revenue growth, but growth nonetheless, during this period of economic uncertainty for consumers.

GENBAND is the market-leading developer of next generation IP infrastructure solutions. We now maintain a 2.3% ownership stake in GENBAND by virtue of its September merger with one of our legacy partner companies, NextPoint Networks. The combined company has revenues of approximately $150 million in services or market size to $12 billion. GENBAND's aggressive product development is aimed squarely at the integration of emerging technologies like security control, packet inspection, all aimed at telecom service providers. Many businesses are facing headwinds of economic turbulence today. While all of our businesses are positioned well with major trends to drive their growth, we have advised all of our partner companies to use their cash wisely in this climate and take advantage of their strong position over weaker competitors.

I will now turn the call over to Steve Zarrilli, our CFO, and Steve will review with you our financial strategies and our performance there. Go ahead, Steve.

Steve Zarrilli

Thanks, Peter. Our earnings news release and accompanying financial statements detail the performance of Safeguard and our partner companies. Rather than repeat that information, I want to remind you of our focus during the third quarter on three strategic financial initiatives. Number one, strengthen Safeguard's balance sheet by repurchasing debt and maintaining a strong cash position. Number two, reduce corporate expenses. And number three, retain our flexibility to enhance valuation through an ongoing share buy-back program and potential reverse stock split transaction. We can report good progress across the board with regard to these initiatives.

During the third quarter, Safeguard repurchased $38 million in face value of our outstanding convertible debentures for $30 million or less than 79% of face value. This transaction resulted in a gain of approximately $7.6 million. We issued $150 million in face value of these debentures at 2.65% in 2004. The current balance of outstanding debentures is $91 million in face value with the market value of $63 million as of September 30, 2008. We continually assess the best uses of our cash, and anticipate maintaining our opportunistic approach to debt repurchases.

On the corporate expense front, we are improving our efficiency. Operating expenses for the third quarter including stock-based compensation and depreciation expense, were down 28% to $4.2 million compared with $5.9 million for the same period in 2007. We are continually exploring ways to maximize the cost efficient use of our corporate infrastructure in relation to assets under management. Additional cost reductions may be achieved in future quarters.

After the Safeguard Board's recent authorization to repurchase up to 10 million of our shares, we bought back 975,000 shares at an average price of $1.31 per share during the second and third quarters. The total cost was $1.3 million. In today's environment, we are carefully balancing debt and equity repurchases with capital deployments and new partner companies and continued support of our existing partner companies. And we are aware of the value of having cash versus needing cash. We continue to raise the bar for cash deployments in today's climate.

Looking at Safeguard's balance sheet from a parent-only perspective, we ended the third quarter with $107.1 million in cash, cash equivalents, and marketable securities, excluding restricted securities of $2 million and cash held in escrow of approximately $6.9 million. Our cash balance decreased from the end of the second quarter primarily due to three reasons. Debt and equity repurchases of $31.3 million, deployment of $6.4 million in a new partner company Swaptree and a yet-to-be-announced new life sciences partner company including converted notes for that company. And deployment of $7.1 million in four existing partner companies to support their growth. Year-to-date, deployments in new and existing partner companies totaled $19.9 million.

At our annual meeting in May, shareholders authorized the Board to complete a reverse stock split at an exchange ratio of no less than 1 for 4 and no more 1 for 8, at any time prior to our 2009 annual meeting of shareholders. The Board will continue to assess whether it will pursue any reverse split based on macroeconomic conditions, our stock price, and various other factors.

As Peter described, we remain very confident in the future of our partner companies. While some of them are experiencing slower growth in this uncertain environment, others have been largely protected from economic conditions and continue to grow impressively. As Peter mentioned, Clarient continues to meet or exceed our expectations. Clarient achieved revenue of $19 million for the three months ended September 30th, and $51.8 million for the nine months ended September 30th. This compares to $11.9 million and $30.6 million for the same periods in 2007. Clarient also achieved adjusted EBITDA of $1.7 million and $3.6 million for the three and nine-months ended September 30th. I am sorry -- adjusted EBITDA of $1.4 million for the three-month period ended September 30. These results represent significant achievement over the same periods in 2007. Management of Clarient continues to explore ways to augment its capital base. Safeguard remains committed to Clarient to ensure the management team has the appropriate funding and other resources necessary to continue its growth.

We are updating our revenue guidance for 2008. We expect aggregate revenue of Safeguard's partner companies in the range of $155 million to $165 million for the year. However, please note that the aggregate revenue guidance is not adjusted to reflect our new partner company Swaptree because it is a pre-revenue company, and does not impact our aggregate revenue expectations. And it removes in its entirety the revenue associated with NextPoint given its merger with GENBAND.

Considering our 2.3% ownership stake in GENBAND, we have removed GENBAND's revenue from this guidance since we do not have any real influence over GENBAND's direction and believe the exclusion of such data allows us to better reflect our partner companies' aggregate performance. Our original guidance at the beginning of the year, excluding NextPoint, would have been $135 million to $150 million. Among our life science partners, we expect 2008 life science aggregate revenue to be between $100 million and $105 million, modestly above previous guidance of $85 million to $100 million. We anticipate 2008 technology partner aggregate revenue to be between $55 million to $60 million, modestly below previous guidance of $55 million to $65 million, when adjusted to exclude NextPoint. As you remember, there is a one quarter lag in reporting our interest in the results of minority-held companies.

On that note, I'll turn it back over to Peter for some summary thoughts before we open the call to your questions.

Peter Boni

Thanks, Steve. While these are unprecedented times for the U.S. and really global economies, but remember, Safeguard's strategy allows us to take advantage of market peaks and valleys. Our focus on targeted areas of technology and life sciences sectors is no coincidence. These high-growth sectors operate with different economic cycles. This dynamic provides Safeguard with a level of diversification that, in part, shelters us from these broad economic swings. At the same time, Safeguard's strategy is to deploy, build, and realize value with exit means. We can follow the proven methodology of buying low and selling high. We do this by deploying capital from a healthy balance sheet so high-quality companies when valuations are the most attractive. As we enhance value in these companies, we can realize gains when the macroeconomic environment is more favorable. This strategy has been the foundation of Safeguard's success for over 55 years.

On that note, Diego, please open the lines up for questions from our listeners.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Bob Labick with CJS Securities. Please state your question.

Bob Labick - CJS Securities

Good morning. Thanks for all the information you have given us.

Peter Boni

Hi Bob.

Bob Labick - CJS Securities

Hi. A couple of questions. Peter, you began to discuss this. I was hoping you could expand on one of the comments. Obviously in the difficult macro time right now, you said you are focusing internally on enhancing value, and you also alluded to the fact that you have told your companies to use cash wisely. Could you just give us a global perspective of some of the messages you are giving to your companies in these difficult times, and also what areas can you focus internally to maximize value?

Peter Boni

Okay, Bob. Some combination of Steve Zarrilli and I will take your questions. On October 2nd, I believe, when we had our Analyst Day, that piggybacked on our advisory board meeting where we had all of the CEOs of our partner companies in. And recognizing the macroeconomic environment, we all gave them guidance to preserve and protect their cash. Cash is absolutely king in this climate. And to take their strong cash balance, their strong market position, and aggressively use that, especially against a weaker competitors, be predatory in their marketing as well.

Also, we think this environment is an opportunity for them to enhance their own businesses with the potential acquisition of weaker competitors if they can find a product offering that is strategically sound to expand their business or a channel of distribution to expand their business or a customer set to expand their business. So this is the guidance we have given to our firms, across the board, both in technology and in life sciences.

Regarding the exit climate, we think the exit climate is somewhat retarded in this environment. We might achieve an exit in any one of our companies at any given period of time, but we are focused on timing our exits to maximize risk-adjusted value. Our fiscal planning for 2009 is not planning any exits, although we continue to position for exits, and we'll be opportunistic as it relates to maximizing risk-adjusted value. My crystal ball is not very good for 2009, especially the back half, but for the front half, I am not anticipating anything more than what we are seeing right now.

Bob Labick - CJS Securities

Okay. Great. And then just going from that and taking your perspective, given your expertise in technology and life sciences, I was wondering if you can give us your global thoughts given the credit crunch and everything else. On what you are seeing or what your partner companies are seeing in their actual businesses as it relates to IT spending or growth and hiring initiatives or new product trials. From your vantage point above each of these industries and your companies within, what global trends are you seeing emerge from companies in these industries?

Steve Zarrilli

Okay, Bob. In general, the technology businesses that we have are still growing, thanks to these five major trends that really are driving the growth. But in general, some of that growth has slowed as compared to what we had seen prior to this economic malaise that we have. The life sciences businesses continue to go gangbusters. Companies like Clarient and Advance BioHealings are really over their initial forecasts for the year. Cellumen is making great strives in the penetration of the marketplace with their offering as well. So we really have an environment where the vision of being in two different fields that are somewhat operating on different economic cycles has played to our benefit in our aggregate revenue, in our growth.

Bob Labick - CJS Securities

Okay. Great. I will ask one more and get back in queue, but Steve just mentioned you are exploring ways to maximize the infrastructure that you have in place. I was wondering if you could, at least, give us a couple of the opportunities you are thinking about the pros and cons, and what we might expect over the next year or two could happen to maximize your infrastructure.

Peter Boni

Bob, because many of these things are still works in process, I will be able to give you a little bit of a sense, but I cannot get into too many details at this moment. We recognize though that we have an corporate infrastructure that could be leveraged across a broader set of assets, if you will, under management. So what we continue to do is look for unique ways in which to augment either existing pools of capital or ways in which we can leverage this infrastructure against other existing pools of capital that exist.

So one of the things that we are going to be looking at, not only in the fourth quarter but in 2009, are ways in which we can actually potentially execute against some of those ideas that we have. We are just in the beginning processes of having some exploratory dialogue with a number of different parties, and hopefully as 2009 begins to unfold, we will be a little more transparent and a little bit more specific about some of these activities.

Bob Labick - CJS Securities

Great. Thanks very much. I will get back in queue.

Operator

Thank you. Our next question comes from Scott Nussbaum with Broadlawn. Please state your question.

Scott Nussbaum - Broadlawn

Could you refresh my memory? I think you mentioned at the beginning of the conference call the total value -- total dollars deployed by Safeguard into your existing portfolio companies?

Steve Zarrilli

Hi, Scott. $120 million since I joined the company in 2005 in our current portfolio.

Scott Nussbaum - Broadlawn

And since you joined, everything that existed before you joined has now been sold, correct?

Peter Boni

All but two companies. When I joined there were twelve companies. We have divested 10 of those 12, and received some $275 million between us and our partner companies on the varying divestitures.

Scott Nussbaum - Broadlawn

So the $120 million, the current carrying value of that is?

Peter Boni

Steve, can you address that?

Steve Zarrilli

The current carrying value of that $120 million is approximately -- I do not have that information in front of me. I am going to say it's approximately $70 million. I apologize.

Scott Nussbaum - Broadlawn

$70 million or so. I am just trying to get some rough numbers. That is good enough. And the net operating loss carried forward. You are still at about $450 million as of 9-30?.

Steve Zarrilli

No. They are down to about $350 million due to the expiration of certain NOLs that occurred during late 2007 and into early 2008.

Scott Nussbaum - Broadlawn

Okay. You may want to update the October investor presentation slides on your web site that still say $450 million.

Steve Zarrilli

Thank you.

Scott Nussbaum - Broadlawn

Okay, I am going to get back in queue. I am going to look at some things. Thank you.

Operator

Thank you. (Operator Instructions). Our next question comes from Bill Sutherland with Boenning & Scattergood. Please state your question.

Bill Sutherland - Boenning & Scattergood

Thank you. Good morning.

Peter Boni

Hi Bill.

Bill Sutherland - Boenning & Scattergood

Hi, Peter. Steve, you gave out the deployments in the quarter. I got the new at $6.4 million. What was the existing company, deployment?

Steve Zarrilli

It was NuPathe.

Bill Sutherland - Boenning & Scattergood

And size? I am sorry.

Steve Zarrilli

I am sorry?

Bill Sutherland - Boenning & Scattergood

What was the amount?

Steve Zarrilli

Approximately $2 million.

Bill Sutherland - Boenning & Scattergood

$2 million. Okay, just did not catch it the first time. Would you mind, Peter, a little more color or maybe some statements there on Rubicor? Where they stand and what needs to happen there?

Peter Boni

The short story, Rubicor, we remain excited with a billion dollar market opportunity for their products. They have three FDA-approved products for a minimally invasive cancer biopsy, lumpectomy, and coring. We have employed Corn Ferry to help us with the CEO search there. We have also engaged a banker to assist us with a capital raise from both strategic as well as financial sources, and feel very confident that the demand for the biopsy product because of their strong intellectual property position will really be there.

Bill Sutherland - Boenning & Scattergood

So I guess I am trying to figure out what the hitch is, given the tone of your comments. And then as the financing occurs, assuming it occurs, do you think you will maintain your 36% stake?

Peter Boni

I cannot be speculative as to what that financing will look like, Bill, until it happens, but a new CEO is certainly paramount to the financing of the company. And this is not unusual as well, as the company transitions from a founding team to a professional CEO once we get into the commercialization phase.

Bill Sutherland - Boenning & Scattergood

Okay. Thanks, Peter.

Operator

Our next question comes from Sam [Robosky] with SER Asset Management.

Sam Robosky - SER Asset Management

Good morning, gentlemen.

Peter Boni

Hi Sam.

Sam Robosky - SER Asset Management

This is a tough time that everybody has experienced. One, the significance of your $350 million NOL? Is there any other thoughts other than trying to sell any of your companies to utilize this? Is there any possibility of matching up with anybody that might be able to utilize the NOL in some way or fashion that would give greater value to Safeguard?

Steve Zarrilli

Sam, we continue to explore ways in which to more quickly utilize that asset. As you recognize or as you probably realize that if we try to acquire an operating company, as an example, to shelter its income from taxation using our NOLs, that there would be potentially some limitations to that, but that could be an alternative. We also look to see if there are ways to create alternative pools of capital that, in doing so, could we potentially leverage the value of those NOLs into some other structures that we may create to augment our capital base. So we are continually looking at it recognizing that they will expire over the next so many years, and we want to try to make sure that we are aggressively considering ways in which we can take advantage of them. But there is nothing specific to speak to at this moment in time as to a particular initiative that we have underway that will specifically address how we are going to use them.

Sam Robosky - SER Asset Management

Thank you.

Operator

Our next question comes from Bill Sutherland with Boenning & Scattergood. Please state your question.

Bill Sutherland - Boenning & Scattergood

Yes. Thank you. A quick follow-up here. Did I hear correctly when you were talking about the outlook for exits? I think you said unlikely in the course of '09, or did I not hear you correctly?

Peter Boni

What we stated, Bill, is that given the external environment, our own fiscal planning has assumed that we would not see any exits in 2009 although we continue to position for exits and look for opportunities to time our exits to maximize risk-adjusted value. It is possible but our own fiscal planning is not planning it.

Bill Sutherland - Boenning & Scattergood

Okay. So basically, it is a comment on your conservatism in terms of husbanding cash, more than trying to divine the market nine months out?

Peter Boni

Exactly. If we have an exit, we have opportunities to take a look at that cash utilization given the change in the external climate.

Bill Sutherland - Boenning & Scattergood

Understood. Thanks, Peter.

Peter Boni

Do you want to amplify that?

Steve Zarrilli

Bill, just to -- actually two points. On the previous carrying value question, just for greater specificity, it is $82 million. But to your point with regard to cash, we continually run, as you would expect and probably anticipate, a variety of different cash projection models, but what we are trying to do is make sure A, we have enough cash to support our existing partner companies, be opportunistic in the marketplace as it relates to our debt, and then also realize that there will be opportunities for potential new deployments in the year, recognizing we raised the bar somewhat from the standpoint of quality, but we want to make sure that where we have the capacity to deal with all three of those potential needs of cash during 2009. And we do that with and without projections around exits during the course of the next, what I will call five quarters.

Operator

Thank you. Our next question comes from Sam [Robosky] with SER Asset Management. Please state your question.

Sam Robosky - SER Asset Management

Just one follow-up relative to the price of the stock and your ability to reverse split and the New York Stock Exchange, and relative to possibility management buying stock if the company is not buying stock, what is your plans of buying stock now at the low current price even with the authorization? And what is the requirement of reverse split considering trading below a dollar in the New York Stock Exchange?

Steve Zarrilli

We will continue to evaluate the potential use of our cash with regard to stock repurchase, though we do tend to lean more heavily towards being opportunistic around debt repurchase than we do stock buy back given our belief and views as to how that benefits our shareholders. As it relates to where our stock trades, if I understand your question correctly, in relationship to the NYSE requirements, we will -- we do need to make sure that we stay attentive to those requirements. If our average 38-day trailing share price average falls below a dollar, there are certain requirements that we are going to have to meet with regard to the Exchange. And we may need to then consider whether or not a reverse stock split would be appropriate at that point in time.

Sam Robosky - SER Asset Management

Are you --

Peter Boni

The rules are they give you a six month rectify, so we have plenty of opportunity to do that.

Sam Robosky - SER Asset Management

So you have plenty of time to reverse split. So presumably you will not do anything until the New York Stock Exchange requires you to do it?

Peter Boni

I cannot be speculative there, but the short story is we have shareholder approval overwhelmingly to take that action, and we will keep our eye on it, and do the appropriate thing at the appropriate time.

Sam Robosky - SER Asset Management

Alright, good luck.

Peter Boni

Thank you.

Operator

Our next question comes from Scott Nussbaum with Broadlawn. Please state your question.

Scott Nussbaum - Broadlawn

I was just adding up some of the numbers here. The Company is selling at such a discount to its net operating value with this very large net operating loss carry forward. Are the net operating loss carry forwards usable if another similar business were to acquire Safeguard, and they had gains elsewhere in their portfolio? So, if a private equity firm bought the whole company, could those net operating losses be used to shield gains in their portfolio?

Steve Zarrilli

To a point. There would be significant limitations applied to the amount of NOLs that could be used in any given year. So that asset to an acquirer would not be as beneficial as to our ability to find ways in which to use it within our own business.

Scott Nussbaum - Broadlawn

Does Safeguard qualify as a financial institution to benefit from the new rules with the financial bailout package where they increase the flexibility for using NOL carry forwards?

Steve Zarrilli

No.

Scott Nussbaum - Broadlawn

Have you explored that specifically?

Steve Zarrilli

We have tentatively with our advisors.

Scott Nussbaum - Broadlawn

Okay. The discount NAV is so extreme at this point, my understanding was in 2006, a large compensation package was put into place that incented senior management and the investment professionals based on achieving market cap thresholds in the stock. Are you rethinking that now?

Steve Zarrilli

We have not re-thought it. That plan remains in place. It represents a vast majority of the equity incentive compensation for our executive management team. As you pointed out, Sam, that 75% approximately of that -- I'm sorry. Scott, of that amount represents vesting that occurs only upon achieving that particular share price or market capitalization. This year, though, we did put into play an additional compensation -- equity incentive compensation program and issued a small amount of options to our executive management team wherein those options are tied to a specific pool of capital that is deployed in 2008. And in future years, we will do the same thing once a year. And investing will occur only when we achieve certain cash on cash returns associated with that designated pool of capital.

Scott Nussbaum - Broadlawn

It seems to me the executive compensation plan is so far out of the money at this point, that your own investment professionals would want to buy into the company. Even taking the company private and rolling it into another similar business at a $1.50 a share representing twice the market cap would still be a 50% discount to NAV, and might give the current management team and executives a chance to participate on the upside at a much more material way than waiting for the existing targets to be achieved which could take five or ten years given how far out of the money they are. Have you guys thought about that?

Peter Boni

Well, we have enhanced the option plan with the vesting on a cash-on-cash return. If we all worked for a venture capital or private equity firm, our carry would be based upon receiving the cash-on-cash return and that takes a little while. That does not take a couple of quarters. That is a longer term gain, and we have the ability to compete for the best and brightest people for that longer term gain for cash-on-cash return.

Scott Nussbaum - Broadlawn

I think you would all want to buy into the company at this point and not trust the capital markets to address the valuation issue given how the stock market value has declined so precipitously over the last year despite what seems to be good internal progress.

Peter Boni

We agree with the good internal progress most certainly. We are always in a position of buying or selling something, and with insider trading rules, we have a very narrow window when we might be able to do market buys on our stock.

Scott Nussbaum - Broadlawn

I mean something more dramatic than market buys and buying back shares. I would think the current management team would be excited about taking the entire company private at these levels.

Peter Boni

We continue to evaluate opportunities that build shareholder value, Scott, and I cannot be speculative as to what they might be.

Scott Nussbaum - Broadlawn

Okay. Thank you .

Operator

Thank you. Our next question comes from Chris Cook with Zazove Associates. Please state your question.

Chris Cook - Zazove Associates

Yes. Thanks for taking my question. At what level is corporate burn now? I may have missed it, but I was just curious. How much cash flow are you guys going through at corporate?

Steve Zarrilli

Cash burn is $4 million a quarter. We are looking at other ways in which to continually refine that number, and we have a significant reduction since 2007, almost a 30% reduction on a quarterly basis.

Chris Cook - Zazove Associates

And what is the total number of portfolio companies you guys have?

Steve Zarrilli

Sixteen.

Chris Cook - Zazove Associates

Sixteen? So you spend about $1 million at corporate per company per year?

Peter Boni

Keep in mind that is one way you can look at it, but more importantly the way we look at it is really is in three primary buckets. What is the cost of being a public company? There are certain expenses as you are well aware of compliance and insurance and things of that nature. Two, what is the cost of maintaining a quality deal teams not only for the purpose of investing capital but also in working with the companies and ultimately harvesting that capital. And then three, what is the other support structure that we need not only for the operations of Safeguard but probably more importantly as they relate to the operations of our partner companies. We are able to legitimately and significantly leverage our financial, legal, marketing, and other operational skill sets that we have resident here into the operations of these partner companies literally on a week-by-week basis.

Operator

Thank you. Ladies and gentlemen, there are no further questions at this time. I will now turn the conference back over to management for any closing comments.

Peter Boni

Okay. Well thank very much for your continued interest, and I want to amplify the comment that Chris made. That we continue to feel good about the execution of our game plan. We feel as though we have made great progress and are excited about the growth of the variety of our partner companies, as we build value there, and position them to realize value with well-timed exits. We are in a macroeconomic environment now that is pretty tough. For us, actually, this is a significant opportunity to deploy capital. The best and the brightest companies will gain financing in this climate, and they will be at very attractive price points, on top of that. So for the long-term, this is a very attractive environment for Safeguard and for our companies, and we continue to execute the game plan. We look forward to continually giving you updates.

Operator

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you all for your participation.

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Source: Safeguard Scientifics, Inc., Q3 2008 Earnings Call Transcript
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