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Safeguard Scientifics, Inc. (NYSE:SFE)

Q3 2009 Earnings Call Transcript

November 4, 2009 9:00 am ET

Executives

John Shave - VP, Business Development & Corporate Communications

Peter Boni - President and CEO

Steve Zarrilli - SVP and CFO

Analysts

Bob Labick - CJS Securities

Sam Rebotsky - SER Asset Management

Operator

Greetings ladies and gentlemen and welcome to the Safeguard Scientifics 2009 third quarter conference call. At this time all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. It is now my pleasure to introduce your host John Shave, Vice President of Investor Relations and Corporate Communication for Safeguard Scientifics. Thank you Mr. Shave, you may begin.

John Shave

Good morning and thank you for joining us for Safeguard Scientifics third quarter 2009 conference call.

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 begin with a review of the quarter's highlights and Steve will discuss financial results and strategies for Safeguard. After that we will open the lines for questions.

Before we begin, I must remind you that today’s presentation includes 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 risk of acquisitions or dispositions of interests in partner 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 expect, anticipate, believe and intend will be used in our discussion of goals or events in the future. The management cannot be certain that final outcomes will be as described today. We encourage you to read Safeguard’s filings with the SEC including our Form 10-K, which describe in detail the risks and uncertainties associated with managing our business. The company does not assume any obligations to update any forward-looking statements made today.

Here’s Safeguard’s President and CEO. Peter Boni.

Peter Boni

Thanks John. Thank you all for joining us today for the Q3, 2009 progress report on Safeguard Scientifics and our partner companies.

Safeguard built to realize value in several areas during the three months ending September 30. Our successful execution of several corporate initiatives combined with exciting developments net income our partner companies, and the gradual improvement in capital markets resulted in enhanced visibility and measurable momentum with targeted institutional investors. Throughout 2009, we have been focusing on strengthening Safeguard’s financial position.

During the quarter, we bolstered our cash balance with $51 million of net proceeds from the August sale of 18.4 million of common stock at Clarient, a fast growing provider of cancer diagnostic services. The shares were sold in an underwritten public secondary offering that was heavily oversubscribed. Our remaining position in Clarient consists of approximately 28 million shares and 2.75 million warrants at various strike prices, which have a combined market value of $92 million as of yesterday’s market close. Safeguard still owns 28.3% of Clarient’s outstanding common stock on an as converted basis.

Safeguard’s cash, cash equivalents, and marketable securities balance of September 30 was $131 million, that is up from $86 million at June 30. In part, we owe Safeguard’s enhanced balance sheet strength to our success in cultivating strong alliances and syndication partnerships with large and reputable private equity and venture capital investors. Earlier in 2009, we helped to engineer a private placement in Clarient of $40 million by Oak Investment Partners. Oak is a multi-stage VC firm with more than $8 billion in committed capital. That placement which was made out in a 11% premium to market with no warrants coverage speaks volumes about Clarient’s opportunity.

Completion of the Clarient Oak placement has benefitted Safeguard, Clarient, and Oak. For Safeguard in particular, we captured $19.5 million in cash from Clarient’s borrowings under a $30 million mezz debt facility with us. The completed transaction also released over $12 million in cash collaterals supporting our guarantees of Clarient debt with third parties. In addition, we eliminated any contractual commitment to provide additional capital to Clarient going forward. These transactions contributed to the improvement of Safeguard’s debt-to-equity ratio to 1:3 as of September 30 from 1:1 on December 31 of last year.

I will upgrade you on the progress of Clarient’s business later in today’s call. Another corporate initiative that took place during the third quarter was a 1-for-6 reverse split of Safeguard’s common stock. This transaction has increased trading volume in Safeguard equity, broadened the company’s appeal to institutional investors, and reduced trading costs. Moreover, the reverse split will help reduce certain administrative expenses for us going forward.

Safeguard’s business model calls for the deployment of growth capital in and the development of high potential life sciences and technology businesses that exploit five strategic trends; maturity, migration, convergence, compliance, and cost containment. We time our exits from partner companies’ ownership positions to achieve targeted. risk-adjusted returns on capital of 3 to 5 exit at a minimum. Exits may be realized through privately negotiated sale 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.

During the third quarter, we announced that we deployed capital in a new technology partner company, MediaMath, based in New York City. MediaMath is a leading online media trading company that offers agencies and their advertisers unprecedented reach and performance through a combination of algorithmic bidding and unique data integration creating an efficiency of search with the branding [ph] impact of display advertising. MediaMath serves billions of highly targeted ads per month on behalf of more than 20 top tier advertising agencies. Safeguard deployed $6.5 million of capital in July of 2009 and we owned an 18% stake in MediaMath.

Subsequent to the third quarter, Safeguard announced that deployed capital as part of a $17 million Series B financing of a new life sciences partner company, Quinnova Pharmaceuticals, a specialty pharmaceutical company that develops and markets novel prescription dermatology drugs based upon an innovative delivery platform applied directly to the skin. Safeguard’s participation was $5 million and up to an additional $1 million of debt for a 26% stake.

Quinnova is an expansion stage company that has a growing market penetration and a strong pipeline of products that are driving revenue and commercial execution. Our support will help facilitate Quinnova’s new drug application and medical device clinical trials as well. Quinnova has already received FDA approval for its program technology phone delivery system for treating diseases such as dermatitis, fungal infections, psoriasis, acne and the like. We are really excited to welcome Quinnova to the Safeguard team.

In addition to capital deployments, well-timed exits are also an important element of Safeguard’s value creation machinery. While our deal teams continue to evaluate exit opportunities, current market conditions while they appear to be rebounding are not yet optimal to achieve our targeted returns. On a daily basis, we meet with potential partners that are really starved for growth capital however many of these opportunities do not clear our strategic growth hurdles. We have said this often and it bears repeating, we remain disciplined and focused on enhancing value in our partner companies rather than pursuing exits simply for activity sake. Exit opportunities may arise at any time and in different forms but in this challenging business climate, we are working everyday to build value in our partner companies, drive their growth. and keep their spending plans in line.

Now, let’s drill down into Q3 progress on some of the Safeguard partner companies. Clarient, Safeguard’s only publicly traded partner company continues to bring up solid topline growth during Q3 with a 13% increase in revenues compared to 2008. For the nine months ending in September, Clarient’s revenues were up 32% from the same period last year. Finance management also took a big step towards improving the company’s billing and collections processes. A comprehensive, 15-month analysis of billing and collections was recently completed. With this new information, Clarient expects to have a clearer picture of its receivables and future collections, revenues, bad debts, profits and cash flows. These new estimates resulted in Clarient’s revision of 2009 revenue guidance to the range of $90 million to $94 million from $96 million to $101 million.

We believe that Clarient is well positioned for continued growth and profitability, despite today’s shifting landscape for potential healthcare reforms as well. Clarient continues to make steady additions of new commercial customers for its cancer diagnostic services, and to increase its test volumes and lineup of diagnostic products and services. Moreover, Clarient’s laboratories continue to operate at efficiency levels well above the industry norm. Clarient recently did a 90-minute conference call and for any more color on Clarient, I really encourage anyone really interested to take a listen to that conference call.

Next, Safeguard is about a whole host of high potential companies not just one. Let’s highlight some of our five development stage companies, enterprises that are proving our technology developing prototypes, refining their business models, and building partnerships.

Avid Radiopharmaceuticals is a leader in the development of molecular imaging products to enable early diagnosis and prognosis of neurodegenerative diseases. Avid remains on track with Phase III clinical trials for its lead compound, AV-45, for imaging amyloid plaques in the brain for Alzheimer's disease, and it anticipates completion and an NDA submission later next year. Avid has a robust pipeline of product including its AV-133 Parkinson’s disease imaging compound which is currently in Phase II trials, and its compound for diabetes which is currently in proof of concept Phase I clinical trials. In addition during the third quarter, Avid announced that they hired a Vice President of Marketing and Sales, Chris Bunting, to foster Avid’s next phase of growth specifically through the commercialization of its Alzheimer's product. Now, Chris brings more than 20 years of marketing and sales experience to Avid, most recently having served as the Global Brand Director for Neurology at GE Healthcare and previously with GlaxoSmithKleine. Safeguard deployed $10 million of capital in Avid since May of 2007 and it has a 14% ownership stake.

Swaptree is the largest integrated on-line platform for trading books, CDs, DVDs and video games. It continues to grow its user base and continues its leadership in the market. In addition, the company is moving to initial revenue stage in 2010. Safeguard deployed $3.4 million of capital in Swaptree in July of last year and we own a 29% stake.

NuPathe reported superior efficacy in their Phase III trials for migraines. Since then. industry interest in the company has markedly increased. In addition, NuPathe just announced this week that they are partnering with SurModics to develop and ultimately commercialize new paths treatment for Parkinson’s disease. SurModics is publicly traded on the NASDAQ and they provide drug delivery and service modification technologies throughout the healthcare industry.

Of our four initial revenue stage companies, let’s highlight our newest member Molecular Biometrics. Molecular Biometrics will begin commercial sales this year in Asia, in the European, and Australian markets where the company’s noninvasive procedure that will increase the probability of pregnancy and reduce the incidents of multiple births in in-vitro fertilization. Pivotal trials in the US remain on track. Safeguard deployed $6 million in Molecular Biometrics since September of last year and we have a 38% position. We are happy to see MB’s progress through the developmental through the initial revenue stage, and we look forward to keeping you abreast of their commercialization progress.

Of our expansion stage companies, the one we would like to highlight is Portico Systems, which is one of our IT healthcare companies. We expect to be moving into the high traction stage in the near term. Portico offers software and services to health plans to help them reduce administrative, medial and IT costs. Portico continues to grow revenues at double-digit rates and in addition with recent acquisitions and contracts with global healthcare companies such as CIGNA and MMM Holdings, Portico now serves 33 healthcare systems with 42 million members nationally. During the quarter, the company was included on the Healthcare Informatics 100 List of top healthcare IT companies in the world, based upon revenue growth, for the second consecutive year. Safeguard has deployed $9.3 million of capital in Portico since August 2006 and we have a 46% ownership position.

Included in Safeguard’s high traction stage partner companies are Advanced BioHealing, Advantage Healthcare Solutions, Bridgevine, and Clarient. They are all reporting solid growth nearing breakeven or driving further bottom line profitability and gaining commercial traction. I have already talked about Clarient, so let’s take a look at the progress of ABH, AHS and Bridgevine.

ABH is the leader in regenerative medicine, recently highlighted at our Investor Day event in October that it had achieved an annual revenue run rate of $80 million based upon its Q3 results due to the surging demand of its FDA-approved Dermagraft product for diabetic foot ulcers. Annual cases of diabetic foot ulcers in the US alone are estimated at nearly 1 million. ABH is aggressively expanding its US commercial sales force and is exploring new applications of its products in domestic and international markets. Going forward, the company expects growth to continue, expects to launch Dermagraft internationally, and expects to execute its venous leg ulcer trial, and then execute soft tissue repair studies and then expand sales related to the US government disaster (inaudible) initiatives. Safeguard deployed $10.8 million of capital in ABH since February 2007 and it has a 28% ownership stake.

Advantage Healthcare Solutions (NYSE:AHS) uses a proven, proprietary software platform to deliver medical billing solutions to hospital physician groups. The company is now among the 25 largest medical billing firms in the US due to its continued organic growth and its strategic acquisitions. The company has doubled in size, it is now cash flow positive and profitable, with multiple acquisition prospects still being explored. They move from the expansion stage to the high traction phase in Q3. Safeguard deployed $11.5 million of capital in the AHS since November 2006 and has a 39% ownership position.

Bridgevine is the leading Internet marketing platform that allows consumers to compare and purchase digital services online, such as Internet, telephone, Voice-over-IP, TV, music, and the like. The company saw solid growth in Q3 due to its continued expansion of its lineup of products and services, and its increases in its merchant base. Safeguard deployed $10 million of capital in Bridgevine since August 2007 and has a 24% ownership position.

Now, let me turn the call over to Steve Zarrilli, our chief financial officer, and Steve will review Safeguard’s financial strategies and our performance there. Go ahead, Steve.

Steve Zarrilli

Thanks Peter. Our third quarter earnings news release and financial statements were distributed earlier this morning. During the third quarter, we recognized impairment charges of $5.8 million related to our holdings in GENBAND and $3.9 million related to our holdings in Tengion.

GENBAND continues to pursue several exciting opportunities in the telecommunications equipment market, however given the uncertainty of various exit outcomes for Safeguard’s interest in GENBAND, we have decided to writedown our carrying value. Tengion continues to make good progress on its clinical and preclinical programs but given certain external market conditions and the relative difficulty for development stage life science companies in raising capital, we have decided to write down our carrying value.

We also recognized a net gain on the mark to market of our holdings in Clarient of $15.1 million and realized the loss of $7.3 million based on the proceeds we received from our sale of Clarient shares in August relative to the carrying value of such shares at June 30, 2009.

In summary, our guidance on aggregate revenue for 2009 remains unchanged at $200 million to $220 million. Safeguard has improved its financial strength and flexibility throughout the year largely due to increases in our cash balance and reductions in our debt levels. I would be happy to elaborate on our third quarter financial performance during the Q&A period.

Balance sheet strength and prudent use of cash remain Safeguard's top priorities for the remainder of 2009. We intend to continue to evaluate and pursue opportunities to reduce operating expenses where possible, refinance our convertible debt or acquire it at a discount, manage cash deployments conservatively in our support of partner companies, and augment existing capital with well-timed exists or alternative pools of capital. Our debt to equity ratio was 1:1 on December 31, 2008, and today it's 1:3. Our goal is to satisfy our convertible debt obligation on or before March 2011, which represents the first put date available to the holders of such instruments. Satisfying this obligation could take the form of either a repurchase at a discount prior to the put date or refinancing such obligations with terms more conducive to our business activities.

At September 30, 2009, we had $131 million in cash, cash equivalents and marketable securities excluding cash held in escrow. During the quarter, primary uses of cash included $3.9 million for operating expenses, the deployment of a combined $4.2 million during the period to support the capital needs of existing partner companies, and $6.7 million for 18% ownership position in MediaMath, as Peter has explained.

In today’s volatile economic environment, expense control remains the spotlight. Through September 30, 2009, corporate operating expenses including stock-based compensation and depreciation were $12.9 million down 5% for the same period of 2008. Currently we project Safeguard’s 2009 operating expenses in the range of $17 million to $17.5 million or on a cash basis approximating $13.5 million.

Earlier I noted that our revenue guidance for 2009 is unchanged. We expect to aggregate revenue of Safeguard’s continuing partner companies to be in the range of $200 million to $220 million for the year. That is up from a $173 million in 2008. For our life science partner companies, 2009 aggregate revenue is projected at $145 million to $155 million. For the technology group, we anticipate aggregate revenue to be between $55 million to $65 million. GENBAND and MediaMath are not included in our revenue guidance and partner companies Avid, Garnet, NuPathe, and Tengion are pre-revenue companies and will not impact our aggregate revenue expectations.

As you may recall, there is a one-quarter lag in reporting our interests in the results of minority held companies. Over the last 12 months, Safeguard has advised its companies to conserve their cash, use predatory and aggressive competitive tactics and be opportunistic regarding potential M&A activities. They have headed our advice well.

Peter, I will turn it back over to you.

Peter Boni

Thanks Steve. Claudia, let’s open the phone lines up and take any questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question is coming from Bob Labick with CJS Securities.

Bob Labick - CJS Securities

Good morning.

Steve Zarrilli

Hi Bob.

Bob Labick - CJS Securities

Hi. I recognized that you have just mentioned you had a very long 90-minute call for Clarient last night. I was hoping to ask a quick question to kind of summarize that call if you could help us understand, it sounds like there was a change in the reimbursement rate recognition. If you could elaborate on the changes made and just tell us has everything been done now, is it behind them and what kind of impact did the changes or will the changes made have on a go-forward growth or collections for the company?

Peter Boni

Okay, thanks Bob for the question. Steve, would you take that one?

Steve Zarrilli

Sure. So Bob, it really was more of a refinement of their processes internally and looking at data that had now become available to them through the further sophistication of their billing system, that allows them to look at two things

a, what has been the historical track record of cash collections for certain payor groups and, b, that cash collection history, how was it to be used in estimating future potential non-collectible scenarios within the existing receivables that they had.

The revenue adjustment that Clarient spoke to last night was the result of a change in estimate and that change in estimate was basically the reversal of approximately $1.9 million worth of revenue, which represented revenue that had accumulated over the course of about three to four quarters wherein management looked at the cash collections related to certain payors and made a determination that that revenue probably should be recognized when received rather than when the services are billed. And they are going to use that history now going forward to apply the same principles on a quarter-by-quarter basis.

So our expectations based upon our in-depth conversations with management is that the volatility that you saw in this quarter should not continue to persist in future quarters and the primary reason being they are now in a position with 15 months of historical data to be able to apply this precision, if you will, to both their revenue recognition and their bad debt allowance in a way that they have never really had the opportunity to in the past, especially when you think about the world that Clarient lived in when they were completely outsourcing their billion in collection processes. So, they are better shaped with better information with the ability to now look at both revenue recognition and bad debt allowances at a level of detail that they have not had available to them in the past.

Bob Labick - CJS Securities

Okay, great, so it sounds like the actions taken have put this behind them, how does this impact Clarient on a go-forward basis in terms of their growth, anyway I do not imagine that it does, I would just like to understand that and then their future collections and expectations for DSS.

Peter Boni

We continue to believe – first of all, their core market base has very solid fundamentals, very positive. They are expanding and trending in the right direction, their core business is still in growth mode. They have great promise for continued growth, more (inaudible) expansion and so on. They are increasing their billings per test on top of that and seeing increased performance and continued expansion.

Steve Zarrilli

And Bob, if you listened to the call from Clarient and as we learned through our interactions with management, first of all, they are still growing volume very substantially quarter over quarter, and when you look at 2009, even with their revised guidance, it is well over 22% in comparison to 2008 from a revenue perspective. So, we are very confident that management will continue to apply the diligence that it needs to with regards to receivables in managing those DSOs to a lower level. And as Ronnie Andrews pointed out in his 90 minutes of communication last night, the most significant financial metric that management is being measured against and potentially rewarded against or not from a financial perspective this year was around revenue precision, and the management of cash, and the impact of that cash on DSOs and receivable realization.

So, we put the right elements in place for management to stay focused on this as the most important priority for them and you would expect that that would be the case especially on how important that is from a working capital perspective. And now with this enhanced information, with the ability to continue to strengthen their understanding of the underlying elements of their revenue and their receivables, we are very confident that management is going to continue to execute against the objectives that we laid out for them.

Bob Labick - CJS Securities

Okay, great, that is very helpful color on Clarient. Moving to some other companies, ABH, Avid and NuPathe each as Peter mentioned in his opening remarks are (inaudible), I was hoping you could give us some kind of mild posts or timing in terms of the quarter, I am not looking for days, or weeks, or months or anything but when should we expect additional information from these companies as they are nearing some timeframe when added in any more capital or other events may happen which could lead to exit, so what is the next couple of quarters looking like for those companies?

Peter Boni

Good question, Bob. Avid has stated that they expect to complete Phase III trials for their Alzheimer's product within the first half of next year. Now, NuPathe has already completed Phase III and they met the data points on all indications and they stated publicly that they are working for an NDA that is expected sometime in 2010, and there continues now to be a high strategic interest in the company as a result of the broadly put efficacy as a result of their Phase III trials.

Bob Labick - CJS Securities

Okay, great, and then ABH, which is my last one.

Peter Boni

I am not sure what your thoughts –

Bob Labick - CJS Securities

Yes, right, they did not -- I guess they were – obviously they are growing faster, they have mentioned at your Analysts’ Day a significant run rate growth for 2010, do they need any more capital going forward or what are your plans with that company that you venture [ph]?

Peter Boni

ABH continues to grow in its core market in the United States. They are on plan for later in 2010 to gain approval internationally and in effect that will double the market potential for their products specifically in the foot ulcers application, and they are going through the FDA process now for the same product to be approved in venous leg ulcer applications. That will once again double the market size that the company has as its potential. So, they are executing according to their game plan. There continues to be a high degree of strategic interest for what now is a high profile, rapidly growing, profitable company in its industry and it is speculative for me to state what might happen on that but there continues to be a good deal of interest in the firm both from strategic and financial players.

Bob Labick - CJS Securities

Okay, perfect. Thank you very much.

Peter Boni

You are welcome.

Operator

(Operator instructions) Our next question is coming from Sam Rebotsky [ph] with SER Asset Management.

Sam Rebotsky - SER Asset Management

Good morning, Peter and Steven.

Steve Zarrilli

Hi Sam.

Sam Rebotsky - SER Asset Management

As far as the Clarient, how many shares do you own?

Peter Boni

We have about 30 million shares of Clarient, which includes two point something million of warrants that we are yet to execute, 2.75 million warrants and that is a little under 30% of the company.

Sam Rebotsky - SER Asset Management

So at this point, marking to market, you were marked at the closing price as of September 30.

Peter Boni

That is correct.

Sam Rebotsky - SER Asset Management

Okay and now you had a plan on – what is your plan on any type of transaction occurring in the next year, because you have a certain plan of different strategies, do you have anything that you expect to occur for any of your positions that you own?

Peter Boni

That is all speculative Sam that I cannot comment.

Sam Rebotsky - SER Asset Management

In other words – okay, one other thing that you had planned as far as the reverse split, you expect it to have greater interest in the stock, what has been your impact on talking to institutional people as far as taking positions based on the reverse split?

Peter Boni

On a quantitative basis Sam, we have seen trading volume increase that is an indicative of lower equity. We continue to experience greater interest in the company from growth prospects, institutions that are growth investors as opposed to value investors, so we think we have broadened the appeal. It is too early to state what the impact has been on institutional ownership. It has only been six weeks or so since we have done this.

Operator

(Operator instructions).

Peter Boni

Thanks very much, ladies and gentlemen, for your interest on Safeguard and we look forward to keeping you up to date on our activity and our progress of building value going forward.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time and we thank you for your participation.

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