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Executives

John Shave – VP, Business Development and Corporate Communications

Peter Boni – President and CEO

Steve Zarrilli – SVP and CFO

Analysts

Greg Mason – Stifel Nicolaus

Matt Dolan – ROTH Capital Partners

Paul Knight – CLSA

Nick Helen – Sidoti

Safeguard Scientifics, Inc. (SFE) Q2 2011 Earnings Call July 27, 2011 9:00 AM ET

Operator

Good day, ladies and gentlemen. And welcome to the Safeguard Scientifics Second Quarter 2011 Results Conference Call. At this time, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Mr. John Shave, Vice President of Business Development and Corporate Communications.

John Shave

Good morning. Thank you for joining us for Safeguard Scientifics second quarter financial results 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 second quarter 2011 highlights and other developments and Steve will discuss Safeguard’s financial results and strategies. After that, we will open up the lines for your questions.

Before we begin, I must remind you that today’s presentation includes forward-looking statements. Reliance on forward-looking statements involve 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 partner companies, capital spending by customers and the effect of regulatory and economic conditions generally, as well as the development of the life sciences and technology markets and other uncertainties that are described in our filings.

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. 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 described in detail the risks and uncertainties associated with managing our business. The company does not assume any obligation to update any forward-looking statements made today.

Now here is Safeguard’s President and CEO, Peter Boni.

Peter Boni

Thanks, John. And thank you all for joining us today for updates on Safeguard Scientifics and our partner companies. Results for the second quarter ending June 30th were distributed earlier today. Our progress quarter-over-quarter and over the past six months has not only been significant but we’re really pleased with our progress, the strategic game plan is firing on all cylinders.

More hard work lies ahead but we believe Safeguard is well-positioned with a talented team or continue growth and we really couldn’t be more optimistic about Safeguards’ prospects.

Value creation has been the driver behind Safeguards exceptional financial activity and achievements over the past quarter. Consider the following, we deployed $45.8 million of capital in new and existing partner companies including NovaSom, PixelOptics and OvaRex.

We formally announced that we will acquire a 36% interest in Penn Mezzanine, the management company in General Partner. Penn Mezzanine is a lending firm that will provide subordinated debt and structure that could be financing to lower middle market businesses in the middle Atlantic and adjacent regions. We committed $3.7 million of initial capital with the potential to deploy an additional $26.3 million over a several year period.

We believe this strategic partnership is an important diversification for the Safeguard business platform and it will generate solid opportunities for fee income and profit participation for us. This transaction is also expected to close by the end of August.

We announced two great acquisitions of our partner companies by prominent top tier multinational firms, Shire’s acquisition of Advanced BioHealing and McKesson’s acquisition of Portico Systems.

Portico officially closed yesterday for which Safeguard expects to receive $38.1 million in aggregate cash proceeds, that represents a four times cash-on-cash return and a 36% IRR, now that’s on the heels of GE Healthcare and Eli Lilly’s acquisition of Clarient and Avid Radiopharmaceuticals respectively that occurred in December of 2010.

As a result of all this activity, Safeguard enjoys improved financial strength and flexibility with excellent liquidity and access to capital.

In March, we repurchase substantially all of Safeguard’s convertible notes due in 2024. Our debt-to-equity ratio improved to 1 to 8 at June 30th, that’s from 1 to 3 at year end 2010 and 1 to 2 at year end 2009. Now in 2006 as we embarked upon this current strategy that ratio stood at 1 to 1. So as you can see, we’ve improved a much of our long-term obligations with exit expectations and cash deployment plans.

Value creation is both the objective and the motivation behind Safeguard’s progress. Our life sciences and technology partner companies remain well-positioned for continued growth and improved profitability. Our deal teams continue to evaluate promising, high potential businesses in our targeted verticals.

Now, our optimism is really high for creating additional value in 2011 and beyond. That confidence stems from Safeguard’s disciplined focus on specific segments of life sciences and technology industries that exploit five strategic growth driving themes maturity, migration, convergence, compliance and cost containment.

In life sciences we target opportunities in the areas of lower relative technological and regulatory risk, namely in the molecular and point-of-care diagnostics, medical devices, regenerative medicine, specialty pharmaceuticals and selected healthcare services.

In technology, we pursue companies developing transaction-enabling applications with a recurring revenue business model and Internet new media, financial technology, IT healthcare and some selected business services.

Our deal teams continually evaluate near-term high potential capital deployment opportunities. We view over a 1,000 proposals annually. We also may find an opportunity or two in a later stage firm, generally defined as lower middle market opportunities. The aggregate cash-on-cash return target for those later stage deals might be two to three times cash-on-cash versus the current three to five, but the anticipated time horizon may be shorter as well.

We typically deploy up to $25 million in growth capital for company and then time our exits from ownership positions in these companies to achieve aggregated targeted risk adjusted returns on capital three to five times.

Exit opportunities may arise in any time and in different forms including privately negotiated sales securities of assets, public offerings of securities or in the case of a publicly traded partner company, the sale of securities on the open market.

If an opportunity clears our strategic growth and return hurdles, we’ll respond appropriately. We will not deploy capital or pursue exit simply for activity’s sake. Now we’ve said this often and we can’t really say it enough, discipline is the hallmark of the strategy. In the meantime, we’ll continue to work to build value in Safeguard’s partner companies, drive their growth and keep their spending plans in line.

Safeguard’s new partnership with NovaSom illustrates an important strategic theme in our deployment of growth capital. In June, we lead a $35 million series D financing of NovaSom, a pioneer and a leader at the at home diagnostics for obstructive sleep apnea.

Safeguard provided $20 million in equity financing existing investors provided an additional $15 million. Proceeds are being used to increase NovaSom’s penetration of the healthcare payor and provider markets and to improve the company’s proprietary diagnostic medical device and cloud-based patient management portals. Safeguard now holds a 34% primary ownership position NovaSom.

Why NovaSom, our life sciences team identified an established leader and a fast growing $4 billion domestic market. NovaSom’s home sleep test is portable, FDA approved instrument that’s approved for reimbursement through Medicare and can detect obstructive sleep apnea at home for patients convenience and enhanced accuracy.

There were some innovative home service delivery model combined with a pioneer and cloud-based portal technology connects NovaSom with physicians, therapy providers and payors to achieve alignment and patient preference, cost and quality objectives.

Finally, only about 5% of the 3 million sleep tests conducted annually in the U.S. are done at home. Our 2015 home testing is projected to comprise nearly 50% of sleep tests. NovaSom competes in a market with small regional distributors of home test devices and larger national providers. Recent strategic acquisitions in this sector have been completed at attractive multiples.

Focus, discipline and execution characterize Safeguard’s capital deployment at NovaSom, an established leader with regulatory and reimbursement clearance for its fully commercialized product and a fast growing multi-billion dollar market.

Safeguard can add value with capital and then management support, as NovaSom works to expand its distribution channels. NovaSom is already at the expansion stage.

In Q2, we also deployed $25 million of $45 million equity and debt financing around for PixelOptics, a medical technology company that’s commercialized and the world’s first and only electronically processing prescription eyewear. This innovative company is changing the standard of care for eyeglass wearers.

PixelOptics noble approach to vision correction is revolutionizing how eyeglass wearers will be able to transition between near and far distances. The company’s product and power represents the most significant technological advance and prescription eyewear in the last 50 years, featuring the most advanced electronic innovations and partners substantially reduces or eliminates the perceived distortion and other limitations associated with multi-focus lenses. Public comps are trading in the average of 2.2 enterprise value. According to a March 21st research note published by Stevens, Safeguard has a 25% primary ownership in PixelOptics.

Now, let’s just review some specific recent developments and a few of our other partner companies that underscore the power of the Safeguard business model.

Within the Internet new media companies, MediaMap is benefiting from the rapidly rising tide of digital advertising growth. Market research firm eMarketer recently forecasted that online advertising spending is set to increase 20% in 2011 to more than $31 billion. By 2015 online advertising is expected to represent 28% of U.S. ad spending.

MeidaMath’s revenue continues to grow at double-digit rates in 2011, building on 2010’s performance where revenue was up over 150% from the previous year. The company’s enterprise class, digital media buying and reporting platform was first to market in 2007 and enabled advertising agencies and advertisers to analyze billions of daily impressions. Last year, MediaMath launched its enhanced media buying platform called TerminalOne, with a user interface that allows marketers to directly manage campaigns according to specific objectives.

MediaMath is also growing its domestic and international operations, opening offices in L.A., Chicago, Boston, D.C, Ontario, Canada and London. Additional offices are planned later this year in both Latin American and Asia. MediaMath is recognized as one of the hottest companies in digital advertising and it’s now ranked by Online Media, Silicon Valley Insider and Ernst & Young among the top 100 private companies globally. In addition, Safeguard has deployed $15.7 million in MediaMath since 2009 for a 23% primary ownership position.

Progress continues at NuPathe, a specialty pharma company that develops – is commercializing branded therapeutics for diseases of the central nervous system. Earlier this year, the FDA accepted NuPathe’s NDA for its lead product candidate, Zelrix, a single-use transdermal patch being used to treat migraine. Zelrix is the first ever submission to the FDA of a transdermal patch for the treatment of migraine. If approved, the patch should provide an attractive option for the millions of underserved migraine patients who would benefit from a treatment that consistently addresses both headache pain and migraine related nausea.

Migraine related nausea also referred to as MRN, is a common symptom of migraine that is under-reported, is debilitating and more debilitating than the headache. It can cause patients to delay taking their medication or avoid treatment altogether. The company is preparing for the commercial launch of Zelrix earlier next year. During the second quarter, the company presented long-term data that supports the headache relief and nausea improvement in patients using Zelrix.

NuPathe was also granted a patient for its migraine patch added seasoned sales and marketing executives to its commercial team and received a $10 million term loan under its secured credit facility. NuPathe has two additional proprietary product candidates, one for the continuous symptomatic treatment of Parkinson’s disease and the other for the long-term treatment of schizophrenia and bipolar disorder. Both are in pre-clinical development.

NuPathe’s IPO of common stock in August 2010 raised $43 million in gross proceeds. Safeguard has deployed $18.3 million in NuPathe since September 2006 and we own an 18% of its outstanding common shares. So in the interest of time I’ll stop there, but I encourage you to look at our press release that was issued early this morning and learn more about the progress of Safeguard’s other partner companies.

Let me turn it over now to, Steve Zarrilli, our Chief Financial Officer and Steve will give you an update on Safeguard’s financial strategies and our performance. Go ahead Steve.

Steve Zarrilli

Thanks, Peter. I would like to outline some trends and Safeguard’s financial performance and remind today’s listeners of this management team’s strategic focus.

Over the past five years, the Safeguard team has delivered meaningful and measurable results for shareholders, despite unprecedented volatility in the capital markets.

Our success is being driven by disciplined focus on making the right deployment decisions in areas of the market for which we have deployed a substantial amount of industry expertise. The company’s cash and marketable securities balance has grown to more than $260 million. What is as impressive is the strength and the depth of our deal pipeline. This pipeline continues to remain very strong with high potential opportunities in the targeted sectors of life sciences and technology. This disciplined focus is at the heart of Safeguard’s success in deploying growth capital, building value and partnered companies, realizing that value and then communicating our progress, concisely, consistently and credibly.

Focusing on these fundamentals is what has allowed Safeguard to report cash-on-cash return multiples ranging from 3 to 13 times on our most recent exit transactions involving large multinational companies interested in the commercial success of our partner companies. We remain committed to these core disciplines in driving our future capital deployment activities.

We also believe that participation and activities related to the co-management of various fund platforms will future augment our capital deployment strategy and value creation for our shareholders. Penn mezzanine is an example of our co-managed fund where we will leverage our capital alongside experienced fund managers. In addition, we continue to explore ways to raise other pools of capital, which we will be responsible for managing.

Referring to these pools of capital as co-participation funds, these pools of capital would augment our existing capital resources and leverage our industry expertise. These fund strategies serve to produce management fee income and carry interest for Safeguard.

Some key financial metrics for the second quarter include, at June 30 we had $263 million in cash, cash equivalents and marketable securities, excluding cash held in escrow of $6.4 million and restricted cash equivalence of $14.5 million. During the quarter, primary uses of cash were, one, the deployment of $20 million and $25 million respectively and the two new life science partner companies as Peter mentioned, NovaSom in June and PixelOptics in April along with a less about $800,000 in follow-on funding for Alverix.

Cash operating expenses of $3.1 million included – cash operating expenses were $3.1 million. This total excludes interest, non-cash stock-based compensation and depreciation expense. For 2011, we continue to project cash operating expenses in the range of $17 million to $18 million. That range reflects the addition of experienced deal team professionals as well as certain anticipated corporate development expenses.

We also reiterate our expected use of cash of between $100 million and $150 million in 2011 for these major initiatives, repayment of debt, corporate expenses, capital deployment into new partner companies, follow-on funding for current partner companies and the expansion of our platform.

Year-to-date, we have deployed approximately $15 million into new partner companies, provided $10 million in follow-on funding to existing partner companies and used $31 million to repurchase debt. We believe that Safeguard and its partner companies remain well positioned for continued revenue traction and value creation in 2011 and beyond. For 2011, Safeguard projects aggregate partner company revenue for its technology group to be in the range of $180 million to $190 million, representing 29% to 36% growth year-over-year and unchanged since the beginning of the year.

Following the sales of Clarient and Advanced BioHealing, our remaining life science partner companies are either in the pre-revenue or early commercialization stages. Accordingly, we do not expect significant revenue to be generated by these companies until they are further along in their development, nor do we consider revenue – significant indicator of their near-term progress.

For 2011, Safeguard projects aggregate partner company revenue for its life sciences group to be approximately $12 million. As a reminder, Safeguard reports the revenue of its partner companies on a one quarter lag basis. Our partner companies continue to execute aggressively. They are using their cash to grow and in certain situations generating cash and making strategic and opportunistic acquisition. We work with the management teams of each partner company to evaluate levels of existing and required capital, strength of personnel resources and unique opportunities for growth.

Our focus on these ongoing processes allows Safeguard to assist partner management – partner company management teams in unique ways to drive value creation and majority.

Now with that, I’ll turn it back over to Peter.

Peter Boni

Thanks Steve. Sharon, could I ask you to open up the phones for any questions?

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Greg Mason with Stifel Nicolaus, you may begin.

Greg Mason – Stifel Nicolaus

Good morning, gentlemen. The revenue guidance that you gave for the technology and life sciences businesses, obviously historical numbers have changed given the exists. Could you give us some back-year data of kind of the same company revenues, so we can get a sense for how those revenues have grown over the past three to four years?

Peter Boni

Hi Greg, the one to really look at are the technology firms, on an apples-to-apples basis. In 2007, they did in the aggregate $46 million. In 2008, they did $63 million, in 2009, $87 million, in 2010, a $139 million. So, you can see the forecast of growth is off of a $139 million in 2010.

Greg Mason – Stifel Nicolaus

Okay. Great. And could talk a little bit about the diluted share count? Last quarter, I believe, it was $20.7 million and this quarter jumped to $24 million. Could you talk about, what is included this quarter in the diluted shares?

Peter Boni

Steve can I ask you to take that?

Steve Zarrilli

The principal change there is how in a prior quarter, there would have been an anti-dilutive effect of certain equity instruments, because we had substantial gains in this current quarter, those shares are then added to the calculation, because they are no longer anti-dilutive.

Greg Mason – Stifel Nicolaus

So, could you give us – what has been kind of the change, assuming there was no anti-dilutive impact? Has there been a jump in the potential auction shares or the diluted numbers, if you take out that anti-dilutive impact last quarter?

Peter Boni

That is by far the most significant portion of the change and there is nothing else of any significant magnitude or of real substance that would have caused that number to change otherwise.

Greg Mason – Stifel Nicolaus

Okay. Great. And can we talk a little bit about the potential new hedge in mezzanine investment? Are you guys investing in owning the management contract? Are you investing in an actual fund that will be making the loans and getting a return off of that?

Peter Boni

We have provided capital into a management company, which today is managing roughly $64 million of capital of which we have provided $26.7 million or $26.3 million of additional capital over and above the $3.7 million that we used to capitalize the management company.

Our ownership will apply to the platform that’s created. So if this experience group of fund managers is capable of going out with our hub and raising subsequent pools of capital and what is traditionally referred to as funds, we will benefit from those future activities as well as the current pool of capital that exist today. So we own 36% of the management company.

Greg Mason – Stifel Nicolaus

Great. And can you talk about of the portion that’s going to be invested in the pool of capital that’s going to be making as well as, what is your expectations for the coupons off of those loans and what’s been kind of historical track record of this team?

Peter Boni

So this team has a historical track record that ranges between 18% and 22% on IRR basis.

Our expectation is that the average size of deployments from this fund in the form of subordinated or junior debt or sub-mezzanine debt will be somewhere between $2 million to $5 million on average, that the expected coupon on these instruments would be similar to what you would expect in the marketplace today for mezzanine loans which would average between 12% and 14%.

There may be some additional warrant coverage associated with these transactions in fact there would be most likely additional warrant coverage that would hopefully target a return on any particular deployment somewhere between 18% and 22%.

In certain cases, we were also be able to potentially acquire some equity along side of providing debt into these target companies and we will look at those situations as a way to further increase our level of opportunity within a particular situation.

Greg Mason – Stifel Nicolaus

Okay. Great. Then one last question I’ll hop off, you said NovaSom is in the expansion stage, can you remind us again what levels of revenues the expansion stage implies?

Peter Boni

Expansion is a range of $5 million to $20 million.

Greg Mason – Stifel Nicolaus

Great. Thank you.

Peter Boni

Sure.

Operator

Thank you. Our next question comes from Matt Dolan with ROTH Capital Partners. You may begin.

Matt Dolan – ROTH Capital Partners

Hey guys, good morning. Thanks for taking the questions.

Peter Boni

Sure, Matt.

Matt Dolan – ROTH Capital Partners

Just Peter, considering all the exits you had in recent quarters and I think you mentioned later stage deals in your prepared remarks. Can you give us an update on the deployment strategy, do you expect to get more aggressive now that the portfolio has some room. And secondly, how much sure should we think about these companies being?

Peter Boni

We have given guidance of a $150 million for 2011 and we should consider that guidance. And the guidance was for not only deployment of capital into new partner companies, but the repayment of debt, corporate expenses other than funding for our current funded companies and then expansion platform. We’re consistent with that. We have a rich pipeline and we continue to be selective and disciplined in the execution of our game plan in the deployment of capital, but the strategy remains same.

Matt Dolan – ROTH Capital Partners

Okay. Steve you covered the debt fund rather, you’ve spoken about other alternate pools of capital, is Pen mezzanine where you’re sticking today or are you still evaluating other opportunities that might be out there?

Steve Zarrilli

We are consistently evaluating other opportunities that are being presented to us. So we think Pen mezzanine represents a good first example of where we can potentially take some of our strategy thoughts.

The trick would be and Peter uses the word disciplined, the trick would be to use that discipline as well in the formation of those opportunities to make sure that we are partnering with the right types of fund managers, those that actually can truly augment what we are doing here at Safeguard and provide for not only an extension of our existing strategy, but the right level of diversification.

In addition to that we’ve referred to co-managed opportunities, which is what Pen mezzanine represents. We are still very actively looking for an opportunity to create a co-participation fund, basically a scenario of which we will apply a certain amount of capital along side of externally raised capital for which we will manage a 100% and have full benefit of the management fee in the carried interest associated with that capital.

Matt Dolan – ROTH Capital Partners

Okay. Great. And then two more quick ones, on Penn mezzanine, 30 million over several years, can you give us any feel for the cadence of deployments there. Is that something that will be fully invested in a couple of year’s time, just trying to gauge how the interest off of those deals should play into our model?

Steve Zarrilli

Yeah. The short answer is – think about somewhere between $8 and $10 million a year. The longer answer is the pace of deployment will be factored along two lines. One it will be the initial capital that’s deployed in any particular situation. And there will be a little bit of capital that’s held behind if in the event that there is some follow on opportunity within a particular opportunity that we’ve already provided debt funding for.

So, but generally speaking I think you are safe in thinking about $8 to $10 million over the next 30 to 36 months. And the expectation is for successful in deploying that capital and beginning to build that track record that already augments the fund manager’s existing track record that that team would then be out in the marketplace to raise the next pool of capital, which would be targeted in the $75 to $100 million range.

Operator

Thank you. Our next question comes from Paul Knight with CLSA. You may begin.

Paul Knight – CLSA

Hi, Peter. With the dozen or so diagnostics acquisitions, I have seen in the market here the last six months, where is that affecting the deal flow you’re seeing on that side, on the life science area and where do you think values are in your portfolio? Often down I guess is the general answer on that?

Peter Boni

Sure. Hi, Paul. The diagnostics sector has been an active one and we have been active in the diagnostics sector. It is an area that we have targeted, it’s a remaining target and we continue to see very pronounced deal flow there. The x values are really based upon the value that the ownership is unable to produce and we have been fortunate that’s far to be able to realize some significant valuation metrics based upon the performance of those firms and we expect that to continue as long as we continue to groom our organizations, groom our companies and then position them for well timed exit.

Paul Knight – CLSA

You want to have more assets a year from now on the life science side or are you happy with the balance we have now?

Peter Boni

Our life sciences and technology teams are both competing with one another for the access to the company war chest and those that bring the very best deals forward with the very best prospects for cash on cash return will be the ones where we unlock the treasury chest what we’ve seen to-date has been a fairly decent balance, maybe with a tilt towards healthcare.

Paul Knight – CLSA

And is there any new color on PixelOptics I think the recent transaction of yours?

Peter Boni

Steve, I’ll let you comment on Pixels.

Steve Zarrilli

Soft launch occurred in the early part of the summer, going well. Hard launch in the Southeast begins in Earnest next week.

Paul Knight – CLSA

Thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Nick Helen with Sidoti. You may begin.

Nick Helen – Sidoti

Good morning guys.

Peter Boni

Hi Nick.

Nick Helen – Sidoti

First question I had was, just getting back to the ABH acquisition. I was wondering if you could give us a little insight into what exactly the rationale was behind, why they agreed to be acquired instead of going public. I mean, I guess what kind of role did you guys have in that decision if any?

Peter Boni

Well, ABH as everyone knows was near the end of their road show and ready to price their IPO. And they had a good deal of activity going on during that period of time. Shire came in and essentially made an offer that was a 25% premium to that midpoint of pricing that was announced at the outset of the IPO. Risk adjusted returns of valuation analysis, the board where Safeguard had a prominent position made that decision. Safeguard did not singularly make that decision.

Nick Helen – Sidoti

Okay.

Peter Boni

But that was a significant return for all shareholders and would be shareholders, terrific were the opportunity to expand Shire’s platform and really great to give the ABH personnel a platform from which to continue to grow their business.

Nick Helen – Sidoti

Okay. And then lastly just kind of a housekeeping question, where do we stand right now in-terms of annual loans that you guys have on the books?

Peter Boni

Yeah. So Nick, we start with $266 million. We expect that we will use about a $150 million of that number to net-down to about a $103 million when all said and done.

Nick Helen – Sidoti

So, $103 million that’s after all the excess from the share?

Peter Boni

That’s the excess including the impact of the receipt of that growth.

Nick Helen – Sidoti

Okay. All right. Perfect. All right. Thanks guys.

Operator

Thank you. I am showing no further questions at this time. I would now like to turn conference back over to Safeguard for closing remarks.

Peter Boni

Thanks, Sharon. Well, once again we appreciate the interest of our shareholders at Safeguard Scientifics both significant minority and majority positions. The equity supplemented by debt and not only private but public companies with our own capital and manage capital from strategic and financial sources. We look forward to keeping you posted on our progress. Thanks again.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation and have a wonderful day.

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