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Safeguard Scientifics, Inc. (NYSE:SFE)

Q1 2008 Earnings Call Transcript

May 1, 2008 9:00 am ET

Executives

John Shave – VP, IR and Corporate Communications

Peter Boni – President and CEO

Ray Land – SVP and CFO

Analysts

Bob Labick – CJS Securities

Bill Dituyo [ph] – Boenning & Scattergood

John Gibbons – Oden Partners

Operator

Good morning. My name is Christy and I will be your conference operator today. At this time, I would like to welcome everyone to the Safeguard Scientifics first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be question-and-answer session (Operator instructions) Thank you.

I would now like to turn the call over to John Shave, Vice President of Investor Relations and Corporate Communications. Thank you. Mr. Shave, you may begin your conference.

John Shave

Good morning and thank you for joining us for our first quarter 2008 earnings conference call. Joining me on today's call are Peter Boni, President and Chief Executive Officer, and Ray Land, Senior Vice President and CFO at Safeguard. During today's call, Peter will review Safeguard's the first quarter 2008 highlights, Ray will then review financial results for Safeguard and our partner companies. That will be followed by a question-and-answer session.

Before we begin, we would like remind you that we will be making forward-looking statements during this presentation. Safeguard would like to caution you concerning reliance on forward-looking statements. Since they involve certain risks and uncertainties, included but not limited to risks associated with the uncertainty of future performance of our partner companies, acquisitions or dispositions of interests in partner companies, the effect of economic conditions generally, capital spending by customers, development of technology in life sciences markets in which Safeguard focuses, and other uncertainties. During the course of today's call, we will use words such as expect, anticipate, believe and intend and that will be used when referring to future goals or events. The company cannot be certain that the financial outcomes described today will occur. Safeguard's 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 the language in these filings. The company does not assume any obligation to update any forward-looking statements made today.

Please note as a result of the bundled sale definitive agreement Acsis, Alliance Consulting, and Laureate are now discontinued operations. Therefore, our reported revenues for the quarter ended March 31, 2008 result from the consolidation of our one remaining majority owned company, Clarient.

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

Peter Boni

Thanks, John, and thank you for joining us on Q1 2008 conference call. Before reviewing Q1 results and accomplishments with you, I'd like to update you on the planned bundled sale of our position in six partners companies to Saints Capital. As we previously announced, Safeguard signed a definitive agreement to exit its ownership position in three majority held partner companies, Acsis, Alliance Consulting and Laureate Pharma, and three minority held partner companies, NextPoint Networks,

Neuronyx and ProModel Corporation, through a transaction with Saints Capital.

We previously reported that we expected to receive gross cash proceeds from the bundled of $100 million and expected to record a gain of approximately $16 million. However, in late April, certain shareholders at NextPoint Networks decided to exercise contractual co-sale rights that will allow them to participate in the sale to Saints and that will reduce the gross cash proceeds we'll receive to $78.1 million.

In addition, Saints will relieve Safeguard of an aggregate of $31.5 million in debt guarantees concerning certain companies being sold. During the first quarter, we wrote down an aggregate carry value of the bundled companies by $500,000 to the total of the anticipated gross proceeds, net of the cost necessary to complete the transaction. As previously reported, $10 million of the cash proceeds will be held in escrow through April 2009. Safeguard will now retain an ownership interest in NextPoint Networks of 10.5%.

Upon closing this bundled sale, Safeguard will have 14 partner companies that are tightly aligned with our strategy to focus on specific high-growth segments within technology and life sciences. The transaction will provide Safeguard with additional flexibility to pursue exciting new growth opportunities.

Now, let's review Safeguard's first quarter highlights. Consolidated revenue adjusted for discontinued operations for the first quarter was $15.9 million. That is an increase of 80% from the first quarter of 2007. This is entirely from Clarient. Their performance in Q1 was quite strong. Our consolidated net loss for the first quarter was $11.5 million compared to $8.9 million in the first quarter of 2007, excluding discontinued operations. Those discontinued operations represent results from Safeguard's majorette-held partner companies, Acsis, Alliance Consulting and Laureate Pharma. In Q1 2007, they also included the results of Pacific Title & Arts Studio, as well as Clarient's Technology Group.

Looking at the majority-held partner company performance, including those companies reported in discontinued ops, from a revenue standpoint, the life sciences sector continues to outperform technology. Combined first quarter revenue of our pre-bundled transaction majority held life sciences companies, Clarient and Laureate Pharma, was $22.9 million. Now that is up 66% from a year ago. Combined revenue for our pre-bundled transaction majority-held partner companies, Acsis and Alliance Consulting Group, was $26.7 million in the Q1 and that is up 4% compared to a year ago. Alliance was basically flat while Acsis showed good growth.

As you know, we are a holding company, not competition operating company. Our strategy as a holding company is to deploy capital in exciting life sciences and technology companies, build value in those companies and realize the value through strategically timed exits. When we deploy capital, we look to five broad strategic themes that we believe are creating opportunities for entrepreneurial businesses in both the technology and life sciences sectors. Those themes are maturity, migration, convergence, compliance and cost containment. Maturity: Maturing population, the impact that will have or the maturing technology infrastructure in a consolidating industry. There is migration and both technology migration such as analog to digital and business model migration such as the move from perpetual software licenses to the on-demand subscription licenses. Convergence such as in the – of devices, diagnostics and therapeutics or the information technology converging within life sciences technology in both products and services. Compliance from agencies and acts such as HIPAA, Sarbanes Oxley, the FDA, the Patriot Act, the SEC and so on. And then cost containment driven by trends to reduce costs by improving efficiencies and effectiveness while reducing redundancies in IT as well as in the healthcare environment. These are the themes that we keep in mind when we look to acquire interests in new partner companies. We are looking for businesses that have identified a sizable market and an opportunity that is poised to fill an emerging need.

Now, as I mentioned in our fourth quarter call, we are evaluating a number of opportunities that would represent investments at the lower end of our stated $5 million to $50 million range. In doing so, the overall [ph] profile of our partner companies may shift to be more weighted towards equity or cost method companies versus consolidated companies. Unlike private equity firms, Safeguard isn't reliant upon heavy debt loads to acquire stakes in partner companies. Therefore, there is no large debt load to handle. Our strategy is to partner and build value rather than take over management on operations. In addition, Safeguard's strategy does not include acquiring stakes in distressed, ailing or troubled companies that are too difficult or time consuming to fix. Instead, Safeguard seeks growth situations that are amplified by the major trends that I just outlined. Our pipeline of investment opportunities is very robust right now. We are pleased with the level of discussion with an impressive list of quality opportunities.

The second step in our game plan is to build value in our holdings. As I described last quarter, the 14 partner companies we will have remaining after the bundled sale are in various stages of maturity. The first is these four categories is development stage companies. These companies are proving out technology, developing prototypes and forming early partnerships. They could be in the FDA approval process and they have begun initial commercialization or they have beta-stage customers. Today, Avid Radiopharmaceuticals, Newpath, and our Stealth Technology Company are development stage companies. Avid should be entering Phase II clinical trials this year for two imaging compounds that aim to improve the diagnosis of Alzheimer's and Parkinson's disease. Our Stealth Company is moving from alpha testing to beta testing as it gears up for a full-blown launch in the social information management space.

The second group is initial revenue stage companies. These companies are gaining initial customer traction, early market penetration and they are building their management teams, their organizations and their infrastructures. Safeguard life sciences partner companies, Alverix, Cellumen, and Rubicor Medical fall into this category of initial revenue stage companies. Alverix continues to see early revenue from its points-of-care diagnostics device that's bringing lab-quality diagnostics directly into the doctor's office. Cellumen has entered the market with its cellular level tool sold to pharmaceutical companies to reduce the cost of drug trials by quickly identifying winners and losers in drug discovery. Rubicor Medical, a producer of minimally invasive breast cancer biopsy and tissue removal technology is building relationships for potential partnerships. They will be featuring their newly configured biopsy device at the Annual Breast Surgeons Conference held in New York City later this week and they are expecting a good deal with fanfare.

Next, we have expansion stage companies. These companies have a commercial grade solution, are experiencing expanded market penetration. They have the management team and the infrastructure in place to generate revenue and manage rapid growth. Today, Safeguard technology partner companies, Advantedge Healthcare Solutions, Authentium, Beyond.com and Portico Systems are considered expansion stage companies. Advantedge Healthcare is a technology-based hospital physicians billing practice that's executing according to plan with its new CEO onboard. Authentium recently launched its SafeCentral identity protection technology for online transactions. Beyond.com, one of the largest networks of online niche career communities renewed its partnership with Yahoo! Portico Systems, the software solution provider to help your networks, executed its plan in Q1 and it remains on track for strong growth in 2008.

Finally, there is a high-traction stage partner companies, including technology partner companies, Bridgevine and NextPoint Networks, and life sciences partner companies Advanced BioHealing and Clarient. These companies are experiencing rapid growth, are close to breakeven or are already profitable and have a high degree of commercial traction. Bridgevine continues to experience robust growth ahead of its already aggressive plans in the first quarter. NextPoint continues to focus on aggressive revenue growth through top-tier customers and partnerships while consolidating operations after its merger of NextTone and Reef Point. Advanced BioHealing or ABH is a leader in the science of regenerative medicine and they recorded revenues over $7 million for Q1. They recorded their first $3 million-month in March. Revenues were driven by additional traction from its FDA-approved Dermagraft product for diabetic foot ulcers and revenue growth plans for 2008 remain aggressive and the company is evaluating the introduction of additional product offerings. Its aggressive growth plans are on track. And publicly traded Clarient, a cancer diagnostics company, reported Q1 revenues of $15.9 million or 80% growth from the first quarter of '07. They also reported positive adjusted EBIDTA of $1.4 million. The company is expecting continued strong growth in 2008.

Now, as you can imagine, the strategies we use to build value in our partner companies varies as they move from one stage to the next. Of course, realizing the value that we have help build in our partner companies is the third leg of Safeguard strategy. While our expansion stage and high traction partner companies would be the most obvious exit companies, in reality, we could realize exits at our partner companies at any one of those four stages during their growth. But, as you know, we have been hit by a steep decline in the public markets and continued uncertainty in the private equity markets. Venture capital-backed exits dropped significant in the first quarter of 2008.

A recent report from VentureStore [ph] shows that merger and acquisition market saw 80 deals valued at $7.78 billion in Q1 of 2008. That is a steep decline from the 110 deals valued at over $15 billion in the previous quarter and 105 deals at $10 billion in the first quarter of 2007. It is the lowest M&A deals since the first quarter of 2003, when 77 deals took place in a year that this was the decade's worst for the market.

Initial public offerings came to a virtual halt in the first quarter with only six venture-backed companies managing to go public, raising just $391 million. That is down from $1.9 billion raised in 25 offerings in the fourth quarter of '07 and $1.2 billion in 13 offerings in the first quarter of '07. That being said, strategically attractive businesses can find a valuable exit even in tougher times. According to the investment banking community, firms with strong management, a large addressable market with attractive growth, a performance that is growing rapidly and a defensible positioning are the most desirable and also most valuable.

Now, we at Safeguard will continue to work to find and build value in these opportunities and realize that value with well-timed exits. In order to provide you with more tools and transparency to allow you to better analyze and fairly value Safeguard, Ray will provide you with an update of our aggregate revenue and our growth expectations from our post-bundle partner companies. On that note, let me turn to call over to Ray.

Ray Land

Thanks, Peter. I will present Safeguard's first quarter 2008 results and then discuss the aggregate revenue performance of our partner companies which should help you get a sense of the value we are building in those companies. For the first quarter of 2008, Safeguard reported consolidated revenue of $15.9 million, up 80% from the first quarter of 2007. We reported a net loss excluding discontinued operations of $11.5 million compared to net loss of $8.9 million in the first quarter of 2007. As a result of the bundled sale definitive agreement, Acsis, Alliance Consulting and Laureate are now reported as discontinued operations. Therefore, Safeguard's reported revenues for the quarter ended March 31, 2008 result from the consolidation of our one remaining majority owned company, Clarient.

In the first quarter of 2008, Clarient's revenue increased 80% to $15.9 million from $8.8 million in the comparable 2007 quarter. This increase was driven by a combination of improved test service mix, higher Medicare reimbursement rates and increased volume. The increase in volume reflects Clarient's successful efforts to expand their presence in the leukemia and lymphoma markets. Clarient's gross margins grew from 42% to nearly 62%. Clarient's loss from operations was reduced from $3.3 million to $200,000 by the combination of higher revenues and cost containment measures that Clarient put in place at the end of 2007.

As disclosed in our press release, Clarient reported $1.4 million in positive adjusted earnings before interest expense, income taxes, depreciation and amortization, and stock-based compensation. Equity losses for our minority owned partner companies in the first quarter were higher than the prior year by $4.6 million, mainly due to the change in our portfolio mix which included more equity method partner companies in 2008 than in 2007. In 2007, total aggregate revenue for our 14 post-bundle partner companies was $115 million for the periods during which they were a part of Safeguard's portfolio. In 2008, we expect that aggregate revenue from our 14 post-bundle partners will be in the range of $175 million to $200 million.

Looking at life sciences and technology independently, aggregate revenue for the life sciences companies in 2007 was $52 million and we expect 2008 life science revenue in the range of $75 million to $82 million. Technology post-bundle companies posted revenue in 2007 of $63 million. We anticipate their 2008 revenue to be in the range of $100 million to $118 million. Please keep in mind that minority companies are reported on a quarter lag basis. We will continue to update our full-year aggregate life science and technology company revenue expectations on a quarterly basis. Safeguard management is still evaluating potential uses of our cash and we will update you on the outcome of these discussions after we close the bundle sale transaction.

Now, let me turn the call back over to Peter before we open up the call for questions.

Peter Boni

Thanks, Ray. While there is a lot of activity at Safeguard with our bundled sale, our overall strategy remains unchanged. We are executing on our strategy to identify and partner with high-growth life sciences and technology companies. We continue to fuel the growth of these partners and seek well-timed strategic exits. We are excited about the opportunities ahead and we look forward to realizing their value.

On that note, Christy, will you please open the lines up, so that Ray and I can take any questions.?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Bob Labick with CJS Securities.

Peter Boni

Hello, Bob.

Operator

Bob Labick, your line is opened.

Bob Labick – CJS Securities

Can anyone hear me?

Peter Boni

Hi, Bob. I hear you. I did hear you. I don't know. Christy, perhaps we can go back to Bob.

Operator

(Operator instructions) Bob, your line is opened.

Bob Labick – CJS Securities

Okay. Can you hear me now?

Peter Boni

Yes, Bob.

Bob Labick – CJS Securities

Okay, great.

Peter Boni

The wonders of modern science.

Bob Labick – CJS Securities

Amazing, right? Okay, let's see, first question I wanted to ask was with regard to the bundled sale, obviously you had to value each of the components separately, it becomes more relevant to the point where your NextPoint or previously NextTone is coming back to you and you will maintain ownership in that. It appears that you've valued or somebody had valued the entire NextPoint NextTone Company at $210 million, just looking at your $22 million stake or 10.5%. Could you discuss with us how the valuation of NextPoint was created, what parameters, and how we should think about that holding and position in the future?

Peter Boni

I will let Ray address that. But, essentially, we sold the bundle of companies for some purposes that might have been broken out. But we really sold a bundle for a bundle price.

Ray Land

At this point, we are not disclosing the allocation and the fair market values of the individual bundle sale.

Bob Labick – CJS Securities

No, I appreciate – I am not trying to ask for the other five. But, obviously you have disclosed NextPoint to the extent that 10.5% equals $22 million. So, I was just trying to understand who came up with that determining value and what methodology was used.

Ray Land

The buyers set a price.

Bob Labick – CJS Securities

I am sorry.

Ray Land

Same set of price for NextPoint.

Peter Boni

Saints allocated the amount of moneys per company. We negotiated a bundle transaction and did not consider putting a value on any individual company. We sold them in a bundle.

Bob Labick – CJS Securities

Okay. Moving on to Clarient, obviously their quarter (inaudible) results significant growth and sequential growth. I haven't had a chance yet to go over their call from last night. But I was hoping you could maybe expand a little bit upon your comments, obviously, in terms of the primary drivers. You've mentioned Medicare reimbursement there too, but I guess the main question is, were there any one-times in the quarter or is this a sustainable growth rate, not rate going forward, but starting point going forward, the $16 million in sales?

Peter Boni

Well, first of all, Clarient has given guidance for the year that they continue to see robust opportunities for them. They have put together an enormously strong sales and marketing engine with a powerful product offering. Awhile back, they were focused on breast cancer. Now, they have a product offering that goes to the five major causes of cancer, not only breast, but prostate, lymphoma, lung and colon cancer. It is that growth in all of those areas and the product mix that has helped generate higher gross margins, number one. Certainly, the price increment and Medicare reimbursement assisted that, number two. And number three, because of the increases in volume that they have and the magic of Dr. Michael Pellini and the operational role that he has taken in Clarient, we have more operational efficiency. So, it is not one, it is not the other, it is not the third. It is a composite of all of those that have helped grow gross margin from 42% to 62% and gave them their first EBITDA positive performance and not only EBITDA positive, but it was seven figures of EBITDA positive. So, Clarient has been executing this game plan for sometime and you know the old adages, if you keep pounding away, eventually the breaks come. They have kept pounding away and those results are evident of that focus and intensity that they've been working upon. So we are really pleased with Clarient and we are proud of their accomplishments.

Bob Labick – CJS Securities

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

Peter Boni

Sure.

Operator

Your next question comes from the line of Bill Sutherland with Boenning & Scattergood.

Bill Dituyo – Boenning & Scattergood

Good morning. This is actually Bill Dituyo [ph] for Bill Sutherland.

Peter Boni

Hi, Bill.

Bill Dituyo – Boenning & Scattergood

Hi. Just to add on to the previous question about the Saints Capital deal, could you just give us a little more color to why the terms were changed and also why you have decided to keep a 10.5% stake?

Peter Boni

First of all, the terms were not changed. But, part of the terms in our arrangements with the other shareholders of the other companies was a co-sale right. And the shareholders of NextPoint opted to participate in that co-sale, participate in the rights of the co-sale. So in essence, that is how we have retained the 10%.

Bill Dituyo – Boenning & Scattergood

So, the 10.5% was kind of –

Peter Boni

That is a standard term and condition in any deal. Most companies have these deals when there is a syndication. So there is no magic in that.

Bill Dituyo – Boenning & Scattergood

Okay, great. Thank you. Just one final question. Could you also explain the (inaudible) carrying value for Acsis change from this quarter to previous quarter?

Peter Boni

I will ask Ray to comment on the carrying value.

Ray Land

The carrying value changes depending on the amount of losses or cash in that's given to each of our partner companies. But, as you know, Acsis is now being reported in discontinued operations.

Bill Dituyo – Boenning & Scattergood

I guess it was a pretty good increase from previous quarter.

Ray Land

Yes, it increased from – when you say increase, if you look at our partner company financial data schedule, we had a net loss of $2.6 million for the three months ended March 31, 2007 for Acsis. That was reduced to $655,000 in the three months ended March 31, 2008. It is a significant reduction, not increase.

Bill Dituyo – Boenning & Scattergood

Okay. I just have carrying value for Acsis at year-end of $15 million and now we are showing it as $16.5 million.

Ray Land

Looks like I have the wrong numbers.

Peter Boni

We will get back to you, Bill.

Bill Dituyo – Boenning & Scattergood

Okay. Those are my questions. Thank you.

Operator

(Operator instructions) Your next question comes from the line of John Gibbons with Oden Partners.

John Gibbons – Oden Partners

Good morning, gentlemen.

Peter Boni

Hi, John.

John Gibbons – Oden Partners

My question is, you talked about the standard terms of this right to participate on the co-sale. Does that create a sort of a tripwire if you are going to bundle other deals embedded in the portfolio or is that just sort of the facts of that particular transaction?

Peter Boni

That is the standard term that oftentimes is found when one syndicates with other investors.

John Gibbons – Oden Partners

These are the existing investors, right?

Peter Boni

That's correct.

John Gibbons – Oden Partners

Okay. So, that is actually quite positive that they want to do this, right? Should we interpret that as positive?

Peter Boni

I think that is the fact of life. We recognize this was a secondary sale as well. It is not " tripwire" to use your terminology if the whole company were packaged up and sold. It is just a shareholder right that's oftentimes granted during a syndication.

John Gibbons – Oden Partners

Right. So, it has nothing to do with the total sale, just has to do with the syndication?

Peter Boni

That's correct.

John Gibbons – Oden Partners

Okay. Thank you very much. I just haven't seen that before.

Peter Boni

Okay. It is a standard term, John.

John Gibbons – Oden Partners

Thank you.

Operator

(Operator instructions)

Peter Boni

Okay. Ladies and gentlemen, thank you very much for your interest. As a reminder, Safeguard will be attending and presenting at the JMP Securities Seventh Annual Conference on May 19 in sunny downtown San Francisco. That will be live webcast and that will be available on safeguard.com as well. Thanks for your interest. Thanks for participating. We look forward to keeping you abreast of our progress.

Operator

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

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