Safeguard Scientifics, Inc.
Q4 2007 Earnings Call Transcript

Published: 8 Apr 2008

[Operator:]

Welcome everyone to the Safeguard Scientifics fourth quarter and year-end conference call. (Operator Instructions) I would now like to turn the call over to John Shave, Vice President of Investor Relations and Corporate Communications.

[John Shave:]

Thank you for joining us for our fourth quarter 2007 earnings conference call. I am John Shave and joining me on today’s call are Peter Boni, President and Chief Executive Officer and Ray Land, Senior Vice President and Chief Financial Officer at Safeguard. During today’s call Peter will review Safeguard’s fourth quarter and full year 2007 highlights and Ray will then review financial results for Safeguard and our partner companies. Then we will open up the call for questions. Before we begin, we would like to 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 including but not limited to risks associated with the uncertainty of future performance of our partner companies, acquisitions or dispositions of interest in partner companies, the effect of economic conditions generally, capital spending by customers, development of the technology in life sciences markets in which Safeguard focuses and other uncertainties. During the course of today’s call words such as expect, anticipate, believe and intend will be used when referring to goals or events in the future. The company cannot be certain that the final outcomes will be as described today. 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 those filings and the company does not assume any obligations to update forward-looking statements made today. With that I will turn the call over to Safeguard’s CEO, Peter Boni.

[Peter J. Boni:]

Before we review the 2007 results, I would like to highlight that Safeguard recently announced that it signed a definitive agreement to exit the ownership position in three majority-held and three-minority held partner companies through a transaction with Saints Capital. Valued at approximately $100 million, the sale is expected to generate an accounting gain of approximately $16 million and close before the end of the second quarter 2008. The transaction will also release Safeguard of an aggregate of $31.5 million of debt guarantees concerning certain of those partner companies being sold. The partner companies included in this transaction are Acsis, Alliance Consulting Group, Laureate Pharma, NextPoint Networks, Neuronyx and ProModel Solutions. Through this transaction, we will more fully align our partner companies with our strategy to focus on specific and identified high growth segments within technology and life sciences sectors. In addition, this transaction provides Safeguard with the flexibility to pursue exciting new growth opportunities. Following the close of the bundled sale, in an effort to provide additional transparency we’ll begin to provide aggregate revenue for our technology and life sciences partner companies and also group them based upon what we believe to be the evolution of their maturity. Ray will cover aggregate revenues during a portion of the call. Now let me give you an overview of the stages of our partner companies post-bundle. We group our partner companies in one of four stages. The first group is developmental-stage companies. These companies are proving out technology, developing prototypes. They could be in the FDA approval process, could have begun initial commercialization, and/or they have beta stage customers. Today we consider Avid Radiopharmaceuticals, NuPathe, and our stealth technology company as development-stage companies. The second group is initial revenue-stage company. These companies are seeking initial customer traction and are building their management teams, their organizations and their infrastructures. Safeguard life sciences partner companies Alverix, Cellumen and Rubicor Medical are considered initial revenue-stage companies. 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 produce revenue and manage growth. Today Safeguard technology partner companies Advantedge Healthcare Solutions, Authentium, Beyond.com and Portico Systems are considered expansion-stage companies. And finally, high traction companies, including technology partner company Bridgevine that was formerly Broadband National and life sciences partner companies Advanced BioHealing and Clarient. These companies are experiencing rapid growth, prospects of profitability and/or are now profitable and they have the most degree of commercial traction. These four stages provide us with an indication as to our partner companies’ progress to a liquidity event which ultimately can occur throughout any of the four stages. We’ll continue to provide you with updates so you can monitor the evolution of these companies’ developments, improvements in their potential exit progress and increments to their value. Now, let’s review Q4 and year-end 2007 highlights. Safeguard started 2007 with a focus on deploying capital in exciting high potential life sciences and technology companies, building value in these companies and realizing that value through strategic, well timed exits. In 2007 we executed in each of these areas. The addition of key staff members during the year including CFO, Ray Land, and General Counsel, Brian Sisko, contributed to our ability to deliver against our objectives in ‘07, and the addition of a life science savvy Board member, Dr. Robert Rosenthal, added to our strategic depth and our domain expertise. On a post-bundle basis Safeguard’s only majority owned company will be Clarient. In Q4 our two majority life sciences partner companies Clarient, which is publicly held, and Laureate Pharma, which is privately held and now part of the bundled sale, saw combined revenue growth of 60% in the fourth quarter and 78% for the full year. As you have been hearing the technology sector has had its challenges recently. Our partner companies are not immune to the impact of the broader markets. Our majority held technology partners, Acsis and Alliance Consulting Group, saw combined revenue decline 13% in Q4 of ‘07. With Acsis reporting a revenue increase of 12% for the same period, it is Alliance that has experienced the revenue growth issue, more on that later. But none of our companies are reliant upon retail, construction, or mortgage finance, the sectors that are most affected by today’s down draft. Although our partner companies are not immune to the impact of broader markets, we believe especially that our post-bundle partner companies are positioned for continued growth with positive momentum. These companies represent, with the exception of Clarient, investments made in Safeguard since 2006. When we deploy capital, we’ve identified five strategic things that we believe are present in both technology and life sciences. They guide our placement of capital

[Raymond J. Land:]

I will first present Safeguard’s fourth quarter and full year 2007 results, and then provide you with some additional metrics that will help you gauge the value we are building in our partner companies. As we reported today, for the fourth quarter of 2007 Safeguard reported consolidated revenue of $47.7 million, up 8% from $44.2 million in the fourth quarter of 2006. We had a net loss of $15.1 million compared to a net loss of $12.3 million in the fourth quarter of 2006. On a full year basis, Safeguard’s consolidated revenue was $176.1 million in 2007, up 8% from $162.6 million in 2006. Net loss for 2007 was $68.1 million compared to a net loss of $43.9 million in 2006. All these figures are exclusive of discontinued operations. Among our life science majority-held partners, publicly held Clarient reported their fourth quarter results with record revenue of $12.4 million, an increase of over 50% from the prior year. On a full year basis, Clarient’s revenues increased 55% to $43 million. The increase in revenue over 2006 was due to increasing volume from the company’s diagnostics services. Their losses narrowed considerably. As Peter mentioned, Clarient’s 2007 year-end financial reporting delay caused the delay in Safeguard’s 2007 Form 10-K filing. As we discussed in our Form 12b-25 filing this was related to a delay in the preparation of Clarient’s financial statement. Our analysis as to the cause of the delay revealed that Safeguard has two material weaknesses as disclosed in Item 9A of our 10-K. The first is that we need to ensure that Clarient has effective policies and procedures to identify financial reporting risks on a timely basis. The second is that we need to assist Clarient in improving their accountability controls over their third-party billing provider and help them improve their controls over their estimation of the allowance for bad debt. More information regarding the material weaknesses is presented in Item 9A of our 10-K which was filed yesterday. As previously reported, Clarient entered into a revolving credit facility with Safeguard, which provides Clarient with $21 million in debt financing availability. Currently there is $8.6 million of available credit remaining under the Safeguard credit facility. We believe that our debt facility provides Clarient with access to sufficient amounts of capital during 2008 to continue to operate and grow its business. However, due to Clarient’s recent history of debt covenant violations there is a risk that Clarient might trigger debt covenant defaults again in the coming year which would allow Comerica to call their loan. Therefore, KPMG has issued a going concern opinion with regard to Clarient’s financial statements. With regard to our other partner companies, Laureate Pharma reported record revenue growth of 2007 of $27.1 million, up 131% from 2006. Q4 was also Laureate’s third consecutive quarter of positive EBITDA performance. On the technology side, Acsis saw fourth quarter revenue of $6.1 million, a 12% year-over-year increase. Alliance Consulting saw fourth quarter revenue decrease to $21.1 million as compared to $26 million a year ago. The decrease was due in large part to weakness in their financial services and manufacturing verticals, and to competition, deferral of several engagements and the loss of a major customer. Equity losses for our minority owned partner companies in the fourth quarter were higher than the prior year by $3.8 million, principally due to the fact that we had more equity method partner companies in 2007 than in 2006. For the full year, equity losses for the life sciences companies were higher than the prior year by $7.4 million, and for the technology companies equity losses were higher than the prior year by $3.8 million. Five of the equity companies were new in 2007. In accordance with Generally Accepted Accounting Principles, Safeguard’s consolidated revenue only represents revenue from our four majority-held companies and excludes revenue from minority owned partner companies. As we move forward, we will be improving the transparency of Safeguard by providing aggregate revenue for our partner companies, whether majority owned or not. In that context, total 2007 aggregate revenue for all of our post-bundle partner companies was $85 million. It’s important to remember that of the 13 post-bundle partner companies, seven were new partner companies in 2007. So for those companies, we only include revenues for the month subsequent to our acquisition. We anticipate that the total 2008 aggregate revenue for our 13 post-bundle companies will be in the range of $135 million to $150 million. With regard to life sciences, 2007 aggregate revenue was $52 million and we expect 2008 life sciences revenue in a range of $75 to $82 million. Technology post-bundle 2007 revenue was $33 million and we anticipate their 2008 revenue to be in a range of $60 to $68 million. Please keep in mind that our minority partner companies are reported on a quarter lag basis. Each quarter we will update our annual revenue guidance. With regard to the proceeds from the bundled sale, we’ve had some suggestions from our investors as to how we might use those proceeds. The first thing to keep in mind is that we won’t receive the $100 million until the transaction closes. After the bundled sale, we will continue to have a combination of majority and minority stakes in 13 healthy growing companies, who will need cash to fuel further growth and value creation. In addition, we have an active and strong pipeline of new high potential situations that are being evaluated for acquisition. And of course, we have $129 million of convertible bonds that can be put to the company in March of 2011. Once the bundled sale transaction with Saints Capital is closed, we’ll take all of these cash needs into consideration and then outline our program for future cash utilization. This should be done around the latter part of the second quarter. Also, there have been some questions from investors about our exposure to auction rate securities. We have no investments in auction rate securities and our investment policy prohibits investing in this type of security. Now let me turn the call back over to Peter, before we open up the call for questions.

[Peter J. Boni:]

We believe Safeguard is solidly executing our game plan. In 2008, we plan to continue our strategy of deploying new capital, building value and realizing that value. The pipeline of potential high growth partners remains very strong and we’re actively pursuing deals. We continue to build value and add value to our partner companies and we continue to realize that value as we position and exit from partnerships strategically to maximize shareholder value.

[Operator:]

(Operator Instructions) Your first question comes from Bob Labick - CJS Securities.

[Bob Labick:]

In regards to the sale to Saints, obviously, it’s going to take a couple of months to close, is there anything that you’re expecting to be a problem or is it more formalities. And can you discuss, do you have any break-up fees, has there been a go-shop provision, or are you trying to sell these stakes to anybody else at this given time and if there is a go-shop, when does that end?

[Peter J. Boni:]

It’s a formality to close and we are following that formality and we are anticipating the close in the second quarter, Bob. There was a break-up fee as a part of the definitive agreement.

[Bob Labick:]

Could you remind us what it is?

[Peter J. Boni:]

I’m not sure if we’ve disclosed that, Bob.

[Bob Labick:]

Then use of proceeds, Ray obviously outlined a bunch of opportunities. Could you tell us are there any restrictions for share repurchase or any requirements you would have to pass through in order to be able to repurchase shares?

[Peter J. Boni:]

There is no legal restriction that I’m aware of. We’ll outline our cash utilization when the deal closes.

[Bob Labick:]

In regards to Clarient, obviously you pointed us to a couple of places in the Ks of each. But, could you just speak operationally and just give us a bigger sense, what happened at Clarient operationally that was a problem, how has it been addressed, and has it been resolved?

[Raymond J. Land:]

As you can see in their 10-K, press release and also on our discussion, Clarient is a rapidly growing company and had rapid growth in 2007. They had a deterioration in their collection of accounts receivable that during their analysis of the problem with the credit refunds they discovered they had to make an addition of $1.8 million to their bad debt expense for the year. They also discovered during the closing process that there was a backlog of credit adjustments at their third-party billing service provider that had not been processed on a timely basis during 2007 and some actually related to 2006. So, this delayed the financial closing and resulted in material weaknesses being identified at both Clarient and Safeguard with regard to the financial reporting.

[Bob Labick:]

Where we do stand now? What is the resolution? Is this entirely behind us or are they still investigating?

[Raymond J. Land:]

Yes, this is entirely behind us now in terms of adjustments to the financial statements. What we need to do now is as disclosed in Item 9A of the Form 10-K, as to the remediation steps that we are taking and one of the major steps will be bringing the billing system in-house during the second quarter of 2008. Now that project had been started and been budgeted for prior to the discovery of the credit adjustments that weren’t processed. In addition, we will be implementing new analytics in high risk areas like accounts receivable and bad debt at both the Safeguard level and the Clarient level and we will be using internal audit to on a quarterly basis go in and do a review of the bad debt expense calculation and the credit refunds. So, we think that the adjustments are behind us and we think that the remediation steps will prevent this from occurring in the future.

[Operator:]

Your next question comes from John [Gibbon].

[John [Gibbon]:]

Ray, could you just remind us, since we are right on the subject, what is the amount of the Comerica debt?

[Raymond J. Land:]

The amount of the Comerica debt at Clarient is $9 million. And that’s fully utilized.

[John [Gibbon]:]

Right, but you’ve got $9 left to go in your revolver to them.

[Raymond J. Land:]

[inaudible]

[Operator:]

Your next question comes from Bill Sutherland - Boenning & Scattergood.

[Bill Sutherland:]

The revenue breakout for the post-bundled companies, could you let us get a sense of the run rate as you were exiting ‘07 for the life science and IT companies?

[Raymond J. Land:]

So, you would like to analyze the fourth quarter run rate and we would prefer not to do that. It can be a misleading number because first of all these are growth companies, so the first quarter, second quarter, third quarter, fourth can be significantly different and some of their revenues may be seasonal.

[Peter J. Boni:]

We also do things on a quarter lag basis, Bill, recognizing we’re dealing with private companies. So I think we’ll be in a better posture next quarter to review fourth quarter.

[Raymond J. Land:]

We’ll have a wraparound as we move forward. We acquired a lot of these companies in 2007, so we have partial year revenues in those years. So as we get the quarters behind us we’ll start to get wraparounds where we can compare four quarters of revenue to four quarters of comparable prior period revenue. And that’s one of the reasons we didn’t use a growth rate because we didn’t think that was representative and that’s why we are using aggregate dollars.

[Bill Sutherland:]

Well, that’s what I’m trying to just sort of get a little closer to what it might be. What if we just looked at ‘07 full year for these companies, whether they were part of you or not?

[Raymond J. Land:]

Well we said that was $85 million.

[Peter J. Boni:]

That wasn’t a full year, however.

[Raymond J. Land:]

No, it wasn’t.

[Bill Sutherland:]

That’s what I’m saying. What was your full-year number?

[Peter J. Boni:]

You are dealing with some companies, Bill, that were acquired by Safeguard and they weren’t necessarily using what we would consider public GAAP accounting principles prior to that period of time. So it’s not a fair number. Like Ray stated, when we have four quarters of operations under Safeguard we are better positioned to do that.

[Raymond J. Land:]

Yes, but the $85 million is just the total and it’s on a lag basis for the month that we own the companies.

[Peter J. Boni:]

What you should take away from that, however, is that we have an exciting group of post-bundled companies that reflect our strategy and are undergoing some significant growth as a result.

[Raymond J. Land:]

And we are limiting our guidance to this disclosure only.

[Operator:]

At this time there are no further questions.

[Peter J. Boni:]

Well, thanks very much for your interest and we look forward to keeping you apprised of Safeguard’s progress as we progress through 2008. We are very excited about it and we’d like to share with you as we go along.