Safeguard Scientifics, Inc.
Q3 2009 Earnings Call Transcript

Published: 4 Nov 2009

[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

[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

[Peter Boni:]

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

[Operator:]

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

[Bob Labick:]

Good morning.

[Steve Zarrilli:]

Hi Bob.

[Bob Labick:]

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:]

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:]

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:]

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

[Peter Boni:]

I am not sure what your thoughts –

[Bob Labick:]

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:]

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:]

Good morning, Peter and Steven.

[Steve Zarrilli:]

Hi Sam.

[Sam Rebotsky:]

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:]

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:]

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:]

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.