SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended December 31, 2010

 

Commission File Number 1-5620

 

Safeguard Scientifics, Inc.

(Exact name of Registrant as specified in its charter)

 

 

(610) 293-0600

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of June 30, 2010, the aggregate market value of the Registrant’s common stock held by non-affiliates of the registrant was $213,153,252 based on the closing sale price as reported on the New York Stock Exchange.

 

The number of shares outstanding of the Registrant’s Common Stock, as of March 3, 2011 was 20,644,164.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive proxy statement (the “Definitive Proxy Statement”) to be filed with the Securities and Exchange Commission for the Company’s 2011 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.

 

 

SAFEGUARD SCIENTIFICS, INC.

 

FORM 10-K

 

DECEMBER 31, 2010

 

 

PART I

 

Cautionary Note concerning Forward-Looking Statements

 

Except for the historical information and discussions contained herein, statements contained in this Annual Report on Form 10-K may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Our forward-looking statements are subject to risks and uncertainties. The risks and uncertainties that could cause actual results to differ materially, include, among others, managing rapidly changing technologies, limited access to capital, competition, the ability to attract and retain qualified employees, the ability to execute our strategy, the uncertainty of the future performance of our companies, acquisitions and dispositions of companies, the inability to manage growth, compliance with government regulations and legal liabilities, additional financing requirements, the effect of economic conditions in the business sectors in which our companies operate, and other uncertainties described in the Company’s filings with the Securities and Exchange Commission. Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied on as an indication of future performance. The Company does not assume any obligation to update any forward-looking statements or other information contained in this news release.

 

 

Business Overview

 

Safeguard’s charter is to build value in growing businesses by providing capital and strategic, operational and management resources. Safeguard participates in expansion financings, corporate spin-outs, management buyouts, recapitalizations, industry consolidations, and early-stage financings. Our vision is to be the preferred catalyst to build great companies across diverse capital platforms. Throughout this document, we use the term “partner company” to generally refer to those companies that we have an economic interest in and that we are actively involved in influencing the development of, through board representation and management support in addition to our equity ownership stake. From time to time, in addition to our partner companies, we also hold relatively small economic interests in other enterprises that we are not actively involved in the management of.

 

We strive to create long-term value for our shareholders by helping partner companies increase their market penetration, grow revenue and improve cash flow. We focus principally on companies in which we anticipate deploying up to $25 million and that operate in two sectors:

 

Life Sciences — including companies focused on molecular and point-of-care diagnostics, medical devices, regenerative medicine, specialty pharmaceuticals and selected healthcare services; and

 

Technology — including companies focused on internet/new media, financial services IT, healthcare IT and selected business services that have transaction-enabling applications with a recurring revenue stream.

 

As we continue to develop and grow, we will consider partner companies in additional sectors; participating in different capital structures; other types of partner company relationships; and extensions to our business model which leverage our core capabilities.

 

In 2010, our management team executed against the following objectives, to:

 

 

To meet our strategic objectives during 2011, Safeguard will focus on:

 

 

We incorporated in the Commonwealth of Pennsylvania in 1953. Our corporate headquarters are located at 435 Devon Park Drive, Building 800, Wayne, Pennsylvania 19087.

 

Significant 2010 Highlights

 

Here are our key developments from 2010:

 

 

Our Strategy

 

We currently focus principally on companies that address the strategic challenges facing businesses today and the opportunities they present. We believe these challenges have five general themes:

 

 

These strategic themes tend to drive growth and attract entrepreneurs who need capital, operational support and strategic guidance. Safeguard deploys capital, combined with management expertise, process excellence and marketplace insight, to provide tangible benefits to our partner companies.

 

Our corporate staff (28 employees at December 31, 2010) is dedicated to creating long-term value for our shareholders by helping our partner companies build value and by finding additional acquisition opportunities.

 

Identifying Partner Company Opportunities

 

Safeguard’s go-to-market strategy, marketing and sourcing activities within our sectors of focus (Life Sciences and Technology) are designed to generate a large volume of high-quality opportunities to acquire majority or primary shareholder stakes in partner companies. Our principal focus is to acquire stakes in growth-stage companies with attractive growth prospects in the technology and life sciences sectors. Generally, we prefer to deploy capital into companies:

 

 

Our sourcing efforts are targeted primarily in the eastern U.S. However, in-bound deal leads generate opportunities throughout the U.S. and Canada. Leads come from a variety of sources, including investment bankers, syndication partners, existing partner companies and advisory board members.

 

Our Life Sciences Group currently targets companies with Product or Technology-Enabled Service business models that represent lesser regulatory risk and companies in the molecular and point-of-care diagnostics, medical device, regenerative medicine, specialty pharmaceuticals and selected healthcare services vertical markets.

 

Our Technology Group currently targets companies with recurring revenue, transaction-enabled applications or software as a service business models and companies in the internet/new media, financial services IT, healthcare IT and selected business services vertical markets.

We believe there are many opportunities within these business models and vertical markets, and our sourcing activities are focused on finding candidate companies and evaluating how well they align with our criteria. However, we recognize we may have difficulty identifying candidate companies and completing transactions on terms we believe appropriate. As a result, we cannot be certain how frequently we will enter into transactions with new or existing partner companies.

 

Competition.  We face intense competition from other companies that acquire, or provide capital to life sciences and technology businesses. Competitors include venture capital and, occasionally, private equity investors, as well as companies seeking to make strategic acquisitions. Many providers of growth capital also offer strategic guidance, networking access for recruiting and general advice. Nonetheless, we believe we are an attractive capital provider to potential partner companies because our strategy and capabilities offer:

 

 

Helping Our Partner Companies Build Value

 

We offer operational and management support to each of our partner companies through our experienced professionals. Our employees have expertise in business and technology strategy, sales and marketing, operations, finance, legal and transactional support. We provide hands-on assistance to the management teams of our partner companies to support their growth. We believe our strengths include:

 

 

Strategic Support.  By helping our partner companies’ management teams remain focused on critical objectives through the provision of human, financial and strategic resources, we believe we are able to accelerate their development and success. We play an active role in developing the strategic direction of our partner companies, including:

 

 

Management and Operational Support.  We provide management and operational support, as well as ongoing planning and development assessment. Our executives and Advisory Board members provide mentoring,

advice and guidance to develop partner company management. Our executives serve on the boards of directors of partner companies, working with them to develop and implement strategic and operating plans. We measure and monitor achievement of these plans through regular operational and financial performance measurements. We believe these services provide partner companies with significant competitive advantages within their respective markets.

 

Realizing Value

 

In general, we will hold our stake in a partner company as long as we believe the risk-adjusted value of that stake is maximized by our continued ownership and effort. From time to time, we engage in discussions with other companies interested in our partner companies, either in response to inquiries or as part of a process we initiate. To the extent we believe that a partner company’s further growth and development can best be supported by a different ownership structure or if we otherwise believe it is in our shareholders’ best interests, we may sell some or all of our stake in the partner company. These sales may take the form of privately negotiated sales of stock or assets, public offerings of the partner company’s securities and, in the case of publicly traded partner companies, sales of their securities in the open market. In the past, we have taken partner companies public through rights offerings and directed share subscription programs. We will continue to consider these (or similar) programs to maximize partner company value for our shareholders. We expect to use proceeds from these sales (and sales of other assets) primarily to pursue opportunities to create new partner company relationships or for other working capital purposes, either with existing partner companies or at Safeguard.

 

Our Partner Companies

 

An understanding of our partner companies is important to understanding Safeguard and its value-building strategy. Following are descriptions of certain of our partner companies in which we owned a stake at December 31, 2010. The indicated ownership percentage is presented as of December 31, 2010 and reflects the percentage of the vote we are entitled to cast based on issued and outstanding voting securities (on a common stock equivalent basis), excluding the effect of options, warrants and convertible debt (primary ownership).

 

LIFE SCIENCES PARTNER COMPANIES

 

 

Headquartered in Westport, Connecticut, Advanced BioHealing develops and commercializes living cell therapies that repair damaged human tissue and enable the body to heal itself. Its lead product, Dermagraft^®, is a bio-engineered skin substitute that assists in restoring damaged tissue and supports the body’s natural healing process. It is FDA approved to treat diabetic foot ulcers and is the focus of an ongoing pivotal trial in subjects with venous leg ulcers (VLUs) to assess the product’s safety and efficacy in the promotion of healing VLUs. According to Advanced BioHealing, to date, more than 250,000 applications of Dermagraft have been administered in over 1,000 wound care centers and outpatient clinics nationwide. www.advancedbiohealing.com

 

 

Headquartered in San Jose, California, Alverix provides next-generation instrument and connectivity platforms for diagnostic Point-of-Care testing. Building upon a 30-year legacy within Hewlett Packard and Agilent, Alverix was spun off as a privately held company in 2007. Alverix’s systems enable laboratory class performance in a mobile, inexpensive format, extending testing beyond high volume sites to physician office labs, retail clinics, emerging markets and the home. Alverix’s target markets include infectious disease, drugs of abuse, cardiac markers and cholesterol/lipids, among others. With strength in product design, product development and high volume manufacturing, Alverix is leading the transition of diagnostic testing from the laboratory to all locations where immediate results are critical to patient care. www.alverix.com

 

Alverix’s business is based on patented optical sensing technology and proprietary imaging enhancement algorithms developed at Hewlett-Packard and refined at Agilent and Avago Technologies. Using off-the-shelf parts, the company has created a low-cost, next-generation meter platform that overcomes several limitations of current

bench-top instrumentation. By partnering with assay companies as an OEM provider, Alverix can extend diagnostic testing beyond high volume labs into lower volume sites.

 

 

Headquartered in Boston, Massachusetts, Good Start Genetics is a diagnostic company that is developing a more accurate and comprehensive pre-pregnancy genetic test based on proprietary gene sequencing technology, designed to replace single-disorder-only tests currently on the market. The Company’s affordable pre-pregnancy test utilizes an advanced DNA sequencing technology to screen for a panel of genetic disorders including those recommended by the American Congress of Obstetricians and Gynecologists and the American College of Medical Genetics. Good Start Genetics’ offering will allow improved identification of carriers of heritable genetic disorders, enabling physicians to help prospective parents make more knowledgeable medical decisions before conception. Good Start Genetics’ platform also can be used in oncology, cardiovascular and adult genetic disorders. www.goodstartgenetics.com

 

Good Start Genetics’ next-generation sequencing technology is designed to deliver a higher detection rate and improved clinical performance compared to currently available screening methods, such as genotyping and single nucleotide polymorphism analysis. Higher detection rates provide physicians with more accurate results and more clinically relevant genetic information. The Company expects to offer its test exclusively through board certified physicians in the U.S. starting in 2011.

 

 

Headquartered in Norwood, Massachusetts, Molecular Biometrics, Inc. is developing novel clinical diagnostic tools for applications in personalized medicine. Its first product, ViaMetrics-E^tm is intended to be a rapid, non-invasive procedure designed to enhance in vitro fertilization (IVF) outcomes. Ultimately, the goal of ViaMetrics-E is to reduce the number of embryos transferred during an IVF cycle, as well as the complications and healthcare costs that accompany multiple births. www.molecularbiometrics.com

 

To offset low pregnancy success rates, couples often request the implantation of multiple embryos to increase their chances, resulting in multiple birth pregnancies for one-third of couples. Molecular Biometrics seeks to improve the likelihood of selecting a viable embryo, increase the success rate within IVF and reduce the number of needed cycles for couples. The patented technology may also be applicable to other areas of reproductive medicine, and neurodegenerative and other diseases.

 

 

Headquartered in Conshohocken, Pennsylvania, NuPathe is a specialty pharmaceutical company focused on the development and commercialization of branded therapeutics for diseases of the central nervous system, including neurological and psychiatric disorders. NuPathe’s most advanced product candidate, Zelrix^tm, is a single-use, transdermal sumatriptan patch being developed for the treatment of migraine headaches. In addition to Zelrix, NuPathe has two proprietary product candidates in preclinical development: NP201 for the continuous symptomatic treatment of Parkinson’s disease and NP202 for the long-term treatment of schizophrenia and bipolar disorder. www.nupathe.com

 

Migraine-related GI disturbances, including nausea and vomiting, reduce (or even prevent) the effectiveness of oral treatments. In addition, many patients on triptan therapy experience recurring migraines despite their medication. The lack of adequate therapies addressing these needs has created an opportunity for the SmartRelief^tm patch.

 

 

Headquartered in East Norriton, Pennsylvania, Tengion is a clinical-stage, organ-regeneration company with programs for urologic, renal and gastrointestinal regeneration. It has pioneered the Autologous Organ Regeneration Platform^tm that enables Tengion to create proprietary product candidates that are intended to harness the intrinsic regenerative pathways of the body to produce a range of native-like organs and tissues. Tengion’s product

candidates seek to eliminate the need to: utilize other tissues of the body for a purpose to which they are poorly suited; procure donor organs; or administer anti-rejection medications. www.tengion.com

 

Patients suffering from severe bladder disease often opt for radical cystectomy, bladder augmentation or removal. Bowel tissue is generally used to replace bladder tissue, although these procedures have a number of significant complications that increase patient morbidity. By incorporating a patient’s own cells into a biodegradable scaffold, the Tengion Neo-Bladder products serve as a template that, once implanted, recruit other cells to develop and regenerate the organ.

 

Tengion’s products address the shortage of donor organs, the risk of organ rejection and the high cost and toxicity of anti-rejection medications.

 

TECHNOLOGY PARTNER COMPANIES

 

 

Headquartered in Warren, New Jersey, AHS is a provider of physician billing and practice management services and software to hospital-based physician groups, large office-based physician practices, and ambulatory surgery centers throughout the United States. AHS’ technology efficiently collects patient demographic and clinical information and speeds the reimbursement of third-party claims and patient payments, enabling physicians and providers to maximize revenue and decrease their billing and practice management costs, frequently in dramatic ways. AHS is an IBM Business Partner for physician billing solutions. www.ahsrcm.com

 

AHS is a growing provider with proven technology, operating in a fragmented market for outsourced revenue cycle management comprised of many “mom and pop” companies. The AHS management team has extensive experience in acquiring smaller competitors and in developing effective revenue-cycle technology platforms.

 

AHS plans to grow both organically and via acquisition, purchasing companies at below-to-average industry multiples and then achieving significant margin synergies through proprietary technology.

 

 

Headquartered in King of Prussia, Pennsylvania, Beyond.com is the world’s largest network of niche career communities, providing access to thousands of top-tier industry and local web sites. Beyond’s career search services and networking tools enable job seekers and employers to create targeted connections across thousands of online communities. Beyond delivers a one-of-a-kind recruitment solution that provides the targeted exposure of a specialized job board, reinforced by the breadth and volume of a larger career network. www.beyond.com

 

Approximately 90% of job seekers search locally. Beyond.com capitalizes on the fact that most job seekers search locally, monetizing its network of local and niche career websites via job postings, career services, lead generation and online advertising. As the online jobs-search market consolidates, Beyond.com is exploring growth opportunities through acquisition.

 

Much of the growth in online job recruitment is expected to come from small and medium-sized businesses, posting local ads for jobs, a trend that favors Beyond.com’s business model.

 

 

Headquartered in Vero Beach, Florida, Bridgevine is an online performance marketing company. Its proprietary AMP^tm technology — a seamless and highly automated campaign management, merchandising, fulfillment and business intelligence platform — connects advertising clients with new, high-quality customers. Bridgevine’s broad catalog of brands and unique technology are major reasons why thousands of third-party retail sites, retail outlets, call centers, and equipment manufacturers use the Bridgevine platform to offer complementary services to their own customers. According to Bridgevine, since 2003, the company has facilitated more than 8 million transactions and generated over $1 billion in incremental revenue for a growing list of nationally recognized advertisers. www.bridgevine.com

Bridgevine raised capital to develop proprietary software that exploits the explosive growth of broadband, cable, voice and other digital service subscriptions. Bridgevine’s structure and technology generate solid margins, and increasing revenue and market share.

 

Bridgevine competes at the convergence of two markets: 1) digital service customer acquisition, and 2) online lead generation.

 

 

Headquartered in New York City, MediaMath is a provider of digital media trading technology and services. Its TerminalOne^® platform is the first and only enterprise-class demand side platform, providing an unmatched combination of supply, data, analytics, workflow automation and optimization to return focus to marketing strategy rather than media execution. MediaMath drives results for dozens of agencies representing the world’s leading brands — including units within all seven global agency holding companies — on thousands of worldwide campaigns. www.mediamath.com

 

MediaMath’s combination of algorithmic bidding and data integration provides advertisers with the efficiencies of search and the branding impact of display advertising. Exchange-traded advertising plays an increasingly important role in online advertising.

 

As consumers spend more time on the Internet, online ad expenditures are growing at the expense of traditional media. The Internet is more measureable and less expensive than traditional media and is the only medium where marketers can reach consumers through the entire buying cycle from initial awareness to purchase to post-sale feedback.

 

 

Headquartered in Blue Bell, Pennsylvania, Portico Systems’ innovative solutions enable health plans to reduce administrative, medical and IT costs. Portico’s exclusive focus on provider operations and 500+ staff-years of provider experience has allowed Portico to design the only modular end-to-end provider platform. www.porticosys.com

 

According to a Gartner study, worldwide healthcare IT spending (hardware, software, services and telecommunications) exceeded $77 billion in 2007 and was projected to grow at a compound annual rate of 5% through 2011, with software and services highlighted as key growth areas. The U.S. component of that market was estimated at approximately $34 billion in 2008 by DataMonitor. The approximate 250 Tier 1 and Tier 2 healthcare plans targeted by Portico spend more than $300 million annually on IT infrastructure. Ancillary target markets include pharmaceutical companies.

 

 

Headquartered in Palm Beach Gardens, Florida, SafeCentral, Inc. is a developer of security software applications and technologies for data loss prevention on the endpoint, the user’s browser. The SafeCentral product is web session security, in one click. SafeCentral is the secure companion to everyday Web browsing, providing end-to-end security against unauthorized network access and data and identity theft by locking out desktop malware and establishing trusted Web connections. It features patent-pending TSX technology to block key loggers, screen scrapers, and other malware agents, even on an already infected PC; SecureDNS to ensure a connection to the actual site, eliminating man-in-the-middle attacks; automated “launch anywhere” protection for seamless integration into your existing browsing habits; and peace of mind when transferring sensitive information or transacting online. www.safecentral.com

 

Consumers and businesses will seek next-generation software to protect against growing threats of online identity theft and data piracy. SafeCentral is developing various channels to distribute its software to end customers.

 

Headquatered in Boston, Massachusetts, Swap.com enables consumers to swap books, music, movies, video games and fashion, using its website and offline events. www.swap.com

 

Swap.com is taking advantage of and leveraging several Internet trends including the success of e-Commerce sites such as eBay and Amazon.com, and the growth of member-centric organizations such as Facebook and MySpace.

 

Other Initiatives

 

As we continue to develop and grow, we will consider partner companies in additional sectors; participating in different capital structures; other types of partner company relationships; and extensions to our business model which leverage our core capabilities.

 

FINANCIAL INFORMATION ABOUT OPERATING SEGMENTS

 

Information on revenue, operating income (loss), equity income (loss) and net income (loss) from continuing operations for each operating segment of Safeguard’s business for each of the three years in the period ended December 31, 2010 and assets as of December 31, 2010 and 2009 is contained in Note 18 to the Consolidated Financial Statements.

 

OTHER INFORMATION

 

The operations of Safeguard and its partner companies are subject to environmental laws and regulations. Safeguard does not believe that expenditures relating to those laws and regulations will have a material adverse effect on the business, financial condition or results of operations of Safeguard.

 

AVAILABLE INFORMATION

 

Safeguard is subject to the informational requirements of the Securities Exchange Commission Act of 1934, as amended. Therefore, we file our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and other information with, and furnish other reports to, the Securities and Exchange Commission (“SEC”). You can read and copy such documents at the SEC’s public reference facilities in Washington, D.C., New York, New York and Chicago, Illinois. You may obtain information on the operation of the SEC’s public reference facilities by calling the SEC at 1-800-SEC-0330. Such material may also be accessed electronically by means of the SEC’s home page on the internet at www.sec.gov or through Safeguard’s Internet website at www.safeguard.com. Such documents are available as soon as reasonably practicable after electronic filing of the material with the SEC. Copies of these reports (excluding exhibits) also may be obtained free of charge, upon written request to: Investor Relations, Safeguard Scientifics, Inc., 435 Devon Park Drive, Building 800, Wayne, Pennsylvania 19087.

 

The internet website addresses for Safeguard and its partner companies are included in this report for identification purposes. The information contained therein or connected thereto are not intended to be incorporated into this Annual Report on Form 10-K.

 

The following corporate governance documents are available free of charge on Safeguard’s website: the charters of our Audit, Compensation and Nominating & Corporate Governance Committees, our Corporate Governance Guidelines and our Code of Business Conduct and Ethics. We also will post on our website any amendments to or waivers of our Code of Business Conduct and Ethics that relate to our directors and executive officers.

 

You should carefully consider the information set forth below. The following risk factors describe situations in which our business, financial condition and/or results of operations could be materially harmed, and the value of our securities may be adversely affected. You should also refer to other information included or incorporated by reference in this report.

 

Our business depends upon our ability to make good decisions regarding the deployment of capital into new or existing partner companies and, ultimately, the performance of our partner companies, which is uncertain.

 

If we make poor decisions regarding the deployment of capital into new or existing partner companies, our business model will not succeed. Our success as a company ultimately depends on our ability to choose the right partner companies. If our partner companies do not succeed, the value of our assets could be significantly reduced and require substantial impairments or write-offs and our results of operations and the price of our common stock would be adversely affected. The risks relating to our partner companies include:

 

 

These and other risks are discussed in detail under the caption “Risks Related to Our Partner Companies” below.

 

Our partner companies (and the nature of our interests in them) could vary widely from period to period.

 

As part of our strategy, we continually assess the value to our shareholders of our interests in our partner companies. We also regularly evaluate alternative uses for our capital resources. As a result, depending on market conditions, growth prospects and other key factors, we may at any time:

 

 

Therefore, the nature of our holdings could vary significantly from period to period.

 

Our consolidated financial results also may vary significantly based upon which, if any of our partner companies are included in our Consolidated Financial Statements. For example: For the period from January 1, 2009 through May 14, 2009 and the year ended December 31, 2008, we consolidated the results of operations of Clarient in continuing operations. On May 14, 2009, we deconsolidated Clarient and between such date and

December 2010 (when we sold our remaining interests in Clarient) we accounted for our holdings in Clarient under the fair value option.

 

Our business model does not rely, or plan, upon the receipt of operating cash flows from our partner companies. Our partner companies generally provide us with no cash flow from their operations. We rely on cash on hand, liquidity events and our ability to generate cash from capital raising activities to finance our operations.

 

We need capital to develop new partner company relationships and to fund the capital needs of our existing partner companies. We also need cash to service and repay our outstanding debt, finance our corporate overhead and meet our existing funding commitments. As a result, we have substantial cash requirements. Our partner companies generally provide us with no cash flow from their operations. To the extent our partner companies generate any cash from operations; they generally retain the funds to develop their own businesses. As a result, we must rely on cash on hand, partner company liquidity events and new capital raising activities to meet our cash needs. If we are unable to find ways of monetizing our holdings or to raise additional capital on attractive terms, we may face liquidity issues that will require us to curtail our new business efforts, constrain our ability to execute our business strategy and limit our ability to provide financial support to our existing partner companies.

 

Fluctuations in the price of the common stock of our publicly traded holdings may affect the price of our common stock.

 

Fluctuations in the market prices of the common stock of our publicly traded holdings may affect the price of our common stock. The market prices of our publicly traded holdings have been highly volatile and subject to fluctuations unrelated or disproportionate to operating performance.

 

Intense competition from other acquirors of interests in companies could result in lower gains or possibly losses on our partner companies.

 

We face intense competition from other capital providers as we acquire and develop interests in our partner companies. Some of our competitors have more experience identifying, acquiring and selling companies and have greater financial and management resources, brand name recognition or industry contacts than we have. Despite making most of our acquisitions at a stage when our partner companies are not publicly traded, we may still pay higher prices for those equity interests because of higher valuations of similar public companies and competition from other acquirers and capital providers, which could result in lower gains or possibly losses.

 

We may be unable to obtain maximum value for our holdings or to sell our holdings on a timely basis.

 

We hold significant positions in our partner companies. Consequently, if we were to divest all or part of our holdings in a partner company, we may have to sell our interests at a relative discount to a price which may be received by a seller of a smaller portion. For partner companies with publicly traded stock, we may be unable to sell our holdings at then-quoted market prices. For instance, the trading volume and public float in the common stock of NuPathe, one of our two publicly traded partner companies, is small relative to our holdings. As a result, any significant open-market divestiture by us of our holdings in these partner companies, if possible at all, would likely have a material adverse effect on the market price of their common stock and on our proceeds from such a divestiture. Additionally, we may not be able to take our partner companies public as a means of monetizing our position or creating shareholder value.

 

Registration and other requirements under applicable securities laws may adversely affect our ability to dispose of our holdings on a timely basis.

Our success is dependent on our executive management.

 

Our success is dependent on our executive management team’s ability to execute our strategy. A loss of one or more of the members of our executive management team without adequate replacement could have a material adverse effect on us.

 

Our business strategy may not be successful if valuations in the market sectors in which our partner companies participate decline.

 

Our strategy involves creating value for our shareholders by helping our partner companies build value and, if appropriate, accessing the public and private capital markets. Therefore, our success is dependent on the value of our partner companies as determined by the public and private capital markets. Many factors, including reduced market interest, may cause the market value of our publicly traded partner companies to decline. If valuations in the market sectors in which our partner companies participate decline, their access to the public and private capital markets on terms acceptable to them may be limited.

 

Our partner companies could make business decisions that are not in our best interests or with which we do not agree, which could impair the value of our holdings.

 

Although we may seek a controlling or influential equity interest and participation in the management of our partner companies, we may not be able to control the significant business decisions of our partner companies. We may have shared control or no control over some of our partner companies. In addition, although we currently own a controlling or influential interest in some of our partner companies, we may not maintain those levels of interest. Acquisitions of interests in partner companies in which we share or have no control, and the dilution of our interests in or loss of control of partner companies, will involve additional risks that could cause the performance of our interests and our operating results to suffer, including:

 

 

Our inability to control our partner companies also could prevent us from assisting them, financially or otherwise, or could prevent us from liquidating our interests in them at a time or at a price that is favorable to us. Additionally, our partner companies may not act in ways that are consistent with our business strategy. These factors could hamper our ability to maximize returns on our interests and cause us to incur losses on our interests in these partner companies.

 

We may have to buy, sell or retain assets when we would otherwise not wish to do so in order to avoid registration under the Investment Company Act.

 

The Investment Company Act of 1940 regulates companies which are engaged primarily in the business of investing, reinvesting, owning, holding or trading in securities. Under the Investment Company Act, a company may be deemed to be an investment company if it owns investment securities with a value exceeding 40% of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless an exemption or safe harbor applies. We refer to this test as the “40% Test.” Securities issued by companies other than consolidated partner companies are generally considered “investment securities” for purpose of the Investment Company Act; unless other circumstances exist which actively involve the company holding such interests in the management of the underlying company. We are a company that partners with growth-stage companies to build value; we are not engaged primarily in the business of investing, reinvesting or trading in securities. We are in compliance with the 40% Test. Consequently, we do not believe that we are an investment company under the Investment Company Act.

 

We monitor our compliance with the 40% Test and seek to conduct our business activities to comply with this test. It is not feasible for us to be regulated as an investment company because the Investment Company Act rules are inconsistent with our strategy of actively helping our partner companies in their efforts to build value. In order to

continue to comply with the 40% Test, we may need to take various actions which we would otherwise not pursue. For example, we may need to retain a controlling interest in a partner company that we no longer consider strategic, we may not be able to acquire an interest in a company unless we are able to obtain a controlling ownership interest in the company, or we may be limited in the manner or timing in which we sell our interests in a partner company. Our ownership levels also may be affected if our partner companies are acquired by third parties or if our partner companies issue stock which dilutes our controlling ownership interest. The actions we may need to take to address these issues while maintaining compliance with the 40% Test could adversely affect our ability to create and realize value at our partner companies.

 

Economic disruptions and downturns may have negative repercussions for the Company.

 

Events in the United States and international capital markets, debt markets and economies may negatively impact the Company’s ability to pursue certain tactical and strategic initiatives, such as accessing additional public or private equity or debt financing for itself or for its partner companies and selling the Company’s interests in partner companies on terms acceptable to the Company and in time frames consistent with our expectations.

 

We have had material weaknesses in our internal controls over financial reporting in the recent past and cannot provide assurance that additional material weaknesses will not be identified in the future. Our failure to effectively maintain our internal control over financial reporting could result in material misstatements in our Consolidated Financial Statements which could require us to restate financial statements, cause us to fail to meet our reporting obligations, cause investors to lose confidence in our reported financial information and/or have a negative effect on our stock price.

 

We cannot assure that material weaknesses in our internal controls over financial reporting will not be identified in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in additional material weaknesses, or could result in material misstatements in our Consolidated Financial Statements. These misstatements could result in a restatement of financial statements, cause us to fail to meet our reporting obligations and/or cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

 

Risks Related to our Partner Companies

 

Most of our partner companies have a history of operating losses and/or limited operating history and may never be profitable.

 

Most of our partner companies have a history of operating losses or limited operating history, have significant historical losses and may never be profitable. Many have incurred substantial costs to develop and market their products, have incurred net losses and cannot fund their cash needs from operations. We expect that the operating expenses of certain of our partner companies will increase substantially in the foreseeable future as they continue to develop products and services, increase sales and marketing efforts, and expand operations.

 

Our partner companies face intense competition, which could adversely affect their business, financial condition, results of operations and prospects for growth.

 

There is intense competition in the technology and life sciences marketplaces, and we expect competition to intensify in the future. Our business, financial condition, results of operations and prospects for growth will be materially adversely affected if our partner companies are not able to compete successfully. Many of the present and potential competitors may have greater financial, technical, marketing and other resources than those of our partner companies. This may place our partner companies at a disadvantage in responding to the offerings of their competitors, technological changes or changes in client requirements. Also, our partner companies may be at a competitive disadvantage because many of their competitors have greater name recognition, more extensive client bases and a broader range of product offerings. In addition, our partner companies may compete against one another.

The success or failure of many of our partner companies is dependent upon the ultimate effectiveness of newly-created information technologies, medical devices, healthcare diagnostics etc.

 

Our partner companies’ business strategies are often highly dependent upon the successful launch and commercialization of an innovative information technology, medical device, healthcare diagnostic etc. Despite all of our efforts to understand the research and development underlying the innovation or creation of such technologies, etc. before we deploy capital to a partner company, often times the performance of the technology, device etc. never matches the expectations of us or the partner company. In those situations, it is likely that we will incur a partial or total loss of the capital which we deployed in such partner company.

 

Our partner companies may fail if they do not adapt to changing marketplaces.

 

If our partner companies fail to adapt to changes in technology and customer and supplier demands, they may not become or remain profitable. There is no assurance that the products and services of our partner companies will achieve or maintain market penetration or commercial success, or that the businesses of our partner companies will be successful.

 

The technology and life sciences marketplaces are characterized by:

 

 

Our future success will depend on our partner companies’ ability to adapt to these evolving marketplaces. They may not be able to adequately or economically adapt their products and services, develop new products and services or establish and maintain effective distribution channels for their products and services. If our partner companies are unable to offer competitive products and services or maintain effective distribution channels, they will sell fewer products and services and forego potential revenue, possibly causing them to lose money. In addition, we and our partner companies may not be able to respond to the marketplace changes in an economically efficient manner, and our partner companies may become or remain unprofitable.

 

Our partner companies may grow rapidly and may be unable to manage their growth.

 

We expect some of our partner companies to grow rapidly. Rapid growth often places considerable operational, managerial and financial strain on a business. To successfully manage rapid growth, our partner companies must, among other things:

 

 

If our partner companies are unable to manage their growth successfully, their ability to respond effectively to competition and to achieve or maintain profitability will be adversely affected.

Based on our business model, some or all of our partner companies will need to raise additional capital to fund their operations at any given time. We may not be able to fund some or all of such amounts and such amounts may not be available from third parties on acceptable terms, if at all.

 

We cannot be certain that our partner companies will be able to obtain additional financing on favorable terms, if at all. Because our resources and our ability to raise capital are not unlimited, we may not be able to provide partner companies with sufficient capital resources to enable them to reach a cash-flow positive position, even if we wished to do so. General economic disruptions and downturns may also negatively affect the ability of some of our partner companies to fund their operations from other stockholders and capital sources. We also may fail to accurately project the capital needs of partner companies. If partner companies need to but are not able to raise capital from us or other outside sources, then they may need to cease or scale back operations. In such event, our interest in any such partner company will become less valuable.

 

Economic disruptions and downturns may negatively affect our partner companies’ plans and their results of operations.

 

Many of our partner companies are largely dependent upon outside sources of capital to fund their operations. Disruptions in the availability of capital from such sources will negatively affect the ability of such partner companies to pursue their business models and will force such companies to revise their growth and development plans accordingly. Any such changes will, in turn, affect the ability of the Company to realize the value of its capital deployments in such companies.

 

In addition, downturns in the economy as well as possible governmental responses to such downturns and/or to specific situations in the economy could affect the business prospects of certain of our partner companies, including, but not limited to, in the following ways: weaknesses in the financial services industries; reduced business and/or consumer spending; and/or systematic changes in the ways the healthcare system operates in the United States.

 

Some of our partner companies may be unable to protect their proprietary rights and may infringe on the proprietary rights of others.

 

Our partner companies assert various forms of intellectual property protection. Intellectual property may constitute an important part of partner company assets and competitive strengths. Federal law, most typically, copyright, patent, trademark and trade secret laws, generally protects intellectual property rights. Although we expect that our partner companies will take reasonable efforts to protect the rights to their intellectual property, third parties may develop similar intellectual property independently. Moreover, the complexity of international trade secret, copyright, trademark and patent law, coupled with the limited resources of our partner companies and the demands of quick delivery of products and services to market, create a risk that partner company efforts to prevent misappropriation of their technology will prove inadequate.

 

Some of our partner companies also license intellectual property from third parties and it is possible that they could become subject to infringement actions based upon their use of the intellectual property licensed from those third parties. Our partner companies generally obtain representations as to the origin and ownership of such licensed intellectual property. However, this may not adequately protect them. Any claims against our partner companies’ proprietary rights, with or without merit, could subject the companies to costly litigation and divert their technical and management personnel from other business concerns. If our partner companies incur costly litigation and their personnel are not effectively deployed, the expenses and losses incurred by our partner companies will increase and their profits, if any, will decrease.

 

Third parties have and may assert infringement or other intellectual property claims against our partner companies based on their patents or other intellectual property claims. Even though we believe our partner companies’ products do not infringe any third-party’s patents, they may have to pay substantial damages, possibly including treble damages, if it is ultimately determined that they do. They may have to obtain a license to sell their products if it is determined that their products infringe another person’s intellectual property. Our partner companies might be prohibited from selling their products before they obtain a license, which, if available at all, may require them to pay substantial royalties. Even if infringement claims against our partner companies are without merit,

defending these types of lawsuits takes significant time, is expensive and may divert management attention from other business concerns.

 

Certain of our partner companies could face legal liabilities from claims made against their operations, products or work.

 

Because manufacture and sale of certain partner company products entail an inherent risk of product liability, certain partner companies maintain product liability insurance. Although none of our current partner companies have experienced any material losses in this regard, there can be no assurance that they will be able to maintain or acquire adequate product liability insurance in the future and any product liability claim could have a material adverse effect on a partner company’s financial stability, revenues and results of operations. In addition, many of the engagements of our partner companies involve projects that are critical to the operation of their clients’ businesses. If our partner companies fail to meet their contractual obligations, they could be subject to legal liability, which could adversely affect their business, operating results and financial condition. Partner company contracts typically include provisions designed to limit their exposure to legal claims relating to their services and products. However, these provisions may not protect our partner companies or may not be enforceable. Also, as consultants, some of our partner companies depend on their relationships with their clients and their reputation for high-quality services and integrity to retain and attract clients. As a result, claims made against our partner companies’ work may damage their reputation, which in turn could impact their ability to compete for new work and negatively impact their revenue and profitability.

 

Our partner companies’ success depends on their ability to attract and retain qualified personnel.

 

Our partner companies depend upon their ability to attract and retain senior management and key personnel, including trained technical and marketing personnel. Our partner companies also will need to continue to hire additional personnel as they expand. At present, none of our partner companies have employees represented by labor unions. Although our partner companies have not been the subject of a work stoppage, any future work stoppage could have a material adverse effect on their respective operations. A shortage in the availability of the requisite qualified personnel or work stoppage would limit the ability of our partner companies to grow, to increase sales of their existing products and services, and to launch new products and services.

 

Government regulations and legal uncertainties may place financial burdens on the businesses of our partner companies.

 

Failure to comply with applicable requirements of the FDA or comparable regulation in foreign countries can result in fines, recall or seizure of products, total or partial suspension of production, withdrawal of existing product approvals or clearances, refusal to approve or clear new applications or notices and criminal prosecution. Manufacturers of pharmaceuticals and medical diagnostic devices and operators of laboratory facilities are subject to strict federal and state regulation regarding validation and the quality of manufacturing and laboratory facilities. Failure to comply with these quality regulation systems requirements could result in civil or criminal penalties or enforcement proceedings, including the recall of a product or a “cease distribution” order. The enactment of any additional laws or regulations that affect healthcare insurance policy and reimbursement (including Medicare reimbursement) could negatively affect our partner companies. If Medicare or private payors change the rates at which our partner companies or their customers are reimbursed by insurance providers for their products, such changes could adversely impact our partner companies.

 

Some of our partner companies are subject to significant environmental, health and safety regulation.

 

Some of our partner companies are subject to licensing and regulation under federal, state and local laws and regulations relating to the protection of the environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials, as well as to the safety and health of manufacturing and laboratory employees. In addition, the federal Occupational Safety and Health Administration has established extensive requirements relating to workplace safety.

 

None.

 

 

Our corporate headquarters and administrative offices in Wayne, Pennsylvania contain approximately 20,000 square feet of office space in one building. We currently lease our corporate headquarters under a lease with approximately 3.5 years remaining.

 

 

We, as well as our partner companies, are involved in various claims and legal actions arising in the ordinary course of business. While in the current opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our consolidated financial position or results of operations, no assurance can be given as to the outcome of these lawsuits, and one or more adverse rulings could have a material adverse effect on our consolidated financial position and results of operations, or that of our partner companies. See Note 15 included in “Item 8 — Financial Statements and Supplementary Data” in this Annual Report on Form 10-K for a discussion of ongoing claims and legal actions.

 

 

ANNEX TO PART I — EXECUTIVE OFFICERS OF THE REGISTRANT

 

 

Mr. Boni joined Safeguard as President and Chief Executive Officer in August 2005. Prior to joining Safeguard, Mr. Boni was an Operating Partner for Advent International, a global private equity firm with $10 billion under management, from April 2004 to August 2005; Chairman and Chief Executive Officer of Surebridge, Inc., an applications outsourcer serving the mid-market, from March 2002 to April 2004; Managing Principal of Vested Interest LLC, a management consulting firm, from January 2001 to March 2002; and President and Chief Executive Officer of Prime Response, Inc., an enterprise applications software provider, from February 1999 to January 2001.

 

Mr. Datin joined Safeguard as Executive Vice President and Managing Director, Life Sciences Group in September 2005. Mr. Datin served as Chief Executive Officer of Touchpoint Solutions, Inc., a provider of software that enables customers to develop and deploy applications, content and media on multi-user interactive devices, from December 2004 to June 2005; Group President in 2004, and as Group President, International, from 2001 to 2003, of Dendrite International, a provider of sales, marketing, clinical and compliance solutions and services to global pharmaceutical and other life sciences companies; and Group Director, Corporate Business Strategy and Planning at GlaxoSmithKline, from 1999 to 2001, where he also was a member of the company’s Predictive Medicine Board of Directors that evaluated acquisitions and alliances. His prior experience also includes international assignments with and identifying strategic growth opportunities for E Merck and Baxter.

 

Mr. Kemmerer joined Safeguard as Principal, Technology Group, in June 2004, became Senior Vice President, Technology in April 2006, Senior Vice President and Managing Director, Technology in April 2008 and Executive Vice President and Managing Director, Technology in September 2008. Mr. Kemmerer served most recently as

Director of Kennet Venture Partners, a venture capital firm for which he worked from November 2000 to June 2004 and previously as Principal, Mergers and Acquisitions of Broadview International, for whom he worked from August 1997 to November 2000.

 

Mr. Sisko joined Safeguard as Senior Vice President and General Counsel in August 2007. Prior to joining Safeguard, Mr. Sisko served as Chief Legal Officer, Senior Vice President and General Counsel of Traffic.com (at the time, a public company), a former partner company of Safeguard that is a leading provider of accurate, real-time traffic information in the United States, from February 2006 until June 2007 (following its acquisition by NAVTEQ Corporation in March 2007); Chief Operating Officer from February 2005 to January 2006 of Halo Technology Holdings, Inc., a public holding company for enterprise software businesses (Halo Technology Holdings filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code in August 2007); ran B/T Business and Technology, an advisor and strategic management consultant to a variety of public and private companies, from January 2002 to February 2005; and was a Managing Director from April 2000 to January 2002, of Katalyst, LLC, a venture capital and consulting firm. Mr. Sisko also previously served as Senior Vice President — Corporate Development and General Counsel of National Media Corporation, at the time a New York Stock Exchange-listed multi-media marketing company with operations in 70 countries, and as a partner in the corporate finance, mergers and acquisitions practice group of the Philadelphia-based law firm, Klehr, Harrison, Harvey, Branzburg & Ellers LLP.

 

Mr. Zarrilli joined Safeguard as Senior Vice President and Chief Financial Officer in June 2008. Prior to joining Safeguard, Mr. Zarrilli co-founded, in 2004, the Penn Valley Group, a middle-market management advisory and private equity firm, and served as a Managing Director until June 2008, and continues to serve as non-executive chairman of the Penn Valley Group. While at the Penn Valley Group, Mr. Zarrilli also served as Acting Senior Vice President, Acting Chief Administrative Officer and Acting Chief Financial Officer of Safeguard from December 2006 to June 2007. Mr. Zarrilli also served as the Chief Financial Officer, from 2001 to 2004, of Fiberlink Communications Corporation, a provider of remote access VPN solutions for large enterprises; as the Chief Executive Officer, from 2000 to 2001, of Concellera Software, Inc., a developer of content management software; as the Chief Executive Officer, from 1999 to 2000, and Chief Financial Officer, from 1994 to 1998, of US Interactive, Inc. (at the time a public company), a provider of internet strategy consulting, marketing and technology services (US Interactive filed for bankruptcy protection under Chapter 11 of the United States Bankruptcy Code in January 2001); and, previously, with Deloitte & Touche from 1983 to 1994. Mr. Zarrilli is a director and Chairman of the Audit Committee of NutriSystem, Inc.

 

 

Safeguard’s common stock is listed on the New York Stock Exchange (Symbol: SFE). The high and low sale prices reported within each quarter of 2010 and 2009 were as follows:

 

The high and low sale prices reported in the first quarter of 2011 through March 3, 2011 were $21.35 and $16.25, respectively, and the last sale price reported on March 3, 2011, was $20.35. No cash dividends have been declared in any of the years presented, and Safeguard has no present intention to declare cash dividends. Sale prices for periods prior to August 27, 2009 have been restated to reflect a one-for-six reverse split of our common stock which became effective on August 27, 2009.

 

As of March 3, 2011, there were approximately 26,500 beneficial holders of Safeguard’s common stock.

 

The following graph compares the cumulative total return on $100 invested in our common stock for the period from December 31, 2005 through December 31, 2010 with the cumulative total return on $100 invested for the same period in the Russell 2000 Index and the Wilshire 4500 Index. In light of the diverse nature of Safeguard’s business and based on our assessment of available published industry or line-of-business indices, we determined that no single industry or line-of-business index would provide a meaningful comparison to Safeguard. Further, we did not believe that we could readily identify an appropriate group of industry peer companies for this comparison. Accordingly, under SEC rules, we selected the Wilshire 4500 Index, a published market index in which the median market capitalization of the included companies is similar to our own. Safeguard’s common stock is included as a component of the Russell 2000 and Wilshire 4500 indices.

 

Comparison of Cumulative Total Returns

 

 

 

 

The following table sets forth our selected consolidated financial data for the five-year period ended December 31, 2010. The selected consolidated financial data presented below should be read in conjunction with Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 8. Consolidated Financial Statements and Notes thereto included in this report. The historical results presented herein may not be indicative of future results. During the five-year period ended December 31, 2010, certain consolidated partner companies, or components thereof, were sold. These businesses are reflected in discontinued operations through their respective disposal dates: Acsis, Inc., Alliance Consulting Group Associates, Inc. and Laureate Pharma, Inc. (May, 2008), Pacific Title & Art Studio Inc. (March 2007), Clarient’s technology business (March 2007) and Mantas (October 2006). The accounts of Clarient are included in continuing operations through May 14, 2009, the date of its deconsolidation.

 

Consolidated Statements of Operations Data

 

 

Cautionary Note concerning Forward-Looking Statements

 

This Annual Report on Form 10-K contains forward-looking statements that are based on current expectations, estimates, forecasts and projections about Safeguard Scientifics, Inc. (“Safeguard” or “we”), the industries in which we operate and other matters, as well as management’s beliefs and assumptions and other statements regarding matters that are not historical facts. These statements include, in particular, statements about our plans, strategies and prospects. For example, when we use words such as “projects,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “should,” “would,” “could,” “will,” “opportunity,” “potential” or “may,” variations of such words or other words that convey uncertainty of future events or outcomes, we are making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Our forward-looking statements are subject to risks and uncertainties. Factors that could cause actual results to differ materially, include, among others, managing rapidly changing technologies, limited access to capital, competition, the ability to attract and retain qualified employees, risks associated with the development and commercialization of innovative technologies, etc, the ability to execute our strategy, the uncertainty of the future performance of our partner companies, acquisitions and dispositions of companies, the inability to manage growth, compliance with government regulation and legal liabilities, additional financing requirements, labor disputes and the effect of economic conditions in the business sectors in which our partner companies operate, all of which are discussed in Item 1A. “Risk Factors.” Many of these factors are beyond our ability to predict or control. In addition, as a result of these and other factors, our past financial performance should not be relied on as an indication of future performance. All forward-looking statements attributable to us, or to persons acting on our behalf, are expressly qualified in their entirety by this cautionary statement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report might not occur.

 

Overview

 

Safeguard’s charter is to build value in growing businesses by providing partner companies with capital and a range of strategic, operational and management resources. Safeguard may participate in expansion financings, corporate spin-outs, management buy-outs, recapitalizations, industry consolidations and early-stage financings. Our vision is to be the preferred catalyst to build great companies across diverse capital platforms.

 

We strive to create long-term value for our shareholders by helping our partner companies increase market penetration, grow revenue and improve cash flow. We focus principally on companies in which we anticipate deploying up to $25 million and that operate in two categories:

 

Life Sciences — including companies focused on molecular and point-of-care diagnostics, medical devices, regenerative medicine, specialty pharmaceuticals and selected healthcare services; and

 

Technology — including companies focused on internet/new media, financial services IT, healthcare IT and selected business services that have transaction-enabling applications with a recurring revenue stream.

 

Principles of Accounting for Ownership Interests in Partner Companies

 

We account for our interests in our partner companies and private equity funds using one of the following methods: consolidation, fair value, equity, cost or available-for-sale. The accounting method applied is generally determined by the degree of our influence over the entity, primarily determined by our voting interest in the entity.

 

Consolidation Method.  We account for partner companies in which we maintain a controlling financial interest, generally those in which we directly or indirectly own more than 50% of the outstanding voting securities, using the consolidation method of accounting. Upon consolidation of our partner companies, we reflect the portion of equity (net assets) in a subsidiary not attributable, directly or indirectly, to the parent company as a noncontrolling interest in the Consolidated Balance Sheet. The noncontrolling interest is presented within equity, separately from the equity of the parent company. Losses attributable to the parent company and the noncontrolling interest may exceed their interest in the subsidiary’s equity. As a result, the noncontrolling interest shall continue to be attributed

its share of losses even if that attribution results in a deficit noncontrolling interest balance as of each balance sheet date. Revenue, expenses, gains, losses, net income or loss are reported in the Consolidated Statements of Operations at the consolidated amounts, which include the amounts attributable to the parent company’s common shareholders and the noncontrolling interest. As of and for the year ended December 31, 2010, we did not hold a controlling interest in any of our partner companies.

 

Fair Value Method.  We accounted for our holdings in Clarient, our publicly traded partner company, under the fair value option following its deconsolidation on May 14, 2009 and through the date of the sale of the remainder of our interests in Clarient in December 2010. Unrealized gains and losses on the mark-to-market of our holdings in Clarient and realized gains and losses on the sale of any of our holdings in Clarient were recognized in Income (loss) from continuing operations in the Consolidated Statements of Operations.

 

Equity Method.  We account for partner companies whose results are not consolidated, but over whom we exercise significant influence, using the equity method of accounting. We also account for our interests in some private equity funds under the equity method of accounting, based on our non-controlling general and limited partner interests. Under the equity method of accounting, our share of the income or loss of the company is reflected in Equity loss in the Consolidated Statements of Operations. We report our share of the income or loss of the equity method partner companies on a one quarter lag.

 

When the carrying value of our holdings in an equity method partner company is reduced to zero, no further losses are recorded in our Consolidated Statements of Operations unless we have outstanding guarantee obligations or have committed additional funding to the equity method partner company. When the equity method partner company subsequently reports income, we will not record our share of such income until it equals the amount of our share of losses not previously recognized.

 

Cost Method.  We account for partner companies which are not consolidated or accounted for under the equity method or fair value method under the cost method of accounting. Under the cost method, our share of the income or losses of such partner companies is not included in the Company’s Consolidated Statements of Operations. The Company includes the carrying value of cost method partner companies in Ownership interests in and advances to partner companies on the Consolidated Balance Sheets.

 

Available-for-Sale Securities.  We account for our ownership interests in Tengion and NuPathe, our publicly traded partner companies, as available-for-sale securities. Available-for-sale securities are carried at fair value, based on quoted market prices, with the unrealized gains and losses, net of tax, reported as a separate component of equity. Unrealized losses are charged against net loss when a decline in the fair value is determined to be other than temporary.

 

Critical Accounting Policies and Estimates

 

Accounting policies, methods and estimates are an integral part of the Consolidated Financial Statements prepared by management and are based upon management’s current judgments. These judgments are normally based on knowledge and experience with regard to past and current events and assumptions about future events. Certain accounting policies, methods and estimates are particularly important because of their significance to the financial statements and because of the possibility that future events affecting them may differ from management’s current judgments. While there are a number of accounting policies, methods and estimates affecting our financial statements as described in Note 1 to our Consolidated Financial Statements, areas that are particularly significant include the following:

 

 

Impairment of Ownership Interests In and Advances to Partner Companies

 

On a periodic basis, but no less frequently than at the end of each quarter, we evaluate the carrying value of our equity and cost method partner companies for possible impairment based on achievement of business plan objectives and milestones, the financial condition and prospects of the company, market conditions and other relevant factors. The business plan objectives and milestones we consider include, among others, those related to financial performance, such as achievement of planned financial results or completion of capital raising activities, and those that are not primarily financial in nature, such as hiring of key employees or the establishment of strategic relationships. We then determine whether there has been an other than temporary decline in the value of our ownership interest in the company. Impairment to be recognized is measured as the amount by which the carrying value of an asset exceeds its fair value. The adjusted carrying value of a partner company is not increased if circumstances suggest the value of the partner company has subsequently recovered.

 

The fair value of privately held partner companies is generally determined based on the value at which independent third parties have invested or have committed to invest in these companies, or based on other valuation methods including discounted cash flows, valuations of comparable public companies and valuations of acquisitions of comparable companies. The fair value of our ownership interests in private equity funds is generally determined based on the value of our pro rata portion of the funds’ net assets and estimated future proceeds from sales of investments provided by the funds’ managers. The fair value of our ownership interests in our publicly traded partner companies is determined by reference to quoted prices in an active market for the partner company’s publicly traded common stock.

 

Our partner companies operate in industries which are rapidly evolving and extremely competitive. It is reasonably possible that our accounting estimates with respect to the ultimate recoverability of the carrying value of ownership interests in and advances to partner companies could change in the near term and that the effect of such changes on our Consolidated Financial Statements could be material. While we believe that the current recorded carrying values of our equity and cost method companies are not impaired, there can be no assurance that our future results will confirm this assessment or that a significant write-down or write-off will not be required in the future.

 

Total impairment charges related to ownership interests in and advances to our equity and cost method partner companies were as follows:

 

 

Impairment charges related to equity method partner companies are included in Equity loss in the Consolidated Statements of Operations. Impairment charges related to cost method and available-for-sale partner companies are included in Other income (loss), net in the Consolidated Statements of Operations.

 

Income Taxes

 

We are required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our Consolidated Balance Sheets. We must assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent that we believe recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance in a period, we must include an expense within the tax provision in the Consolidated Statements of Operations. We have recorded a valuation allowance to reduce our deferred tax assets to an amount that is more likely than not to be realized in future years. If we determine in the future that it is more likely than not that the net deferred tax assets would be realized, then the previously provided valuation allowance would be reversed.

Commitments and Contingencies

 

From time to time, we are a defendant or plaintiff in various legal actions which arise in the normal course of business. Additionally, we have received distributions as both a general partner and a limited partner from private equity funds. In certain circumstances, we may be required to return a portion or all the distributions we received as a general partner of a fund for a further distribution to such fund’s limited partners (“clawback”). We are also a guarantor of various third-party obligations and commitments and are subject to the possibility of various loss contingencies arising in the ordinary course of business (see Note 15). We are required to assess the likelihood of any adverse outcomes to these matters as well as potential ranges of probable losses. A determination of the amount of provision required for these commitments and contingencies, if any, which would be charged to earnings, is made after careful analysis of each matter. The provision may change in the future due to new developments or changes in circumstances. Changes in the provision could increase or decrease our earnings in the period the changes are made.

 

Stock-Based Compensation

 

We measure all employee stock-based compensation awards using a fair value method and record such expense in our Consolidated Statements of Operations.

 

We estimate the grant date fair value of stock options using the Black-Scholes option-pricing model which requires the input of highly subjective assumptions. These assumptions include estimating the expected term of the award and the estimated volatility of our stock price over the expected term. Changes in these assumptions and in the estimated forfeitures of stock option awards can materially affect the amount of stock-based compensation recognized in the Consolidated Statements of Operations. The requisite service periods for market-based stock option awards are based on our estimate of the dates on which the market conditions will be met as determined using a Monte Carlo simulation model. Changes in the derived requisite service period or achievement of market capitalization targets earlier than estimated can materially affect the amount of stock-based compensation recognized in the Consolidated Statements of Operations. The requisite service periods for performance-based awards are based on our best estimate of when the performance conditions will be met. Compensation expense is recognized for performance-based awards for which the performance condition is considered probable of achievement. Changes in the requisite service period or the estimated probability of achievement of performance conditions can materially affect the amount of stock-based compensation recognized in the Consolidated Statements of Operations.

 

Results of Operations

 

Prior to deconsolidating Clarient on May 14, 2009, we presented Clarient as a separate segment. In December 2010 Clarient was acquired by GE Healthcare. From May 14, 2009 through the date of the sale of Clarient, we accounted for our retained interest in Clarient at fair value with unrealized gains and losses on the mark-to-market of our Clarient holdings and realized gains and losses on the sale of any of our Clarient holdings included in Other income (loss), net in the Consolidated Statements of Operations. During 2009, we re-evaluated our reportable operating segments and we made the determination that Clarient would no longer be reported as a separate segment since we did not separately evaluate Clarient’s performance based upon its operating results. The mark-to-market activity associated with Clarient and the gain recorded upon its disposition is included in the Life Sciences segment. The results of operations of all of our partner companies are reported in our Life Sciences and Technology segments. The Life Sciences and Technology segments also include the gain or loss on the sale of respective partner companies, except for gains and losses included in discontinued operations.

 

On May 6, 2008, we consummated a transaction (the “Bundle Transaction’) pursuant to which we sold all of our equity and debt interests in Acsis, Inc. (“Acsis”), Alliance Consulting Group Associates, Inc. (“Alliance Consulting”), Laureate Pharma, Inc. (“Laureate Pharma”), ProModel Corporation (“ProModel”) and Neuronyx, Inc. (“Neuronyx”) (collectively, the “Bundle Companies”). Of the companies included in the Bundle Transaction, Acsis, Alliance Consulting and Laureate Pharma were majority-owned partner companies and Neuronyx and ProModel were minority-owned partner companies. We have presented the results of operations of Acsis, Alliance Consulting and Laureate Pharma as discontinued operations for all periods presented.

Our management evaluates the Life Sciences and Technology segments’ performance based on equity income (loss) which is based on the number of partner companies accounted for under the equity method, our voting ownership percentage in these partner companies and the net results of operations of these partner companies and Other income or loss associated with cost method partner companies.

 

Other items include certain expenses, which are not identifiable to the operations of our operating business segments. Other items primarily consist of general and administrative expenses related to corporate operations, including employee compensation, insurance and professional fees, interest income, interest expense, other income (loss) and equity income (loss) related to private equity holdings. Other Items also includes income taxes, which are reviewed by management independent of segment results.

 

The following tables reflect our consolidated operating data by reportable segment. Segment results include our share of income or losses for entities accounted for under the equity method, when applicable. Segment results also include impairment charges and gains or losses related to the disposition of partner companies, except for those reported in discontinued operations. All significant inter-segment activity has been eliminated in consolidation. Our operating results, including net income (loss) before income taxes by segment, were as follows:

 

 

There is intense competition in the markets in which our partner companies operate, and we expect competition to intensify in the future. Additionally, the markets in which these companies operate are characterized by rapidly changing technology, evolving industry standards, frequent introduction of new products and services, shifting distribution channels, evolving government regulation, frequently changing intellectual property landscapes and changing customer demands. Their future success depends on each company’s ability to execute its business plan and to adapt to its respective rapidly changing markets.

 

As previously stated, throughout this document, we use the term “partner company” to generally refer to those companies that we have an economic interest in and that we are actively involved in influencing the development of, usually through board representation in addition to our equity ownership stake.

 

For purposes of the following listing of our Life Science and Technology partner companies, we omit from the listing companies which we have since sold our interest in or which we no longer consider to be active partner companies because we no longer actively influence the operations of such entities.

Life Sciences

 

The following active partner companies as of December 31, 2010 were included in Life Sciences:

 

 

 

 

Results for the Life Sciences segment were as follows:

 

 

Year ended December 31, 2010 versus year ended December 31, 2009

 

Results of operations for the year ended December 31, 2009 include the results of operations of Clarient for the 134 days in the period from January 1, 2009 through May 14, 2009 that Clarient was consolidated. Upon the deconsolidation of Clarient on May 14, 2009, we no longer reported revenue, cost of sales, selling, general and administrative expenses interest income and interest expense from Clarient’s continuing operations in our results of operations. Prior to that date, for the periods presented, all of our Life Science segment revenue, cost of sales, selling, general and administrative expenses, interest income and interest expense from continuing operations were attributable to Clarient.

 

Other Income (Loss), Net.  Other Income (Loss), net in 2010 related primarily to a $43.0 million gain on the sale of Clarient to GE Healthcare in December 2010, a $20.3 million gain on the sale of Avid to Eli Lilly and Company in December 2010, unrealized gains of $22.4 million on the mark-to-market of our holdings in Clarient

prior to its sale, partially offset by $3.2 million in impairment charges associated with our holdings in Tengion, including amounts recognized both when Tengion was classified as a cost method partner company and when Tengion was classified as available-for-sale.

 

On May 14, 2009, we deconsolidated our holdings in Clarient because we ceased to have a controlling financial interest in Clarient and recognized an unrealized gain on deconsolidation of $106.0 million as of that date. In addition, we recognized an unrealized gain of $19.5 million on the mark-to-market of our holdings in Clarient through December 31, 2009, which was offset by a $7.3 million realized loss on the sale of 18.4 million shares of common stock of Clarient in the third quarter of 2009 and an impairment charge of $3.9 million related to our holdings in Tengion.

 

Equity Loss.  Equity loss fluctuates with the number of Life Sciences partner companies accounted for under the equity method, our voting ownership percentage in these partner companies and the net results of operations of these partner companies. We recognize our share of losses to the extent we have cost basis in the equity of the partner company or we have outstanding commitments or guarantees. Certain amounts recorded to reflect our share of the income or losses of our partner companies accounted for under the equity method are based on estimates and on unaudited results of operations of those partner companies and may require adjustments in the future when audits of these entities are made final. We report our share of the results of our equity method partner companies on a one quarter lag basis.

 

Equity loss for Life Sciences decreased $4.5 million for the year ended December 31, 2010 compared to the prior year primarily due to an unrealized gain of $5.8 million on the decrease of our ownership interest in NuPathe upon completion of NuPathe’s initial public offering, partially offset by a $1.8 million impairment charge related to our holdings in Molecular Biometrics.

 

Year ended December 31, 2009 versus year ended December 31, 2008

 

Equity Loss.  Equity loss for Life Sciences decreased $7.6 million for the year ended December 31, 2009 compared to 2008. Included in equity loss for the year ended December 31, 2009 were impairment charges and equity losses of $4.0 million associated with Rubicor Inc., a former partner company, and $0.8 million in impairment charges associated with Acelerate, Inc. (“Acelerate”, formerly Cellumen, Inc.), also a former partner company. Also included in 2008 Equity loss were expenses of $2.5 and $1.3 million associated with acquired in-process research and development related to our holdings in Molecular Biometrics and NuPathe, respectively.

 

Technology

 

The following active partner companies as of December 31, 2010 were included in Technology:

 

Results for the Technology segment were as follows:

 

 

Year ended December 31, 2010 versus year ended December 31, 2009

 

Other Income (Loss), Net.  Other income (loss), net decreased $5.9 million in 2010 compared to the prior year. The 2009 loss was entirely attributable to an impairment related to our holdings in GENBAND, a former partner company.

 

Equity Loss.  Equity loss fluctuates with the number of Technology partner companies accounted for under the equity method, our voting ownership percentage in these partner companies and the net results of operations of these partner companies. We recognize our share of losses to the extent we have cost basis in the equity partner company or we have outstanding commitments or guarantees. Certain amounts recorded to reflect our share of the income or losses of our partner companies accounted for under the equity method are based on estimates and on unaudited results of operations of those partner companies and may require adjustments in the future when audits of these entities are made final. We report our share of the results of our equity method partner companies on a one quarter lag. Equity loss increased $3.1 million in 2010 compared to the prior year. The increase was due primarily to a $1.5 million impairment charge related to our holdings in SafeCentral, Inc. (“SafeCentral,” formerly Authentium, Inc.) as well as larger losses incurred at certain partner companies in 2010.

 

Year ended December 31, 2009 versus year ended December 31, 2008

 

Other Income (Loss), Net.  Other income (loss), net increased $3.6 million in 2009 compared to the prior year. The 2009 loss was entirely attributable to an impairment related to our holdings in GENBAND, a former partner company. The 2008 loss reflected an impairment related to our holdings in Kadoo Inc., a former partner company.

 

Equity Loss.  Equity loss for Technology decreased $3.8 million for the year ended December 31, 2009 compared to the prior year. The decrease was due principally to smaller losses incurred at certain partner companies and an impairment charge of $2.6 million related to our holdings in SafeCentral recorded in 2008.

 

Corporate Operations

 

 

Year Ended December 31, 2010 versus year ended December 31, 2009

 

General and Administrative.  Our general and administrative expenses consist primarily of employee compensation, insurance, professional services such as legal, accounting and consulting, and travel-related costs.

General and administrative expenses increased $2.3 million in 2010 as compared to the prior year primarily due to a $1.8 million increase in employee costs and a $0.7 million increase in professional fees partially offset by a $0.4 million decrease in insurance costs. General and administrative expenses decreased $1.8 million in 2009 as compared to the prior year, primarily due to a $1.5 million decrease in severance costs, a $0.9 million decrease in professional fees and a $0.9 million decrease in other administrative expenses offset by an increase in employee costs of $1.5 million.

 

Stock-Based Compensation.  Stock-based compensation consists primarily of expense related to grants of stock options, restricted stock and deferred stock units to our employees.

 

Stock-based compensation increased $0.8 million in 2010 compared to the prior year, primarily due to higher expense related to restricted stock units driven by the acceleration of expense recognized for grants to directors and executives who have reached retirement age and higher expense related to market-based awards due to acceleration of expense based on increases in our stock price. Stock-based compensation increased $1.2 million in 2009 as compared to the prior year, primarily due to stock option forfeitures during 2008. Stock-based compensation expense related to market-based awards was $1.7 million, $1.5 million and $0.4 million in 2010, 2009 and 2008, respectively. Stock-based compensation expense related to service-based awards was $1.2 million, $1.0 million and $1.1 million in 2010, 2009 and 2008, respectively. Stock-based compensation expense related to corporate operations is included in Selling, general and administrative expenses in the Consolidated Statements of Operations.

 

Interest Income.  Interest income includes all interest earned on cash and marketable security balances.

 

Interest income increased $0.2 million in 2010 compared to the prior year. The increase was due to higher average cash balances in the second half of 2010. Interest income decreased $2.6 million in 2009 compared to the prior year. The decrease was due to declining interest rates and lower average cash balances over 2008.

 

Interest Expense.  Interest expense is primarily related to our 2024 and 2014 Debentures. As discussed below under Liquidity and Capital Resources, we exchanged a portion of our 2024 Debentures effective March 26, 2010. The increase in interest expense of $2.8 million compared to the prior year is related to the higher coupon rate of 10.125% payable on our 2014 Debentures as compared to a 2.625% coupon rate on the 2024 Debentures and accretion of the discount and amortization of debt issuance costs in the amount of $0.5 million associated with our 2014 Debentures.

 

Interest expense decreased $1.0 million in 2009 as compared to the prior period. The decline was attributable to the repurchase of $7.8 million in face value of the 2024 Debentures in 2009.

 

Other Income (Loss), net.  Other income (loss), net in 2010 included an $8.5 million loss on exchange of $46.9 million in face value of our convertible senior debentures, partially offset by a $0.3 million gain on sales of legacy assets and $0.3 million related to a change in our estimated net clawback liability attributable to a private equity fund.

 

Other income (loss), net in 2008 included a net gain of $9.0 million on the repurchase of $43 million in face value of the 2024 Debentures, a $2.5 million net gain on the sale of company interests, including the receipt of escrowed funds from a legacy asset and a $1.0 million gain on distributions from private equity funds.

 

Income Tax (Expense) Benefit

 

Our consolidated net income tax (expense) benefit for 2010, 2009 and 2008 was $0.0 million in each year. We have recorded a valuation allowance to reduce our net deferred tax asset to an amount that is more likely than not to be realized in future years. Accordingly, the income tax expense that would have been recognized in 2010 and 2009 and the net operating loss benefit that would have been recognized in 2008 was offset by changes in the valuation allowance.

 

Discontinued Operations

 

The following are reported in discontinued operations for all periods through their respective sale date.

In May 2008, we sold all of our equity and debt interests in Acsis, Alliance Consulting, Laureate Pharma, ProModel and Neuronyx in the Bundle Transaction. The gross proceeds from the Bundle Transaction were $74.5 million, of which $6.4 million was placed in escrow pending expiration of a claims period, plus amounts advanced to certain Bundle Companies during the time between the signing of the Bundle Transaction agreement and its consummation.

 

In March 2007, we sold Pacific Title & Art Studio for net cash proceeds of approximately $21.9 million, including $2.3 million held in escrow. As a result of the sale, we recorded a pre-tax gain of $2.7 million in 2007. In the first quarter of 2010, we received the final $0.5 million in cash from the escrow account. This amount was recorded as income from discontinued operations in 2009.

 

In March 2007, Clarient sold its technology business and related intellectual property for an aggregate purchase price of $12.5 million. The $12.5 million consisted of $11.0 million in cash and an additional $1.5 million in contingent consideration, subject to the satisfaction of certain post-closing conditions through March 2009. Clarient received the contingent consideration and recorded the $1.5 million in income from discontinued operations in 2009.

 

Income from discontinued operations in 2009 of $2.0 million was attributable to the receipt by Clarient of $1.5 million contingent consideration, prior to the deconsolidation of Clarient, and our receipt of $0.5 million from escrow related to the sale of Pacific Title & Art Studio. The loss from discontinued operations in 2008 of $9.2 million was primarily attributable to operating losses incurred by Acsis, Alliance Consulting and Laureate Pharma of $1.6 million, an impairment loss of $3.6 million related to the write down of the aggregate carrying value of the Bundle Companies to the anticipated net proceeds, a $1.4 million pre-tax gain on disposal of the Bundle Companies, a $0.9 million charge to accrue for severance payments due the former CEO of Alliance Consulting and charges totaling $2.7 million related to additional compensation paid to the former CEO of Pacific Title & Art Studio in connection with the March 2007 sale and related legal fees.

 

Liquidity And Capital Resources

 

Parent Company

 

We fund our operations with cash on hand as well as proceeds from sales of and distributions from partner companies, private equity funds and marketable securities. In prior periods, we have also used sales of our equity and the issuance of debt as sources of liquidity and may do so in the future. Our ability to generate liquidity from sales of partner companies, sales of marketable securities and from equity and debt issuances has been adversely affected from time to time by adverse circumstances in the U.S. capital markets and other factors.

 

As of December 31, 2010, we had $183.4 million of cash and cash equivalents and $42.4 million of marketable securities for a total of $225.8 million. In addition, $6.4 million of cash was held in escrow, including accrued interest, related to the Bundle Transaction and $16.8 million was held in a restricted escrow account to service interest on the 2014 Debentures, as discussed below.

 

In December 2010, Clarient was acquired by GE Healthcare, a unit of GE, via a public tender offer for all outstanding common and preferred shares of Clarient, followed by a second step merger of Clarient with an indirect subsidiary of GE. In connection with the transactions, we received gross proceeds of $153.4 million and paid retention bonuses to Clarient management in the amount of $6.9 million, resulting in net proceeds of $146.5 million. We held a 27.5% primary ownership stake in Clarient at the time of the sale.

 

In December 2010, Avid was acquired by Eli Lily and Company resulting in net proceeds to us of $32.3 million. We held a 13% primary ownership interest in Avid at the time of the sale. Depending on the achievement of certain milestones, we could receive additional proceeds of $60.0 million, as well as an additional $3.4 million currently being held in escrow.

 

In December 2010, we received cash proceeds of $2.6 million on the sale of Quinnova Pharmaceuticals, Inc. Depending on certain milestones, we could receive additional proceeds of $2.2 million.

 

In connection with the Bundle Transaction, an aggregate of $6.4 million of the gross proceeds from the sale were placed in escrow pending the expiration of a predetermined notification period, subject to possible extension

in the event of a claim against the escrowed amounts. On April 25, 2009, the purchaser in the Bundle Transaction notified us of claims being asserted against the entire escrowed amounts. We do not believe that such claims are valid and have instituted legal action to obtain the release of such amounts from escrow. The proceeds being held in escrow will remain there until the dispute over the claims have been settled or determined pursuant to legal process.

 

In February 2004, we completed the sale of $150 million of 2.625% convertible senior debentures with a stated maturity of March 15, 2024 (the “2024 Debentures”). Through December 31, 2010, we have repurchased a total of $71.8 million in face value of the 2024 Debentures. Interest on the 2024 Debentures is payable semi-annually. At the debentures holders’ option, the 2024 Debentures are convertible into our common stock through March 14, 2024, subject to certain conditions. The adjusted conversion rate of the debentures is $43.3044 of principal amount per share. The closing price of our common stock at December 31, 2010 was $17.08. The 2024 Debentures holders have the right to require us to repurchase the 2024 Debentures on March 21, 2011, March 20, 2014 or March 20, 2019 at a repurchase price equal to 100% of their face amount, plus accrued and unpaid interest. The 2024 Debentures holders also have the right to require repurchase of the 2024 Debentures upon certain events, including sale of all or substantially all of our common stock or assets, liquidation, dissolution, a change in control or the delisting of our common stock from the New York Stock Exchange if we were unable to obtain a listing for our common stock on another national or regional securities exchange. Subject to certain conditions, we have the right to redeem all or some of the 2024 Debentures. We expect the holders of the 2024 Debentures to exercise their rights to require us to repurchase the entire $31.3 million in face value of the outstanding 2024 Debentures on March 21, 2011.

 

On March 10, 2010, we entered into agreements with institutional holders of an aggregate of $46.9 million in face value of our 2024 Debentures to exchange the 2024 Debentures held by such holders for $46.9 million in face amount of newly issued 10.125% senior convertible debentures, due 2014 (the “2014 Debentures”). The exchange became effective on March 26, 2010. The remaining $31.3 million outstanding face amount of the 2024 Debentures remains outstanding under the original terms and has been classified as a current liability on the Consolidated Balance Sheet as of December 31, 2010 because the first required repurchase date is within one year. We recorded a loss on exchange of $8.5 million determined as the excess of the fair value of the 2014 Debentures at the exchange date over the carrying value of the exchanged 2024 Debentures. This loss is reported in Other income (loss), net in the Consolidated Statements of Operations for the year ended December 31, 2010.

 

At December 31, 2010, the fair value of the $31.3 million outstanding 2024 Debentures was approximately $30.8 based on quoted market prices as of such date.

 

As discussed above, in March 2010, we issued $46.9 million in face value of our 2014 Debentures in an exchange transaction. Interest on the 2014 Debentures is payable semi-annually. As required by the terms of the 2014 Debentures, at issuance we placed approximately $19.0 million in a restricted escrow account to service interest associated with the 2014 Debentures through their maturity. At the debentures holders’ option, the 2014 Debentures are convertible into our common stock prior to March 15, 2013 subject to certain conditions, and at anytime after March 15, 2013. The conversion rate of the 2014 Debentures is $16.50 of principal amount per share. The closing price of our common stock at December 31, 2010 was $17.08. The 2014 Debentures holders have the right to require repurchase of the 2014 Debentures upon certain events, including sale of all or substantially all of our common stock or assets, liquidation, dissolution, a change in control or the delisting of our common stock from the New York Stock Exchange if we were unable to obtain a listing for our common stock on another national or regional securities exchange. Subject to certain conditions, we may mandatorily convert all or some of the 2014 Debentures at any time after March 15, 2012. If we elect to mandatorily convert any of the 2014 Debentures, we will be required to pay any interest that would have accrued and become payable on the debentures through their maturity. Upon a conversion of the 2014 Debentures, we have the right to settle the conversion in stock, cash or a combination thereof.

 

Because the 2014 Debentures may be settled in cash or partially in cash upon conversion, we have separately accounted for the liability and equity components of the 2014 Debentures. The carrying amount of the liability component was determined at the exchange date by measuring the fair value of a similar liability that does not have an associated equity component. The carrying amount of the equity component represented by the embedded conversion option was determined by deducting the fair value of the liability component from the carrying value of the 2014 Debentures as a whole. The carrying value of the 2014 Debentures as a whole was equal to their fair value

at the exchange date. We are amortizing the excess of the face value of the 2014 Debentures over their carrying value to interest expense over their term. At December 31, 2010, the fair value of the $46.9 million outstanding 2014 Debentures was approximately $63.4 million based on a convertible bond valuation model.

 

In May 2008, our Board of Directors authorized us, from time to time and depending on market conditions, to repurchase shares of our outstanding common stock, with up to an aggregate value of $10.0 million, exclusive of fees and commissions. Approximately 4 thousand fractional shares were repurchased in 2009 for $44 thousand in connection with our one-for-six stock split in August 2009. During the year ended December 31, 2008, we repurchased approximately 163 thousand shares of common stock at a cost of $1.3 million.

 

We are party to a loan agreement which provides us with a revolving credit facility in the maximum aggregate amount of $50 million in the form of borrowings, guarantees and issuances of letters of credit (subject to a $20 million sublimit). Actual availability under the credit facility is based on the amount of cash maintained at the bank as well as the value of our public and private partner company interests. This credit facility bears interest at the prime rate for outstanding borrowings, subject to an increase in certain circumstances. Other than for limited exceptions, we are required to maintain all of our depository and operating accounts and the lesser of $80 million or 75% of our investment and securities accounts at the bank. The credit facility, as amended December 31, 2010, matures on December 31, 2012. Under the credit facility, we provided a $6.3 million letter of credit expiring on March 19, 2019 to the landlord of CompuCom Systems, Inc.’s Dallas headquarters which has been required in connection with our sale of CompuCom Systems in 2004. Availability under our revolving credit facility at December 31, 2010 was $43.7 million.

 

We have committed capital of approximately $0.4 million, including conditional commitments to provide partner companies with additional funding and commitments made to various private equity funds in prior years. These commitments are expected to be funded in the next 12 months.

 

The transactions we enter into in pursuit of our strategy could increase or decrease our liquidity at any point in time. As we seek to acquire interests in technology and life sciences companies, provide additional funding to existing partner companies, or commit capital to other initiatives, we may be required to expend our cash or incur debt, which will decrease our liquidity. Conversely, as we dispose of our interests in partner companies from time to time, we may receive proceeds from such sales, which could increase our liquidity. From time to time, we are engaged in discussions concerning acquisitions and dispositions which, if consummated, could impact our liquidity, perhaps significantly.

 

In May 2001, we entered into a $26.5 million loan agreement with Warren V. Musser, our former Chairman and Chief Executive Officer. In December 2006, we restructured the obligation to reduce the amount outstanding to $14.8 million, bearing interest at a rate of 5.0% per annum. Since 2001 and through December 31, 2010, we have received a total of $16.8 million in payments on the loan. We received nominal amounts of cash from the sale of collateral in 2009 and no payments in 2010. We received cash from the sale of collateral in early 2011 in the amount of $0.1 million. As a result, the carrying value of the loan at December 31, 2010 was $0.1 million.

 

We have received distributions as both a general partner and a limited partner from certain private equity funds. Under certain circumstances, we may be required to return a portion or all the distributions we received as a general partner of a fund for further distribution to such fund’s limited partners (“clawback”). The maximum clawback we could be required to return related to our general partner interest is $2.2 million, of which $0.9 million was reflected in accrued expenses and other current liabilities and $1.3 million was reflected in Other long-term liabilities on the Consolidated Balance Sheet at December 31, 2010. We paid $1.1 million of our estimated clawback liabilities in 2010.

 

Our previous ownership in the general partners of the funds that have potential clawback liabilities ranges from 19-30%. The clawback liability is joint and several, such that we may be required to fund the clawback for other general partners should they default. The funds have taken several steps to reduce the potential liabilities should other general partners default, including withholding all general partner distributions and placing them in escrow and adding rights of set-off among certain funds. We believe our potential liability due to the possibility of default by other general partners is remote.

For the reasons we presented above, we believe our cash and cash equivalents at December 31, 2010, availability under our revolving credit facility and other internal sources of cash flow will be sufficient to fund our cash requirements for at least the next 12 months, including debt repayments, commitments to our existing companies and funds, possible additional funding of existing partner companies and our general corporate requirements. Our acquisition of new partner company interests is always contingent upon our availability of cash to fund such deployments, and our timing of monetization events directly affects our availability of cash.

 

Analysis of Parent Company Cash Flows

 

Given no partner companies were consolidated during the year ended December 31, 2010, only Parent Company Cash Flows for the years ended December 31, 2009 and 2008 are presented below. Cash flow activity was as follows:

 

 

Cash Used In Operating Activities

 

Year ended December 31, 2009 versus year ended December 31, 2008.  Net cash used in operating activities increased $0.6 million in 2009 as compared to 2008. The increase is primarily attributable to $1.2 million in cash used for interest payments on the 2024 Debentures in 2009 for which interest payments were previously made using restricted marketable securities held in escrow, partially offset by lower corporate operating expenditures.

 

Cash Provided by Investing Activities

 

Year ended December 31, 2009 versus year ended December 31, 2008.  Net cash provided by investing activities decreased $11.5 million in 2009 as compared to 2008. The decrease was attributable to an $84.5 million decrease in proceeds from the sale of discontinued operations, a $10.3 million net increase in purchases of marketable securities and a $5.4 million increase in cash paid to acquire ownership interests in companies and funds, partially offset by a $57.0 million increase in proceeds from sales of and distributions from companies and funds, a $16.5 million decrease in advances to partner companies, a $14.3 million increase in repayment of advances from partner companies and a $0.9 decrease in restricted cash.

 

Cash Used In Financing Activities

 

Year ended December 31, 2009 versus year ended December 31, 2008.  Net cash used in financing activities decreased $27.6 million. The decrease was primarily attributable to a $26.3 million decrease in cash used to repurchase certain of our 2024 Debentures, as well as a $1.3 million decrease in cash used to repurchase our common stock as compared to the prior year.

 

Consolidated Working Capital From Continuing Operations

 

Consolidated working capital from continuing operations increased to $197.8 at December 31, 2010 compared to $106.0 at December 31, 2009. The increase was primarily due to the sale of our interests in Clarient and Avid in December 2010 resulting in net sale proceeds to Safeguard of $146.5 and $32.3 million, respectively.

Analysis of Consolidated Cash Flows

 

Cash flow activity was as follows:

 

 

Cash Used In Operating Activities

 

Year ended December 31, 2010 versus year ended December 31, 2009.  Net cash used in operating activities decreased $3.2 million in 2010 as compared to the prior year. The change was primarily related to cash used in operating activities of Clarient in the prior year period prior to its deconsolidation of $4.5 million, partially offset by cash used for interest payments on the 2024 and 2014 Debentures.

 

Year ended December 31, 2009 versus year ended December 31, 2008.  Net cash used in operating activities decreased $2.3 million in 2009 as compared to the prior year. The decrease was primarily attributable to the deconsolidation of Clarient. The decrease was partially offset by $1.2 million in cash used for interest payments on the 2024 Debentures in 2009 for which interest payments were previously made using restricted marketable securities held in escrow, partially offset by lower corporate operating expenditures.

 

Cash Provided by Investing Activities

 

Year ended December 31, 2010 versus year ended December 31, 2009.  Net cash provided by investing activities increased $131.8 million in 2010 as compared to the prior year. The increase was primarily related to a $122.5 million increase in proceeds from sales of and distributions from companies and funds, a $21.0 million net decrease in cash paid to acquire marketable securities, a $15.5 million decrease in cash paid to acquire ownership interests in partner companies and funds, a $2.0 million decrease in restricted cash, a $2.1 million decrease in capital expenditures and a $2.7 million decrease in cash related to the deconsolidation of subsidiary cash in the prior year period, partially offset by $18.9 million of cash transferred to escrow to service interest payments on the 2014 Debentures, a $10.4 million increase in advances to partner companies and a $3.7 million decrease in repayment of advances to partner companies.

 

Year ended December 31, 2009 versus year ended December 31, 2008.  Net cash provided by investing activities decreased $32.8 million in 2009 as compared to the prior year. The decrease was attributable to an $82.2 million decrease in proceeds from the sale of discontinued operations, a $10.3 million net increase in purchases of marketable securities, a $5.4 million increase in cash paid to acquire ownership interests in companies and funds, a $2.0 million increase in restricted cash and a $2.7 million decrease in cash resulting from the deconsolidation of Clarient, partially offset by a $57.0 million increase in proceeds from sales of and distributions from companies and funds, a $2.9 million decrease in advances to partner companies, a $5.7 million increase in repayment of advances from partner companies, a $2.8 million decrease in the cash used in discontinued operations, and a $1.4 million decrease in capital expenditures.

 

Cash Provided by (Used In) Financing Activities

 

Year ended December 31, 2010 versus year ended December 31, 2009.  Net cash provided by financing activities decreased by $11.2 million in 2010 as compared to the prior year. The decrease was primarily related to a $28.1 million decrease in proceeds received from the issuance of subsidiary common stock, partially offset by a $9.5 million reduction in payments on revolving credit facilities, a $7.3 million reduction in the repurchase of convertible senior debentures and a $0.8 million increase related to the issuance of our common stock associated with stock option exercises.

Year ended December 31, 2009 versus year ended December 31, 2008.  Net cash provided by financing activities increased $42.8 million in 2009 as compared to the prior year. The increase was primarily related to a $27.1 million increase in proceeds from the issuance of subsidiary common stock, a $26.3 million decrease in cash used to repurchase certain of our 2024 Debentures and a $1.3 million decrease in cash used to repurchase our common stock in the prior year period, partially offset by $7.1 million net repayments of outstanding borrowings and a $4.8 million decrease in cash provided from financing activities of discontinued operations.

 

Contractual Cash Obligations and Other Commercial Commitments

 

The following table summarizes our contractual obligations and other commercial commitments as of December 31, 2010, by period due or expiration of the commitment.

 

 

 

 

 

We have agreements with certain employees that provide for severance payments to the employee in the event the employee is terminated without cause or if the employee terminates his employment for “good reason.” The maximum aggregate cash exposure under the agreements was approximately $8 million at December 31, 2010.

 

We remain guarantor of Laureate Pharma’s Princeton, New Jersey facility lease (the “Laureate Lease Guaranty”). Such guarantee may extend through the lease expiration in 2016 under certain circumstances. However, we are entitled to indemnification in connection with the continuation of such guaranty. As of December 31, 2010, scheduled lease payments to be made by Laureate Pharma over the remaining lease term equaled $7.1 million.

 

As of December 31, 2010, Safeguard had federal net operating loss carryforwards and federal capital loss carryforwards totaling approximately $266.5 million. The net operating loss carryforwards expire in various amounts from 2011 to 2030. The capital loss carryforwards expire in 2013.

 

We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the consolidated financial position or results of operations.

 

 

We are exposed to equity price risks on the marketable portion of our ownership interests in our partner companies. At December 31, 2010, these interests include our equity positions in NuPathe and Tengion, our publicly-traded partner companies, which have experienced significant volatility in their stock prices. Historically, we have not attempted to reduce or eliminate our market exposure related to these types of interests. Based on closing market prices at December 31, 2010, the fair market value of our holdings in NuPathe and Tengion were $24.0 million and $1.5 million, respectively. A 20% decrease in NuPathe and Tengion’s stock price would result in an approximate $5.1 million decrease in the aggregate fair value of our holdings in these companies.

 

In February 2004, we completed the issuance of $150.0 million of our 2024 Debentures with a stated maturity of March 15, 2024. Through March 31, 2010, we repurchased $71.8 million in face value of the 2024 Debentures. Interest payments are due in March and September of each year. The holders of these 2024 Debentures have the right to require repurchase of the remaining outstanding 2024 Debentures on March 21, 2011, March 20, 2014 or March 20, 2019 at a repurchase price equal to 100% of their face amount plus accrued and unpaid interest. On March 10, 2010, we entered into agreements with institutional holders of an aggregate of $46.9 million in face value of our 2024 Debentures to exchange the 2024 debentures held by such holders for $46.9 million in face amount of our 2014 Debentures. The exchange became effective on March 26, 2010. Although contractually due in 2024, the remaining $31.3 million outstanding face amount of the 2024 Debentures has been classified as due in 2011 to reflect the first required repurchase date and to conform with the presentation of the 2024 Debentures as a current liability on the Consolidated Balance Sheet at December 31, 2010.

 

 

We have historically had very low exposure to changes in foreign currency exchange rates, and as such, have not used derivative financial instruments to manage foreign currency fluctuation risk.

 

We maintain cash and cash equivalents and marketable securities with various financial institutions. The financial institutions are highly rated.

 

The following Consolidated Financial Statements, and the related Notes thereto, of Safeguard Scientifics, Inc. and the Reports of Independent Registered Public Accounting Firm are filed as a part of this Form 10-K.

 

 

The Board of Directors and Stockholders

Safeguard Scientifics, Inc.:

 

We have audited Safeguard Scientifics, Inc.’s (the Company) internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Safeguard Scientifics, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A.(b)). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Safeguard Scientifics, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Safeguard Scientifics, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income (loss), changes in equity and cash flows for each of the years in the three-year period ended December 31, 2010, and our report dated March 4, 2011 expressed an unqualified opinion on those consolidated financial statements.

 

 

Philadelphia, Pennsylvania

March 4, 2011

 

The Board of Directors and Stockholders

Safeguard Scientifics, Inc.:

 

We have audited the accompanying consolidated balance sheets of Safeguard Scientifics, Inc. (the “Company”) and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, comprehensive income (loss), changes in equity and cash flows for each of the years in the three-year period ended December 31, 2010. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Safeguard Scientifics, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Safeguard Scientifics, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 4, 2011 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

 

 

Philadelphia, Pennsylvania

March 4, 2011

SAFEGUARD SCIENTIFICS, INC.

CONSOLIDATED BALANCE SHEETS

 

 

See Notes to Consolidated Financial Statements.

SAFEGUARD SCIENTIFICS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See Notes to Consolidated Financial Statements.

SAFEGUARD SCIENTIFICS, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)