| SAFEGUARD SCIENTIFICS INC Item 1A Risk Factors You should carefully consider the information set forth below before making an investment decision |
| If any of the following risks actually occur, our business, financial condition or results of operations could be materially harmed, and the value of our securities may decline |
| You should also refer to other information included or incorporated by reference in this report |
| Risks Related to Our Business Our business depends upon the performance of our partner companies, which is uncertain |
| 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 could decline |
| The risks relating to our partner companies include: § many of our partner companies have a history of operating losses or a limited operating history; § intensifying competition affecting the products and services our partner companies offer could adversely affect their businesses, financial condition, results of operations and prospects for growth; § inability to adapt to the rapidly changing marketplaces; 24 _________________________________________________________________ [79]Table of Contents § inability to manage growth; § the need for additional capital to fund their operations, which we may not be able to fund or which may not be available from third parties on acceptable terms, if at all; § inability to protect their proprietary rights and infringing on the proprietary rights of others; § certain of our partner companies could face legal liabilities from claims made against their operations, products or work; § the impact of economic downturns on their operations, results and growth prospects; § inability to attract and retain qualified personnel; and § government regulations and legal uncertainties may place financial burdens on the businesses of our partner companies |
| The identity of 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, change the partner companies on which we focus, sell some or all of our interests in any of our partner companies or otherwise change the nature of our interests in our partner companies |
| Therefore, the nature of our holdings in them could vary significantly from period to period |
| Our consolidated financial results may also vary significantly based upon the partner companies that are included in our financial statements |
| For example: § For the twelve months ended December 31, 2005, we consolidated the results of operations of Alliance Consulting, Clarient, Laureate Pharma, Mantas and Pacific Title |
| § In December 2005, we completed the purchase of Acsis and we have consolidated the results of operations of the acquired business from the date of the transaction |
| Our partner companies currently provide us with little cash flow from their operations so 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 acquire new partner companies 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 funding committments to private equity funds |
| As a result, we have substantial cash requirements |
| Our partner companies currently provide us with little 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, 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 partner companies may affect the price of our common stock |
| Fluctuations in the market price of the common stock of our publicly traded partner companies are likely to affect the price of our common stock |
| The market price of our publicly traded partner companies’ common stock has been highly volatile and subject to fluctuations unrelated or disproportionate to operating performance |
| The aggregate market value of our interests in our publicly-traded partner companies at December 31, 2005 (Clarient (Nasdaq: CLRT) and eMerge Interactive (Nasdaq: EMRG)) was approximately dlra48dtta2 million, and at March 7, 2006 (Clarient, eMerge Interactive and Traffic |
| 25 _________________________________________________________________ [80]Table of Contents Intense competition from other acquirers of interests in companies could result in lower gains or possibly losses on our partner companies |
| We face intense competition from companies with similar business strategies and from other capital providers as we acquire and develop interests in our partner companies |
| Some of our competitors have more experience identifying and acquiring companies and have greater financial and management resources, brand name recognition or industry contacts than we have |
| Although most of our acquisitions will be made at a stage when our partner companies are not publicly traded, we may pay higher prices for those equity interests because of higher trading prices for securities 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 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 |
| The trading volume and public float in the common stock of our publicly-traded partner companies are small relative to our holdings |
| As a result, any significant divestiture by us of our holdings in these partner companies 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 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 interest in some of our partner companies, we may not maintain this controlling 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: § the management of a partner company having economic or business interests or objectives that are different than ours; and § partner companies not taking our advice with respect to the financial or operating difficulties they may encounter |
| 26 _________________________________________________________________ [81]Table of Contents Our inability to adequately 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 recognize 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 40prca of the value of its total assets (excluding government securities and cash items) on an unconsolidated basis, unless an exemption or safe harbor applies |
| ” Securities issued by companies other than majority-owned subsidiaries are generally considered “investment securities” for purpose of the Investment Company Act |
| We are a company that partners with revenue - stage information technology and life sciences 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 40prca Test |
| Consequently, we do not believe that we are an investment company under the Investment Company Act |
| We monitor our compliance with the 40prca 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 40prca Test, we may need to take various actions which we would otherwise not pursue |
| For example, we may need to retain a majority 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 majority 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 may also be affected if our partner companies are acquired by third parties or if our partner companies issue stock which dilutes our majority ownership |
| The actions we may need to take to address these issues while maintaining compliance with the 40prca Test could adversely affect our ability to create and realize value at our partner companies |
| Many 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 information 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 |
| 27 _________________________________________________________________ [82]Table of Contents Our partner companies may fail if they do not adapt to the rapidly changing information technology and life sciences marketplaces |
| If our partner companies fail to adapt to rapid 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 information technology and life sciences marketplaces are characterized by: § rapidly changing technology; § evolving industry standards; § frequent new products and services; § shifting distribution channels; § evolving government regulation; § frequently changing intellectual property landscapes; and § changing customer demands |
| Our future success will depend on our partner companies’ ability to adapt to this rapidly evolving marketplace |
| 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 rapid technology changes in an economically efficient manner, and our partner companies may become or remain unprofitable |
| 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: § rapidly improve, upgrade and expand their business infrastructures; § scale-up production operations; § develop appropriate financial reporting controls; § attract and maintain qualified personnel; and § maintain appropriate levels of liquidity |
| 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 |
| Our partner companies may need to raise additional capital to fund their operations, which we may not be able to fund or which may not be available from third parties on acceptable terms, if at all |
| Our partner companies may need to raise additional funds in the future and we cannot be certain that they will be able to obtain additional financing on favorable terms, if at all |
| Because our resources and our ability to raise capital are limited, we may not be able to provide our partner companies with sufficient capital resources to enable them to reach a cash flow positive position |
| If our partner companies need to, but are not able to raise capital from other outside sources, then they may need to cease or scale back operations |
| 28 _________________________________________________________________ [83]Table of Contents 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 our partner companies’ assets and competitive strengths |
| Federal law, most typically, copyright, patent, trademark and trade secret, generally protects intellectual property rights |
| Although we expect that our partner companies will take reasonable efforts to protect the rights to their intellectual property, the complexity of international trade secret, copyright, trademark and patent law, coupled with the limited resources of these partner companies and the demands of quick delivery of products and services to market, create a risk that their efforts will prove inadequate to prevent misappropriation of our partner companies’ technology, or third parties may develop similar technology independently |
| 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 our partner companies to costly litigation and the diversion of 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 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 take significant time, may be 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 |
| The manufacture and sale of certain of our partner companies’ products entails an inherent risk of product liability |
| Certain of our partner companies maintain product liability insurance |
| Although none of our partner companies to date have experienced any material losses, 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 our partner companies’ revenues and income |
| 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 |
| The provisions our partner companies typically include in their contracts, which are designed to limit their exposure to legal claims relating to their services and the applications they develop, 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 revenues and profitability |
| Our partner companies are subject to the impact of economic downturns |
| The results of operations of our partner companies are affected by the level of business activity of their clients, which in turn is affected by the levels of economic activity in the industries and markets that they serve |
| In addition, the businesses of certain of our information technology companies may lag behind economic cycles in an industry |
| Any significant downturn in the economic environment, which could include labor disputes in these industries, could result in reduced demand for the products and services offered by our partner companies which could 29 _________________________________________________________________ [84]Table of Contents negatively impact their revenues and profitability |
| In addition, an economic downturn could cause increased pricing pressure which also could have a material adverse impact on the revenues and profitability of our partner companies |
| Our partner companies’ success depends on their ability to attract and retain qualified personnel |
| Our partner companies are dependent upon their ability to attract and retain senior management and key personnel, including trained technical and marketing personnel |
| Our partner companies will also need to continue to hire additional personnel as they expand |
| Although these 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 |
| If either the USA PATRIOT Act or the Basel Capital Accord are repealed, the demand for services and/or products of certain of our partner companies may be negatively impacted |
| 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 |