FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 30, 2001 Commission File Number 1-5620
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SAFEGUARD SCIENTIFICS, INC.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-1609753
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(state or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
800 The Safeguard Building, 435 Devon Park Drive Wayne, PA 19087
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610) 293-0600
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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 and 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 X No
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Number of shares outstanding as of November 14, 2001
Common Stock 117,682,573
SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION
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Page
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Item 1 - Financial Statements:
Consolidated Balance Sheets -
September 30, 2001 (unaudited) and December 31, 2000 3
Consolidated Statements of Operations (unaudited) -
Three and Nine Months Ended September 30, 2001 and 2000 4
Consolidated Statements of Cash Flows (unaudited) -
Nine Months Ended September 30, 2001 and 2000 5
Notes to Consolidated Financial Statements 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations 19
Item 3 - Quantitative and Qualitative Disclosures About Market Risk 32
PART II - OTHER INFORMATION
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Item 1 - Legal Proceedings 33
Item 6 - Exhibits and Reports on Form 8-K 33
Signatures 35
2
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
SEPTEMBER 30, DECEMBER 31,
2001 2000
- ------------------------------------------------------------------------------------------------------------------------
(unaudited)
ASSETS
Current Assets
Cash and cash equivalents, restricted cash and short-term investments $ 285,361 $ 219,431
Trading securities 175,005 3,446
Accounts receivable, less allowances 168,391 246,949
Income tax receivable 55,000 14,474
Inventories 38,794 78,187
Prepaid expenses and other current assets 11,593 10,440
- ------------------------------------------------------------------------------------------------------------------------
Total current assets 734,144 572,927
Property and equipment, net 64,093 52,951
Ownership interests in and advances to affiliates 218,481 616,875
Available-for-sale securities 4,937 214,343
Intangibles, net 149,542 123,002
Deferred taxes 6,798 39,708
Related party note receivable 25,357 --
Other 24,008 28,453
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TOTAL ASSETS $ 1,227,360 $ 1,648,259
========================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current maturities of long-term debt $ 9,250 $ 5,250
Accounts payable 105,317 123,130
Accrued expenses 133,265 130,722
Other current liabilities 168,798 --
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Total current liabilities 416,630 259,102
Long-term debt 18,982 13,493
Minority interest 111,735 106,462
Other long-term liabilities 1,331 164,765
Convertible subordinated notes 200,000 200,000
Commitments and contingencies
SHAREHOLDERS' EQUITY
Preferred stock -- --
Common stock 11,815 11,815
Additional paid-in capital 744,529 758,946
Retained earnings (deficit) (263,582) 172,716
Accumulated other comprehensive income (loss) 779 (712)
Unamortized deferred compensation (1,698) --
Treasury stock, at cost (13,161) (38,328)
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Total shareholders' equity 478,682 904,437
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,227,360 $ 1,648,259
========================================================================================================================
See notes to consolidated financial statements.
3
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
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(unaudited)
REVENUE
Product sales $ 334,501 $ 664,091 $ 1,246,635 $ 1,819,696
Service sales 90,836 73,925 256,961 210,392
Other 6,836 4,630 19,798 12,719
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Total revenue 432,173 742,646 1,523,394 2,042,807
Operating Expenses
Cost of sales--product 301,220 606,981 1,126,009 1,672,924
Cost of sales--service 57,829 43,701 167,277 136,322
Selling and service 34,285 37,456 108,284 111,441
General and administrative 42,405 51,848 124,440 146,877
Depreciation and amortization 10,009 8,032 29,469 24,391
Restructuring -- -- -- 5,169
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Total operating expenses 445,748 748,018 1,555,479 2,097,124
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(13,575) (5,372) (32,085) (54,317)
Other income (loss), net (12,860) 34,457 (50,435) 119,477
Interest income 3,007 7,543 9,981 16,190
Interest and financing expense (7,631) (10,762) (23,107) (31,512)
- ------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES, MINORITY
INTEREST AND EQUITY LOSS (31,059) 25,866 (95,646) 49,838
Income taxes 587 13,865 6,773 (3,241)
Minority interest (671) (3,884) (2,969) 2,985
Equity loss (44,940) (61,035) (344,456) (43,002)
- ------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (76,083) $ (25,188) $ (436,298) $ 6,580
========================================================================================================================
NET INCOME (LOSS) PER SHARE
Basic $ (0.65) $ (0.22) $ (3.72) $ 0.06
Diluted $ (0.65) $ (0.22) $ (3.73) $ 0.06
WEIGHTED AVERAGE SHARES OUTSTANDING
Basic 117,300 117,095 117,279 113,131
Diluted 117,300 117,095 117,279 115,958
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See notes to consolidated financial statements.
4
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
NINE MONTHS ENDED
SEPTEMBER 30,
2001 2000
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(unaudited)
OPERATING ACTIVITIES
Net income (loss) $ (436,298) $ 6,580
Adjustments to reconcile to net cash provided by (used in)
operating activities:
Depreciation and amortization 29,469 24,391
Deferred income taxes (7,503) (18,643)
Equity loss 344,456 43,002
Other (income) loss, net 50,435 (119,477)
Stock-based compensation 376 11,830
Minority interest 1,781 (1,791)
Changes in assets and liabilities, net of effect of acquisitions
and dispositions:
Accounts receivable, net 169,410 (41,291)
Inventories 54,164 38,036
Accounts payable, accrued expenses and other (19,966) (38,816)
- -----------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 186,324 (96,179)
INVESTING ACTIVITIES
Proceeds from sales of available-for-sale securities 11,612 85,658
Proceeds from sales of and distributions from affiliates 93,672 74,474
Advances to affiliates (13,948) (30,793)
Repayment of advances to affiliates 406 15,550
Acquisitions of ownership interests in affiliates
and subsidiaries, net of cash acquired (64,404) (442,440)
Acquisitions by subsidiaries, net of cash acquired (104,338) (750)
Advances to related party, net (26,708) --
Decrease in short-term investments and restricted cash 86,728 --
Capital expenditures (21,642) (9,265)
Other, net (2,381) (2,473)
- -----------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (41,003) (310,039)
FINANCING ACTIVITIES
Borrowings on revolving credit facilities 24,862 963,216
Repayments on revolving credit facilities (21,983) (928,637)
Borrowings on long-term debt 5,305 2,151
Repayments on long-term debt (1,972) (7,426)
Repurchase of company common stock - (43,611)
Issuance of Company common stock, net 139 614,940
Issuance of subsidiary common stock 488 1,894
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Net cash provided by financing activities 6,839 602,527
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NET INCREASE IN CASH AND CASH EQUIVALENTS 152,160 196,309
Cash and cash equivalents at beginning of period 133,201 49,813
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CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 285,361 $ 246,122
========================================================================================================================
See notes to consolidated financial statements.
5
SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 2001
1. GENERAL
The accompanying unaudited interim consolidated financial statements were
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. The 2000 Form 10-K should be read in conjunction with the
accompanying statements. These statements include all adjustments (consisting
only of normal recurring adjustments) which the Company believes are necessary
for a fair presentation of the statements. The interim operating results are not
necessarily indicative of the results for a full year.
2. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative
Instruments and Hedging Activities", as amended. SFAS 133 establishes new
standards of accounting and reporting for derivative instruments and hedging
activities. SFAS 133 requires that all derivatives be recognized at fair value
in the statement of financial position, and that the corresponding gains or
losses be reported either in the statements of operations or as a component of
comprehensive income, depending on the type of hedging relationship that exists.
If the derivative is determined to be a hedge, depending on the nature of the
hedge, changes in the fair value of the derivatives are offset against the
change in the fair value of the hedged assets, liabilities or firm commitments
through the statements of operations or recognized in other comprehensive income
until the hedged item is recognized in the statement of operations. The
ineffective portion of a derivative's change in fair value is immediately
recognized in earnings. The Company currently holds derivative instruments and
engages in certain hedging activities, which have been accounted for as
described in note 6. The Company adopted SFAS 133 on January 1, 2001.
3. COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) is the change in equity of a business enterprise
from transactions and other events and circumstances from non-owner sources. In
addition to net income (loss), the Company's source of comprehensive income
(loss) is from net unrealized appreciation (depreciation) on its holdings
classified as available-for-sale. Reclassification adjustments result from the
recognition in net income of unrealized gains or losses that were included in
comprehensive income (loss) in prior periods. The following summarizes the
components of comprehensive income (loss), net of income taxes:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
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(in thousands)
(unaudited)
NET INCOME (LOSS) $ (76,083) $ (25,188) $ (436,298) $ 6,580
=================================================================================================================
OTHER COMPREHENSIVE INCOME
(LOSS), BEFORE TAXES:
Unrealized holding gains (losses) (3,481) (69,461) (8,372) (23,713)
Reclassification adjustments 6,095 (1,999) 10,666 (54,587)
RELATED TAX (EXPENSE) BENEFIT:
Unrealized holding (gains) losses 1,218 24,311 2,930 8,300
Reclassification adjustments (2,133) 700 (3,733) 19,104
- -----------------------------------------------------------------------------------------------------------------
OTHER COMPREHENSIVE INCOME (LOSS) 1,699 (46,449) 1,491 (50,896)
- -----------------------------------------------------------------------------------------------------------------
COMPREHENSIVE LOSS $ (74,384) $ (71,637) $ (434,807) $ (44,316)
=================================================================================================================
6
4. RECLASSIFICATIONS
Certain prior year amounts have been reclassified to conform to the current year
presentation.
5. CASH AND CASH EQUIVALENTS, RESTRICTED CASH AND SHORT-TERM INVESTMENTS
At September 30, 2001, cash and cash equivalents consist of commercial paper and
other deposits that are readily convertible into cash. At December 31, 2000,
restricted cash of $35 million was primarily invested in money market
investments and was used as collateral under a guarantee arrangement (note 19).
At December 31, 2000, short-term investments of $51 million represented
commercial paper with maturities ranging from 92 to 208 days.
6. FINANCIAL INSTRUMENTS
In 1999, in order to mitigate the Company's market exposure and generate cash,
the Company entered into two forward sale contracts related to 3.4 million
shares of its holdings in Tellabs common stock. The Company pledged these shares
of Tellabs under contracts that expire in March and August 2002 and, in return,
received approximately $139 million of cash. At maturity, the Company is
required to deliver cash or Tellabs stock with a value determined by the stock
price of Tellabs at maturity. The number of Tellabs shares to be delivered at
maturity will range between 2.7 million to 3.4 million depending on the price of
Tellabs stock at that date. The Company currently intends to deliver shares of
Tellabs to settle these contracts.
The forward sale contracts are considered derivative financial instruments
that have been designated as fair value hedging instruments under SFAS 133. The
Company's objective relative to the use of these hedging instruments is to limit
the Company's exposure to and benefits from price fluctuations in the underlying
equity securities. Pursuant to SFAS 133, the Company transferred its Tellabs
holdings into the trading category from the available-for-sale category
effective January 1, 2001. At September 30, 2001, the fair value of our holdings
in Tellabs and the value of the forward sale contracts are included in the
caption trading securities on the consolidated balance sheets. The Company
accounts for the forward sale arrangements as hedges and has determined that the
hedges are highly effective. Changes in the value of the hedge instrument are
substantially offset by changes in the value of the underlying securities. The
hedging of the Tellabs common stock was part of the Company's overall risk
management strategy, which includes the preservation of cash and the value of
securities used to fund ongoing operations and future acquisition opportunities.
The Company does not hold or issue any derivative financial instruments for
trading purposes.
The net gain recognized during the three months ended September 30, 2001
was $3.3 million. This amount reflects a $34.2 million gain on the change in the
fair value of the hedging contract, reduced by a $30.9 million loss on the
change in fair value of the Tellabs holdings. The net loss recognized during the
nine months ended September 30, 2001 was $13.3 million. This amount reflects a
$111.5 million gain on the change in the fair value of the hedging contract,
reduced by a $124.8 million loss on the change in fair value of the Tellabs
holdings. These gains (losses) are reflected in other income (loss), net in the
consolidated statements of operations. The effect of the transition accounting
at January 1, 2001, prescribed in SFAS 133 was not material.
The Company's liability of $169 million in connection with these
transactions is included in other current liabilities on the consolidated
balance sheet at September 30, 2001. The initial cost of the transaction, $4.3
million, is being amortized over the life of the agreement through the
statements of operations.
The risk of loss to the Company in the event of nonperformance by the
counterparty under the forward sale contracts is not considered to be
significant. Although the forward sale contracts expose the Company to market
risk, fluctuations in the fair value of these contracts are mitigated by
expected offsetting fluctuations in the pledged securities.
7
7. OWNERSHIP INTERESTS IN AND ADVANCES TO AFFILIATES
The following summarizes the carrying value of the Company's ownership interests
in and advances to affiliates accounted for under the equity method or cost
method of accounting. The ownership interests are classified according to
applicable accounting methods at September 30, 2001 and December 31, 2000.
SEPTEMBER 30, DECEMBER 31,
2001 2000
-------------------------------------------
(in thousands)
(unaudited)
EQUITY METHOD
Public companies $ 48,981 $267,062
Non-public companies 139,023 309,369
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188,004 576,431
COST METHOD
Non-public companies 19,527 33,101
ADVANCES TO AFFILIATES 10,950 7,343
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$ 218,481 $616,875
=======================================================================================
The market value of the Company's public companies accounted for under the
equity method was $114 million and $339 million at September 30, 2001 and
December 31, 2000.
At September 30, 2001, the Company's carrying value in its partner companies
accounted for under the equity method exceeded its share of the underlying
equity in the net assets of such companies by $64.5 million which is included in
ownership interests in and advances to affiliates on the consolidated balance
sheets. This excess relates to ownership interests acquired through September
30, 2001, and is being amortized generally over a three to ten-year period.
Amortization expense of $20.0 million and $17.2 million for the nine months
ended and $5.5 million and $10.0 million for the three months ended September
30, 2001 and 2000, is included in equity loss in the consolidated statements of
operations.
As of September 30, 2001, the Company had advances to partner companies that
mature on various dates through May 2004 and bear interest at fixed rates
between 5.3% and 9.0% and variable rates consisting of the prime rate (6% at
September 30, 2001) plus 1 - 2%. During management's ongoing review of the
recoverability of recorded carrying values versus their estimated fair value, it
was determined that the carrying value of the Company's ownership interests in
advances to affiliates were not fully recoverable. The Company recorded
impairment charges for companies accounted for under the equity method totaling
$5.3 million for the three months ended September 30, 2001 and $63.9 million and
$4.7 million for the nine months ended September 30, 2001 and 2000. The amount
of the impairment charge was determined by comparing the carrying value of our
interest in the affiliate to the estimated fair value. Impairment charges
associated with equity method companies are reported as part of equity loss on
the consolidated statements of operations. Impairment charges related to cost
method companies are reported in other income (loss), net (see note 12).
8
8. AVAILABLE-FOR-SALE SECURITIES
Available-for-sale securities consisted of the following:
SEPTEMBER 30, 2001 DECEMBER 31, 2000
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CARRYING MARKET CARRYING MARKET
VALUE VALUE VALUE VALUE
- -------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Tellabs (a) $ - $ -- $212,731 $190,654
Pac-West Telecomm 3,500 1,383 9,872 8,465
Brandywine Realty Trust(b) 39 47 8,561 10,619
Other public companies 194 3,507 2,086 4,605
Unrealized appreciation (depreciation) 1,204 (18,907)
- --------------------------------------------------- --------------
$4,937 $214,343
=================================================== ==============
(a) As discussed in note 6, the Company entered into forward sale contracts on
its Tellabs holdings in 1999. Also as discussed in note 6, these holdings
were reclassified to trading securities on January 1, 2001.
(b) The Company sold a majority of its holdings in Brandywine in June 2001.
9. DEBT
The following is a summary of long-term debt:
SEPTEMBER 30, DECEMBER 31,
2001 2000
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(in thousands)
(unaudited)
Parent company and other recourse debt $23,793 $18,240
Subsidiary debt (non-recourse to parent) 4,439 503
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Total debt 28,232 18,743
Current maturities of long-term debt (9,250) (5,250)
- -----------------------------------------------------------------------------------------------
Long-term debt $18,982 $13,493
===============================================================================================
In November 2001, the Company entered into a commitment for a new credit
facility to provide for the issuances of letters of credit up to $10 million.
Outstanding letters of credit under the credit facility must be cash secured.
The new credit facility is subject to an unused commitment fee of 0.25% per
annum payable quarterly, and is subject to reduction based on deposits
maintained at the bank. The Company terminated its former credit facility in
November 2001. The former credit facility provided for borrowings up to $100
million and provided for unused commitment fees of 0.4% and an annual agent's
fee. As of September 30, 2001, a letter of credit totaling $3.0 million was
outstanding. Availability under the former credit facility was determined by the
market value of those securities pledged as collateral.
Parent company and other recourse debt includes primarily mortgage
obligations and bank credit facilities of consolidated partner companies. These
obligations bear interest at fixed rates between 7.75% to 9.75%, and variable
rates consisting of the prime rate plus 1%.
At September 30, 2001, CompuCom has a $100 million working capital facility
and a $150 million receivables securitization facility. The working capital
facility, which matures in May 2002, bears interest at LIBOR plus an agreed upon
spread and is secured by a lien on CompuCom's assets. Availability under the
facility is subject to a borrowing base calculation. As of September 30, 2001,
availability under
9
the working capital facility was approximately $52 million, and there were no
amounts outstanding. The securitization facility's pricing is based on a
designated short-term interest rate plus an agreed upon spread. CompuCom has an
agreement with two financial institutions that allows it to sell, at a discount,
an interest in a portion of its trade accounts receivable to each such financial
institution. As collections reduce receivables balances sold, CompuCom may sell
interests in new receivables to bring the amount available up to the maximum
allowed. CompuCom records these transactions as sales of accounts receivable.
These sales are reflected as reductions of accounts receivable on the
consolidated balance sheets and are included in net cash provided by operating
activities on the consolidated statements of cash flows. Amounts outstanding as
sold receivables at September 30, 2001 consisted of two certificates totaling
$87 million, one certificate for $37 million with an April 2002 maturity date
and one certificate for $50 million with an October 2003 maturity date. Both
facilities are subject to CompuCom's compliance with selected financial
covenants and ratios.
10. SHAREHOLDERS' EQUITY
In June 2001, the Company granted 279,000 shares of its common stock to its
employees, with a fair value on the date of grant of $1.3 million (or $4.785 per
share). In July and August 2001, the Company granted 170,000 shares, of its
common stock to executives, with a fair value on the date of grant of $0.7
million (or $4.32 per share). The value of the shares is being amortized over
the vesting period of 2 years. During the three and nine months ended September
30, 2001, the Company recorded $207,000 and $228,000 of expense related to these
grants.
As discussed in note 17, the Company issued shares of its common stock in
the first quarter of 2001 in connection with the acquisition of Palarco.
11. RESTRUCTURING
In 2000, CompuCom effected a restructuring plan designed to reduce its cost
structure by closing its distribution facility located in Houston, Texas,
closing and consolidating three office sites and reducing its workforce. As a
result, CompuCom recorded a restructuring charge of $5.2 million in the first
quarter of 2000. During 1998, CompuCom recorded a $16.4 million restructuring
charge, primarily consisting of costs associated with the closing of facilities
and disposing of related fixed assets, as well as employee severance and
benefits related to a reduction in workforce. Restructuring activity during 2001
is summarized as follows:
ACCRUAL AT ACCRUAL AT
DEC. 31, 2000 CASH PAYMENTS SEPT. 30, 2001
- ------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
RESTRUCTURING - 2000
Lease termination costs $1,770 $ (294) $ 1,476
Employee severance and related benefits 10 (10) --
- ------------------------------------------------------------------------------------------------------------
$1,780 $ (304) $ 1,476
============================================================================================================
RESTRUCTURING - 1998
Lease termination costs $ 710 $ (224) $ 486
============================================================================================================
The remaining accrual at September 30, 2001 is reflected in accrued liabilities
on the consolidated balance sheet and is expected to be adequate to cover actual
amounts to be paid. Differences, if any, between the estimated amounts accrued
and actual amounts paid will be reflected in operating expenses in future
periods.
10
12. OTHER INCOME (LOSS), NET
Other income (loss), net, consists of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Gain (loss) on sale of public holdings, net $ (1,182) $ 742 $ 210 $ 62,573
Gain on sale of private partner companies, net 267 36,461 1,785 56,270
Unrealized gain (loss) on derivative financial instruments 3,257 -- (13,271) --
Unrealized loss on trading securities, net (675) (1,273) (1,801) (2,093)
Other, primarily impairment charges (14,527) (1,473) (37,358) 2,727
- --------------------------------------------------------------------------------------------------------------------
$ (12,860) $ 34,457 $ (50,435) $ 119,477
====================================================================================================================
For the three and nine months ended September 30, 2001, the Company
recorded impairment charges of $14.5 million and $37.4 million for the other
than temporary decline in the carrying value of certain partner companies
accounted for under the cost method (see note 7).
13. INCOME TAXES
Income taxes are accounted for under the asset and liability method whereby
deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis, using the tax rate expected to be in effect when the taxes are actually
paid or recovered. The measurement of deferred tax assets is reduced, if
necessary, by a valuation allowance.
The Company's consolidated income tax benefit recorded for the three months
ended September 30, 2001, was $0.6 million, net of a recorded valuation
allowance of $22.3 million. The Company's consolidated income tax benefit
recorded for the nine months ended September 30, 2001, was $6.8 million, net of
a recorded valuation allowance of $138.0 million. The Company has recorded a
valuation allowance to reduce its deferred tax asset to an amount that is more
likely than not to be realized in future years.
11
14. NET INCOME PER SHARE
The calculations of net income (loss) per share were:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- ---------------------------------------------------------------------------------------------------------------
(in thousands except per share amounts)
(unaudited)
Basic:
Net income (loss) $ (76,083) $ (25,188) $ (436,298) $ 6,580
- ---------------------------------------------------------------------------------------------------------------
Average common shares outstanding 117,300 117,095 117,279 113,131
- ---------------------------------------------------------------------------------------------------------------
Basic $ (0.65) $ (0.22) $ (3.72) $ 0.06
===============================================================================================================
Diluted:
Net income (loss) $ (76,083) $ (25,188) $ (436,298) $ 6,580
Public company equity adjustment (328) (232) (1,076) (25)
- ---------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ (76,411) $ (25,420) $ (437,374) $ 6,555
- ---------------------------------------------------------------------------------------------------------------
Average common shares outstanding 117,300 117,095 117,279 113,131
Effect of: Dilutive options -- -- -- 2,827
- ---------------------------------------------------------------------------------------------------------------
Average common shares assuming dilution 117,300 117,095 117,279 115,958
- ---------------------------------------------------------------------------------------------------------------
Diluted $ (0.65) $ (0.22) $ (3.73) $ 0.06
===============================================================================================================
If a consolidated or equity method public company has dilutive options or
securities outstanding, diluted net income (loss) per share is computed first by
deducting from income (loss) the income attributable to the potential exercise
of the dilutive options or securities of the company. This impact is shown as an
adjustment to net income (loss) for purposes of calculating diluted net income
(loss) per share.
The computation of average common shares outstanding for the three and nine
months ended September 30, 2001, excludes 0.3 million shares of non-vested
restricted stock granted in 2001.
Approximately 0.1 million and 0.3 million weighted average common stock
equivalents related to stock options and approximately 8.3 million shares
representing the weighted average effect of assumed conversion of the
convertible subordinated notes were excluded from the denominator in the
calculation of diluted loss per share for the three and nine months ended
September 30, 2001, because their effect was anti-dilutive. Approximately 2.0
million weighted average common stock equivalents related to stock options and
approximately 8.3 million shares representing the weighted average effect of
assumed conversion of the convertible subordinated notes were excluded from the
denominator in the calculation of diluted loss per share for the three months
ended September 30, 2000, because their effect was anti-dilutive.
12
15. PARENT COMPANY FINANCIAL INFORMATION
Parent Company financial information is provided to present the financial
position and results of operations of the Company as if the less than wholly
owned consolidated companies were accounted for under the equity method of
accounting for all periods presented during which the Company owned its interest
in these companies.
BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
2001 2000
--------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
ASSETS
Cash and cash equivalents, restricted cash
and short-term investments $ 183,775 $ 204,004
Trading securities 175,005 3,446
Income tax receivable 55,000 14,474
Other current assets 20,945 15,548
Ownership interests in and advances to affiliates 351,545 759,914
Available-for-sale securities 4,937 214,233
Related party note receivable 25,357 -
Other 84,246 113,415
--------------------------------------------------------------------------------------------------
Total Assets $ 900,810 $ 1,325,034
==================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 35,817 $ 42,899
Other current liabilities 168,798 -
Long-term debt 17,115 13,421
Other long-term liabilities 398 164,277
Convertible subordinated notes 200,000 200,000
Shareholders' equity 478,682 904,437
--------------------------------------------------------------------------------------------------
Total Liabilities and Shareholders' Equity $ 900,810 $ 1,325,034
==================================================================================================
The carrying values of the Company's less than wholly owned consolidated
subsidiaries, primarily CompuCom, Tangram and SOTAS and including PTM
Productions at September 30, 2001, are included in ownership interests in and
advances to affiliates.
STATEMENTS OF OPERATIONS
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- --------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Revenue $ 18,059 $ 8,810 $ 52,631 $ 22,192
Operating expenses 29,592 26,866 84,571 72,703
- --------------------------------------------------------------------------------------------------------------
(11,533) (18,056) (31,940) (50,511)
Other income (loss), net (12,860) 34,457 (50,435) 117,519
Interest and financing expense, net (3,930) 1,354 (9,907) (2,379)
- --------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes
and equity loss (28,323) 17,755 (92,282) 64,629
Income taxes 1,108 15,711 8,934 (3,850)
Equity loss (48,868) (58,654) (352,950) (54,199)
- --------------------------------------------------------------------------------------------------------------
Net income (loss) $ (76,083) $ (25,188) $ (436,298) $ 6,580
==============================================================================================================
13
The Company's shares of the income or losses of its less than wholly owned
consolidated subsidiaries, primarily CompuCom, Tangram and SOTAS for the three
and nine months ended September 30, 2001 and 2000, including PTM Productions for
the three and nine months ended September 30, 2001, and including Arista through
its sale in July 2000, are reflected in equity loss.
16. OPERATING SEGMENTS
Our reportable segments include General Safeguard Operations, Partner Company
Operations and CompuCom Operations. General Safeguard Operations includes the
expenses of providing strategic and operational support to the Company's partner
companies and private equity funds, and also includes the effect of certain
private equity funds which the Company accounts for under the equity method.
General Safeguard Operations also includes the effect of transactions and other
events incidental to the Company's ownership interests in its partner companies
and its operations in general. Partner Company Operations reflects the
operations of all of the Company's partner companies other than CompuCom
(included in CompuCom Operations). The partner companies included under Partner
Company Operations are accounted for under either the consolidation or the
equity method. CompuCom Operations includes the results of our majority-owned
subsidiary, CompuCom. The following table reflects consolidated operating data
by reported segments (in thousands). All significant intersegment activity has
been eliminated. Accordingly, segment results reported exclude the effect of
transactions between the Company and its subsidiaries.
14
The following summarizes information related to the Company's segments (in
thousands). All significant intersegment activity has been eliminated.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
----------------------- -------------------
(unaudited)
SUMMARY OF CONSOLIDATED NET INCOME (LOSS)
General Safeguard Operations $ (27,090) $ 35,807 $ (86,499) $ 98,295
Partner Company Operations (49,426) (63,480) (352,097) (90,426)
CompuCom Operations 433 2,485 2,298 (1,289)
- ------------------------------------------------------------------------------------------------------------------------
$ (76,083) $ (25,188) $ (436,298) $ 6,580
========================================================================================================================
GENERAL SAFEGUARD OPERATIONS
Revenue $ 6,836 $ 4,630 $ 19,798 $ 12,719
Operating expenses
General and administrative 17,127 22,059 48,301 61,207
Depreciation and amortization 676 457 2,119 1,312
- ------------------------------------------------------------------------------------------------------------------------
Total operating expenses 17,803 22,516 50,420 62,519
- ------------------------------------------------------------------------------------------------------------------------
(10,967) (17,886) (30,622) (49,800)
Other income (loss), net (12,860) 34,457 (50,435) 117,519
Interest and financing, net (4,040) 1,259 (9,877) (2,678)
- ------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and
equity income (loss) (27,867) 17,830 (90,934) 65,041
Income taxes 1,860 (8,902) 1,796 (42,590)
Equity income (loss) (1,083) 26,879 2,639 75,844
- ------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) from General Safeguard Operations $ (27,090) $ 35,807 $ (86,499) $ 98,295
========================================================================================================================
PARTNER COMPANY OPERATIONS
Revenue $ 20,577 $ 13,140 $ 55,839 $ 27,890
Operating expenses
Cost of sales 13,619 5,072 34,017 9,788
Selling and service 4,999 3,640 14,581 9,551
General and administrative 2,863 2,531 9,464 12,993
Depreciation and amortization 3,783 1,965 9,721 5,700
- ------------------------------------------------------------------------------------------------------------------------
Total operating expenses 25,264 13,208 67,783 38,032
- ------------------------------------------------------------------------------------------------------------------------
(4,687) (68) (11,944) (10,142)
Interest and financing, net (129) (152) (317) (847)
- ------------------------------------------------------------------------------------------------------------------------
Loss before income taxes and equity loss (4,816) (220) (12,261) (10,989)
Income taxes (753) 24,654 7,259 39,180
Minority Interest - - - 229
Equity loss (43,857) (87,914) (347,095) (118,846)
- ------------------------------------------------------------------------------------------------------------------------
Net Loss from Partner Company Operations $(49,426) $(63,480) $(352,097) $(90,426)
========================================================================================================================
COMPUCOM OPERATIONS
Revenue
Product sales $ 332,877 $ 656,383 $ 1,234,956 $ 1,805,488
Service sales 71,883 68,493 212,801 196,710
- ------------------------------------------------------------------------------------------------------------------------
404,760 724,876 1,447,757 2,002,198
- ------------------------------------------------------------------------------------------------------------------------
Operating expenses
Cost of sales - Product 299,792 604,404 1,121,887 1,669,369
Cost of sales - Service 45,638 41,206 137,382 130,089
Selling and service 29,286 33,816 93,703 101,890
General and administrative 22,415 27,258 66,675 72,677
Depreciation and amortization 5,550 5,610 17,629 17,379
Restructuring - - - 5,169
- ------------------------------------------------------------------------------------------------------------------------
Total operating expenses 402,681 712,294 1,437,276 1,996,573
- ------------------------------------------------------------------------------------------------------------------------
2,079 12,582 10,481 5,625
Other income, net - - - 1,958
Interest and financing, net (455) (4,326) (2,932) (11,797)
- ------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest 1,624 8,256 7,549 (4,214)
Income taxes (520) (1,887) (2,282) 169
Minority interest (671) (3,884) (2,969) 2,756
- ------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) from CompuCom Operations $ 433 $ 2,485 $ 2,298 $ (1,289)
========================================================================================================================
15
17. BUSINESS COMBINATIONS
Acquisitions by the Company
In January 2001, the Company acquired 100% of Palarco, Inc. for cash and
stock, and an additional amount which is dependent upon the achievement of
certain performance targets during the two years after the acquisition. Palarco
is a provider of global information technology solutions, and provides a key
services component to Safeguard's infrastructure strategy by augmenting the
breadth and depth of Safeguard's consulting and implementation capabilities.
In August 2000, aligne, the Company's wholly owned subsidiary, acquired
100% of K Consultants, Inc. for cash and an additional amount which was
dependent upon achievement of certain performance targets of K Consultants
during the first 12 months after the acquisition. K Consultants provides
eBusiness infrastructure consulting services, including strategy, architecture,
implementation and support.
In February 2000, the Company acquired the remaining 20% voting ownership
in aligne in exchange for shares of the Company's common stock.
These transactions were accounted for as purchases and, accordingly, the
consolidated financial statements reflect the operations of these companies
since the acquisition date.
In connection with its acquisitions, the Company has contingent
consideration payable dependent upon the achievement of certain performance
targets. This additional amount is payable in cash and stock and is recorded
when earned as additional purchase price. As of September 30, 2001, the Company
has accrued $5.4 million of additional purchase price to be paid in the fourth
quarter of 2001. In addition to the amounts earned as of September 30, 2001, the
maximum amount of additional contingent consideration to be earned based on
future performance is approximately $6.8 million to be paid in common stock
(payable in 2002).
Acquisitions by Subsidiaries
On July 16, 2001, CompuCom purchased certain assets and assumed certain
liabilities of Excell Data Corporation for approximately $27 million in
available cash. The net assets acquired were used by Excell primarily in its
business of high-end technical applications development, network infrastructure
design and deployment and worldwide event technical planning and support.
Essentially all of the Excell workforce, consisting of technical application
developers, consultants and administrative personnel, were hired as part of the
Excell acquisition. The purpose of the Excell acquisition is to expand the suite
of CompuCom's service offerings.
On January 10, 2001, CompuCom purchased certain assets of MicroAge
Technology Services, L.L.C. The assets were purchased out of bankruptcy court
and primarily consisted of trade accounts receivable as well as vendor accounts
receivable and inventory. The purchase price of approximately $79 million (after
post-closing adjustments) was financed using available cash. The purchased
assets were used by MTS primarily in its business as a systems integrator of
personal computer products. As part of the MTS acquisition, CompuCom also hired
certain of MTS' national sales force, technical service personnel and
administrative personnel.
These business combinations are being accounted for as purchases and,
accordingly, the consolidated financial statements reflect the operations of the
acquired entities since their acquisition dates. CompuCom has not completed the
allocation of the purchase price of these acquisitions. Therefore, the
allocation of the purchase price could be adjusted once the valuation of the
assets acquired and liabilities assumed is completed.
The following unaudited pro forma financial information presents the
combined results of operations of the Company as if the acquisitions had
occurred as of January 1, 2000, after giving effect to certain adjustments,
including amortization of goodwill, increased interest and financing expense on
debt related to the acquisitions and related income tax effects. The pro forma
results of operations are not indicative of the actual results that would have
occurred had the acquisitions been consummated at the beginning of the period
presented and is not intended to be a projection of future results.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2000 2000
--------------------------- -----------------------
(in thousands except per share amounts)
Total revenues $ 1,018,933 $ 3,000,939
Net loss $ (32,009) $ (8,387)
Diluted income (loss) per share $ (0.27) $ (0.07)
16
Unaudited pro forma results for the three and nine months ended September 30,
2001, after giving effect to the 2001 acquisitions, would not have been
materially different from the amounts reported.
18. COMMITMENTS AND CONTINGENCIES
Litigation Arising Out Of The Initial Public Offering of Opus360 Corporation
Beginning in April 2001, the Company, CompuCom Systems, Inc., a Company
affiliate, and an officer of Safeguard who served as a Director of Opus360
Corporation, were named in putative class actions filed in federal court in New
York. The plaintiffs allege material misrepresentations and/or omissions in
connection with the initial public offering of Opus360 Corporation stock on
April 7, 2000.
The cases are brought against Opus360, its officers and directors
(including the Safeguard officer), Safeguard, CompuCom, and Opus360's
underwriters. In these cases, the plaintiffs allege, among other things, that
the prospectus and registration statement for Opus360's initial public offering
contained misrepresentations and/or omissions regarding: (1) Opus360's products,
including Opus Xchange; (2) Opus360's cash flow and liquidity, including its
"cash burn" rate; and (3) Opus360's relationships with its customers. Plaintiffs
assert claims under Sections 11, 12 and 15 of the Securities Act of 1933.
Plaintiffs seek damages in an amount in excess of $70 million. The cases have
been consolidated into a single proceeding and the court has approved the
designation of a lead plaintiff and the retention of lead plaintiffs' counsel.
Plaintiffs have filed a consolidated and amended complaint. Safeguard and the
other defendants have moved to dismiss this complaint for failure to state a
claim upon which relief may be granted. While the outcome of this litigation is
uncertain, the Company believes that it has valid defenses to plaintiffs' claims
and intends to defend the lawsuits vigorously.
Gilman v. Safeguard Scientifics, Inc. and Warren V. Musser
On June 26, 2001, the Company and Warren V. Musser, the Company's former
Chairman, were named as defendants in a putative class action filed in federal
court in Philadelphia. Plaintiffs allege that defendants failed to disclose that
Mr. Musser had pledged some or all of his Safeguard stock as collateral to
secure margin trading in his personal brokerage accounts. Plaintiffs allege that
defendants' failure to disclose the pledge, along with their failure to disclose
several margin calls and the consequences thereof on Safeguard's stock price,
violated the federal securities laws. Plaintiffs allege claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934.
On August 17, 2001, a second putative class action was filed against the
Company and Mr. Musser asserting claims similar to those brought in the first
proceeding. In addition, plaintiffs in the second case allege that the
defendants failed to disclose possible or actual manipulative aftermarket
trading in the securities of the Company's partner companies, the impact of
competition on prospects for one or more of the Company's partner companies and
the Company's lack of a superior business plan.
The Company expects that these two cases will be consolidated for further
proceedings and that it will respond to the allegations following consolidation.
While the outcome of this litigation is uncertain, the Company believes that it
has valid defenses to plaintiffs' claims and intends to defend the lawsuit
vigorously.
The Company and its subsidiaries are involved in various other 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 Company's consolidated financial position or results of
operations.
19. RELATED PARTY TRANSACTIONS
During October 2000, the Company extended a $10 million loan to the Company's
former Chairman and Chief Executive Officer, Mr. Musser, and guaranteed a $35
million loan to Musser, each in connection with his margin loan arrangements.
Mr. Musser had incurred margin debt and obligations with respect to margin debt
at several brokerage firms. The securities subject to the margin account
included approximately 8,000,000 shares of Safeguard common stock. With the goal
of maintaining an orderly trading market for Safeguard's stock, Safeguard
extended the guarantee and advanced the loan. The $10 million loan bore interest
at the prime rate and was payable in full on March 15, 2001. On December 3,
2000, Mr. Musser repaid in full the principal and accrued interest on the $10
million loan. Mr. Musser's obligations to the Company under the guarantee
arrangements were secured by interests in securities and real estate. In May
2001, Safeguard
17
consummated a definitive agreement with Mr. Musser under which the Company
loaned Mr. Musser $26.5 million to repay in full Mr. Musser's margin loans which
were guaranteed by the Company and to pay certain tax obligations and expenses.
As a result of the repayment of these margin loans, the Company's $35 million
guarantee was extinguished. The loan bears interest at an annual rate of 7% and
is payable on demand at any time after January 1, 2003. Mr. Musser granted the
Company security interests in securities and real estate as collateral. Until
April 30, 2006, the Company will have recourse only against the collateral.
There can be no assurance that the proceeds realized by the Company in the
future from dispositions of the collateral will be sufficient to repay the loan
in full. After April 30, 2006, the Company will have recourse against Mr. Musser
personally, except with respect to certain ongoing compensation to be received
by Mr. Musser. The Company has the right to sell the collateral at any time and
apply the net after-tax proceeds from the sales of the collateral against
amounts outstanding on the loan. The outstanding balance of the loan at
September 30, 2001 was approximately $25.4 million.
In 1999, the Company loaned an officer and a director of CompuCom $0.8
million to exercise CompuCom stock options. Interest on the note accrues at a
rate of 4.3% per annum, and principal and interest on the note is due on
December 31, 2001.
In 2001, the Company entered into employment agreements with certain of its
executive officers. The Company agreed to pay severance amounts under certain
circumstances. During the three months ended September 30, 2001, the Company
recorded expense of $3.1 million and made payments of $0.3 million under these
agreements. The remaining liability of $2.8 million is included in accrued
expenses on the consolidated balance sheets. In October 2001, the Company made
payments under these arrangements to an executive officer in the amount of $2.1
million.
During October 2001, the Company appointed a new Chief Executive Officer
and a new Chairman. During the fourth quarter of 2001, the Company entered into
an employment agreement with the new Chief Executive Officer providing for,
among other things, a base salary of $500,000 per year and a grant of 1,000,000
options at a price per share of $2.115, the fair market value on the date of
grant. In addition, the Company entered into an employment agreement with the
Company's former Chairman and Chief Executive Officer providing for annual
payments of $650,000 per year for life. The Company also entered into an
arrangement with its new Chairman under which he will receive annual fees of
$75,000 and a grant of 75,000 options at a price per share of $2.115.
18
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The statements contained in this report that are not historical facts are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements involve certain risks,
uncertainties and other factors that could cause actual results to be materially
different than those contemplated by these statements. These risks and
uncertainties include the factors described elsewhere in this report and in our
filings with the SEC, including our Annual Report on Form 10-K for the year
ended December 31, 2000. We do not assume any obligation to update any
forward-looking statements or other information contained in this report.
Although we refer in this report to the companies in which we have acquired
an equity ownership interest as our "partner companies" and that we indicate
that we have a "partnership" with these companies, we are not a "partner" in a
legal sense, and do not act as an agent or legal representative for any of our
partner companies, we do not have the power or authority to legally bind any of
our partner companies and we do not have the types of liabilities in relation to
our partner companies that a general partner of a partnership would have.
Certain amounts for prior periods in the consolidated financial statements,
and in the discussion below, have been reclassified to conform with current
period presentations.
GENERAL
We are a leader in identifying, developing and operating emerging
technology companies through our extensive network of partner companies and
private equity funds (collectively, affiliates). Our operations are classified
into three operating segments: i) General Safeguard Operations; ii) Partner
Company Operations; and iii) CompuCom Operations. We acquire interests in
developing technology companies, provide management support and operations
services, and integrate these companies into our operating network. We focus on
what we believe to be the most significant market sectors of the infrastructure
technology industry. We believe our experience developing technology companies,
our expertise in and focus on infrastructure technology and the reach of our
network enable us to identify and attract companies with significant potential
for success in the infrastructure technology market.
Our principal mission is to create long-term shareholder value. We believe
shareholder value is maximized by retaining and promoting the entrepreneurial
culture of the partner companies that we operate. The entrepreneurs of our
partner companies generally retain significant equity interests in their
businesses, and their interests as shareholders remain aligned with ours. We
provide operational and management services to each of our partner companies in
the areas of business and technology strategy, sales and marketing, operations,
finance and legal and transactional support, and provide hands-on assistance to
the management of the partner company in support of its growth. The level of
involvement varies and in some circumstances includes the provision of full-time
interim personnel. Since we are a long-term partner, we pursue various
alternatives to maximize the long-term value of our partner companies. These
alternatives include preparing our partner companies for initial public
offerings, assisting with mergers and acquisitions and facilitating additional
capital raising activities.
We participate in managing 12 private equity funds which are located on our
corporate campus. In addition, we are a limited partner in 5 other private
equity funds and an investor in 2 similar entities. Collectively, these 19
entities, which have over $4.0 billion of committed capital, augment our network
by providing us with an expanded base through which we conduct our operations,
including acquisition syndication opportunities. We believe our network of
private equity funds creates opportunities for us and our partner companies to
form strategic alliances and partnerships that may develop or enhance their
businesses. Also, the personal relationships and expertise of the professionals
employed by these funds are important resources for developing and evaluating
acquisition opportunities. We frequently refer opportunities that may not fit
our operating strategy or deal criteria to an appropriate fund.
Because we acquire significant interests in technology-related developing
companies, many of which generate net losses, we have experienced, and expect to
continue to experience, significant volatility in our quarterly results. While
some of our affiliates have consistently reported losses, we have recorded net
income in certain periods and experienced significant volatility from period to
period due, in part, to one-time transactions and other events incidental to our
ownership interests in and advances to affiliates. We do not know if we will
report net income in any period. These transactions and events include
dispositions of, and changes to, our affiliate ownership interests, dispositions
of our holdings of
19
affiliates and impairment charges. On a continuous basis, but no less frequently
than at the end of each quarterly reporting period, we evaluate the carrying
value of our ownership interests in and advances to each of our affiliates for
possible impairment based on achievement of business plan objectives and
milestones, the fair value of each ownership interest in and advances to each
affiliate relative to its carrying value, the financial condition and prospects
of the affiliate 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 the hiring of key employees or the establishment of strategic
relationships.
We operate in an industry which is rapidly evolving and extremely
competitive. It is reasonably possible that our accounting estimates with
respect to the useful life and ultimate recoverability of the carrying value,
including goodwill, 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 affiliates 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 of the carrying value
will not be required in the future.
EFFECT OF VARIOUS ACCOUNTING METHODS ON THE CONSOLIDATED FINANCIAL STATEMENTS
The various interests that we acquire in our partner companies and private
equity funds are accounted for under three broad methods: consolidation, equity
and cost. The applicable accounting method is generally determined based on our
voting interest in the entity.
Consolidation. Partner companies in which we directly or indirectly own
more than 50% of the outstanding voting securities are generally accounted for
under the consolidation method of accounting. If this majority voting ownership
is likely to be temporary, we account for the company under the equity method.
Under the consolidation method, a partner company's results of operations are
included within our consolidated statements of operations. Participation of
other partner company shareholders in the income or losses of a consolidated
partner company is reflected in minority interest in our consolidated statements
of operations. The minority interest amount adjusts our consolidated net income
(loss) to reflect only our share of the earnings or losses of the consolidated
partner company. CompuCom Systems, Inc., Tangram Enterprise Solutions, Inc.,
SOTAS, Inc. and aligne, incorporated were consolidated in 2001 and 2000. In
August 2000, aligne acquired 100% of K Consultants. In January 2001, we acquired
100% of Palarco, Inc. Effective August 2001, we consolidated our ownership in
PTM Productions. Each of these partner companies was consolidated from the date
we acquired directly or indirectly more than 50% of the outstanding voting
securities interest. Arista Knowledge Systems, Inc. was sold in July 2000 and is
included in our consolidated operating results through its sale date.
Equity Method. Partner companies and private equity funds whose results we
do not consolidate, but over whom we exercise significant influence, or for whom
majority voting ownership is likely to be temporary, are generally accounted for
under the equity method of accounting. Whether or not we exercise significant
influence with respect to a partner company depends on an evaluation of several
factors including, among others, our representation on the partner company's
board of directors and ownership level, which is generally a 20% to 50% interest
in the voting securities of the partner company, including voting rights
associated with our holdings in common, preferred and other convertible
instruments in the partner company. Under the equity method of accounting, a
partner company's results of operations are not reflected within our
consolidated statement of operations; however, our share of the income or losses
of the partner company is reflected in equity income (loss) in our consolidated
statements of operations. The share of income or losses is generally based upon
our voting ownership of the partner company's securities, which may be different
from the percentage of the economic ownership of the partner company held by us.
We also account for our interests in some private equity funds under the equity
method of accounting, based on our respective general and limited partner
interests.
20
The effect of an affiliate's net results of operations on our results of
operations is the same under either the consolidation method of accounting or
the equity method of accounting, because under each of these methods only our
share of the income or losses of an affiliate is reflected in our net results of
operations in the consolidated statements of operations. Our partner companies
accounted for under the equity method of accounting at September 30, 2001
included:
PARTNER VOTING VOTING
COMPANY OWNERSHIP OWNERSHIP
SINCE 9/30/01 12/31/00
----- ------- --------
PUBLICLY TRADED:
Cambridge Technology Partners 1991 (a) 17%
ChromaVision Medical Systems 1996 31% 30%
DocuCorp International 1995 20% 18%
eMerge Interactive 1997 16% 17%
Internet Capital Group 1996 14% 14%
Lifef/x 1996 44% 12%
OAO Technology Solutions(b) 1996 31% 31%
Sanchez Computer Associates 1986 24% 25%
USDATA Corporation 1994 43% 40%
PRIVATELY HELD:
Agari 2001 44% n/a
AgWeb.com 2000 43% 43%
Atlas Commerce 2000 34% 35%
Buystream 2000 27% 31%
iMedium 1999 31% 31%
Kanbay 1998 30% 30%
Mantas 2001 30% n/a
NexTone Communications 2000 37% 38%
Nextron Communications 1995 49% 54%
Persona 1999 30% 30%
QuestOne Decision Sciences 1997 31% 31%
TechSpace 2000 42% 45%
ThinAirApps 2000 34% 34%
Wireless OnLine 2000 42% 43%
(a) The Company sold its holdings in Cambridge Technology Partners in July
2001.
(b) The Company sold its holdings in OAO Technology Solutions in October 2001.
We have representation on the boards of directors of these partner
companies. Although we own less than 20% of the voting stock of some of these
companies, we believe we have the ability to exercise significant influence
based on our representation on each company's board of directors and other
factors. We own greater than 50% of the voting stock of some of these companies;
however, we believe majority voting ownership is temporary. In addition to our
holdings in equity and debt securities, we also periodically make advances to
our affiliates in the form of promissory notes. The carrying value of advances
to affiliates totaled $11.0 million and $7.3 million at September 30, 2001 and
December 31, 2000.
Cost Method. Partner companies and private equity funds that we do not
account for under either the consolidation or the equity method of accounting
are accounted for under the cost method of accounting. Under this method, our
share of the income or losses of these entities is not included in our
consolidated statements of operations. However, the effect of the change in
market value of cost method holdings classified as trading securities is
reflected in our results of operations during each reporting period.
21
EFFECT OF VARIOUS ACCOUNTING METHODS ON THE PRESENTATION OF OUR CONSOLIDATED
FINANCIAL STATEMENTS
The presentation of our financial statements may differ from period to
period primarily due to the applicable accounting method used for recognizing
our equity interests in the operating results of an affiliate. For example, the
presentation of our financial statements are significantly influenced by the
consolidated results of operations of CompuCom, which we consolidate based on
our 59% voting interest.
To understand our net results of operations and financial position without
the effect of consolidating our consolidated partner companies, please refer to
note 15 of our consolidated financial statements, which summarizes our parent
company statements of operations and balance sheets and presents consolidated
partner companies as if they were accounted for under the equity method of
accounting. Our share of the income or losses of the consolidated partner
companies is included in equity income (loss) in the parent company statements
of operations. The carrying value of these companies is included in ownership
interests in and advances to affiliates in the parent company balance sheets.
Although the parent company statements of operations and balance sheets
presented in note 15 reflect our historical results, they are not necessarily
indicative of future parent company balance sheets and statements of operations.
NET RESULTS OF OPERATIONS
The following table reflects consolidated operating data by reported
segments. All significant intersegment activity has been eliminated.
Accordingly, segment results reported exclude the effect of transactions between
us and our subsidiaries.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
- -------------------------------------------------------------------------------------------------------------------------
2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
SUMMARY OF CONSOLIDATED NET INCOME (LOSS)
General Safeguard Operations $ (27,090) $ 35,807 $ (86,499) $ 98,295
Partner Company Operations (49,426) (63,480) (352,097) (90,426)
CompuCom Operations 433 2,485 2,298 (1,289)
- -------------------------------------------------------------------------------------------------------------------------
$ (76,083) $ (25,188) $ (436,298) $ 6,580
=========================================================================================================================
22
NET RESULTS OF OPERATIONS - GENERAL SAFEGUARD OPERATIONS
General Safeguard Operations includes the expenses of providing strategic
and operational support to our affiliates, and also includes the effect of
certain private equity funds that we account for under the equity method.
General Safeguard Operations also includes the effect of transactions and other
events incidental to our ownership interests in our partner companies and our
operations in general.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Revenue $ 6,836 $ 4,630 $ 19,798 $ 12,719
Operating expenses
General and administrative 17,127 22,059 48,301 61,207
Depreciation and amortization 676 457 2,119 1,312
- ------------------------------------------------------------------------------------------------------------------------
Total operating expenses 17,803 22,516 50,420 62,519
- ------------------------------------------------------------------------------------------------------------------------
(10,967) (17,886) (30,622) (49,800)
Other income (loss), net (12,860) 34,457 (50,435) 117,519
Interest and financing, net (4,040) 1,259 (9,877) (2,678)
- ------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and equity income (27,867) 17,830 (90,934) 65,041
Income taxes 1,860 (8,902) 1,796 (42,590)
Equity income (loss) (1,083) 26,879 2,639 75,844
- ------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) from General Safeguard Operations $ (27,090) $ 35,807 $ (86,499) $ 98,295
========================================================================================================================
Revenue. Revenue consists of management fees charged to private equity
funds for operational and management services. Revenue was $6.8 million and $4.6
million for the three months ended September 30, 2001 and 2000, and $19.8
million and $12.7 million for the nine months ended September 30, 2001 and 2000.
This increase was related to the formation of additional private equity funds
during 2000.
General and Administrative. Our general and administrative expenses consist
primarily of employee compensation, outside services such as legal, accounting
and consulting, and travel-related costs. General and administrative expenses
were $17.1 million for the three months ended September 30, 2001 compared to
$22.1 million in 2000. Excluding general and administrative costs related to the
private equity funds, general and administrative costs decreased $7.0 million
for the three months ended September 30, 2001 compared to the prior year period.
General and administrative costs decreased $12.9 million for the nine months
ended September 30, 2001 compared to the same period in 2000. Excluding general
and administrative costs related to the private equity funds and $11.8 million
of non-cash charges in 2000, general and administrative costs decreased $11.9
million for the nine months ended September 30, 2001 compared to the prior year
period. These decreases are the result of certain cost reduction efforts
undertaken in the fourth quarter of 2000 and during 2001, including a reduction
in employee compensation and travel-related costs as a result of the reduction
in headcount, and reduced consulting fees.
23
Other Income (Loss), Net. Other income (loss), net, for the General
Safeguard Operations segment consisted of the following:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- -------------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Gain on sale of public holdings, net $ (1,182) $ 742 $ 210 $ 60,615
Gain on sale of private partner companies, net 267 36,461 1,785 56,270
Unrealized loss on derivative financial instrument 3,257 - (13,271) -
Unrealized loss on trading securities, net (675) (1,273) (1,801) (2,093)
Other, primarily impairment charges (14,527) (1,473) (37,358) 2,727
- -------------------------------------------------------------------------------------------------------------------
$ (12,860) $ 34,457 $ (50,435) $ 117,519
===================================================================================================================
During the three months ended September 30, 2001, we sold shares of public
holdings for aggregate net proceeds of $35.1 million and recorded losses of $1.2
million. During the nine months ended September 30, 2001, we sold shares of
public holdings for aggregate net proceeds of $53.6 million and recorded gains
of $0.2 million. During the three months ended September 30, 2000, we sold
shares of public holdings for aggregate net proceeds of $5.4 million and
recorded gains of $0.7 million. During the nine months ended September 30, 2000,
we sold shares of public holdings, including Diamond Technology Partners and
eMerge Interactive (in its IPO), for aggregate net proceeds of $91.3 million and
recorded gains of $60.6 million.
We implemented SFAS 133 effective January 1, 2001. The net gain recognized
during the three months ended September 30, 2001 on the Tellabs forward sale
contracts was $3.3 million, including a $34.2 million gain on the change in fair
value of the hedging contract, reduced by a $30.9 million loss on the change in
fair value of the Tellabs holdings. The net loss recognized during the nine
months ended September 30, 2001 on these forward sale contracts was $13.2
million. This loss includes a $111.5 million gain on the change in the fair
value of the hedging contract, reduced by a $124.7 million loss on the change in
fair value of the Tellabs holdings.
Included in other income (loss), net, for the three and nine months ended
September 30, 2001 are impairment charges of approximately $14.5 million and
$37.4 million for certain holdings accounted for under the cost method
determined to have experienced an other than temporary decline in value.
Interest and Financing Expense, Net. Interest expense was $4.0 million for
the three months ended September 30, 2001 versus $1.3 million of income for the
three months ended September 30, 2000. Interest expense was $9.9 million for the
nine months ended September 30, 2001 and $2.7 million for the nine months ended
September 30, 2000. The change is due to higher interest income earned in 2000
on funds raised in our April 2000 follow-on public offering and from strategic
investors, partially offset by lower interest rates.
Income Taxes. The Company's consolidated income tax benefit recorded for
the three months ended September 30, 2001, was $0.6 million net of a recorded
valuation allowance of $22.3 million. The Company's consolidated income tax
benefit recorded for the nine months ended September 30, 2001, was $6.8 million
net of a recorded valuation allowance of $138.0 million. The Company has
recorded a valuation allowance to reduce its deferred tax asset to an amount
that is more likely than not to be realized in future years.
24
NET RESULTS OF OPERATIONS - PARTNER COMPANY OPERATIONS
Partner Company Operations reflects the operations of all of our partner
companies other than CompuCom (included in CompuCom Operations). The partner
companies included in Partner Company Operations are accounted for under either
the consolidation or the equity method.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Revenue $ 20,577 $ 13,140 $ 55,839 $ 27,890
Operating expenses
Cost of sales 13,619 5,072 34,017 9,788
Selling and service 4,999 3,640 14,581 9,551
General and administrative 2,863 2,531 9,464 12,993
Depreciation and amortization 3,783 1,965 9,721 5,700
- ------------------------------------------------------------------------------------------------------------------------
Total operating expenses 25,264 13,208 67,783 38,032
- ------------------------------------------------------------------------------------------------------------------------
(4,687) (68) (11,944) (10,142)
Interest and financing, net (129) (152) (317) (847)
- ------------------------------------------------------------------------------------------------------------------------
Loss before income taxes and equity loss (4,816) (220) (12,261) (10,989)
Income taxes (753) 24,654 7,259 39,180
Minority Interest - - - 229
Equity loss (43,857) (87,914) (347,095) (118,846)
- ------------------------------------------------------------------------------------------------------------------------
Net Loss from Partner Company Operations $ (49,426) $ (63,480) $ (352,097) $ (90,426)
========================================================================================================================
Revenue. Revenue consists of charges for consulting services by our wholly
owned subsidiary, aligne, K Consultants subsequent to its acquisition by aligne
in August 2000, and Palarco subsequent to its acquisition in January 2001.
Revenue also includes sales by Tangram and SOTAS. Revenue was $20.6 million and
$13.1 million for the three months ended September 30, 2001 and 2000, and $55.8
million and $27.9 million for the nine months ended September 30, 2001 and 2000.
The increase in revenue in 2001 was the result of the acquisitions of K
Consultants in August 2000 and Palarco in January 2001.
Operating Expenses. Operating expenses were $25.3 million and $13.2 million
for the three months ended September 30, 2001 and 2000 and $67.8 million and
$38.0 million for the nine months ended September 30, 2001 and 2000. The
increase in expenses in 2001 was the result of the acquisitions of K Consultants
and Palarco.
Equity Loss. A significant portion of our net results of operations is
derived from companies in which we hold a significant minority ownership
interest. Under the equity method of accounting, if we exercise significant
influence over a partner company, we record our share of the income or losses of
that partner company in our consolidated statements of operations. The share of
income or losses is generally based upon our voting ownership of the partner
company's securities. Our carrying value for a partner company accounted for
under the equity method includes the unamortized excess of the cost of our
interest in the partner company over its equity in the underlying net assets
determined at the date of acquisition. This excess is amortized on a
straight-line basis generally over a 3 to 10 year period and is included in
equity loss in the consolidated statements of operations.
Equity loss fluctuates with the number of companies accounted for under the
equity method, our voting ownership percentage in these companies, the
amortization of goodwill related to newly acquired equity method companies and
the net results of operations of these companies. Equity loss also includes
impairment charges when management determines there has been an other than
temporary decline in the carrying value of its ownership interest relative to
the fair value.
Equity loss was $43.9 million and $87.9 million for the three months ended
September 30, 2001 and 2000. During the three months ended September 30, 2001
and 2000, we accounted for 24 and 34 companies on the equity method. During the
three months ended September 30, 2000 Internet Capital Group's equity loss was
$36.4 million compared to $0 in the three months ended September 30, 2001.
Goodwill amortization of $5.5 million and $10.0 million is included in equity
loss for the three months ended September 30, 2001 and 2000. Write-downs for the
other than temporary declines in value of
25
partner companies of $5.3 million for the three months ended September 30, 2001
and zero in 2000, are also included in equity loss. The remaining equity loss of
$33.1 million and $41.5 million for the three months ended September 30, 2001
and 2000 relates to our share of 24 and 33 partner company operating results, a
majority which have losses.
Equity loss was $347.1 million and $118.8 million for the nine months ended
September 30, 2001 and 2000. During the nine months ended September 30, 2001, we
accounted for 34 companies on the equity method versus 38 in 2000. During the
nine months ended September 30, 2001 and 2000, $136.5 and $11.6 million losses
were attributable to Internet Capital Group. Goodwill amortization of $20.0
million and $17.2 million is included in equity loss for the nine months ended
September 30, 2001 and 2000. Write-downs for the other than temporary declines
in value of partner companies of $63.9 million and $4.7 million for the nine
months ended September 30, 2001 and 2000, are also included in equity loss. The
remaining equity loss of $126.7 million and $85.3 million for the nine months
ended September 30, 2001 and 2000 relates to our share of 33 and 37 partner
company operating results, a majority which have losses.
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.
Many of our privately held, equity method partner companies are
technology-related companies with limited operating histories that have not yet
generated significant revenues and have incurred substantial losses in 2000 and
the nine months ended September 30, 2001. We expect these losses to continue in
Q4 2001 and beyond. We expect to continue to acquire interests in more
technology-related companies that may have operating losses and that we may
account for under the equity method. Additionally, we expect certain of our
existing partner companies to continue to invest in their products and services
and to recognize operating losses. As a result, equity losses could continue to
increase significantly. Additionally, we operate in an industry that is rapidly
evolving and extremely competitive. It is reasonably possible that the
impairment factors evaluated by management will change in subsequent periods,
given that we operate in a volatile business environment. This could result in
material impairment charges in future periods.
NET RESULTS OF OPERATIONS - COMPUCOM OPERATIONS
CompuCom Operations reflects the results of our majority-owned subsidiary,
CompuCom.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2001 2000 2001 2000
- ------------------------------------------------------------------------------------------------------------------------
(in thousands)
(unaudited)
Revenue
Product sales $ 332,877 $ 656,383 $ 1,234,956 $ 1,805,488
Service sales 71,883 68,493 212,801 196,710
- ------------------------------------------------------------------------------------------------------------------------
404,760 724,876 1,447,757 2,002,198
Operating expenses
Cost of sales - Product 299,792 604,404 1,121,887 1,669,369
Cost of sales - Service 45,638 41,206 137,382 130,089
Selling and service 29,286 33,816 93,703 101,890
General and administrative 22,415 27,258 66,675 72,677
Depreciation and amortization 5,550 5,610 17,629 17,379
Restructuring - - - 5,169
- ------------------------------------------------------------------------------------------------------------------------
Total operating expenses 402,681 712,294 1,437,276 1,996,573
- ------------------------------------------------------------------------------------------------------------------------
2,079 12,582 10,481 5,625
Other income, net - - - 1,958
Interest and financing, net (455) (4,326) (2,932) (11,797)
- ------------------------------------------------------------------------------------------------------------------------
Income (loss) before income taxes and minority interest 1,624 8,256 7,549 (4,214)
Income taxes (520) (1,887) (2,282) 169
Minority interest (671) (3,884) (2,969) 2,756
- ------------------------------------------------------------------------------------------------------------------------
Net Income (Loss) from CompuCom Operations $ 433 $ 2,485 $ 2,298 $ (1,289)
========================================================================================================================
26
On July 16, 2001, CompuCom purchased certain assets and assumed certain
liabilities of Excell Data Corporation (Excell) for approximately $27 million in
available cash. The net assets acquired were used by Excell primarily in its
business of high-end technical applications development, network infrastructure
design and deployment and worldwide event technical planning and support.
Essentially all of the Excell workforce, consisting of technical application
developers, consultants and administrative personnel, were hired as part of the
Excell acquisition. The purpose of the Excell acquisition is to expand
CompuCom's service offerings.
On January 10, 2001, CompuCom purchased certain assets of MicroAge
Technology Services, L.L.C. (MTS). The assets were purchased out of bankruptcy
court and primarily consisted of trade accounts receivable as well as vendor
accounts receivable and inventory. The purchase price of approximately $79
million (after post-closing adjustments) was financed using available cash. The
purchased assets were used by MTS primarily in its business as a systems
integrator of personal computer products. As part of the MTS acquisition,
CompuCom also hired certain of MTS' national sales force, technical service
personnel and administrative personnel.
Product Revenue. Product revenue, which is primarily derived from the sale
of desktop, networking and mobile computing products, as well as peripherals and
software-related products and licenses to corporate clients, decreased 49% in
the three months ended September 30, 2001 and decreased 32% for the nine months
ended September 30, 2001 when compared to the same periods in 2000. On a
sequential quarter basis, product revenue declined 21% from the second quarter
of 2001 to the third quarter of 2001. The product revenue decrease was primarily
a result of both a decline in units sold and lower average selling prices,
partially offset by additional product revenue generated as a result of the MTS
acquisition and an increase in software license revenue. CompuCom believes the
decreased volume can be attributed to general economic weakness which has
resulted in lower demand for personal computer products primarily by its Fortune
1000 client base. As a result of this economic slowdown, product purchases and
IT projects are being delayed, downsized or cancelled. In addition, product
revenue has been negatively impacted by certain clients electing to participate
in certain manufacturers' direct fulfillment programs, thereby fulfilling their
product requirements directly from the manufacturer.
Service Revenue. Service revenue increased 4.9% in the three months ended
September 30, 2001 compared to 2000 and increased 8.2% for the nine months ended
September 30, 2001 compared to 2000. On a sequential quarter basis, service
revenue increased 4.2% from the second quarter of 2001 compared to the third
quarter of 2001. Service revenue is primarily derived from all aspects of
desktop outsourcing, including field engineering, as well as help desk and
LAN/WAN network outsourcing, configuration, asset tracking, software management,
mobile computing services, IT consulting, application development, network
infrastructure and deployment, event technical planning and support and services
provided in support of certain manufacturers' direct fulfillment initiatives.
Service revenue reflects revenue generated by the actual performance of specific
services and does not include product sales associated with service projects.
The increase in service revenue was primarily due to increased service revenue
related to field engineering and help desk outsourcing, the majority of which
was related to the MTS acquisition, as well as the impact of the Excell
acquisition. Partially offsetting these increases were declines in demand for
services directly related to the sale of product and CompuCom's consulting
services. The increase in service revenue from the second quarter of 2001 to the
third quarter of 2001 was due primarily to the Excell acquisition, partially
offset by decreased service revenue primarily related to field engineering and
help desk outsourcing.
Product Gross Margin. Product gross margin as a percentage of product
revenue was 9.9% and 7.9% for the three months ended September 30, 2001 and 2000
and 9.2% and 7.5% for the nine months ended September 30, 2001 and 2000. Product
gross margin as a percentage of product revenue was 9.0% in the second quarter
of 2001. This increase was primarily due to a decline in revenue generated by
higher volume, lower margin clients, a relative increase in the amount of vendor
volume incentives and the achievement of other operational efficiencies.
Partially offsetting the increase in gross margin was the impact of the increase
in lower margin software license revenue.
Service Gross Margin. Service gross margin as a percentage of service
revenue was 36.5% and 39.8% for the three months ended September 30, 2001 and
2000 and 35.4% and 33.9% for the nine months ended September 30, 2001 and 2000.
The decrease in service gross margin for the three month period was primarily
due to lower utilization of CompuCom's service-related resources as a result of
lower demand for CompuCom's product-dependent and consulting services. In
addition, the gross margin percentage generated on Excell revenue is lower
relative to the collective gross margin percentage of CompuCom's other
service-related offerings. The increase in service gross margin for the nine
month period is primarily due to improvements in the management and utilization
of service-related resources.
27
Due to both the general economic environment and competitive conditions,
CompuCom expects to continue to experience competitive pressure on both revenue
and gross margin, the result of which may be to report lower revenue and related
gross margin when compared to the comparable prior year period or the previous
quarter.
Selling and Service. Selling and service expense decreased $4.5 million for
the three months ended September 30, 2001 compared to 2000, and decreased $8.2
million for the nine months ended September 30, 2001 compared to 2000. The
decrease relates primarily to CompuCom's cost management efforts relative to
personnel and infrastructure, partially offset by personnel and infrastructure
costs associated with the Excell acquisition, as well as increased personnel and
training costs and investments in the service infrastructure associated with
supporting the service business. Selling and service expenses were 7.2% and 4.7%
of revenue for the three months ended September 30, 2001 and 2000 and 6.5% and
5.1% for the nine months ended September 30, 2001 and 2000. CompuCom attributes
this percentage increase primarily to the decline in product revenue for the
comparable periods.
General and Administrative. General and administrative expenses decreased
$4.9 million in the three months ended September 30, 2001 compared to the prior
year period and decreased $6.0 million in the nine months ended September 30,
2001 compared to the prior year period. The decrease is reflective of CompuCom's
ongoing cost management efforts relative to personnel-related and infrastructure
costs. CompuCom's operating expenses are reported net of reimbursements by
certain vendors for specific training, promotional and marketing programs. These
reimbursements offset the expenses incurred by CompuCom.
Restructuring. In 2000, CompuCom implemented a restructuring plan designed
to reduce its cost structure by closing and consolidating certain sites and
reducing its workforce. As a result, CompuCom recorded a restructuring charge of
$5.2 million in the first quarter of 2000.
Interest and financing expense, net was $0.5 million and $4.3 million for
the three months ended September 30, 2001 and 2000 and $2.9 million and $11.8
million for the nine months ended September 30, 2001 and 2000. The decrease in
interest and financing expense was primarily due to CompuCom's improved
management of working capital, as well as lower financing requirements resulting
from the decline in product revenue. The decline in interest and financing
expense was also due to the effect of greater interest income generated from
investing increased available cash as well as lower effective borrowing rates in
2001 as compared to 2000.
LIQUIDITY AND CAPITAL RESOURCES
We have funded our operations with proceeds from the issuance of equity
securities and convertible notes, proceeds from forward sale contracts, proceeds
from sales of partner companies and distributions from private equity funds. Our
ability to raise proceeds from sales of publicly traded partner companies could
be adversely affected by market declines.
In November 2001, we entered into a commitment for a new credit agreement
to provide for the issuances of letters of credit up to $10 million. We
occasionally use letters of credit to provide transactional support to our
partner companies. Outstanding letters of credit under the agreement must be
cash secured. The new credit facility is subject to an unused commitment fee of
0.25% per annum payable quarterly, and is subject to reduction based on deposits
maintained at the bank. We terminated our former credit facility in November
2001. The former credit facility provided for borrowings up to $100 million and
provided for unused commitment fees of 0.4% and an annual agent's fee. As of
September 30, 2001, a letter of credit totaling $3.0 million was outstanding.
Availability under the former credit facility was determined by the market value
of those securities pledged as collateral.
In 1999, in order to mitigate our market exposure and generate cash, we
entered into two forward sale contracts related to 3.4 million shares of its
holdings in Tellabs common stock. We pledged these shares of Tellabs under
contracts that expire in March and August 2002 and, in return, received
approximately $139 million of cash. At maturity, we are required to deliver cash
or Tellabs stock with a value determined by the stock price of Tellabs at
maturity. The number of Tellabs shares to be delivered at maturity will range
between 2.7 million to 3.4 million depending on the price of Tellabs stock at
that date. We currently intend to deliver shares of Tellabs to settle these
contracts.
Our cash and cash equivalents at September 30, 2001 and other internal
sources of cash flow are expected to be sufficient to fund our cash requirements
for at least the next twelve months, including commitments to our existing
affiliates, our current operating plan to acquire interests in new affiliates
and our general corporate requirements.
In October 2000, we guaranteed a $35 million loan to our Chairman and CEO,
Mr. Musser, in connection with margin loan arrangements. In May 2001, we
consummated a definitive agreement with Mr. Musser under which we loaned Mr.
Musser $26.5 million to repay in full Mr. Musser's margin loans which were
guaranteed by us and to pay certain tax obligations and expenses. As a result of
the repayment of these margin loans, our $35 million guarantee was extinguished.
The loan bears interest at an annual rate of 7% and is payable on demand at any
time after January 1, 2003. Mr. Musser granted us security interests in
securities and real estate as collateral. Until April 30, 2006, we will have
recourse only against the collateral. There can be no assurance that the
proceeds realized by the Company in the future from dispositions of the
collateral will be sufficient to repay the loan in full. After April 30, 2006,
we will have recourse against Mr. Musser personally, except with respect to
certain ongoing compensation
28
to be received by Mr. Musser. We have the right to sell the collateral at any
time and apply the net after-tax proceeds from the sales of collateral against
amounts outstanding on the loan. The outstanding balance of the loan at
September 30, 2001 was approximately $25.4 million.
At September 30, 2001 we were contingently obligated for $9.9 million of
guarantee commitments. Additionally, we have committed capital of approximately
$84.7 million, including commitments made in prior years to various affiliates,
to be funded over the next several years, including approximately $39.8 million
which is expected to be funded in the next twelve months. If a consolidated
partner company achieves agreed upon performance criteria over the next year, we
will be obligated to pay up to an aggregate amount of $6.8 million primarily in
common stock as additional purchase price consideration to the former
shareholders of the company.
CompuCom maintains separate, independent financing arrangements, which are
non-recourse to us and are secured by certain assets of CompuCom. CompuCom's
working capital requirements are generally funded through financing arrangements
and internally generated funds.
At September 30, 2001, CompuCom has a $100 million working capital facility
and a $150 million receivables securitization facility. The working capital
facility, which matures in May 2002, bears interest at LIBOR plus an agreed upon
spread and is secured by a lien on CompuCom's assets. Availability under the
facility is subject to a borrowing base calculation. As of September 30, 2001,
availability under the working capital facility was approximately $52 million,
and there were no amounts outstanding. The securitization facility's pricing is
based on a designated short-term interest rate plus an agreed upon spread.
CompuCom has an agreement with two financial institutions that allows it to
sell, at a discount, an interest in a portion of its trade accounts receivable
to each such financial institution. As collections reduce receivables balances
sold, CompuCom may sell interests in new receivables to bring the amount
available up to the maximum allowed. Amounts outstanding as sold receivables at
September 30, 2001 consisted of two certificates totaling $87 million, one
certificate for $37 million with an April 2002 maturity date and one certificate
for $50 million with an October 2003 maturity date. Both facilities are subject
to CompuCom's compliance with selected financial covenants and ratios.
CompuCom's liquidity continues to be negatively impacted by the dollar
volume of certain manufacturers' rebate programs. Under these programs, CompuCom
is required to pay a higher initial amount for product and claim a rebate from
the manufacturer to reduce the final cost. The collection of these rebates can
take an extended period of time. Due to these programs, CompuCom's initial cost
for the product is often higher than the sales price CompuCom can obtain from
its clients. These programs are a material factor in CompuCom's financing needs.
As of September 30, 2001, CompuCom was owed approximately $24 million under
these vendor rebate programs.
CompuCom's ability to make distributions to its shareholders is limited by
restrictions in CompuCom's financing agreements and CompuCom's working capital
needs. We do not consider CompuCom's liquidity to be a source of liquidity to
us.
Consolidated working capital increased to $318 million at September 30,
2001 compared to $314 million at December 31, 2000. The increase is due to an
increase in cash and cash equivalents offset by decreases in receivables and
inventories.
Cash provided by operating activities increased in 2001 compared to 2000
due to increased operating cash flow by CompuCom. This is primarily attributable
to decreases in receivables and inventories. CompuCom's receivables have
decreased primarily due to the decline in revenue relative to the fourth quarter
of 2000. Partially offsetting the impact of CompuCom's lower revenue levels was
a reduction in the amount of receivables utilized under their securitization
facility. The decrease in CompuCom's inventories is primarily due to lower
product demand and CompuCom's ongoing efforts to minimize risk associated with
suppliers' price protection and returns programs by maintaining lower inventory
levels, which resulted in higher inventory turns.
Cash used in investing activities primarily reflects the acquisition of
ownership interests in and advances to affiliates. Cash used in investing
activities also reflects acquisitions by our subsidiaries. The decrease relates
primarily to reduced acquisition activity in 2001 and the decrease in short-term
investments and restricted cash, partially offset by reduced sales of securities
and sales of and distributions from affiliates.
During the first nine months of 2001, we made net commitments of
approximately $49.3 million to acquire interests in and make advances to partner
companies, and we funded $77.9 million to partner companies and private equity
funds. From October 1, 2001 through November 12, 2001, we funded $8.2 million of
commitments made prior to September 30, 2001.
In October 2001, we sold all of our holdings on OAO Technology Solutions
for total proceeds of $12 million, including $9.5 million in cash.
29
Our general operations are not capital asset intensive, and capital
expenditures in any year normally will not be significant in relation to our
overall financial position. There were no material capital asset purchase
commitments at September 30, 2001.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards (SFAS) No. 141, "Business Combinations", and
SFAS No. 142, "Goodwill and Other Intangible Assets". SFAS No. 141 requires that
the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria
that intangible assets acquired in a purchase method business combination must
meet to be recognized and reported apart from goodwill, noting that any purchase
price allocable to an assembled workforce may not be accounted for separately.
SFAS No. 142 will require that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 will
also require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets". We are required to adopt the
provisions of SFAS No. 141 immediately, except with regard to business
combinations initiated prior to July 1, 2001, and SFAS No. 142 will become
effective January 1, 2002. Furthermore, any goodwill and any intangible asset
determined to have an indefinite useful life that are acquired in a purchase
business combination completed after June 30, 2001 will not be amortized, but
will continue to be evaluated for impairment in accordance with the appropriate
pre-SFAS No. 142 accounting literature. Goodwill and intangible assets acquired
in business combinations completed before July 1, 2001 will continue to be
amortized prior to the adoption of SFAS No. 142. SFAS No. 141 will require that
upon adoption of SFAS No. 142, we will be required to evaluate our existing
intangible assets and goodwill that were acquired in prior purchase business
combinations, and to make any necessary reclassifications in order to conform
with the new criteria in SFAS No. 141 for recognition apart from goodwill. Upon
adoption of SFAS No. 142, we will be required to reassess the useful lives and
residual values of all intangible assets acquired in purchase business
combinations, and make any necessary amortization period adjustments by the end
of the first interim period after adoption. In addition, to the extent an
intangible asset is identified as having an indefinite useful life, we will be
required to test the intangible asset for impairment in accordance with the
provisions of SFAS No. 142 within the first interim period. Any impairment loss
will be measured as of the date of adoption and recognized as the cumulative
effect of a change in accounting principle in the first interim period. In
connection with the transitional goodwill impairment evaluation, SFAS No. 142
will require that we perform an assessment of whether there is an indication
that goodwill and equity-method goodwill is impaired as of the date of adoption.
To accomplish this, we must identify its reporting units and determine the
carrying value of each reporting unit by assigning the assets and liabilities,
including the existing goodwill and intangible assets, to those reporting units
as of the date of adoption. We will then have up to six months from the date of
adoption to determine the fair value of each reporting unit and compare it to
the reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and we must perform the second step of the transitional
impairment test. In the second step, we must compare the implied fair value of
the reporting unit's goodwill, determined by allocating the reporting unit's
fair value to all of it assets (recognized and unrecognized) and liabilities in
a manner similar to a purchase price allocation in accordance with SFAS No. 141,
to its carrying amount, both of which would be measured as of the date of
adoption. This second step is required to be completed as soon as possible, but
no later than the end of the year of adoption. Any transitional impairment loss
will be recognized as the cumulative effect of a change in accounting principle
in our statement of operations.
At September 30, 2001, we had unamortized goodwill in the amount of $214.0
million which will be subject to transition provisions of SFAS No. 141 and 142.
Amortization expense related to goodwill was $40.8 million for the nine months
ended September 30, 2001. Because of the extensive effort needed to comply with
adopting SFAS No's. 141 and 142, it is not practicable to reasonably estimate
the impact of adopting these statements on our financial statements at the date
of this report, including whether any transitional impairment losses will be
required to be recognized as the cumulative effect of a change in accounting
principle.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 requires entities to record the fair value
of a liability for an asset retirement obligation in the period in which it is
incurred. We will adopt SFAS No. 143 in fiscal year 2003. We do not expect the
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provisions of SFAS No. 143 to have any significant impact on our financial
condition or results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which supercedes both SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and the accounting and reporting provisions of APB
Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of
Disposal of a Segment of a Business and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions" (Opinion 30), for the disposal of a segment
of a business (as previously defined in that Opinion). SFAS No. 144 retains the
fundamental provisions in SFAS No. 121 for recognizing and measuring impairment
losses of long-lived assets held for use and long-lived assets to be disposed of
by sale, while also resolving significant implementation issues associated with
SFAS No. 121. SFAS No. 144 retains the basic provisions of Opinion 30 on how to
present discontinued operations in the income statement but broadens the
presentation to include a component of an entity (rather than a segment of a
business). Unlike SFAS No. 121, an impairment assessment under SFAS No. 144 will
never result in a write-down of goodwill. Rather, goodwill is evaluated for
impairment under SFAS No. 142, "Goodwill and Other Intangible Assets".
We are required to adopt SFAS 144 in fiscal year 2002. Management does not
expect the adoption of SFAS 144 for long-lived assets held for use to have a
material impact on our financial statements because the impairment assessment
under SFAS 144 is largely unchanged from SFAS No. 121. The provisions of the
Statement for assets held for sale or other disposal generally are required to
be applied prospectively after the adoption date to newly initiated disposal
activities. Therefore, management cannot determine the potential effects that
adoption of SFAS 144 will have on our financial statements.
FACTORS THAT MAY AFFECT FUTURE RESULTS
We operate in a rapidly changing environment that involves a number of
risks, some of which are beyond our control. Forward-looking statements in this
report and those made from time to time by us through our senior management team
are made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Factors that could cause actual results to differ
materially from results anticipated in forward-looking statements are described
in our SEC filings, including our Annual Report on Form 10-K for the year ended
December 31, 2000. These factors include, but are not limited to, the following:
- - Industry-specific conditions affecting the infrastructure technology
business sector in which many of our affiliates operate, such as intense
competition, rapid changes in technology and customer demands, frequent new
product introductions and shifting distribution channels.
- - Many of our affiliates are early-stage companies with limited operating
histories, no historical profits and financing requirements that they may
not be able to satisfy. These affiliates may not have operating income or
net income in the future and their financial results may vary dramatically
from quarter to quarter.
- - We may have problems raising money we need in the future to fund the needs
of our affiliates and to make acquisitions of affiliates.
- - We may incur significant costs to avoid investment company status and may
suffer adverse consequences if deemed to be an investment company.
- - Our strategy of selling assets of our interests in some of the affiliates
that we have acquired and developed is dependent on the strength of the
public equity market and on the level of activity in the mergers and
acquisitions market in the affiliates' industry, as well as on the
requirements of the Federal securities laws regulating the sale of
securities.
- - Our financial results are likely to vary dramatically from quarter to
quarter depending upon various events. These events include the financial
results of our affiliates and the way that the partner companies are
reflected in our consolidated financial statements, sales of partner
companies or our interests in partner companies and distributions from
private equity funds which we manage or in which we have an interest.
- - Our stock price may be subject to significant fluctuation because the value
of some of our partner companies fluctuates and because of market
conditions generally.
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to equity price risks on the marketable portion of our
securities. These securities include equity positions in companies in the
technology industry, many of which have experienced significant volatility in
their stock prices. Historically, we have not attempted to reduce or eliminate
our market exposure on securities (except the Tellabs transactions as described
below). Based on closing market prices at September 30, 2001, the fair market
value of our holdings in public securities was approximately $206 million
(excluding our holdings in Tellabs). A 20% decrease in equity prices would
result in an approximate $41 million decrease in the fair value of our publicly
traded securities.
In 1999, we entered into two forward sale contracts related to our
remaining holdings in Tellabs. We pledged 3.4 million shares of Tellabs for
three years and in return received approximately $139 million in cash. At the
end of the term, we have the option to deliver cash or Tellabs shares with a
value determined by the stock price of Tellabs at maturity. The number of
Tellabs shares to be delivered at maturity ranges from 2.7 million to 3.4
million shares (or the cash value thereof).
CompuCom is exposed to interest rate risk primarily through its receivables
securitization and working capital facilities. CompuCom utilizes these
facilities to meet its working capital and other financing needs. At September
30, 2001, the securitization facility had borrowings of approximately $87
million, and there were no borrowings on the working capital facility. If
CompuCom's effective interest rate were to increase by 100 basis points, or
1.00%, CompuCom's annual interest and financing expense would increase by $1.2
million based on CompuCom's average balances utilized under its facilities
during the nine months ended September 30, 2001. Our share of this increase
would be approximately $0.7 million after deduction for minority interest but
before income taxes.
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PART II
OTHER INFORMATION
Item 1. Legal Proceedings
Safeguard and various associated entities and persons have been named in two
putative class action proceedings, one of which arises out of the initial public
offering of Opus 360 Corporation. These proceedings are described in Note 18 of
the Notes to Consolidated Financial Statements contained in Item 1 of Part I of
this Form 10-Q, which note is incorporated by reference in its entirety into
this Item 1 of Part II.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
------ -----------
3.1 Safeguard Scientifics, Inc. Amended Bylaws (2) (Exhibit 3.1)
10.1 Fourth Amendment to Inventory and Working Capital Financing Agreement dated as of January
10, 2001 by and between CompuCom Systems, Inc. and IBM Credit Corporation (1)
(Exhibit 10.28.5)
10.2 Credit Agreement dated May 23, 2001, by and among Safeguard Scientifics, Inc., Safeguard
Scientifics (Delaware), Inc., Safeguard Delaware, Inc., and PNC Bank, NA (exhibits omitted)
(4) (Exhibit 10.2)
10.3 Consulting Agreement dated July 3, 2001 between Safeguard Scientifics, Inc. and Vincent G.
Bell, Jr. (4) (Exhibit 10.3)
10.4 Amended and Restated Demand Note dated May 18, 2001 given by Warren V. Musser for advances
by Bonfield Insurance, LTD (4) (Exhibit 10.4)
10.5 Agreement to Restructure by and among Warren V. Musser and Hillary Grinker Musser and
Safeguard Scientifics, Inc. and Bonfield Insurance, LTD, dated as of April 16, 2001 (4)
(Exhibit 10.5)
10.6 Amendment to Agreement to Restructure by and among Warren V. Musser and Hillary Grinker
Musser and Safeguard Scientifics, Inc. and Bonfield Insurance, LTD, dated May 18, 2001 (4)
(Exhibit 10.6)
10.7 Amendment Number 1, dated as of May 17, 2001 to the Series 2000-1 Supplement, dated as of
October 2, 2000, by and among CSI Funding, Inc., CompuCom Systems, Inc., Lloyds TSB Bank PLC
and Wells Fargo Bank Minnesota, National Association (f/k/a Norwest Bank Minnesota, National
Association). (3) (Exhibit 10.7)
33
10.8 Amendment Number 2, dated as of May 17, 2001 to the Series 1999 -1 Supplement, dated as of
May 7, 1999, as amended and restated as of August 20, 1999 and as amended by Amendment
Number 1, dated as of October 2, 2000, by and among CSI Funding, Inc., CompuCom Systems,
Inc., PNC Bank, National Association, Market Street Funding Corporation and Wells Fargo Bank
Minnesota, National Association (f/k/a Norwest Bank Minnesota, National Association). (3)
(Exhibit 10.8)
10.9* Employment Agreement dated July 10, 2001 between Safeguard Scientifics, Inc. and Jerry L.
Johnson
10.10* Employment Agreement dated July 10, 2001 between Safeguard Scientifics, Inc. and N. Jeffrey
Klauder
10.11* Employment Agreement dated July 10, 2001 between Safeguard Scientifics, Inc. and Harry
Wallaesa
10.12* Separation Agreement dated August 28, 2001 between Safeguard Scientifics, Inc. and Gerald A.
Blitstein
10.13* Employment Agreement dated August 28, 2001 between Safeguard Scientifics, Inc. and
Christopher J. Davis
* Filed herewith
(1) Filed on April 2, 2001 as an Exhibit to the Company's Annual Report on Form 10-K and incorporated herein
by reference.
(2) Filed on May 15, 2001 as an Exhibit to Form 10-Q and incorporated herein by reference.
(3) Filed on August 14, 2001 as Exhibits to CompuCom Systems, Inc.'s Form 10-Q, and incorporated herein by
reference.
(4) Filed on August 14, 2001 as an Exhibit to Form 10-Q and incorporated herein by reference.
(b) Reports on Form 8-K
No reports on Form 8-K have been filed by the registrant
during the three months ended September 30, 2001.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SAFEGUARD SCIENTIFICS, INC.
(Registrant)
Date: November 14, 2001 /s/ Anthony L. Craig
---------------------------------------
Anthony L. Craig
Chief Executive Officer and President
Date: November 14, 2001 /s/ Christopher J. Davis
---------------------------------------
Christopher J. Davis
Executive Vice President and Chief
Financial Officer
(Principal Financial and Principal
Accounting Officer)
35