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 March 31, 2000 Commission File Number 1-5620
-------------- ------
SAFEGUARD SCIENTIFICS, INC.
- --------------------------------------------------------------------------------
(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
--------------
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
------- -------
Number of shares outstanding as of May 12, 2000
Common Stock 118,123,676
SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
------------------------------ ----
Item 1 - Financial Statements:
Consolidated Balance Sheets -
March 31, 2000 (unaudited) and December 31, 1999.................... 3
Consolidated Statements of Operations (unaudited) -
Three Months Ended March 31, 2000 and 1999.......................... 4
Consolidated Statements of Cash Flows (unaudited) -
Three Months Ended March 31, 2000 and 1999.......................... 5
Notes to Consolidated Financial Statements.......................... 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations................... 18
Item 3 - Quantitative and Qualitative Disclosures About Market Risk...... 29
PART II - OTHER INFORMATION
---------------------------
Item 2 - Changes in Securities and Use of Proceeds....................... 30
Item 4 - Submission of Matters to a vote of Security Holders............. 31
Item 6 - Exhibits and Reports on Form 8-K................................ 31
Signatures............................................................... 33
2
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
2000 1999
---------- ------------
(unaudited)
Assets
Current Assets
Cash and cash equivalents.................................. $ 4,658 $ 49,813
Accounts receivable, less allowances....................... 222,629 259,383
Inventories................................................ 101,175 129,826
Prepaid expenses and other current assets.................. 16,678 16,488
---------- ----------
Total current assets........................................ 345,140 455,510
Property and equipment, net................................. 54,092 56,234
Ownership interests in and advances to partner companies.... 759,195 529,381
Available-for-sale securities............................... 234,161 302,940
Excess of cost over net assets of businesses acquired, net.. 126,007 119,288
Other....................................................... 33,214 36,526
---------- ----------
Total Assets................................................ $1,551,809 $1,499,879
========== ==========
Liabilities and Shareholders' Equity
Current Liabilities
Current maturities of long-term debt....................... $ 3,751 $ 11,019
Accounts payable........................................... 138,449 183,781
Accrued expenses........................................... 116,091 126,871
---------- ----------
Total current liabilities................................... 258,291 321,671
Long-term debt.............................................. 65,024 14,532
Deferred taxes.............................................. 82,616 110,556
Minority interest........................................... 98,900 102,808
Other long-term liabilities................................. 180,679 175,611
Convertible subordinated notes.............................. 200,000 200,000
Commitments and contingencies
Shareholders' Equity
Preferred stock............................................. -- --
Common stock................................................ 10,740 10,475
Additional paid-in capital.................................. 247,480 133,969
Retained earnings........................................... 414,718 385,120
Accumulated other comprehensive (loss) income............... (5,193) 45,137
Treasury stock, at cost..................................... (1,446) --
---------- ----------
Total shareholders' equity.................................. 666,299 574,701
---------- ----------
Total Liabilities and Shareholders' Equity.................. $1,551,809 $1,499,879
========== ==========
See notes to consolidated financial statements.
3
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
Three Months Ended March 31,
----------------------------
2000 1999
-------- --------
(unaudited)
Revenue
Product sales................................... $507,308 $425,467
Service sales................................... 68,143 74,418
Other........................................... 3,745 3,007
-------- --------
Total revenue.................................... 579,196 502,892
Operating Expenses
Cost of sales--product.......................... 468,905 388,312
Cost of sales--service.......................... 47,014 47,991
Selling and service............................. 36,633 36,497
General and administrative...................... 48,227 27,368
Depreciation and amortization................... 8,330 5,725
Restructuring................................... 5,169 --
-------- --------
Total operating expenses......................... 614,278 505,893
-------- --------
(35,082) (3,001)
Gains on issuance of stock by partner companies.. -- 326
Other income, net................................ 50,021 51,333
Interest income.................................. 1,194 744
Interest expense................................. (10,698) (7,732)
-------- --------
Income Before Income Taxes, Minority
Interest and Equity Income (Loss)............... 5,435 41,670
Income taxes..................................... (15,937) (13,003)
Minority interest................................ 8,599 1,951
Equity income (loss)............................. 31,501 (6,470)
-------- --------
Net Income....................................... $ 29,598 $ 24,148
======== ========
Net Income Per Share
Basic........................................... $ 0.28 $ 0.25
Diluted......................................... $ 0.26 $ 0.24
Weighted Average Shares Outstanding
Basic........................................... 105,523 95,252
Diluted......................................... 117,310 104,557
See notes to consolidated financial statements.
4
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended March 31,
----------------------------
2000 1999
--------- ---------
(unaudited)
Operating Activities
Net income......................................................... $ 29,598 $ 24,148
Adjustments to reconcile to net cash provided by operating
activities:
Depreciation and amortization..................................... 8,330 5,725
Deferred income taxes............................................. (840) (2,109)
Equity (income) loss.............................................. (31,501) 6,470
Gain on issuance of stock by partner companies.................... -- (326)
Other income, net................................................. (50,021) (51,333)
Minority interest, net of taxes................................... (5,159) (1,171)
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable, net.......................................... 21,959 59,564
Inventories....................................................... 28,651 6,153
Accounts payable, accrued expenses, and other..................... (49,896) (41,828)
--------- ---------
Net cash (used in) provided by operating activities.............. (48,879) 5,293
Investing Activities
Proceeds from sales of available-for-sale securities............... 57,756 9,080
Proceeds from sales of partner company ownership interests......... 21,173 49,927
Advances to partner companies...................................... (14,025) (14,483)
Repayment of advances to partner companies......................... 10,050 2,300
Acquisitions of ownership interests in partner companies and
subsidiaries, net of cash acquired................................ (211,394) (52,745)
Acquisitions by subsidiaries, net of cash acquired................. (750) --
Proceeds from sale of building..................................... -- 39,791
Capital expenditures............................................... (2,536) (1,801)
Other, net......................................................... (858) (2,242)
--------- ---------
Net cash (used in) provided by investing activities.............. (140,584) 29,827
Financing Activities
Borrowings on revolving credit facilities.......................... 345,570 195,300
Repayments on revolving credit facilities.......................... (298,238) (270,543)
Borrowings on long-term debt....................................... 1,000 -
Repayments on long-term debt....................................... (5,802) (25,190)
Proceeds from financial instruments................................ -- 71,205
Repurchase of Company common stock................................. -- (253)
Issuance of Company common stock................................... 100,557 1,329
Issuance of subsidiary common stock................................ 1,221 583
--------- ---------
Net cash provided by (used in) financing activities.............. 144,308 (27,569)
--------- ---------
Net (Decrease) Increase in Cash and Cash Equivalents............... (45,155) 7,551
Cash and cash equivalents at beginning of period................... 49,813 6,257
--------- ---------
Cash and Cash Equivalents at End of Period......................... $ 4,658 $ 13,808
========= =========
See notes to consolidated financial statements.
5
SAFEGUARD SCIENTIFICS, INC.
Notes to Consolidated Financial Statements
March 31, 2000
1. General
-------
The accompanying unaudited interim consolidated financial statements were
prepared in accordance with generally accepted accounting principles for
interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. The 1999 Form 10-K, as
amended, 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. Comprehensive Income
--------------------
Comprehensive income is the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. Excluding net income, the Company's source of
comprehensive income is from net unrealized appreciation 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 in prior periods. The following summarizes
the components of comprehensive income (loss), net of income taxes, (in
thousands):
Three Months Ended
March 31,
2000 1999
-------- -------
(Unaudited)
Net Income............................... $ 29,598 $24,148
-------- -------
Other Comprehensive Loss, Before Taxes:
Unrealized holding losses........... (31,600) (6,167)
Reclassification adjustments........ (45,831) (5,872)
Related Tax Benefit:
Unrealized holding losses........... 11,060 2,158
Reclassification adjustments........ 16,041 2,055
-------- -------
Other Comprehensive Loss................. (50,330) (7,826)
-------- -------
Comprehensive (Loss) Income.............. ($20,732) $16,322
======== =======
3. Reclassifications
-----------------
Certain prior year amounts have been reclassified to conform to the current
year presentation.
4. Stock Split
-----------
On February 28, 2000, the Board of Directors approved a three-for-one split
to the Company's shareholders of record on March 13, 2000. All share and
per share data have been restated to reflect a three-for-one split of the
Company's common stock as if the stock split occurred as of January 1,
1999.
6
5. Financial Investments
---------------------
In 1999, in order to mitigate the Company's market exposure and generate
cash from holdings in Tellabs, the Company entered into two forward sale
contracts related to 3.4 million shares of its holdings in Tellabs. The
Company pledged these shares of Tellabs under contracts that expire in 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's liability of $179 million in connection with these
transactions is included in other long-term liabilities as of March 31,
2000. These liabilities are carried at fair value, based on quoted market
prices, with the unrealized gains and losses, net of tax, reported as a
separate component of shareholders' equity. The initial cost of the
transaction ($2.4 million) is being amortized as an adjustment of yield
over the life of the agreement through the statement of operations.
The Company's holdings in Tellabs are included in non-current assets under
the caption "available-for-sale securities." These securities are carried
at fair value, based on quoted market prices, with the unrealized gains and
losses, net of tax, is reported as a separate component of shareholders'
equity.
The Company has only limited involvement with derivative financial
instruments and does not use them for trading purposes. The risk of loss to
the Company in the event of nonperformance by the counterparty under the
forward sales contract is not considered to be significant. Although the
forward sales 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
6. Ownership Interests in and Advances to Partner Companies
--------------------------------------------------------
The following summarizes the Company's ownership interests in and advances
to partner companies accounted for under the equity method or cost method
of accounting (in thousands). The ownership interests are classified
according to applicable accounting methods at March 31, 2000 and December
31, 1999. Market value reflects the price of publicly traded holdings at
the close of business at the respective date, and excludes warrants that
are not currently exercisable.
March 31, 2000 December 31, 1999
-------------------------------- ---------------------
Carrying Market Voting Carrying Market
Value Value Interest Value Value
-------- ----------- --------- -------- -----------
(Unaudited)
Equity Method
Cambridge Technology Partners.. $ 55,577 $ 136,946 16% $ 49,181 $ 254,556
ChromaVision Medical Systems... 12,517 81,201 27% 13,626 81,201
DocuCorp International......... 9,914 17,848 17% 9,995 22,249
eMerge Interactive............. 4,539 158,965 13% 7,201 --(a)
Internet Capital Group......... 251,434 3,286,095 14% 189,068 6,169,208
LifeF/X........................ -- 75,464 12% -- 86,823
OAO Technology Solutions....... 16,496 42,507 30% 16,448 42,853
Sanchez Computer Associates.... 10,821 220,872 25% 11,686 258,995
Pac-West Telecomm.............. 7,770 74,226 7% 7,613 62,943
USDATA Corporation............. 12,598 88,116 38% 15,920 82,406
US Interactive................. 10,919 91,506 13% 9,769 107,795
Non-public companies........... 292,979 162,130
-------- --------
685,564 492,637
Cost Method
Non-public companies........... 42,489 16,266
Advances to Partner Companies.. 31,142 20,478
-------- --------
$759,195 $529,381
======== ========
(a) eMerge Interactive was not publicly traded until 2000.
Internet-related stocks have experienced significant volatility. For example,
at March 31, 2000, the market value of the Company's holdings in Internet
Capital Group was $3.3 billion. Based on the high and low stock prices from
January 1, 2000 through May 12, 2000, the market value of the Company's
holdings in Internet Capital Group has ranged from $7.3 billion to $1.1
billion.
At March 31, 2000, 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 $190 million. This excess
relates to ownership interests acquired through March 31, 2000, and is being
amortized generally over a ten-year period. Amortization expense of $3.0
million and $0.9 million, is included in "equity income (loss)" in the
accompanying consolidated statements of operations for the three months ended
March 31, 2000 and 1999, respectively.
As of March 31, 2000, 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 8% and variable rates consisting of the prime rate (9% at
March 31, 2000) plus 1%. The Company also has short-term advances to partner
companies of $6 million at March 31, 2000, which is included in "accounts
receivable, less allowances" on the consolidated balance sheets.
8
7. Available-for-Sale Securities
-----------------------------
Available-for-sale securities consisted of the following (in thousands):
March 31, 2000 December 31, 1999
------------------ ------------------
Carrying Market Carrying Market
Value Value Value Value
-------- -------- -------- --------
(Unaudited)
Tellabs...................... $212,731 $212,535 $212,731 $216,595
Diamond Technology Partners.. 373 6,433 710 57,436
First Consulting Group....... 2,049 2,126 9,115 9,023
e4L.......................... 1,457 979 1,457 1,532
Brandywine Realty Trust...... 8,561 8,552 8,561 8,177
Other public companies....... 3,080 3,536 6,480 10,177
Unrealized appreciation...... 5,910 63,886
-------- --------
$234,161 $302,940
======== ========
During the three months ended March 31, 2000, the Company sold a portion of
its interest in Diamond Technology Partners.
8. Debt
----
The following is a summary of long-term debt (in thousands):
March 31, December 31,
2000 1999
--------- ------------
(Unaudited)
Parent Company and Other Recourse Debt
Revolving credit facilities............... $32,115 $ --
Other..................................... 18,153 25,325
------- --------
50,268 25,325
Subsidiary Debt (Non-Recourse to Parent)
CompuCom.................................. 18,400 --
Other..................................... 107 226
------- --------
18,507 226
------- --------
Total debt................................ 68,775 25,551
Current maturities of long-term debt...... (3,751) (11,019)
------- --------
Long-term debt............................ $65,024 $ 14,532
======= ========
In April 2000, the Company increased the availability under the bank
revolving credit facility to $300 million from $200 million. Of the $300
million, $250 million matures in April 2005 and is secured by certain
equity securities the Company holds of its publicly traded partner
companies (the Pledged Securities). The remaining $50 million is unsecured,
with availability limited to the lesser of $50 million or 10% of the value
of the Pledged Securities. The $50 million facility matures in April 2001.
There was $32.1 million outstanding under the total facility at March 31,
2000.
9
CompuCom has financing arrangements consisting of a $250 million receivable
securitization facility and a $200 million working capital facility. Both
facilities mature in May 2002. The securitization facility allows CompuCom
to sell an interest in its accounts receivable on a revolving basis and is
accounted for as a sale of accounts receivable in accordance with Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". As of
March 31, 2000, $160 million of the securitization facility was utilized.
Availability under the working capital facility is subject to a borrowing
base calculation. As of March 31, 2000, availability under the working
capital facility was $68.8 million, of which $18.4 million was outstanding.
In accordance with the terms of the agreement, the working capital facility
is scheduled to be reduced from $200 million to $175 million in May 2000.
9. Shareholders' Equity
--------------------
Common Stock
In February 2000, the Company acquired the remaining 20% voting ownership
in aligne incorporated in exchange for 160,434 shares of the Company's
common stock with a market value of $8.2 million.
In March 2000, the Company closed the sale of 2.2 million shares of its
common stock for $100 million to Textron in a private placement. Textron
and the Company intend to work together to offer consulting services to
each other and their respective partner companies and subsidiaries and
explore a variety of potential strategic relationships with each other.
In April 2000, the Company completed a follow-on public offering, selling
8.6 million shares of its common stock, including exercise in full of the
underwriters' overallotment option, at $50 per share. Net proceeds to the
Company were approximately $414 million (net of underwriters' commission
and offering expenses).
In April 2000, the Company completed the sale of shares of its common stock
to IBM and Compaq, and formed strategic relationships with both companies.
Net proceeds to the Company from these transactions aggregated $100
million.
Stock Based Compensation
In February 2000, the Company granted 75,000 shares of restricted stock to
an executive. The fair value on the date of grant was $48.21 per share.
These shares vested immediately. The Company uses APB Opinion No. 25 to
account for stock-based compensation. The Company recorded compensation
expense related to this restricted stock award of $3.6 million during the
three months ended March 31, 2000.
During the three months ended March 31, 2000, the Company recorded $6
million of expense related to the termination of two of its former
executives.
10
10. Restructuring
-------------
During the first quarter of 2000, CompuCom effected a restructuring plan
designed to reduce its cost structure by closing its distribution facility
in Houston, Texas, closing and consolidating three office facilities, and
reducing its workforce. As a result, CompuCom recorded a restructuring
charge of $5.2 million in the first quarter of 2000, the effect of which
was approximately $2.6 million to the Company's pretax earnings, after
recording minority interest. The charge consists primarily of costs
associated with the closing and consolidation of certain facilities and
disposing of related fixed assets, as well as employee severance and
benefits related to the reduction in workforce. The following unaudited
table provides a detail of the charges and cash payments made by category
as well as the amounts accrued as of March 31, 2000 (in thousands):
Restructuring Cash Accrual at
Charge Payments Other(1) March 31, 2000
------ -------- -------- --------------
Lease termination costs.................. $2,904 $ (8) $ -- $2,896
Employee severance and related benefits.. 1,800 (999) -- 801
Other.................................... 465 (87) (310) 68
------ ------- ----- ------
Total.................................... $5,169 $(1,094) $(310) $3,765
====== ======= ===== ======
(1) Consists of non-cash charges for the write-off of leasehold
improvements at the closed facilities.
The $3.8 million accrued at March 31, 2000 is reflected in accrued
liabilities in the Company's Consolidated Balance Sheets.
Lease termination costs include the estimated cost to close the three
office facilities and represents the amount to either fulfill CompuCom's
obligation under signed lease contracts, the net expense expected to be
incurred to sublet the facilities, or the estimated amount to be paid to
terminate the lease contracts before the end of their term. In developing
the estimated costs, CompuCom has consulted with a professional real estate
firm with knowledge of market rent rates in all applicable markets where
CompuCom has space. Assumptions have been used for market rent rates and
the estimated amount of time to sublet the facilities. Payments, net of
proceeds derived from subleases, are charged against the accrual as
incurred. The remaining accrual at March 31, 2000 relates to three leases
for the office facilities that have not been sublet or terminated.
Severance is paid based on associates' years of service as well as their
level within the organization. The reduction included 308 associates, of
which 1 was an executive officer. The reduction in workforce included
associates from the following areas: sales, services and general and
administrative, who were located at certain branch locations, corporate
offices and the Houston distribution center. The remaining accrual at March
31, 2000 relates to severance payments which are being paid to many of the
former associates and are expected to be substantially complete by the end
of 2000.
Other restructuring charges primarily include the write-off of leasehold
improvements at the Houston distribution center.
11
During the fourth quarter of 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. The
following unaudited table provides a summary by category of the
restructuring accrual for the three months ended March 31, 2000 (in
thousands):
Accrued at Cash Accrual at
December 31, 1999 Payments March 31, 2000
----------------- --------- --------------
Employee severance and related benefits.. $ 560 $ (94) $466
Lease termination costs.................. 1,240 (741) 499
------ ----- ----
Total.................................... $1,800 $(835) $965
====== ===== ====
CompuCom expects all restructuring activities to be substantially complete
by the end of 2000 and believes the restructuring accruals are adequate.
11. Other Income, Net
-----------------
Other income, net, consists of the following (in thousands):
Three Months Ended
March 31,
2000 1999
------- -------
(Unaudited)
Unrealized gain (loss) on Tellabs stock.......... $ -- $49,639
Gain on sale of Diamond stock.................... 44,613 --
Gain on sale of other public holdings............ 7,643 5,872
Gain on distributions from private equity funds.. -- 2,701
Other, primarily impairment charges.............. (2,235) (6,879)
------- -------
$50,021 $51,333
======= =======
For the three months ended March 31, 2000 and 1999, the Company recorded
impairment charges of $2.4 million and $6.6 million, respectively, for the
other than temporary decline in the carrying value of certain partner
companies.
12
12. Net Income Per Share
--------------------
The calculations of EPS were (in thousands except per share amounts):
Three Months Ended
March 31,
2000 1999
-------- --------
(Unaudited)
Basic EPS
---------
Net Income......................................... $ 29,598 $ 24,148
======== ========
Average common shares outstanding.................. 105,523 95,252
======== ========
Basic EPS.......................................... $ 0.28 $ 0.25
======== ========
Diluted EPS
-----------
Net Income......................................... $ 29,598 $ 24,148
Effect of: Public holdings (a).................... (1,133) (54)
Dilutive securities (b)................ 1,776 725
-------- --------
Adjusted Net Income................................ $ 30,241 $ 24,819
======== ========
Average common shares outstanding.................. 105,523 95,252
Effect of: Dilutive options....................... 3,624 1,921
Dilutive securities (b)................ 8,163 7,384
-------- --------
Average number of common shares assuming dilution.. 117,310 104,557
======== ========
Diluted EPS........................................ $ 0.26 $ 0.24
======== ========
(a) Represents the dilutive effect of public company common stock
equivalents and convertible securities.
(b) Represents the dilutive effect of the Company's 5% 1999 convertible
subordinated notes for the three months ended March 31, 2000, and the
Company's 6% 1996 convertible subordinated notes for the three months
ended March 31, 1999.
13
13. 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 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 March 31, December 31,
2000 1999
---- ----
(Unaudited)
Assets
Cash and cash equivalents................................. $ 1,749 $ 33,536
Other current assets...................................... 19,268 39,204
Ownership interests in and advances to partner companies.. 893,751 687,925
Available-for-sale securities............................. 234,161 302,940
Other..................................................... 64,404 45,584
---------- ----------
Total assets.............................................. $1,213,333 $1,109,189
========== ==========
Liabilities and Shareholders' Equity
Current liabilities....................................... $ 37,950 $ 35,621
Long-term debt............................................ 46,558 14,354
Other long-term liabilities............................... 262,526 284,513
Convertible subordinated notes............................ 200,000 200,000
Shareholders' equity...................................... 666,299 574,701
---------- ----------
Total liabilities and shareholders' equity................ $1,213,333 $1,109,189
========== ==========
The carrying value of the Company's less than wholly owned subsidiaries,
primarily CompuCom, Tangram, SOTAS and Arista at March 31, 2000, and
including aligne at December 31, 1999, are included in "ownership interests
in and advances to partner companies."
Statements of Operations
------------------------
Three Months Ended
March 31,
2000 1999
---- ----
(Unaudited)
Revenue.............................................. $ 6,521 $ 3,207
Operating expenses................................... 25,720 7,037
-------- --------
(19,199) (3,830)
Gain on issuance of stock by partner companies....... -- 326
Other income, net.................................... 50,021 51,333
Interest, net........................................ (4,916) (2,541)
-------- --------
Income before income taxes and equity income (loss).. 25,906 45,288
Income taxes......................................... (19,337) (13,699)
Equity income (loss)................................. 23,029 (7,441)
-------- --------
Net income........................................... $ 29,598 $ 24,148
======== ========
The Company's shares of the income or losses of its less than wholly owned
subsidiaries, primarily CompuCom, Tangram, SOTAS and Arista for the three
months ended March 31, 2000 and CompuCom, Tangram and aligne for the three
months ended March 31, 1999, are reflected in the caption "equity income
(loss)".
14
14. Operating Segments
------------------
The Company's reportable segments, determined in accordance with SFAS 131,
are General Safeguard Operations, Partner Company Operations and CompuCom
Operations. General Safeguard Operations represent the expenses of
providing strategic and operational support to the Company's partner
companies, and the related administrative costs. General Safeguard
Operations also includes the effect of transactions and other events
incidental to the Company's ownership interests in its partner companies
and the Company's operations in general. Partner Company Operations
reflects operations of all partner companies other than CompuCom. CompuCom
Operations reflects the results of operations of CompuCom.
15
The following summarizes information related to the Company's segments (in
thousands). All significant intersegment activity has been eliminated.
Three Months Ended March 31,
----------------------------
2000 1999
-------- --------
(Unaudited)
Summary of Consolidated Net Income
General Safeguard Operations....................... $ 16,833 $ 28,993
Partner Company Operations......................... 17,654 (3,664)
CompuCom Operations................................ (4,889) (1,181)
-------- --------
$ 29,598 $ 24,148
======== ========
General Safeguard Operations
Revenue............................................ $ 5,727 $ 3,007
Operating expenses
General and administrative........................ 24,643 6,578
Depreciation and amortization..................... 1,077 459
-------- --------
Total operating expenses.......................... 25,720 7,037
-------- --------
(19,993) (4,030)
Gain on issuance of stock by partner companies.... -- 326
Other income, net................................. 50,021 51,333
Interest, net..................................... (5,024) (2,613)
-------- --------
Income before income taxes........................ 25,004 45,016
Income taxes...................................... (8,171) (16,023)
-------- --------
Net Income from General Safeguard Operations....... $ 16,833 $ 28,993
======== ========
Partner Company Operations
Revenue............................................ $ 6,048 $ 6,565
Operating expenses
Cost of Sales..................................... 1,309 1,454
Selling and service............................... 2,499 1,927
General and administrative........................ 3,605 1,723
Depreciation and amortization..................... 1,242 834
-------- --------
Total operating expenses.......................... 8,655 5,938
-------- --------
(2,607) 627
Interest, net..................................... (215) (45)
-------- --------
Income (loss) before income taxes,
minority interest and equity income (loss)....... (2,822) 582
Income taxes (expense) benefit.................... (11,025) 2,265
Minority interest................................. -- (41)
Equity income (loss).............................. 31,501 (6,470)
-------- --------
Net Income (Loss) from Partner Company Operations.. $ 17,654 $ (3,664)
======== ========
CompuCom Operations
Revenue............................................ $567,421 $493,320
Operating expenses
Cost of Sales..................................... 513,479 434,849
Selling and service............................... 34,134 34,570
General and administrative........................ 21,110 19,067
Depreciation and amortization..................... 6,011 4,432
Restructuring..................................... 5,169 --
-------- --------
Total operating expenses.......................... 579,903 492,918
-------- --------
(12,482) 402
Interest, net..................................... (4,265) (4,330)
-------- --------
Income before income taxes and minority interest.. (16,747) (3,928)
Income taxes...................................... 3,259 755
Minority interest................................. 8,599 1,992
-------- --------
Net Loss from CompuCom Operations.................. $ (4,889) $ (1,181)
======== ========
16
15. Business Combinations
---------------------
Acquisitions by the Company
In February 2000, the Company acquired the remaining 20% voting ownership
in aligne in exchange for 160,434 shares of the Company's common stock with
a market value of $8.2 million.
In February 1999, the Company acquired an 80% voting ownership in aligne in
exchange for 1.3 million shares of the Company's common stock with a market
value of $16.5 million. In June 1999, the Company acquired a 75% voting
ownership in SOTAS for $9.4 million and assumed certain liabilities.
Acquisitions by Subsidiaries
In May 1999, CompuCom purchased from ENTEX Information Services, Inc.
certain assets of its Technology Acquisition Services Division (Entex) in a
cash transaction. This acquisition was structured as an asset purchase.
Under the terms of the agreement, CompuCom paid approximately $137 million
and assumed certain liabilities for the acquired assets, which consisted
primarily of inventory, certain fixed assets and the Erlanger, Kentucky
distribution center. The initial purchase price allocation for this
acquisition is preliminary and may be adjusted upon completion of the final
valuation work.
The following unaudited pro forma financial information (in thousands
except per share amounts) presents the combined results of operations of
the Company as if the acquisitions had occurred as of January 1, 1999,
after giving effect to certain adjustments, including amortization of
goodwill, increased interest 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
March 31, 1999
------------------
Total Revenues.............. $937,235
Net Earnings................ $ 21,838
Diluted earnings per share.. $ 0.21
16. Subsequent Events
-----------------
As discussed in Note 9, in April 2000, the Company completed a public
offering of 8.6 million shares of its common stock at $50 per share.
As discussed in Note 9, in April 2000, the Company completed a sale of its
common stock for $100 million to certain strategic investors, bringing the
total raised from strategic investors to $200 million in 2000.
As discussed in Note 8, in April 2000, the Company increased its
availability under its bank revolving credit facilities to $300 million
from $200 million.
17
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations contains forward-looking statements that involve
risks and uncertainties. Our actual results could differ materially from
those anticipated in these forward-looking statements as a result of
certain factors, including those set forth elsewhere in this report and the
risks discussed in our other SEC filings. The following discussion should
be read in conjunction with our Financial Statements and related Notes
thereto included elsewhere in this report.
General
We are a leading Internet company actively engaged in the Internet
infrastructure business through our extensive network of partner companies.
We acquire interests in developing Internet infrastructure companies and
incubate and integrate these companies into our network. We focus on what
we believe to be the most significant market sectors of the Internet
infrastructure industry: software, communications and eServices. We believe
that our experience developing technology companies, our expertise in and
focus on Internet infrastructure and the reach of our network, which
includes Internet Capital Group's business-to-business electronic commerce
companies, enable us to identify and attract companies with significant
potential for success in the Internet infrastructure market. We intend to
be the premier network of Internet infrastructure companies offering
solutions, seamless connectivity and eServices to businesses engaged in
electronic commerce.
Our principal mission is to promote long-term shareholder value. We believe
shareholder value is maximized by retaining and promoting the
entrepreneurial culture of our partner companies. 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 a full range of operational and management services to each of
our partner companies through dedicated teams of Safeguard professionals.
Each team has expertise in the areas of business and technology strategy,
sales and marketing, operations, finance, legal and transactional support,
and human resources, and provides 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 providing
additional capital. We typically retain a significant ownership position in
our partner companies after they complete their initial public offerings.
We developed the Safeguard Subscription Program to give our shareholders
the opportunity to participate in the initial public offerings of our
partner companies. The offering ratio varies, but is based on the number of
shares being offered under the program by the partner company in relation
to the number of Safeguard shares outstanding at the time of an offering.
We completed Safeguard Subscription Programs in conjunction with the
initial public offerings of Internet Capital Group, Inc., US Interactive,
Inc. and Pac-West Telecomm, Inc. in 1999, and with the initial public
offering of eMerge Interactive, Inc. in February 2000 and OPUS360
Corporation in April 2000.
Our net income could fluctuate significantly from quarter to quarter. There
can be no assurance that we will report net income in each period.
18
Effect of Various Accounting Methods on the Consolidated Financial
Statements
The various interests that we acquire in our partner companies are
accounted for under three broad methods: consolidation, equity and cost.
The applicable accounting method is generally determined based on our
voting interest in a partner company.
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. Under this 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 the caption "minority interest" in our consolidated
statements of operations. Minority interest adjusts our consolidated net
income to reflect only our share of the income or losses of the
consolidated partner company. CompuCom Systems, Inc., Tangram Enterprise
Solutions, Inc., and aligne, incorporated were consolidated in 2000 and
1999. During the three months ended June 30, 1999, we acquired controlling
majority voting interests in SOTAS, Inc., and Arista Knowledge Systems Inc.
Each of these partner companies was consolidated from the date we acquired
directly or indirectly more than 50% of the outstanding voting securities
interest.
Equity Method. Partner companies whose results we do not consolidate, but
over whom we exercise significant influence, 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, 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
the caption "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.
Our partner companies accounted for under the equity method of accounting
at March 31, 2000 and December 31, 1999 included:
Partner Voting Voting
Company Ownership Ownership
Since 3/31/00 12/31/99
----- ------- --------
Publicly Traded
Cambridge Technology Partners (Massachusetts), Inc... 1991 16% 16%
ChromaVision Medical Systems, Inc.................... 1996 27% 27%
DocuCorp International, Inc.......................... 1995 17% 17%
eMerge Interactive, Inc.............................. 1997 13% 19%
Internet Capital Group, Inc.......................... 1996 14% 14%
LifeF/X, Inc......................................... 1996 12% 13%
OAO Technology Solutions, Inc........................ 1996 30% 31%
Pac-West Telecomm, Inc............................... 1998 7% 7%
Sanchez Computer Associates, Inc..................... 1986 25% 26%
USDATA Corporation................................... 1994 38% 38%
US Interactive, Inc.................................. 1998 13% 13%
19
Partner Voting Voting
Company Ownership Ownership
Since 3/31/00 12/31/99
------- ------- --------
Privately Held
4anything.com, Inc............................. 1999 28% 28%
AgWeb.com, Inc................................. 2000 41% N/A
The Basketball Network LLC, d/b/a HoopsTV.com.. 1999 24% 24%
Buystream.com.................................. 2000 34% N/A
Extant, Inc.................................... 1999 15% 21%
fob.com, Inc................................... 2000 30% N/A
iMedium, Inc................................... 1999 31% 23%
Integrated Visions, Inc........................ 1998 49% (a) 49%(a)
Kanbay LLC..................................... 1998 27% 28%
Mi8 Corporation................................ 2000 38% N/A
Nextone Communications, Inc.................... 2000 38% N/A
PrivaSeek, Inc................................. 1999 30% 33%
QuestOne Decision Sciences Corporation......... 1997 35% 35%
RealTIME Media, Inc............................ 1999 43% 43%
RedLeaf Group LLC.............................. 2000 30% N/A
Techspace LLC.................................. 2000 49% N/A
Techspace Ventures LLC......................... 2000 78% N/A
Vitts Networks, Inc............................ 1999 42% 48%
WebTelecomm, Inc............................... 2000 42% N/A
Who? Vision Systems, Inc....................... 1998 29% (a) 29%(a)
Wireless OnLine, Inc........................... 2000 43% N/A
XL Vision, Inc................................. 1995 18% 18%
(a) We owned non-voting convertible securities in these companies.
However, we believe we have the ability to exercise significant
influence based on our representation on the board of directors and
other factors. This percentage represents the voting ownership
assuming the conversion of all non-voting convertible securities.
At March 31, 2000, we owned voting securities in all the privately held
companies listed except Integrated Visions and Who? Vision Systems. We have
representation on the board of directors of all of the above partner
companies. Although we own less than 20% of the voting stock of some of the
above companies, we believe we have the ability to exercise significant
influence based on our representation on the board of directors and other
factors. We also account for our interests in some private equity funds
under the equity method of accounting, based on our general and limited
partner interest. In addition to our holdings in voting and non-voting
equity and debt securities, we also periodically make advances to our
partner companies in the form of promissory notes. We had advances to
equity method partner companies totaling $36 million at March 31, 2000.
Many of our privately held, equity method partner companies are Internet-
related companies with limited operating histories that have not generated
significant revenues and incurred substantial losses in 2000. We expect
these losses to continue in 2000. Our equity losses may also increase as a
result of our acquisition of interests in, and operation of, additional
Internet-related companies.
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 earnings or losses of these companies 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.
20
Effect of Various Accounting Methods on the Presentation of our 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 a partner
company. For example, the presentation of our financial statements is
significantly influenced by the consolidated results of operations of
CompuCom, which we consolidated based on our 60% 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 13 to our consolidated financial statements, which summarizes
our parent company statements of operations and balance sheets and presents
our consolidated partner companies as if they were accounted for under the
equity method of accounting for all periods presented. 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 partner companies" in the parent company balance sheets.
Although the parent company statements of operations and balance sheets
presented in note 13 reflect our historical results, they are not
necessarily indicative of future parent company balance sheets and
statements of operations.
Net Results of Operations
Our reportable segments include General Safeguard Operations, Partner
Company Operations and CompuCom Operations. General Safeguard Operations
represents the expenses of providing strategic and operational support to
our partner companies, and the related administrative costs. General
Safeguard Operations include the effect of transactions and other events
incidental to our ownership interests in our partner companies and our
operations in general. Partner Company Operations reflects operations of
all partner companies other than CompuCom. The partner companies included
under Partner Company Operations have been accounted for under the
consolidated, equity or cost method depending on their particular
circumstances. CompuCom Operations reflects the consolidated results of
CompuCom. All significant intersegment activity has been eliminated.
21
The following summarizes information related to the Company's segments (in
thousands). All significant intersegment activity has been eliminated.
Three Months Ended March 31,
----------------------------
2000 1999
-------- --------
(Unaudited)
Summary of Consolidated Net Income
General Safeguard Operations....................... $ 16,833 $ 28,993
Partner Company Operations......................... 17,654 (3,664)
CompuCom Operations................................ (4,889) (1,181)
-------- --------
$ 29,598 $ 24,148
======== ========
General Safeguard Operations
Revenue............................................ $ 5,727 $ 3,007
Operating expenses
General and administrative........................ 24,643 6,578
Depreciation and amortization..................... 1,077 459
-------- --------
Total operating expenses.......................... 25,720 7,037
-------- --------
(19,993) (4,030)
Gain on issuance of stock by partner companies.... -- 326
Other income, net................................. 50,021 51,333
Interest, net..................................... (5,024) (2,613)
-------- --------
Income before income taxes........................ 25,004 45,016
Income taxes...................................... (8,171) (16,023)
-------- --------
Net Income from General Safeguard Operations....... $ 16,833 $ 28,993
======== ========
Partner Company Operations
Revenue............................................ $ 6,048 $ 6,565
Operating expenses
Cost of Sales..................................... 1,309 1,454
Selling and service............................... 2,499 1,927
General and administrative........................ 3,605 1,723
Depreciation and amortization..................... 1,242 834
-------- --------
Total operating expenses.......................... 8,655 5,938
-------- --------
(2,607) 627
Interest, net..................................... (215) (45)
-------- --------
Income (loss) before income taxes,
minority interest and equity income (loss)....... (2,822) 582
Income taxes (expense) benefit.................... (11,025) 2,265
Minority interest................................. -- (41)
Equity income (loss).............................. 31,501 (6,470)
-------- --------
Net Income (Loss) from Partner Company Operations.. $ 17,654 $ (3,664)
======== ========
CompuCom Operations
Revenue............................................ $567,421 $493,320
Operating expenses
Cost of Sales..................................... 513,479 434,849
Selling and service............................... 34,134 34,570
General and administrative........................ 21,110 19,067
Depreciation and amortization..................... 6,011 4,432
Restructuring..................................... 5,169 --
-------- --------
Total operating expenses.......................... 579,903 492,918
-------- --------
(12,482) 402
Interest, net..................................... (4,265) (4,330)
-------- --------
Income before income taxes and minority interest.. (16,747) (3,928)
Income taxes...................................... 3,259 755
Minority interest................................. 8,599 1,992
-------- --------
Net Loss from CompuCom Operations.................. $ (4,889) $ (1,181)
======== ========
22
Net Results of Operations--General Safeguard Operations
During the three months ended March 31, 1999, aligne's operating results
were included in the Partner Company Operations segment. During the first
quarter of 2000, we acquired the remaining 20% of aligne. As a result,
effective January 1, 2000, aligne's results of operations are included in
the General Safeguard Operations segment.
Revenue. Revenue consists of administrative service fees charged to certain
partner companies and private equity funds for operational and management
services provided through a team of our professionals, and, effective
January 1, 2000, charges for consulting services by our wholly owned
subsidiary, aligne. Revenue was $5.7 million for the three months ended
March 31, 2000, and $3.0 million for the three months ended March 31, 1999.
The increase was the result of an increase in the number of partner
companies, and the inclusion of aligne's revenues. Effective April 1,
2000, the Company will no longer charge administrative services fees to its
partner companies. These fees accounted for $0.7 million of revenue for the
three months ended March 31, 2000.
General and Administrative. Our general and administrative costs consist
primarily of employee compensation, outside services such as legal,
accounting, marketing and consulting, and travel-related costs. General and
administrative expenses were $24.6 million for the three months ended March
31, 2000 and $6.6 million for the three months ended March 31, 1999. The
increase was primarily a result of approximately $10 million of non-cash
compensation charges related primarily to severance packages for two former
executives and a restricted stock grant. Excluding these non-cash charges,
general and administrative expenses increased $8.0 million, reflecting the
growth in the number of partner companies to 45 at March 31, 2000 compared
to 27 at March 31, 1999. The increase represents expenses incurred to
support the growing number and related activities of the Company and our
partner companies, including payroll-related, professional fees and
marketing costs. We expect these costs to continue to be higher compared to
historical periods due to the increased resources needed to support the
increasing number of partner companies.
Depreciation and Amortization. The increase in depreciation and
amortization relates to amortization of goodwill associated with our
holdings in aligne.
Other Income, net. Other income, net, consisted of the following (in
thousands):
Three Months Ended
March 31,
2000 1999
---- ----
Unrealized gain (loss) on Tellabs stock.......... $ -- $49,639
Gain on sale of Diamond stock.................... 44,613 --
Gain on sale of other public holdings............ 7,643 5,872
Gain on distributions from private equity funds.. -- 2,701
Other, primarily impairment charges.............. (2,235) (6,879)
------- -------
$50,021 $51,333
======= =======
For the three months ended March 31, 2000, and 1999 we recorded impairment
charges of $2.4 million, and $6.6 million, respectively, for the other than
temporary decline in the carrying value of some partner companies.
23
Interest, net. Interest expense, net, was $5.0 million for the three months
ended March 31, 2000 and $2.6 million for the three months ended March 31,
1999. The increase was primarily due to the accretion of the obligation and
the amortization of the cost of the two forward sale contracts entered into
during March 1999 and August 1999.
Income Taxes. Our consolidated effective tax rate remained consistent at
35% for the three months ended March 31, 2000 and 1999.
Net Results of Operations--Partner Company Operations
Revenue. Revenue was $6.0 million for the three months ended March 31, 2000
and $6.6 million for the three months ended March 31, 1999. The decrease is
a result of aligne no longer being included in the Partner Company
Operations segment, partially offset by the inclusion of revenue related to
SOTAS and Arista subsequent to our acquiring a majority voting interest in
the second quarter of 1999.
Operating Expenses. Operating expenses were $8.7 million for the three
months ended March 31, 2000 and $5.9 million for the three months ended
March 31, 1999. The increase in operating expenses in 2000 was primarily
the result of the inclusion of operating expenses related to SOTAS and
Arista subsequent to our acquiring a majority voting interest in the second
quarter of 1999, partially offset by the exclusion of aligne's expenses in
2000.
Equity Income (Loss). A significant portion of our net results of
operations is derived from companies in which we hold a significant
minority ownership interest. Equity income (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. The significant increase in equity income in
2000 from 1999 reflects increased net income at Internet Capital Group.
Internet Capital Group reported net income of $352.0 million for the three
months ended March 31, 2000 compared to $20.1 million for the same period
in 1999. The increase in Internet Capital Group's results related primarily
to a pre-tax gain of $449 million for the shares of Ariba, Inc. it received
in exchange for its ownership in Tradex Technologies, Inc., and pre-tax
gains of approximately $177 million relating primarily to VerticalNet's
issuance of shares for its acquisition of Tradeum, Inc. Our share of
Internet Capital Group's income for the three months ended March 31, 2000,
was approximately $50 million. Excluding our share of Internet Capital
Group, our equity losses increased as a result of operating losses at some
of our existing partner companies and an increase in the number of
companies accounted for under the equity method in 2000, a majority of
which have operating losses. During the three months ended March 31, 2000,
we accounted for 33 companies under the equity method of accounting
compared to 12 companies during the comparable 1999 period. Many of our
partner companies accounted for under the equity method are Internet-
related companies with substantial losses. We expect to continue to acquire
interests in more Internet-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.
24
Net Results of Operations--CompuCom Operations
CompuCom provides people, process, and technology to deliver infrastructure
solutions that optimize electronic business and enterprise applications.
CompuCom's revenues are primarily derived from sales of distributed desktop
computer products and configuration, network integration and technology
support.
Revenue. Revenue was $567.4 million for the three months ended March 31,
2000 and $493.3 million for the three months ended March 31, 1999. The
increase in revenue is primarily due to the May 1999 acquisition of the
Technology Acquisition Services Division of Entex Information Services.
Negatively impacting first quarter revenue was lower demand resulting from
CompuCom's clients Year 2000 concerns and spending on Year 2000 remediation
projects that occurred in 1999 and not in 2000, as well as manufacturer
direct selling and fulfillment strategies.
Gross Margin. Gross margin was 9.5% for the three months ended March 31,
2000 and 11.9% for the three months ended March 31, 1999. The decrease is
due to reductions in the amount of manufacturer volume incentives and
increased competition from direct marketers and other corporate resellers
of personal computer products, as well as lower utilization in consulting
services. CompuCom anticipates a continued reduction in the amount of
manufacturer sponsored volume incentives, which could lower product margins
even further. CompuCom expects to experience continued pressure on both
product revenue and product gross margin, when compared to the comparable
prior period.
Selling and Service Expenses. Selling and service expenses were 6.0% of
revenue for the three months ended March 31, 2000 and 7.0% of revenue for
the three months ended March 31, 1999. CompuCom attributes this decline to
increased leverage of its infrastructure resulting from the Entex
acquisition and its own cost reduction efforts.
General and Administrative Expense. General and administrative expenses
increased $2.0 million to $21.0 million for the three months ended March
31, 2000 from $19.1 million for the three months ended March 31, 1999. The
increase was due to increases in distribution and administrative personnel
to support CompuCom's growth as a result of the Entex acquisition. As a
percentage of revenue, general and administrative expenses were 3.7% for
the three months ended March 31, 2000 and 3.9% for the three months ended
March 31, 1999. This decrease is due to increased leverage of CompuCom's
infrastructure resulting from the Entex acquisition and its own cost
reduction efforts relative to its revenue base.
Depreciation and Amortization Expense. Depreciation and amortization
expense was $6.0 million for the three months ended March 31, 2000 and $4.4
million for the three months ended March 31, 1999. The increase is due
primarily to goodwill amortization related to the May 1999 Entex
acquisition and software license amortization.
Restructuring Expense. During the first quarter of 2000, CompuCom
implemented a restructuring plan designed to reduce CompuCom's cost
structure by closing certain facilities, consolidating one facility, and
reducing its workforce. As a result, CompuCom recorded a restructuring
charge of $5.2 million in the first quarter of 2000, primarily consisting
of costs associated with the closing and consolidation of certain
facilities and disposing of related fixed assets as well as employee
severance and benefits related to the reduction in workforce. Of the $5.2
million charged to operations, approximately $1.4 million was paid through
March 31, 2000.
Interest, Net. Interest expense, net slightly decreased for the three
months ended March 31, 2000, as compared to the same period in 1999.
25
Liquidity and Capital Resources
We have funded our operations with our bank credit facility, proceeds from
issuance of convertible notes, proceeds from the issuance of equity
securities, proceeds from forward sale contracts, and proceeds from sales
of partner companies.
In April 2000, we completed a follow-on public offering, selling 8.6
million shares of our common stock, including exercise in full of the
underwriters' overallotment option, at $50 per share. The net proceeds to
us were approximately $414 million, net of underwriters' commission and
offering expenses.
On March 15, 2000, we filed a Registration Statement on Form S-3 with the
Securities and Exchange Commission to sell from time to time up to $500
million of our common stock to certain strategic investors and
institutional investors. In April 2000, we completed the first tranche of
this offering with a sale to certain strategic investors. Net proceeds from
these stock sales totaled $100 million.
Sales of equity securities generated proceeds of approximately $79 million
in 2000 and $59 million in 1999.
The Company has availability under its bank revolving credit facility of
$300 million. Of the $300 million, $250 million matures in April 2005 and
is secured by certain equity securities the Company holds of its publicly
traded partner companies (the Pledged Securities), including CompuCom. The
value ascribed to these Pledged Securities for purposes of permitting
borrowings under the bank revolving credit facility exceeds the total
availability under the bank revolving credit facility. The remaining $50
million is unsecured, with availability limited to the lesser of $50
million or 10% of the value of the Pledged Securities. The $50 million
facility matures in April 2001. There was $32.1 million outstanding under
the total facility at March 31, 2000.
The proceeds of our public offering and our offering to certain strategic
and institutional investors, availability under our bank credit facilities,
and other internal sources of cash flow are expected to be sufficient to
fund our cash requirements through 2000, including commitments to our
existing partner companies, our current operating plan to acquire new
partner companies, our general corporate requirements, and the repurchase
of up to $100 million of the our common stock from time to time in the open
market as authorized by the Company's Board of Directors in May 2000. At
March 31, 2000, we were contingently obligated for approximately $33
million of guarantee commitments. Additionally, we had committed capital of
approximately $232 million, including commitments made in prior years, to
various partner companies and private equity funds, to be funded over the
next several years.
Availability under our bank credit facility is determined by the market
value of the publicly traded partnership companies pledged as collateral.
If the stock markets experience a significant decline, availability under
the credit facilities could be reduced significantly and could have an
adverse effect on our ability to borrow under the facilities. In addition,
our ability to raise proceeds from sales of publicly traded partner
companies could also be adversely affected. As a result, our ability to
acquire interests in new partnership companies and support our existing
partnership companies with additional funding could be limited.
CompuCom maintains separate, independent financing arrangements, which are
non-recourse to us and are secured by certain assets of CompuCom. During
recent years, CompuCom has utilized bank financing arrangements and
internally generated funds to fund its cash requirements.
26
CompuCom has financing arrangements consisting of a $250 million receivable
securitization facility and a $200 million working capital facility. Both
facilities mature in May 2002. The securitization facility allows CompuCom
to sell an interest in its accounts receivable on a revolving basis and is
accounted for as a sale of accounts receivable in accordance with Statement
of Financial Accounting Standards No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities". As of
March 31, 2000, $160 million of the securitization facility was utilized.
Availability under the working capital facility is subject to a borrowing
base calculation. As of March 31, 2000, availability under the working
capital facility was $68.8 million, of which $18.4 million was outstanding.
In accordance with the terms of the agreement, the working capital facility
is scheduled to be reduced from $200 million to $175 million in May 2000.
Both the securitization facility and the working capital facility 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 vendor rebate programs. Under these programs, CompuCom is
required to pay a higher initial price for product and claim a rebate to
reduce that price. The collection of these rebates can take several months.
Due to these programs, CompuCom's initial price for the product is often
higher than the sales price CompuCom obtains from its customers. As of
March 2000, these programs are a material factor in CompuCom's financing
needs. As of March 31, 2000, CompuCom was owed approximately $65 million
under these programs.
Consolidated working capital decreased to $86.8 million at March 31, 2000
from $133.8 million at December 31, 1999. The decrease is a result of a
reduction in cash, which was used primarily for the cost of ownership
interests we acquired and other net outflows during in the first quarter of
2000.
Cash provided by operating activities decreased in 2000 compared to 1999
due to reduced operating results at CompuCom.
Cash used in investing activities reflects the acquisition of ownership
interests in and advances to new and existing partner companies. Partially
offsetting these activities during the three months ended March 31, 2000
and 1999, were proceeds from the sales of equity securities.
During the first quarter of 2000, we committed approximately $200 million
and funded $143 million to acquire interests in and make advances to 11 new
partner companies, including the following Internet infrastructure partner
companies: Buytream.com, fob.com, Mi8 Corporation, Nextone Communications,
TechSpace LLC, Wireless-Online and Web Telecom. We also funded
approximately $77 million to acquire interests in and make advances to our
existing private partner companies and private equity funds. In addition,
we acquired the remaining 20% interest in aligne in exchange for
approximately 160,434 shares of our common stock with a market value of
approximately $8.2 million, and purchased approximately $7 million of
shares of our publicly traded partner companies in the open market.
From April 1, 2000 through May 12, 2000, we funded $47 million of
commitments made prior to March 31, 2000. Additionally, from April 1, 2000
through May 12, 2000, we committed $93 million and funded $53 million to
acquire ownership interests in or make advances to new and existing partner
companies and private equity funds.
The Company's operations are not capital intensive, and capital
expenditures in any year normally would not be significant in relation to
the overall financial position of the Company. Capital asset requirements
are generally funded through bank credit facilities, internally generated
funds or other financing sources. There were no material capital asset
purchase commitments at March 31, 2000.
27
Recent Accounting Pronouncements
We do not expect the adoption of recently issued accounting pronouncements
to have a significant impact on our net results of operations, financial
position or cash flows.
Safe Harbor Statement
Certain statements in this report describing the plans, goals, strategies,
intentions, forecasts, and expectations of our partner companies or us
constitute what are sometimes termed "forward-looking statements." The
following important factors could cause actual results to differ materially
from those in such forward-looking statements.
Our business depends on the performance of our partner companies, which is
uncertain. In general, our partner companies depend on the continuing
growth of the Internet as a medium for commercial transactions, and on the
growth of the Internet infrastructure market in particular. The Internet
infrastructure industry is intensely competitive, characterized by rapid
changes in technology and customer demands, frequent new product
introductions, and shifting distribution channels. Many of our partner
companies are early-stage companies with limited operating history and no
historical profits, and compete against companies with greater resources
and name recognition.
Fluctuations in the price of the common stock of our publicly traded
partner companies, especially Internet Capital Group, may affect the price
of our common stock. On May 9, 2000, our equity interest in Internet
Capital Group had a market value of approximately $1.3 billion, which was
significant compared to our market value of $4.3 billion. The price of
Internet Capital Group's common stock has been, and may continue to be,
highly volatile. Our continuing growth is also dependent on the continuing
strength of the market for securities of Internet infrastructure companies
in general and initial public offerings of those companies in particular.
Competition to acquire interests in Internet infrastructure companies is
intense, which could reduce the returns we can achieve on our acquisitions.
28
Item 3. 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
Internet industry, many of which have experienced significant historical
volatility in their stock prices. We typically do not attempt to reduce or
eliminate our market exposure on securities. Based on closing market prices at
March 31, 2000, the fair value of our holdings in public securities was
approximately $4.8 billion (excluding warrants that are unexercisable).
Approximately $3.3 billion of these equity securities at March 31, 2000
consisted of holdings in Internet Capital Group. A 20% decrease in equity prices
would result in an approximate $1.0 billion decrease in the fair values 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 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).
Availability under our bank credit facilities is determined by the market value
of the publicly traded securities pledged as collateral. The market value of our
publicly traded securities would have to decrease by more than 50% from their
value on May 12, 2000 before the amount of our collateral would be insufficient
to enable us to fully use this facility. Additionally, we are exposed to
interest rate risk primarily through our bank credit facility. At March 31,
2000, there were $32.1 million of borrowings outstanding under these facilities.
CompuCom is exposed to interest rate risk primarily through its receivables
securitization and working capital facilities. CompuCom utilizes borrowings on
these facilities to meet its working capital needs and other borrowing needs. At
March 31, 2000, the securitization facility had borrowings of approximately $160
million and the working capital facility had borrowings of $18 million. If
CompuCom's effective interest rate were to increase 75 basis points, or 0.75%,
CompuCom's annual interest expense would increase by approximately $1.8 million
based on CompuCom's average borrowings during the three months ended March 31,
2000. Our share of this increase would be approximately $0.9 million after
deduction for minority interest before taxes.
29
PART II
OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.
(a) On February 15, 2000, the Company acquired from the two minority
shareholders of aligne incorporated the remaining 20% of the outstanding common
stock of aligne not already owned by the Company. In exchange, the Company
issued 160,434 shares of the Company's common stock with a market value of
approximately $8 million. The registrant believes that the sale was exempt from
registration under Section 4(2) of the Securities Act of 1933, as amended,
because the sale was made to a limited group of persons, each of whom was
believed to have been a sophisticated investor and was purchasing for investment
without a view to further distribution. Restrictive legends were placed on stock
certificates evidencing the shares.
(b) On February 28, 2000, the Company adopted a Shareholder Rights Plan which is
described in the Company's Current Report on Form 8-K, filed with the Securities
and Exchange Commission on February 29, 2000, which is hereby incorporated by
reference herein.
30
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
The Company held its Annual Meeting of Shareholders on May 11, 2000. At the
meeting the shareholders voted in favor of the following items listed in the
Proxy Statement dated April 10, 2000:
I. ELECTION OF DIRECTORS
FOR WITHHELD
--- --------
Warren V. Musser 95,752,257 785,836
Robert E. Keith, Jr. 95,795,772 742,321
Harry Wallaesa 95,621,988 916,105
Vincent G. Bell, Jr. 95,747,111 790,982
Walter W. Buckley, III 95,747,031 791,062
Michael J. Emmi 95,775,835 762,258
Robert A. Fox 95,554,679 983,414
Jack L. Messman 95,550,252 987,841
Russell E. Palmer 95,769,186 768,907
John W. Poduska, Sr., Ph.D. 95,785,833 752,260
Heinz C. Schimmelbusch, Ph.D. 95,533,317 1,004,776
Hubert J.P. Schoemaker, Ph.D. 95,796,150 741,943
Carl J. Yankowski 95,754,202 783,891
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
Number Description
------ -----------
10.1* Restricted Stock Grant Letter dated February 28, 2000
from Safeguard Scientifics, Inc. to a certain executive.
(Exhibits Omitted)
10.2* Term note dated April 13, 2000 from a certain executive
to Safeguard Scientifics, Inc.
10.3* Form of Promissory Notes dated April 6, 2000 given by
certain executives for advances by Safeguard of income
tax withholdings on restricted stock grants.
10.4* Amended and Restated Credit Agreement among Safeguard
Scientifics, Inc., Safeguard Scientifics (Delaware),
Inc., Safeguard Delaware, Inc., and PNC Bank , N.A.
(Exhibits Omitted)
10.5* Executive Employment Agreement dated March 13, 2000,
between Anthony F. Pellegrini and CompuCom Systems, Inc.
27* Financial Data Schedule (electronic filing only)
* filed herewith
31
(b) On February 29, 2000, the Company filed a Current Report on Form 8-K
to report under Item 5 the following:
. the Company's Board of Directors approval of a three-for-one
split of the outstanding shares of Common Stock of the
Company, in the form of a dividend of two shares of Common
Stock of the Company outstanding at the close of business on
March 13, 2000;
. the adoption of the shareholder rights plan;
. that the Company and Textron Inc. entered into a Transaction
Agreement, dated February 28, 2000, providing for the
purchase by Textron Inc. of 727,273 Common Shares (or
2,181,819 Common Shares after giving effect to the Stock
Split) for an aggregate purchase price of $100 million.
. On February 10, 2000, the Board of Directors of the Company
amended and restated the Bylaws of the Company. The amended
and restated Bylaws are filed as Exhibit 3 hereto.
. the financial results for the fourth quarter of 1999.
On March 1, 2000, the Company filed a Current Report on Form 8-K to
report under Item 5 a three-for-one stock split on the Company's
Common Stock effected in the form of a stock dividend to holders of
record on March 13, 2000, the filing of a registration statement for
an underwritten public offering of Common Stock of the Company, and
the appointment of Gerald Blitstein to senior vice president and chief
financial officer of the Company.
32
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: May 15, 2000 /s/ HARRY WALLAESA
----------------------------------------
Harry Wallaesa
President and Chief Operating Officer
Date: May 15, 2000 /s/ GERALD A. BLITSTEIN
----------------------------------------
Gerald A. Blitstein
Senior Vice President and Chief
Financial Officer
(Principal Financial and Principal
Accounting Officer)
33