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 June 30, 2000 Commission File Number 1-5620
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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 August 9, 2000
Common Stock 117,044,488
SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
------------------------------ ----
Item 1 - Financial Statements:
Consolidated Balance Sheets -
June 30, 2000 (unaudited) and December 31, 1999..................... 3
Consolidated Statements of Operations (unaudited) -
Three and Six Months Ended June 30, 2000 and 1999................... 4
Consolidated Statements of Cash Flows (unaudited) -
Six Months Ended June 30, 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.. 30
PART II - OTHER INFORMATION
----------------------------
Item 6 - Exhibits and Reports on Form 8-K............................ 31
Signatures........................................................... 32
2
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
June 30, December 31,
2000 1999
---------- ----------
(unaudited)
Assets
Current Assets
Cash and cash equivalents.................................. $ 319,878 $ 49,813
Accounts receivable, less allowances....................... 287,070 259,383
Inventories................................................ 116,576 129,826
Prepaid expenses and other current assets.................. 18,378 16,488
---------- ----------
Total current assets........................................ 741,902 455,510
Property and equipment, net................................. 51,475 56,234
Ownership interests in and advances to partner companies.... 849,867 529,381
Available-for-sale securities............................... 333,410 302,940
Excess of cost over net assets of businesses acquired, net.. 124,846 119,288
Other....................................................... 46,634 36,526
---------- ----------
Total Assets................................................ $2,148,134 $1,499,879
========== ==========
Liabilities and Shareholders' Equity
Current Liabilities
Current maturities of long-term debt....................... $ 6,511 $ 11,019
Accounts payable........................................... 198,070 183,781
Accrued expenses........................................... 103,422 126,871
---------- ----------
Total current liabilities................................... 308,003 321,671
Long-term debt.............................................. 26,520 14,532
Deferred taxes.............................................. 96,817 110,556
Minority interest........................................... 101,439 102,808
Other long-term liabilities................................. 224,362 175,611
Convertible subordinated notes.............................. 200,000 200,000
Commitments and contingencies
Shareholders' Equity
Preferred stock............................................. -- --
Common stock................................................ 11,815 10,475
Additional paid-in capital.................................. 760,713 133,969
Retained earnings........................................... 416,888 385,120
Accumulated other comprehensive income...................... 21,211 45,137
Treasury stock, at cost..................................... (19,634) --
---------- ----------
Total shareholders' equity.................................. 1,190,993 574,701
---------- ----------
Total Liabilities and Shareholders' Equity.................. $2,148,134 $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, Six Months Ended,
June 30 June 30
------------------- -----------------------
2000 1999 2000 1999
-------- -------- ---------- ----------
(unaudited) (unaudited)
Revenue
Product sales................................... $629,080 $730,137 $1,136,388 $1,155,604
Service sales................................... 68,324 79,246 136,467 153,664
Other........................................... 4,344 3,199 8,089 6,206
-------- -------- ---------- ----------
Total revenue.................................... 701,748 812,582 1,280,944 1,315,474
Operating Expenses
Cost of sales--product.......................... 579,732 671,596 1,048,637 1,059,908
Cost of sales--service.......................... 45,607 51,131 92,621 99,122
Selling and service............................. 36,616 42,445 73,249 78,942
General and administrative...................... 45,627 34,116 93,854 61,484
Depreciation and amortization................... 8,029 8,353 16,359 13,982
Restructuring................................... -- -- 5,169 --
-------- -------- ---------- ----------
Total operating expenses......................... 715,611 807,641 1,329,889 1,313,438
-------- -------- ---------- ----------
(13,863) 4,941 (48,945) 2,036
Gains on issuance of stock by partner companies.. -- -- -- 326
Other income, net................................ 30,314 30,787 80,335 82,120
Interest income.................................. 7,453 799 8,647 1,543
Interest expense................................. (10,052) (10,055) (20,750) (17,883)
-------- -------- ---------- ----------
Income Before Income Taxes, Minority
Interest and Equity Income (Loss)............... 13,852 26,472 19,287 68,142
Income taxes..................................... (1,169) (6,199) (17,106) (19,202)
Minority interest................................ (1,730) (2,274) 6,869 (323)
Equity income (loss)............................. (8,783) (6,486) 22,718 (12,956)
-------- -------- ---------- ----------
Net Income....................................... $ 2,170 $ 11,513 $ 31,768 $ 35,661
======== ======== ========== ==========
Net Income Per Share
Basic........................................... $0.02 $0.11 $0.29 $0.36
Diluted......................................... $0.02 $0.11 $0.26 $0.35
Weighted Average Shares Outstanding
Basic........................................... 116,732 100,419 111,127 97,851
Diluted......................................... 119,333 107,010 114,254 105,954
See notes to consolidated financial statements.
4
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
( in thousands)
Six Months Ended June 30,
-------------------------
2000 1999
--------- ---------
(unaudited)
Operating Activities
Net income......................................................... $ 31,768 $ 35,661
Adjustments to reconcile to net cash provided by operating
activities:
Depreciation and amortization..................................... 16,359 13,982
Deferred income taxes............................................. (855) (7,306)
Equity (income) loss.............................................. (22,718) 12,956
Gain on issuance of stock by partner companies.................... -- (326)
Other income, net................................................. (80,335) (82,120)
Minority interest, net of taxes................................... (4,121) 194
Changes in assets and liabilities, net of effect of acquisitions:
Accounts receivable, net.......................................... (20,157) (140,864)
Inventories....................................................... 13,250 19,013
Accounts payable, accrued expenses, and other..................... 11,356 138,901
--------- ---------
Net cash used in operating activities (55,453) (9,909)
Investing Activities
Proceeds from sales of available-for-sale securities............... 57,756 13,163
Proceeds from sales of partner company ownership interests......... 43,743 53,216
Advances to partner companies...................................... (24,193) (26,569)
Repayment of advances to partner companies......................... 10,050 2,732
Acquisitions of ownership interests in partner companies and
subsidiaries, net of cash acquired................................ (336,288) (105,513)
Acquisitions by subsidiaries, net of cash acquired................. (750) (137,235)
Proceeds from sale of building..................................... 617 39,791
Capital expenditures............................................... (4,928) (5,634)
Other, net......................................................... (22,170) (7,555)
--------- ---------
Net cash used in investing activities............................ (276,163) (173,604)
Financing Activities
Borrowings on revolving credit facilities.......................... 603,163 522,765
Repayments on revolving credit facilities.......................... (593,038) (531,910)
Borrowings on long-term debt....................................... 1,819 --
Repayments on long-term debt....................................... (6,158) (25,372)
Proceeds from issuance of convertible subordinated notes
net,.............................................................. -- 193,998
Proceeds from financial instruments................................ -- 71,205
Repurchase of Company common stock................................. (19,074) (2,695)
Issuance of Company common stock, net.............................. 613,542 4,510
Issuance of subsidiary common stock................................ 1,427 688
--------- ---------
Net cash provided by financing activities........................ 601,681 233,189
--------- ---------
Net Increase in Cash and Cash Equivalents.......................... 270,065 49,676
Cash and cash equivalents at beginning of period................... 49,813 6,257
--------- ---------
Cash and Cash Equivalents at End of Period......................... $ 319,878 $ 55,933
========= =========
See notes to consolidated financial statements.
5
SAFEGUARD SCIENTIFICS, INC.
Notes to Consolidated Financial Statements
June 30, 2000
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 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 Six Months Ended
June 30, June 30
--------------------- --------------------
2000 1999 2000 1999
--------- -------- -------- ---------
(Unaudited)
Net Income........................................ $ 2,170 $11,513 $ 31,768 $ 35,661
-------- ------- -------- --------
Other Comprehensive Income (Loss), Before Taxes:..
Unrealized holding gains (losses)................ 39,474 (4,815) 7,874 (10,982)
Reclassification adjustments 1,148 (2,630) (44,683) (8,502)
Related Tax Benefit:
Unrealized holding (gains) losses................ (13,816) 1,685 (2,756) 3,844
Reclassification adjustments..................... (402) 921 15,639 2,976
-------- ------- -------- --------
Other Comprehensive Income (Loss)................. 26,404 (4,839) (23,926) (12,664)
-------- ------- -------- --------
Comprehensive Income.............................. $ 28,574 $ 6,674 $ 7,842 $ 22,997
======== ======= ======== ========
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 $225 million in connection with these transactions
is included in other long-term liabilities as of June 30, 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 ($4.3 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, 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 June 30, 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.
June 30, 2000 December 31, 1999
------------------------------------------ -----------------------
Carrying Market Voting Carrying Market
Value Value Interest Value Value
----------- ---------------- ----------- -------- -------------
(Unaudited)
Equity Method
Cambridge Technology Partners.. $ 56,193 $ 89,780 17% $ 49,181 $ 254,556
ChromaVision Medical Systems... 11,269 70,219 27% 13,626 81,201
DocuCorp International......... 10,206 11,005 18% 9,995 22,249
eMerge Interactive............. 30,867 120,889 16% 7,201 --(a)
Internet Capital Group......... 250,358 1,363,480 14% 189,068 6,169,208
LifeF/X........................ -- 41,564 12% -- 86,823
OAO Technology Solutions....... 17,529 19,158 31% 16,448 42,853
Pac-West Telecomm.............. --(b) --(b) --(b) 7,613 62,943
Sanchez Computer Associates.... 10,169 149,344 25% 11,686 258,995
USDATA Corporation............. 9,192 54,059 41% 15,920 82,406
US Interactive................. --(b) --(b) --(b) 9,769 107,795
Non-public companies............ 372,242 162,130
-------- --------
768,025 492,637
Cost Method
Non-public companies........... 49,610 16,266
Advances to Partner Companies.. 32,232 20,478
-------- --------
$849,867 $529,381
======== ========
(a) eMerge Interactive was not publicly traded until 2000.
(b) Pac-West Telecomm and US Interactive are now accounted for as available-
for-sale securities as a result of a decrease in our ownership during 2000.
Internet-related stocks have experienced significant volatility. For example,
at June 30, 2000, the market value of the Company's holdings in Internet
Capital Group was $1.4 billion. Based on the high and low stock prices from
January 1, 2000 through August 9, 2000, the market value of the Company's
holdings in Internet Capital Group has ranged from $7.3 billion to $0.8
billion.
At June 30, 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 $252 million which is included
in "Ownership Interest in and Advances to Partner Companies" on the
consolidated balance sheets. This excess relates to ownership interests
acquired through June 30, 2000, and is being amortized generally over a ten-
year period. Amortization expense of $4.2 million and $7.2 million, is
included in "equity income (loss)" in the accompanying consolidated statements
of operations for the three and six months ended June 30, 2000.
As of June 30, 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 8.0% and variable rates
8
consisting of the prime rate (9.5% at June 30, 2000) plus 1%. The Company also
has short-term advances to partner companies of $5 million at June 30, 2000,
which is included in "accounts receivable, less allowances" on the
consolidated balance sheets.
7. Available-for-Sale Securities
-----------------------------
Available-for-sale securities consisted of the following (in thousands):
June 30, 2000 December 31, 1999
-------------------------- -------------------------
Carrying Market Carrying Market
Value Value Value Value
---------------- -------- ----------- -----------
(Unaudited)
Tellabs...................... $212,731 $230,936 $212,731 $216,595
Diamond Technology Partners.. -- -- 710 57,436
US Interactive............... 10,919 33,115 --(a) --(a)
Pac-West..................... 9,982 49,249 --(a) --(a)
Opus360...................... 8,781 10,007 --(b) --(b)
Brandywine Realty Trust...... 8,561 9,551 8,561 8,177
Other public companies....... (607) 552 17,052 20,732
Unrealized appreciation...... 83,043 63,886
-------- --------
$333,410 $302,940
======== ========
(a) These holdings were included in "Ownership Interests in and Advances to
Partner Companies" at December 31, 1999 since they were accounted for on
the equity method.
(b) Opus 360 was not publicly traded until 2000.
8. Debt
----
The following is a summary of long-term debt (in thousands):
June 30, December 31,
2000 1999
------- --------
(Unaudited)
Parent Company and Other Recourse Debt
Other......................................................... $20,714 $ 25,325
------- --------
Subsidiary Debt (Non-Recourse to Parent)
CompuCom...................................................... 11,800 --
Other......................................................... 517 226
------- --------
12,317 226
------- --------
Total debt.................................................... 33,031 25,551
Current maturities of long-term debt.......................... (6,511) (11,019)
------- --------
Long-term debt................................................ $26,520 $ 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
9
2001. There were no amounts outstanding under the total facility at June 30,
2000 or December 31, 1999.
Other long-term debt includes mortgage obligations and bank credit facilities
of consolidated partner companies. These obligations bear interest rates
ranging from 7.75% to 9.75%.
CompuCom has financing arrangements which total $375 million, consisting of a
$200 million receivable securitization facility and a $175 million working
capital facility. During the second quarter of 2000, CompuCom reduced the
securitization facility from $250 million to $200 million and the working
capital facility was reduced, as planned, from $200 million to $175 million.
The securitization facility, which matures in May 2002 and has pricing based
on a designated short term interest rate plus an agreed-upon spread, 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
June 30, 2000, $173 million of the securitization facility was utilized.
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 working capital facility is subject to a
borrowing base calculation. As of June 30, 2000, availability under the
working capital facility was approximately $92.2 million, of which $11.8
million was outstanding.
Both financing arrangements are subject to CompuCom's compliance with selected
financial covenants and ratios.
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.
In the second quarter of 2000, the Company purchased 529,000 shares of its
common stock for an aggregate of $20 million, or $36.07 per share.
10
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.
In April 2000, the Company granted stock options to non-employee consultants.
These options vested immediately and have a four year term. The Company uses
Statement of Financial Accounting Standards No. 123 to account for non-
employee stock-based compensation. This standard requires the use of an
option pricing model, in order to determine the amount of compensation expense
to be recognized. The Company recorded compensation expense related to this
option grant of $1.7 million during the three months ended June 30, 2000.
10. Restructuring
-------------
During the first quarter of 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 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 June 30,
2000 (in thousands):
Restructuring Cash Accrual at
Charge Payments Other June 30, 2000
------------- --------- ------ -------------
Lease termination costs.................. $2,904 $ (666) $ -- $2,238
Employee severance and related benefits.. 1,800 (1,564) -- 236
Other.................................... 465 (87) (318) 60
------ ------- ----- ------
Total.................................... $5,169 $(2,317) $(318) $2,534
====== ======= ===== ======
The $2.5 million accrued at June 30, 2000 is reflected in accrued liabilities
on the Company's Consolidated Balance Sheets.
Lease termination costs include the estimated costs to close the three office
facilities and represent the amount required to fulfill CompuCom's obligations
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 necessary to sublet the facilities. Payments, net of proceeds
derived from subleases, are charged against the accrual as incurred. The
remaining accrual at June 30, 2000 relates to two leases for the office
facilities that have not been sublet or terminated
11
Severance is paid based on associates' years of service as well as their level
within the organization. The reduction in workforce included 308 associates,
of which one was an executive officer. The reduction in workforce included
associates from the following areas: sales, service, and general and
administrative, who were located at certain of CompuCom's branch locations,
corporate offices, and the Houston distribution center. The remaining accrual
at June 30, 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.
During the fourth quarter of 1998, the 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 table provides a summary by category and rollforward of the changes
in this restructuring accrual for the six months ended June 30, 2000 (in
thousands):
Accrued at Cash Accrual at
December 31, 1999 Payments June 30, 2000
----------------- --------- -------------
Lease termination costs................. $1,240 $ (931) $309
Employee severance and related benefit.. 560 (185) 375
------ ------- ----
Total................................... $1,800 $(1,116) $684
====== ======= ====
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 Six Months Ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
------- -------- ------- --------
(Unaudited)
Unrealized gain on Tellabs stock................. $ -- $ 35,910 $ -- $ 85,549
Gain on sale of Diamond stock.................... 7,358 3,546 51,971 3,546
Gain on sale of private partner companies........ 19,760 250 19,809 419
Gain on sale of other public holdings............ 2,066 -- 9,860 5,872
Gain on distributions from private equity funds.. -- 1,889 -- 4,590
Unrealized loss on trading securities............ (820) -- (820) --
Other, primarily impairment charges.............. 1,950 (10,808) (485) (17,856)
------- -------- ------- --------
$30,314 $ 30,787 $80,335 $ 82,120
======= ======== ======= ========
For the three and six months ended June 30, 2000 and the three and six months
ended June 30, 1999, the Company recorded impairment charges of $1.2 million,
$2.0 million, $3.2 million, and $9.4 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 Six Months Ended
June 30, June 30,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
(Unaudited)
Basic EPS
---------
Net income................................ $ 2,170 $ 11,513 $ 31,768 $ 35,661
======== ======== ======== ========
Average common shares outstanding......... 116,732 100,419 111,127 97,851
======== ======== ======== ========
Basic EPS................................. $ 0.02 $ 0.11 $ 0.29 $ 0.36
======== ======== ======== ========
Diluted EPS
-----------
Net income................................ $ 2,170 $ 11,513 $ 31,768 $ 35,661
Effect of: Public holdings (a)........... (123) (160) (1,736) (44)
Dilutive securities (b)....... -- 365 -- 1,090
-------- -------- -------- --------
Adjusted Net Income....................... $ 2,047 $ 11,718 $ 30,032 $ 36,707
======== ======== ======== ========
Average common shares outstanding......... 116,732 100,419 111,127 97,851
Effect of: Dilutive options.............. 2,601 2,946 3,127 2,599
Dilutive securities (b)....... -- 3,645 -- 5,504
-------- -------- -------- --------
Average number of common shares
assuming dilution..................... 119,333 107,010 114,254 105,954
======== ======== ======== ========
Diluted EPS............................... $ 0.02 $ 0.11 $ 0.26 $ 0.35
======== ======== ======== ========
(a) Represents the dilutive effect of public company common stock equivalents
and convertible securities.
(b) Represents the dilutive effect of the Company's 1996 convertible
subordinated notes for the three and six months ended June 30, 1999. The
Company's 1999 convertible subordinated notes were anti-dilutive for all
periods presented.
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 June 30, December 31,
2000 1999
---------- ----------
(Unaudited)
Assets
Cash and cash equivalents................................. $ 314,495 $ 33,536
Other current assets...................................... 48,460 39,204
Ownership interests in and advances to partner companies.. 983,283 687,925
Available-for-sale securities............................. 333,410 302,940
Other..................................................... 77,932 45,584
---------- ----------
Total assets.............................................. $1,757,580 $1,109,189
========== ==========
Liabilities and Shareholders' Equity
Current liabilities....................................... $ 31,412 $ 35,621
Long-term debt............................................ 14,595 14,354
Other long-term liabilities............................... 320,580 284,513
Convertible subordinated notes............................ 200,000 200,000
Shareholders' equity...................................... 1,190,993 574,701
---------- ----------
Total liabilities and shareholders' equity................ $1,757,580 $1,109,189
========== ==========
The carrying value of the Company's less than wholly owned subsidiaries,
primarily CompuCom, Tangram, SOTAS and Arista at June 30, 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 Six Months Ended
June 30, June 30,
------------------- -------------------
2000 1999 2000 1999
-------- ------- -------- --------
(Unaudited)
Revenue......................................... $ 6,861 $ 3,436 $ 13,382 $ 6,643
Operating expenses.............................. 20,117 8,467 45,837 15,408
-------- ------- -------- --------
(13,256) (5,031) (32,455) (8,765)
Gain on issuance of stock by partner companies.. -- -- -- 326
Other income, net............................... 28,356 30,787 78,377 82,120
Interest, net................................... 1,183 (2,931) (3,733) (5,568)
-------- ------- -------- --------
Income before income taxes and equity loss...... 16,283 22,825 42,189 68,113
Income taxes.................................... (224) (5,270) (19,561) (18,969)
Equity loss..................................... (13,889) (6,042) 9,140 (13,483)
-------- ------- -------- --------
Net income...................................... $ 2,170 $11,513 $ 31,768 $ 35,661
======== ======= ======== ========
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 and
six months ended June 30, 2000 and including aligne for the three and six
months ended June 30, 1999, are reflected in the caption "equity 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 include 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 Six Months Ended
June 30, June 30,
-------------------- -----------------------
2000 1999 2000 1999
-------- -------- --------- ----------
(Unaudited)
Summary of Consolidated Net Income
General Safeguard Operations....................... $ 23,717 $ 14,867 $40,550 $ 43,860
Partner Company Operations......................... (22,938) (4,643) (5,284) (8,307)
CompuCom Operations................................ 1,391 1,289 (3,498) 108
-------- -------- ---------- ----------
$2,170 $ 11,513 $31,768 $35,661
======== ======== ========== ==========
General Safeguard Operations
Revenue............................................ $ 6,561 $ 3,199 $12,288 $ 6,206
Operating expenses
Cost of sales..................................... 1,104 -- 2,235 --
General and administrative........................ 17,915 8,095 41,427 14,673
Depreciation and amortization..................... 1,098 372 2,175 735
-------- -------- ---------- ----------
Total operating expenses.......................... 20,117 8,467 45,837 15,408
-------- -------- ---------- ----------
(13,556) (5,268) (33,549) (9,202)
-------- -------- ---------- ----------
Gain on issuance of stock by partner companies.... -- -- -- 326
Other income, net................................. 28,356 30,787 78,377 82,120
Interest, net..................................... 1,291 (3,007) (3,733) (5,716)
-------- -------- ---------- ----------
Income before income taxes and equity income...... 16,091 22,512 41,095 67,528
Income taxes...................................... (9,208) (7,645) (17,379) (23,668)
Equity income..................................... 16,834 -- 16,834 --
-------- -------- ---------- ----------
Net Income from General Safeguard Operations....... 23,717 14,867 40,550 43,860
======== ======== ========== ==========
Partner Company Operations
Revenue............................................ $ 4,503 $ 6,798 $10,551 $ 13,363
Operating expenses
Cost of sales..................................... 1,172 2,024 2,481 3,478
Selling and service............................... 3,412 2,130 5,911 4,057
General and administrative........................ 4,578 1,550 8,183 3,273
Depreciation and amortization..................... 1,173 1,334 2,415 2,168
-------- -------- ---------- ----------
Total operating expenses.......................... 10,335 7,038 18,990 12,976
-------- -------- ---------- ----------
(5,832) (240) (8,439) 387
-------- -------- ---------- ----------
Interest, net..................................... (684) (52) (899) (97)
-------- -------- ---------- ----------
Income (loss) before income taxes,
minority interest and equity income (loss)....... (6,516) (292) (9,338) 290
Income taxes (expense) benefit.................... 8,966 2,270 (2,059) 4,535
Minority interest................................. 229 (135) 229 (176)
Equity income (loss).............................. (25,617) (6,486) 5,884 (12,956)
-------- -------- ---------- ----------
Net Loss from Partner Company Operations........... $(22,938) $ (4,643) $(5,284) $ (8,307)
======== ======== ========== ==========
CompuCom Operations
Revenue............................................ $690,684 $802,595 $1,258,105 $1,295,915
Operating expenses
Cost of sales..................................... 623,063 720,703 1,136,542 1,155,552
Selling and service............................... 33,204 40,315 67,338 74,885
General and administrative........................ 23,134 24,471 44,244 43,538
Depreciation and amortization..................... 5,758 6,647 11,769 11,079
Restructuring..................................... -- -- 5,169 --
-------- -------- ---------- ----------
Total operating expenses.......................... 685,159 792,136 1,265,062 1,285,054
-------- -------- ---------- ----------
5,525 10,459 (6,957) 10,861
Other income, net 1,958 - 1,958 -
-------- -------- ---------- ----------
Interest, net..................................... (3,206) (6,207) (7,471) (10,537)
-------- -------- ---------- ----------
Income before income taxes and minority interest.. 4,277 4,252 (12,470) 324
Income taxes (expense) benefit.................... (927) (824) 2,332 (69)
Minority interest................................. (1,959) (2,139) 6,640 (147)
-------- -------- ---------- ----------
Net Income (Loss) from CompuCom Operations......... $ 1,391 $ 1,289 $(3,498) $ 108
======== ======== ========== ==========
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 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 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 Six Months Ended
June 30, 1999 June 30, 1999
------------------ ----------------
Total Revenues.............. $1,001,126 $1,939,403
Net Earnings................ $ 8,497 $ 30,335
Diluted earnings per share.. $ 0.08 $ 0.30
16. Commitments and Contingencies
-----------------------------
The Company and its subsidiaries are involved in various claims and legal
actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
17. Subsequent Events
-----------------
On July 6, 2000, Arista Knowledge Systems, a consolidated subsidiary, was
acquired by DigitalThink (Nasdaq:DTHK).
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, including without limitation our
Registration Statement on Form S-3 dated April 6, 2000. 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 operating company actively engaged in the Internet
infrastructure business through our extensive network of partner companies. We
acquire interests in developing Internet infrastructure companies and
accelerate their growth 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
June 30, 2000 and December 31, 1999 included:
Partner Voting Voting
Company Ownership Ownership
Since 6/30/00 12/31/99
------- ------- --------
Publicly Traded
Cambridge Technology Partners (Massachusetts), Inc... 1991 17% 16%
ChromaVision Medical Systems, Inc.................... 1996 27% 27%
DocuCorp International, Inc.......................... 1995 18% 17%
eMerge Interactive, Inc.............................. 1997 16% 19%
Internet Capital Group, Inc.......................... 1996 14% 14%
LifeF/X, Inc......................................... 1996 12% 13%
OAO Technology Solutions, Inc........................ 1996 31% 31%
Pac-West Telecomm, Inc............................... 1998 --(b) 7%
Sanchez Computer Associates, Inc..................... 1986 25% 26%
USDATA Corporation................................... 1994 41% 38%
US Interactive, Inc.................................. 1998 --(b) 13%
19
Partner Voting Voting
Company Ownership Ownership
Since 6/30/00 12/31/99
------- ------- --------
Privately Held
4anything.com, Inc.............................. 1999 39% 28%
AgWeb.com, Inc.................................. 2000 43% N/A
Atlas Commerce.................................. 2000 30% N/A
The Basketball Network LLC, d/b/a HoopsTV.com... 1999 24% 24%
Buystream.com................................... 2000 33% N/A
Ethentica (formerly Who? Vision Systems, Inc.).. 1998 29%(a) 29%(a)
Extant, Inc..................................... 1999 15% 21%
fob.com, Inc.................................... 2000 30% N/A
iMedium, Inc.................................... 1999 31% 23%
Kanbay LLC...................................... 1998 27% 28%
Mi8 Corporation................................. 2000 38% N/A
Nextone Communications, Inc..................... 2000 38% N/A
Nextron......................................... 1995 48% 57%
Persona (formerly PrivaSeek, Inc.).............. 1999 29% 33%
Presideo (formerly Integrated Visions, Inc.).... 1998 46%(a) 49%(a)
QuestOne Decision Sciences Corporation.......... 1997 31% 35%
RealTIME Media, Inc............................. 1999 43% 43%
RedLeaf Group LLC............................... 2000 31% N/A
Techspace LLC................................... 2000 31% N/A
Techspace Ventures LLC.......................... 2000 70% N/A
Thin Air Apps LLC............................... 2000 34% N/A
Vitts Networks, Inc............................. 1999 42% 48%
WebTelecomm, Inc................................ 2000 42% N/A
Wireless OnLine, Inc............................ 2000 43% N/A
XL Vision, Inc.................................. 1995 42% 18%
(a) We own 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.
(b) As of June 30, 2000, these holdings are accounted for under the cost
method.
At June 30, 2000, we owned voting securities in all the privately held
companies listed except Presideo. 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 $37.2 million at June 30, 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
20
method holdings classified as trading securities is reflected in our results
of operations during each reporting period.
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 Six Months Ended
June 30, June 30,
------------------- ---------------------
2000 1999 2000 1999
-------- -------- -------- ----------
(Unaudited)
Summary of Consolidated Net Income
General Safeguard Operations............................. $ 23,717 $ 14,867 $ 40,550 $ 43,860
Partner Company Operations............................... (22,938) (4,643) (5,284) (8,307)
CompuCom Operations...................................... 1,391 1,289 (3,498) 108
-------- -------- ----------- -----------
$2,170 $ 11,513 $ 31,768 $ 35,661
======== ======== =========== ===========
General Safeguard Operations
Revenue.................................................. $ 6,561 $ 3,199 $ 12,288 $ 6,206
Operating expenses
Cost of sales........................................... 1,104 -- 2,235 --
General and administrative.............................. 17,915 8,095 41,427 14,673
Depreciation and amortization........................... 1,098 372 2,175 735
-------- -------- ----------- -----------
Total operating expenses................................ 20,117 8,467 45,837 15,408
-------- -------- ----------- -----------
(13,556) (5,268) (33,549) (9,202)
-------- -------- ----------- -----------
Gain on issuance of stock by partner companies.......... -- -- -- 326
Other income, net....................................... 28,356 30,787 78,377 82,120
Interest, net........................................... 1,291 (3,007) (3,733) (5,716)
-------- -------- ----------- -----------
Income before income taxes and equity income............ 16,091 22,512 41,095 67,528
Income taxes............................................ (9,208) (7,645) (17,379) (23,668)
Equity income........................................... 16,834 -- 16,834 --
-------- -------- ----------- -----------
Net Income from General Safeguard Operations............. 23,717 14,867 40,550 43,860
======== ======== =========== ===========
Partner Company Operations
Revenue.................................................. $ 4,503 $ 6,798 $ 10,551 $ 13,363
Operating expenses
Cost of sales........................................... 1,172 2,024 2,481 3,478
Selling and service..................................... 3,412 2,130 5,911 4,057
General and administrative.............................. 4,578 1,550 8,183 3,273
Depreciation and amortization........................... 1,173 1,334 2,415 2,168
-------- -------- ----------- -----------
Total operating expenses................................ 10,335 7,038 18,990 12,976
-------- -------- ----------- -----------
(5,832) (240) (8,439) 387
-------- -------- ----------- -----------
Interest, net........................................... (684) (52) (899) (97)
-------- -------- ----------- -----------
Income (loss) before income taxes,
minority interest and equity income (loss)............. (6,516) (292) (9,338) 290
Income taxes (expense) benefit.......................... 8,966 2,270 (2,059) 4,535
Minority interest....................................... 229 (135) 229 (176)
Equity income (loss).................................... (25,617) (6,486) 5,884 (12,956)
-------- -------- ----------- -----------
Net Loss from Partner Company Operations.................. $(22,938) $ (4,643) $ (5,284) $ (8,307)
======== ======== =========== ===========
CompuCom Operations
Revenue.................................................. $690,684 $802,595 $1,258,105 $1,295,915
Operating expenses
Cost of sales........................................... 623,063 720,703 1,136,542 1,155,552
Selling and service..................................... 33,204 40,315 67,338 74,885
General and administrative.............................. 23,134 24,471 44,244 43,538
Depreciation and amortization........................... 5,758 6,647 11,769 11,079
Restructuring........................................... -- -- 5,169 --
-------- -------- ----------- -----------
Total operating expenses................................ 685,159 792,136 1,265,062 1,285,054
-------- -------- ----------- -----------
5,525 10,459 (6,957) 10,861
-------- -------- ----------- -----------
Other income, net 1,958 -- 1,958 --
Interest, net........................................... (3,206) (6,207) (7,471) (10,537)
-------- -------- ----------- -----------
Income before income taxes and minority interest........ 4,277 4,252 (12,470) 324
Income taxes (expense) benefit.......................... (927) (824) 2,332 (69)
Minority interest....................................... (1,959) (2,139) 6,640 (147)
-------- -------- ----------- -----------
Net Income (Loss) from CompuCom Operations............... $ 1,391 $ 1,289 $ (3,498) $ 108
======== ======== =========== ===========
22
Net Results of Operations--General Safeguard Operations
During the three and six months ended June 30, 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 management fees charged to 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 $6.6 million and $12.3
million for the three and six months ended June 30, 2000, respectively, and
$3.2 million and $6.2 million for the three and six months ended June 30,
1999, respectively. 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, we no longer charge administrative services fees to our partner
companies. These fees accounted for $0.4 million of revenue for the six months
ended June 30, 2000, and $0.7 million and $1.4 million for the three and six
months ended June 30, 1999, respectively.
General and Administrative. General and administrative expenses were $17.9
million and $8.1 million for the three months ended June 30, 2000 and 1999.
The increase was a result of approximately $2.3 million of non-cash
compensation charges related to stock options granted to non-employee
consultants. The increase was also a result of expenses incurred related to
our growing number of partner companies, which increased to 49 at June 30,
2000 versus 31 at June 30, 1999. These expenses included payroll-related,
professional fees and marketing costs. General and administrative expenses
were $41.4 million and $14.7 million for the six months ended June 30, 2000
and 1999. The increase was a result of $12.3 million of non-cash compensation
charges related to severance packages for two former executives, a restricted
stock grant, and stock options granted to non-employee consultants. The
increase is also a result of increased expenses incurred related to our
partner companies. 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 Six Months Ended
June 30, June 30,
------------------ ------------------
2000 1999 2000 1999
------- -------- ------- --------
(Unaudited)
Unrealized gain on Tellabs stock................. $ -- $ 35,910 $ -- $ 85,549
Gain on sale of Diamond stock.................... 7,358 3,546 51,971 3,546
Gain on sale of private partner companies........ 19,760 250 19,809 419
Gain on sale of other public holdings............ 108 -- 7,902 5,872
Gain on distributions from private equity funds.. -- 1,889 -- 4,590
Unrealized loss on trading securities............ (820) -- (820) --
Other, primarily impairment charges.............. 1,950 (10,808) (485) (17,856)
------- -------- ------- --------
$28,356 $ 30,787 $78,377 $ 82,120
======= ======== ======= ========
23
For the three and six months ended June 30, 2000, the Company recorded
impairment charges of $1.2 million and $2.0 million, respectively, and $3.2
million and $9.4 million for the three and six months ended June 30, 1999,
respectively, for the other than temporary decline in the carrying value of
some partner companies.
Interest, net. Interest, net, was $1.3 million of income for the three months
ended June 30, 2000 compared to $3.0 million of expense for the three months
ended June 30, 1999. Interest, net, was $3.7 million of expense for the six
months ended June 30, 2000 compared $5.7 million of expense for the six months
ended June 30, 1999. The change is due to interest income earned in 2000 from
funds raised in our follow-on public offering and from strategic investors,
partially offset by increased interest expense as a result of our subordinated
notes issued in June 1999 and 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 and six months ended June 30, 2000 and 1999, respectively.
Equity Income (Loss). Equity income was $16.8 million for the three and six
months ended June 30, 2000. This income is attributable to our wholly-owned
subsidiaries' direct ownership interest in a private equity fund.
Net Results of Operations--Partner Company Operations
Revenue. Revenue was $4.5 million and $10.6 million for the three and six
months ended June 30, 2000, respectively and $6.8 million and $13.4 million
for the three and six months ended June 30, 1999, respectively. 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 $10.3 million and $19.0 million
for the three and six months ended June 30, 2000, respectively and $7.0
million and $13.0 million for the three and six months ended June 30, 1999,
respectively. 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. Equity
loss was $25.6 million for the three months ended June 30, 2000 versus $6.5
million for the three months ended June 30, 1999. During the three months
ended June 30, 2000, we accounted for 34 partner companies on the equity
method versus 22 in 1999. During the three months ended June 30, 2000, $25.1
million of equity loss was attributable to Internet Capital Group, and $29.5
million of equity income was attributable to our holdings in private equity
funds. The remaining $30.0 million equity loss relates to our share of 33
partner companies operating results, a majority of which have losses.
Equity income was $5.9 million for the six months ended June 30, 2000 versus
of equity loss of $13.0 million for the six months ended June 30, 1999. During
the first half of 2000, $24.8 million of equity income was attributable to
Internet Capital Group, and $32.1 million of equity income was attributable to
our
24
holdings in private equity funds. The remaining $51.0 million of equity loss
relates to our share of 36 partner companies operating results, a majority of
which have losses.
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.
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 $690.7 million and $1,258.1 million for the three and
six months ended June 30, 2000, respectively and $802.6 million and $1,295.9
million for the three and six months ended June 30, 1999, respectively. 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 and second 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 9.8% and 9.7% for the three and six months
ended June 30, 2000 and 10.2% and 10.8% for the three and six months ended
June 30, 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. CompuCom also expects to experience
continued pressure in the short term on both service revenue and service gross
margin.
Selling and Service Expenses. Selling and service expenses were 4.8% and 5.4%
of revenue for the three and six months ended June 30, 2000 and 5.0% and 5.8%
of revenue for the three and six months ended June 30, 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 was
$23.1 million and $44.2 million for the three and six months ended June 30,
2000, respectively and $24.5 million and $43.5 million for the three and six
months ended June 30, 1999, respectively. The increase for the six months
ended June 30, 2000 was due to increases in distribution and administrative
personnel as a result of the Entex acquisition. As a percentage of revenue,
general and administrative expenses were 3.3% and 3.5% for the three and six
months ended June 30, 2000 and 3.0% and 3.4% for the three and six months
ended June 30, 1999.
Depreciation and Amortization. Depreciation and amortization expense was $5.8
million and $11.8 million for the three and six months ended June 30, 2000,
and $6.6 million and $11.1 million for the
25
three and six months ended June 30, 1999. During the three months ended June
30, 1999, CompuCom recorded $0.7 million in incremental amortization as a
result of completing the allocation of the purchase price on two acquisitions.
The increase for the six month period 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 $2.3
million was paid through June 30, 2000.
Interest, Net. Interest expense, net decreased for the three and six months
ended June 30, 2000, as compared to the same period in 1999. During the three
months ended June 30, 1999, CompuCom incurred approximately $1.0 million in
charges related to the extension of its previous credit facilities until new
credit facilities were finalized. These charges, along with greater financing
requirements in the second quarter 1999 due to the TASD acquisition, were the
primary reasons for the decline in financing expenses for the three and six
months ended June 30, 2000.
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 $99 million
during the six months ended June 30, 2000, excluding CompuCom's sale of equity
securities which generated proceeds of $3 million.
We have availability under our bank revolving credit facility of $300 million.
Of the $300 million, $250 million matures in April 2005 and is secured by
certain equity securities we hold of our 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
were no amounts outstanding under the total facility at June 30, 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 June of 2001, including commitments to our existing
partner companies, our current operating plan to acquire new partner
companies, our general
26
corporate requirements, and the repurchase of up to $100 million of our common
stock from time to time in the open market as authorized by our Board of
Directors in May 2000. At June 30, 2000, we were contingently obligated for
approximately $21 million of guarantee commitments. Additionally, we had
committed capital of approximately $233 million, including commitments made in
prior years, to various partner companies and private equity funds, to be
funded over the next several years, including $171 million which is expected
to be funded in the next twelve months.
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
partner companies and support our existing partner 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.
CompuCom has financing arrangements consisting of a $200 million receivable
securitization facility and a $175 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 June
30, 2000, $173 million of the securitization facility was utilized.
Availability under the working capital facility is subject to a borrowing base
calculation. As of June 30, 2000, availability under the working capital
facility was $92.2 million, of which $11.8 million was outstanding. 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. These programs are a
material factor in CompuCom's financing needs. As of June 30, 2000, CompuCom
was owed approximately $60 million under these programs.
Consolidated working capital increased to $433.9 million at June 30, 2000 from
$133.8 million at December 31, 1999. The increase is a result of an increase
in cash, driven by our follow-on public offering and sale of our stock to
strategic investors.
Cash used in operating activities increased in 2000 compared to 1999 due to
reduced operating results at CompuCom and a reduction in Compucom's
receivables securitization facility of approximately $50 million.
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 and six months ended June 30,
2000 and 1999, were proceeds from the sales of equity securities.
27
During the first six months of 2000, we committed approximately $250 million
to acquire interests in and make advances to 14 new partner companies,
including Atlas Commerce, Buystream.com, fob.com, Mi8 Corporation, Nextone
Communications, TechSpace LLC, Thin Air Apps, Wireless-Online and Web Telecom
and we committed $75 million to three new private equity funds. During the
first six months of 2000, we funded $193 million to new partner companies, $89
million to existing partner companies, $29 million to new and existing private
equity funds. In addition, we purchased approximately $38 million of shares of
our publicly traded partner companies in the open market. During the second
quarter of 2000, we purchased 528,000 shares of our common stock in the open
market for a total of $20 million, or $36.07 per share.
From July 1, 2000 through August 9, 2000, we funded $48 million of commitments
made prior to June 30, 2000. Additionally, from July 1, 2000 through August 9,
2000, we committed and funded $9 million to acquire ownership interests in or
make advances to new and existing partner companies and private equity funds.
We also purchased 659,000 shares of our common stock for approximately $20.1
million.
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 June 30, 2000.
Recent Accounting Pronouncements
In June 1998, FASB issued SFAS No. 133, "Accounting for Derivatives and
Hedging Activities," which establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts (collectively referred to as derivatives), and for hedging
activities. SFAS No. 133, as amended by SFAS No. 137, is effective for all
fiscal quarters of fiscal years beginning after June 15, 2000. We are
currently analyzing the potential impact of SFAS No 133. on our results of
operations, financial position and cash flows upon the adoption of this
standard.
In October 1999, the Chief Accountant of the Securities and Exchange
Commission requested that the Financial Accounting Standards Board Emerging
Issues Task Force, or the EITF, address a number of accounting and financial
reporting issues that the Securities and Exchange Commission believes has
developed with respect to Internet businesses.
In December 1999, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". This was followed by Staff Accounting Bulletin No. 101A,
"Implementation Issues Related to SAB 101", in March 2000 and by Staff
Accounting Bulletin No. 101B, "Second Amendment: Revenue Recognition in
Financial Statements" SAB 101B", in June 2000. These bulletins summarize
certain of the SEC's views about applying generally accepted accounting
principles to revenue recognition in financial statements. The impact of SAB
101B on the Company was to delay the implementation date of SAB 101 until the
fourth quarter of 2000. The SEC is providing this guidance due, in part, to
the large number of revenue recognition issues that registrants encounter.
The Company is in the process of analyzing the implications of these bulletins
and is anticipating that further implementation guidance will be forthcoming
from the SEC.
28
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 June 30, 2000, our equity interest in Internet Capital Group
had a market value of approximately $1.4 billion, which was significant
compared to our market value of $3.8 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.
29
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 June 30, 2000, the fair value of our holdings in public securities was
approximately $2.3 billion (excluding warrants that are not exercisable).
Approximately $1.4 billion of these equity securities at June 30, 2000
consisted of holdings in Internet Capital Group. A 20% decrease in equity
prices would result in an approximate $0.5 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
35% from their value on June 30, 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 June 30, 2000, there were no 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 June 30, 2000, the securitization facility had borrowings of approximately
$173 million and the working capital facility had borrowings of $11.8 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 $1.6
million based on CompuCom's average borrowings during the six months ended
June 30, 2000. Our share of this increase would be approximately $0.8 million
after deduction for minority interest before taxes.
30
PART II
OTHER INFORMATION
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)(1)
10.2 Term note dated April 13, 2000 from a certain executive
to Safeguard Scientifics, Inc.(1)
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.(1)
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)(1)
10.5 Executive Employment Agreement dated March 13, 2000,
between Anthony F. Pellegrini and CompuCom Systems,
Inc.(1)
27* Financial Data Schedule (electronic filing only)
* filed herewith
(1) Incorporated by reference from registrant's Form 10-Q for the
quarter ended March 31, 2000 dated May 15, 2000 and made a part
hereof by such reference.
(b) On May 16, 2000, the Company filed a Current Report on Form 8-K to
report under Item 5 the following:
On May 11, 2000, Safeguard Scientifics, Inc. ("Safeguard") announced
by a press release that its Board of Directors authorized the
repurchase of up to $100 million of Safeguard's Common Stock in the
open market when conditions and prices are favorable.
31
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: August 14, 2000 /s/ Harry Wallaesa
----------------------------------------
Harry Wallaesa
President and Chief Operating Officer
Date: August 14, 2000 /s/ Gerald A. Blitstein
----------------------------------------
Gerald A. Blitstein
Senior Vice President and Chief Financial
Officer (Principal Financial and Principal
Accounting Officer)
32