FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended September 30, 1999 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 November 12, 1999
Common Stock 34,825,229
SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
------------------------------ ----
Item 1 - Financial Statements:
Consolidated Balance Sheets -
September 30, 1999 (unaudited) and December 31, 1998......................... 3
Consolidated Statements of Operations (unaudited) -
Three and Nine Months Ended September 30, 1999 and 1998...................... 4
Consolidated Statements of Cash Flows (unaudited) -
Nine Months Ended September 30, 1999 and 1998................................ 5
Notes to Consolidated Financial Statements................................... 6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations........................17
Item 3 - Quantitative and Qualitative Disclosures About Market Risk...........30
PART II - OTHER INFORMATION
---------------------------
Item 5 - Other Information....................................................31
Item 6 - Exhibits and Reports on Form 8-K.....................................32
Signatures....................................................................34
2
SAFEGUARD SCIENTIFICS, INC.
Consolidated Balance Sheets
(in thousands)
September 30, December 31,
Assets 1999 1998
-------------- ---------------
(UNAUDITED)
Current Assets
Cash and cash equivalents $ 71,538 $ 6,257
Short-term investments - 143,103
Receivables less allowances 358,767 296,093
Inventories 156,406 138,551
Other current assets 4,325 5,006
-------------- ---------------
Total current assets 591,036 589,010
Property, Plant, and Equipment, Net 67,937 96,840
Other Assets
Equity ownership in partner companies 611,573 288,336
Notes and other receivables 36,365 20,182
Excess of cost over net assets of businesses acquired, net 119,329 65,137
Other 29,389 9,185
-------------- ---------------
Total other assets 796,656 382,840
-------------- ---------------
Total Assets $ 1,455,629 $ 1,068,690
============== ===============
Liabilities and Shareholders' Equity
Current Liabilities
Current debt obligations $ 4,818 $ 2,366
Accounts payable 183,242 161,700
Accrued expenses 116,176 172,953
-------------- ---------------
Total current liabilities 304,236 337,019
Long-Term Debt 165,149 205,044
Deferred Taxes 58,379 12,562
Minority Interest 99,617 98,544
Other Long-Term Liabilities 147,975 1,317
Convertible Subordinated Notes 200,000 71,345
Shareholders' Equity
Common stock 3,480 3,280
Additional paid-in capital 133,142 62,470
Retained earnings 306,572 261,594
Accumulated other comprehensive income 39,347 37,294
Treasury stock, at cost (2,268) (21,779)
-------------- ---------------
Total shareholders' equity 480,273 342,859
-------------- ---------------
Total Liabilities and Shareholders' Equity $ 1,455,629 $ 1,068,690
============== ===============
See notes to consolidated financial statements.
3
SAFEGUARD SCIENTIFICS, INC.
Consolidated Statements of Operations
(in thousands except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
------------------------------------- --------------------------------------
1999 1998 1999 1998
---------------- ---------------- ---------------- -----------------
(UNAUDITED) (UNAUDITED)
Revenues
Net Sales
Product $ 809,683 $ 535,850 $ 1,965,287 $ 1,449,220
Service 87,973 73,203 241,637 204,265
---------------- ---------------- ---------------- -----------------
Total net sales 897,656 609,053 2,206,924 1,653,485
Other income, net 35,606 104,392 125,801 128,320
---------------- ---------------- ---------------- -----------------
Total revenues 933,262 713,445 2,332,725 1,781,805
Costs and Expenses
Cost of sales- product 740,898 482,128 1,800,806 1,295,217
Cost of sales- service 55,138 48,269 154,260 135,293
Selling and service 48,578 46,570 127,520 127,336
General and administrative 38,443 24,763 99,927 69,021
Depreciation and amortization 10,042 5,968 25,379 15,879
Interest and financing 10,136 8,651 26,664 21,145
Loss from equity holdings, net 10,846 4,714 23,802 467
---------------- ---------------- ---------------- -----------------
Total costs and expenses 914,081 621,063 2,258,358 1,664,358
---------------- ---------------- ---------------- -----------------
Earnings Before Minority Interest and
Taxes on Income 19,181 92,382 74,367 117,447
Minority interest (4,847) (818) (5,170) (7,407)
---------------- ---------------- ---------------- -----------------
Earnings Before Taxes On Income 14,334 91,564 69,197 110,040
Provision for taxes on income 5,017 32,322 24,219 39,712
---------------- ---------------- ---------------- -----------------
Net Earnings $ 9,317 $ 59,242 $ 44,978 $ 70,328
================ ================ ================ =================
Earnings Per Share
Basic $ 0.27 $ 1.85 $ 1.35 $ 2.20
Diluted $ 0.26 $ 1.71 $ 1.29 $ 2.04
Average Common Shares Outstanding
Basic 34,761 32,010 33,339 31,920
Diluted 35,509 34,983 35,380 35,112
See notes to consolidated financial statements.
4
SAFEGUARD SCIENTIFICS, INC.
Consolidated Statements of Cash Flows
(in thousands)
Nine Months Ended September 30,
------------------------------------------
1999 1998
----------------- ----------------
(UNAUDITED)
Operating Activities
Net earnings $ 44,978 $ 70,328
Adjustments to reconcile net earnings to cash provided (used)
by operating activities
Depreciation and amortization 25,379 15,879
Deferred income taxes 10,252 (9,202)
Loss from equity holdings, net 23,802 467
Other income, net, from sales of securities and other gains (113,378) (117,495)
Minority interest, net 3,102 4,444
Cash provided (used) by changes in working capital items,
excluding the effect of business acquisitions
Receivables (63,068) (153)
Inventories 76,972 62,799
Accounts payable, accrued expenses, and other (8,406) 18,304
----------------- ----------------
Cash provided (used) by operating activities (367) 45,371
Proceeds from sales of securities and other gains, net 79,718 36,811
----------------- ----------------
Cash provided by operating activities and
sales of securities and other gains, net 79,351 82,182
Other Investing Activities
Equity ownership and notes acquired, net (193,436) (112,565)
Business acquisitions, net of cash acquired (147,235) (49,288)
Capital expenditures (8,398) (14,902)
Proceeds from sale of building 39,791 -
Other, net (1,652) (1,478)
----------------- ----------------
Cash used by other investing activities (310,930) (178,233)
Financing Activities
Net borrowings (repayments) on revolving credit facilities (13,797) 100,483
Net borrowings (repayments) on term debt (25,622) 1,868
Issuance of convertible subordinated notes, net 193,852 -
Proceeds from financial instruments, net 139,309 -
Repurchase of Company common stock (2,695) (9,867)
Issuance of Company common stock 4,580 2,386
Issuance of subsidiary common stock 1,233 738
----------------- ----------------
Cash provided by financing activities 296,860 95,608
----------------- ----------------
Increase (Decrease) in Cash and Cash Equivalents 65,281 (443)
Cash and Cash Equivalents - beginning of year 6,257 5,382
----------------- ----------------
Cash and Cash Equivalents - End of Period $ 71,538 $ 4,939
================= ================
See notes to consolidated financial statements.
5
SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1999
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 1998 Form 10-K should be
read in conjunction with the accompanying statements. These statements
include all adjustments (consisting only of normal recurring adjustments)
which the Company believes are necessary for a fair presentation of the
statements. The interim operating results are not necessarily indicative of
the results for a full year.
2. Reclassifications
-----------------
Certain amounts in the 1998 financial statements have been reclassified to
conform to the 1999 presentation.
3. Business Combinations
---------------------
In February 1999, the Company acquired an 80% fully diluted ownership in
aligne, Inc. in exchange for 441,518 shares of the Company's common stock
with a market value of approximately $17 million. aligne is a strategic
technology management consulting firm whose services include high level and
in-depth evaluations of complex sourcing alternatives, IT cost baselining
and benchmarking, vendor/customer negotiations, interim CIO services, IT
strategy, and IT process re-engineering. The transaction was accounted for
as a purchase and, accordingly, the consolidated financial statements
reflect the operations of aligne since the acquisition date. The
acquisition resulted in goodwill of approximately $17 million, which is
being amortized over ten years. One of the principal's of aligne was
appointed as the Company's new President and Chief Operating Officer.
In June 1999, the Company acquired a 75% fully diluted ownership in SOTAS,
Inc. for $10 million. SOTAS develops, markets, and sells telecommunications
technology and related products and services. The transaction was accounted
for as a purchase and, accordingly, the consolidated financial statements
reflect the operations of SOTAS since the acquisition date. The acquisition
resulted in goodwill of approximately $10 million, which is being amortized
over ten years.
During 1998, CompuCom completed three business combinations for
approximately $49 million in cash. In addition, CompuCom assumed
liabilities of approximately $95 million. These business combinations were
accounted for as purchases and, accordingly, the consolidated financial
statements reflect the operations of the acquired entities since the
respective acquisition dates.
In May 1999, CompuCom purchased from ENTEX Information Services, Inc.
certain assets of its Technology Acquisition Services Division (TASD) in a
cash transaction. This acquisition was structured as an asset purchase.
Under the terms of the agreement, CompuCom paid approximately $137 million
for the acquired assets, which consisted primarily of inventory, certain
fixed assets, and the Erlanger, Kentucky distribution center. The
transaction was accounted for as a purchase and, accordingly, the
consolidated financial statements reflect the operations of the acquired
entity since the acquisition date. CompuCom has allocated the purchase
price to the assets and liabilities acquired based on estimated fair value
as of the date of acquisition. Such allocations have been based on
preliminary estimates of fair value which may be revised at a later date.
6
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, 1998,
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 Nine Months Ended
September 30, 1998 September 30, 1998
------------------ ------------------
Total Revenues $1,154,736 $3,382,337
Net Earnings $ 55,068 $ 61,911
Diluted earnings per share $ 1.59 $ 1.82
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.
Nine Months Ended
September 30, 1999
------------------
Total Revenues $2,956,654
Net Earnings $ 39,652
Diluted earnings per share $ 1.15
4. Comprehensive Income
--------------------
Comprehensive income is the change in equity of a business enterprise
during a period resulting from transactions and other events and
circumstances from non-owner sources. Excluding net earnings, the Company's
source of comprehensive income is from net unrealized appreciation on its
public holdings classified as available-for-sale. The following summarizes
the components of comprehensive income (loss), net of income taxes, (in
thousands):
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- ------------------------------
1999 1998 1999 1998
--------------------------------------------------------------------
(Unaudited)
Net Earnings $ 9,317 $ 59,242 $ 44,978 $ 70,328
------------- ------------- ------------ -------------
Other Comprehensive Income (Loss), Before Taxes:
Unrealized holding gains (losses) (13,448) (21,262) (24,430) (1,071)
Reclassification adjustments (1,524) - (10,026) 1,058
Related Tax (Expense) Benefit:
Unrealized holding gains (losses) 4,707 7,222 8,551 375
Reclassification adjustments 533 - 3,509 (370)
------------- ------------- ------------ -------------
Other Comprehensive Income (Loss) (9,732) (14,040) (22,396) (8)
------------- ------------- ------------ -------------
Comprehensive Income (Loss) $ (415) $ 45,202 $ 22,582 $ 70,320
============= ============= ============ =============
In August 1999, the Company recorded an adjustment in accumulated other
comprehensive income for $24.4 million related to the change in classification
of its Tellabs holdings.
7
5. Financial Instruments
---------------------
The Company may selectively enter into agreements to reduce the impact of
stock market volatility on its ownership in publicly traded companies.
These may include agreements to protect against a possible decline in the
market value of the particular company. The Company does not enter into
agreements for trading or speculative purposes. The counterparties to these
agreements are major financial institutions.
In March 1999, the Company entered into a forward sale contract related to
two million shares of its holdings in Tellabs, Inc. The Company pledged two
million shares of Tellabs for three years and in return received
approximately $71 million of cash. At the end of the term, the Company has
the option to deliver cash or Tellabs shares with a value determined by the
stock price of Tellabs at maturity. The number of Tellabs shares to be
delivered at maturity ranges from 1.6 million to two million shares (or the
cash value thereof). The proceeds from this transaction were used to pay
down a portion of the Company's bank revolving credit facility. The
liability related to this transaction is included in "Other Long-Term
Liabilities" on the Consolidated Balance Sheets.
In August 1999, the Company entered into an additional forward sale
contract on its remaining Tellabs holdings. The Company pledged 1.4 million
shares of Tellabs for three years and in return received approximately $68
million of cash. At the end of the term, the Company has the option to
deliver cash or Tellabs shares with a value determined by the stock price
of Tellabs at maturity. The number of Tellabs shares to be delivered at
maturity ranges from 1.1 million to 1.4 million shares (or the cash value
thereof). The proceeds from this transaction are being used primarily to
acquire interests in or make advances to new and existing partner companies
and affiliated venture funds. The liability related to this transaction is
included in "Other Long-Term Liabilities" on the Consolidated Balance
Sheets.
Under these contracts, all of the Company's holdings in Tellabs are pledged
under forward sale contracts that expire in 2002. As a result of the
restrictions on the sale of these shares under these contracts, the Company
changed the classification of these holdings to available-for-sale in
August of 1999. As a result, the Company's holdings in Tellabs are included
in non-current assets under the caption "Equity Ownership in Partner
Companies" as of September 30, 1999.
All share data related to Tellabs common stock have been retroactively
adjusted to reflect a two-for-one stock split effective May 17, 1999.
8
6. Equity Ownership in Partner Companies
-------------------------------------
The following summarizes the Company's non-current holdings in partner
companies (in thousands). These holdings are classified according to the
applicable accounting method at September 30, 1999. Market value reflects
the price of publicly traded securities at the close of business at the
respective date. Unrealized appreciation reflects the net excess of market
value over carrying value of publicly traded securities classified as
available-for-sale under the cost method.
September 30, 1999 December 31, 1998
----------------------------- -------------------------------
Carrying Market Carrying Market
Value Value Value Value
------------ ------------ ------------- -------------
(Unaudited)
Equity Method
Cambridge $ 51,675 $ 140,612 $ 35,248 $ 190,217
ChromaVision 14,891 66,558 11,304 22,419
DocuCorp 9,956 19,880 3,226 8,035
Internet Capital Group 55,752 1,594,468 19,183 19,183(b)
OAO 16,484 16,934 16,472 16,551
Sanchez 11,576 220,872 10,620 91,965
USDATA 17,377 19,972 7,053 5,545
US Interactive 10,314 55,308 10,832 10,832(b)
Non-public companies 106,080 72,180
------------ -------------
294,105 186,118
Cost Method
Tellabs 212,731 192,130 - -(a)
Diamond 2,583 44,560 3,120 21,337
e4L 1,457 5,985 2,035 32,299
First Consulting Group 9,115 5,821 8,490 11,308
Other public companies 9,059 8,637 5,579 11,648
Unrealized appreciation 22,188 57,368
Non-public companies 60,335 25,626
------------ -------------
$ 611,573 $ 288,336
============ =============
(a) The market value of Tellabs of $143 million at December 31, 1998 is
included in "Short-term Investments" on the Consolidated Balance
Sheets.
(b) The market values of Internet Capital Group and US Interactive equal
their carrying values at December 31, 1998 since Internet Capital
Group and US Interactive were not publicly traded until 1999.
The following summarized unaudited financial information for partner
companies accounted for on the equity method at September 30, 1999 has been
compiled from the unaudited financial statements of the respective
companies and reflects certain historical adjustments (in thousands):
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------- -------------------------------
1999 1998 1999 1998
-------------- -------------- ------------- -------------
Net Sales
Public companies $ 244,297 $ 211,677 $ 696,731 $ 601,281
Non-public companies:
Intellisource 33,773 35,480 106,499 97,483
Kanbay 11,540 10,056 32,004 25,882
MultiGen-Paradigm 3,725 3,400 13,861 12,407
Pac-West Telecomm 37,016 9,500 67,280 29,432
QuestOne 3,972 3,162 12,203 6,871
Other 7,247 12,874 25,226 37,800
-------------- -------------- ------------- -------------
$ 341,570 $ 286,149 $ 953,804 $ 811,156
============== ============== ============= =============
9
7. Debt
----
The Company has available $200 million under its bank revolving credit
facilities. Of the $200 million, $150 million matures in May 2002 and is
secured by certain equity securities the Company holds of its publicly
traded partner companies (the Pledged Securities), including CompuCom. 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 had an original maturity date of April 1999, which the
Company has extended to April 2000. There were no borrowings outstanding
under the total facility at September 30, 1999.
In the first quarter of 1999, CompuCom sold its corporate headquarters
building in a sale/leaseback transaction. The proceeds from the sale were
used to pay down CompuCom's long-term debt. As part of the transaction,
CompuCom entered into a 20-year operating lease on the building.
In May 1999, CompuCom replaced its credit agreements with a $225 million
working capital facility and a $175 million receivables securitization
facility. The new $225 million working capital facility bears interest at a
rate of LIBOR plus an agreed upon spread and is secured by certain assets
of CompuCom. This facility is fully available subject to a borrowing base
and compliance with certain covenants. As of September 30, 1999, CompuCom
had sufficient collateral to enable it to fully utilize the working capital
facility, and had $150 million outstanding as of September 30, 1999. The
working capital facility was reduced by $25 million in September 1999 and
will be reduced by an additional $25 million in May 2000, and matures in
May 2002. On the new $175 million receivables securitization, the effective
rate is based on a designated short-term interest rate plus an agreed upon
spread. This securitization has a term of three years, subject to certain
covenant compliance. 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
planned, the Company increased the securitization to $250 million in
September 1999. The securitization facility was fully utilized at September
30, 1999.
The following is a summary of long-term debt (in thousands):
September 30, December 31,
1999 1998
----------------- -----------------
(Unaudited)
Parent Company and Other Recourse Debt
Revolving credit facilities $ - $ 108,107
Other 15,349 15,874
----------------- -----------------
15,349 123,981
Subsidiary Debt (Non-Recourse to Parent)
CompuCom 150,410 83,429
Other 4,208 -
----------------- -----------------
Total debt 169,967 207,410
Current debt obligations (4,818) (2,366)
----------------- -----------------
Long-term debt $ 165,149 $ 205,044
================= =================
8. Convertible Subordinated Notes
------------------------------
In June 1999, the Company issued $200 million of 5% Convertible
Subordinated Notes (1999 Notes) due June 15, 2006. The 1999 Notes were
originally convertible into the Company's Common Stock at $77.625 per
share, subject to adjustment under certain conditions including rights
offerings and Directed Share Subscription Programs (DSSP) to the Company's
shareholders. Interest is payable semi-annually. The 1999 Notes are
redeemable in whole or in part at the option of the Company on
10
or after June 18, 2002, for a maximum of 102.5% of face value depending on
the date of redemption and subject to certain restrictions. The Company
used approximately $111 million of the net proceeds to repay all of the
Company's outstanding indebtedness under its revolving credit facility and
borrowings from partner companies. In August 1999, the Company's
shareholders were given the opportunity to participate in the initial
public offering (IPO) of Internet Capital Group through a DSSP. Pursuant to
the terms of the 1999 Notes, the conversion rate of the Notes was adjusted
to $76.0786 per share as a result of the IPO of Internet Capital. In August
1999 and November 1999, the Company's shareholders were given the
opportunity to participate in the IPOs of US Interactive and Pac-West
Telecomm, respectively, through DSSP's. Pursuant to the terms of the 1999
Notes, the conversion rate of the Notes was adjusted to $75.0441 per share
as a result of these IPOs.
In April 1999, the Company notified the holders of its previously issued
Convertible Subordinated Notes (1996 Notes) of its intent to redeem all of
the outstanding 1996 Notes on June 2, 1999. All holders converted the 1996
Notes into common stock and, as a result of the conversions, the Company
issued approximately 2.4 million shares.
9. Other Income
------------
Other income consists of the effect of transactions and other events
primarily related to our ownership interests in our partner companies and
our operations in general. Other income may include, among other items,
gains or losses on the sales of all or a portion of our ownership in
partner companies, gains or losses on the issuance of stock by our partner
companies to reflect the change in our share of the net equity of these
companies, and distributions received from our associated venture funds.
Other income may also include administrative service fees, which represent
charges to certain partner companies for operational and management
services provided through a team of Safeguard professionals, interest
income, charges incurred in the disposition of certain partner companies,
and provisions for equity ownership in partner companies and notes.
Other income consists of the following (in millions):
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
1999 1998 1999 1998
---------------------------------------------------------------------
(Unaudited)
Coherent/Tellabs merger $ - $ 245.4 $ - $ 245.4
Unrealized gain (loss) on Tellabs (7.4) (123.8) 72.2 (123.8)
Sale of stock by Internet Capital 35.4 - 35.4 -
Sales of Internet Capital holdings 9.3 - 9.3 -
Sales of Cambridge holdings - - - 15.0
Sales of Tellabs holdings - - 5.9 -
Sales of other public holdings 1.5 - 11.0 1.1
Distributions from Venture Funds - 3.3 4.6 9.5
Administrative Service Fees 3.0 2.8 9.2 8.7
Other (6.2) (23.3) (21.8) (27.6)
------------- ------------- ------------ ------------
$ 35.6 $ 104.4 $ 125.8 $ 128.3
============= ============= ============ ============
In August 1998, Tellabs acquired Coherent, and Safeguard received
approximately 7.0 million shares (adjusted for May 1999 stock split) of
Tellabs in exchange for all of its Coherent shares. The market value of the
Tellabs shares received on the date of exchange was used to determine the
gain. Subsequent to the merger, we accounted for our holdings in Tellabs as
trading securities, resulting in
11
a $123.8 million loss through September 30, 1998 as a result of the decline
in Tellabs stock price subsequent to the merger.
Through August 1999, the Company's holdings in Tellabs were classified as a
trading security and, accordingly, the effect of the change in market value
of Tellabs was reflected in the Company's results of operations. As
discussed in Note 5, the Company changed this classification as a result of
certain forward sale contracts entered into in 1999, and changes in the
fair value of the Company's Tellabs holdings following this change in
classification are recorded in shareholders' equity.
As a result of the Internet Capital IPO in August 1999, our share of
Internet Capital's net equity increased by $35.4 million. This gain was
recorded in accordance with SEC Staff Accounting Bulletin No. 84. The
Company also sold a portion of its holdings in Internet Capital's IPO.
Sales of other public holdings in 1999 include the sales of the Company's
holdings in Excite and BEA Systems in the first and third quarters of 1999,
respectively, and the sale of a portion of the Company's holdings in
Diamond in the second quarter of 1999.
10. Restructuring
-------------
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. Of the
total amount, $2.4 million had been paid through December 31, 1998 and
$10.0 million was paid in 1999 through September 30.
The following is a summary of the components of the restructuring charge
(in thousands):
Restructuring Accrued at Accrued at
Charge December 31, 1998 September 30, 1999
----------------- ----------------- ------------------
Lease termination costs $ 7,259 $ 6,415 $ 1,826
Employee severance and related benefits 3,804 2,986 689
Disposal of assets, net of estimated proceeds 3,044 2,907 1,596
Other 2,330 1,780 -
----------------- ----------------- ------------------
Total $ 16,437 $ 14,088 $ 4,111
================= ================= ==================
CompuCom expects the restructuring activities to be substantially completed
by the end of 1999 and believes the restructuring accrual is reasonable.
12
11. Earnings Per Share
------------------
The calculations of Earnings Per Share (EPS) were (in thousands except per
share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- --------------------------------
1999 1998 1999 1998
-------------- -------------- -------------- --------------
(Unaudited) (Unaudited)
Basic EPS
---------
Net earnings $ 9,317 $ 59,242 $ 44,978 $ 70,328
============== ============== ============== ==============
Average common shares outstanding 34,761 32,010 33,339 31,920
============== ============== ============== ==============
Basic EPS $ 0.27 $ 1.85 $ 1.35 $ 2.20
============== ============== ============== ==============
Diluted EPS
-----------
Net earnings $ 9,317 $ 59,242 $ 44,978 $ 70,328
Effect of: Public holdings (a) (91) (220) (600) (814)
Dilutive securities (b) - 725 1,090 2,269
-------------- -------------- -------------- --------------
$ 9,226 $ 59,747 $ 45,468 $ 71,783
============== ============== ============== ==============
Average common shares outstanding 34,761 32,010 33,339 31,920
Effect of: Dilutive options 748 512 825 643
Dilutive securities (b) - 2,461 1,216 2,549
-------------- -------------- -------------- --------------
Average number of common shares assuming dilution 35,509 34,983 35,380 35,112
============== ============== ============== ==============
Diluted EPS $ 0.26 $ 1.71 $ 1.29 $ 2.04
============== ============== ============== ==============
(a) Represents the dilutive effect of public company common stock
equivalents and convertible securities.
(b) Represents the dilutive effect of the Company's 1996 Notes for the
nine months ended September 30, 1999, as well as the three and nine
months ended September 30, 1998. The 1999 Notes are excluded from all
periods presented, as they are anti-dilutive; and therefore, they do
not impact the calculation of diluted EPS.
12. Shareholders' Equity
--------------------
In May 1999, the Company approved an increase in the number of authorized
common shares to 500 million from 100 million and authorized 1 million
shares of blank check preferred stock in lieu of the 55,424 currently
authorized shares of preferred stock.
In connection with the conversion of the 1996 Notes into Common Stock (see
Note 8), the Company recorded in shareholders' equity the principal amount
of the converted 1996 Notes as well as forfeited interest and the related
unamortized deferred charges totaling approximately $71.6 million.
13. Parent Company Financial Information
------------------------------------
Condensed Financial Information is provided to reflect the results of
operations and financial position of the "Parent Company", or the Company
without the effect of consolidating its less than wholly owned
subsidiaries.
13
The following summarizes the Parent Company Balance Sheets of Safeguard
Scientifics, Inc. and its wholly owned subsidiaries (in thousands). These
Parent Company Balance Sheets differ from the Consolidated Balance Sheets due
to the exclusion of the assets and liabilities of the Company's less than
wholly owned subsidiaries, primarily CompuCom and Tangram, and, at September
30, 1999, aligne, Arista and SOTAS, with the carrying values of these
companies included in "Equity ownership in partner companies".
September 30, December 31,
1999 1998
----------------- -----------------
Assets (Unaudited)
Short-term investments $ - $ 143,103
Other current assets 80,322 30,766
Equity ownership in partner companies 766,689 413,596
Other 80,700 49,830
----------------- -----------------
Total assets $ 927,711 $ 637,295
================= =================
Liabilities and Shareholders' Equity
Current liabilities $ 23,531 $ 80,824
Long-term debt 14,544 123,115
Other liabilities 209,363 19,152
Convertible subordinated notes 200,000 71,345
Shareholders' equity 480,273 342,859
----------------- -----------------
Total liabilities & shareholders' equity $ 927,711 $ 637,295
================= =================
The following summarizes the Parent Company's holdings in less than wholly
owned subsidiaries (in thousands). Market value reflects the price of
publicly traded securities at the close of business at the respective date.
September 30, 1999 December 31, 1998
--------------------------------------- -----------------------------------------
Carrying Market Carrying Market
Value Value Value Value
---------------- ------------------ ------------------ ------------------
(Unaudited)
Cambridge $ 51,675 $ 140,612 $ 35,248 $ 190,217
CompuCom 126,162 106,309 121,832 98,538
Internet Capital Group 55,752 1,594,468 19,183 19,183(b)
Tangram 4,067 15,673 3,428 41,795
Tellabs 212,731 192,130 - -(a)
Other public 125,000 464,526 130,076 231,939
Other 191,302 103,829
---------------- ------------------
$ 766,689 $ 413,596
================ ==================
(a) The market value of Tellabs of $143 million at December 31, 1998 is
included in "Short-term Investments" on the Consolidated Balance Sheets.
(b) The market value of Internet Capital Group equals its carrying value at
December 31, 1998 since Internet Capital Group was not publicly traded
until 1999.
14
Parent Company Financial Information (continued)
------------------------------------------------
The following summarizes the Parent Company Statements of Operations of
Safeguard Scientifics, Inc. and its wholly owned subsidiaries (in
thousands). These Parent Company Statements of Operations differ from the
Consolidated Statements of Operations by excluding the revenues and related
costs and expenses of the Company's less than wholly owned subsidiaries,
primarily CompuCom and Tangram, and for the three and nine months ended
September 30, 1999, aligne, Arista and SOTAS, with the Company's share of
the earnings or losses of these companies reflected in the caption
"(Income) loss from equity holdings, net".
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------- -----------------------------------
1999 1998 1999 1998
--------------- --------------- --------------- ---------------
(UNAUDITED) (UNAUDITED)
Revenues
Other Income $ 37,646 $ 104,683 $ 126,731 $ 129,214
Costs and Expenses
Cost of sales and operating expenses 14,313 9,441 36,970 26,367
(Income) loss from equity holdings, net 11,652 4,111 23,450 (3,871)
--------------- --------------- --------------- ---------------
Total costs and expenses 25,965 13,552 60,420 22,496
--------------- --------------- --------------- ---------------
Earnings Before Taxes On Income 11,681 91,131 66,311 106,718
Provision for taxes on income 2,364 31,889 21,333 36,390
--------------- --------------- --------------- ---------------
Net Earnings $ 9,317 $ 59,242 $ 44,978 $ 70,328
=============== =============== =============== ===============
14. Operating Segments
------------------
The Company's reportable segments consist of CompuCom, Tangram, general
corporate operations, and other. CompuCom's operations are defined in two
segments - sales of distributed desktop computer products (product); and
service and other, which includes configuration, network integration, and
technology support (service and other). Tangram's operations include the
design, development, sale, and implementation of enterprise-wide asset
tracking and software management solutions. General corporate operations
consist of identifying, acquiring, managing, and operating partner
companies, most of which are engaged in information technology businesses.
Other includes the operations of aligne, Arista and SOTAS.
15
The following summarizes information related to the Company's segments (in
thousands). All significant intersegment activity has been eliminated.
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- ----------------------------------------
1999 1998 1999 1998
---------------- ----------------- ----------------- -----------------
Net Sales (UNAUDITED) (UNAUDITED)
CompuCom
Product $ 806,191 $ 531,640 $ 1,955,526 $ 1,438,913
Service and Other 83,151 71,690 229,731 199,726
---------------- ----------------- ----------------- -----------------
889,342 603,330 2,185,257 1,638,639
Tangram 4,836 5,723 14,741 14,846
Other 3,478 - 6,926 -
---------------- ----------------- ----------------- -----------------
$ 897,656 $ 609,053 $ 2,206,924 $ 1,653,485
================ ================= ================= =================
Gross Margin(a)
CompuCom
Product $ 65,615 $ 49,586 $ 155,700 $ 143,994
Service and Other 29,049 23,898 79,327 65,809
---------------- ----------------- ----------------- -----------------
94,664 73,484 235,027 209,803
Tangram 4,241 5,172 12,421 13,172
Other 2,715 - 4,410 -
---------------- ----------------- ----------------- -----------------
$ 101,620 $ 78,656 $ 251,858 $ 222,975
================ ================= ================= =================
Operating Profit (Loss)
CompuCom
Product $ 6,508 $ 2,075 $ (396) $ 17,489
Service and Other 11,247 5,018 29,076 11,167
---------------- ----------------- ----------------- -----------------
17,755 7,093 28,680 28,656
Interest and financing, net (6,909) (5,322) (17,446) (13,337)
---------------- ----------------- ----------------- -----------------
10,846 1,771 11,234 15,319
---------------- ----------------- ----------------- -----------------
Tangram 325 538 1,080 985
---------------- ----------------- ----------------- -----------------
General Corporate
Other income, net 35,606 104,392 125,801 128,320
Loss from equity holdings, net (10,846) (4,714) (23,802) (467)
Interest and financing, net (3,227) (3,329) (9,218) (7,808)
General corporate expense, net (10,959) (6,028) (27,295) (18,159)
Minority interest (4,847) (818) (5,170) (7,407)
---------------- ----------------- ----------------- -----------------
5,727 89,503 60,316 94,479
---------------- ----------------- ----------------- -----------------
Other (2,564) (248) (3,433) (743)
---------------- ----------------- ----------------- -----------------
Earnings Before Taxes on Income $ 14,334 $ 91,564 $ 69,197 $ 110,040
================ ================= ================= =================
(a) Total gross margin reconciles to the Consolidated Statements of Operations
by subtracting cost of sales from net sales.
16
Management's Discussion and Analysis of
Financial Condition and Results of Operations
General
-------
Safeguard Scientifics, Inc. (the Company) is an information technology (IT)
holding company that identifies, acquires, operates and manages Internet-
focused companies and has interests in private equity funds. The Company is
now focusing on IT companies engaged in e-commerce, e-business software and
services, and e-communications. The Company believes that these sectors
provide compelling opportunities for success driven by the rapid growth of the
Internet as a fundamental business tool. The Company generally acquires
ownership interests in companies that allow it to have a significant influence
over their direction and management. These positions may represent either a
majority or minority ownership interest, although the Company is generally the
largest shareholder of our partner companies. The Company assigns a dedicated
team assigned to each partner company and actively assists our partner
companies in their management, operations and finances.
The Company's principal mission is to promote long-term shareholder value.
Safeguard's approach reflects its belief that shareholder value is maximized
by retaining and promoting the entrepreneurial energy and creativity of the
managers of our partner companies. The entrepreneurs of its partner companies
generally retain significant equity interests in their businesses, and their
interests as shareholders remain aligned with the Company's. Safeguard
provides a full range of operational and management services through a team of
Safeguard professionals dedicated to that partner company. Each team has
expertise in the areas of business/technology strategy, sales and marketing,
operations, finance, and legal and transactional support, and provides hands-
on assistance to the management of the partner companies in support of their
growth. The level of involvement varies and in some circumstances includes
the provision of full-time interim personnel. Since Safeguard partners with
an indeterminate time frame, it seeks different ways to maximize the long-term
value of its partner companies. This is achieved through Rights IPOs directed
solely to holders of Safeguard Common Stock, Directed Share Subscription
Programs (DSSP) as part of traditional IPOs, mergers, sales, open-market
transactions, follow-on acquisitions or the divestiture of Safeguard's
position over time. Safeguard typically retains a significant ownership
position in a partner company after the partner company conducts its IPO.
The DSSP was developed by the Company to allow the Company's shareholders who
own at least 100 shares in a single account on a given record date the
opportunity to participate in a portion of the IPO of a Safeguard partner
company. The offering ratio varies but is based on the number of shares being
offered under the program by the IPO company in relation to the number of
Safeguard shares outstanding at the time of an offering.
The Company believes the best way to build future value for its shareholders
is to be involved in Internet markets. As the Company acquires interests in
and operates more Internet-related companies, it could experience increased
volatility in its earnings, as many early stage Internet companies have
operating losses. For several years, the Company has had a financial model of
exceeding the prior year's quarterly earnings per share (EPS) by $.01. This
was essentially accomplished through sales of securities. Given the
volatility of the technology market, especially Internet-related stocks, the
Company will no longer sell securities solely to achieve a targeted EPS. As a
result, the Company's net earnings could fluctuate significantly from quarter
to quarter. There can be no guarantee that the Company will report net
earnings in each period.
17
As discussed in Note 5 to the Consolidated Financial Statements, the Company
changed the classification of its Tellabs holdings in August of 1999. As a
result, changes in the fair value of Tellabs holdings are no longer included
in the Company's net earnings subsequent to the change in classification. As
disclosed in Note 9 to the Consolidated Financial Statements, this amount had
been significant in 1999.
Because many of our partner companies are not majority-owned subsidiaries,
changes in the value of our interests in partner companies and the income/loss
attributable to them could require us to register as an investment company at
some point in the future, unless we take action to avoid being required to
register. However, we believe that we can take steps to avoid being required
to register under the Investment Company Act which would not adversely affect
our operations or shareholder value.
Effect of Various Accounting Methods on the Consolidated Financial Statements
-----------------------------------------------------------------------------
Consolidation. The net sales and related costs and expenses of a partner
company are included in the Company's consolidated operating results if the
Company owns more than 50% of the outstanding voting securities of the partner
company. Participation of shareholders other than the Company in the earnings
or losses of a more than 50% owned partner company is reflected in the caption
"Minority interest" in the Consolidated Statements of Operations. Minority
interest adjusts consolidated net earnings to reflect only the Company's share
of the earnings or losses of the partner company. CompuCom Systems, Inc. and
Tangram Enterprise Solutions, Inc. are consolidated in 1999 and 1998. In
February and June 1999, the Company acquired an 80% and 75% voting ownership
in aligne, Inc. and SOTAS, Inc., respectively. These transactions were
accounted for as purchases and, accordingly, the consolidated financial
statements reflect the operations of these companies since the acquisition
dates.
Equity Method. Partner companies in which the Company owns 50% or less of the
outstanding voting securities, in which significant influence is exercised,
are generally accounted for on the equity method of accounting. Significant
influence is presumed at a 20% ownership level; however, the Company applies
the equity method for certain companies in which it owns less than 20% of the
voting interest when it exerts significant influence through representation on
those companies' Boards of Directors and other means. On the equity method of
accounting, a partner company's revenues and related costs and expenses are
not included in the Company's consolidated operating results; however, the
Company's share of the earnings or losses of the partner company is reflected
in the caption "(Income) loss of equity holdings, net" in the Consolidated
Statements of Operations.
The net effect of a partner company's results of operations on the Company's
net earnings is the same under either consolidation accounting or the equity
method of accounting, as only the Company's share of the earnings or losses of
a partner company is included in the Company's net earnings in the
Consolidated Statements of Operations.
Cost Method. Partner companies not consolidated or accounted for on the
equity method are accounted for on the cost method of accounting under which
the Company's share of the earnings or losses of such companies is not
included in the Company's Consolidated Statements of Operations. However, the
effect of the change in market value of cost method holdings classified as
trading securities is reflected in the Company's results of operations each
reporting period. The Company's holdings in Tellabs were classified as
trading securities until August 1999 when the Company entered into an
additional forward sale contract that restricted the sale of all of the
Company's holdings in Tellabs. As a result, effective August 1999, the
Company's holdings in Tellabs are classified as
18
available-for-sale with changes in fair value, net of taxes, included as a
component of shareholders' equity.
Effect of Various Accounting Methods on the Presentation of the Consolidated
----------------------------------------------------------------------------
Financial Statements
--------------------
If the Company's ownership in any of the partner companies changes
significantly, the Company's consolidated revenues and related costs and
expenses may fluctuate primarily due to the applicable accounting method used
for recognizing its participation in the operating results of that company.
As mentioned below in Operations Overview, the Company's consolidated revenues
and related costs and expenses are significantly influenced by the results of
operations of CompuCom. At September 30, 1999, the Company owns approximately
51% of CompuCom's outstanding common stock and owns preferred stock which
gives it 60% of the vote for CompuCom's directors.
CompuCom competes in the computer reseller industry which has been undergoing
significant transformation and consolidation. Several of CompuCom's
competitors have been growing through acquisitions and others have been
acquired. In addition, companies previously engaged in the retail channel
have begun to enter the corporate reseller market, and several computer
manufacturers are beginning to sell directly to corporate customers,
heightening the competition.
As a result, while growing internally, CompuCom is also looking to strengthen
its market share through acquisitions, including one which was completed in
May 1999. If CompuCom were to use its stock for the acquisitions or if some
other dilutive event were to occur, the Company's voting interest in CompuCom
could decrease below 50%. Under current generally accepted accounting
principles, the Company would cease consolidating CompuCom's results and
instead would account for its holdings in CompuCom on the equity method
provided the Company maintained the ability to exercise significant influence
over CompuCom's ordinary course of business. The Company's share of CompuCom's
earnings on the equity method versus consolidation would differ only to the
extent that the Company's ownership of CompuCom changed. However, the
presentation of the Consolidated Statements of Operations and Balance Sheets
would change dramatically.
Note 13 to the Company's Consolidated Financial Statements summarizes the
Parent Company Statements of Operations and Balance Sheets of the Company for
the same periods presented in the Consolidated Financial Statements. These
statements differ from the Consolidated Financial Statements by excluding the
revenues, costs, expenses, assets, and liabilities of the Company's less than
wholly owned subsidiaries (primarily CompuCom and Tangram) and instead
treating these companies as if they were accounted for on the equity method.
The Company's share of the results of operations of less than wholly owned
subsidiaries is included in "(Income) loss of equity holdings, net" and the
carrying value of these companies is included in "Equity ownership in partner
companies" in the Parent Company Statements of Operations and Balance Sheets,
respectively.
Although the Parent Company Statements of Operations and Balance Sheets
presented in Note 13 are accurate relative to the Company's historical
Consolidated Financial Statements, they are not necessarily indicative of
future Parent Company Statements of Operations and Balance Sheets.
Operations Overview
--------------------
The Company's operations have been classified into the following business
segments: CompuCom, Tangram, general corporate operations, and other.
CompuCom's operations are further defined into two segments-sales of
distributed desktop computer products (product) and configuration, network
integration, and technology support (service and other). Tangram's operations
include the design,
19
development, sale, and implementation of enterprise-wide asset tracking and
software management solutions. General corporate operations consists of
developing and operating partner companies, most of which are engaged in
information technology businesses. Other includes the operations of aligne,
Arista and SOTAS.
Three Months Ended September 30, 1999 Compared to September 30, 1998
Net sales increased 47% to $898 million in 1999 compared to $609 million in
1998 as CompuCom experienced a 47% sales increase. The increase at CompuCom
was due primarily to a 52% product sales increase resulting from the
acquisition of the Technology Acquisition Services Division (TASD) of Entex
Information Services, Inc. during the second quarter of 1999. CompuCom's
service sales increased 23% to $83 million in 1999 from $68 million in 1998,
which was primarily due to increases in both configuration and field
engineering, both of which benefited by an increase in product unit sales
volume. CompuCom represented 99% of the Company's total consolidated net
sales in 1999.
The Company's overall gross margin was 11.3% in 1999 compared to 12.9% in
1998. The decrease is primarily attributable to reduced product gross margins
at CompuCom, which decreased to 8.1% in 1999 compared to 9.3% in 1998.
CompuCom attributes this decline primarily to heightened competition from
direct marketers and other corporate resellers and a reduction in manufacturer
sponsored incentives. CompuCom expects to continue to experience lower product
gross margin percentages when compared to the comparable prior year period.
CompuCom's service gross margin was 34.9% in 1999 compared to 32.3% in 1998.
The increase was primarily caused by improved performance in its field
engineering business. In the short term, CompuCom expects to continue to
experience improved service gross margin percentages when compared to the
comparable prior year period.
Other income in 1999 includes gains of $10.9 million resulting from the sale
of a portion of the Company's holdings in Internet Capital and the Company's
holdings in BEA Systems. The Internet Capital shares were sold in Internet
Capital's IPO in August 1999. Additionally, as a result of Internet Capital
completing its IPO, the Company's share of Internet Capital's net equity
increased. This increase adjusted the Company's carrying value in Internet
Capital and resulted in a gain of $35.4 million, which was recorded in other
income in 1999. Other income in 1999 also includes an unrealized $7.4 million
loss resulting from the decrease in the market price of Tellabs.
Other income in 1998 included a gain of approximately $245.3 million as a
result of the Coherent Communications Systems Corporation merger with Tellabs,
an unrealized loss of approximately $123.8 million resulting from the decrease
in the market price of Tellabs subsequent to the merger, and distributions
received from the Company's affiliated venture funds.
Partially offsetting other income in these years were charges incurred in the
disposition of certain partner companies, and provisions for equity ownership
in partner companies and notes. Other income of varying magnitude has been
realized in recent years, primarily as a result of the change in the fair
value of the Company's holdings in Tellabs and the timing of sales of
securities. Prior amounts are not necessarily indicative of amounts which may
be realized in the future.
(Income) loss from equity holdings fluctuates with the Company's ownership
percentage and the operating results of partner companies accounted for on the
equity method. The change in income (loss) from equity holdings for the three
months ended September 30, 1999 compared to the same period in 1998 reflects
increased operating losses at certain partner companies and an increase in the
20
number of companies accounted for on the equity method, a majority of which
have operating losses. The Company expects certain of its partner companies
to continue to invest in their products and services and to recognize
operating losses. Additionally, the Company expects to acquire interests in
more Internet-related companies, and many early stage Internet companies have
operating losses. As a result, losses from equity holdings could increase
significantly.
In 1999, the Company's public partner companies accounted for on the equity
method include Cambridge, ChromaVision, DocuCorp, Internet Capital Group, OAO
Technology Solutions (OAOT), Sanchez, USDATA Corporation, and US Interactive.
Cambridge announced its third quarter 1999 results with revenue growth driven
by increased global demand for Cambridge's e-Business Solutions, which
increased 41% year over year. This increase was partially offset by the
impact of clients' completing Y2K remediation work in lieu of traditional IT
solutions such as package implementations and customer client-server
applications. Net income was $10.7 million, or $.18 per share (diluted)
compared to net income of $9.7 million, or $.16 per share (diluted) for the
same period in 1998. Safeguard owns approximately 16% of Cambridge's
outstanding voting securities at September 30, 1999.
During the third quarter, ChromaVision received FDA clearance for use of the
ACIS(TM) with the immunohistochemical staining method, a method widely used to
characterize cancer and infectious disease. A significant number of ACIS(TM)
applications currently under development use this method. Also during the
quarter, the Company completed the validation of its application for the
detection of HER2/neu, a breast cancer test, using trial results involving
over 1,000 patients. For this year's third quarter, ChromaVision reported a
net loss of $3.2 million, or $.18 loss per share, as compared to $1.9 million,
or $0.11 loss per share for the same period last year. The increase in the
net loss for the third quarter was due to incremental sales and administrative
costs related to staffing and commercial launch activities coupled with
research and development costs associated with the addition of new ACIS(TM)
applications. Safeguard owns approximately 30% of ChromaVision's outstanding
voting securities at September 30, 1999.
Internet Capital Group completed its IPO in August 1999. During the third
quarter, two of Internet Capital Group's partner companies completed initial
public offerings, Breakaway Solutions (BWAY) and US Interactive (USIT).
Safeguard owns approximately 14% of Internet Capital Group's outstanding
voting securities at September 30, 1999.
Sanchez reported revenues for the quarter ended September 30, 1999 of $17.5
million, compared to $12.1 million for the same period in 1998. Net earnings
for the quarter increased to $2.6 million, or $.10 per share (diluted)
compared to net income of $2.1 million, or $.09 per share (diluted) for the
same period in 1998. Between Sanchez and the company's subsidiary, e-
PROFILETM Inc., the end-to-end e-banking outsourcing solution, Sanchez is
engaged in projects with six new e-commerce clients worldwide. Safeguard owns
approximately 26% of Sanchez's outstanding voting securities at September 30,
1999.
During the quarter, USDATA completed its acquisition of essentially all of the
assets and certain liabilities of Smart Shop Software, Inc., which provides
business software to make-to-order small and medium manufacturers. Safeguard
owns approximately 33% of USDATA's outstanding voting securities at September
30, 1999.
Safeguard completed a DSSP in conjunction with US Interactive's IPO in August
1999. For the quarter ended September 30, 1999, US Interactive reported
revenues of $9.9 million, an increase of 117% from the same period a year ago
and a 29% sequential increase over the $7.6 million for the
21
second quarter of 1999. The net loss for the third quarter was $4.1 million.
Basic and diluted EPS for the third quarter was a loss of $0.29. Safeguard
owns approximately 13% of US Interactive's outstanding voting securities at
September 30, 1999.
Selling and service expenses increased in absolute dollars primarily due to
CompuCom's acquisition of TASD, which resulted in an increase in sales and
sales support personnel. Selling and service expenses decreased as a
percentage of sales to 5.4% from 7.6% for the comparable period in 1998
primarily due to increased leverage of CompuCom's infrastructure resulting
from the TASD acquisition and its own cost reduction efforts.
General and administrative expenses increased in absolute dollars and as a
percentage of sales primarily due to increased expenditures at CompuCom to
continue the expansion of its electronic commerce capabilities, increases in
distribution and administrative personnel to support CompuCom's revenue growth
and expenses related to the TASD acquisition, and increased expenses at the
Company to support the growing activities of its partner companies.
CompuCom's general and administrative expenses are reported net of
reimbursements by certain manufacturers for specific training, promotional,
and marketing programs. These reimbursements offset the expenses incurred by
CompuCom.
Depreciation and amortization increased primarily due to increased
amortization at CompuCom primarily due to the TASD acquisition. In addition,
also as a result of the TASD acquisition, certain property and equipment
depreciation increased due to increases in distribution and administrative
personnel.
Interest and financing expense increased in 1999 compared to 1998 primarily as
a result of increased borrowing levels at CompuCom due to the acquisition of
TASD. The increase was also due to interest expense related to the issuance
by the Company of $200 million of Convertible Subordinated Notes in June 1999.
These increases were partially offset by the elimination of interest due to
the conversion of $71 million of the Company's 1996 Notes into the Company's
Common Stock in the second quarter of 1999.
Minority interest increased as a result of increased operating results at
CompuCom. Future profitability at CompuCom will depend on its ability to
successfully integrate the TASD acquisition into its operations, to
effectively manage inventory levels in response to changes in its major
suppliers' price protection and return programs, to grow its services
business, to effectively manage the utilization of service personnel, and to
respond to increased competition from its suppliers' direct selling
initiatives. It also depends on CompuCom's ability to reduce operating
expenses at a pace equal to the decline in margin percentages, competitive
pricing, short-term interest rate fluctuations, general economic conditions,
employee turnover and possible future litigation, as well as the risks and
uncertainties set forth from time to time in CompuCom's other public reports
and filings and public statements.
The Company's effective tax rate of 35% in 1999 approximated the percentage
for 1998.
The Company's net earnings decreased in 1999 compared to 1998 primarily due to
decreases in other income, and reduced operating results for partner companies
accounted for on the equity method, partially offset by increased earnings at
CompuCom. Other income of varying magnitude have been realized in recent
years. The Company's net earnings could fluctuate significantly from period
to
22
period, depending on the operations of its holdings accounted for on the
equity method and the timing of sales of securities. There can be no guarantee
that the Company will report net earnings in each period.
Nine Months Ended September 30, 1999 Compared to September 30, 1998
Net sales increased 33% to $2.2 billion in 1999 compared to $1.7 billion in
1998 as CompuCom experienced a 33% sales increase. The increase at CompuCom
was due primarily to the acquisition of TASD during the second quarter of
1999. CompuCom's service sales increased 20% to $226 million in 1999 from
$188 million in 1998, which was primarily due to increases in both
configuration and field engineering, which are typically driven in part by
product unit sales volume. CompuCom represented 99% of the Company's total
consolidated net sales in 1999.
The Company's overall gross margin was 11.4% in 1999 compared to 13.6% in
1998. The decrease is primarily attributable to reduced product gross margins
at CompuCom, which decreased to 7.9% in 1999 compared to 10.0% in 1998.
CompuCom attributes this decline primarily to heightened competition from
direct marketers and other corporate resellers and a reduction in manufacturer
sponsored incentives. CompuCom's service gross margin was 34.4% in 1999
compared to 31.9% in 1998. The increase was primarily caused by improved
performance in its field engineering business.
As a result of Internet Capital's IPO in August 1999, the Company's share of
Internet Capital Group's net equity increased and resulted in a gain of $35.4
million. This gain was recorded in other income in 1999. Other income in
1999 also includes a $72.2 million gain resulting from the increase in the
market price of Tellabs, $5.9 million gain on the sales of Tellabs stock and a
gain of $9.3 million on sales of Internet Capital holdings. Other income in
1999 also includes the sale of the Company's holdings in Excite and BEA
Systems, a portion of its holdings in Diamond, and distributions received from
the Company's affiliated venture funds. Other income in 1998 included a gain
of approximately $245.3 million as a result of the Coherent Communications
merger with Tellabs and an unrealized loss of approximately $123.8 million
resulting from the decrease in the market price of Tellabs subsequent to the
merger. Other income in 1998 included the sales of a portion of the Company's
interest in Cambridge and distributions received from the Company's affiliated
venture funds. Partially offsetting in these years were charges incurred in
the disposition of certain partner companies, and provisions for equity
ownership in partner companies and notes. Other income of varying magnitude
has been realized in recent years, primarily as a result of the change in the
fair value of the Company's holdings in Tellabs and the timing of sales of
securities. Prior amounts are not necessarily indicative of amounts which may
be realized in the future. As discussed in Note 5 to the Consolidated
Financial Statements, the Company changed the classification of its Tellabs
holdings in August of 1999. As a result, changes in the fair value of Tellabs
holdings will no longer be included in the Company's net earnings.
(Income) loss from equity holdings fluctuates with the Company's ownership
percentage and the operating results of partner companies accounted for on the
equity method. The change in income (loss) from equity holdings for the nine
months ended September 30, 1999 compared to the same period in 1998 reflects
increased operating losses at certain partner companies, the elimination of
the Company's share of earnings of Coherent a result of the Coherent/Tellabs
merger, an increase in the number of companies accounted for on the equity
method, a majority which have operating losses, and reduced operating results
at Cambridge as a result of approximately $9 million of non-recurring charges
in the second quarter of 1999.
Selling and service expenses increased slightly in absolute dollars due to
CompuCom's purchase of TASD, which resulted in an increase in sales and sales
support personnel, partially offset by
23
CompuCom's cost reduction efforts related to the 1998 restructuring. Selling
and service expenses decreased as a percentage of sales primarily due to
increased leverage of CompuCom's infrastructure resulting from the TASD
acquisition and its own cost reduction efforts.
General and administrative expenses increased in absolute dollars and as a
percentage of sales primarily due to increased expenditures at CompuCom to
continue the expansion of its electronic commerce capabilities, increases in
distribution and administrative personnel to support CompuCom's revenue growth
and expenses related to the TASD acquisition and increased expenses at the
Company to support the growing activities of its partner companies.
CompuCom's general and administrative expenses are reported net of
reimbursements by certain manufacturers for specific training, promotional,
and marketing programs. These reimbursements offset the expenses incurred by
CompuCom.
Depreciation and amortization increased primarily due to increased
amortization at CompuCom as a result of the two business combinations
completed during the second quarter of 1998, and the TASD acquisition
completed during the second quarter of 1999, as well as increased depreciation
expense for certain property and equipment due to increases in distribution
and administrative personnel.
Interest and financing expense increased in 1999 compared to 1998 primarily as
a result of amortization of fees at CompuCom resulting from the early
termination of CompuCom's financing arrangements, and higher borrowing levels
at CompuCom due to the acquisition of TASD. The increase was also due to
higher average borrowing levels by the Company to fund interests in new or
existing partner companies.
Minority interest decreased as a result of decreased operating results at
CompuCom.
The Company's effective tax rate decreased to 35% in 1999 compared to 36% for
1998 due to the realization of previously unrecorded tax benefits attributable
to the difference between the book basis and tax basis of certain of the
Company's holdings as well as the application of lower tax rates against
realized securities gains. The realization of previously unrecorded tax
benefits as well as the application of lower tax rates against realized
securities gains occurred in the third quarter of 1998.
The Company's net earnings decreased in 1999 compared to 1998 primarily due to
decreased earnings at CompuCom and reduced operating results for partner
companies accounted for on the equity method. Other income of varying
magnitude have been realized in recent years. The Company's net earnings
could fluctuate significantly from period to period, depending on the
operations of its holdings accounted for on the equity method and the timing
of sales of securities. There can be no guarantee that the Company will
report net earnings in each period.
Liquidity and Capital Resources
-------------------------------
The Company has historically used its bank credit facility and proceeds from
sales of securities to fund its cash requirements. In addition, in February
1996, the Company issued $115 million of 6% Convertible Subordinated Notes
primarily to pay down its outstanding borrowings and fund commitments to new
and existing partner companies. These notes were all converted into the
Company's Common Stock prior to June 30, 1999. The Company issued 2.4 million
shares as a result of the conversions.
In June 1999, the Company issued $200 million of 5% Convertible Subordinated
Notes due June 2006. The Notes are convertible into the Company's Common Stock
at $77.625 per share, subject to adjustment under certain conditions. The
Company used approximately $111 million of the net
24
proceeds to repay all of the Company's outstanding indebtedness under its
revolving credit facility and borrowings from partner companies.
In March 1999, the Company entered into a forward sale contract relating to
two million shares of its holdings in Tellabs, Inc. The Company pledged two
million shares of Tellabs for three years and in return received approximately
$71 million of cash. At the end of the term, the Company has the option to
deliver cash or Tellabs shares with a value determined by the stock price of
Tellabs at maturity. The number of Tellabs shares to be delivered at maturity
ranges from 1.6 million to two million shares (or the cash value thereof). The
proceeds from this financing transaction were used to pay down a portion of
the Company's bank revolving credit facility.
In August 1999, the Company entered into an additional forward sale contract
relating to its remaining holdings in Tellabs, Inc. The Company pledged 1.4
million shares of Tellabs for three years and in return received approximately
$68 million of cash. At the end of the term, the Company has the option to
deliver cash or Tellabs shares with a value determined by the stock price of
Tellabs at maturity. The number of Tellabs shares to be delivered at maturity
ranges from 1.1 million to 1.4 million shares (or the cash value thereof).
The proceeds from this transaction are being used primarily to acquire
interests in or make advances to new and existing partner companies and
affiliated venture funds.
The Company has availability under its bank revolving credit facility of $200
million. Of the $200 million, $150 million matures in May 2002 and is secured
by certain equity securities the Company holds of its publicly traded partner
companies (the Pledged Securities), including CompuCom. The value of these
Pledged Securities 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 2000. There were no
borrowings outstanding under the facilities at September 30, 1999.
The Company has revolving credit facilities with certain partner companies
whereby the Company may borrow up to $20 million from these partner companies
on a revolving basis at a rate that varies with the Company's effective
borrowing rate. At September 30, 1999, there were no borrowings under these
agreements.
During the three quarters of 1999 and through November 15, 1999, the Company
utilized approximately $88 million to acquire interests in and make advances
to seven new partner companies, including 4anything.com, Extant, iMedium, Opus
360, Redleaf, SOTAS and Vitts. The Company also utilized approximately $97
million to acquire interests in and make advances to its existing private
partner companies and affiliated venture funds. In addition, the Company
acquired an interest in aligne in exchange for 441,518 shares of the Company's
Common Stock with a market value of approximately $17 million, and purchased
approximately $30 million of shares of its publicly traded partner companies.
During the first quarter of 1999, the Company sold a portion of its interests
in Tellabs for net proceeds totaling $47 million. During the third quarter of
1999, the Company sold a portion of its interest in Internet Capital's IPO for
net proceeds totaling $10 million.
Availability under the Company's revolving credit facilities, cash and cash
equivalents at September 30, 1999, and other internal sources of cash flow are
expected to be sufficient to fund the Company's cash requirements through
1999, including commitments to new or existing partner companies and general
corporate requirements. The Company is contingently obligated for
approximately $33 million of guarantee commitments, and has committed capital
of approximately $105 million to various partner companies, venture funds, and
private equity partnerships, to be funded over the next several years.
25
Availability under the Company's bank credit facility is determined by the
market value of the publicly traded partner 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 the Company's ability to borrow under the facilities. In addition,
the Company's ability to raise proceeds from sales of securities could also be
adversely effected. As a result, the Company's ability to acquire interests
in new partner companies and support its existing partner companies with
additional funding could be limited.
CompuCom maintains separate, independent financing arrangements, which are
non-recourse to the Company 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. During the quarter
ended March 31, 1999 CompuCom sold its corporate headquarters building in a
sale/leaseback transaction. The proceeds for the sale were approximately $40
million, of which $36 million was used to pay down long-term debt. As part of
the transaction, CompuCom entered into a 20-year operating lease on the
building.
In May 1999, CompuCom replaced its credit agreements with a $225 million
working capital facility and a $175 million receivables securitization
facility. The new $225 million working capital facility bears interest at a
rate of LIBOR plus an agreed upon spread and is secured by certain assets of
CompuCom. This facility is fully available subject to a borrowing base and
compliance with certain covenants. As planned, CompuCom increased the
securitization facility to $250 million in September 1999. As of September
30, 1999 CompuCom has fully utilized the Securitization with pricing based on
a designated short term interest rate plus an agreed-upon spread. As of
September 30, 1999, CompuCom had sufficient collateral to enable it to fully
utilize the working capital facility, and had $150 million outstanding as of
September 30, 1999. As negotiated in the second quarter of 1999, the working
capital facility was reduced by $25 million in September 1999 and will be
reduced by an additional $25 million in May 2000, and matures in May 2002. The
working capital facility bears interest at LIBOR plus an agreed upon spread
and is secured by a lien on the Company's assets. Availability under the
Revolver is subject to a borrowing base calculation and compliance with
certain financial covenants. CompuCom does not expect its effective interest
rate under the new facilities to be materially different from the levels it
experienced in 1998.
CompuCom's liquidity continues to be negatively impacted by the increase in
the dollar volume of the rebate programs of its principal suppliers. 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 the increased volume of product sold under these
programs, CompuCom's initial purchase price for the product is often higher
than the sales price CompuCom obtains from its customers. As of September
1999, these programs are a major factor in CompuCom's financing needs. As of
September 30, 1999, CompuCom was owed approximately $77 million under these
programs.
In May 1999, CompuCom purchased from ENTEX Information Services, Inc. certain
assets of its Technology Acquisition Services Division (TASD) in a cash
transaction. Under the terms of the agreement, CompuCom paid approximately
$137 million for the acquired assets.
Consolidated working capital increased to $287 million at September 30, 1999
from $252 million at December 31, 1998, primarily as a result of an increase
in accounts receivable and inventory, and a decrease in accrued liabilities,
partially offset by increase in accounts payable, all primarily a result of
the TASD acquisition by CompuCom. The working capital increase was also
partially offset by the change in classification of Tellabs.
26
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 September 30, 1999.
Year 2000 Readiness Disclosure
------------------------------
The Company is currently addressing the Year 2000 issue, which results from
the fact that many computer programs were previously written using two digits
rather than four to define the applicable year. Programs written in this way
may recognize a date ending in "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations. The Company has completed its assessment of its
computer information systems. The Company has replaced all computer systems
and software which were determined to be non-compliant. These replacements
were generally part of the Company's program of regularly upgrading its
computer systems, and the Company has not incurred and does not expect to
incur any material extraordinary expense to remediate its systems. The Company
has completed testing and implementation of its computer systems. The Company
has received verification from its vendors that its information systems are
Year 2000 ready its non-information systems are substantially Year 2000 ready.
The Company expects to complete any remaining necessary remediation of non-
information systems by December 1999. The Company has a back-up generator in
its data center which enables a "disaster recovery" area to support critical
computer and telecommunications in the case of a power loss.
The Company has engaged in a regular program of surveying its partner
companies regarding their Year 2000 readiness. The Company's most significant
consolidated subsidiary, CompuCom, has substantially completed assessment,
remediation and validation of its computer information systems. CompuCom
completed three business acquisitions during 1998 and one during 1999.
CompuCom has integrated the operations of those companies, including replacing
their major information systems with CompuCom's information systems. CompuCom
has surveyed its vendors and suppliers regarding their Year 2000 readiness,
and has received confirmation of compliance for the systems currently in use.
CompuCom upgraded, replaced, or decommissioned all non-compliant vendors'
systems. As a reseller of computer products, CompuCom only passes through to
its customers the applicable vendor's warranties; it makes no warranties
regarding Year 2000 compliance on any of the products it resells. However, if
one of CompuCom's major vendors or suppliers is found to be Year 2000 non-
compliant, CompuCom could experience a material adverse effect on its results
of operations. CompuCom is currently developing a contingency plan to operate
in the event its computer systems or those of its vendors, suppliers, or
customers are not Year 2000 compliant. CompuCom currently anticipates that it
will spend approximately $1.4 million on Year 2000 compliance, of which
approximately $1.2 million has been spent through September 1999.
The Company's other partner companies have assessed their internal systems for
Year 2000 readiness and have substantially completed remediation or
replacement and validation. The partner companies expect their internal
systems to be ready for the Year 2000. The partner companies have mostly
completed assessing Year 2000 readiness of their vendors and business
partners. The partner companies are also in varying stages of developing
contingency plans to operate in the event of a Year 2000 problem. Contingency
plans for certain companies include creation of back-up data centers,
installation of back-up power supplies, and scheduling of IT staff over the
turn of the year. Most of the partner companies are in the business of
providing software products, information technology services, or outsourcing
services. Those partner companies which produce software or products with
embedded programming believe that the current version of their products are
Year 2000 compliant. Certain partner companies are continuing to determine
the extent to which
27
previously sold software products and services were non-compliant. Some older
companies may not be able to assess products sold many years ago. The partner
companies generally have attempted to enter into software license agreements
and service agreements with their customers that limit their liability,
including for Year 2000 problems. Many of the software companies' customers
have maintenance agreements under which the company has upgraded or offered to
upgrade previously sold software to Year 2000 compliant versions. They are
generally encouraging their other customers to upgrade older non-compliant
versions to new compliant versions. The total cost and time which will be
incurred by the partner companies on the Year 2000 readiness effort cannot
presently be determined. There can be no assurance that all necessary work
will be completed in time, or that such costs will not materially adversely
impact one or more of such partner companies. Certain of the partner companies
have provided Year 2000 remediation services to clients, and could incur
liability to their customers if that work is not properly completed in time.
In addition, required spending on the Year 2000 effort will cause customers of
most of the Company's partner companies to reallocate at least part of their
information systems budgets. Although several partner companies have offerings
which may be useful in such efforts, such reallocations could materially
adversely affect the results of operations of many partner companies. A most
reasonably likely worst case scenario for the Company would arise if its
partner companies were to be held responsible by their clients for failure in
the clients' IT systems due to Year 2000 non-compliance. Such claims could be
complicated and costly to defend, regardless of the merit of the claims.
28
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 document describing the plans, goals, strategies,
intentions, forecasts, and expectations of the Company or its partner
companies 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.
The information technology industry is highly competitive, characterized by
rapid product development cycles, frequent price reductions, and early product
obsolescence, and is generally dominated by companies with greater resources
than the Company and its partner companies. Certain of the Company's partner
companies offer complex products or services which have lengthy sales cycles,
which makes sales forecasts difficult to make, and can lead to substantial
fluctuations in quarterly operating results. Emerging technology companies,
including many of the Company's partner companies, often encounter obstacles
and delays in developing products, service offerings, and markets.
Competition to acquire successful emerging information technology companies is
substantial, particularly in the areas the Company is targeting. The Company
may not be able to invest in companies in the targeted areas at valuations it
considers to be reasonable. The Company is dependent on the financial market
for information technology companies in general and for initial public
offerings of those companies in particular. The market for securities of
internet-related companies in particular is extremely volatile. If those
markets become unfavorable for an extended period of time, the Company's
ability to complete rights offerings and IPO's of its partner companies when
planned and the Company's ability to generate gains from sales of securities
could be materially adversely affected. In addition, the Company's ability to
borrow under its revolving credit facilities could be adversely affected as
availability under these facilities is determined by the value of the publicly
traded securities pledged by the Company as collateral. As a result, the
Company's ability to acquire interests in new partner companies and support
its existing partner companies with additional funding could be limited.
Shares of Internet Capital Group stock held by the Company constitute a
substantial majority of the fair market value of the Company's assets. The
market price of these shares is extremely volatile. Any substantial decline
in the price of those shares would likely cause a similar decline in the price
of the Company's common stock.
Clients of the Company's partner companies could reallocate part or all of
their information systems budgets to address the Year 2000 issue, which could
materially reduce the demand for the products and services of the Company's
partner companies. The Company's and its partner companies' business
operations could be materially adversely affected if they or their vendors,
business partners, or customers do not timely complete any necessary
remediation efforts to their own systems and products. There is likely to be
an extraordinary amount of litigation regarding the Year 2000 issue over the
next several years, and information technology providers may be attractive
targets for such litigation. Such litigation could have a material adverse
impact on the Company's and its partner companies' operations and financial
conditions.
29
Item 3. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
Safeguard is exposed to equity price risks on its ownership interests in
publicly traded and other securities, most of which we acquired as private
companies and took public through rights offerings or as part of traditional
IPO's. These securities are generally in companies in the information
technology industry sector. Many of the companies are considered small
capitalization stocks. Safeguard typically does not attempt to reduce or
eliminate its market exposure on securities. Based on closing market prices
at September 30, 1999, the fair market value of the Company's holdings in
public securities was approximately $2.5 billion. Approximately $1.6 billion
of these equity securities at September 30, 1999 consisted of our holdings in
Internet Capital Group, $221 million consisted of our holdings in Sanchez
Computer Associates, $192 million consisted of our holdings in Tellabs and
$141 million consisted of our holdings in Cambridge. A 20% decrease in equity
prices would result in an approximate $505 million decrease in the fair value
of our publicly traded securities accounted for on the equity method or
classified as available-for-sale at September 30, 1999. In March and August
1999, Safeguard entered into forward sale contracts related to its holding in
Tellabs. The Company pledged 3.4 million shares of Tellabs for three years
and in return received approximately $139.3 million in cash. At the end of
the term, the Company has the option to deliver cash or Tellabs shares with a
value determined by the stock price of Tellabs at maturity. The number of
Tellabs shares to be delivered at maturity ranges from 2.7 million to 3.4
million shares (or the cash value thereof). As discussed in Note 5 to the
Consolidated Financial Statements, the Company now classifies its Tellabs
holdings as available for sale and, as a result, changes in the fair value of
Tellabs holdings are no longer included in the Company's net earnings
subsequent to the change in classification. As disclosed in Note 9 to the
Consolidated Financial Statements, this amount had been significant in 1999.
Availability under Safeguard's bank credit facilities is determined by the
market value of the publicly traded securities pledged as collateral. As of
September 30, 1999, Safeguard had sufficient collateral to enable it to fully
utilize this facility. Additionally, Safeguard is exposed to interest rate
risk primarily through its bank credit facility. At September 30, 1999, there
were no borrowings outstanding.
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 September 30, 1999, the securitization facility had borrowings of
approximately $250 million and the working capital facility had borrowings of
$150 million. If CompuCom's effective interest rate were to increase 75 basis
points (.75%), the effect on the Company's financial statements would not be
material.
30
Item 5. Other Information
-----------------
In August 1999, the Company completed directed share subscription programs
(DSSP) in conjunction with the initial public offerings of Internet Capital
Group, Inc. (Nasdaq: ICGE) and US Interactive, Inc. (Nasdaq: USIT). In the
DSSP for Internet Capital, the Company's shareholders received an offer to
purchase 1 share of Internet Capital common stock for each 10 shares of the
Company's common stock held as of a set record date and under certain
conditions and restrictions. In the DSSP for US Interactive, the Company's
shareholders received an offer to purchase 1 share of US Interactive common
stock for each 20 shares of the Company's common stock held as of a set record
date and under certain conditions and restrictions. The Company owns
approximately 14% and 13% of the outstanding voting securities of Internet
Capital and US Interactive, respectively, at September 30, 1999.
In November 1999, the Company completed a DSSP in conjunction with the initial
public offerings of Pac-West Telecomm, Inc. (Nasdaq: PACW). Under the DSSP,
the Company's shareholders received an offer to purchase 1 share of Pac-West
common stock for each 10 shares of the Company's common stock held as of a set
record date and under certain conditions and restrictions. The Company owns
approximately 7% of the outstanding voting securities of Pac-West, after
completion of the offering.
In October 1999, the Company announced a DSSP in conjunction with the initial
public offering of eMERGE Interactive, Inc. Under the DSSP, the Company's
shareholders will receive an offer to purchase 1 share of eMERGE common stock
for each 10 shares of the Company's common stock held as of a set record date
and under certain conditions and restrictions. The offering will be made only
by means of a prospectus subject to the effectiveness of a registration
statement to be filed with the Securities and Exchange Commission.
In November 1999 CompuCom Systems appointed Edward Coleman as its new CEO
effective December 1, 1999. Mr. Coleman was previously with Computer Sciences
Corporation, where he was instrumental in expanding CSC's management
consulting, systems integration, and outsourcing services.
31
Item 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
Number Description
------ -----------
2.1 Asset Purchase Agreement, dated as of May 10, 1999 by and
between CompuCom Systems, Inc. and Entex Information
Services, Inc. (2)
4.1 Safeguard Scientifics, Inc. 1999 Equity Compensation Plan (3)
4.2 Indenture, dated as of June 9, 1999, between Safeguard
Scientifics, Inc. and Chase Manhattan Trust Company, National
Association, as trustee, including the form of 5.0%
Convertible Subordinated Note due 2006 (4)
4.3 Purchase Agreement of Safeguard Scientifics, Inc. to issue
and sell to Credit Suisse First Boston Corporation
Convertible Subordinated Notes due June 15, 2006. (Exhibits
omitted) (3)
4.4 Registration Rights Agreement between Safeguard Scientifics,
Inc. and Credit Suisse First Boston Corporation (4)
10.1 Amendment to Amended and Restated Credit Agreement, dated
April 12, 1999, among Safeguard Scientifics, Inc., Safeguard
Scientifics (Delaware), Inc., Safeguard Delaware, Inc. and
PNC Bank, N.A. (Exhibits omitted) (1)
10.2 Form of Promissory Notes dated June 11, 1999 given by certain
executives for advances by Safeguard of income tax
withholdings on restricted stock grants. (3)
10.3 Non-Competition, Referral and Non-Disclosure Agreement dated
as of May 10, 1999, by and between CompuCom Systems, Inc. and
ENTEX Information Services, Inc. (2)
10.4 CompuCom Receivables MasterTrust I Pooling and Servicing
Agreement, dated as of May 7, 1999, between Norwest Bank
Minnesota National Association, CompuCom Systems, Inc., and
CSI Funding, Inc. (3)
10.5 CompuCom Receivables MasterTrust I Pooling and Servicing
Agreement Series 1999-1 Supplement, dated as of May 7, 1999,
among PNC Bank, National Association, Market Street Capital
Corporation, Norwest Bank Minnesota, National Association,
CompuCom Systems, Inc., and CSI Funding, Inc. (3)
10.6 Inventory and Working Capital Financing Agreement, dated as
of May 11, 1999, between IBM Credit Corporation and CompuCom
Systems, Inc. (3)
32
10.7 Attachment A to Inventory and Working Capital Financing
Agreement dated May 11, 1999. (3)
10.8 Receivables Contribution and Sale Agreement dated May 7, 1999
between CompuCom Systems, Inc. and CSI Funding, Inc. (3)
10.9 Form of Promissory Notes dated August 27, 1999 given by
certain executives for advances by Safeguard of income tax
withholdings on restricted stock grants. *
10.10 Form of Term Note dated July 22, 1999, between Safeguard
Delaware, Inc. and John Halvey. *
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, 1999 dated May 17, 1999 and made a part
hereof by such reference.
(2) Incorporated by reference from registrant's 8-K dated May 10,
1999 and made a part hereof by such reference.
(3) Incorporated by reference from registrant's Form 10-Q for the
quarter ended June 30, 1999 dated August 16, 1999 and made a part
hereof by such
reference.
(4) Incorporated by reference from registrant's Form 10-Q/A for the
quarter ended June 30, 1999 dated September 2, 1999 and made a
part hereof by such reference.
(b) On May 25, 1999, the Company filed a report on Form 8-K dated May 10, 1999
in conjunction with the acquisition of certain assets of Entex Information
Systems, Inc.'s Technology Acquisition Services Division by CompuCom
Systems, Inc., the Company's majority-owned subsidiary. CompuCom purchased
product inventory, certain fixed assets and Entex's Kentucky distribution
center for approximately $137 million in cash.
On July 26, 1999, the Company filed a report on Form 8-K/A which amended
Item 7 of the Form 8-K filed by the Company on May 25, 1999 to include
financial statements that were not available at the time of the filing of
the initial report.
33
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SAFEGUARD SCIENTIFICS, INC.
(Registrant)
Date: November 15, 1999 /s/ Harry Wallaesa
----------------------------------------
Harry Wallaesa
President and Chief Operating Officer
Date: November 15, 1999 /s/ Michael W. Miles
----------------------------------------
Michael W. Miles
Senior Vice President and Chief
Financial Officer (Principal Financial
and Principal Accounting Officer)
34