FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended March 31, 1998 Commission File Number 1-5620
SAFEGUARD SCIENTIFICS, INC.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-1609753
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(state or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
800 The Safeguard Building, 435 Devon Park Drive Wayne, PA 19087
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610)293-0600
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities and
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirements for the past 90
days.
Yes X No
------- -------
Number of shares outstanding as of May 14,1998
Common Stock 31,993,705
SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION Page
------------------------------ ----
Item 1 - Financial Statements:
Consolidated Balance Sheets -
March 31, 1998 (unaudited) and December 31, 1997.........................3
Consolidated Statements of Operations (unaudited)-
Three Months Ended March 31, 1998 and 1997...............................4
Consolidated Statements of Cash Flows (unaudited)-
Three Months Ended March 31, 1998 and 1997...............................5
Notes to Consolidated Financial Statements...............................6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations......................11
PART II - OTHER INFORMATION
---------------------------
Item 4 - Submission of Matters to a Vote of Security Holders................20
Item 5 - Other Information..................................................20
Item 6 - Exhibits and Reports on Form 8-K...................................20
Signatures..................................................................21
2
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
ASSETS 1998 1997
-------------------------- ---------------------------
(UNAUDITED)
Current Assets
Cash and cash equivalents $ 5,128 $ 5,382
Receivables less allowances 182,985 187,385
Inventories 232,575 198,053
Other current assets 5,829 6,459
--------- ----------
Total current assets 426,517 397,279
Property, Plant, and Equipment 121,880 105,188
Less accumulated depreciation and amortization (33,048) (28,221)
--------- ----------
Total property, plant, and equipment, net 88,832 76,967
Other Assets
Investments 224,529 185,111
Notes and other receivables 22,850 21,035
Excess of cost over net assets of
businesses acquired, net 28,835 26,168
Other 8,754 7,981
--------- ----------
Total other assets 284,968 240,295
--------- ----------
Total Assets $800,317 $714,541
--------- ----------
--------- ----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities
Current debt obligations $ 3,476 $ 3,396
Accounts payable 119,275 74,025
Accrued expenses 79,742 91,857
--------- ----------
Total current liabilities 202,493 169,278
Long-Term Debt 149,517 127,089
Deferred Taxes 27,850 20,044
Minority Interest and Other 102,365 100,179
Convertible Subordinated Notes 72,345 90,881
Shareholders' Equity
Common stock 3,280 3,280
Additional paid-in capital 62,108 49,952
Retained earnings 156,531 151,471
Treasury stock, at cost (7,539) (13,339)
Net unrealized appreciation on investments 31,367 15,706
--------- ----------
Total shareholders' equity 245,747 207,070
--------- ----------
Total Liabilities and Shareholders' Equity $800,317 $714,541
--------- ----------
--------- ----------
See notes to consolidated financial statements.
3
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
Three Months Ended March 31,
------------------------------------------------
1998 1997
------------------ --------------------------
(UNAUDITED)
Revenues
Net Sales
Product $379,271 $385,405
Services 62,627 62,171
-------- --------
Total net sales 441,898 447,576
Securities and other gains, net 7,852 7,201
Other income 3,497 2,686
-------- --------
Total revenues 453,247 457,463
Costs and Expenses
Cost of sales - product 333,420 342,068
Cost of sales - services 41,123 40,262
Selling and service 37,396 33,616
General and administrative 21,195 19,723
Depreciation and amortization 4,273 5,234
Interest and financing 5,803 5,198
Income from equity investments, net (1,505) (104)
-------- --------
Total costs and expenses 441,705 445,997
-------- --------
Earnings Before Minority Interest and Taxes on Income 11,542 11,466
Minority interest (3,109) (3,979)
-------- --------
Earnings Before Taxes On Income 8,433 7,487
Provision for taxes on income 3,373 2,995
-------- --------
Net Earnings $ 5,060 $ 4,492
-------- --------
-------- --------
Earnings Per Share
Basic $ .16 $ .14
Diluted $ .15 $ .14
Average Common Shares Outstanding
Basic 31,714 31,122
Diluted 32,403 32,032
See notes to consolidated financial statements.
4
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended March 31,
--------------------------------------------------
1998 1997
-------------------------- --------------------
(UNAUDITED)
Operating Activities
Net earnings $ 5,060 $ 4,492
Adjustments to reconcile net earnings to
cash provided (used) by operating activities
Depreciation and amortization 4,273 5,234
Deferred income taxes (262) (179)
Income from equity investments, net (1,505) (104)
Securities and other gains, net (7,852) (7,201)
Minority interest, net 1,865 2,387
Cash provided (used) by changes in
working capital items
Receivables 10,837 66,514
Inventories (34,522) 41,290
Accounts payable, accrued expenses, and other 31,419 (80,648)
-------- --------
Cash provided by operating activities 9,313 31,785
Proceeds from securities and other gains, net 8,405 987
-------- --------
Cash provided by operating activities and
securities and other gains, net 17,718 32,772
Other Investing Activities
Investments and notes acquired, net (24,893) (19,247)
Capital expenditures (4,746) (6,395)
Business acquisitions, net of cash acquired (4,023)
Other, net (507) (591)
-------- --------
Cash (used) by other investing activities (34,169) (26,233)
Financing Activities
Net borrowings (repayments) on
revolving credit facilities 15,675 (15,869)
Net borrowings (repayments) on term debt 517 (797)
Repurchase of Company common stock (854) (177)
Issuance of Company common stock 649 1,121
Issuance of subsidiary common stock 210 1,701
-------- --------
Cash provided (used) by financing 16,197 (14,021)
-------- --------
Decrease in Cash and Cash Equivalents (254) (7,482)
Cash and Cash Equivalents - beginning of year 5,382 12,881
-------- --------
Cash and Cash Equivalents - End of Period $ 5,128 $ 5,399
-------- --------
-------- --------
See notes to consolidated financial statements.
5
SAFEGUARD SCIENTIFICS, INC.
Notes to Consolidated Financial Statements
March 31, 1998
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 Summary of Accounting
Policies and Notes to Consolidated Financial Statements included in the
1997 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. Comprehensive Income
The Company adopted Statement of Financial Accounting Standard No. 130,
"Reporting Comprehensive Income" (SFAS 130), which was effective for fiscal
years beginning after December 15, 1997. SFAS 130 establishes standards for
reporting and display of comprehensive income and its components in a full
set of general purpose financial statements. Comprehensive income is the
change in equity of a business enterprise during a period from transactions
and other events and circumstances from non-owner sources. Other than net
earnings, the Company's source of comprehensive income is from net
unrealized appreciation on its investments which is disclosed separately in
the Shareholders' Equity section of the Consolidated Balance Sheets. Total
comprehensive income (the sum of net earnings and the change in unrealized
appreciation on investments) was $20.7 million and $6.5 million for the
quarters ended March 31, 1998 and 1997, respectively.
3. Reclassifications
Certain amounts in the 1997 consolidated financial statements have been
reclassified to conform with the 1998 presentation.
6
4. Investments
The following summarizes the Company's investments (in thousands).
Investments are classified according to the applicable accounting method at
March 31, 1998. 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.
March 31, 1998 December 31, 1997
---------------------------------------- ------------------------------------
Carrying Market Carrying Market
Value Value Value Value
------------------ ----------------- ------------------- -------------
(UNAUDITED)
Equity Investees
Cambridge $ 26,126 $433,542 $ 24,679 $371,394
ChromaVision 12,905 44,565 4,689 30,044
Coherent 16,154 223,399 14,799 135,008
OAO 14,602 45,123 13,887 43,716
Sanchez 8,219 63,620 7,196 89,068
USDATA 7,237 21,390 7,194 13,325
Non-public companies 35,389 34,655
-------- --------
120,632 107,099
Diamond 1,526 26,878 1,526 14,717
DocuCorp 3,469 15,836 7,718
Integrated Systems Consulting Group 1,891 9,864 1,891 7,785
Other public companies 14,961 16,795 15,393 20,104
Unrealized appreciation 47,526 23,796
Non-public companies 34,524 27,688
--------- ---------
$224,529 $185,111
--------- ---------
--------- ---------
The following summarized financial information for investees accounted for
on the equity method of accounting at March 31, 1998 has been compiled from
the unaudited financial statements of the respective investees and reflects
certain historical adjustments (in thousands):
Three Months Ended March 31,
1998 1997
--------------------- ---------------------
(UNAUDITED)
Net Sales:
Public companies $190,027 $128,687
Non-public companies:
Multigen 3,393 2,266
RMS 20,813 21,273
Other 11,606 9,689
-------- --------
$225,839 $161,915
-------- --------
-------- --------
Net sales of companies accounted for on the cost method of accounting are
not included above and include Diamond Technology, Integrated Systems
Consulting Group, DocuCorp International, Intellisource, Diablo, and
Whisper.
7
5. Debt
In April 1998, the Company increased the availability under its bank
revolving credit facility to $200 million from $150 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 partnership companies,
including CompuCom (the "Pledged Securities"). The remaining $50 million is
unsecured, matures in April 1999, with availability limited to the lesser
of $50 million or 10% of the value of the Pledged Securities. There was
$30.9 million outstanding under the total facility at March 31, 1998.
The following is a summary of long-term debt (in thousands):
March 31, December 31,
1998 1997
----------------- -----------------
(UNAUDITED)
Parent Company and Other Recourse Debt
Revolving credit facilities $ 47,100 $ 22,200
Other 14,693 7,822
--------- ---------
61,793 30,022
--------- ---------
Subsidiary Debt (Non-Recourse to Parent)
CompuCom 91,200 100,425
Other 38
--------- ---------
91,200 100,463
--------- ---------
Total debt 152,993 130,485
Current debt obligations (3,476) (3,396)
--------- ---------
Long-term debt $149,517 $127,089
-------- --------
-------- --------
6. Earnings Per Share
The calculations of Earnings Per Share (EPS) were (in thousands except
per share amounts):
Three Months Ended March 31,
1998 1997
--------------- --------------
(UNAUDITED)
Basic EPS
Net earnings $ 5,060 $ 4,492
Average common shares outstanding 31,714 31,122
Basic EPS $ .16 $ .14
---------- --------------
---------- --------------
Diluted EPS
Net earnings $ 5,060 $ 4,492
Adjustment (a) (206) (88)
---------- --------------
4,854 4,404
Average common shares outstanding 31,714 31,122
Effect of dilutive options 689 910
---------- --------------
Average number of common shares assuming dilution 32,403 32,032
Diluted EPS $ .15 $ .14
---------- --------------
---------- --------------
(a) Net earnings are adjusted for the dilutive effect of public investee common
stock equivalents and convertible securities.
8
7. 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.
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 Systems, Inc. and
Tangram Enterprise Solutions, Inc. (Tangram), with the carrying value of
these companies included in "Investments".
March 31, December 31,
ASSETS 1998 1997
------- -------
(UNAUDITED)
Current assets $ 16,216 $ 11,710
Investments 350,804 310,877
Other 50,208 37,567
--------- ---------
Total assets $ 417,228 $ 360,154
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 16,306 $ 18,525
Long-term debt 61,317 29,689
Other liabilities 21,513 13,989
Convertible subordinated notes 72,345 90,881
Shareholders' equity 245,747 207,070
--------- ---------
Total liabilities & shareholders' equity $ 417,228 $ 360,154
--------- ---------
--------- ---------
The following summarizes the Parent Company's investments 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.
March 31, 1998 December 31, 1997
------------------------------- ------------------------------
Carrying Market Carrying Market
Value Value Value Value
------------- -------------- -------------- -------------
(UNAUDITED)
CompuCom $124,065 $211,504 $122,613 $211,504
Tangram 2,210 83,590 3,153 68,570
Cambridge 26,126 433,542 24,679 371,394
Coherent 16,154 223,399 14,799 135,008
Other public 112,336 244,071 75,572 218,759
Other 69,913 70,061
-------- --------
$350,804 $310,877
-------- --------
-------- --------
9
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). 1997 included net sales and cost of sales and operating
expenses of $7.7 million and $7.2 million, respectively, related to Pioneer
which was sold in mid-1997. 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, with the
Company's share of the earnings or losses of these companies reflected in
the caption "Equity income, net ".
Three Months Ended March 31,
1998 1997
---------------- -------------
(UNAUDITED)
Revenues
Net sales $ 7,717
Securities and other gains, net $ 7,852 7,201
Other income 3,824 3,116
-------- --------
Total revenues 11,676 18,034
Costs and Expenses
Cost of sales and operating expenses 7,799 13,687
Equity income, net (3,185) (1,545)
-------- --------
Total costs and expenses 4,614 12,142
-------- --------
Earnings Before Taxes On Income 7,062 5,892
Provision for taxes on income 2,002 1,400
-------- --------
Net Earnings $ 5,060 $ 4,492
-------- --------
-------- --------
10
Management's Discussion and Analysis of
Financial Condition and Results of Operations
General
The Company's business strategy is the development of primarily
information technology-oriented, entrepreneurially-driven partnership companies
to achieve superior returns for its shareholders. The Company provides to its
partnership companies and associated venture funds active strategic management,
operating guidance, acquisition and disposition assistance, board and management
recruitment, and innovative financing. The Company offers its shareholders,
through the rights offering process, the opportunity to acquire direct ownership
in selected partnership companies which it believes are ready for public
ownership.
If the Company's ownership in any of the partnership 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.
The revenues and related costs and expenses of a partnership company
are included in the Company's consolidated operating results if the Company owns
more than 50% of the outstanding voting securities of the partnership company.
Participation of shareholders other than the Company in the earnings or losses
of a more than 50% owned partnership company is reflected in the caption
"Minority interest" in the Consolidated Statements of Operations. Minority
interest adjusts consolidated earnings to reflect only the Company's share of
the earnings or losses of the partnership company. The partnership companies
that are consolidated in the first quarter of 1998 are CompuCom Systems, Inc.
and Tangram Enterprise Solutions, Inc. Premier Solutions Ltd. and Pioneer Metal
Finishing, which were sold in mid-1997, were included in the Company's
consolidated operating results in the first quarter of 1997.
Investments in companies in which the Company owns 50% or less of the
outstanding voting securities, in which significant influence is exercised, are
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% because it exerts
significant influence through representation on those companies' Boards of
Directors and other means. On the equity method of accounting, a partnership
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 partnership company is reflected in the caption
"Income from equity investments, net" in the Consolidated Statements of
Operations.
The net effect of a partnership 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 partnership company is included in the Company's net earnings in the
Consolidated Statements of Operations.
11
Investments 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.
As mentioned in Operations Overview, the Company's consolidated
revenues and related costs and expenses are significantly influenced by
CompuCom's results of operations. At March 31, 1998, 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, heightening the competition.
As a result, while growing internally, CompuCom is also looking to
strengthen its market share through acquisitions. If CompuCom were to use its
stock for 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 investment 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 7 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 "Equity income, net" and the carrying value of these
companies is included in "Investments" in the Parent Company Statements of
Operations and Balance Sheets, respectively.
Although the Parent Company Statements of Operations and Balance Sheets
presented in Note 7 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.
12
Operations Overview
Net sales by industry segment were (in thousands):
Three Months Ended March 31,
-----------------------------------------
1998 1997
-------------- ----------------
(UNAUDITED)
Information Technology
Microcomputer Systems and Services $437,752 $431,889
Information Solutions 4,146 2,603
-------- --------
441,898 434,492
Other 13,084
-------- --------
Total Net Sales $441,898 $447,576
-------- --------
-------- --------
Net sales decreased slightly in the first quarter of 1998 compared to
the first quarter of 1997 due primarily to the sale of Premier and Pioneer
(Other) in mid-1997, partially offset by increased sales at CompuCom
(Microcomputer Systems and Services) and Tangram (Information Solutions).
CompuCom's services sales increased 6% while product sales increased slightly.
The increase in product sales is due to an increase in the number of desktop,
laptop, and server units sold, partially offset by a decrease in the average
unit sales prices as compared to the prior year. CompuCom has embarked on a
strategy of product growth facilitated through the hiring of additional sales
representatives and strategic acquisitions, including two acquisitions announced
in April 1998 (See Liquidity and Capital Resources). The increase in services
sales is due to increases in configuration and field engineering, both of which
have benefited from the increase in product unit sales, partially offset by a
decrease in CompuCom's systems engineering group. CompuCom represented 99% of
the Company's total consolidated net sales in the first quarter of 1998 and
1997. As a result of the relative significance of CompuCom in the consolidated
results, fluctuations in the financial results of other business units have
tended to have a minimal impact.
Net earnings were $5.06 million, or $.15 a share (diluted) in 1998,
compared to $4.49 million, or $.14 a share (diluted), for the same period in
1997. The Company's increased net earnings in the first quarter of 1998
resulted primarily from improved results at Tangram, increased equity income,
and higher securities and other gains, partially offset by decreased earnings
at CompuCom and the loss of earnings of Pioneer due to its sale in 1997.
CompuCom's net earnings decreased primarily as a result of continued
investments in its service business through the hiring and training of
additional engineer and support personnel and lower services margins. Future
improved profitability at CompuCom will depend on its ability to hire and
retain quality service personnel while effectively managing the utilization
of such personnel. It will also depend on increased focus on providing
technical service and support to customers, product demand, competition,
manufacturer product availability and pricing changes, effective utilization
of vendor programs, successfully managing the implementation and operation of
the channel assembly programs of its major suppliers, adequately integrating
recent and potential future acquisitions, and control of operating expenses.
13
The following summarizes significant pre-tax securities and other gains (in
millions):
Three Months Ended March 31,
1998 1997
-------------- ---------------
(UNAUDITED)
Cambridge $7.6 $5.5
Diamond 4.3
DocuCorp 1.6
Other (1.3) (2.6)
---- ----
$7.9 $7.2
---- ----
---- ----
Securities and other gains in 1998 include the open market sales of a
portion of the Company's interest in Cambridge Technology Partners and the sale
of shares in the DocuCorp International rights offering to the Company's
shareholders. Partially offsetting these gains were charges incurred in the
disposition of investments and provisions for other investments and notes.
Securities and other gains in 1997 included the open market sales of a portion
of the Company's interest in Cambridge and the sale of shares in the Diamond
Technology Partners rights offering to the Company's shareholders. Partially
offsetting these gains were charges incurred in the disposition of investments
and provisions for other investments and notes. Securities and other gains of
varying magnitude have been realized in recent years; prior gains are not
necessarily indicative of gains which may be realized in the future.
Income from equity investments fluctuates with the Company's ownership
percentage and the operating results of investees accounted for on the equity
method. Equity income increased in 1998 due to the continued strong overall
performance of the Company's public equity investments and a decrease in the
Company's share of losses at its private equity investments. The Company's
public investments accounted for on the equity method in the first quarter of
1998 include Cambridge, ChromaVision Medical Systems, Coherent Communications,
DocuCorp, OAO Technology Solutions, Sanchez Computer Associates and USDATA
Corporation.
Cambridge's revenues and earnings increased 62% and 52%, respectively,
as it continues to see increased demand for its services worldwide. Cambridge
continues to expand its service offerings through investing in and enhancing
proprietary service methodologies and increasing network and educational
services. Safeguard owns approximately 16% of Cambridge's common stock at March
31, 1998.
14
ChromaVision continued to achieve significant milestones in the first
quarter of 1998 including the commencement of clinical trials for the use of
immunohistochemistry reagent methods in conjunction with the Automated Cellular
Imaging System for diagnostic applications. ChromaVision reported an increased
net loss for the first quarter of 1998 compared to 1997 primarily due to
increased research and product development expenditures related to clinical
trials and the addition of technical personnel. ChromaVision also recently
entered into a collaborative alliance with IDEA Research LLC for the continued
development of ChromaVision's Down syndrome application as part of a litigation
settlement agreement. In February 1998, the Company purchased an additional 6%
of ChromaVision's common stock in a private transaction with an unrelated third
party. Safeguard owns approximately 26% of ChromaVision's common stock at March
31, 1998.
Coherent's revenues and earnings increased 20% and 27%, respectively,
in the first quarter of 1998 compared to the same period in 1997. Sales were
especially strong in Europe and Latin America. The Company owns approximately
31% of the common stock of Coherent at March 31, 1998. In February 1998,
Coherent announced its intention to merge with Tellabs, Inc. in an exchange of
common stock at the rate of 0.72 shares of Tellabs for each share of Coherent.
All initial filings required by various governmental entities have been made.
The SEC has completed its review of the merger, and Coherent's shareholders
approved the merger on May 12, 1998. There is no assurance the transaction will
be completed as it is subject to various conditions and approvals by appropriate
government agencies. The Company's pretax gain from the transaction, if
completed, would be approximately $220 million based on the current price of
Tellabs common stock, and the Company would own less than 5% of Tellabs, Inc.
The ultimate gain recorded by the Company will vary based on the value of
Tellabs stock at the completion of the transaction.
During the first quarter of 1998, DocuCorp completed the rights
offering of its common stock to the Company's shareholders. As a result of the
rights offering, the Company owns less than 7% of DocuCorp's common stock at
March 31, 1998. Accordingly, the Company will discontinue accounting for its
investment in DocuCorp on the equity method of accounting subsequent to the
first quarter.
OAO's earnings for the first quarter of 1998 were marginally above the
same period in 1997, primarily due to $546,000 of start-up costs to develop a
new line of business. During the quarter, OAO announced it had expanded its
strategic relationship with IBM Global Services to provide applications
maintenance and enhancements for IBM Global Services' Raleigh, NC Applications
Development and Maintenance group. The work will be performed at OAO's
Canadian-based software laboratories, which also began operations in the first
quarter of 1998. OAO has recently experienced margin pressures from its largest
customer, IBM, which has resulted in revenue reductions on several contracts.
OAO expects that future quarters will be negatively affected by this trend and
is beginning initiatives to invest in new lines of business and reduce operating
costs. Safeguard owns approximately 29% of OAO's common stock at March 31, 1998.
15
Sanchez's revenues increased 60% and earnings increased 66% in the
first quarter of 1998 compared to the same period in 1997. Sanchez continued
to add to its impressive list of global customers by signing substantial
agreements with Bankers Trust, Kredyt Bank PBI (one of Poland's top ten
financial institutions), Inter Advies N.V. (a subsidiary of ING Group N.V.),
and Federal Home Loan Bank of Pittsburgh. Safeguard owns approximately 25% of
Sanchez's common stock at March 31, 1998.
USDATA reported a reduced loss from continuing operations in the
first quarter of 1998 compared to the first quarter of 1997 primarily due to
its expense reduction program. In February 1998, USDATA announced its
intention to dispose of its system integration and hardware servicing business
and focus primarily on growing and expanding its software business, and
recognized an estimated loss on disposal and loss from operations until the
date of disposal of approximately $1.7 million in the first quarter of 1998.
Safeguard owns approximately 25% of USDATA's common stock at March 31, 1998.
Costs and Expenses
The Company's overall gross margin was 15.2% and 14.6% in the first
quarter of 1998 and 1997, respectively. CompuCom's product gross margin for the
first quarter of 1998 was 11.6% compared to 10.4% for the same period in 1997.
This increase is due in part to a change in the mix of products sold, and an
increase in the amount of manufacturer-sponsored incentives which lowered the
average cost of units sold. Future product margins at CompuCom will be
influenced by competitive pressures from other resellers in the industry, direct
marketers, manufacturers' pricing strategies, CompuCom's ability to successfully
manage the channel assembly programs of its major vendors, and the level of
low-margin sales. CompuCom's integration of acquired companies could also affect
future product margins. CompuCom's services gross margin for the first quarter
decreased to 32.2% in 1998 from 36.0% in 1997. The decrease was primarily caused
by lower than anticipated systems engineering revenue as well as lower
utilization in CompuCom's system engineering group due to the completion of
additional training and certification programs. CompuCom participates in certain
manufacturer-sponsored programs designed to increase sales of specific products.
These programs, excluding volume incentive programs and specific product rebates
offered by certain manufacturers, are not material when compared to CompuCom's
overall financial results.
Selling and service and general and administrative expense as a
percentage of net sales increased to 13.3% in 1998 from 11.9% in 1997 primarily
as a result of increased costs at CompuCom partially offset by the elimination
of selling, general, and administrative costs resulting from the sale of Premier
and Pioneer in 1997. The increase at CompuCom was principally the result of
increases in services operating expenses as CompuCom continued its investment in
its services business through the hiring and training of additional sales,
engineering, and support personnel. 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.
16
Depreciation and amortization decreased in the first quarter of 1998
primarily due to the elimination of depreciation and amortization resulting from
the sale of Premier and Pioneer in 1997, partially offset by increased
depreciation at CompuCom. The increase at CompuCom is primarily associated with
its new corporate headquarters and operations campus, which was fully occupied
in the second half of 1997, upgrading its hardware and software at both
corporate and branch locations, and an increase in capital expenditures to
support headcount additions.
Interest and financing expense increased in the first quarter of l998
compared to the same period in 1997 primarily as a result of increased
borrowings at CompuCom as it took advantage of prompt-pay discounts offered by
its larger vendors, and increased borrowings by the Company, partially offset by
the elimination of interest resulting from the sale of Premier and the
elimination of interest due to the conversion of $18.5 million of the Company's
Convertible Subordinated Notes into the Company's Common Stock in February 1998.
Liquidity and Capital Resources
In February 1996, the Company issued $115 million of 6% Convertible
Subordinated Notes (the "Notes") due February 1, 2006. The Notes are convertible
into the Company's Common Stock at $28.985 per share. Through March 1998,
approximately $42.7 million of Notes were converted into 1,471,619 shares of the
Company's Common Stock.
In April 1998, the Company increased the availability under its
bank revolving credit facility to $200 million from $150 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 partnership companies,
including CompuCom (the "Pledged Securities"). The value of these Pledged
Securities significantly exceeds the total availability under the bank
revolving credit facility. The remaining $50 million is unsecured, matures in
April 1999, with availability limited to the lesser of $50 million or 10% of
the value of the Pledged Securities. There was $30.9 million outstanding
under the total facility at March 31, 1998.
The Company has revolving credit facilities with certain partnership
companies whereby the Company may borrow up to $17 million from these
partnership companies on a revolving basis at a rate that varies with the
Company's effective borrowing rate. At March 31, 1998, $16.2 million was
outstanding under these agreements.
Availability under the Company's revolving credit facilities,
proceeds from the sales from time to time of selected publicly-traded
securities, and other internal sources of cash flow should be sufficient to
fund the Company's cash requirements for the next twelve months, including
investments in new or existing partnership companies, general corporate
requirements, and the repurchase of the Company's Common Stock from time to
time in the open market. In connection with certain investments, the Company
is contingently obligated for approximately $33 million of possible future
investment and guarantee commitments. In addition, it has committed capital of
$114 million to various venture funds and private equity partnerships, to be
funded over the next several years. CompuCom maintains separate, independent
financing arrangements, which are non-recourse to the Company and are secured
by certain assets of
17
CompuCom. During recent years, CompuCom has utilized operating earnings, bank
financing arrangements, long-term subordinated notes, and internally generated
funds to fund its cash requirements. CompuCom's financing arrangements consist
of a $125 million working capital facility, a $175 million revolving
Securitization Facility, and a $25 million real estate loan (collectively, the
"credit agreements"). At March 31, 1998, approximately $88.2 million was
outstanding under the working capital facility and the real estate loan, and the
Securitization Facility was fully utilized. The credit agreements mature in
November 2002, except for the real estate loan which is due in quarterly
installments beginning April 1999. CompuCom is currently evaluating other
permanent financing options for the real estate loan. Compucom is also in the
process of expanding its other financing arrangements.
In April 1998, CompuCom announced it had signed definitive agreements
with Computer Integration Corporation (CIC) and Dataflex Corporation (Dataflex)
under which CompuCom would acquire the stock of CIC and Dataflex for cash. Under
the terms of the agreements with CIC and Dataflex, the total purchase prices are
approximately $17 million and $25 million, respectively. The CIC acquisition was
completed in May 1998; the Dataflex acquisition is expected to be completed in
the second quarter.
Cash flow provided by operating activities decreased in 1998 primarily
due to an increase in inventory at CompuCom resulting from pricing incentives by
CompuCom's vendors near the end of the quarter, partially offset by an increase
in accounts payable at CompuCom.
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 are no material capital asset purchase
commitments at March 31, 1998.
Year 2000
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 conducted an assessment of its
computer information systems and believes that it will not need to incur any
material extraordinary expense to correct its systems which are not Year 2000
compliant on a timely basis. The Company has also surveyed its majority-owned
and equity investee partnership companies regarding this issue. The Company's
most significant consolidated subsidiary, CompuCom, has completed initial
assessment of its computer information systems, and has plans in place to
complete remediation and begin testing during 1998. The rest of the Company's
partnership companies are in varying stages of assessing, remediating, and
testing for internal Year 2000 compliance and assessing Year 2000 compliance of
their vendors, business partners, and customers. Most of the partnership
companies are in the business of providing software products, information
technology consulting, or outsourcing services. Those partnership companies
which produce software or products with embedded programming believe that the
current version of their
18
products either are Year 2000 compliant or will be revised to be compliant in
1998. Certain partnership companies are continuing to determine the extent to
which previously sold software products and services were non-compliant. The
total cost and time which will be incurred by the partnership companies on the
Year 2000 issue 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 partnership companies. In
addition, required spending on the Year 2000 effort will cause customers of most
of the Company's partnership companies to reallocate at least part of their
information systems budgets. Although several partnership companies have
offerings which may be useful in such efforts, such reallocations could
materially adversely affect the results of operations of many partnership
companies.
Recently Issued Pronouncements
In 1997 and 1998, the Financial Accounting Standards Board (FASB)
issued pronouncements relating to the presentation and disclosure of information
related to segment data and the disclosure of information about pensions and
other postretirement benefits, respectively. The Company is required to adopt
the provisions of these pronouncements, if applicable, for the year ending
December 31, 1998. The adoption of these pronouncements will not have an impact
on the Company's financial position and results of operations, but may change
the presentation of certain of the Company's notes and data related to the
Consolidated Financial Statements.
19
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its Annual Meeting of Shareholders on May 7, 1998. At
the meeting, the shareholders voted in favor of electing as directors the
thirteen nominees named in the Proxy Statement dated April 2, 1998.
The number of votes cast were as follows:
I. ELECTION OF DIRECTORS
FOR WITHHELD
--------- ---------
Warren V. Musser 27,896,972 85,993
Judith Areen 27,866,396 102,169
Vincent G. Bell, Jr. 27,882,897 85,668
Donald R. Caldwell 27,888,647 79,918
Robert A. Fox 27,884,322 84,243
Delbert W. Johnson 27,889,422 79,143
Robert E. Keith, Jr. 27,714,518 254,047
Peter Likins, Ph.D. 27,890,422 78,143
Jack L. Messman 27,890,647 77,918
Russell E. Palmer 27,887,722 80,843
John W. Poduska, Sr., Ph.D. 26,503,392 1,465,173
Heinz Schimmelbusch, Ph.D. 27,870,922 97,643
Hubert J.P. Schoemaker, Ph.D. 27,890,122 78,443
Item 5. Other Information
A rights offering to the Company's shareholders of 6,720,000 shares of
DocuCorp International was completed on March 31, 1998. The Company, which sold
approximately 1,200,000 shares of DocuCorp stock as part of the offering, owns
approximately 7% of DocuCorp common stock at March 31, 1998.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Number Description
-------- -----------
10.1 Amended and Restated Credit Agreement,
dated April 17, 1998, among Safeguard
Scientifics, Inc., Safeguard Scientifics
(Delaware), Inc., Safeguard Delaware,
Inc. and PNC Bank, N.A. (exhibits omitted)
27 Financial Data Schedule (electronic filing
only)
(b) No reports on Form 8-K have been filed by the Registrant
during the quarter ended March 31, 1998.
20