SELECTED FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
1998 1997 1996 1995 1994
------------- ------------ ---------- ---------- ----------
Net sales............................................. $2,275,143 $1,985,225 $2,062,809 $1,517,740 $1,412,026
Net earnings.......................................... 110,123(1) 21,501 19,927 18,263 15,740
Earnings per share
Basic............................................. 3.46(1) .69 .67 .63 .56
Diluted........................................... 3.22(1) .66 .61 .53 .47
Total assets.......................................... 1,068,690(2) 714,541(3) 936,070 742,874 617,155
Long-term debt, including current portion
CompuCom.......................................... 83,429 100,425(3) 239,946 123,461 137,310
Other............................................. 123,981 30,060 21,419 110,835 98,838
Convertible subordinated notes........................ 71,345 90,881 102,131 -- --
Shareholders' equity.................................. 342,859(1) 207,070 169,011 154,309 110,547
No cash dividends have been declared in any of the years presented, and the
Company has no present intention to declare cash dividends.
(1) Increase relates primarily to net securities gains from Coherent/Tellabs
transactions (see Note 2 to the Consolidated Financial Statements).
(2) Increase relates primarily to recording the Company's investment in Tellabs
at fair value, increased investments, and increased assets at CompuCom resulting
from acquisitions in 1998 (see Notes 2 and 10 to the Consolidated Financial
Statements).
(3) Reflects the effect of $175 million in off-balance sheet financing at
CompuCom which reduced accounts receivable and long-term debt (see Note 3 to the
Consolidated Financial
Statements).
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Safeguard Scientifics, Inc. (the Company) develops and operates emerging
growth information technology companies. The Company's present emphasis is in
eCommerce, enterprise applications, and network infrastructure, all of which
are expected to benefit from the growing use of the Internet as a fundamental
business tool. The Company operates as a long-term partner, working closely
with its partnership companies to provide various operational and management
services to build value in preparation for public rights offerings and
beyond. The Company's partnership companies include privately held companies
and public companies that together form a community of shared resources. The
Company also assists in managing and working with several venture capital
funds. The Company's primary goal is to achieve superior returns for its
shareholders by bringing companies which it believes are ready for public
ownership to its shareholders through the rights offering process. This
process gives shareholders the opportunity to acquire direct ownership in
selected partnership companies at their initial public offering price. Not
all of the Company's private holdings are appropriate for this process;
therefore, the Company also considers mergers, sales, traditional initial
public offerings, and subscription offerings.
Consistent with its past approach, the Company plans to acquire
interests in early to mid-stage companies that can become leaders in their
respective markets. The Company is already active in the Internet through the
involvement of over 10 of its partnership companies, including Internet
Capital Group. Recognizing the growing importance of the Internet, the
Company sponsored the formation of Internet Capital in 1996 to focus
exclusively on owning, operating, and managing business-to-business eCommerce
companies. The Company owns approximately 26% of Internet Capital's
outstanding voting securities at December 31, 1998.
The Company feels the best way to build future value for its
shareholders is to be involved in Internet markets. As the Company acquires
interests in 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 shares of publicly traded
partnership companies. Given the volatility of the technology market,
especially Internet-related stocks, the Company will no longer sell shares of
publicly traded partnership companies solely to achieve a targeted EPS. As a
result, the Company's net earnings could fluctuate significantly from quarter
to quarter, depending on when the Company decides to sell those securities.
There can be no guarantee that the Company will report net earnings in each
period.
EFFECT OF VARIOUS ACCOUNTING METHODS ON THE
CONSOLIDATED FINANCIAL STATEMENTS
The net sales 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 share-holders 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 net earnings to reflect
only the Company's share of the earnings or losses of the partnership
company. CompuCom Systems, Inc. and Tangram Enterprise Solutions, Inc. are
consolidated in 1998 and 1997. Premier Solutions Ltd. and Pioneer Metal
Finishing, which were sold in 1997, also were included
in the Company's consolidated operating results through their
respective sale dates.
Partnership 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% 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 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 "Equity in losses (income) of affiliates" 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.
Partnership 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 investments classified as
trading securities is reflected in the Company's results of operations each
reporting period.
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.
As mentioned in Operations Overview, the Company's consolidated
revenues and related costs and expenses are significantly influenced by the
results of operations of CompuCom. At December 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, including three
acquisitions which were completed in 1998. 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 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 14 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 loss (income)" 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 14 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). Tangram's operations include
the design, development, sale, and implementation of enterprise-wide asset
tracking and software management solutions. General corporate operations
consists of developing and operating partnership companies, most of which are
engaged in information technology businesses. Other primarily includes
Pioneer and Premier which were sold during 1997 and Commercial Real Estate
which was sold during 1996.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED
DECEMBER 31, 1997
Net sales increased 15% to $2.3 billion in 1998 compared to $2.0 billion in
1997 as CompuCom experienced a 16% sales increase. The increase at CompuCom
was due primarily to a 17% product sales increase resulting from the
acquisitions of Computer Integration Corporation (CIC) and Dataflex
Corporation (the acquisitions) during the second quarter of 1998. Excluding
the acquisitions, CompuCom's product sales increased approximately 4% in
1998, and CompuCom sold 26% more desktop, laptop, and server units. However,
a decline in the average sales prices of these units as a result of
manufacturer price reductions lessened the impact of this unit growth on
sales. Although the trend of declining average sales prices continued to slow
in 1998 relative to 1997, CompuCom expects to be
continually impacted by this trend in the short-term, as CompuCom must sell
more units to generate the same amount of product sales. CompuCom's service
sales increased 9% to $257.9 million in 1998 from $236.2 million in 1997,
which was primarily due to increases in field engineering, which is driven in
part by product unit sales volume and by the acquisitions. Excluding the
acquisitions, service sales increased approximately 5%. CompuCom represented
99% of the Company's total consolidated net sales in 1998.
The Company's overall gross margin was 13.3% in 1998 compared to 14.4%
in 1997. The decrease is primarily attributable to reduced gross margins at
CompuCom. CompuCom's product gross margin decreased to 9.8% in 1998 compared
to 10.4% in 1997. CompuCom attributes this to a decline in billed margins due
to heightened competition from other corporate resellers and direct
marketers. CompuCom expects to continue to experience declining product gross
margins in the short-term. CompuCom's service gross margin was 32.0% in 1998
compared to 35.7% in 1997. The decrease was primarily caused by lower billing
per engineer for CompuCom's service personnel, particularly in the systems
engineering group. CompuCom does not expect to see improvement in its service
gross margin percentage in the short-term.
Securities and other gains in 1998 include a $245.3 million gain on the
merger of Coherent Communications Systems Corporation and Tellabs, Inc.,
partially offset by a $48.6 million loss comprised of unrealized losses
resulting from the decline in the market price of Tellabs subsequent to the
merger and gains on the sales of Tellabs stock. Securities and other gains in
1998 also include the open market sales of a portion of the Company's
interest in Cambridge Technology Partners, the gain resulting from the merger
of Integrated Systems Consulting Group with First Consulting Group, and
distributions received from the Company's associated venture funds.
Securities and other gains in 1997 included the open market sales of a
portion of the Company's interest in Cambridge, the sale of shares of Diamond
Technology Partners and ChromaVision Medical Systems in rights offerings to
the Company's shareholders, and distributions received from the Company's
associated venture funds. The Company also recorded gains in 1997 from the
sale of Premier and Pioneer. Partially offsetting securities and other gains
in these years was a write-down of the Company's holdings in Sybase due to
the other than temporary decline in the market price of that stock, charges
incurred in the disposition of certain partnership companies, 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.
Equity in losses (income) of affiliates fluctuates with the Company's
ownership percentage and the operating results of partnership companies
accounted for on the equity method. In 1998, the Company discontinued
accounting for its investment in Coherent on the equity method of accounting
as a result of the Coherent/Tellabs merger. In addition, the Company recorded
its share of merger-related and other one-time charges at certain partnership
companies. Equity income decreased as a result of the above transactions as
well as increased operating losses at certain partnership companies,
partially offset by the continued strong overall performances at Cambridge
and Sanchez Computer Associates, and increased earnings at Internet Capital
resulting from securities sales. In 1998, the Company's public investments
accounted for on the equity method include Cambridge, ChromaVision, OAO
Technology Solutions (OAOT), Sanchez, and USDATA Corporation. The Company
expects certain of its partnership 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,
equity losses of affiliates could increase significantly.
Cambridge reported 40% revenue growth in 1998 with earnings up 50%,
excluding business combination costs. At year end, approximately 50% of its
projects worldwide contained an Internet or interactive component. The
Company owns approximately 15% of Cambridge's common stock at December 31,
1998.
ChromaVision is making significant progress with clinical trials for its
Automated Cellular Imaging System (ACIS-TM-). ChromaVision submitted an
application to the FDA in November 1998 to use the ACIS-TM- for
Immunohistochemical (IHC) applications. Clearance from the FDA, which is
expected in the first quarter of 1999, would rapidly accelerate expansion of
the spectrum of clinical tests that can be performed on the ACIS-TM-
platform. The Company's increased losses primarily resulted from the
increased level of development and costs associated with the FDA application.
The Company owns approximately 26% of ChromaVision's common stock at
December 31, 1998.
OAOT initiated management and cost restructurings in 1998 which are
expected to result in annualized pretax savings in excess of $3 million.
Combined with two acquisitions in 1998, a $60 million IT staffing
augmentation services company and an Enterprise Resource Planning integrator,
OAOT is targeting higher margin service business in 1999. It also announced a
10-year contract for approximately $150 million with IBM Global Services to
provide application development and maintenance services in support of IBM's
application outsourcing contract with AT&T. The Company owns approximately
34% of OAOT's common stock at December 31, 1998.
Sanchez reported an 84% increase in earnings per share in 1998 with 53%
revenue growth. Sanchez also recently announced the formation of a dedicated
electronic banking service center through an agreement to purchase a banking
technology center near Pittsburgh. The new service offering, called
e-Profile.com, will allow leading financial institutions to launch new direct
banks from an operations and technology perspective in 30 to 90 days with
little or no up-front capital. The Company owns approximately 27% of
Sanchez's common stock at December 31, 1998.
USDATA announced its return to profitability in the fourth quarter of
1998 following 7 quarters of losses. USDATA also sold its hardware business
during 1998. The Company owns approximately 26% of USDATA's common stock at
December 31, 1998.
In October 1998, CompuCom's Board of Directors approved a restructuring
plan designed to reduce CompuCom's cost structure by approximately 1.25% to
1.5% of sales by closing branch facilities and reducing CompuCom's workforce
by approximately 10%. As a result, CompuCom recorded a restructuring charge
in the fourth quarter 1998 of $16.4 million (pretax), the effect of which is
approximately
$8.1 million (pretax) to the Company's earnings, after recording minority
interest. The charge primarily consists of costs associated with the closing
of certain facilities and disposing of related fixed assets, as well as
employee severance and benefits related to the reduction in workforce.
CompuCom continues to maintain a local presence in all current markets
through the use of its virtual office strategy. As a result of its fourth
quarter 1998 restructuring, CompuCom expects to realize reductions in
operating expenses, primarily in selling and general and administrative
expenses, from its fourth quarter 1998 levels. These reductions may not
result in lower operating expenses in comparison to the respective period of
the prior year (see Note 5 to the Consolidated Financial Statements).
Selling and service expenses increased in absolute dollars and as a
percentage of sales in 1998 primarily due to increased expenses at CompuCom.
The increases at CompuCom were primarily due to an increase in the sales
force as a result of the CIC and Dataflex acquisitions, the hiring of
additional sales representatives, higher commission expense, growth in its
service business, and increased spending on training as a result of the
increase in the size of the engineering force.
General and administrative expenses increased in absolute dollars
primarily due to increased expenses at CompuCom and increased corporate
expenses incurred to support the growing activities of the partnership
companies. The increase was partially offset by the elimination of expenses
resulting from the sale of Pioneer in 1997. The increases at CompuCom were
primarily due to expenditures to broaden its eCommerce capabilities, costs
related to its ongoing campus recruiting program, and costs associated with
the integration of CIC and Dataflex. 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 an increase at
CompuCom, which was partially offset by the elimination of depreciation and
amortization resulting from the sale of Premier and Pioneer in 1997. The
increase at CompuCom is associated with upgrading its hardware and software
and increased depreciation and amortization as a result of the acquisitions
completed during the first half of 1998. As a result of CompuCom's fourth
quarter 1998 restructuring, CompuCom expects to realize a slight decrease in
depreciation expense associated with the closing of branch facilities and
disposal of those related depreciable assets.
Interest and financing expenses increased in 1998 compared to 1997
primarily as a result of increased borrowings at CompuCom to fund the
acquisitions of CIC and Dataflex, and increased borrowings by the Company
primarily to fund interests in new or existing partnership companies,
partially offset by the elimination of interest due to the conversion of
$19.5 million of the Company's Convertible Subordinated Notes (Notes) into
the Company's Common Stock in 1998.
Minority interest decreased as a result of decreased earnings at
CompuCom, including its fourth quarter 1998 restructuring charge. Future
profitability at CompuCom will depend on its ability to effectively manage
inventory levels in response to changes in its major suppliers' price
protection and return programs, its ability to effectively manage the
utilization of service personnel, and its ability to respond to increased
competition from its suppliers' direct selling initiatives. It also depends
on CompuCom's ability to reduce operating expenses, demand for product,
competition, manufacturer product availability, effective utilization of
vendor programs, and its ability to implement its virtual office strategy as
part of its fourth quarter 1998 restructuring.
The effective tax rate decreased to 35.8% in 1998 compared to 40% for
1997 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 investments as well as the application of lower tax
rates against realized investment gains.
The Company's net earnings increased significantly in 1998 compared to
1997 primarily due to higher securities and other gains related to
Coherent/Tellabs transactions, partially offset by decreased earnings at
CompuCom. Securities and other gains of varying magnitude have been realized
in recent years. The Company's net earnings could fluctuate significantly
from period to period, depending on when the Company decides to sell shares
of publicly traded partnership companies. There can be no guarantee that the
Company will report net earnings in each period.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED
DECEMBER 31, 1996
Net sales decreased 4% in 1997 compared to 1996 primarily attributable to
the sale of Premier and Pioneer during 1997 and decreased product sales at
CompuCom as CompuCom primarily focused on increasing earnings through growth
in its higher-margin service business in 1997. In addition, CompuCom believes
the decrease in product sales is also attributable to an increase in direct
marketers' market share and CompuCom's efforts during much of 1997 to reduce
the amount of low-margin product business. CompuCom's total sales decreased
2% for the year with service sales increasing 40% while product sales
decreased 6%. CompuCom represented 98% and 97% of the Company's total
consolidated net sales in 1997 and 1996, respectively.
The Company's overall gross margin was 14.4% in 1997 compared to 13.1%
for 1996. The increase is attributable to increased product margins at
CompuCom as well as increased service sales at CompuCom which generated
higher gross margins relative to product sales. Product margins increased to
10.4% in 1997 compared to 10.0% in 1996 primarily due to a reduction in the
relative volume of sales to some of CompuCom's larger customers, which
typically generate lower product margins, and an increase in the amount of
manufacturer-sponsored incentives in 1997 compared to 1996. Service gross
margin increased to 35.7% in 1997 from 33.3% in 1996 primarily due to
increased productivity of CompuCom's service engineers.
Securities and other gains in 1997 included the open market sales of a
portion of the Company's interest in Cambridge, the sale of shares of Diamond
and ChromaVision in rights offerings to the Company's shareholders, and
distributions received from the Company's associated venture funds. The
Company also recorded gains in 1997 from the sale of Premier and Pioneer.
Securities and other gains in 1996 included the open market sales of a
portion of the Company's interests in Coherent and Cambridge, and the sale of
shares of Integrated Systems
and Sanchez in rights offerings to the Company's shareholders. Securities and
other gains in 1996 also included the sale of the Company's remaining
interest in Gandalf Technologies and the Company's share of CompuCom's gain
from the sale of substantially all of its holdings in PC Service Source.
Partially offsetting securities and other gains in these years was a
write-down of the Company's holdings in Sybase due to the other than
temporary decline in the market price of that stock, charges incurred in the
disposition of partnership companies, and provisions for other investments
and notes.
Increased equity income from most of the Company's public investments in
1997 was more than offset by the Company's share of losses at certain
private, early stage equity affiliates and increased amortization of the
excess of carrying value of equity affiliates over the Company's share of the
underlying net assets. The Company's public equity investments accounted for
on the equity method in 1997 included Cambridge, ChromaVision, Coherent,
OAOT, Sanchez, and USDATA.
Selling and service expenses increased in 1997 compared to 1996
primarily due to CompuCom's costs to manage and expand its growing service
business. General and administrative expenses, in absolute dollars and as a
percentage of sales, increased in 1997 compared to 1996 primarily due to
CompuCom's continued investment in its information system resources required
to broaden eCommerce capabilities and improve efficiency within its customer
center, Tangram's investment in workforce and research and development for
Asset Insight-TM-, and increased corporate expenses incurred to support the
growing activities of the partnership companies. These increases were
partially offset by the elimination of expenses resulting from the sale of
Premier and Pioneer in 1997.
Depreciation and amortization decreased in 1997 primarily due to the
sale of Premier and Pioneer in 1997 and the Company's commercial real estate
operations in 1996, partially offset by increased depreciation at CompuCom.
The increase at CompuCom is primarily associated with its new corporate
headquarters and operations campus and enhancements to CompuCom's information
systems.
Interest and financing expenses decreased slightly in l997 compared to
1996 primarily as a result of the conversion of approximately $24.2 million
of the Company's Notes in the fourth quarter of 1996 and the first quarter of
1997 into the Company's Common Stock and the elimination of interest
resulting from the sale of Premier and Pioneer in 1997 and the Company's
commercial real estate operations in 1996, partially offset by increased
borrowings by the Company. CompuCom's borrowing levels, including the
receivables securitization facility, were slightly higher in 1997 when
compared to 1996; however, this was offset by a lower effective rate for 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically used its bank credit facility and proceeds from
sales of publicly traded partnership companies to fund its cash requirements.
In addition, in February 1996, the Company issued $115 million of 6%
Convertible Subordinated Notes due February 1, 2006. The Notes are
convertible into the Company's Common Stock at $28.985 per share. The Company
used approximately $67 million of the net proceeds to repay all of the
outstanding indebtedness under its bank revolving credit facility at that
date. Through March 1999, approximately $43.7 million of Notes have been
converted into 1,506,119 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
(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 and matures in April 1999,
with availability limited to the lesser of $50 million or 10% of the value of
the Pledged Securities. The Company intends to renew the $50 million bank
revolving credit facility in 1999. There was $88.1 million outstanding under
the total facility at December 31, 1998.
The Company has revolving credit facilities with certain partnership
companies whereby the Company may borrow up to $20 million from these
partnership companies on a revolving basis at a rate that varies with the
Company's effective borrowing rate. At December 31, 1998, $20 million was
outstanding under these agreements.
During 1998, the Company invested approximately $48 million in seven new
partnership companies, including US Interactive, Kanbay, Pac-West Telecomm,
Integrated Visions, and Who? Vision. The Company invested approximately $73
million during 1998 in its existing private partnership companies and
associated venture funds. The Company also purchased approximately $20
million of shares of its publicly traded partnership companies, and
repurchased 765,000 shares of the Company's Common Stock in the open market
for approximately $19 million. The Company received approximately 3.5 million
shares of Tellabs in connection with the merger of Coherent with Tellabs and
received approximately 451,000 shares of First Consulting in connection with
the merger of Integrated Systems with First Consulting. During 1998, the
Company sold a portion of its interests in Cambridge and Tellabs for net
proceeds totaling $87 million.
Availability under the Company's revolving credit facilities, proceeds
from the sales from time to time of selected publicly traded partnership
companies, 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 partnership companies, general corporate
requirements, and the repurchase of the Company's Common Stock from time to
time in the open market. The Company is contingently obligated for
approximately $30 million of guarantee commitments, and has committed capital
of approximately $100 million to various partnership companies, venture
funds, and private equity partnerships, to be funded over the next several
years.
Availability under the Company's bank credit facility is determined by
the market value of the publicly traded partnership companies pledged as
collateral. If the stock markets experience a significant decline,
availability under the credit facilities could be reduced significantly and
could have an adverse effect on the Company's ability to borrow under the
facilities. In addition, the Company's ability to raise proceeds from sales
of publicly traded partnership companies could also be adversely effected. As
a result, the Company's ability to acquire interests in new partnership compa-
nies and support its existing partnership 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 operating earnings, bank
financing arrangements, and internally generated funds to fund its cash
requirements. CompuCom's liquidity has been 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 price for the product is often
higher than the sales price CompuCom can obtain from its customers. At
December 31, 1998, these programs are a major factor in CompuCom's financing
needs.
CompuCom's financing arrangements consist of a $165 million working
capital facility (increased from $125 million in June 1998), a $175 million
receivables securitization facility, and a $25 million real estate loan
(collectively, the "credit agreements"). At December 31, 1998, approximately
$81.1 million was outstanding under the working capital facility and the real
estate loan, and the receivables securitization facility was fully utilized.
The working capital facility matures in November 2002 and the real estate
loan is due in quarterly installments beginning April 1999. The receivables
securitization facility expires on April 15, 1999.
At December 31, 1998, CompuCom was not in compliance with certain
financial covenants under the credit agreements. However, CompuCom received
an amendment related to such covenants from its lenders up to and including
April 15, 1999. CompuCom is currently negotiating a replacement receivables
securitization and working capital facility and expects to execute
agreements prior to April 15, 1999. Although these facilities are expected to
contain provisions that could result in lower interest rates as CompuCom's
financial performance improves, the initial interest rates are expected to be
higher than CompuCom's current effective interest rates. If CompuCom is not
successful in implementing the replacement facilities, its management
believes there are a number of viable alternatives to ensure continued
financing. CompuCom also expects to complete a sale/leaseback on its
headquarters building during the first quarter of 1999, with the proceeds
used to payoff the real estate loan and pay down a portion of the working
capital facility.
In 1998, CompuCom completed three business combinations for
approximately $49 million in cash. These business combinations were accounted
for as purchases.
Consolidated working capital increased to $252 million at December 31,
1998, compared to $228 million at December 31, 1997. The increase was
primarily due to the classification of the Company's Tellabs holdings as a
trading security following the Coherent/Tellabs merger in August 1998, as
well as an increase in accounts receivable at CompuCom as a result of two
acquisitions completed in the second quarter of 1998 which resulted in higher
sales in the fourth quarter of 1998 compared to the fourth quarter of 1997.
These increases were partially offset by an increase in accounts payable at
CompuCom resulting from the timing of product receipts and the mix of
vendors, and a decrease in inventory due to CompuCom's effort to reduce its
risk associated with changes in its suppliers price protection and return
programs and increase its inventory turns.
Cash flow provided by operating activities decreased in 1998 as
operating cash flow for 1997 included the effect of CompuCom's receivables
securitization facility in which $175 million of accounts receivable were
sold with the proceeds used to pay down long-term debt.
The Company has sold approximately 300,000 shares of Tellabs in the
first quarter through March 5, 1999, generating proceeds of approximately $24
million. The Company is considering certain hedging strategies to partially
protect against possible declines in the price of its Tellabs holdings.
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 December 31, 1998.
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 or is replacing during
the first quarter of 1999 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 will perform
testing and complete implementation of its computer systems during the second
quarter of 1999. The Company is in the process of surveying its vendors of
non-information systems including telecommunications and security systems,
and expects to complete remediation, if necessary, during 1999. If the
Company determines that its non-information systems are non-compliant and are
at risk to not be remedied in time, it will develop a contingency plan.
The Company has engaged in a regular program of surveying its
partnership companies regarding their Year 2000 readiness. The Company's most
significant consolidated subsidiary, CompuCom, has completed initial
assessment of its computer information systems, and plans to complete
remediation and testing by June 1999. Initial assessment and remediation of
CompuCom's non-information systems is currently expected to be completed
during the first quarter of 1999. CompuCom completed three business
acquisitions during 1998. 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 85% of the systems currently in use.
CompuCom plans to upgrade or replace any systems which are not Year 2000
compliant during the second quarter of 1999. 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 loss
of revenues and earnings. 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 $800,000 has been spent through December 31, 1998.
Almost all of the balance of the Company's partnership companies have
completed assessing their internal Year 2000 readiness, and the rest expect
to complete assessment in the first quarter of 1999. The partnership
companies are in varying stages of remediating and testing their internal
systems and assessing Year 2000 readiness of their vendors, business
partners, and customers. The partnership companies are also in varying stages
of developing contingency plans to operate in the event of a Year 2000
problem. Most of the partnership companies are in the business of providing
software products, information technology services, or outsourcing services.
Those partnership companies which produce software or products with embedded
programming believe that the current version of their products are Year 2000
compliant. Certain partnership companies are continuing to determine the
extent to which previously sold software products and services were
non-compliant. Some older companies may not be able to assess products sold
many years ago. The partnership 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 will 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 partnership 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 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.
SAFE HARBOR STATEMENT
Certain statements in this annual report describing the plans, goals,
strategies, intentions, forecasts, and expectations of the Company or its
partnership 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 part-nership companies. Certain of
the Company's partnership 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 partnership
companies, often encounter obstacles and delays in developing products,
service offerings, and markets. Such delays and obstacles could affect the
Company's ability to complete rights offerings when planned.
Competition to invest in or 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. If the current
uncertainty in those markets continues for an extended period of time, the
Company's ability to complete rights offerings when planned and the Company's
ability to generate gains from sales of publicly traded partnership companies
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 partnership companies and
support its existing partnership companies with additional funding could be
limited. The market for securities of Internet-related companies is extremely
volatile, and the Company's participation in Internet-related companies could
cause the Company's stock to become more volatile.
Clients of the Company's partnership 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 partnership companies. The Company's and its partnership 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 partnership companies' operations and
financial conditions.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
December 31 1998 1997
- ----------- ---------- ----------
Assets
Current Assets
Cash and cash equivalents.......................................................................... $ 6,257 $ 5,382
Short-term investments............................................................................. 143,103 --
Receivables less allowances ($4,769-1998; $2,872-1997)............................................. 296,093 187,385
Inventories........................................................................................ 138,551 198,053
Other current assets............................................................................... 5,006 6,459
- ----------- ---------- ----------
Total current assets............................................................................. 589,010 397,279
Property, Plant, and Equipment, Net.................................................................... 96,840 76,967
Other Assets
Investments........................................................................................ 288,336 185,111
Notes and other receivables........................................................................ 20,182 21,035
Excess of cost over net assets of businesses acquired, net......................................... 65,137 26,168
Other.............................................................................................. 9,185 7,981
- ----------- ---------- ----------
Total other assets............................................................................... 382,840 240,295
---------- ----------
Total Assets........................................................................................... $1,068,690 $ 714,541
---------- ----------
---------- ----------
Liabilities and Shareholders' Equity
Current Liabilities
Current debt obligations........................................................................... $ 2,366 $ 3,396
Accounts payable................................................................................... 161,700 74,025
Accrued expenses................................................................................... 172,953 91,857
---------- ----------
Total current liabilities........................................................................ 337,019 169,278
Long-Term Debt....................................................................................... 205,044 127,089
Deferred Taxes....................................................................................... 12,562 20,044
Minority Interest and Other.......................................................................... 99,861 100,179
Convertible Subordinated Notes....................................................................... 71,345 90,881
Shareholders' Equity
Common stock, par value $.10 per share
Authorized 100,000,000 shares; Issued 32,799,342 shares........................................... 3,280 3,280
Additional paid-in capital......................................................................... 62,470 49,952
Retained earnings.................................................................................. 261,594 151,471
Accumulated other comprehensive income............................................................. 37,294 15,706
Treasury stock, at cost (1,252,995 shares-1998; 1,563,626 shares-1997)............................. (21,779) (13,339)
---------- ----------
Total shareholders' equity....................................................................... 342,859 207,070
---------- ----------
Total Liabilities and Shareholders' Equity............................................................. $1,068,690 $ 714,541
---------- ----------
---------- ----------
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Year Ended December 31 1998 1997 1996
- ----------------------- ---------- ---------- ----------
Revenues
Net sales
Product....................................................................... $1,994,965 $1,724,220 $1,856,889
Service....................................................................... 280,178 261,005 205,920
---------- ---------- ----------
Total net sales................................................................. 2,275,143 1,985,225 2,062,809
Securities and other gains, net................................................. 193,665 26,857 30,373
Other income.................................................................... 14,691 12,932 8,646
---------- ---------- ----------
Total revenues.............................................................. 2,483,499 2,025,014 2,101,828
Costs and Expenses
Cost of sales-product........................................................... 1,787,370 1,534,310 1,655,893
Cost of sales-service........................................................... 185,561 164,882 137,065
Selling and service............................................................. 172,349 136,646 128,467
General and administrative...................................................... 96,647 87,538 84,235
Depreciation and amortization................................................... 21,738 18,132 20,645
Interest and financing.......................................................... 29,720 22,359 23,916
Equity in losses (income) of affiliates......................................... 2,083 (417) (1,539)
Restructuring................................................................... 16,437 -- --
---------- ---------- ----------
Total costs and expenses.................................................... 2,311,905 1,963,450 2,048,682
---------- ---------- ----------
Earnings Before Minority Interest and Taxes on Income............................. 171,594 61,564 53,146
Minority interest............................................................... (47) (25,727) (19,934)
---------- ---------- ----------
Earnings Before Taxes on Income................................................... 171,547 35,837 33,212
Provision for taxes on income................................................... 61,424 14,336 13,285
---------- ---------- ----------
Net Earnings...................................................................... $ 110,123 $ 21,501 $ 19,927
---------- ---------- ----------
Earnings Per Share
Basic........................................................................... $ 3.46 $ .69 $ .67
Diluted......................................................................... $ 3.22 $ .66 $ .61
Average Common Shares Outstanding
Basic........................................................................... 31,833 31,249 29,900
Diluted......................................................................... 34,914 31,996 31,348
---------- ---------- ----------
---------- ---------- ----------
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
Year Ended December 31 1998 1997 1996
- ---------------------- ---------- --------- ----------
Operating Activities
Net earnings.................................................................... $ 110,123 $ 21,501 $ 19,927
Adjustments to reconcile net earnings to cash provided (used) by
operating activities
Depreciation and amortization................................................. 21,738 18,132 20,645
Deferred income taxes......................................................... 28,909 (2,566) 1,910
Equity in losses (income) of affiliates....................................... 2,083 (417) (1,539)
Securities and other gains, net............................................... (193,665) (26,857) (30,373)
Minority interest, net........................................................ 28 15,436 11,960
Cash provided (used) by changes in working capital items
Receivables................................................................... (32,301) 210,578 (113,719)
Inventories................................................................... 68,840 35,498 (36,595)
Accounts payable, accrued expenses, and other................................. 69,313 (123,759) 38,454
---------- --------- ----------
Cash provided (used) by operating activities.................................... 75,068 147,546 (89,330)
Proceeds from securities and other gains, net................................... 94,838 71,318 53,350
---------- --------- ----------
Cash provided (used) by operating activities and
securities and other gains, net.................................................. 169,906 218,864 (35,980)
Other Investing Activities
Investments and notes acquired, net............................................. (137,375) (78,412) (59,270)
Business acquisitions, net of cash acquired..................................... (49,679) -- (6,937)
Capital expenditures............................................................ (17,582) (31,314) (49,984)
Other, net...................................................................... (1,988) 449 (14,197)
---------- --------- ----------
Cash used by other investing activities........................................... (206,624) (109,277) (130,388)
Financing Activities
Net borrowings (repayments) on revolving credit facilities...................... 52,754 (117,766) 27,131
Net (repayments) borrowings on term debt........................................ (2,269) (168) 24,165
Issuance of convertible subordinated notes, net................................. -- -- 112,109
Repurchase of Company common stock.............................................. (18,672) (9,488) --
Issuance of Company common stock................................................ 4,135 5,819 5,210
Issuance of subsidiary common stock............................................. 1,645 4,517 3,367
---------- --------- ----------
Cash provided (used) by financing activities...................................... 37,593 (117,086) 171,982
---------- --------- ----------
Increase (Decrease) in Cash and Cash Equivalents.................................. 875 (7,499) 5,614
Cash and cash equivalents-beginning of year....................................... 5,382 12,881 7,267
---------- --------- ----------
Cash and Cash Equivalents-End of Year............................................. $ 6,257 $ 5,382 $ 12,881
---------- --------- ----------
---------- --------- ----------
See Notes to Consolidated Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
Accumulated
Common Stock Additional Other Treasury Stock
-------------------- Paid-In Retained Comprehensive ---------------------
Shares Amount Capital Earnings Income Shares Amount
---------- ------ ---------- -------- ------------- ---------- ---------
Balance--December 31, 1995..................... 32,799,342 $3,280 $20,709 $110,043 $30,748 3,434,828 $(10,471)
Net earnings................................... 19,927
Stock options exercised, net................... 3,323 (759,011) 1,887
Conversion of convertible
subordinated notes............................ 11,364 (443,988) 1,419
Subsidiaries' equity transactions.............. 170
Other comprehensive loss....................... (23,388)
Balance--December 31, 1996..................... 32,799,342 3,280 35,566 129,970 7,360 2,231,829 (7,165)
Net earnings................................... 21,501
Stock options exercised, net................... 3,784 (670,649) 2,035
Repurchase of common stock..................... 390,577 (9,488)
Conversion of convertible
subordinated notes............................ 9,731 (388,131) 1,279
Subsidiaries' equity transactions.............. 871
Other comprehensive income..................... 8,346
Balance--December 31, 1997..................... 32,799,342 3,280 49,952 151,471 15,706 1,563,626 (13,339)
Net earnings................................... 110,123
Stock options exercised, net................... (66) (401,631) 4,201
Repurchase of common stock..................... 765,000 (18,672)
Conversion of convertible
subordinated notes............................ 13,189 (674,000) 6,031
Subsidiaries' equity transactions.............. (605)
Other comprehensive income..................... 21,588
Balance--December 31, 1998..................... 32,799,342 $3,280 $62,470 $261,594 $37,294 1,252,995 $(21,779)
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
Year Ended December 31 1998 1997 1996
- ---------------------- --------- -------- ---------
Net Earnings....................................................... $110,123 $21,501 $ 19,927
--------- -------- ---------
Other Comprehensive Income (Loss), Before Taxes:
Unrealized holding gains (losses) on investments............... 43,676 10,706 (39,937)
Reclassification adjustments................................... (10,103) 1,940 4,500
Related Tax (Expense) Benefit:
Unrealized holding gains (losses) on investments............... (15,591) (3,640) 13,579
Reclassification adjustments................................... 3,606 (660) (1,530)
--------- -------- ---------
Other Comprehensive Income (Loss).................................. 21,588 8,346 (23,388)
--------- -------- ---------
Comprehensive Income (Loss)........................................ $131,711 $29,847 $ (3,461)
--------- -------- ---------
--------- -------- ---------
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF THE COMPANY--Safeguard Scientifics, Inc. (the Company) is an
operating company that develops and operates partnership companies. Most of
the partnership companies are engaged in information technology businesses,
broadly defined to include all activities related to the acquisition,
processing, and dissemination of information and related technology and
services to improve business and personal productivity.
The most significant of the Company's partnership companies provides
computing and communications infrastructure services. This includes the
procurement and configuration of personal computers and servers as well as
application software development, implementation, and desktop/network
support services. They also provide IT strategy consultation. Almost half of
the partnership companies are involved with the Internet in aspects that
include the development of eCommerce models; the design, development,
hosting, and support of distributed eCommerce applications; and the provision
of security products and services to virtual enterprises. Many of the
Company's partnership companies operate in multiple vertical industries,
including healthcare, insurance, and financial services. The remaining
partnership companies are principally engaged in the development, sale, and
implementation of strategic business software, document management, and
multimedia and telecommunications technology and services. The Company also
has a robust incubation strategy which will increasingly focus on the
companies in the areas of eCommerce, enterprise applications, and network
infrastructure.
PRINCIPLES OF CONSOLIDATION--The Consolidated Financial Statements include
the accounts of the Company and its majority-owned subsidiaries, primarily
CompuCom Systems, Inc. and Tangram Enterprise Solutions, Inc. All significant
intercompany accounts and transactions have been eliminated. The effect of
adjustments to the Company's carrying values of these subsidiaries resulting
from the subsidiaries' underlying equity transactions is included in the
Company's Additional Paid-In Capital.
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% of the voting
interest when it exerts significant influence through representation on those
companies' Boards of Directors and other means. The amount by which the
Company's carrying value exceeds its share of the underlying net assets of
equity affiliates is amortized on a straightline basis which adjusts the
Company's share of the affiliates' earnings or losses.
All other investments are accounted for on the cost method. Certain cost
method investments are classified as available-for-sale and are recorded at
fair value, based on quoted market prices, with the unrealized gains or
losses, net of tax, included as a separate component of shareholders' equity.
The Company's investment in Tellabs, Inc. is classified as a trading security
and is reported at fair value, based on quoted market prices, with the net
gain or loss included in net earnings. All other investments are stated at
the lower of cost or net realizable value.
The Company continually evaluates investments for indications of
impairment based on the market value of each investment relative to cost,
financial condition, near-term prospects of the investment, and other
relative factors.
In 1997, the Company sold its Pioneer Metal Finishing division and all
of the assets of Premier Solutions Ltd. As a result, these entities are only
included in the Company's Consolidated Financial Statements through their
respective sale dates.
ACCOUNTING ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS--The Company considers all highly liquid
instruments with an original maturity of 90 days or less at the time of
purchase to be cash equivalents.
INVENTORIES, primarily finished goods, are stated at the lower of average
cost or market. The Company continually assesses the appropriateness of the
inventory valuations considering obsolete, slow-moving, and non-salable
inventory.
PROPERTY, PLANT, AND EQUIPMENT includes $75.2 million and $57.7 million of
land, buildings, and improvements and $65.1 million and $47.5 million of
machinery and equipment at December 31, 1998 and 1997, respectively.
Property, plant, and equipment are carried at cost less accumulated
depreciation and amortization of $43.5 million and $28.2 million at December
31, 1998 and 1997, respectively. The provision for depreciation and
amortization is based on the estimated useful lives of the assets (buildings
and improvements--3 to 40 years; machinery and equipment--3 to 12 years) and
is computed primarily on the straight-line method.
EXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED (goodwill) is amortized
on a straight-line basis primarily over 7 to 20 years. Accumulated
amortization at December 31, 1998 and 1997, was $29.1 million and $24.0
million, respectively. The Company continually evaluates goodwill for
indications of impairment based on the forecasted undiscounted cash flow from
the related business activity (including possible proceeds from a sale of the
business).
RECEIVABLES SECURITIZATION--CompuCom has an agreement with a financial
institution that allows CompuCom to sell, on a revolving basis, an interest
in a portion of its accounts receivable. During 1997, the receivables
securitization facility was amended such that the sale is required to be
accounted for in accordance with Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" (SFAS 125), which requires these transactions
to be accounted for as a sale of receivables. Sales of receivables are
reflected as a reduction in "Receivables less allowances" on the Consolidated
Balance Sheets. CompuCom is retained as servicer of the receivables; however,
the cost to service the receivables is not material.
TAXES ON INCOME are reduced by allowable tax credits. Deferred taxes are
accounted for using the asset and liability method of accounting for income
taxes. Under this method, deferred taxes are recognized for the tax
consequences of "temporary differences" by applying enacted statutory tax
rates applicable to future years to differences between the financial
statement carrying amounts and the tax basis of existing assets and
liabilities.
FINANCIAL INSTRUMENTS--The Company's financial instruments, principally cash,
accounts receivable, accounts payable, and accrued expenses, are carried at
cost which approximates fair value due to the short-term maturity of these
instruments. The Company's long-term debt is carried at cost which
approximates fair value as the debt bears interest at rates approximating
current market rates. At December 31, 1998, the market value of the Company's
Convertible Subordinated Notes was approximately $72.8 million based on
quoted market prices.
EARNINGS PER SHARE (EPS) is computed on net earnings using the weighted
average number of common shares outstanding during each year. Dilutive EPS
includes common stock equivalents (unless anti-dilutive) which would arise
from the exercise of stock options and conversion of other convertible
securities and is adjusted, if applicable, for the effect on net earnings of
such transactions. Dilutive EPS calculations adjust net earnings for the
dilutive effect of common stock equivalents and convertible securities issued
by the Company's public subsidiary or equity affiliates.
REVENUE RECOGNITION--Product sales are generally recognized upon shipment
with provisions made for anticipated returns, which historically have not
been material. Service sales are generally recognized when the service is
rendered or ratably if performed over a service contract period.
VENDOR PROGRAMS--CompuCom receives volume incentives and rebates from certain
manufacturers related to sales of certain products which are recorded as a
reduction of cost of sales when earned. CompuCom also receives manufacturer
reimbursements for certain training, promotional, and marketing activities
that offset the expenses incurred by CompuCom.
STOCK-BASED COMPENSATION--The Company applies Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) for stock
options and other stock-based awards while disclosing pro forma net earnings
and net earnings per share as if the fair value method had been applied in
accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123).
COMPREHENSIVE INCOME--In 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130),
which requires companies to report and display comprehensive income and its
components in 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. Excluding net earnings, the
Company's source of other comprehensive income is from net unrealized
appreciation on its investments classified as available-for-sale.
Reclassification adjustments result from the recognition in net earnings of
gains or losses that were included in comprehensive income in prior periods.
SEGMENT INFORMATION--At December 31, 1998, the Company adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131), which requires companies to
present financial and descriptive segment information (see Note 15).
2. INVESTMENTS
SHORT-TERM INVESTMENTS
In August 1998, Coherent Communications Systems Corporation merged with
Tellabs. Prior to the merger, the Company owned 31% of Coherent and accounted
for its investment on the equity method. The Company received approximately
3.5 million shares of Tellabs in exchange for all of its Coherent shares and
recorded a pretax book gain of $245.3 million in 1998. At December 31, 1998,
the Company owns approximately 2.1 million shares of Tellabs.
The Company's investment in Tellabs is classified as a trading security
(classified as "Short-term investments" on the Consolidated Balance Sheets).
NON-CURRENT INVESTMENTS
The following summarizes the Company's non-current investments (in
thousands). Investments are classified according to the applicable accounting
method at December 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. The table
excludes the Company's holdings in Tellabs (classified as "Short-term
investments" on the Consolidated Balance Sheets), which has a market value of
$143.1 million at December 31, 1998.
December 31 1998 1997
- ----------- -------------------- ---------------------
Carrying Market Carrying Market
Value Value Value Value
--------- -------- ---------- --------
Equity Affiliates (voting %)
Cambridge Technology Partners (15%)........................... $ 35,248 $190,217 $ 24,679 $371,394
ChromaVision Medical Systems (26%)............................ 11,304 22,419 4,689 30,044
Coherent Communications Systems Corporation................... -- -- 14,799 135,008
OAO Technology Solutions (34%)................................ 16,472 16,551 13,887 43,716
Sanchez Computer Associates (27%)............................. 10,620 91,965 7,196 89,068
USDATA Corporation (26%)...................................... 7,053 5,545 7,194 13,325
Non-public companies.......................................... 23,784 18,453
-------- --------
104,481 90,897
Other
Diamond Technology Partners................................... 3,120 21,337 1,526 14,717
DocuCorp International........................................ 3,226 8,035 7,718 7,718(b)
First Consulting Group(a)..................................... 8,490 11,308 1,891 7,785
e4L (formerly National Media)................................. 2,035 32,299 2,035 1,563
Other public companies........................................ 10,388 11,648 13,358 18,541
Unrealized appreciation....................................... 57,368 23,796
Non-public companies.......................................... 99,228 43,890
-------- --------
$288,336 $185,111
(a) First Consulting Group merged with Integrated Systems Consulting Group in
December 1998.
(b) The market value of DocuCorp equals its carrying value at December 31,
1997 since DocuCorp was not publicly traded until 1998.
The following summarized financial information for investees accounted for on
the equity method at December 31, 1998, has been compiled from the unaudited
financial statements of the respective investees and reflects certain
historical adjustments (in thousands):
Balance Sheets
December 31 1998 1997
- ----------- -------- --------
Current assets................................. $453,829 $344,400
Non-current assets............................. 187,797 105,898
-------- --------
Total assets................................... $641,626 $450,298
-------- --------
-------- --------
Current liabilities............................ $198,683 $138,871
Non-current liabilities........................ 26,106 27,036
Shareholders' equity........................... 416,837 284,391
-------- --------
Total liabilities and
shareholders' equity.......................... $641,626 $450,298
-------- --------
-------- --------
Results of Operations
Year Ended December 31 1998 1997 1996
- ---------------------- -------- -------- --------
Net Sales
Public companies............................... $792,320 $574,267 $394,816
Non-public companies:
MultiGen-Paradigm............................ 16,530 18,387 14,105
QuestOne..................................... 11,571 4,794 2,671
Other........................................ 21,633 18,616 --
-------- -------- --------
$842,054 $616,064 $411,592
-------- -------- --------
Net Income....................................... $ 7,503 $ 11,857 $ 12,267
-------- -------- --------
-------- -------- --------
The following summarized sales information for selected investments
accounted for on the cost method at December 31, 1998, has been compiled from
the unaudited financial statements of the respective companies and reflects
certain historical adjustments (in thousands):
Year Ended December 31 1998 1997 1996
- ---------------------- -------- -------- --------
Net Sales
Public companies................................ $121,471 $ 91,578 $ 65,999
Non-public companies:
Intellisource................................. 135,291 112,182 85,273
Kanbay........................................ 35,700 19,563 12,235
Pac-West Telecomm............................. 42,211 29,551 12,969
US Interactive................................ 16,645 13,095 4,455
Other......................................... 28,289 27,649 9,862
-------- -------- --------
$379,607 $293,618 $190,793
-------- -------- --------
-------- -------- --------
Average cost is generally used to compute securities and other gains.
Pretax securities gains related to Coherent/Tellabs transactions for the year
ended December 31, 1998, were $196.7 million, which consists of the $245.3
million gain on the merger, partially offset by a $48.6 million loss
comprised of unrealized losses resulting from the decline in the market price
of Tellabs subsequent to the merger and gains on the sales of 1.4 million
shares of Tellabs stock (for net proceeds of $71.0 million). Fluctuations in
the price of Tellabs stock may have a significant impact on the Company's
future reported net earnings.
Securities and other gains in 1998 also include the open market sales of
a portion of the Company's interest in Cambridge, the gain resulting from the
merger of Integrated Systems with First Consulting, and distributions
received from the Company's associated venture funds. Securities and other
gains in 1997 included the open market sales of a portion of the Company's
interest in Cambridge, the sale of shares of Diamond and ChromaVision in
rights offerings to the Company's shareholders, and distributions received
from the Company's associated venture funds. The Company also recorded gains
in 1997 from the sale of Premier and Pioneer. Securities and other gains in
1996 included the open market sales of a portion of the Company's interest in
Cambridge and Coherent and the sale of shares of Sanchez in a rights offering
to the Company's shareholders. Partially offsetting securities and other
gains in each year was a write-down of the Company's holdings in Sybase due
to the other than temporary decline in the market price of that stock,
charges incurred in the disposition of partnership companies, and provisions
for other investments and notes receivable.
3. DEBT
The following is a summary of long-term debt (in thousands):
December 31 1998 1997
- ----------- -------- --------
Parent Company and Other
Recourse Debt
Revolving credit facilities............................... $108,107 $ 22,200
Other..................................................... 15,874 7,822
-------- --------
123,981 30,022
Subsidiary Debt
(Non-Recourse to Parent)
CompuCom.................................................. 83,429 100,425
Other..................................................... -- 38
-------- --------
83,429 100,463
-------- --------
Total debt................................................ 207,410 130,485
Current debt obligations.................................. (2,366) (3,396)
-------- --------
Long-term debt............................................ $205,044 $127,089
-------- --------
-------- --------
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
(the Pledged Securities), including CompuCom. The remaining $50 million is
unsecured and matures in April 1999, with availability limited to the lesser
of $50 million or 10% of the value of the Pledged Securities. The Company
intends to renew the $50 million bank revolving credit facility in 1999. The
bank revolving credit facility bears interest at the prime rate and/or, at
the Company's option, at LIBOR (approximately 5.06% at December 31, 1998)
plus 1.25% and is subject to a commitment fee ranging from 0.2% to 0.3% on
the unused portion. At December 31, 1998, $88.1 million is outstanding under
the bank revolving credit facility. The Company borrowed a maximum of $123.2
million and $15.8 million during 1998 and 1997, respectively.
The Company had aggregate indebtedness of $20 million under revolving
credit facilities to certain partnership companies as of December 31, 1998.
These facilities are payable on demand and bear interest at the Company's
effective borrowing rate less .75%. The Company has the intent and ability,
if necessary, to repay these facilities with proceeds from its bank
revolving credit facility; accordingly, they are classified as long-term.
CompuCom has $365 million of separate, independent financing
arrangements which are secured by certain assets of CompuCom and consist of a
$165 million working capital facility, a $175 million receivables
securitization facility, and a $25 million real estate loan. In 1998,
CompuCom amended its working capital facility, increasing the availability to
$165 million from $125 million. The interest rates on the working capital
facility and the real estate loan are currently LIBOR plus 1.375%, subject to
adjustment based on certain performance criteria. There was $56.1 million and
$25.0 million outstanding under the working capital facility and the real
estate
loan, respectively, at December 31, 1998. The working capital facility
matures in November 2002; the real estate loan is due in quarterly
installments beginning April 1999.
The interest rate applicable to CompuCom's receivables securitization
facility is based upon the bank's commercial paper rate (4.95% at December
31, 1998) plus 85 basis points. Discounts associated with the sale of
receivables totaled $10.8 million and $4.7 million for 1998 and 1997,
respectively, and are included in "Interest and financing" in the
Consolidated Statements of Operations. At December 31, 1998, $173.6 million
was outstanding under this facility. The receivables securitization facility
expires on April 15, 1999. CompuCom is currently negotiating a replacement
receivables securitization facility and expects to execute an agreement prior
to April 15, 1999.
The credit facilities of the Company and CompuCom generally require some
or all of the following: the maintenance of specified levels of tangible net
worth, debt to tangible net worth and net earnings, specified interest
coverage ratios, and limitations on the amount available for dividends,
capital expenditures, investments, and third party guarantees. At December
31, 1998, CompuCom was not in compliance with certain financial covenants
under its credit facilities. CompuCom received an amendment related to such
covenants from its lenders for periods up to and including April 15, 1999.
CompuCom is currently negotiating a replacement working capital facility and
expects to execute an agreement prior to April 15, 1999.
The aggregate net assets of subsidiaries which are restricted and
unavailable for dividends at December 31, 1998, is approximately $106 million.
Aggregate maturities of long-term debt during future years are (in
millions): $2.4-1999; $5.0-2000; $8.7-2001; $178.5-2002; $1.2-2003; and
$11.6-thereafter.
Interest paid in 1998, 1997, and 1996 was $31.5 million, $21.9 million,
and $22.0 million, respectively, of which $4.9 million, $5.8 million, and
$3.4 million in 1998, 1997, and 1996, respectively, related to the Company's
Convertible Subordinated Notes.
4. CONVERTIBLE SUBORDINATED NOTES
In February 1996, the Company issued $115 million of 6% Convertible
Subordinated Notes (Notes) due February 1, 2006. The Notes are convertible
into the Company's Common Stock at $28.985 per share. Interest is payable
semi-annually. The Notes are redeemable in whole or in part at the option of
the Company on or after February 2, 1999, for a maximum of 104% of face value
depending on the date of redemption and subject to certain restrictions.
In 1998, 1997, and 1996, approximately $19.5 million, $11.3 million, and
$12.9 million of notes, respectively, were converted into 674,000, 388,131,
and 443,988 shares, respectively, of the Company's Common Stock. The Company
recorded in shareholders' equity the principal amount of the converted notes
as well as forfeited interest and a proportionate share of the related
unamortized deferred charges.
5. RESTRUCTURING
In October 1998, CompuCom's Board of Directors approved a restructuring plan
designed to reduce CompuCom's cost structure by closing certain facilities
and reducing its workforce. As a result, CompuCom has recorded a
restructuring charge in the fourth quarter of 1998 in the amount of $16.4
million, the effect of which is approximately $8.1 million to the Company's
pretax earnings, after recording minority interest.
The restructuring charge of $16.4 million consists primarily of costs
associated with the closing of facilities and disposing of related fixed
assets as well as employee severance and benefits related to the reduction in
workforce. Of the total amount, approximately $2.4 million had been paid
through December 31, 1998. The remainder is included in "Accrued expenses" on
the Consolidated Balance Sheets. The following is a summary of the components
of the restructuring charge (in thousands):
Expensed in Accrued at
1998 December 31, 1998
----------- -----------------
Lease termination costs........................... $ 7,259 $ 6,415
Employee severance and
related benefits................................ 3,804 2,986
Disposal of assets, net of
estimated proceeds.............................. 3,044 2,907
Other............................................. 2,330 1,780
----------- -----------------
$16,437 $14,088
----------- -----------------
----------- -----------------
Severance is paid based on associates' years of service as well as their
level within the organization. The reduction in workforce includes 457
associates, of which two were executive officers.
The amount accrued at December 31, 1998, for lease termination costs is
the estimated cost for 65 facilities throughout the country to fulfill
CompuCom's obligations under signed lease contracts, to sublet certain
facilities, or to pay to terminate lease contracts before the end of their
terms. CompuCom has consulted with a professional real estate firm with
knowledge of market rent rates in all applicable markets where CompuCom has
space. Assumptions have been used for market rent rates and the estimated
amount of time to sublet certain facilities. Payments, net of proceeds
derived from subleases, are being charged against the accrual as incurred.
The amount accrued at December 31, 1998, for disposal of fixed assets
includes an estimate of proceeds to be received from the sale of those
assets. The assets primarily consist of furniture, fixtures, and computer
equipment associated with the facilities being closed.
Other restructuring charges primarily include amounts such as the
write-off of leasehold improvements, estimated legal expense, estimated costs
to ship fixed assets to CompuCom's headquarters in Dallas, and estimated
commissions to be paid to the real estate firm for subleasing activity.
As the majority of CompuCom's restructuring related charges in 1998 are
estimates and have not yet been paid, the actual amounts paid could differ
from those estimates. Any differences between the estimated amounts and
actual amounts paid will be reflected in operating expenses in future periods.
6. INCOME TAXES
The provision for income taxes is comprised of the following (in thousands):
Year Ended December 31 1998 1997 1996
- ---------------------- ------- -------- -------
Current...................................... $32,515 $16,902 $11,375
Deferred..................................... 28,909 (2,566) 1,910
------- -------- -------
$61,424 $14,336 $13,285
------- -------- -------
State taxes on income included above......... $ 776 $ 2,235 $ 1,607
------- -------- -------
------- -------- -------
Total income tax expense differed from the amounts computed by applying the
U.S. Federal income tax rate of 35% to earnings before income taxes as a
result of the following:
Year Ended December 31 1998 1997 1996
- ---------------------- ------- ------- ------
Statutory tax provision...................................... 35.0% 35.0% 35.0%
Increase (decrease) in taxes resulting from:
Non-deductible goodwill amortization....................... 0.9 3.4 4.1
Book/tax basis difference on securities sold............... (0.4) -- (0.9)
State taxes, net of federal tax benefit.................... 0.4 4.1 3.1
Income taxed at rates other than statutory rate............ (0.1) (2.5) (1.3)
------- ------- ------
35.8% 40.0% 40.0%
------- ------- ------
------- ------- ------
The tax effects of temporary differences that give rise to significant
portions of the non-current deferred tax assets and deferred tax liabilities
are presented below (in thousands):
December 31 1998 1997
- ----------- ------- --------
Deferred tax assets:
Subsidiary/investee carrying values..................... $ 3,656 $ 3,539
Accounts receivable allowances.......................... 1,227 1,034
Inventories, reserves and tax
capitalized costs..................................... 15,905 5,141
Other................................................... 15,865 2,522
------- --------
Gross deferred tax assets............................... 36,653 12,236
Less valuation allowance................................ (850) (1,600)
------- --------
Deferred tax assets..................................... 35,803 10,636
------- --------
Deferred tax liabilities:
Subsidiary/investee carrying values..................... (16,472) (11,522)
Accelerated depreciation................................ (3,252) (4,521)
Unrealized appreciation
on investments........................................ (20,075) (8,091)
Other................................................... (8,566) (6,546)
------- --------
Deferred tax liabilities................................ (48,365) (30,680)
------- --------
Net deferred tax liabilities............................ $(12,562) $(20,044)
------- --------
------- --------
The above table excludes $48.4 million of current deferred tax
liabilities attributable to the difference between the book basis and tax
basis of the Company's investment in Tellabs, which is included in "Accrued
expenses" on the Consolidated Balance Sheets.
The valuation allowance relates to the uncertainty surrounding the
realization of tax benefits attributable to the difference between the book
basis and tax basis of certain of the Company's investments. Tax benefits
relating to changes in the valuation allowance for deferred tax assets are
reported as an income tax benefit in the Consolidated Statements of
Operations in the period recognized. Management believes it is more likely
than not that the remaining deferred tax assets will be realized through
future taxable earnings or implementation of tax planning strategies.
Income taxes paid were $9.8 million, $13.5 million, and $18.4 million in
1998, 1997, and 1996, respectively.
The Company has not recognized a deferred tax liability for the
difference between the book basis and tax basis of its investment in the
common stock of its subsidiaries (such difference relates primarily to
unremitted earnings of the subsidiaries), because the Company does not expect
this basis difference to become subject to tax at the parent level. The
Company believes it can implement certain tax strategies to recover its
investment in these subsidiaries tax-free.
7. EARNINGS PER SHARE
The calculations of EPS were (in thousands except per share amounts):
Year Ended December 31 1998 1997 1996
- ---------------------- -------- ------- --------
Basic:
Net earnings................................. $110,123 $21,501 $19,927
-------- ------- --------
Average common shares outstanding............ 31,833 31,249 29,900
-------- ------- --------
Basic EPS.................................... $ 3.46 $ .69 $ .67
-------- ------- --------
Diluted:
Net earnings................................. $110,123 $21,501 $19,927
Effect of: Public investees(a)............... (606) (328) (779)
Dilutive securities(b)............ 2,967 -- --
-------- ------- --------
Adjusted earnings............................ $112,484 $21,173 $19,148
-------- ------- --------
Average common shares outstanding............ 31,833 31,249 29,900
Effect of: Dilutive options.................. 554 747 1,448
Dilutive securities(b)............ 2,527 -- --
-------- ------- --------
Average number of common shares
assuming dilution.......................... 34,914 31,996 31,348
-------- ------- --------
Diluted EPS.................................. $ 3.22 $ .66 $ .61
-------- ------- --------
-------- ------- --------
(a) Represents the dilutive effect of public investee common stock
equivalents and convertible securities.
(b) Represents the dilutive effect of the Company's 6% Convertible
Subordinated Notes for the year ended December 31, 1998. For the years
ended December 31, 1997 and 1996, the Convertible Subordinated Notes
were anti-dilutive; therefore, they do not impact the calculation of
diluted EPS in these years.
At December 31, 1998, 1997, and 1996, outstanding options to purchase
approximately 80,000, 502,000, and 91,000 shares of Common Stock at an
average price of $35.35, $32.56, and $35.07 per share were anti-dilutive and
are not included in the calculations of diluted EPS, because the options'
exercise price was greater than the average market price of common shares for
each respective period.
The Company repurchased $18.6 million and $9.8 million of its Common
Stock in the open market in 1998 and 1997, respectively, at an average price
of $24.33 in 1998 and $24.46 in 1997. The Company is authorized to purchase
up to an additional $18.4 million at December 31, 1998.
8. PREFERRED STOCK
Shares of Preferred Stock, par value $10 per share, are voting and are issuable
in one or more series with rights and preferences as to dividends, redemption,
liquidation, sinking funds, and conversion determined by the Board of Directors.
At December 31, 1998 and 1997, there were 55,423 shares authorized and none
outstanding.
9. STOCK-BASED COMPENSATION
Options may be granted to Company employees, directors, and consultants under
various stock option plans. Generally, outstanding options vest over periods not
exceeding four years after the date of grant and expire eight years after the
date of grant. To the extent allowable, all grants are incentive stock options.
All options granted under the plans to date have been at prices which have been
equal to the fair market value at the date of grant. At December 31, 1998, the
Company reserved approximately 2.1 million shares of Common Stock for possible
future issuance under its stock option plans. Several subsidiaries also maintain
stock option plans for their employees and directors.
Option activity under the Company's plans is summarized below (in thousands
except per share amounts):
1998 1997 1996
------------------ ------------------ ----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ ---------- ------ --------
Outstanding at beginning of year............................ 1,737 $17.58 2,078 $10.82 2,702 $ 7.11
Options granted............................................. 312 27.36 350 31.59 190 32.96
Options exercised........................................... (441) 6.12 (673) 4.56 (774) 2.86
Options canceled............................................ (11) 35.98 (18) 22.88 (40) 19.24
------ -------- ------ ---------- ------ --------
Outstanding at end of year.................................. 1,597 $22.09 1,737 $17.58 2,078 $10.82
------ -------- ------ ---------- ------ --------
------ -------- ------ ---------- ------ --------
Options exercisable at year-end............................. 863 867 1,150
Shares available for future grant........................... 506 807 1,139
------ -------- ------ ---------- ------ --------
------ -------- ------ ---------- ------ --------
The following summarizes information about the Company's stock options
outstanding at December 31, 1998:
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------------------------------- ---------------------------
Weighted Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Life Exercise Exercisable Exercise
Prices (in thousands) (in years) Price (in thousands) Price
- ---------------------------------------------- -------------- ----------------- --------- --------------- ---------
$ 2.04 - $ 3.92................................ 222 2.12 $ 2.91 222 $ 2.91
4.31 - 5.75................................ 152 3.24 4.73 152 4.73
21.00 - 23.50................................ 425 4.88 22.62 314 22.61
26.13 - 29.25................................ 287 7.79 26.66 8 26.32
31.00 - 42.63................................ 511 6.52 32.56 167 32.77
------------- ----------------- --------- -------------- --------
$ 2.04 - $42.63................................ 1,597 5.39 $22.09 863 $16.38
------------- ----------------- --------- -------------- --------
------------- ----------------- --------- -------------- --------
In February 1999, the Company's Board of Directors approved the 1999
Equity Compensation Plan, which will provide for the grant of stock options
to participating employees, directors, and consultants of the Company.
Initially, 3,000,000 shares will be reserved for issuance under the new plan,
which is subject to shareholder approval at the Company's Annual Meeting in
May 1999. In March 1999, the Company granted options to purchase 500,000
shares of the Company's Common Stock to its new president and chief operating
officer, including 100,000 options granted outside of existing stock option
plans. The option price is equal to the fair market value of the Company's
stock on the date of grant.
The Company, its subsidiaries, and its affiliates accounted for on the
equity method apply APB 25 and related interpretations in accounting for
stock option plans. Had compensation cost been recognized consistent with
SFAS 123, the Company's consolidated net earnings and earnings per share
would have been reduced to the pro forma amounts indicated below (in
thousands except per share amounts):
Year Ended December 31 1998 1997 1996
- ---------------------- -------- ------- -------
Consolidated net earnings As reported $110,123 $21,501 $19,927
Pro forma $ 99,411 $17,314 $15,986
Earnings per share
Basic As reported $ 3.46 $ .69 $ .67
Pro forma $ 3.12 $ .55 $ .53
Diluted As reported $ 3.22 $ .66 $ .61
Pro forma $ 2.92 $ .53 $ .48
Per share weighted average fair value of
stock options issued on date of grant $ 13.14 $ 14.97 $ 14.64
The following range of assumptions were used by the Company, its
subsidiaries, and its affiliates accounted for on the equity method to
determine the fair value of stock options granted in 1998, 1997, and 1996
using the Black-Scholes option-pricing model:
Subsidiaries and
Company Affiliates
------------ -----------------
Dividend yield...................... 0% 0%
Expected volatility................. 40% to 48% 30% to 75%
Average expected
option life........................ 5 years 3.5 to 6 years
Risk-free interest rate............ 4.4% to 6.8% 4.2% to 7.1%
The full impact of calculating compensation cost for stock options under
SFAS 123 is not reflected in the pro forma consolidated net earnings amounts
presented above, because compensation cost is reflected over an option's
vesting period and compensation cost for options granted prior to January 1,
1995 is not considered.
10. BUSINESS COMBINATIONS
In 1998, CompuCom completed three business combinations for approximately $49
million in cash. 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. CompuCom has
not completed the final allocation of the purchase price for these acquisitions;
accordingly, the amount of goodwill could be adjusted once the allocation is
finalized.
11. RELATED PARTY TRANSACTIONS
In 1998, the Company loaned an officer and director of the Company $500,000
evidenced by a term note receivable. Interest on the note accrues at the rate of
4.33% per annum. The note was fully repaid in March 1999.
In 1998, CompuCom loaned two officers and directors $796,875 and $2.0
million evidenced by term notes receivable. Interest on the notes accrue at
rates of 4.3% and 5.1% per annum, respectively. Principal on the notes is due
on December 31, 2001, and October 22, 2003, respectively. The loan proceeds
were used to exercise stock options. In January 1999, the Company loaned an
officer of CompuCom $806,078 to exercise CompuCom stock options. Interest on
the note accrues at a rate of 4.3% per annum, and principal on the note is
due on December 31, 2001.
As discussed in Note 3, the Company had aggregate indebtedness of $20
million under revolving credit facilities to certain partnership companies as
of December 31, 1998.
12. LEASES
The Company and its subsidiaries conduct a portion of its operations in leased
facilities and leases machinery and equipment under leases expiring at various
dates to 2004.
Future minimum lease payments under non-cancelable operating leases with
initial or remaining terms of one year or more at December 31, 1998, are (in
millions): $4.6-1999; $3.7-2000; $2.4-2001; $0.8-2002; $0.6-2003; and
$0.6-thereafter.
Total rental expense under operating leases was $11.7 million, $10.2
million, and $14.5 million in 1998, 1997, and 1996, respectively.
13. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are involved in various claims and legal
actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
In connection with interests in certain partnership companies, the
Company is contingently obligated for approximately $30 million of guarantee
commitments. In addition, it has committed capital of approximately $100
million to various partnership companies, venture funds, and private equity
partnerships, to be funded over the next several years.
14. 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 Company presents complete Condensed Financial Information in Schedule I
to its Form 10-K.
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, with carrying
values of these companies included in "Investments."
Balance Sheets
December 31 1998 1997
- --------------- -------- ---------
Assets
Short-term investments............................. $143,103 $ --
Other current assets............................... 30,766 11,710
Investments........................................ 413,596 310,877
Other.............................................. 49,830 37,567
-------- ---------
Total assets......................................... $637,295 $360,154
-------- ---------
-------- ---------
Liabilities and Shareholders' Equity
Current liabilities................................ $ 80,824 $ 18,525
Long-term debt..................................... 123,115 29,689
Other liabilities.................................. 19,152 13,989
Convertible subordinated notes..................... 71,345 90,881
Shareholders' equity............................... 342,859 207,070
-------- ---------
Total liabilities and
shareholders' equity................................ $637,295 $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 on December 31 of each
year. The table excludes the Company's holdings in Tellabs (classified as
"Short-term investments" on the Consolidated Balance Sheets), which has a
market value of $143.1 million at December 31, 1998.
December 31 1998 1997
- ----------- -------------------- -------------------
Carrying Market Carrying Market
Value Value Value Value
--------- -------- --------- --------
CompuCom................................ $121,832 $ 98,538 $122,613 $211,504
Tangram................................. 3,428 41,795 3,153 68,570
Cambridge............................... 35,248 190,217 24,679 371,394
Coherent................................ -- -- 14,799 135,008
Other public............................ 130,076 221,107 83,290 226,477
Other................................... 123,012 62,343
--------- --------
$413,596 $310,877
The market value of the Company's holdings in CompuCom increased to
approximately $122 million at March 1, 1999.
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, with the Company's share of the earnings or losses of
these companies reflected in the caption "Equity loss (income)." 1997
included net sales and cost of sales and operating expenses of $16.0 million
and $14.6 million, respectively, related to Pioneer which was sold in
mid-1997.
Statements of Operations
Year Ended December 31 1998 1997 1996
- ---------------------- --------- -------- --------
Revenues
Net sales.................................... $ -- $ 15,982 $ 30,286
Securities and other gains, net.............. 193,665 24,025 26,011
Other income................................. 15,888 14,223 10,273
--------- -------- --------
Total revenues............................ 209,553 54,230 66,570
--------- -------- --------
Costs and Expenses
Cost of sales and operating expenses......... 36,574 45,389 54,376
Equity loss (income)......................... 1,846 (14,873) (12,345)
--------- -------- --------
Total costs and expenses.................. 38,420 30,516 42,031
--------- -------- --------
Earnings Before Taxes on Income................ 171,133 23,714 24,539
Provision for taxes on income................ 61,010 2,213 4,612
--------- -------- --------
Net Earnings................................... $110,123 $ 21,501 $ 19,927
--------- -------- --------
--------- -------- --------
15. OPERATING SEGMENTS
In 1998, the Company adopted SFAS 131, which requires the reporting of
operating segments using the "management approach" versus the "industry
approach" previously required. The Company's reportable segments consist of
CompuCom, Tangram, general corporate operations, and other. CompuCom's
operations are defined into two segments--sales of distributed desktop
computer products (product) and configuration, network integration, and
technology support (service). Tangram's operations include the design,
development, sale, and implementation of enterprise-wide asset tracking and
software management solutions. General corporate operations consists of
developing and operating partnership companies, most of which are engaged in
information technology businesses. Other includes Pioneer and Premier which
were sold during 1997, Commercial Real Estate which was sold during 1996, and
other reconciling items.
The following summarizes information related to the Company's segments
(in thousands). All significant intersegment activity has been eliminated.
Assets are the owned or allocated assets used by each operating segment.
Year Ended December 31 1998 1997 1996
- ---------------------- ---------- ---------- ----------
Net Sales
CompuCom
Product....................................... $1,980,578 $1,699,268 $1,816,504
Service....................................... 273,887 250,534 178,686
---------- ---------- ----------
2,254,465 1,949,802 1,995,190
Tangram......................................... 20,678 14,074 11,142
Other........................................... -- 21,349 56,477
---------- ---------- ----------
$2,275,143 $1,985,225 $2,062,809
---------- ---------- ----------
---------- ---------- ----------
Gross Margin(a)
CompuCom
Product....................................... $ 193,727 $ 176,234 $ 180,851
Service....................................... 90,233 91,311 60,112
---------- ---------- ----------
283,960 267,545 240,963
Tangram......................................... 18,252 12,123 8,733
Other........................................... -- 6,365 20,155
---------- ---------- ----------
$ 302,212 $ 286,033 $ 269,851
---------- ---------- ----------
---------- ---------- ----------
Operating Profit (Loss)
CompuCom
Product....................................... $ 17,852 $ 38,073 $ 55,545
Service....................................... 17,995 28,860 159
---------- ---------- ----------
35,847 66,933 55,704
Interest and financing, net................... (18,742) (14,947) (14,764)
Restructuring................................. (16,437) -- --
---------- ---------- ----------
668 51,986 40,940
---------- ---------- ----------
Tangram......................................... 1,764 (2,256) (625)
---------- ---------- ----------
General Corporate
Securities and other gains, net............... 193,665 26,857 30,373
Equity in (losses) income of affiliates....... (2,083) 417 1,539
Interest and financing, net................... (10,978) (7,412) (9,152)
General corporate expense, net................ (10,345) (9,612) (8,661)
Minority interest............................. (47) (25,727) (19,934)
---------- ---------- ----------
170,212 (15,477) (5,835)
---------- ---------- ----------
Other........................................... (1,097) 1,584 (1,268)
---------- ---------- ----------
Earnings Before Taxes on Income................. $ 171,547 $ 35,837 $ 33,212
---------- ---------- ----------
---------- ---------- ----------
Total Assets
CompuCom
Product....................................... $ 339,778 $ 323,970 $ 542,970
Service....................................... 212,403 146,812 157,803
---------- ---------- ----------
552,181 470,782 700,773
Tangram......................................... 15,170 14,077 12,946
General Corporate............................... 501,339 229,682 172,781
Other........................................... -- -- 49,570
---------- ---------- ----------
$1,068,690 $ 714,541 $ 936,070
---------- ---------- ----------
---------- ---------- ----------
(a) Total gross margin reconciles to the Consolidated Statements of
Operations by subtracting cost of sales from net sales.
Independent Auditors' Report
The Board of Directors and Shareholders
Safeguard Scientifics, Inc.
Wayne, Pennsylvania
We have audited the accompanying consolidated balance sheets of Safeguard
Scientifics, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, cash flows, shareholders' equity,
and comprehensive income for each of the years in the three year period ended
December 31, 1998. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits. We did
not audit the financial statements of certain nonsubsidiary investee companies.
The Company's investment in these nonsubsidiary investee companies at December
31, 1998 and 1997, was $69.4 million and $75.8 million, respectively, and its
equity in earnings of these nonsubsidiary investee companies was $7.8 million
and $6.0 million for the years ended December 31, 1998 and 1997, respectively.
The financial statements of these nonsubsidiary investee companies were audited
by other auditors whose reports have been furnished to us, and our opinion,
insofar as it relates to the amounts included for these nonsubsidiary investee
companies, is based solely on the reports of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits and the reports
of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Safeguard
Scientifics, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
KPMG LLP
Philadelphia, Pennsylvania
February 8, 1999
Statement of Management's
Financial Responsibility
Management has prepared and is responsible for the integrity and
objectivity of the consolidated financial statements and related financial
information in this Annual Report. The statements are prepared in conformity
with generally accepted accounting principles. The financial statements
reflect management's informed judgment and estimation as to the effect of
events and transactions that are accounted for or disclosed.
Management maintains a system of internal control at each business unit.
This system, which undergoes continual evaluation, is designed to provide
reasonable assurance that assets are safeguarded and records are adequate for
the preparation of reliable financial data. In determining the extent of the
system of internal control, management recognizes that the cost should not
exceed the benefits derived. The evaluation of these factors requires
estimates and judgment by management.
KPMG LLP is engaged to render an opinion as to whether management's
financial statements present fairly, in all material respects, Safeguard
Scientifics, Inc.'s financial condition and operating results in accordance
with generally accepted accounting principles. The scope of their engagement
included a review of the internal control system, tests of the accounting
records, and other auditing procedures to the extent deemed necessary to
render their opinion on the financial statements. Their report is presented
above.
The Audit Committee of the Board of Directors meets with the
independent auditors and management to satisfy itself that they are
properly discharging their responsibilities. The auditors have direct
access to the Audit Committee.
Safeguard Scientifics, Inc.
/s/ Michael W. Miles
- ----------------------------
Michael W. Miles
Senior Vice President and Chief Financial Officer
QUARTERLY FINANCIAL DATA
The following table presents unaudited supplementary quarterly financial data
for the years ended December 31, 1998 and 1997 (in thousands, except per
share data):
Quarters Ended
-----------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
--------- --------- ----------- ----------
1998
Net Sales................................................. $441,898 $602,534 $609,053 $621,658
After-tax Operating Earnings (Losses)(1).................. 2,214 2,885 (5,130) (14,137)
After-tax Securities and Other Gains, Net................. 4,711 5,228 65,154(2) 49,228(2)
Net Earnings.............................................. 5,060 6,026 59,242(2) 39,795(2)
Earnings Per Share
Basic................................................. .16 .19 1.85 1.26
Diluted............................................... .15 .18 1.71 1.18
1997
Net Sales................................................. $447,576 $502,706 $505,312 $529,631
After-tax Operating Earnings(1)........................... 2,559 5,437 5,476 7,351
After-tax Securities and Other Gains, Net................. 4,321 4,103 4,010 3,680
Net Earnings.............................................. 4,492 5,636 5,265 6,108
Earnings Per Share
Basic................................................. .14 .18 .17 .20
Diluted............................................... .14 .17 .16 .19
(1) Before securities and other gains and minority interest.
(2) Increase relates primarily to net securities gains from Coherent/Tellabs
transactions (see Note 2 to the Consolidated Financial Statements).
Net 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.
Earnings per share calculations for each of the quarters are based on the
weighted average number of shares outstanding in each period. Diluted
earnings per share calculations adjust net earnings for the dilutive effect
of public investee common stock equivalents and convertible securities. The
Company's Convertible Subordinated Notes were dilutive for the quarters ended
September 30 and December 31, 1998, but were anti-dilutive for all other
periods presented. Therefore, the sum of the quarters may not necessarily
equal the year to date earnings per share.
COMMON STOCK DATA
The Company's Common Stock is listed on the New York Stock Exchange (Symbol:
SFE). As of March 1, 1999, there were approximately 25,000 beneficial holders
of the Company's Common Stock. The high and low sale prices reported within
each quarter for the years ended December 31, 1998 and 1997, are as follows:
1998 1997
--------------- ---------------
High Low High Low
------- ------ ------ ------
First Quarter............................ $38.44 $30.13 $32.63 $16.88
Second Quarter........................... 45.38 34.63 33.00 19.75
Third Quarter............................ 41.44 23.50 32.06 25.00
Fourth Quarter........................... 31.75 17.13 36.50 27.50
The high and low sale prices reported in 1999 through March 1 were $47.25 and
$27.50, respectively, and the last sale price reported on March 1, 1999, was
$37.06. No cash dividends have been declared in any of the years presented,
and the Company has no present intention to declare cash dividends.