FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For Quarter Ended MARCH 31, 1999 Commission File Number 1-5620
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SAFEGUARD SCIENTIFICS, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA 23-1609753
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(state or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
800 THE SAFEGUARD BUILDING, 435 DEVON PARK DRIVE WAYNE, PA 19087
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (610) 293-0600
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Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities and
Exchange Act of 1934 during the preceding 12 months (or for such
shorter period that the registrant was required to file such reports)
and (2) has been subject to such filing requirements for the past 90
days.
Yes X No
----- -----
Number of shares outstanding as of MAY 13, 1999
Common Stock 33,108,713
SAFEGUARD SCIENTIFICS, INC.
QUARTERLY REPORT FORM 10-Q
INDEX
PART I - FINANCIAL INFORMATION PAGE
------------------------------ ----
Item 1 - Financial Statements:
Consolidated Balance Sheets -
March 31, 1999 (unaudited) and December 31, 1998............................3
Consolidated Statements of Operations (unaudited) -
Three Months Ended March 31, 1999 and 1998..................................4
Consolidated Statements of Cash Flows (unaudited) -
Three Months Ended March 31, 1999 and 1998..................................5
Notes to Consolidated Financial Statements..................................6
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations................14
Item 3 - Quantitative and Qualitative Disclosures About Market Risk...............24
PART II - OTHER INFORMATION
Item 5 - Other Information........................................................25
Item 6 - Exhibits and Reports on Form 8-K.........................................25
Signatures........................................................................26
2
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
March 31, December 31,
ASSETS 1999 1998
----------- -----------
(Unaudited)
CURRENT ASSETS
Cash and cash equivalents $ 13,808 $ 6,257
Short-term investments 164,924 143,103
Receivables less allowances 235,879 296,093
Inventories 132,398 138,551
Other current assets 4,996 5,006
----------- -----------
Total current assets 552,005 589,010
PROPERTY, PLANT, AND EQUIPMENT, NET 58,165 96,840
+
OTHER ASSETS
Investments 327,856 288,336
Notes and other receivables 18,359 20,182
Excess of cost over net assets of businesses acquired, net 80,279 65,137
Other 9,444 9,185
----------- -----------
Total other assets 435,938 382,840
----------- -----------
TOTAL ASSETS $ 1,046,108 $ 1,068,690
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current debt obligations $ 896 $ 2,366
Accounts payable 165,340 161,700
Accrued expenses 145,009 172,953
----------- -----------
Total current liabilities 311,245 337,019
LONG-TERM DEBT 106,175 205,044
DEFERRED TAXES 5,619 12,562
MINORITY INTEREST 96,883 98,544
OTHER LONG-TERM LIABILITIES 78,056 1,317
CONVERTIBLE SUBORDINATED NOTES 71,345 71,345
SHAREHOLDERS' EQUITY
Common stock 3,280 3,280
Additional paid-in capital 69,909 62,470
Retained earnings 285,742 261,594
Accumulated other comprehensive income 29,469 37,294
Treasury stock, at cost (11,615) (21,779)
----------- -----------
Total shareholders' equity 376,785 342,859
----------- -----------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 1,046,108 $ 1,068,690
----------- -----------
----------- -----------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
3
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands except per share data)
Three Months Ended March 31,
----------------------------
1999 1998
--------- ---------
(Unaudited)
REVENUES
Net Sales
Product $ 425,467 $ 379,271
Service 74,418 62,627
--------- ---------
Total net sales 499,885 441,898
Securities and other gains, net 51,659 7,852
Other income 3,751 3,497
--------- ---------
Total revenues 555,295 453,247
COSTS AND EXPENSES
Cost of sales - product 388,312 333,420
Cost of sales - service 47,991 41,123
Selling and service 36,497 37,396
General and administrative 27,368 21,195
Depreciation and amortization 5,725 4,273
Interest and financing 7,732 5,803
Equity in losses (income) of affiliates 6,470 (1,505)
--------- ---------
Total costs and expenses 520,095 441,705
--------- ---------
EARNINGS BEFORE MINORITY INTEREST AND TAXES ON INCOME 35,200 11,542
Minority interest 1,951 (3,109)
--------- ---------
EARNINGS BEFORE TAXES ON INCOME 37,151 8,433
Provision for taxes on income 13,003 3,373
--------- ---------
--------- ---------
NET EARNINGS $ 24,148 $ 5,060
--------- ---------
--------- ---------
EARNINGS PER SHARE
Basic $ .76 $ .16
Diluted $ .71 $ .15
AVERAGE COMMON SHARES OUTSTANDING
Basic 31,751 31,714
Diluted 34,852 32,403
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
4
SAFEGUARD SCIENTIFICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Three Months Ended March 31,
----------------------------
1999 1998
--------- ---------
(Unaudited)
OPERATING ACTIVITIES
Net earnings $ 24,148 $ 5,060
Adjustments to reconcile net earnings to cash provided (used)
by operating activities
Depreciation and amortization 5,725 4,273
Deferred income taxes (2,109) (262)
Equity in losses (income) of affiliates 6,470 (1,505)
Securities and other gains, net (51,659) (7,852)
Minority interest, net (1,171) 1,865
Cash provided (used) by changes in working capital items
Receivables 59,564 10,837
Inventories 6,153 (34,522)
Accounts payable, accrued expenses, and other (40,642) 31,419
--------- ---------
Cash provided by operating activities 6,479 9,313
Proceeds from securities and other gains, net 57,821 8,405
--------- ---------
Cash provided by operating activities and
securities and other gains, net 64,300 17,718
OTHER INVESTING ACTIVITIES
Investments and notes acquired, net (66,678) (24,893)
Business acquisitions, net of cash acquired -- (4,023)
Capital expenditures (1,801) (4,746)
Proceeds from sale of building 39,791 --
Other, net (492) (507)
--------- ---------
Cash used by other investing activities (29,180) (34,169)
FINANCING ACTIVITIES
Net borrowings (repayments) on revolving credit facilities (75,243) 15,675
Net borrowings (repayments) on term debt (25,190) 517
Proceeds from financial instruments, net 71,205 --
Repurchase of Company common stock (253) (854)
Issuance of Company common stock 1,329 649
Issuance of subsidiary common stock 583 210
--------- ---------
Cash provided (used) by financing activities (27,569) 16,197
--------- ---------
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 7,551 (254)
Cash and Cash Equivalents - beginning of year 6,257 5,382
--------- ---------
--------- ---------
CASH AND CASH EQUIVALENTS - END OF PERIOD $ 13,808 $ 5,128
--------- ---------
--------- ---------
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
5
SAFEGUARD SCIENTIFICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
1. GENERAL
The accompanying unaudited interim consolidated financial statements were
prepared in accordance with generally accepted accounting principles for
interim financial information. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting
principles for complete financial statements. The 1998 Form 10-K should be
read in conjunction with the accompanying statements. These statements
include all adjustments (consisting only of normal recurring adjustments)
which the Company believes are necessary for a fair presentation of the
statements. The interim operating results are not necessarily indicative of
the results for a full year.
2. ACQUISITION
In February 1999, the Company acquired an 80% fully diluted ownership in
aligne, Inc. in exchange for 441,518 shares of the Company's common
stock with a market value of approximately $17 million. aligne is a
strategic technology management consulting firm whose services include
high level and in-depth evaluations of complex sourcing alternatives, IT
cost baselining and benchmarking, vendor/customer negotiations, interim
CIO services, IT Strategy, and IT process re-engineering. The
transaction was accounted for as a purchase and, accordingly, the
consolidated financial statements reflect the operations of aligne since
the acquisition date. The acquisition resulted in goodwill of
approximately $17 million which is being amortized over ten years. One
of the principal's of aligne, Inc. was appointed as the Company's new
President and Chief Operating Officer.
3. COMPREHENSIVE INCOME
Comprehensive income is the change in equity of a business enterprise
during a period from transactions and other events and circumstances from
non-owner sources. Excluding net earnings, the Company's source of
comprehensive income is from net unrealized appreciation on its investments
classified as available-for-sale. The following summarizes the components
of comprehensive income (loss), net of income taxes, (in thousands):
Three months ended March 31,
------------------------------------
1999 1998
--------------- -----------------
Net Earnings $24,148 $ 5,060
--------------- -----------------
Other Comprehensive Income (Loss), Before Taxes:
Unrealized holding gains (losses) on
investments (6,167) 24,850
Reclassification adjustments (5,872) (1,120)
Related Tax (Expense) Benefit:
Unrealized holding gains (losses) on
investments 2,158 (8,449)
Reclassification adjustments 2,055 381
--------------- -----------------
Other Comprehensive Income (Loss) (7,826) (15,662)
--------------- -----------------
Comprehensive Income (Loss) $16,322 $20,722
--------------- -----------------
--------------- -----------------
4. RECLASSIFICATIONS
Certain amounts in the 1998 financial statements have been
reclassified to conform with the 1999 presentation.
5. FINANCIAL INSTRUMENTS
In March 1999, the Company entered into a forward sale contract related to
one million shares of its holdings in Tellabs, Inc. The Company pledged one
million shares of Tellabs for three years and in return received
approximately $71 million of cash. At the end of the term, the Company has
6
the option to deliver cash or Tellabs shares with a value determined by
the stock price of Tellabs at maturity. The number of Tellabs shares to be
delivered at maturity ranges from 800,000 to one million shares (or the
cash value thereof). The proceeds from this transaction were used to pay
down a portion of the Company's bank revolving credit facility. The
liability related to this transaction is included in "Other Long-Term
Liabilities" on the Consolidated Balance Sheets.
6. INVESTMENTS
The following summarizes the Company's non-current investments (in
thousands). Investments are classified according to the applicable
accounting method at March 31, 1999. Market value reflects the price of
publicly traded securities at the close of business at the respective date.
Unrealized appreciation reflects the net excess of market value over
carrying value of publicly traded securities classified as
available-for-sale. 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 $165 million at March 31, 1999. In
March 1999, the Company entered into a forward sale contract related to
one million shares of its holdings in Tellabs. See Note 5.
March 31, 1999 December 31, 1998
--------------------------------- ---------------------------------
Carrying Market Carrying Market
Value Value Value Value
-------------- --------------- -------------- ---------------
(Unaudited)
Equity Investees
Cambridge $ 48,722 $133,164 $ 35,248 $190,217
ChromaVision 11,571 29,541 11,304 22,419
OAO 16,445 17,970 16,472 16,551
Sanchez 10,543 73,100 10,620 91,965
USDATA 7,001 8,902 7,053 5,545
Non-public companies 44,454 23,784
--------- ---------
138,736 104,481
Diamond 3,120 26,004 3,120 21,337
DocuCorp 3,226 6,539 3,226 8,035
e4L 2,035 23,807 2,035 32,299
First Consulting Group 8,490 5,851 8,490 11,308
Other public companies 10,786 10,786 10,388 11,648
Unrealized appreciation 45,330 57,368
Non-public companies 116,133 99,228
--------- ---------
--------- ---------
$327,856 $288,336
--------- ---------
--------- ---------
In March 1999, the Company purchased one million shares of Cambridge for
$12 million.
The following summarized financial information for investees accounted for
on the equity method at March 31, 1999 has been compiled from the unaudited
financial statements of the respective investees and reflects certain
historical adjustments (in thousands):
BALANCE SHEETS
March 31, December 31,
--------------- ---------------
1999 1998
--------------- ---------------
Current assets $467,611 $456,511
Non-current assets 222,162 215,489
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Total assets $694,773 $672,000
---------- --------
---------- --------
Current liabilities $212,586 $211,515
Non-current liabilities 72,231 90,363
Shareholders' equity 409,956 370,122
---------- --------
Total liabilities and shareholders' equity $694,773 $672,000
---------- --------
---------- --------
7
RESULTS OF OPERATIONS
Three Months Ended March 31,
----------------------------
1999 1998
---- ----
NET SALES
Public companies $203,036 $179,497
Non-public companies:
MultiGen-Paradigm 3,476 3,393
QuestOne 3,900 2,109
Other 6,927 5,044
-------- --------
$217,339 $190,043
-------- --------
-------- --------
The following summarized sales information for selected investments
accounted for on the cost method at March 31, 1999, has been compiled from
the unaudited financial statements of the respective companies and reflects
certain historical adjustments (in thousands):
Three Months Ended March 31,
----------------------------
1999 1998
---- ----
NET SALES
Public companies $34,894 $27,365
Non-public companies:
Intellisource 37,059 30,362
Kanbay 9,372 7,330
Pac-West Telecomm 14,416 10,252
US Interactive 6,123 4,178
Other 7,932 8,345
-------- -------
$109,796 $87,832
-------- -------
-------- -------
7. DEBT
The Company has available $200 million under its bank revolving credit
facilities. Of the $200 million, $150 million matures in May 2002 and is
secured by certain equity securities the Company holds of its publicly
traded partnership companies (the Pledged Securities), including CompuCom.
The remaining $50 million is unsecured, with availability limited to the
lesser of $50 million or 10% of the value of the Pledged Securities. The
$50 million facility had an original maturity date of April 1999, which the
Company has extended to April 2000. There was $56 million outstanding under
the total facility at March 31, 1999.
During the quarter ended March 31, 1999, CompuCom sold its corporate
headquarters building in a sale/leaseback transaction. The proceeds from
the sale were used to pay down CompuCom's long-term debt. As part of the
transaction, CompuCom entered into a 20-year operating lease on the
building.
In May 1999, CompuCom replaced its credit agreements with a $225 million
working capital facility and a $175 million receivables securitization
facility. The new $225 million working capital facility bears interest
at a rate of LIBOR plus 1.75% and is secured by certain assets of
CompuCom, as defined. This facility is fully available subject to a
borrowing base and compliance with certain convenants related to, among
others, funded debt to EBITDA, the current ratio, and minimum profitability
and tangible net worth levels. Terms of the working capital facility limit
the amounts available for capital ependitures and dividends. This
faciilty matures in May 2002. On the new $175 million receivables
securitization, the effective rate is based on a designated commercial
paper rate plus an agreed upon spread. This securitization has a term of
3 years, subject to certain convenant compliance CompuCom does not
expect its effective interest rate under the new facilities to be
materially different from the levels it experienced in 1998.
8
The following is a summary of long-term debt (in thousands):
March 31, December 31, 1998
1999
---------------- ------------------
(Unaudited)
PARENT COMPANY AND OTHER RECOURSE DEBT
Revolving credit facilities $ 76,000 $108,107
Other 15,778 15,874
--------- --------
91,778 123,981
SUBSIDIARY DEBT (NON-RECOURSE TO PARENT)
CompuCom 15,293 83,429
--------- --------
Total debt 107,071 207,410
Current debt obligations (896) (2,366)
--------- --------
Long-term debt $106,175 $205,044
--------- --------
--------- --------
8. RESTRUCTURING
During the fourth quarter of 1998, CompuCom recorded a $16.4 million
restructuring charge, primarily consisting of costs associated with the
closing of facilities and disposing of related fixed assets as well as
employee severance and benefits related to a reduction in workforce. Of
the total amount, $2.4 million had been paid through December 31, 1998
and $4.7 was paid in the first quarter of 1999. The following is a
summary of the components of the restructuring charge (in thousands):
Restructuring Accrued at Accrual at
Charge December 31, 1998 March 31, 1999
-------------- ------------------ ---------------
Lease termination costs $ 7,259 6,415 3,200
Employee severance and related benefits 3,804 2,986 1,671
Disposal of assets, net of estimated
proceeds 3,044 2,907 2,907
Other 2,330 1,780 1,567
-------- -------- --------
Total $ 16,437 $ 14,088 $ 9,345
-------- -------- --------
-------- -------- --------
9. EARNINGS PER SHARE
The calculations of Earnings Per Share (EPS) were (in thousands except per
share amounts):
Three Months Ended
March 31,
--------------------------------
1999 1998
--------- ---------------
(Unaudited)
BASIC EPS
Net earnings $ 24,148 $ 5,060
-------- --------
-------- --------
Average common shares outstanding 31,751 31,714
-------- --------
-------- --------
Basic EPS $ .76 $ .16
-------- --------
-------- --------
DILUTED EPS
Net earnings $ 24,148 $ 5,060
Effect of: Public investees (a) (54) (206)
Dilutive securities (b) 725 --
-------- --------
$ 24,819 $ 4,854
-------- --------
-------- --------
Average common shares outstanding 31,751 31,714
Effect of: Dilutive options 640 689
Dilutive securities (b) 2,461 --
-------- --------
Average number of common shares assuming 34,852 32,403
dilution
-------- --------
Diluted EPS $ .71 $ .15
-------- --------
-------- --------
(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 three months ended March 31, 1999. For the
three months ended March 31, 1998, the convertible subordinated notes
were anti-dilutive; and therefore, they do not impact the calculation
of diluted EPS in 1998.
9
10. PARENT COMPANY FINANCIAL INFORMATION
Condensed Financial Information is provided to reflect the results of
operations and financial position of the "Parent Company", or the Company
without the effect of consolidating its less than wholly owned
subsidiaries.
The following summarizes the Parent Company Balance Sheets of Safeguard
Scientifics, Inc. and its wholly owned subsidiaries (in thousands). These
Parent Company Balance Sheets differ from the Consolidated Balance Sheets
due to the exclusion of the assets and liabilities of the Company's less
than wholly owned subsidiaries, primarily CompuCom and Tangram, and, at
March 31, 1999, aligne, with the carrying values of these companies
included in "Investments".
March 31, December 31,
1999 1998
------------------- ------------------
ASSETS (Unaudited)
Short-term investments $164,924 $143,103
Other current assets 21,924 30,766
Investments 469,321 413,596
Other 49,179 49,830
-------- --------
Total assets $705,348 $637,295
-------- --------
-------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities $ 77,649 $ 80,824
Long-term debt 90,818 123,115
Other liabilities 88,751 19,152
Convertible subordinated notes 71,345 71,345
Shareholders' equity 376,785 342,859
-------- --------
Total liabilities & shareholders' equity $705,348 $637,295
-------- --------
-------- --------
The following summarizes the Parent Company's investments in less than
wholly owned subsidiaries (in thousands). Market value reflects the price
of publicly traded securities at the close of business at the respective
date. 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 $165 million at March 31, 1999. In March 1999, the
Company entered into a forward sale contract related to one million
shares of its holdings in Tellabs. See Note 5.
March 31, 1999 December 31, 1998
------------------------------- -----------------------------
Carrying Market Carrying Market
Value Value Value Value
------------- -------------- -------------- -----------
(Unaudited)
CompuCom $121,117 $85,721 $121,832 $ 98,538
Tangram 3,782 27,428 3,428 41,795
Cambridge 48,722 133,164 35,248 190,217
Other public 118,547 202,500 130,076 221,107
Other 177,153 123,012
-------- --------
$469,321 $413,596
-------- --------
-------- --------
In March 1999, the Company purchased one million shares of Cambridge for
$12 million.
10
PARENT COMPANY FINANCIAL INFORMATION (CONTINUED)
The following summarizes the Parent Company Statements of Operations of
Safeguard Scientifics, Inc. and its wholly owned subsidiaries (in
thousands). These Parent Company Statements of Operations differ from the
Consolidated Statements of Operations by excluding the revenues and related
costs and expenses of the Company's less than wholly owned subsidiaries,
primarily CompuCom and Tangram, and for the three months ended March 31,
1999, aligne, with the Company's share of the earnings or losses of these
companies reflected in the caption "Equity loss (income)".
Three Months Ended
March 31,
--------------------------
1999 1998
------ -------
(Unaudited)
REVENUES
Securities and other gains, net $51,659 $7,852
Other income 4,023 3,824
------- ------
Total revenues 55,682 11,676
COSTS AND EXPENSES
Cost of sales and operating expenses 10,394 7,799
Equity loss (income) 7,441 (3,185)
------- ------
Total costs and expenses 17,835 4,614
------- ------
EARNINGS BEFORE TAXES ON INCOME 37,847 7,062
Provision for taxes on income 13,699 2,002
------- ------
NET EARNINGS $24,148 $5,060
------- ------
------- ------
11
11. OPERATING SEGMENTS
The Company's reportable segments consist of CompuCom, Tangram, general
corporate operations, and other. CompuCom's operations are defined in two
segments - sales of distributed desktop computer products ("product"); and
service, which includes 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 consist of identifying,
acquiring interests in, and developing partnership companies, most of which
are engaged in information technology businesses.
The following summarizes information related to the Company's segments (in
thousands). All significant intersegment activity has been eliminated.
Three Months Ended
March 31,
-------------- --- --------------
1999 1998
-------------- --------------
(unaudited)
NET SALES
CompuCom
Product 421,292 376,778
Service 72,028 60,974
------- -------
493,320 437,752
Tangram 5,902 4,146
Other 663 --
------- -------
499,885 441,898
------- -------
------- -------
GROSS MARGIN(a)
CompuCom
Product 33,548 43,880
Service 24,923 20,285
------- -------
58,471 64,165
Tangram 4,761 3,190
Other 350 --
------- -------
63,582 67,355
------- -------
------- -------
OPERATING PROFIT (LOSS)
CompuCom
Product (8,777) 7,314
Service 9,292 2,846
------- -------
515 10,160
Interest and financing, net (4,330) (3,755)
------- -------
(3,815) 6,405
------- -------
Tangram 472 51
------- -------
General Corporate
Securities and other gains, net 51,659 7,852
Equity in (losses) income of affiliates (6,470) 1,505
Interest and financing, net (3,402) (2,048)
General corporate expense, net (3,086) (1,972)
Minority interest 1,951 (3,109)
------- -------
40,652 2,228
------- -------
Other (158) (251)
------- -------
EARNINGS BEFORE TAXES ON INCOME 37,151 8,433
------- -------
------- -------
(a) Total gross margin reconciles to the consolidated Statements of
Operations by subtracting cost of sales from net sales.
12
12. BUSINESS COMBINATIONS
In February 1999, the Company acquired an 80% fully diluted ownership in
aligne, Inc. See Note 2. During 1998, CompuCom completed three business
combinations for approximately $49 million in cash. In addition, CompuCom
assumed liabilities of approximately $95 million. These business
combinations were accounted for as purchases and accordingly the
consolidated financial statements reflect the operations of the acquired
entities since the respective acquisition dates.
The following unaudited pro forma financial information (in thousands
except per share amounts) presents the combined results of operations of
the Company as if the acquisitions had occurred as of January 1, 1998,
after giving effect to certain adjustments, including amortization of
goodwill, increased interest expense on debt related to the acquisitions,
and related income tax effects. The pro forma results of operations are not
indicative of the actual results that would have occurred had the
acquisitions been consummated at the beginning of the period presented and
is not intended to be a projection of future results.
Pro forma
Three Months Ended
March 31, 1998
------------------
Total Revenues $574,043
Net Earnings $3,290
Diluted earnings per share $0.10
13. SUBSEQUENT EVENTS
In April 1999, the Company notified the holders of its Convertible
Subordinated Notes (Notes) of its intent to redeem all of the outstanding
Notes on June 2, 1999. Each Note will be redeemed at a price of 104% of its
principal amount, plus interest accrued from February 1, 1999.
Alternatively, each Note is convertible into shares of the Company's common
stock at $28.985 per share prior to the redemption date. The Company
expects all of the holders to convert the Notes into Common Stock and
expects to issue 2.4 million shares as a result of the conversions. From
March 31, 1999 to May 13, 1999, $26 million of Notes have been converted
into 898,912 shares of the Company's Common Stock. As of May 13, 1999,
$45 million of Notes remain outstanding.
As discussed in Note 7, CompuCom entered into new debt arrangements in May
1999.
On May 11, 1999, CompuCom purchased from ENTEX Information Services,
Inc. certain of its Technology Acquisition Services Division (TASD) in a
cash transaction. This acquisition was structured as an asset purchase.
Under the terms of the agreement, CompuCom will pay approximately
$135 million for the acquired assets, which consisted primarily of
inventory, certain fixed assets, and the Erlanger, Kentucky distribution
center. In addition, CompuCom hired approximately 1,000 employees,
primarily sales, sales support and distribution personnel previously
employed by TASD.
On April 15, 1999, CompuCom announced the merger of its majority owned
subsidiary, ClientLink, Inc., with E-Certify Corporation, an internet
security services company. CompuCom retained an ownership position of
approximately 20% of the combined company, which will operate under the
name E-Certify, Inc.
13
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 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.
It believes this is best accomplished by developing these private partnership
companies with a goal of becoming a public company. Safeguard then brings
these companies public through rights offerings to Safeguard Shareholders or
through traditional initial public offerings with a Directed Share
Subscription program to Safeguard Shareholders. These programs give
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 and sales.
The Company approach is to acquire interests in early to mid-stage companies
that can become leaders in their respective markets. Prior to 1999, the Company
was 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. At May 13, 1999, the
Company owns approximately 23% of Internet Capital's outstanding voting
securities.
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 shareholders other than the Company in the earnings
or losses of a more than 50% owned partnership company is reflected in the
caption "Minority interest" in the Consolidated Statements of Operations.
Minority interest adjusts consolidated 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 1999 and 1998. In February 1999, the Company acquired an 80%
fully diluted ownership in aligne, Inc. in exchange for 441,518 shares of the
Company's common stock. The transaction was
14
accounted for as a purchase and, accordingly, the consolidated financial
statements reflect the operations of aligne since the acquisition date.
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 below in Operations Overview, the Company's consolidated
revenues and related costs and expenses are significantly influenced by the
results of operations of CompuCom. At March 31, 1999, the Company owns
approximately 51% of CompuCom's outstanding common stock and owns preferred
stock which gives it 60% of the vote for CompuCom's directors.
CompuCom competes in the computer reseller industry which has been
undergoing significant transformation and consolidation. Several of
CompuCom's competitors have been growing through acquisitions and others
have been acquired. In addition, companies previously engaged in the retail
channel have begun to enter the corporate reseller market, heightening the
competition.
As a result, while growing internally, CompuCom is also looking to
strengthen its market share through acquisitions, including one which was
completed in May 1999. If CompuCom were to use its stock for the
acquisitions or if some other dilutive event were to occur, the Company's
voting interest in CompuCom could decrease below 50%. Under current
generally accepted accounting principles, the Company would cease
consolidating CompuCom's results and instead would account for its
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
15
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 10 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 10 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.
Net sales increased 13% to $500 million in 1999 compared to $442 million in
1998 as CompuCom experienced a 12.7% sales increase. The increase at
CompuCom was due primarily to a 11.8% product sales increase resulting from
the acquisitions of Computer Integration Corporation (CIC) and Dataflex
Corporation (the acquisitions) during the second quarter of 1998. CompuCom
sold 15% more desktop, laptop, and server units in the first quarter of
1999 compared to the same period in 1998. CompuCom's service sales
increased 20% to $69 million in 1999 from $57 million in 1998, which was
primarily due to increases in field engineering, which is driven in part by
product unit sales volume, and by the acquisitions. CompuCom represented
99% of the Company's total consolidated net sales in 1999.
The Company's overall gross margin was 12.7% in 1999 compared to 15.2% in
1998. The decrease is primarily attributable to reduced product gross
margins at CompuCom, which decreased to 8.0% in
1999 compared to 11.6% in 1998. CompuCom attributes this decline to
heightened competition from other corporate resellers and direct marketers,
and a reduction in manufacturer sponsored incentives. CompuCom expects to
continue to experience declining product gross margins in the short term.
CompuCom's service gross margin was 34.0% in 1999 compared to 32.2% in
1998. The increase was primarily caused by increased productivity from
CompuCom's engineers. CompuCom does not expect to see an improvement in its
service gross margins in the short-term.
Securities and other gains in 1999 include a $43.7 million gain resulting
from the increase in the market price of Tellabs and a $5.9 million gain on
the sales of Tellabs stock. Securities and other
16
gains in 1999 also include the sale of the Company's holdings in Excite and
distributions received from the Company's associated venture funds.
Securities and other gains in 1998 included the open market sales of a
portion of the Company's interest in Cambridge Technology Partners and the
sale of shares in the DocuCorp International rights offering to the Company's
shareholders. Partially offsetting securities and other gains in these years
were 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. The change in equity income (loss) for
the three months ended March 31, 1999 compared to the same period in 1998
reflects increased operating losses at certain partnership companies and the
elimination of the Company's share of earnings of Coherent as a result of the
Coherent/Tellabs merger. Additionally, equity in income of affiliates for the
three months ended March 31, 1998 included the Company's share of Internet
Capital Group's $12.8 million gain on the exchange of Matchlogic shares for
shares of Excite. 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.
In 1999, the Company's public investments accounted for on the equity
method include Cambridge, ChromaVision, OAO Technology Solutions (OAOT),
Sanchez, and USDATA Corporation.
Cambridge reported revenue for the first quarter of $151.4 million compared
to $142.2 million in 1998, and net earnings of $.12 per share (diluted)
compared to $.20 per share in the first quarter of 1998. The company also
announced a re-alignment to retain and redeploy its employees in its higher
growth e-business service segments. Safeguard owns approximately 16% of
Cambridge's common stock at March 31, 1999.
During the first quarter of 1999, ChromaVision continued to generate
significant clinical data on current applications for the assessment of
HER2/neu and micrometastases in cancer, cytomegalovirus in immune compromised
patients and Down syndrome. ChromaVision also added two new Automated
Cellular Imaging System (ACIS(TM)) applications to its product pipeline for
quantification of the HIV virus and a test that could potentially provide an
early screen for cancer through routine blood samples. ChromaVision is
awaiting clearance of the 510(k) application filed with the U.S. Food and
Drug Administration (FDA) in November of 1998 would rapidly accelerate
expansion of the spectrum of clinical tests that can be performed on the
ACIS(TM) platform. ChromaVision's increased losses primarily resulted from
planned increases in its sales and marketing staff and technical personnel to
support the commercialization of ACIS(TM). Safeguard owns approximately
26% of ChromaVision's common stock at March 31, 1999.
OAOT revenues increased 55% for the quarter due primarily to the acquisition
of OAO Services, Inc. in July 1998. OAOT is transforming its operating model
to include enterprise solutions that help to adapt data management to the
internet. Managed Services (outsourcing) and Staff Augmentation divisions
continued generating profits, which have been
17
reinvested in the development of new IT solutions. These solutions include
e-business enablement, enterprise application development and implementation,
and healthcare solutions. Management believes that timely investment in
web-centric, digital infrastructure solutions will result in improved
long-term shareholder value. Safeguard owns approximately 33% of OAOT's
common stock at March 31, 1999.
Sanchez announced revenues for the quarter ended March 31, 1999 of $9.7
million, compared to $8.6 million for the same period in 1998. Net earnings
for the quarter totaled $493,000 or $.04 per diluted share, compared to
$833,000 or $.07 per diluted share for the same period in 1998. Sanchez
also announced an acquisition of a data center which will be integrated
into its new Internet service strategy. The new service offering, called
e-PROFILE.com, is an e-banking platform which enables its bank customers to
get online quickly and easily. Safeguard owns approximately 27% of
Sanchez's common stock at March 31, 1999.
USDATA announced its second consecutive profitable quarter with net income of
$.04 per share, for the quarter ended March 31, 1999, compared to a net loss
diluted from continuing operations of $.04 per share, for the same period in
1998. Safeguard owns approximately 26% of USDATA's common stock at March 31,
1999.
Selling and service expenses decreased in absolute dollars and as a
percentage of sales in 1999 primarily due to decreased service expenses at
CompuCom as a result of CompuCom's efforts to reduce its operating expenses
and the restructuring effort completed in late 1998, partially offset by
marketing expenses for its eCommerce unit, PCSave, and consulting fees
associated with the design and implementation of its new sales model.
CompuCom plans to reduce the level of marketing expenses incurred for its
eCommerce unit. However, as a result of the recently announced acquisition
of Entex's product division, CompuCom plans to incur additional consulting
fees during the second quarter of 1999.
General and administrative expenses increased in absolute dollars and as a
percentage of sales primarily due to increased expenditures at CompuCom to
continue the expansion of its electronic commerce capabilities and
increased expenses at the Company to support the growing activities of its
partnership companies. CompuCom's general and administrative expenses are
reported net of reimbursements by certain manufacturers for specific
training, promotional, and marketing programs. These reimbursements offset
the expenses incurred by CompuCom.
Depreciation and amortization increased primarily due to increased
amortization at CompuCom as a result of the acquisitions completed during
the first half of 1998.
Interest and financing expense increased in 1999 compared to 1998 primarily
as a result of increased amortization of fees at CompuCom resulting from
the early termination of CompuCom's financing arrangements, and increased
borrowings by the Company primarily to fund interests in new and 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 operating results at
CompuCom. Future profitability at CompuCom will depend on its ability to
successfully integrate the TASD acquisition into its operations, to
effectively manage inventory levels in response to changes in its major
suppliers' price protection and return programs, to effectively
manage the utilization of service personnel, and to respond to
increased
18
competition from its suppliers' direct selling initiatives. It also depends
on CompuCom's ability to reduce operating expenses at a pace equal to the
decline in margin percentages, competitive pricing, short-term interest rate
fluctuations, general economic conditions, employee turnover and possible
future litigation, as well as the risks and uncertainties set forth from time
to time in CompuCom's other public reports and filings and public statements.
The Company's effective tax rate decreased to 35% in 1999 compared to 40%
for 1998 due to the realization of previously unrecorded tax benefits
attributable to the difference between the book basis and tax basis of
certain of the Company's investments as well as the application of lower
tax rates against realized investment gains.
The Company's net earnings increased significantly in 1999 compared to 1998
primarily due to higher securities and other gains related to the Company's
holdings in Tellabs, partially offset by decreased earnings at CompuCom and
reduced operating results for partnership companies accounted for on the
equity method. 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.
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.
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 1999, the
Company notified the holders of its Convertible Subordinated Notes (Notes) of
its intent to redeem all of the outstanding Notes on June 2, 1999. Each Note
will be redeemed at a price of 104% of its principal amount, plus interest
accrued from February 1, 1999. Alternatively, each Note is convertible into
shares of the Company's common stock at $28.985 per share prior to the
redemption date. The Company expects all of the holders to convert the Notes
into Common Stock and expects to issue 2.4 million shares as a result of the
conversions. From March 31, 1999 to May 13, 1999, $26 million of Notes have
been converted into 898,912 shares of the Company's Common Stock. As of May
13, 1999, $45 million of Notes remain outstanding.
The Company has availability under its bank revolving credit facility of
$200 million. Of the $200 million, $150 million matures in May 2002 and is
secured by certain equity securities the Company holds of its publicly
traded 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,
with availability limited to the lesser of $50 million or 10% of the value
of the Pledged Securities. The $50 million facility had an original
maturity date of April 1999, which the Company has extended to April 2000.
There was $56 million outstanding under the total facility at March 31,
1999.
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
19
rate that varies with the Company's effective borrowing rate. At March 31,
1999, $20 million was outstanding under these agreements.
In March 1999, the Company entered into a forward sale contract relating to
one million shares of its holdings in Tellabs, Inc. The Company pledged one
million shares of Tellabs for three years and in return received
approximately $71 million of cash. At the end of the term, the Company has
the option to deliver cash or Tellabs shares with a value determined by
the stock price of Tellabs at maturity. The number of Tellabs shares to be
delivered at maturity ranges from 800,000 to one million shares (or the
cash value thereof). The proceeds from this transaction were used to pay
down a portion of the Company's bank revolving credit facility.
During the first quarter of 1999, the Company invested approximately $20
million in three new partnership companies and invested approximately $33
million in its existing private partnership companies and associated venture
funds. In addition, the Company acquired an interest in aligne, Inc. in
exchange for 441,518 shares of the Company's common stock with a market value
of approximately $17 million, and purchased approximately $14 million of
shares of its publicly traded partnership companies. During the first quarter
of 1999, the Company sold a portion of its interests in Tellabs for net
proceeds totaling $47 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 and general corporate
requirements. The Company is contingently obligated for approximately $31
million of guarantee commitments, and has committed capital of
approximately $86 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
companies 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 bank financing arrangements and
internally generated funds to fund its cash requirements. During the
quarter ended March 31, 1999 CompuCom sold its corporate headquarters
building in a sale/leaseback transaction. The proceeds from the sale were
approximately $40 million, of which $36 million was used to pay down
long-term debt. As part of the transaction, CompuCom entered into a 20-year
operating lease on the building.
At March 31, 1999, CompuCom's financing arrangements consist of a $165
million working capital facility and a $157 million receivables
securitization facility (collectively, the "credit agreements"). At March
31, 1999, approximately $13 million was outstanding under the working
capital facility and the receivables securitization facility was fully
utilized. In May 1999, CompuCom replaced its credit agreements with a $225
million working capital facility and a $175 million receivables
securitization facility. The new $225 million working capital facility
bears interest at a rate of LIBOR plus 1.75% and is secured by certain
assets of CompuCom, as defined. This facility is fully
20
available subject to a borrowing base and compliance with certain covenants
related to, among others, funded debt to EBITDA, the current ratio, and
minimum profitability and tangible net worth levels. Terms of the working
capital facility limit the amounts available for capital expenditures and
dividends. This facility matures in May 2002. On the new $175 million
receivables securitization the effective rate is based on a designated
commercial paper rate plus an agreed upon spread. This securitization has a
term of 3 years, subject to certain covenant compliance. CompuCom does not
expect its effective interest rate under the new facilities to be materially
different from the levels it experienced in 1998.
CompuCom's liquidity continues to be negatively impacted by the increase in
the dollar volume of the rebate programs of its principal suppliers. Under
these programs, CompuCom is required to pay a higher initial price for
product and claim a rebate to reduce that price. The collection of these
rebates can take several months. Due to the increased volume of product
sold under these programs, CompuCom's initial price for the product is
often higher than the sales price CompuCom can obtain from its customers.
At March 31, 1999, these programs are a major factor in CompuCom's financing
needs. At March 31, 1999, CompuCom was owed $62 million under the
programs.
On May 11, 1999, CompuCom purchased from ENTEX Information Services, Inc.
certain assets of its Technology Acquisition Services Division (TASD) in a
cash transaction. Under the terms of the agreement, CompuCom will pay
approximately $135 million for the acquired assets. CompuCom will use
availability under its working capital facility to fund the acquisition.
Consolidated working capital decreased marginally to $241 million at
March 31, 1999 from $252 million at December 31, 1998.
The Company's operations are not capital intensive, and capital
expenditures in any year normally would not be significant in relation to
the overall financial position of the Company. Capital asset requirements
are generally funded through bank credit facilities, internally generated
funds or other financing sources. There were no material capital asset
purchase commitments at March 31, 1999.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities." This Statement establishes
accounting and reporting standards for derivative instruments and for
hedging activities. It requires that an entity recognize all derivatives as
either assets or liabilities in the statement of financial position and
measure those instruments at fair value. This statement is effective for
all fiscal quarters of fiscal years beginning after June 15, 1999. The
adoption of this standard is not expected to materially impact the
Company's consolidated results, financial condition or long-term liquidity.
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
21
operations. The Company has completed its assessment of its computer
information systems. The Company has replaced all computer systems and
software which were determined to be non-compliant. These replacements were
generally part of the Company's program of regularly upgrading its computer
systems, and the Company has not incurred and does not expect to incur any
material extraordinary expense to remediate its systems. The Company will
perform testing and complete implementation of its computer systems during
the second quarter of 1999. The Company has received verification from its
vendors that its information systems are Year 2000 ready. If the Company
determines that any of 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 testing remediation and
validation by June 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. For the remaining 15%, if
documented complicance is not received, CompuCom's plan is to upgrade,
replace, or decommission if necessary 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 adverse effect on its results of
operations. CompuCom is currently developing a contingency plan to operate in
the event its computer systems or those of its vendors, suppliers, or
customers are not Year 2000 compliant. CompuCom currently anticipates that it
will spend approximately $1.4 million on Year 2000 compliance, of which
approximately $900,000 has been spent through March 31, 1999.
The Company's partnership companies have completed or nearly completed
assessing their internal Year 2000 readiness. 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
22
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 document 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 partnership 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. The market for
Securities of Internet-Related companies in particular is extremely volatile.
If those markets become unfavorable for an extended period of time, the
Company's ability to complete rights offerings and IPO's of its partnership
companies 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.
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.
23
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Safeguard is exposed to equity price risks on its securities in publicly
traded partnership companies, most of which we acquired as private
companies and took public through rights offerings. These securities are
generally in companies in the information technology industry sector. Many
of the companies are considered small capitalization stocks. Safeguard
typically does not attempt to reduce or eliminate its market exposure on
securities. A 20% decrease in equity prices would result in an approximate
$92 million decrease in the fair value of our publicly traded investments
accounted for on the equity method or classified as available-for-sale at
March 31, 1999. Approximately $133 million of the value of these equity
securities at March 31, 1999 consisted of our holdings in Cambridge. A 20%
decrease in equity prices at March 31, 1999 would result in an approximate
$33 million decrease in the fair value of our holdings in Tellabs. Our
Tellabs shares are classified as trading securities. Fluctuations in the
market price of trading securities are included in net earnings. In March
1999, the Company entered into a forward sale contract related to one million
shares of its holdings in Tellabs, Inc. The Company pledged one million
shares of Tellabs for three years and in return received approximately $71
million in cash. At the end of the term, the Company has the option to
deliver cash or Tellabs shares with a value determined by the stock price of
Tellabs at maturity. The number of Tellabs shares to be delivered at maturity
ranges from 800,000 to one million shares (or the cash value thereof).
Availability under Safeguard's bank credit facilities is determined by the
market value of the publicly traded partnership companies pledged as
collateral. A price decrease of 25% would reduce the availability on our $200
million bank credit facilities by approximately $49 million. At March 31,
1999, $56 million was outstanding under the $200 million bank revolving
credit facility.
Safeguard is exposed to interest rate risk primarily through its bank
credit facility. At March 31, 1999, this facility had borrowings of $56
million with an effective interest rate of 6.2%. If Safeguard's effective
interest rate were to increase from 6.2% to 7.5%, the effect on Safeguard's
financial statements would not be material.
CompuCom is exposed to interest rate risk primarily through its receivables
securitization and working capital facilities. CompuCom utilizes borrowings
on these facilities to meet its working capital needs. At March 31, 1999, the
securitization facility had borrowings of approximately $157 million with an
effective interest rate of 4.95% plus an agreed upon spread. At March 31,
1999, the working capital facility had borrowings of $13 million with an
effective interest rate of 7.5%. If CompuCom's effective interest rate were
to increase from 6.9% to 7.5% (a 10% increase), the effect on the Company's
financial statements would not be material.
24
Item 5. OTHER INFORMATION
In May 1999, Internet Capital Group, an Internet holding company primarily
engaged in managing and operating a network of business-to-business eCommerce
companies, has filed a registration statement with the Securities and
Exchange Commission for an initial public offering of its common stock. A
portion of the shares will be offered to Safeguard shareholders as of a
future record date that has yet to be determined. The offering ratio to
Safeguard shareholders and the minimum purchase requirement have not yet been
set. The offering will be made only by means of a prospectus, subject to the
effectiveness of the registration statement. At May 13, 1999, Safeguard owns
approximately 23% of Internet Capital Group's outstanding voting securities.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Number Description
10.1* Amendment to Amended and Restated Credit
Agreement, dated April 12, 1999, among
Safeguard Scientifics, Inc., Safeguard
Scientifics (Delaware), Inc., Safeguard
Delaware, Inc. and PNC Bank, N.A. (exhibits
omitted).
27* Financial Data Schedule (electronic filing
only)
* filed herewith
(b) No reports on Form 8-K have been filed by the Registrant
during the quarter ended March 31, 1999.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SAFEGUARD SCIENTIFICS, INC.
(Registrant)
Date: May 17, 1999 /s/ HARRY WALLAESA
Harry Wallaesa
President and Chief Operating Officer
Date: May 17, 1999 /s/ MICHAEL W. MILES
--------------------
Michael W. Miles
Senior Vice President and Chief Financial Officer
(Principal Financial and Principal Accounting Officer)