10-Q 1 w52490e10-q.txt QUARTERLY REPORT FOR THE PERIOD END JUNE 30, 2001 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For Quarter Ended June 30, 2001 Commission File Number 1-5620 ------------- ------ SAFEGUARD SCIENTIFICS, INC. ------------------------------------------------------------------------------ (Exact name of registrant as specified in its charter) Pennsylvania 23-1609753 ------------------------------------------------------------------------------ (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 ------------------------------------------------------------------------------ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (610) 293-0600 -------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No -------- ---------- Number of shares outstanding as of August 14, 2001 Common Stock 117,578,573 2 SAFEGUARD SCIENTIFICS, INC. QUARTERLY REPORT FORM 10-Q INDEX
PART I - FINANCIAL INFORMATION ------------------------------ Page ---- Item 1 - Financial Statements: Consolidated Balance Sheets - June 30, 2001 (unaudited) and December 31, 2000 3 Consolidated Statements of Operations (unaudited) - Three and Six Months Ended June 30, 2001 and 2000 4 Consolidated Statements of Cash Flows (unaudited) - Six Months Ended June 30, 2001 and 2000 5 Notes to Consolidated Financial Statements 6 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations 19 Item 3 - Quantitative and Qualitative Disclosures About Market Risk 30 PART II - OTHER INFORMATION --------------------------- Item 1 - Legal Proceedings 32 Item 4 - Submission of Matters to a Vote of Security Holders 32 Item 6 - Exhibits and Reports on Form 8-K 32 Signatures 34
2 3 SAFEGUARD SCIENTIFICS, INC. CONSOLIDATED BALANCE SHEETS (in thousands)
JUNE 30, DECEMBER 31, 2001 2000 --------------------------------------------------------------------------------------------------------------- (unaudited) ASSETS Current Assets Cash and cash equivalents, restricted cash and short-term investments $ 248,470 $ 219,431 Trading securities 172,423 3,446 Accounts receivable, less allowances 182,134 246,949 Inventories 40,971 78,187 Prepaid expenses and other current assets 26,131 24,914 --------------------------------------------------------------------------------------------------------------- Total current assets 670,129 572,927 Property and equipment, net 57,980 52,951 Ownership interests in and advances to affiliates 311,758 616,875 Available-for-sale securities 9,709 214,343 Intangibles, net 130,121 123,002 Deferred taxes 49,225 39,708 Related party note receivable 26,033 -- Other 26,072 28,453 --------------------------------------------------------------------------------------------------------------- TOTAL ASSETS $1,281,027 $1,648,259 --------------------------------------------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current maturities of long-term debt $ 5,766 $ 5,250 Accounts payable 122,791 123,130 Accrued expenses 105,353 130,722 --------------------------------------------------------------------------------------------------------------- Total current liabilities 233,910 259,102 Long-term debt 16,287 13,493 Minority interest 109,617 106,462 Other long-term liabilities 168,353 164,765 Convertible subordinated notes 200,000 200,000 Commitments and contingencies SHAREHOLDERS' EQUITY Preferred stock -- -- Common stock 11,815 11,815 Additional paid-in capital 748,173 758,946 Retained earnings (deficit) (187,499) 172,716 Accumulated other comprehensive loss (920) (712) Unamortized deferred compensation (1,314) -- Treasury stock, at cost (17,395) (38,328) --------------------------------------------------------------------------------------------------------------- Total shareholders' equity 552,860 904,437 --------------------------------------------------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,281,027 $1,648,259 ---------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 3 4 SAFEGUARD SCIENTIFICS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands except per share data)
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 --------------------------------------------------------------------------------------------------------------- (UNAUDITED) REVENUE Product sales $ 426,671 $ 640,007 $ 912,134 $1,155,605 Service sales 81,549 68,324 166,125 136,467 Other 6,334 4,344 12,962 8,089 -------------------------------------------------------------------------------------------------------------- Total revenue 514,554 712,675 1,091,221 1,300,161 Operating Expenses Cost of sales--product 382,628 589,280 824,789 1,065,943 Cost of sales--service 52,487 45,607 109,448 92,621 Selling and service 36,104 36,791 73,999 73,985 General and administrative 42,150 46,831 82,035 95,029 Depreciation and amortization 9,766 8,029 19,460 16,359 Restructuring -- -- -- 5,169 -------------------------------------------------------------------------------------------------------------- Total operating expenses 523,135 726,538 1,109,731 1,349,106 -------------------------------------------------------------------------------------------------------------- (8,581) (13,863) (18,510) (48,945) Other income (loss), net (28,300) 32,564 (37,575) 85,020 Interest income 2,988 7,453 6,974 8,647 Interest and financing expense (6,743) (10,052) (15,476) (20,750) -------------------------------------------------------------------------------------------------------------- INCOME (LOSS) BEFORE INCOME TAXES, MINORITY INTEREST AND EQUITY INCOME (LOSS) (40,636) 16,102 (64,587) 23,972 Income taxes (3,071) (1,169) 6,186 (17,106) Minority interest (1,248) (1,730) (2,298) 6,869 Equity income (loss) (65,517) (11,033) (299,516) 18,033 -------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) $(110,472) $ 2,170 $ (360,215) $ 31,768 -------------------------------------------------------------------------------------------------------------- NET INCOME (LOSS) PER SHARE Basic $ (0.94) $ 0.02 $ (3.07) $ 0.29 Diluted $ (0.95) $ 0.02 $ (3.08) $ 0.26 WEIGHTED AVERAGE SHARES OUTSTANDING Basic 117,300 116,732 117,269 111,127 Diluted 117,300 119,333 117,269 114,254 --------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 4 5 SAFEGUARD SCIENTIFICS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
SIX MONTHS ENDED JUNE 30, 2001 2000 -------------------------------------------------------------------------------------------------------------- (unaudited) OPERATING ACTIVITIES Net income (loss) $(360,215) $ 31,768 Adjustments to reconcile to net cash provided by (used in) operating activities: Depreciation and amortization 19,460 16,359 Deferred income taxes (8,213) (855) Equity (income) loss 299,516 (22,718) Other (income) loss, net 37,575 (80,335) Stock-based compensation 376 5,889 Minority interest 1,379 (4,121) Changes in assets and liabilities, net of effect of acquisitions and dispositions: Accounts receivable, net 146,818 (20,157) Inventories 50,345 13,250 Accounts payable, accrued expenses and other (12,960) 5,467 -------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) operating activities 174,081 (55,453) INVESTING ACTIVITIES Proceeds from sales of available-for-sale securities 11,029 57,756 Proceeds from sales of and distributions from affiliates 20,730 43,743 Advances to affiliates (12,582) (24,193) Repayment of advances to affiliates 30 10,050 Acquisitions of ownership interests in affiliates and subsidiaries, net of cash acquired (46,927) (336,288) Acquisitions by subsidiaries, net of cash acquired (79,309) (750) Advances to related party (26,499) -- Decrease in short-term investments and restricted cash 86,728 -- Capital expenditures (14,369) (4,928) Other, net (1,467) (21,553) -------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (62,636) (276,163) FINANCING ACTIVITIES Borrowings on revolving credit facilities 19,549 603,163 Repayments on revolving credit facilities (17,996) (593,038) Borrowings on long-term debt 3,509 1,819 Repayments on long-term debt (1,752) (6,158) Repurchase of company common stock -- (19,074) Issuance of Company common stock, net 139 613,542 Issuance of subsidiary common stock 375 1,427 -------------------------------------------------------------------------------------------------------------- Net cash provided by financing activities 3,824 601,681 -------------------------------------------------------------------------------------------------------------- NET INCREASE IN CASH AND CASH EQUIVALENTS 115,269 270,065 Cash and cash equivalents at beginning of period 133,201 49,813 -------------------------------------------------------------------------------------------------------------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 248,470 $ 319,878 --------------------------------------------------------------------------------------------------------------
See notes to consolidated financial statements. 5 6 SAFEGUARD SCIENTIFICS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2001 1. GENERAL The accompanying unaudited interim consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The 2000 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. NEW ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities", as amended. SFAS 133 establishes new standards of accounting and reporting for derivative instruments and hedging activities. SFAS 133 requires that all derivatives be recognized at fair value in the statement of financial position, and that the corresponding gains or losses be reported either in the statements of operations or as a component of comprehensive income, depending on the type of hedging relationship that exists. If the derivative is determined to be a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are offset against the change in fair value of the hedged assets, liabilities or firm commitments through the statements of operations or recognized in other comprehensive income until the hedged item is recognized in the statement of operations. The ineffective portion of a derivative's change in fair value is immediately recognized in earnings. The Company currently holds derivative instruments and engages in certain hedging activities, which have been accounted for as described in note 6. The Company adopted SFAS 133 on January 1, 2001. 3. COMPREHENSIVE INCOME (LOSS) Comprehensive income (loss) is the change in equity of a business enterprise from transactions and other events and circumstances from non-owner sources. Excluding net income (loss), the Company's source of comprehensive income (loss) is from net unrealized appreciation (depreciation) on its holdings classified as available-for-sale. Reclassification adjustments result from the recognition in net income of unrealized gains or losses that were included in comprehensive income in prior periods. The following summarizes the components of comprehensive income (loss), net of income taxes:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 -------------------------------------------------------------------------------------- (in thousands) (unaudited) NET INCOME (LOSS) $(110,472) $ 2,170 $(360,215) $31,768 -------------------------------------------------------------------------------------- OTHER COMPREHENSIVE INCOME (LOSS), BEFORE TAXES: Unrealized holding gains (losses) (2,809) 39,474 (4,891) 7,874 Reclassification adjustments (4,009) 1,148 4,571 (44,683) RELATED TAX (EXPENSE) BENEFIT: Unrealized holding (gains) losses 983 (13,816) 1,712 (2,756) Reclassification adjustments 1,403 (402) (1,600) 15,639 -------------------------------------------------------------------------------------- OTHER COMPREHENSIVE INCOME (LOSS) (4,432) 26,404 (208) (23,926) -------------------------------------------------------------------------------------- COMPREHENSIVE INCOME (LOSS) $(114,904) $ 28,574 $(360,423) $ 7,842 --------------------------------------------------------------------------------------
6 7 4. RECLASSIFICATIONS Certain prior year amounts have been reclassified to conform to the current year presentation. 5. CASH AND CASH EQUIVALENTS, RESTRICTED CASH AND SHORT-TERM INVESTMENTS At June 30, 2001, cash and cash equivalents consist of commercial paper and other deposits that are readily convertible into cash. At December 31, 2000, restricted cash of $35 million was primarily invested in money market investments and was used as collateral under a guarantee arrangement (note 19). At December 31, 2000, short-term investments of $51 million represented commercial paper with maturities ranging from 92 to 208 days. At June 30, 2001, the restricted cash and short-term investment balances were zero. 6. FINANCIAL INSTRUMENTS In 1999, in order to mitigate the Company's market exposure and generate cash from holdings in Tellabs, the Company entered into two forward sale contracts related to 3.4 million shares of its holdings in Tellabs. The Company pledged these shares of Tellabs under contracts that expire in 2002 and, in return, received approximately $139 million of cash. At maturity, the Company is required to deliver cash or Tellabs stock with a value determined by the stock price of Tellabs at maturity. The number of Tellabs shares to be delivered at maturity will range between 2.7 million to 3.4 million depending on the price of Tellabs stock at that date. The forward sale contracts are considered derivative financial instruments that have been designated as fair value hedging instruments under SFAS 133. The Company's objective relative to the use of these hedging instruments is to limit the Company's exposure to and benefits from price fluctuations in the underlying equity securities. Pursuant to SFAS 133, the Company transferred its Tellabs holdings into the trading category from the available-for-sale category effective January 1, 2001. As of June 30, 2001, the fair value of our holdings in Tellabs and the value of the forward sale contracts are included in the caption trading securities on the consolidated balance sheets. The Company accounts for the forward sale arrangements as hedges and has determined that the hedges are highly effective. Changes in the value of the hedge instrument are substantially offset by changes in the value of the underlying securities. The hedging of the Tellabs common stock was part of the Company's overall risk management strategy, which includes the preservation of cash and the value of securities used to fund ongoing operations and future acquisition opportunities. The Company does not hold or issue any derivative financial instruments for trading purposes. The net loss recognized during the six months ended June 30, 2001 was $16.5 million. This amount reflects a $77.3 million gain on the change in the fair value of the hedging contract excluded from the assessment of the hedge effectiveness, and the ineffective portion of the hedge, reduced by a $93.8 million loss on the change in fair value of the Tellabs holdings. This loss is reflected in other income (loss), net in the consolidated statements of operations. The effect of the transition accounting at January 1, 2001, prescribed in SFAS 133 was not material. The Company's liability of $166 million in connection with these transactions is included in other long-term liabilities on the consolidated balance sheet at June 30, 2001. The initial cost of the transaction ($4.3 million) is being amortized over the life of the agreement through the statements of operations. The risk of loss to the Company in the event of nonperformance by the counterparty under the forward sale contracts is not considered to be significant. Although the forward sale contracts expose the Company to market risk, fluctuations in the fair value of these contracts are mitigated by expected offsetting fluctuations in the pledged securities. 7 8 7. OWNERSHIP INTERESTS IN AND ADVANCES TO AFFILIATES The following summarizes the Company's ownership interests in and advances to affiliates accounted for under the equity method or cost method of accounting. The ownership interests are classified according to applicable accounting methods at June 30, 2001 and December 31, 2000.
JUNE 30, DECEMBER 31, 2001 2000 ------------------------------ (in thousands) (unaudited) EQUITY METHOD Public companies $ 99,257 $267,062 Non-public companies 176,053 309,369 --------------------------------------------------------------------- 275,310 576,431 COST METHOD Non-public companies 24,784 33,101 ADVANCES TO AFFILIATES 11,664 7,343 --------------------------------------------------------------------- $311,758 $616,875 ---------------------------------------------------------------------
The market value of the Company's public companies accounted for under the equity method was $266 million and $339 million at June 30, 2001 and December 31, 2000. At June 30, 2001, the Company's carrying value in its partner companies accounted for under the equity method exceeded its share of the underlying equity in the net assets of such companies by $86.5 million which is included in ownership interests in and advances to affiliates on the consolidated balance sheets. This excess relates to ownership interests acquired through June 30, 2001, and is being amortized generally over a three to ten-year period. Amortization expense of $14.5 million and $7.2 million for the six months ended and $6.8 million and $4.2 million for the three months ended June 30, 2001 and 2000, is included in equity loss in the consolidated statements of operations. As of June 30, 2001, the Company had advances to partner companies that mature on various dates through May 2004 and bear interest at fixed rates between 5.3% and 9.0% and variable rates consisting of the prime rate (6.75% at June 30, 2001) plus 1 - 2%. The Company also has short-term advances to partner companies of $0.9 million at June 30, 2001, which is included in accounts receivable, less allowances, on the consolidated balance sheets. During management's ongoing review of the recoverability of recorded carrying values versus their estimated fair value, it was determined that the carrying value of goodwill and certain other intangible assets were not fully recoverable. The Company recorded impairment charges for companies accounted for under the equity method totaling $20.6 million and $2.3 million for the three months ended June 30, 2001 and 2000 and $58.6 million and $4.7 million for the six months ended June 30, 2001 and 2000. The amount of the impairment charge was determined by comparing the carrying value of our interest in the affiliate to the estimated fair value. Impairment charges associated with equity method companies are reported as part of equity income (loss) on the consolidated statements of operations. Impairment charges related to cost method companies are reported in other income (loss), net (see note 12). 8 9 8. AVAILABLE-FOR-SALE SECURITIES Available-for-sale securities consisted of the following:
JUNE 30, 2001 DECEMBER 31, 2000 ----------------------------------------------------------------------------------------- CARRYING MARKET CARRYING MARKET VALUE VALUE VALUE VALUE ----------------------------------------------------------------------------------------- (in thousands) (unaudited) Tellabs (a) -- -- $212,731 $ 190,654 Pac-West Telecomm $ 9,891 $ 4,940 9,872 8,465 Brandywine Realty Trust(b) 39 762 8,561 10,619 Other public companies 2,030 4,007 2,086 4,605 Unrealized depreciation (2,251) (18,907) ---------------------------------------------- ----------- $ 9,709 $214,343 ---------------------------------------------- -----------
(a) As discussed in note 6, the Company entered into forward sale contracts on its Tellabs holdings in 1999. Also as discussed in note 6, these holdings were reclassified to trading securities on January 1, 2001. (b) The Company sold a majority of its holdings in Brandywine in June 2001. 9. DEBT The following is a summary of long-term debt:
JUNE 30, DECEMBER 31, 2001 2000 ----------------------------------------------------------------------------- (in thousands) (unaudited) Parent company and other recourse debt $ 19,527 $ 18,240 Subsidiary debt (non-recourse to parent) 2,526 503 ----------------------------------------------------------------------------- Total debt 22,053 18,743 Current maturities of long-term debt (5,766) (5,250) ----------------------------------------------------------------------------- Long-term debt $ 16,287 $ 13,493 -----------------------------------------------------------------------------
In May 2001, the Company executed a $100 million revolving credit facility which matures in May 2002, and is secured by certain equity securities the Company holds in its publicly traded partner companies. Availability under our bank credit facility is determined by the market value of these securities pledged as collateral. Based on the provisions of the borrowing base, availability under our bank credit facility at June 30, 2001 was $100 million (less outstanding letters of credit of $0.7 million) and there were no amounts outstanding. The credit facility is subject to the Company's compliance with selected financial covenants. Other long-term debt includes mortgage obligations and bank credit facilities of consolidated partner companies. These obligations bear interest rates ranging from 7.75% to 9.75%. At June 30, 2001, CompuCom has a $100 million working capital facility and a $150 million receivables securitization facility. The $100 million working capital facility bears interest at a rate of LIBOR plus an agreed upon spread and is secured by certain assets of CompuCom. Availability under the facility is subject to a borrowing base calculation. As of June 30, 2001, availability under the working capital facility was approximately $74 million, and there were no amounts outstanding as of June 30, 2001 and December 31, 2000. The working capital facility matures in May 2002. The securitization facility allows CompuCom to sell, without recourse, an interest in its accounts receivable on a revolving basis and is accounted for as a sale of accounts receivable. The effective rate on the $150 million receivables securitization is based on a designated short-term interest rate plus an agreed upon spread. Amounts outstanding as sold receivables at June 30, 2001 consisted of two certificates totaling $106 million, one certificate for $56 million with an April 2002 maturity date and one certificate for $50 9 10 million with an October 2003 maturity date. Both facilities require CompuCom to maintain compliance with selected financial covenants and ratios. 10. SHAREHOLDERS' EQUITY In June 2001, the Company granted 279,000 shares of its common stock to its employees, with a fair value on the date of grant of $1.3 million (or $4.785 per share). The value of the shares is being amortized over the vesting period of 2 years. During the three months ended June 30, 2001, the Company recorded $21,000 of expense related to this grant. As discussed in note 17, the Company issued shares of its common stock in connection with the acquisition of Palarco. 11. RESTRUCTURING In 2000, CompuCom effected a restructuring plan designed to reduce its cost structure by closing its distribution facility located in Houston, Texas, closing and consolidating three office sites and reducing its workforce. As a result, CompuCom recorded a restructuring charge of $5.2 million in the first quarter of 2000. During 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 related to a reduction in workforce. Restructuring activity during 2001 is summarized as follows:
ACCRUAL AT CASH ACCRUAL AT DEC. 31, 2000 PAYMENTS JUNE 30, 2001 --------------------------------------------------------------------------- (in thousands) (unaudited) RESTRUCTURING - 2000 Lease termination costs $ 1,770 $ (197) $1,573 Employee severance and related benefits 10 (10) -- --------------------------------------------------------------------------- $ 1,780 $ (207) $1,573 --------------------------------------------------------------------------- RESTRUCTURING - 1998 Lease termination costs $ 710 $ (159) $ 551 ---------------------------------------------------------------------------
The remaining accrual at June 30, 2001 is reflected in accrued liabilities on the consolidated balance sheet and is expected to be adequate to cover actual amounts to be paid. Differences, if any, between the estimated amounts accrued and actual amounts paid will be reflected in operating expenses in future periods. 10 11 12. OTHER INCOME (LOSS), NET Other income (loss), net, consists of the following:
THREE MONTHS ENDED, SIX MONTHS ENDED, JUNE 30 JUNE 30 2001 2000 2001 2000 ----------------------------------------------------------------------------------------------- (in thousands) (unaudited) Gain on sale of public holdings, net $ 1,551 $ 9,424 $ 1,392 $61,831 Gain on sale of private partner companies,net 1,454 19,760 1,518 19,809 Unrealized loss on derivative financial instruments (12,196) -- (16,528) -- Unrealized loss on trading securities, net (272) (820) (1,126) (820) Other, primarily impairment charges (18,837) 4,200 (22,831) 4,200 ----------------------------------------------------------------------------------------------- $(28,300) $ 32,564 $(37,575) $85,020 -----------------------------------------------------------------------------------------------
For the three and six months ended June 30, 2001, the Company recorded impairment charges of $18.8 million and $22.8 million for the other than temporary decline in the carrying value of certain partner companies accounted for under the cost method (see note 7). 13. INCOME TAXES Income taxes are accounted for under the asset and liability method whereby deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, using the tax rate expected to be in effect when the taxes are actually paid or recovered. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance. The Company's consolidated income tax expense recorded for the three months ended June 30, 2001, was $3.1 million, net of a recorded valuation allowance of $37.9 million. The Company's consolidated income tax benefit recorded for the six months ended June 30, 2001, was $6.2 million, net of a recorded valuation allowance of $115.7 million. The Company has recorded a valuation allowance to reduce its deferred tax asset to an amount that is more likely than not to be realized in future years. 11 12 14. NET INCOME PER SHARE The calculations of net income (loss) per share were:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 --------------------------------------------------------------------------------------- (in thousands except per share amount) (unaudited) Basic: Net income (loss) $(110,472) $ 2,170 $(360,215) $31,768 --------------------------------------------------------------------------------------- Average common shares outstanding 117,300 116,732 117,269 111,127 --------------------------------------------------------------------------------------- Basic $ (0.94) $ 0.02 $ (3.07) $ 0.29 --------------------------------------------------------------------------------------- Diluted: Net income (loss) $(110,472) $ 2,170 $(360,215) $31,768 Effect of: Public holdings (389) (123) (744) (1,736) --------------------------------------------------------------------------------------- Adjusted net income (loss) $(110,861) $ 2,047 $(360,959) $30,032 --------------------------------------------------------------------------------------- Average common shares outstanding 117,300 116,732 117,269 111,127 Effect of: Dilutive options -- 2,601 -- 3,127 --------------------------------------------------------------------------------------- Average common shares assuming dilution 117,300 119,333 117,269 114,254 --------------------------------------------------------------------------------------- Diluted $ (0.95) $ 0.02 $ (3.08) $ 0.26 ---------------------------------------------------------------------------------------
If a consolidated or equity method company has dilutive options or securities outstanding, diluted net income (loss) per share is computed first by deducting from income (loss) the income attributable to the potential exercise of the dilutive options or securities of the company. This impact is shown as an adjustment to net income (loss) for purposes of calculating diluted net income (loss) per share. The computation of average common shares outstanding for the three and six months ended June 30, 2001, excludes 0.3 million shares of non-vested restricted stock granted in June 2001. Approximately 0.1 million and 0.5 million weighted average common stock equivalents related to stock options and approximately 8.3 million and 8.3 million shares representing the weighted average effect of assumed conversion of the convertible subordinated notes were excluded from the denominator in the calculation of diluted loss per share for the three and six months ended June 30, 2001, because their effect was anti-dilutive. 12 13 15. PARENT COMPANY FINANCIAL INFORMATION Parent Company financial information is provided to present the financial position and results of operations of the Company as if the consolidated companies were accounted for under the equity method of accounting for all periods presented during which the Company owned its interest in these companies. BALANCE SHEETS
JUNE 30, DECEMBER 31, 2001 2000 ---------------------------------------------------------------------------- (in thousands) (unaudited) ASSETS Cash and cash equivalents, restricted cash and short-term investments $ 135,722 $ 204,004 Trading securities 172,423 3,446 Other current assets 41,046 30,022 Ownership interests in and advances to affiliates 447,949 759,914 Available-for-sale securities 9,709 214,233 Related party note receivable 26,033 -- Other 133,368 113,415 ---------------------------------------------------------------------------- Total Assets $ 966,250 $ 1,325,034 ---------------------------------------------------------------------------- LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities $ 30,123 $ 42,899 Long-term debt 15,224 13,421 Other long-term liabilities 168,043 164,277 Convertible subordinated notes 200,000 200,000 Shareholders' equity 552,860 904,437 ---------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $ 966,250 $ 1,325,034 ----------------------------------------------------------------------------
The carrying values of the Company's less than wholly owned subsidiaries, primarily CompuCom, Tangram and SOTAS, are included in ownership interests in and advances to affiliates. STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 ------------------------------------------------------------------------------------------- (in thousands) (unaudited) Revenue $ 15,964 $ 6,861 $ 34,572 $ 13,382 Operating expenses 27,639 20,117 54,979 45,837 ------------------------------------------------------------------------------------------- (11,675) (13,256) (20,407) (32,455) Other income (loss), net (28,300) 30,606 (37,575) 83,062 Interest and financing expense, net (3,229) 1,183 (5,977) (3,733) ------------------------------------------------------------------------------------------- Income (loss) before income taxes and equity income (loss) (43,204) 18,533 (63,959) 46,874 Income taxes (2,193) (224) 7,826 (19,561) Equity income (loss) (65,075) (16,139) (304,082) 4,455 ------------------------------------------------------------------------------------------- Net income (loss) $(110,472) $ 2,170 $ (360,215) $31,768 -------------------------------------------------------------------------------------------
13 14 The Company's shares of the income or losses of its less than wholly owned subsidiaries, primarily CompuCom, Tangram and SOTAS for the three and six months ended June 30, 2001, and including Arista for the three and six months ended June 30, 2000, are reflected in equity income (loss). 16. OPERATING SEGMENTS Our reportable segments include General Safeguard Operations, Partner Company Operations and CompuCom Operations. General Safeguard Operations includes the expenses of providing strategic and operational support to the Company's partner companies and private equity funds, and also includes the effect of certain private equity funds which the Company accounts for under the equity method. General Safeguard Operations also includes the effect of transactions and other events incidental to the Company's ownership interests in its partner companies and its operations in general. Partner Company Operations reflects the operations of all of the Company's partner companies other than CompuCom (included in CompuCom Operations). The partner companies included under Partner Company Operations are accounted for under either the consolidation or the equity method. CompuCom Operations includes the results of our majority-owned subsidiary, CompuCom. The following table reflects consolidated operating data by reported segments (in thousands). All significant intersegment activity has been eliminated. Accordingly, segment results reported exclude the effect of transactions between the Company and its subsidiaries. 14 15 The following summarizes information related to the Company's segments (in thousands). All significant intersegment activity has been eliminated.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 ------------------------------------------------------------------------------------------------------------------------ (UNAUDITED) SUMMARY OF CONSOLIDATED NET INCOME (LOSS) General Safeguard Operations $ (41,803) $ 43,696 $ (59,409) $ 62,488 Partner Company Operations (69,651) (41,840) (302,671) (26,946) CompuCom Operations 982 314 1,865 (3,774) ------------------------------------------------------------------------------------------------------------------------ $(110,472) $ 2,170 $ (360,215) $ 31,768 ------------------------------------------------------------------------------------------------------------------------ GENERAL SAFEGUARD OPERATIONS Revenue $ 6,334 $ 4,344 $ 12,962 $ 8,089 Operating expenses General and administrative 16,737 16,654 31,174 39,148 Depreciation and amortization 696 440 1,443 855 ------------------------------------------------------------------------------------------------------------------------ Total operating expenses 17,433 17,094 32,617 40,003 ------------------------------------------------------------------------------------------------------------------------ (11,099) (12,750) (19,655) (31,914) Other income (loss), net (28,300) 30,606 (37,575) 83,062 Interest and financing, net (2,958) 1,102 (5,837) (3,937) ------------------------------------------------------------------------------------------------------------------------ Income (loss) before income taxes and equity income (42,357) 18,958 (63,067) 47,211 Income taxes (820) (21,625) (64) (33,688) Equity income 1,374 46,363 3,722 48,965 ------------------------------------------------------------------------------------------------------------------------ Net Income (Loss) from General Safeguard Operations $ (41,803) $ 43,696 $ (59,409) $ 62,488 ------------------------------------------------------------------------------------------------------------------------ PARTNER COMPANY OPERATIONS Revenue $ 19,511 $ 6,720 $ 35,262 $ 14,750 Operating expenses Cost of sales 9,881 2,276 20,398 4,716 Selling and service 4,806 3,412 9,582 5,911 General and administrative 3,164 5,839 6,601 10,462 Depreciation and amortization 3,005 1,831 5,938 3,735 ------------------------------------------------------------------------------------------------------------------------ Total operating expenses 20,856 13,358 42,519 24,824 ------------------------------------------------------------------------------------------------------------------------ (1,345) (6,638) (7,257) (10,074) Interest and financing, net (49) (495) (188) (695) ------------------------------------------------------------------------------------------------------------------------ Loss before income taxes and equity loss (1,394) (7,133) (7,445) (10,769) Income taxes (1,366) 22,460 8,012 14,526 Minority Interest - 229 - 229 Equity loss (66,891) (57,396) (303,238) (30,932) ------------------------------------------------------------------------------------------------------------------------ Net Loss from Partner Company Operations $ (69,651) $ (41,840) $ (302,671) $ (26,946) ------------------------------------------------------------------------------------------------------------------------ COMPUCOM OPERATIONS Revenue Product sales $ 419,718 $ 637,460 $ 902,079 $1,149,105 Service sales 68,991 64,151 140,918 128,217 ------------------------------------------------------------------------------------------------------------------------ $ 488,709 $ 701,611 $1,042,997 $1,277,322 ------------------------------------------------------------------------------------------------------------------------ Operating expenses Cost of sales - Product 381,824 588,838 822,095 1,064,965 Cost of sales - Service 43,410 43,773 91,744 88,883 Selling and service 31,298 33,379 64,417 68,074 General and administrative 22,249 24,338 44,260 45,419 Depreciation and amortization 6,065 5,758 12,079 11,769 Restructuring - - - 5,169 ------------------------------------------------------------------------------------------------------------------------ Total operating expenses 484,846 696,086 1,034,595 1,284,279 ------------------------------------------------------------------------------------------------------------------------ 3,863 5,525 8,402 (6,957) Other income, net - 1,958 - 1,958 Interest and financing, net (748) (3,206) (2,477) (7,471) ------------------------------------------------------------------------------------------------------------------------ Income (loss) before income taxes and minority interest 3,115 4,277 5,925 (12,470) Income taxes (885) (2,004) (1,762) 2,056 Minority interest (1,248) (1,959) (2,298) 6,640 ------------------------------------------------------------------------------------------------------------------------ Net Income (Loss) from CompuCom Operations $ 982 $ 314 $ 1,865 $ (3,774) ------------------------------------------------------------------------------------------------------------------------
15 16 17. BUSINESS COMBINATIONS Acquisitions by the Company In January 2001, the Company acquired 100% of Palarco, Inc. for cash and stock, and an additional amount which is dependent upon the achievement of certain performance targets during the two years after the acquisition. Palarco is a provider of global information technology solutions, and provides a key services component to Safeguard's infrastructure strategy by augmenting the breadth and depth of Safeguard's consulting and implementation capabilities. In August 2000, aligne, the Company's wholly owned subsidiary, acquired 100% of K Consultants, Inc. for cash and an additional amount which is dependent upon achievement of certain performance targets of K Consultants during the first 12 months after the acquisition. K Consultants provides eBusiness infrastructure consulting services, including strategy, architecture, implementation and support. In February 2000, the Company acquired the remaining 20% voting ownership in aligne in exchange for shares of the Company's common stock. These transactions were accounted for as purchases and, accordingly, the consolidated financial statements reflect the operations of these companies since the acquisition date. In connection with its acquisitions, the Company has contingent consideration payable dependent upon the achievement of certain performance targets. The maximum amount of contingent consideration is approximately $16 million to be paid primarily in common stock (payable through 2003). Acquisitions by Subsidiaries In January 2001, CompuCom purchased certain assets of MicroAge Technology Services, L.L.C. The assets were purchased out of bankruptcy court and primarily consisted of trade accounts receivable as well as vendor accounts receivable and inventory. The purchase price of approximately $79 million (after post-closing adjustments) was financed using available cash. The purchased assets were used by MTS primarily in its business as a systems integrator of personal computer products. As part of the MTS acquisition, CompuCom also hired certain of MTS' national sales force, technical service personnel and administrative personnel. The business combination is being accounted for as a purchase and accordingly the consolidated financial statements reflect the operations of the acquired entity since the acquisition date. CompuCom has not completed the allocation of the purchase price for this acquisition. Therefore, the allocation of the purchase price could be adjusted once the valuation of the assets acquired and liabilities assumed is completed. The following unaudited pro forma financial information presents the combined results of operations of the Company as if the acquisitions had occurred as of January 1, 2000, after giving effect to certain adjustments, including amortization of goodwill, increased interest expense on debt related to the acquisitions, and related income tax effects. The pro forma results of operations are not indicative of the actual results that would have occurred had the acquisitions been consummated at the beginning of the period presented and is not intended to be a projection of future results.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2000 2000 --------------------- ------------------- (in thousands except per share amounts) Total revenues $1,014,504 $1,962,179 Net income (loss) $ (2,645) $ 22,987 Diluted income (loss) per share $ (0.02) $ 0.19
Unaudited pro forma consolidated results for the three and six months ended June 30, 2001, after giving effect to the 2001 acquisitions, would not have been materially different from the amounts reported. Subsequent Acquisition by Subsidiary On July 16, 2001, CompuCom purchased certain assets of Excell Data Corporation ("Excell") pursuant to the terms of the Asset Purchase Agreement dated as of July 11, 2001 entered into by and among CompuCom, Excell and Cambridge Technology Partners, Inc., the parent of Excell. Under the terms of the purchase agreement, CompuCom purchased certain assets of Excell for approximately 16 17 $27 million, subject to certain post-closing adjustments. The net assets acquired were used by Excell primarily in its business of high-end technical applications development, network infrastructure design and deployment and worldwide event technical planning and support. 18. COMMITMENTS AND CONTINGENCIES Litigation Arising Out Of The Initial Public Offering of Opus360 Corporation Beginning in April 2001, Safeguard, CompuCom Systems, Inc., a Safeguard affiliate, and an officer of Safeguard and Safeguard's designee as a Director of Opus360 Corporation, were named in putative class actions filed in federal court in New York. The plaintiffs allege material misrepresentations and/or omissions in connection with the initial public offering of Opus360 Corporation stock on April 7, 2000. The cases are brought against Opus360, its officers and directors (including the Safeguard designee), Safeguard, CompuCom, and Opus360's underwriters. In these cases, the plaintiffs allege, among other things, that the prospectus and registration statement for Opus360's initial public offering contained misrepresentations and/or omissions regarding: (1) Opus360's products, including Opus Xchange; (2) Opus360's cash flow and liquidity, including its "cash burn" rate; and (3) Opus360's relationships with its customers. Plaintiffs assert claims under Sections 11, 12 and 15 of the Securities Act of 1933. Plaintiffs seek damages in an amount in excess of $70 million. Safeguard expects that these cases will be consolidated into a single coordinated proceeding and that it will respond to the allegations following consolidation. While the outcome of this litigation is uncertain, the Company believes that it has valid defenses to plaintiffs' claims and intends to defend the lawsuits vigorously. Gilman v. Safeguard Scientifics, Inc. and Warren V. Musser On June 26, 2001, Safeguard and Warren V. Musser, Safeguard's Chairman, were named as defendants in a putative class action filed in federal court in Philadelphia. Plaintiffs allege that defendants failed to disclose that Mr. Musser had pledged some or all of his Safeguard stock as collateral to secure margin trading in his personal brokerage accounts. Plaintiffs allege that defendants' failure to disclose the pledge, along with their failure to disclose several margin calls and the consequences thereof on Safeguard's stock price, violated the federal securities laws. Plaintiffs allege claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Safeguard has not yet filed an answer to plaintiffs' Complaint. While the outcome of this litigation is uncertain, the Company believes that it has valid defenses to plaintiffs' claims and intends to defend the lawsuit vigorously. The Company and its subsidiaries are involved in various other 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. 19. RELATED PARTY TRANSACTIONS During October 2000, the Company extended a $10 million loan to the Company's Chairman and Chief Executive Officer, Mr. Musser, and guaranteed a $35 million loan to Musser, each in connection with his margin loan arrangements. Mr. Musser had incurred margin debt and obligations with respect to margin debt at several brokerage firms. The securities subject to the margin account included approximately 8,000,000 shares of Safeguard common stock. With the goal of maintaining an orderly trading market for Safeguard's stock, Safeguard extended the guarantee and advanced the loan. The $10 million loan bore interest at the prime rate and was payable in full on March 15, 2001. On December 3, 2000, Mr. Musser repaid in full the principal and accrued interest on the $10 million loan. Mr. Musser's obligations to the Company under the guarantee arrangements were secured by interests in securities and real estate. In May 2001, Safeguard consummated a definitive agreement with Mr. Musser under which the Company loaned Mr. Musser $26.5 million to repay in full Mr. Musser's margin loans which were guaranteed by the Company and to pay certain tax obligations and expenses. As a result of the repayment of these margin loans, the Company's $35 million guarantee was extinguished. The loan bears interest at an annual rate of 7% and is payable on demand at any 17 18 time after January 1, 2003. Mr. Musser granted the Company security interests in securities and real estate as collateral. Until April 30, 2006, the Company will have recourse only against the collateral. There can be no assurance that the proceeds realized by the Company in the future from dispositions of the collateral will be sufficient to repay the loan in full. After April 30, 2006, the Company will have recourse against Mr. Musser personally, except with respect to certain ongoing compensation to be received by Mr. Musser. The Company has the right to sell the collateral at any time and apply the net after-tax proceeds from the sales of collateral against amounts outstanding on the loan. The outstanding balance of the loan at June 30, 2001 was approximately $26 million. During June 2000, John Halvey, a senior officer of Safeguard, resigned from the Company. In connection with his separation, the Company agreed to forgive indebtedness of $0.5 million plus accrued interest in exchange for the transfer by the officer to the Company of shares of capital stock of certain Safeguard affiliates. In addition, Safeguard agreed to pay the officer approximately $0.1 million in respect of relocation and moving expenses. If the officer complies with various confidentiality and other obligations, in March 2002 the Company will forgive other loans to the officer aggregating $0.2 million and will make a $0.1 million severance payment to the employee. In 1999, the Company loaned an officer and a director of CompuCom $0.8 million 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. 18 19 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The statements contained in this report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve certain risks, uncertainties and other factors that could cause actual results to be materially different than those contemplated by these statements. These risks and uncertainties include the factors described elsewhere in this report and in our filings with the SEC, including our Annual Report on Form 10-K for the year ended December 31, 2000. We do not assume any obligation to update any forward-looking statements or other information contained in this report. Although we refer in this report to the companies in which we have acquired an equity ownership interest as our "partner companies" and that we indicate that we have a "partnership" with these companies, we are not a "partner" in a legal sense, and do not act as an agent or legal representative for any of our partner companies, we do not have the power or authority to legally bind any of our partner companies and we do not have the types of liabilities in relation to our partner companies that a general partner of a partnership would have. Certain amounts for prior periods in the consolidated financial statements, and in the discussion below, have been reclassified to conform with current period presentations. GENERAL We are a leader in identifying, developing and operating emerging technology companies through our extensive network of partner companies and private equity funds (collectively, affiliates). Our operations are classified into three operating segments: i) General Safeguard Operations; ii) Partner Company Operations; and iii) CompuCom Operations. We acquire interests in developing infrastructure technology companies, provide management support and operations services, and integrate these companies into our operating network. We focus on what we believe to be the most significant market sectors of the infrastructure technology industry: software, communications and e-Services. We believe our experience developing technology companies, our expertise in and focus on infrastructure technology and the reach of our network enable us to identify and attract companies with significant potential for success in the infrastructure technology market. Our principal mission is to create long-term shareholder value. We believe shareholder value is maximized by retaining and promoting the entrepreneurial culture of the partner companies that we operate. The entrepreneurs of our partner companies generally retain significant equity interests in their businesses, and their interests as shareholders remain aligned with ours. We provide a full range of operational and management services to each of our partner companies through dedicated teams of our professionals. Each team has expertise in the areas of business and technology strategy, sales and marketing, operations, finance and legal and transactional support, and provides hands-on assistance to the management of the partner company in support of its growth. The level of involvement varies and in some circumstances includes the provision of full-time interim personnel. Since we are a long-term partner, we pursue various alternatives to maximize the long-term value of our partner companies. These alternatives include preparing our partner companies for initial public offerings, assisting with mergers and acquisitions and facilitating additional capital raising activities. We participate in managing 11 private equity funds which are located on our corporate campus. In addition, we are a limited partner in 6 other private equity funds. Collectively, these 17 funds, which have over $3.6 billion of committed capital, augment our network by providing us with an expanded base through which we conduct our operations, including acquisition syndication opportunities. We believe our network of private equity funds creates opportunities for us and our partner companies to form strategic alliances and partnerships that may develop or enhance their businesses. Also, the personal relationships and expertise of the professionals employed by these funds are important resources for developing and evaluating acquisition opportunities. We frequently refer opportunities that may not fit our operating strategy or deal criteria to an appropriate fund. Because we acquire significant interests in technology-related developing companies, many of which generate net losses, we have experienced, and expect to continue to experience, significant volatility in our quarterly results. While some of our affiliates have consistently reported losses, we have recorded 19 20 net income in certain periods and experienced significant volatility from period to period due, in part, to one-time transactions and other events incidental to our ownership interests in and advances to affiliates. We do not know if we will report net income in any period. These transactions and events include dispositions of, and changes to, our affiliate ownership interests, dispositions of our holdings of affiliates and impairment charges. On a continuous basis, but no less frequently than at the end of each quarterly reporting period, we evaluate the carrying value of our ownership interests in and advances to each of our affiliates for possible impairment based on achievement of business plan objectives and milestones, the fair value of each ownership interest in and advances to each affiliate relative to its carrying value, the financial condition and prospects of the affiliate and other relevant factors. The business plan objectives and milestones we consider include, among others, those related to financial performance such as achievement of planned financial results or completion of capital raising activities, and those that are not primarily financial in nature, such as the hiring of key employees or the establishment of strategic relationships. We operate in an industry which is rapidly evolving and extremely competitive. It is reasonably possible that our accounting estimates with respect to the useful life and ultimate recoverability of the carrying value, including goodwill, could change in the near term and that the effect of such changes on our consolidated financial statements could be material. While we believe that the current recorded carrying values of our affiliates are not impaired, there can be no assurance that our future results will confirm this assessment or that a significant write-down or write-off of the carrying value will not be required in the future. EFFECT OF VARIOUS ACCOUNTING METHODS ON THE CONSOLIDATED FINANCIAL STATEMENTS The various interests that we acquire in our partner companies and private equity funds are accounted for under three broad methods: consolidation, equity and cost. The applicable accounting method is generally determined based on our voting interest in the entity. Consolidation. Partner companies in which we directly or indirectly own more than 50% of the outstanding voting securities are generally accounted for under the consolidation method of accounting. If this majority voting ownership is likely to be temporary, we account for the company under the equity method. Under the consolidation method, a partner company's results of operations are included within our consolidated statements of operations. Participation of other partner company shareholders in the income or losses of a consolidated partner company is reflected in minority interest in our consolidated statements of operations. The minority interest amount adjusts our consolidated net income (loss) to reflect only our share of the earnings or losses of the consolidated partner company. CompuCom Systems, Inc., Tangram Enterprise Solutions, Inc., SOTAS, Inc. and aligne, incorporated were consolidated in 2001 and 2000. In August 2000, aligne acquired 100% of K Consultants. In January 2001, we acquired 100% of Palarco, Inc. Each of these partner companies was consolidated from the date we acquired directly or indirectly more than 50% of the outstanding voting securities interest. Arista Knowledge Systems, Inc. was sold in July 2000 and is included in our consolidated operating results through its sale date. Equity Method. Partner companies and private equity funds whose results we do not consolidate, but over whom we exercise significant influence, or for whom majority voting ownership is likely to be temporary, are generally accounted for under the equity method of accounting. Whether or not we exercise significant influence with respect to a partner company depends on an evaluation of several factors including, among others, our representation on the partner company's board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the partner company, including voting rights associated with our holdings in common, preferred and other convertible instruments in the partner company. Under the equity method of accounting, a partner company's results of operations are not reflected within our consolidated statement of operations; however, our share of the income or losses of the partner company is reflected in equity income (loss) in our consolidated statements of operations. The share of income or losses is generally based upon our voting ownership of the partner company's securities, which may be different from the percentage of the economic ownership 20 21 of the partner company held by us. We also account for our interests in some private equity funds under the equity method of accounting, based on our respective general and limited partner interests. The effect of an affiliate's net results of operations on our results of operations is the same under either the consolidation method of accounting or the equity method of accounting, because under each of these methods only our share of the income or losses of an affiliate is reflected in our net results of operations in the consolidated statements of operations. Our partner companies accounted for under the equity method of accounting at June 30, 2001 included:
PARTNER VOTING VOTING COMPANY OWNERSHIP OWNERSHIP SINCE 6/30/01 12/31/00 ----- ------- -------- PUBLICLY TRADED: Cambridge Technology Partners 1991 17% 17% ChromaVision Medical Systems 1996 30% 30% DocuCorp International 1995 18% 18% eMerge Interactive 1997 17% 17% Internet Capital Group 1996 14% 14% Lifef/x 1996 46% 12% OAO Technology Solutions 1996 31% 31% Sanchez Computer Associates 1986 25% 25% USDATA Corporation 1994 43% 40% PRIVATELY HELD: AgWeb.com 2000 43% 43% Atlas Commerce 2000 34% 35% Buystream 2000 25% 31% Data Center Direct 2000 76% 76% iMedium 1999 31% 31% Kanbay 1998 30% 30% Mantas 2001 30% n/a Mi8 2000 27% 27% NexTone Communications 2000 37% 38% Nextron Communications 1995 56% 54% Persona 1999 30% 30% QuestOne Decision Sciences 1997 31% 31% Redleaf Group 1999 31% 30% TechSpace 2000 45% 45% ThinAirApps 2000 34% 34% WebTelecom 2000 53% 53% Wireless OnLine 2000 43% 43%
21 22 We have representation on the boards of directors of these partner companies. Although we own less than 20% of the voting stock of some of these companies, we believe we have the ability to exercise significant influence based on our representation on each company's board of directors and other factors. We own greater than 50% of the voting stock of some of these companies; however, we believe majority voting ownership is temporary. In addition to our holdings in equity and debt securities, we also periodically make advances to our affiliates in the form of promissory notes. The carrying value of advances to affiliates totaled $12.5 million and $7.3 million at June 30, 2001 and December 31, 2000. Cost Method. Partner companies and private equity funds that we do not account for under either the consolidation or the equity method of accounting are accounted for under the cost method of accounting. Under this method, our share of the income or losses of these entities is not included in our consolidated statements of operations. However, the effect of the change in market value of cost method holdings classified as trading securities is reflected in our results of operations during each reporting period. EFFECT OF VARIOUS ACCOUNTING METHODS ON THE PRESENTATION OF OUR CONSOLIDATED FINANCIAL STATEMENTS The presentation of our financial statements may differ from period to period primarily due to the applicable accounting method used for recognizing our equity interests in the operating results of an affiliate. For example, the presentation of our financial statements are significantly influenced by the consolidated results of operations of CompuCom, which we consolidate based on our 59% voting interest. To understand our net results of operations and financial position without the effect of consolidating our consolidated partner companies, please refer to note 15 to our consolidated financial statements, which summarizes our parent company statements of operations and balance sheets and presents consolidated partner companies as if they were accounted for under the equity method of accounting. Our share of the income or losses of the consolidated partner companies is included in equity income (loss) in the parent company statements of operations. The carrying value of these companies is included in ownership interests in and advances to affiliates in the parent company balance sheets. Although the parent company statements of operations and balance sheets presented in note 15 reflect our historical results, they are not necessarily indicative of future parent company balance sheets and statements of operations. NET RESULTS OF OPERATIONS The following table reflects consolidated operating data by reported segments. All significant intersegment activity has been eliminated. Accordingly, segment results reported exclude the effect of transactions between us and our subsidiaries.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ----------------------------------------------------------------------------------------------------- 2001 2000 2001 2000 ----------------------------------------------------------------------------------------------------- (in thousands) (unaudited) SUMMARY OF CONSOLIDATED NET INCOME (LOSS) General Safeguard Operations $ (41,803) $ 43,696 $ (59,409) $ 62,488 Partner Company Operations (69,651) (41,840) (302,671) (26,946) CompuCom Operations 982 314 1,865 (3,774) ----------------------------------------------------------------------------------------------------- $ (110,472) $ 2,170 $(360,215) $ 31,768 -----------------------------------------------------------------------------------------------------
22 23 NET RESULTS OF OPERATIONS - GENERAL SAFEGUARD OPERATIONS General Safeguard Operations includes the expenses of providing strategic and operational support to our affiliates, and also includes the effect of certain private equity funds that we account for under the equity method. General Safeguard Operations also includes the effect of transactions and other events incidental to our ownership interests in our partner companies and our operations in general.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 --------------------------------------------------------------------------------------------------------------- (in thousands) (unaudited) Revenue $ 6,334 $ 4,344 $ 12,962 $ 8,089 Operating expenses General and administrative 16,737 16,654 31,174 39,148 Depreciation and amortization 696 440 1,443 855 ---------------------------------------------------------------------------------------------------------------- Total operating expenses 17,433 17,094 32,617 40,003 ---------------------------------------------------------------------------------------------------------------- (11,099) (12,750) (19,655) (31,914) Other income (loss), net (28,300) 30,606 (37,575) 83,062 Interest and financing, net (2,958) 1,102 (5,837) (3,937) ---------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes and equity income (42,357) 18,958 (63,067) 47,211 Income taxes (820) (21,265) (64) (33,688) Equity income 1,374 46,363 3,722 48,965 ---------------------------------------------------------------------------------------------------------------- Net Income (Loss) from General Safeguard Operations $ (41,803) $ 43,696 $ (59,409) $ 62,488 ----------------------------------------------------------------------------------------------------------------
Revenue. Revenue consists of management fees charged to private equity funds for operational and management services. Revenue was $6.3 million and $4.3 million for the three months ended June 30, 2001 and 2000, and $13.0 million and $8.1 million for the six months ended June 30, 2001 and 2000. This increase was related to additional management fees charged to private equity funds as a result of the formation of additional private equity funds during 2000. General and Administrative. Our general and administrative expenses consist primarily of employee compensation, outside services such as legal, accounting and consulting, and travel-related costs. General and administrative were flat for the three months ended June 30, 2001 compared to 2000. Excluding general and administrative costs related to the private equity funds and $2.3 million of non-cash charges in 2000, general and administrative decreased $1.7 million for the three months ended June 30, 2001 compared to the prior year period. The reduction is the result of certain cost reduction efforts undertaken in the fourth quarter of 2000. General and administrative costs decreased $8.0 million for the six months ended June 30, 2001 compared to the same period in 2000. Excluding general and administrative costs related to the private equity funds and $8.0 million of non-cash charges in 2000, general and administrative costs decreased $5.0 million for the six months ended June 30, 2001 compared to the prior year period. The reduction is the result of certain cost reduction efforts undertaken in the fourth quarter of 2000. 23 24 Other Income (Loss), Net. Other income, net, for the General Safeguard Operations segment consisted of the following:
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 ---------------------------------------------------------------------------------------------- (in thousands) (unaudited) Gain on sale of public holdings, net $ 1,551 $ 7,466 $ 1,392 $ 59,873 Gain on sale of private partner companies, net 1,454 19,760 1,518 $ 19,809 Unrealized loss on derivative financial instrument (12,196) -- (16,528) -- Unrealized loss on trading securities, net (272) (820) (1,126) (820) Other, primarily impairment charges (18,837) 4,200 (22,831) 4,200 ---------------------------------------------------------------------------------------------- $(28,300) $ 30,606 $(37,575) $ 83,062 ----------------------------------------------------------------------------------------------
During the three months ended June 30, 2000, we sold shares of public holdings, including Diamond Technology Partners, for aggregate net proceeds of $25.2 million and recorded gains of $7.5 million. During the six months ended June 30, 2000, we sold shares of public holdings, including Diamond Technology Partners and eMerge Interactive (in its IPO), for aggregate net proceeds of $85.9 million and recorded gains of $59.9 million. We implemented SFAS 133 effective January 1, 2001. The net loss recognized during the three months ended June 30, 2001 on the Tellabs forward sale contracts was $12.2 million, including a $60.8 million gain on the change in fair value of the hedging contract excluded from the assessment of the hedge effectiveness, and the ineffective portion of the hedge, reduced by a $73.0 million loss on the change in fair value of the Tellabs holdings. The net loss recognized during the six months ended June 30, 2001 on these forward sale contracts was $16.5 million. This loss includes a $77.3 million gain on the change in the fair value of the hedging contract, reduced by a $93.8 million loss on the change in fair value of the Tellabs holdings. Included in other income, net, for the three and six months ended June 30, 2001 are impairment charges of approximately $18.8 million and $22.8 million for certain holdings accounted for under the cost method determined to have experienced an other than temporary decline in value. Interest and Financing Expense, Net. Interest expense was $3.0 million for the three months ended June 30, 2001 versus $1.1 million of income for the three months ended June 30, 2000. Interest expense was $5.8 million for the six months ended June 30, 2001 and $3.9 million for the six months ended June 30, 2000. The change is due to higher interest income earned in 2000 on funds raised in our April 2000 follow-on public offering and from strategic investors. Income Taxes. The Company's consolidated income tax expense recorded for the three months ended June 30, 2001, was $3.1 million net of a recorded valuation allowance of $37.9 million. The Company's consolidated income tax benefit recorded for the six months ended June 30, 2001, was $6.2 million net of a recorded valuation allowance of $115.7 million. The Company has recorded a valuation allowance to reduce its deferred tax asset to an amount that is more likely than not to be realized in future years. 24 25 NET RESULTS OF OPERATIONS - PARTNER COMPANY OPERATIONS Partner Company Operations reflects the operations of all of our partner companies other than CompuCom (included in CompuCom Operations). The partner companies included in Partner Company Operations are accounted for under either the consolidation or the equity method.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------------------------------------------------------------------------------- 2001 2000 2001 2000 ---------------------------------------------------------------------------------------------------- (in thousands) (unaudited) Revenue $ 19,511 $ 6,720 $ 35,262 $ 14,750 Operating expenses Cost of sales 9,881 2,276 20,398 4,716 Selling and service 4,806 3,412 9,582 5,911 General and administrative 3,164 5,839 6,601 10,462 Depreciation and amortization 3,005 1,831 5,938 3,735 ---------------------------------------------------------------------------------------------------- Total operating expenses 20,856 13,358 42,519 24,824 ---------------------------------------------------------------------------------------------------- (1,345) (6,638) (7,257) (10,074) Interest and financing, net (49) (495) (188) (695) ---------------------------------------------------------------------------------------------------- Loss before income taxes and equity loss (1,394) (7,133) (7,445) (10,769) Income taxes (1,366) 22,460 8,012 14,526 Minority Interest - 229 - 229 Equity loss (66,891) (57,396) (303,238) (30,932) ---------------------------------------------------------------------------------------------------- Net Loss from Partner Company Operations $(69,651) $(41,840) $(302,671) $(26,946) ----------------------------------------------------------------------------------------------------
Revenue. Revenue consists of charges for consulting services by our wholly owned subsidiary, aligne, K Consultants subsequent to its acquisition by aligne in August 2000, and Palarco subsequent to its acquisition in January 2001. Revenue also includes sales by Tangram and SOTAS. Revenue was $19.5 million and $6.7 million for the three months ended June 30, 2001 and 2000, and $35.3 million and $14.8 million for the six months ended June 30, 2001 and 2000. The increase in revenue in 2001 was the result of the acquisitions of K Consultants in August 2000 and Palarco in January 2001. Operating Expenses. Operating expenses were $20.9 million and $13.4 million for the three months ended June 30, 2001 and 2000 and $42.5 million and $24.8 million for the six months ended June 30, 2001 and 2000. The increase in expenses in 2001 was the result of the acquisitions of K Consultants and Palarco. Equity Loss. A significant portion of our net results of operations is derived from companies in which we hold a significant minority ownership interest. Under the equity method of accounting, if we exercise significant influence over a partner company, we record our share of the income or losses of that partner company in our consolidated statements of operations. The share of income or losses is generally based upon our voting ownership of the partner company's securities. Our carrying value for a partner company accounted for under the equity method includes the unamortized excess of the cost of our interest in the partner company over its equity in the underlying net assets determined at the date of acquisition. This excess is amortized on a straight-line basis generally over a 3 to 10 year period and is included in equity income (loss) in the consolidated statements of operations. Equity income (loss) fluctuates with the number of companies accounted for under the equity method, our voting ownership percentage in these companies, the amortization of goodwill related to newly acquired equity method companies and the net results of operations of these companies. Equity income (loss) also includes impairment charges when management determines there has been an other than temporary decline in the carrying value of its ownership interest relative to the fair value. Equity loss was $66.9 million and $57.4 million for the three months ended June 30, 2001 and 2000. During the three months ended June 30, 2001 and 2000, we accounted for 30 and 34 companies on the equity method. During the three months ended June 30, 2000, $25.1 million of our equity loss was attributable to Internet Capital Group. Goodwill amortization of $6.8 million and $4.2 million is included in equity loss for the three months ended June 30, 2001 and 2000. Write-downs for the other than temporary declines 25 26 in value of partner companies of $20.6 million and $2.3 million for the three months ended June 30, 2001 and 2000, are also included in equity loss. The remaining equity loss of $39.5 million and $25.8 million for the three months ended June 30, 2001 and 2000 relates to our share of 30 and 33 partner company operating results, a majority which have losses. Equity loss was $303.2 million and $30.9 million for the six months ended June 30, 2001 and 2000. During the six months ended June 30, 2001, we accounted for 33 companies on the equity method versus 37 in 2000. During the six months ended June 30, 2001, $136.5 million of loss was attributable to Internet Capital Group versus $24.8 million of income for the six months ended June 30, 2000. Goodwill amortization of $14.5 million and $7.2 million is included in equity loss for the six months ended June 30, 2001 and 2000. Write-downs for the other than temporary declines in value of partner companies of $58.5 million and $4.7 million for the six months ended June 30, 2001 and 2000, are also included in equity loss. The remaining equity loss of $93.7 million and $43.8 million for the six months ended June 30, 2001 and 2000 relates to our share of 32 and 36 partner company operating results, a majority which have losses. Certain amounts recorded to reflect our share of the income or losses of our partner companies accounted for under the equity method are based on estimates and on unaudited results of operations of those partner companies and may require adjustments in the future when audits of these entities are made final. Many of our privately held, equity method partner companies are technology-related companies with limited operating histories that have not generated significant revenues and incurred substantial losses in 2000. We expect these losses to continue in 2001. We expect to continue to acquire interests in more technology-related companies that may have operating losses and that we may account for under the equity method. Additionally, we expect certain of our existing partner companies to continue to invest in their products and services and to recognize operating losses. As a result, equity losses could continue to increase significantly. Additionally, we operate in an industry that is rapidly evolving and extremely competitive. It is reasonably possible that the impairment factors evaluated by management will change in subsequent periods, given that we operate in a volatile business environment. This could result in material impairment charges in future periods. NET RESULTS OF OPERATIONS - COMPUCOM OPERATIONS CompuCom Operations reflects the results of our majority-owned subsidiary, CompuCom.
THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, 2001 2000 2001 2000 --------------------------------------------------------------------------------------------------------------- (in thousands) (unaudited) Revenue Product sales $ 419,718 $ 637,460 $ 902,079 $ 1,149,105 Service sales 68,991 64,151 140,918 128,217 ---------------------------------------------------------------------------------------------------------------- 488,709 701,611 1,042,997 1,277,322 ---------------------------------------------------------------------------------------------------------------- Operating expenses Cost of sales - Product 381,824 588,838 822,095 1,064,965 Cost of sales - Service 43,410 43,773 91,744 88,883 Selling and service 31,298 33,379 64,417 68,074 General and administrative 22,249 24,338 44,260 45,419 Depreciation and amortization 6,065 5,758 12,079 11,769 Restructuring - - - 5,169 ---------------------------------------------------------------------------------------------------------------- Total operating expenses 484,846 696,086 1,034,595 1,284,279 ---------------------------------------------------------------------------------------------------------------- 3,863 5,525 8,402 (6,957) Other income, net - 1,958 - 1,958 Interest and financing, net (748) (3,206) (2,477) (7,471) ---------------------------------------------------------------------------------------------------------------- Income (loss) before income taxes and minority interest 3,115 4,277 5,925 (12,470) Income taxes (885) (2,004) (1,762) 2,056 Minority interest (1,248) (1,959) (2,298) 6,640 ---------------------------------------------------------------------------------------------------------------- Net Income (Loss) from CompuCom Operations $ 982 $ 314 $1,865 $ (3,774) ----------------------------------------------------------------------------------------------------------------
26 27 On January 10, 2001, CompuCom purchased certain assets of MicroAge Technology Services, L.L.C. (MTS). The assets were purchased out of bankruptcy court and primarily consisted of trade accounts receivable as well as vendor accounts receivable and inventory. The purchase price of approximately $79 million (after post-closing adjustments) was financed using available cash. The purchased assets were used by MTS primarily in its business as a systems integrator of personal computer products. As part of the MTS acquisition, CompuCom also hired certain of MTS' national sales force, technical service personnel and administrative personnel. Revenue. Product revenue, which is primarily derived from the sale of desktop, networking, and mobile computing products, as well as peripherals and software-related products to corporate clients, decreased approximately 34.2% in the three months ended June 30, 2001 and decreased 21.5% for the six months ended June 30, 2001 compared to 2000. CompuCom believes the decline in product revenue can be attributed to general economic weakness reflected in lower demand for personal computer products as product purchases are being delayed, downsized or cancelled. In addition, CompuCom believes the decline in product revenue is due to the increased competitiveness and aggressiveness of certain manufacturers to sell or fulfill client's requirements in a more direct fashion. Service revenue is primarily derived from all aspects of desktop outsourcing, including field engineering, as well as help desk and LAN/WAN network outsourcing, configuration, asset tracking, software management, mobile computing services, IT consulting and services provided in support of certain manufacturers' direct fulfillment initiatives. Service revenue reflects revenue generated by the actual performance of specific services and does not include product sales associated with service projects. Service revenue increased approximately 7.5% in the three months ended June 30, 2001 compared to 2000 and increased 9.9% for the six months ended June 30, 2001 compared to 2000. The increase in service revenue was primarily due to increased revenue related to field engineering and help desk outsourcing. These increases were partially offset by declines in service revenue due to lower demand for CompuCom's consulting services and manufacturer warranty contracts. Gross Margin. Product gross margin as a percentage of product revenue was 9.0% and 7.6% for the three months ended June 30, 2001 and 2000 and 8.9% and 7.3% for the six months ended June 30, 2001 and 2000. This increase is the result of relatively less high volume, low margin activity with CompuCom's larger clients as well as the benefit realized from certain operational efficiencies, partially offset by the impact of the increase in lower margin software license revenue. Service gross margin as a percentage of service revenue was 37.1% and 31.8% for the three months ended June 30, 2001 and 2000 and 34.9% and 30.7% for the six months ended June 30, 2001 and 2000. The increase was due primarily to improvements in the management and utilization of service-related resources. Due to both the general economic environment and competitive conditions, CompuCom expects to continue to experience competitive pressure on both revenue and gross margin, the result of which may be to report lower revenue and related gross margin when compared to the comparable prior year period. Selling and Service. Selling and service expense decreased $2.1 million for the three months ended June 30, 2001 compared to 2000, and decreased $3.7 million for the six months ended June 30, 2001 compared to 2000. The decrease relates primarily to CompuCom's cost management efforts relative to personnel and infrastructure, partially offset by increased training costs and investments in the service infrastructure associated with supporting the service business. Selling and service expenses were 6.4% and 4.8% of revenue for the three months ended June 30, 2001 and 2000 and 6.2% and 5.3% for the six months ended June 30, 2001 and 2000. CompuCom attributes this percentage increase to the decline in product revenue for the comparable periods and to increased personnel, training costs and investments in the service infrastructure associated with supporting the service business. General and Administrative. General and administrative expenses decreased $2.1 million in the three months ended June 30, 2001 compared to the prior year period and decreased $1.2 million in the six months ended June 30, 2001 compared to the prior year period. The decrease in general and administrative expense is reflective of CompuCom's ongoing cost management efforts relative to personnel-related and infrastructure costs. CompuCom's operating expenses are reported net of reimbursements by certain manufacturers for specific training, promotional and marketing programs. These reimbursements offset the expenses incurred by CompuCom. Restructuring. In 2000, CompuCom implemented a restructuring plan designed to reduce its cost structure by closing and consolidating certain sites and reducing its workforce. As a result, CompuCom recorded a restructuring charge of $5.2 million in the first quarter of 2000. 27 28 Interest and Financing Expense, Net. Interest and financing expense, net was $0.7 million and $3.2 million for the three months ended June 30, 2001 and 2000 and $2.5 million and $7.5 million for the six months ended June 30, 2001 and 2000. The decrease in financing expense is primarily due to CompuCom's improved management of working capital, as well as less financing requirements given the decline in product revenue, resulting in lower financing levels in the three and six months ended June 30, 2001 as compared to the prior year periods. The decline in financing expense was also due to the effect of higher interest income generated from investing increased available cash as well as slightly lower effective interest rates in 2001 as compared to 2000. LIQUIDITY AND CAPITAL RESOURCES We have funded our operations with proceeds from the issuance of equity securities and convertible notes, proceeds from forward sale contracts, proceeds from sales of partner companies and distributions from private equity funds. If the stock markets decline significantly, availability under the credit facility could be reduced significantly and could have an adverse effect on our availability to borrow under the facility. Our ability to raise proceeds for sales of publicly traded partner companies could also be adversely affected by market declines. We have a revolving credit facility of up to $100 million depending on the market value of pledged securities. The facility matures in May 2002 and is secured by certain equity securities we hold of our publicly traded partner companies. Based on the provisions of the borrowing base, availability under the bank facility at June 30, 2001 was $100 million (less outstanding letters of credit of $0.7 million) and there were no amounts outstanding. Our cash and cash equivalents at June 30, 2001 and other internal sources of cash flow are expected to be sufficient to fund our cash requirements for at least the next twelve months, including commitments to our existing affiliates, our current operating plan to acquire interests in new affiliates and our general corporate requirements. In October 2000, we guaranteed a $35 million loan to our Chairman and CEO, Mr. Musser, in connection with margin loan arrangements. In May 2001, we consummated a definitive agreement with Mr. Musser under which we loaned Mr. Musser $26.5 million to repay in full Mr. Musser's margin loans which were guaranteed by us and to pay certain tax obligations and expenses. As a result of the repayment of these margin loans, our $35 million guarantee was extinguished. The loan bears interest at an annual rate of 7% and is payable on demand at any time after January 1, 2003. Mr. Musser granted us security interests in securities and real estate as collateral. Until April 30, 2006, we will have recourse only against the collateral. There can be no assurance that the proceeds realized by the Company in the future from dispositions of the collateral will be sufficient to repay the loan in full. After April 30, 2006, we will have recourse against Mr. Musser personally, except with respect to certain ongoing compensation to be received by Mr. Musser. We have the right to sell the collateral at any time and apply the net after-tax proceeds from the sales of collateral against amounts outstanding on the loan. The outstanding balance of the loan at June 30, 2001 was approximately $26 million. At June 30, 2001 we were contingently obligated for $14 million of guarantee commitments. Additionally, we have committed capital of approximately $127.8 million, including commitments made in prior years to various affiliates, to be funded over the next several years, including approximately $72.6 million which is expected to be funded in the next twelve months. If a consolidated partner company achieves agreed upon performance criteria over the next two years, we will be obligated to pay up to an aggregate amount of $16 million primarily in common stock as additional purchase price consideration to the former shareholders of the company. CompuCom maintains separate, independent financing arrangements, which are non-recourse to us and are secured by certain assets of CompuCom. CompuCom's working capital requirements are generally funded through financing arrangements and internally generated funds. At June 30, 2001, CompuCom has financing arrangements consisting of a $150 million receivables securitization facility and a $100 million working capital facility. The working capital facility matures in May 2002, and availability under the working capital facility is subject to a borrowing base calculation. Availability under the working capital facility was approximately $74 million at June 30, 2001, and no amounts were outstanding. Of the $106 million outstanding on the securitization facility at June 30, 2001, $56 million matures in April 2002 and $50 million in October 2003. Both the receivables securitization facility and the working capital facility are subject to CompuCom's compliance with selected financial covenants and ratios. CompuCom's liquidity continues to be negatively impacted by the dollar volume of certain manufacturers' rebate programs. Under these programs, CompuCom is required to pay a higher initial amount for product and claim a rebate from the manufacturer to reduce the final cost. The collection of these rebates can take an extended period of time. Due to these programs, CompuCom's initial cost for the product is often higher than the sales price CompuCom can obtain from its clients. These programs 28 29 are a material factor in CompuCom's financing needs. As of June 30, 2001, CompuCom was owed approximately $24 million under these vendor rebate programs. CompuCom's ability to make distributions to its shareholders is limited by restrictions in CompuCom's financing agreements and CompuCom's working capital needs. We do not consider CompuCom's liquidity to be a source of liquidity to us. Consolidated working capital increased to $436 million at June 30, 2001 compared to $314 million at December 31, 2000. This increase is due to the reclassification of the Tellabs holdings from available for sale to trading securities, based on the implementation of SFAS 133. Also affecting working capital was an increase in cash and cash equivalents offset by decreases in receivables and inventories. Cash provided by operating activities increased in 2001 compared to 2000 due to increased operating cash flow by CompuCom. This is primarily attributable to decreases in receivables and inventories. CompuCom's receivables have decreased primarily due to the decline in revenue relative to the fourth quarter of 2000. Partially offsetting the impact of CompuCom's lower revenue levels was a reduction in the amount of receivables utilized under their securitization facility. The decrease in CompuCom's inventories is primarily due to lower product demand and CompuCom's ongoing efforts to minimize risk associated with suppliers' price protection and returns programs by maintaining lower inventory levels, which resulted in higher inventory turns. Cash used in investing activities primarily reflects the acquisition of ownership interests in and advances to affiliates. Cash used in investing activities also reflects acquisitions by our subsidiaries. The decrease relates primarily to reduced acquisition activity in 2001 and the decrease in short-term investments and restricted cash, partially offset by reduced sales of securities and sales of and distribution from affiliates. During the first six months of 2001, we made net commitments of approximately $51.4 million to acquire interests in and make advances to partner companies, and we funded $62.6 million to partner companies and private equity funds. From July 1, 2001 through August 10, 2001, we funded $9.7 million of commitments made prior to June 30, 2001. In July 2001, Novell acquired all of the outstanding shares of Cambridge Technology Partners (Massachusetts), Inc. in exchange for Novell common stock. We received 6.9 million shares of Novell, which we subsequently sold for $34.4 million of proceeds. In addition, in August 2001, we completed the sale of our interests in a private equity fund, receiving proceeds of approximately $23 million. On July 16, 2001, CompuCom purchased certain assets and assumed certain liabilities of Excell Data Corporation ("Excell") pursuant to terms of the Assets Purchase Agreement dated as of July 11, 2001 entered into by and among CompuCom, Excell and Cambridge Technology Partners, Inc., the parent of Excell. Under the terms of the purchase agreement, CompuCom purchased certain assets of Excell for approximately $27 million, subject to certain post-closing adjustments. The net assets acquired were used by Excell primarily in its business of high-end technical applications development, network infrastructure design and deployment, and worldwide event technical planning and support. Our general operations are not capital asset intensive, and capital expenditures in any year normally will not be significant in relation to our overall financial position. There were no material capital asset purchase commitments at June 30, 2001. RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations", and SFAS No. 142, "Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. SFAS No. 141 also specifies criteria that intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. SFAS No. 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS No. 142. SFAS No. 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of". The Company is required to adopt the provisions of SFAS No. 141 immediately, except with regard to business combinations initiated prior to July 1, 2001, and SFAS No. 142 will become effective January 1, 2002. Because of the extensive effort needed to comply with adopting SFAS No's. 141 and 142, it is not practicable to reasonably estimate the impact of adopting these statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle. 29 30 FACTORS THAT MAY AFFECT FUTURE RESULTS We operate in a rapidly changing environment that involves a number of risks, some of which are beyond our control. Forward-looking statements in this report and those made from time to time by us through our senior management are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Factors that could cause actual results to differ materially from results anticipated in forward-looking statements are described in our SEC filings, including our Annual Report on Form 10-K for the year ended December 31, 2000. These factors include, but are not limited to, the following: - Industry-specific conditions affecting the infrastructure technology business sector in which many of our affiliates operate, such as intense competition, rapid changes in technology and customer demands, frequent new product introductions and shifting distribution channels. - Many of our affiliates are early-stage companies with limited operating histories, no historical profits and financing requirements that they may not be able to satisfy. These affiliates may not have operating income or net income in the future and their financial results may vary dramatically from quarter to quarter. - We may have problems raising money we need in the future to fund the needs of our affiliates and to make acquisitions of affiliates. - We may incur significant costs to avoid investment company status and may suffer adverse consequences if deemed to be an investment company. - Our strategy of selling assets of our interests in some of the affiliates that we have acquired and developed is dependent on the strength of the public equity market and on the level of activity in the mergers and acquisitions market in the affiliate's industry, as well as on the requirements of the Federal securities laws regulating the sale of securities. - Our financial results are likely to vary dramatically from quarter to quarter depending upon various events. These events include the financial results of our affiliates and the way that the partner companies are reflected in our consolidated financial statements, sales of partner companies or our interests in partner companies and distributions from private equity funds which we manage or in which we have an interest. - Our stock price may be subject to significant fluctuation because the value of some of our partner companies fluctuates and because of market conditions generally. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to equity price risks on the marketable portion of our securities. These securities include equity positions in companies in the technology industry, many of which have experienced significant volatility in their stock prices. Historically, we have not attempted to reduce or eliminate our market exposure on securities (except the Tellabs transactions as described below). Based on closing market prices at June 30, 2001, the fair market value of our holdings in public securities was approximately $375 million (excluding our holdings in Tellabs). A 20% decrease in equity prices would result in an approximate $75 million decrease in the fair value of our publicly traded securities. In 1999, we entered into two forward sale contracts related to our remaining holdings in Tellabs. We pledged 3.4 million shares of Tellabs for three years and in return received approximately $139 million in cash. At the end of the term, we have the option to deliver cash or Tellabs shares with a value determined by the stock price of Tellabs at maturity. The number of Tellabs shares to be delivered at maturity ranges from 2.7 million to 3.4 million shares (or the cash value thereof). Availability under our bank credit facility is determined by the market value of the publicly traded securities pledged as collateral. As of June 30, 2001, $100 million was available under this facility. If the market value of these securities decreased 20%, the availability under the facility would be reduced to $87.2 million. We are also exposed to interest rate risk primarily through our bank credit facility. At June 30, 2001, there were no borrowings outstanding under the facility. 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 and other financing needs. At June 30, 2001, the securitization facility had borrowings of approximately $106 million, and there were no borrowings on the working capital facility. If CompuCom's effective 30 31 interest rate were to increase by 100 basis points, or 1.00%, CompuCom's annual interest and financing expense would increase by $1.3 million based on CompuCom's average borrowings during the six months ended June 30, 2001. Our share of this increase would be approximately $0.8 million after deduction for minority interest but before income taxes. 31 32 PART II OTHER INFORMATION Item 1. Legal Proceedings Safeguard and various associated entities and persons have been named in two putative class action proceedings, one of which arises out of the initial public offering of Opus 360 Corporation. These proceedings are described in Note 18 of the Notes to Consolidated Financial Statements contained in Item 1 of Part I of this Form 10-Q, which note is incorporated by reference in its entirety into this Item 1. Item 4. Submission of Matters to a Vote of Security Holders The Company held its Annual Meeting of Shareholders on May 23, 2001. At the meeting the shareholders voted in favor of the following items listed in the Proxy Statement dated April 17, 2001: I Election of Directors
For Withheld --- -------- Warren V. Musser 95,726,499 4,578,136 Robert E. Keith, Jr. 98,597,200 1,707,435 Harry Wallaesa 98,495,611 1,809,024 Vincent G. Bell, Jr. 95,976,031 4,328,604 Walter W. Buckley, III 94,881,075 5,423,560 Michael J. Emmi 98,714,684 1,589,951 Robert A. Fox 98,508,684 1,795,951 Jack L. Messman 98,554,579 1,750,056 Russell E. Palmer 98,694,031 1,610,604 John W. Poduska, Sr. 98,656,056 1,648,579 Heinz C. Schimmelbusch 98,419,162 1,885,473 Hubert J.P. Schoemaker 98,759,318 1,545,317 Carl J. Yankowski 95,493,184 4,811,451
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Number Description ------ ----------- 3.1*** Safeguard Scientifics, Inc. Amended Bylaws 10.1** Fourth Amendment to Inventory and Working Capital Financing Agreement dated as of January 10, 2001 by and between CompuCom Systems, Inc. and IBM Credit Corporation 10.2* Credit Agreement dated May 23, 2001, by and among Safeguard Scientifics, Inc., Safeguard Scientifics (Delaware), Inc., Safeguard Delaware, Inc., and PNC Bank, NA (exhibits omitted) 10.3* Consulting Agreement dated July 3, 2001 between Safeguard Scientifics, Inc. and Vincent G. Bell, Jr. 10.4* Amended and Restated Demand Note dated May 18, 2001 given by Warren V. Musser for advances by Bonfield Insurance, LTD
32 33 10.5* Agreement to Restructure by and among Warren V. Musser and Hillary Grinker Musser and Safeguard Scientifics, Inc. and Bonfield Insurance, LTD, dated as of April 16, 2001 10.6* Amendment to Agreement to Restructure by and among Warren V. Musser and Hillary Grinker Musser and Safeguard Scientifics, Inc. and Bonfield Insurance, LTD, dated May 18, 2001 10.7**** Amendment Number 1, dated as of May 17, 2001 to the Series 2000-1 Supplement, dated as of October 2, 2000, by and among CSI Funding, Inc., CompuCom Systems, Inc., Lloyds TSB Bank PLC and Wells Fargo Bank Minnesota, National Association (f/k/a Norwest Bank Minnesota, National Association). 10.8**** Amendment Number 2, dated as of May 17, 2001 to the Series 1999 -1 Supplement, dated as of May 7, 1999, as amended and restated as of August 20, 1999 and as amended by Amendment Number 1, dated as of October 2, 2000, by and among CSI Funding, Inc., CompuCom Systems, Inc., PNC Bank, National Association, Market Street Funding Corporation and Wells Fargo Bank Minnesota, National Association (f/k/a Norwest Bank Minnesota, National Association). * Filed herewith ** Filed on April 2, 2001 as Exhibit 10.28.5 to the Company's Annual Report on Form 10-K and incorporated herein by reference. *** Filed on May 15, 2001 as Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the three months ended March 31, 2001, and incorporated herein by reference. ****Filed on August 14, 2001 as Exhibits 10.1 and 10.2 to CompuCom Systems, Inc.'s Quarterly Report on Form 10-Q for the three months ended June 30, 2001, and incorporated herein by reference.
b) Reports on Form 8-K No reports on Form 8-K have been filed by the registrant during the three months ended June 30, 2001. 33 34 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
SAFEGUARD SCIENTIFICS, INC. (Registrant) Date: August 14, 2001 /s/ Vincent G. Bell, Jr. ------------------------------------ Vincent G. Bell, Jr. Acting Chief Executive Officer Date: August 14, 2001 /s/ Gerald A. Blitstein ------------------------------------ Gerald A. Blitstein Executive Vice President and Chief Financial Officer (Principal Financial and Principal Accounting Officer)
34