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Securities and Exchange Commission
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998 Commission File Number 1-5620
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SAFEGUARD SCIENTIFICS, INC.
(Exact name of Registrant as specified in its charter)
Pennsylvania 23-1609753
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
800 The Safeguard Building
435 Devon Park Drive, Wayne, PA 19087
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (610) 293-0600
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of Each Class on which registered
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Common Stock ($.10 par value) New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: NONE
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 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 _____
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. |_|
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Aggregate market value of common stock held by non-affiliates (based on the
closing price on the New York Stock Exchange) on March 25, 1999 was
approximately $1.84 billion. For purposes of determining this amount only,
Registrant has defined affiliates as including (a) the executive officers named
in Part III of this 10-K report, (b) all directors of Registrant, and (c) each
stockholder that has informed Registrant by March 25, 1999 that it is the
beneficial owner of 10% or more of the outstanding common stock of Registrant.
The number of shares outstanding of the Registrant's Common Stock, as of March
25, 1999 was 32,149,402.
DOCUMENTS INCORPORATED BY REFERENCE
The following documents are incorporated by reference in this Form 10-K:
PART I
Item 1(b) Note 15 on page 54 of the Annual Report to Stockholders
for the year ended December 31, 1998, which page is filed as
part of Exhibit 13 hereto.
PART II
Items 5, 6,
7 and 8 Pages 33 to 56 of the Annual Report to Stockholders for the
year ended December 31, 1998, which pages are filed as part of
Exhibit 13 hereto.
PART III
Items 10, 11,
12 and 13 Definitive Proxy Statement relative to the May 20, 1999 annual
meeting of stockholders of Registrant, to be filed within 120
days after the end of the year covered by this Form 10-K
Report.
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PART I
ITEM 1. BUSINESS
(a) GENERAL DEVELOPMENT OF THE BUSINESS
OVERVIEW
Safeguard Scientifics, Inc. is a diversified information technology company that
develops, operates and manages emerging growth information technology companies.
We are currently focusing on emerging opportunities in eCommerce, enterprise
applications, and network infrastructure, all of which are expected to benefit
from the growing use of the Internet as a fundamental business tool. We work
closely with our partnership companies to provide numerous operational and
management services to build value in preparation for public rights offerings
and beyond. These services include active strategic management, operating
guidance, merger and acquisition assistance, board and management recruitment,
and innovative financing. Safeguard operates as a long-term partner. Our
partnership companies include public and privately held companies that together
form a community of shared resources. Safeguard also participates in managing
and working with several venture capital funds.
We believe that Safeguard's strategy of operating through separate partnership
companies rather than through wholly owned subsidiaries or divisions enables us
to achieve superior returns for our stockholders. This strategy enables us to
partner with highly motivated entrepreneurs who have significant equity
ownership stakes in their companies and the chance to reap the rewards of taking
their companies public. We further enhance the returns to our stockholders by
taking selected partnership companies public through our rights offering
process. This process gives our stockholders the opportunity to acquire direct
ownership in selected partnership companies at their IPO price. Not all of our
private partnership companies are appropriate for a rights offering. We also
consider mergers, sales, and traditional IPOs in evaluating the best way to
enhance the value of our private companies. For traditional IPOs we are
considering a program to direct a part of the shares to be offered to Safeguard
stockholders. We currently refer to this as a "subscription offering." After
taking a partnership company public, Safeguard generally retains a significant
ownership interest and board representation, and continues to provide strategic,
managerial, and operational support.
Safeguard is currently active in the Internet through the involvement of over 10
of our partnership companies, including Internet Capital Group. We recognized
the growing importance of the Internet early on, and we sponsored the formation
of Internet Capital Group in 1996 to focus exclusively on developing, operating,
and managing business-to-business eCommerce companies. Because of the tremendous
growth of the Internet in recent years and the success of Internet Capital
Group, we have recently decided to broaden Safeguard's involvement in Internet
markets in order to continue to build value for our stockholders. We are
concentrating on segments that we believe will have staying power in the
volatile Internet markets.
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We define eCommerce as the organization of information and the processing of
business transactions over the Internet (intranets and extranets). The
transactions can be of any type, including those between customers and sellers,
employers and employees, or organizations and their members. eCommerce can
extend existing business models or enable entirely new ones. eCommerce markets
we are seeking to develop include business-to-consumer interaction, content
aggregation and management, emerging technology areas such as intelligent
agent-based searching and tasking, and Internet professional services.
Enterprise applications are software solutions that integrate key operational
aspects of entire organizations. We are seeking to develop opportunities that
provide novel front office enterprise applications, professional services to
integrate, implement and support enterprise applications, and the hosting of
enterprise applications.
Network infrastructure products and services include computing and
communications tools that enable companies to deploy eCommerce and enterprise
applications. Many companies do not have the infrastructures in place to support
leading edge eCommerce and enterprise applications. Network infrastructure
markets we are seeking to develop include network security products and
services, companies that service the ISP market, telecommunications services
that enable eCommerce, products that optimize customers' existing investments in
eCommerce and enterprise applications, and infrastructure management solutions.
Many early and mid-stage Internet companies have operating losses. As we acquire
interests in more of these companies, we could experience significantly
increased equity losses from affiliates.
Safeguard's public partnership companies are: Cambridge Technology Partners,
Inc. (Nasdaq:CATP), ChromaVision Medical Systems, Inc. (Nasdaq:CVSN), CompuCom
Systems, Inc. (Nasdaq:CMPC), Diamond Technology Partners, Incorporated
(Nasdaq:DTPI), DocuCorp International, Inc. (Nasdaq:DOCC), OAO Technology
Solutions, Inc. (Nasdaq:OAOT), Sanchez Computer Associates, Inc.(Nasdaq:SCAI),
Tangram Enterprise Solutions, Inc. (Nasdaq:TESI), and USDATA Corporation
(Nasdaq:USDC).
Safeguard's private partnership companies include: 4anything.com, aligne, Arista
Knowledge Systems, Diablo Research Company, eMerge Vision Systems, Extant,
Integrated Visions, The Intellisource Group, Internet Capital Group, Kanbay,
MegaSystems, MultiGen-Paradigm, Pac-West Telecomm, Pacific Title/Mirage,
QuestOne Decision Sciences, US Interactive, Whisper Communications, Who? Vision
Systems, and XL Vision.
Safeguard also participates in management of the following venture funds:
EnerTech Capital Partners, Pennsylvania Early Stage Partners, Safeguard
International Fund, SCP Private Equity Partners, and TL Ventures I, II, and III.
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RECENT DEVELOPMENTS
Stock market conditions for much of 1998 negatively affected the IPO market. As
a result, Safeguard completed only one rights offering rather than three as
planned. Instead, Safeguard redirected its efforts to strengthening its existing
partnership companies and acquiring interests in new partnership companies.
o The rights offering for DocuCorp International was successfully
completed in the first quarter of 1998. DocuCorp is a provider of
enterprise-wide document automation software products and services.
o Safeguard acquired interests in seven new partnership companies
during 1998: Arista, Integrated Visions, Kanbay, Pennsylvania Early
Stage Partners, Pac-West Telecomm, US Interactive, and Who? Vision.
During the first quarter of 1999, Safeguard acquired interests in
4anything.com, Extant, and aligne.
o Coherent Communication Systems Corporation merged with Tellabs in
August 1998, and Safeguard received approximately 3.5 million shares
of Tellabs common stock in exchange for our holdings in Coherent.
o Integrated Systems Consulting Group merged with First Consulting
Group in December 1998, and Safeguard received common stock and
warrants in First Consulting Group common stock in exchange for our
holdings in ISCG.
o Sentry Technology Group was sold to the Meta Group Inc. in October
1998 for Meta stock and warrants.
o RMS Information Systems merged with Intellisource during the second
quarter of 1998, and Safeguard's shares in RMS were exchanged for
Intellisource shares.
o Our partnership companies completed twelve business acquisitions
during 1998.
o Pennsylvania Early Stage Partners was formed in early 1998 in
cooperation with the Commonwealth of Pennsylvania and the
Pennsylvania Public School Employees Retirement System to invest in
seed stage companies primarily in Pennsylvania.
o In late 1998 CompuCom announced a restructuring plan to move to a
virtual office model and a reduction in workforce, which should
result in significant operating cost savings.
ITEM 1 (b). FINANCIAL INFORMATION ABOUT OPERATING SEGMENTS
Information on net sales, operating profit, and assets employed for each
operating segment of Safeguard's business for the three year period ended
December 31, 1998 is contained in Note 15 to the Consolidated Financial
Statements on page 54 of Safeguard's Annual Report to
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Stockholders for the year ended December 31, 1998, which is filed as part of
Exhibit 13 hereto and is incorporated herein by reference.
ITEM 1 (c). NARRATIVE DESCRIPTION OF BUSINESS
OVERVIEW OF OPERATING SEGMENTS
In 1998, Safeguard adopted SFAS 131, which requires the reporting of operating
segments using the "management approach" versus the "industry approach"
previously required. Safeguard's reportable segments for 1998 consist of general
corporate operations, CompuCom, and Tangram. General corporate operations
consist of developing, operating, and managing emerging growth, information
technology partnership companies, excluding our majority-owned subsidiaries,
CompuCom and Tangram, and participating in the management of venture capital
funds. CompuCom's operations include sales of distributed desktop computer
products, and configuration, network integration, and technology support.
Tangram's operations include the design, development, sale, and implementation
of enterprise-wide asset tracking and software management solutions. CompuCom
and Tangram are majority-owned subsidiaries of Safeguard.
GENERAL CORPORATE OPERATIONS
Operating Strategy
Safeguard seeks to identify companies which are capable of being market leaders
in segments of the information technology industry and which are at a stage of
development that would benefit from Safeguard's support, financing, and market
knowledge. Safeguard generally seeks to acquire a large enough stake in a
partnership company to enable us to have significant influence over the
management and policies of the company and to realize a large enough return to
compensate us for our investment of management time and effort, as well as
capital.
We gain exposure to emerging companies through our reputation as a successful
developer and operator of information technology companies, referrals from our
existing partnership companies, our relationship with venture capital and
private equity funds, our sponsorship of such organizations as the Eastern
Technology Council, entrepreneurial centers at Lehigh University, Temple
University and the University of Pennsylvania, a new eCommerce center at Drexel
University, and the participation of our officers and employees in various
non-profit and charitable organizations. We consider our access to potential
partnership companies to be good.
Emerging companies traditionally seek financing for growth from two primary
sources: independent private venture capital funds and corporate strategic
investors. Each of these sources has disadvantages for the emerging company.
Venture capital funds generally are established for a limited term and their
primary goal is to maximize their financial return within a short time frame. A
venture capital fund often seeks to liquidate its investment in the emerging
company by encouraging either an early initial public offering or a sale. In
addition, traditional venture capital funds generally have limited resources
available to provide managerial and operational support to an emerging company.
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Corporate strategic investors are typically large corporations that invest in
emerging companies to obtain access to a promising product or technology without
incurring the initial cost of development or the diversion of managerial time
and attention necessary to develop new products or technologies. Often these
investments involve both financing support to the emerging company as well as an
arrangement under which the strategic investor obtains access to the products or
technology of the emerging company. While strategic investors are generally able
to provide business development support, the rationale behind the investment of
a strategic investor may be incompatible with the development of the emerging
company. Strategic investors often discourage the emerging company from becoming
a public company.
We believe that our relationship with our partnership companies offers the
benefits of both the venture capital model and the strategic investor model
without the related drawbacks. Safeguard has both the capital and managerial
resources to provide financing and strategic, managerial, and operational
support as needed by an emerging company. In addition, we encourage emerging
companies to achieve the superior returns on investment generally provided by
public offerings, but only if and when it is appropriate for the development of
the business of that emerging company. Because of our unique process of taking
partnership companies public through rights offerings to Safeguard stockholders,
we continue our involvement with partnership companies after their initial
public offerings. This support is often crucial to help a company adjust to the
challenges imposed by the public financial markets.
Our corporate staff provides hands-on assistance to the managers of our
partnership companies in the areas of management, financial, marketing, tax,
risk management, human resources, legal and technical services. We have assisted
partnership companies by providing or locating and structuring financing,
identifying and implementing strategic initiatives, providing marketing
assistance, identifying and recruiting executives and directors, assisting in
the development of equity incentive arrangements for executives and employees,
and providing assistance in structuring, negotiating, documenting, financing,
implementing and integrating mergers and acquisitions.
We also provide a supportive environment to the managers of our partnership
companies by organizing numerous opportunities for them to interact with
managers of other partnership companies to share strategies, ideas, and insights
and to forge business relationships. Twice a year we gather the senior managers
of all of our partnership companies, both private and public, for a "Senior
Partners" conference. We also convene periodic "CFO Conferences" for senior
financial managers of the partnership companies and occasional sessions on more
specific topics, such as investor relations and human resources. While we
encourage our partnership companies to develop business opportunities with each
other, we do not require them to do so. Each partnership company is responsible
for its own success, and it must be free to work with other organizations that
will provide the maximum contribution to its success. Competition for business
even within Safeguard helps keep each partnership company focused on being the
best of breed in their market.
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In recent years, Safeguard has tended to acquire substantial minority ownership
interests rather than majority interests in many of its partnership companies.
In many of these cases, Safeguard, either alone or in conjunction with our
associated venture funds, is the largest single stockholder, and exercises
significant influence over the company. We also generally obtain significant
board representation in these companies.
We believe that the entrepreneurial energy and creativity of the managers of our
partnership companies is an essential component of their success. Our business
strategy of keeping partnership companies as independent businesses with the
chance to go public, rather than folding them into the parent company, is
designed to maintain the necessary entrepreneurial environment. The
entrepreneurs and their teams retain or are granted equity ownership and
incentives in their own companies in order to keep them focused on creating
value for their stockholders, including Safeguard.
Our goal is to maximize the value of our partnership companies for Safeguard's
stockholders, often by taking partnership companies public through a rights
offering at the appropriate time. A rights offering is an initial public
offering of a partnership company directed to Safeguard's stockholders. It
involves the grant by a partnership company to Safeguard's stockholders of
transferable rights to buy shares of the partnership company's stock at the IPO
price. Safeguard stockholders are able to exercise the rights, thereby
participating in initial public offerings of high-growth technology companies
which are usually reserved for large institutional investors, or they may sell
the rights. Safeguard generally retains a significant ownership in partnership
companies after taking them public and also generally retains significant
participation on each company's board of directors. Between our direct
continuing ownership interest in public partnership companies and the strong
identification in the public financial markets of the companies as "Safeguard
rights offering" companies, we retain a substantial interest in the continuing
success of the companies after their IPOs and substantial influence over their
management and strategic direction. Growth in the value of the public
partnership companies benefits Safeguard and also directly benefits our
stockholders who continue to hold the shares purchased in the rights offering.
Not all of our private partnership companies are appropriate for a rights
offering. We also consider mergers, sales, and traditional IPOs in evaluating
the best way to enhance the value of our private companies. Each time one of our
partnership companies undertakes a traditional IPO, we presently intend to try
to direct a part of the shares to be offered to Safeguard stockholders. We are
presently referring to this as a "subscription offering."
Public Partnership Companies
Cambridge Technology Partners is an international management consulting and
systems integration firm. Cambridge combines management consulting, IT strategy
consulting, process innovation and implementation, custom and package software
deployment (including ERP applications), network services, Internet professional
services, and training to rapidly deliver end-to-end business solutions for
clients. Cambridge provides the majority of its services on a fixed-time,
fixed-price model with client involvement at all stages of the process. In
performing
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its services, Cambridge employs a rapid development methodology and conducts
facilitated workshops that bring together key client users, executives, and IT
professionals to achieve consensus on the business case, strategic objectives,
and functionality of a business solution. Cambridge believes that this approach
permits the delivery of results in unprecedented time frames -- typically within
three to twelve months. Upon completion of initial consulting engagements,
Cambridge typically designs and develops one or more strategic software
applications, which often include custom and third-party package software, and
then rolls-out such applications to the organization's end-users. A significant
portion of Cambridge's engagements include an eCommerce component. While the
early stages of a client engagement may result in a relatively small amount of
revenue, a client engagement which involves the design and development of a
strategic software application typically results in fees ranging from $1 million
to $6 million. Because of the size of these assignments, clients may undertake
projects on an irregular basis. However, no customer accounted for more than 5%
of net revenues in 1998. Revenue growth has been negatively impacted by a
general slowdown in the growth of demand and increased competition. Cambridge
has 53 offices and more than 4,400 employees worldwide. Cambridge had 1998
revenues of $612 million, an increase of 40% over 1997. At March 22, 1999,
Safeguard owns approximately 13% of Cambridge's fully diluted common stock.
ChromaVision Medical Systems is a laboratory medical diagnostics company that
develops and manufactures an Automated Cellular Imaging System (ACIS(TM)) for a
wide variety of clinical and research applications. ChromaVision currently
markets the products to research centers and is previewing the system to
university medical centers and commercial laboratories in anticipation of
receiving clearance from the FDA for use of ACIS for immunohistochemical
applications based on a filing made in November 1998, which would result in
several commercialized applications. The ACIS and one application, leukocyte
alkaline phosphatase (LAP), were cleared in June 1997. The ChromaVision ACIS is
designed to identify cells with specific characteristics within a sample of
cells on a microscope slide by detecting color produced by the reaction between
common laboratory reagents and the cells of interest. The intelligent microscope
platform automates the scanning of patient samples and uses proprietary imaging
software to capture digital images of the cell samples to detect the presence,
count the number, and measure the intensity of targeted cells. The system offers
substantial flexibility because the software can be configured to identify
different stains and cellular staining characteristics, thereby allowing the
system to be adopted for use with different reagents to identify a broad range
of targeted cellular conditions.
ChromaVision believes that the ChromaVision ACIS will be attractive to
healthcare providers and beneficial to their patients because of its ability to
deliver superior diagnostic solutions, thus reducing the need for more invasive
or more costly procedures. Tests have demonstrated that the ChromaVision ACIS
can locate a single abnormal cell among 120 million normal cells. This improved
detection capability enables the ChromaVision ACIS to be applied to high-value
rare event detection procedures, including micrometastases/minimum residual
disease cancer detection.
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ChromaVision's initial targeted applications are:
o Breast cancer - ChromaVision is testing the ACIS for use with DAKO's
FDA-cleared HercepTest(TM) to measure the HER-2 protein, which is an
indicator for the use of Genentech's FDA-cleared Herceptin(TM)
breast cancer therapy.
o Micrometastases (MM) and minimum residual disease (MRD) - Clinical
tests indicate that the ACIS can be used to accurately and
cost-effectively detect and quantify MM and MRD, which would make
the ACIS a useful tool for detecting and monitoring various types of
cancer.
o Quantitative viral load for HIV.
o Triple Plus(TM) screen for Down syndrome in fetuses. Clinical trials
are still ongoing for this application.
ChromaVision has signed an exclusive distribution and development agreement with
Sigma Diagnostics for the Triple Plus(TM) and has signed an agreement with DAKO
Corporation to jointly develop, market and sell a tissue-based diagnostic
system, for which HercepTest will be the first application. ChromaVision intends
to offer its systems to hospitals and laboratories on a "per click" basis,
charging a fee for each time the laboratory uses the system to perform a
diagnostic procedure.
ChromaVision is currently marketing its products to physicians and researchers
throughout the world for research use, but it is still a development stage
company and had no material commercial revenues in 1998. Commencement of
commercial revenue generating activities will be contingent on successful
completion of clinical tests and, in most cases, obtaining FDA or foreign
regulatory approvals. ChromaVision is an XL Vision company. At March 22, 1999,
Safeguard owns 23% of ChromaVision's fully diluted stock.
Diamond Technology Partners is a management consulting firm that synthesizes
business strategy with information technology to deliver innovative "digital
strategies," business strategies for the digital age. Diamond delivers its
strategic consulting and information technology solutions through a single,
integrated multi-disciplinary team. Diamond serves clients across the U.S. and
internationally in financial services, consumer products, consumer services,
telecommunications, energy, insurance, and healthcare industries. Diamond had
revenues of $76.2 million for calendar year 1998 compared to $63.2 million for
calendar year 1997. At March 22, 1999, Safeguard owns approximately 7% of
Diamond's fully diluted stock.
DocuCorp is a leading provider of document automation software, professional
services, and process/print outsourcing with over 800 customers in the
insurance, utilities, financial services, and other information-intensive
industries. DocuCorp automates open-architecture, enterprise-wide, high-volume
creation, publishing, archival, and management (including workflow) of
strategic, personalized documents (such as bill presentment, insurance policies,
direct mail correspondence, invoices, and other customer-oriented documents) for
both print and electronic applications including the Internet. DocuCorp had
revenues of $25.2 million for the six months ended January 31, 1999, a 14%
increase over the same period in 1997. At March 22, 1999, Safeguard owns 9% of
the fully diluted stock of DocuCorp.
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OAO Technology Solutions is an enterprise information technology infrastructure
solution company. OAOT provides a wide range of outsourced information
technology ("IT") solutions and professional services, including the operation
of large-scale data center complexes and networks (high volume system of
computers and information networks), distributed systems management,
applications software development and maintenance, staffing services, enterprise
resource planning, integration, implementation and training services, and
software solutions for the managed care market. OAOT provides these solutions
and services, generally on a long-term, fixed-price contractual basis, to its
strategic customers which are global providers of IT outsourcing services. OAOT
works with these strategic customers as part of the IT outsourcing team in
providing services to a wide range end-user customers accepting delivery
responsibility for specific functional roles within the outsourcing engagements.
OAOT's primary strategic customers have been IBM's Global Services and Compaq
Computer Corporation, which accounted for 67% and 23.4% of OAOT's 1998 revenues,
respectively. OAOT acquired OAOT Services and Enterprise Technology Group in
1998 to expand its service offerings. Greg Pratt, formerly CEO of Enterprise
Technology Group, was named the new CEO of OAOT. In January 1999 the company
announced a large multi-year applications development and maintenance contract
with IBM Global Services. OAOT's revenues were $113.3 million in 1998, a 34%
increase from 1997. A significant part of the growth was from the July 1998
acquisition of OAOT Services, Inc.
OAOT's strategy is to build long-term relationships with strategic customers by
understanding their business needs and by providing specific services within
large-scale outsourcing engagements more cost-effectively than other
alternatives. By offering fixed-price contracts, OAOT reduces the execution and
pricing risk for its strategic customers in their large-scale outsourcing
engagements. OAOT has developed and is continuing to expand its international
service delivery capabilities in order to leverage its strategic customers'
increasingly global IT outsourcing efforts.
Large-scale outsourcing engagements typically involve the acquisition of IT
assets by the outsourcing provider from the engagement client. These assets can
range from fixed assets, such as entire data centers and computer networks, to
personnel, such as data center, help desk and programming staff. OAOT's role in
outsourcing engagements usually involves the retention of IT personnel from the
engagement client. By retaining employees as part of its new outsourcing
engagements, to date, OAOT's growth has not been impeded by the availability of
qualified technical personnel and OAOT has avoided the significant staffing
costs and expenses normally associated with new engagements within the IT
services industry. OAOT's future success is highly dependent on its
relationships with a small number of strategic customers and its ability to
effectively manage its fixed-price contracts. At March 22, 1999, Safeguard owns
27% of OAOT's outstanding stock.
Sanchez Computer Associates designs, develops, markets, implements, and supports
a comprehensive banking software system called PROFILE(R) for financial services
organizations worldwide. Sanchez's highly flexible PROFILE family of products is
comprised of several
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integrated modules which operate on open client-server platforms. The primary
module, called PROFILE/Anyware, is a highly flexible, multi-currency,
multi-language bank production system which supports deposit, loan, customer,
transaction processing and bank management requirements through multiple
distribution channels, including the Internet. In early 1999, Sanchez announced
a new service offering called e-PROFILE.com, designed to provide financial
institutions with the ability to offer differentiated direct banking services to
customers via a dedicated e-banking service center. The company will charge a
fee per account processed for its e-PROFILE service, as opposed to up front
license fees and, when used by the customer, implementation service fees and
annual maintenance fees for its PROFILE products.
The PROFILE system is currently licensed to 37 clients in 14 countries serving
in excess of 350 financial institutions. In any given year, the company
typically has three to four customers who each account for in excess of 10% of
its total annual revenues, although in 1998, only one customer exceeded 10% of
total revenues. Sanchez utilizes a direct sales force and strategic
relationships with Compaq, Hewlett-Packard, IBM, PricewaterhouseCoopers,
ComputerLand SA of Poland, and others to market, sell, implement, and support
its products worldwide. Currently, Sanchez is targeting three market segments:
the top-tier banking market (the top 1,000 global banks; the direct banking
market (the on line retail banking business conducted via alternate distribution
channels); and emerging market banks.
Sanchez had total revenues of $44.1 million for 1998, a 53% increase over 1997.
More than half of revenues were from software license fees, with the balance
primarily from implementation, consulting services, and maintenance fees.
Sanchez spent $11.7 million in 1998 on product development. At March 22, 1999,
Safeguard owns approximately 24% of Sanchez's fully diluted stock.
USDATA Corporation is a global supplier of real-time manufacturing application
development software and development tools and related consulting services that
enable an organization's information systems to supervise, monitor, and control
manufacturing and other automated processes and to interface with management
information systems. USDATA's family of software products, marketed under the
name FactoryLink(R), provides a powerful set of software tools designed for
users who are technically competent but who may not be experienced software
programmers.
Its real-time data management capabilities enable customers to reduce operating
costs, shorten cycle times, improve product quality, and increase productivity.
USDATA faces intense competition from larger businesses that offer broader
arrays of integrated solutions.
In mid-1998, USDATA sold its system integration and hardware servicing business.
This business has historically been engaged in the design and turnkey
implementation of integrated third-party data collection systems that allow
remote, real-time data collection using a variety of automatic identification
techniques.
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USDATA'S 1998 revenues from continuing operations were $22.9 million compared to
$22.4 million for 1997.
At March 22, 1999, Safeguard owns approximately 28% of USDATA's fully diluted
stock.
Private Partnership Companies
The following are Safeguard's significant private partnership companies.
4anything.com is a network of vertical community portals, with approximately
2,000 vertical portals. Its portals feature vertically integrated content,
commerce, search, and community. The company generates revenues from
advertising, directories, lead generation, and eCommerce. Pennsylvania Early
Stage Partners provided the first round of financing to 4anything.com in 1998,
and Safeguard acquired 20% of 4anything.com's fully diluted stock in the first
quarter of 1999. The company is still in the development stage and had nominal
revenues in 1998. It expects to commence a significant marketing launch in April
1999.
aligne incorporated is a strategic technology management consulting firm. Its
services include high level and in-depth evaluations of complex sourcing
alternatives, IT cost baselining and benchmarking, vendor/customer negotiations,
interim CIO services, IT strategy, and IT process reengineering. aligne's
clients include Fortune 500 companies in addition to a number of Safeguard
partnership companies. aligne was founded by Harry Wallaesa, now Safeguard's
President and COO. Safeguard acquired 80% of aligne's fully diluted stock in
February 1999.
Arista Knowledge Solutions provides complete solutions for the management of
information and knowledge in global applications. Arista's first product,
Accredix(TM), is under development and targets the Internet-based and
network-based distributed learning market, enabling users to deliver, manage,
and access any type of digital content, track activity with all learners,
accommodate commercial transactions, protect intellectual property rights, and
report learner activities and progress in extreme detail. Accredix can perform
these functions on a real-time basis while acting as a flexible, network-based
interface for learners, instructors, and managers. The company expects to
release the beta version of Accredix in the first half of 1999 and the
commercial version in the second or third quarter of 1999. The company's target
markets include corporate global learning customers, the education industry, and
the military. Arista is a development stage company with nominal revenues in
1998. At March 22, 1999, Safeguard owns approximately 40% of the fully diluted
stock of Arista.
Diablo Research Corporation is a contract engineering company with expertise in
data transmission and control, software and firmware design, digital and RF ASIC
design, functions/systems test design, design services for chip vendors, and
mechanical and industrial design. A number of Diablo's engagements result in the
creation of valuable technology assets which can potentially be spun out into
independent companies. Diablo has previously spun out Whisper Communications to
commercialize its two-way wireless automatic meter reading technology. Diablo
had 1998 revenues of $21.8 million. The company made management
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changes during 1998 to improve its internal processes and operations. At March
22, 1999, Safeguard owns units representing 17% of Diablo's fully diluted
ownership units. Diablo is a limited liability company.
eMerge Vision Systems provides a comprehensive package of eCommerce business
solutions and health management services to the food animal sciences industry.
eMerge Vision's Internet-based information system improves customers' ability to
manage multiple aspects of their business, including health, yield, and
inventory, through a "practice integrated website.(TM)" The company conducts
online cattle auctions which reduces the cost of buying livestock and improves
the health of the animals by reducing the number of times the animals are
transported. The company's infrared technology helps improve detection of sick
animals, and its feed supplements help restore the animals' health. eMerge
Vision's initial target market is the North American cattle industry. eMerge
Vision is an XL Vision company. eMerge Vision has refocused its business
strategy toward food animal sciences, and its 1998 revenues were primarily from
discontinued operations. At March 22, 1999, Safeguard owns 31% of eMerge
Vision's fully diluted stock.
Extant offers wholesale extranet and virtual private network services to
Competitive Local Exchange Carriers (CLECs) and Internet Service Providers
(ISPs). Extant acts as a market maker for CLECs and ISPs, providing a low cost
transport and internet protocol data network that significantly lowers the
information industry's barriers to entry. Extant brings together these
telecommunication providers as a community, offering a high quality, low cost,
responsive information network on which they can exchange traffic among
themselves at better than competitive rates and present to their customers the
appearance of a global footprint. Safeguard acquired 20% of Extant's fully
diluted stock in March 1999.
Integrated Visions is a provider of network security solutions based on
biometric authentication, initially to the healthcare industry. The company's
Privacy Curtain(TM) software enables secure and convenient access to
computerized patient records on intranets, extranets, and across the Internet
for telemedicine applications using biometrics, including fingerprint
identification technologies from Who? Vision Systems. The company's Clinical
Single Sign-On(TM) solution eliminates the need for multiple passwords and
provides compliance with patient record privacy legislation. Integrated Visions'
customers include The Mayo Clinic and Scott & White Medical Center. Integrated
Visions is an XL Vision company. Integrated Visions is a development stage
company and had nominal revenues in 1998. At March 22, 1999, Safeguard owns
approximately 47% of the fully diluted stock of Integrated Visions.
The Intellisource Group is a unique "Services Integrator(TM)" providing
integrated support for its customers' back-office activities, such as facilities
management, communications, accounting, human resources, document management,
etc. The company is the result of a merger in 1998 between two Safeguard
partnership companies, Intellisource, Inc. and RMS Information Systems, Inc.
Intellisource has a joint venture with Shell Services, which received a
long-term outsourcing contract for Shell Oil, and has obtained additional
long-term contracts from Oglethorpe Power, Avon, NASA, and others.
Intellisource's future success depends on its ability
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to effectively manage its fixed-price contracts and to leverage the resources in
its existing engagements to generate and support additional business.
Intellisource had combined 1998 revenues of $135.3 million compared to $112.2
million in 1997. The company is focused on strategies to help it achieve
profitability. At March 22, 1999, Safeguard owns 36% of the fully diluted stock
of Intellisource.
Internet Capital Group was organized in 1996 with Safeguard's sponsorship as the
first Internet operating company to partner exclusively with leading
business-to-business eCommerce firms. Like Safeguard, Internet Capital provides
operational assistance, capital support, expertise, and a strategic network of
business relationships intended to maximize the long-term potential of its
collaborative network of more than 25 business-to-business eCommerce partnership
companies. In February 1999, VerticalNet became Internet Capital's first
partnership company to complete an IPO. At March 22, 1999, Safeguard owns 24% of
the fully diluted stock of Internet Capital.
Kanbay is an IT consulting firm utilizing a multi-site approach to provide
competitively priced system integration solutions. It places project leadership
at the client site and leverages a large group of IT professionals located in
Pune, India. Kanbay assists organizations through IT development and support
outsourcing services, enterprise systems implementation, and systems compliance
and renovation projects. Kanbay also focuses on the implementation and
integration of packaged solutions for the financial industry as well as customer
care, billing, and customer retention for the telecommunications industry.
Kanbay was profitable on 1998 revenues of $35.7 million. At March 22, 1999,
Safeguard owns 28% of the fully diluted stock of Kanbay.
MegaSystems is a full service provider of products and services for the large
format movie theater industry. MegaSystems' technologically advanced large
format projection systems provide low cost, turn-key solutions to meet the needs
of large format theater operators. MegaSystems produced a large format motion
picture on the 1998 Winter Olympics under an exclusive license from the
International Olympic Committee. MegaSystems revenues for 1998 were $2.3
million. At March 22, 1999, Safeguard owns 49% of MegaSystems' fully diluted
stock.
MultiGen-Paradigm develops and markets leading real-time 3D authoring software
tools and turn-key image generator solutions, enabling commercial and military
customers to interactively create, edit, and view applications for visual
simulation, simulation-based training, game development, broadcasting, and urban
simulation. The company released WindowsNT versions of its products in 1998. The
company's Solutions Center provides customers with customized services,
including integration and content development. The company is the result of the
September 1998 merger between MultiGen, Inc. and Paradigm Simulation. The
company's combined 1998 revenues were $16.5 million. At March 22, 1999,
Safeguard owns 20% of MultiGen's fully diluted stock.
Pac-West Telecomm is a high growth, profitable, switch-based CLEC (Competitive
Local Exchange Carrier) with operations in California. The company has three
switches serving all of California and has points-of-presence in each of the 11
local access and transport areas (LATAs) in California, allowing it to originate
and terminate traffic in every LATA in the state. The
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company has also established a strong position in providing Internet Service
Providers (ISPs) with communications solutions. Pac-West Telecomm closed a $150
million debt offering in later 1998 to finance its expansion plans. The company
has over 41,000 ISP lines in service, and had 1998 revenues of $42.2 million. At
March 22, 1999, Safeguard owns 16% of the fully diluted stock of Pac-West
Telecomm.
Pacific Title/Mirage consists of two divisions: Optical and Digital. The Optical
Division provides traditional film effects and services to the majority of
today's motion pictures. The Digital Division provides digital effects and
character animation for the entertainment industry. The company's proprietary
Lifef/x(TM) technology can be used to digitally create photo-realistic animation
of real or fictional characters for use in film, television, and the Internet.
The company had 1998 revenues of $21.6 million compared to $18.6 million in
1997. A significant part of 1998 revenues were generated by a single project.
Other than that project, 1998 revenues were negatively affected by a slowdown in
the motion picture industry and management difficulties. The company is actively
pursuing restructuring alternatives to reduce its losses. At March 22, 1999,
Safeguard owns 49% of the fully diluted stock of Pacific Title/Mirage.
QuestOne Decision Sciences, formerly Technology Systems Corp. develops software
tools and support services that provide enterprise decision optimization
capabilities via breakthrough integrated financial-response time-resource
capacity analysis methods. Areas of application include product development,
product management, capital investments, strategic cycle time reduction, and
mission critical process improvement. QuestOne's client base includes several
Fortune 500 companies. QuestOne's 1998 revenues were $11.6 million compared to
$4.8 million in 1997. At March 22, 1999, Safeguard owns 34% of QuestOne's fully
diluted stock.
US Interactive is an Internet professional services company that draws on a
unique combination of business strategy, marketing, and technology disciplines
to engineer electronic enterprise solutions. The company completed a merger with
Digital Evolution in July 1998, and serves a number of Global 2000 clients. The
company had combined 1998 revenues of $16.6 million compared to $13.1 million in
1997. At March 22, 1999, Safeguard owns 14% of the fully diluted stock of US
Interactive.
Whisper Communications was formed as a spin-out from Diablo Research Company in
1996. Whisper has developed a patented two way, fixed base automatic meter
reading technology which will allow utilities to remotely read meters (gas,
water, or electric) via the use of radio frequency technology and a wireless
communications backbone. Whisper has a large multi-year supply contract as a
subcontractor to Schlumberger to provide automatic meter readers to Illinois
Power, which is currently in the final acceptance phase. Whisper is a
development stage company and had nominal revenues in 1998. At March 22, 1999,
Safeguard owns 27% of the fully diluted stock of Whisper.
Who? Vision Systems is a personal identification company that applies unique
fingerprint imaging technologies to create highly reliable, cost effective
network and eCommerce security products. Who? Vision, an XL Vision spin out in
1998, believes that the ability to e-thenticate(TM)
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- - bind transactions to a particular person, not just a particular machine - is a
critical need for the broader adoption of eCommerce. Who? Vision entered into a
strategic partnership with Philips Flat Display Systems to develop and market a
new line of flat fingerprint sensors. The company's proprietary patent pending
TactileSense(TM) technology, combined with patented and patent pending
technologies from Philips, gives it the ability to become a market-leading
provider of fingerprint sensors for use in portable net devices such as laptops,
PDAs, cell phones, and smart cards. Who? Vision is a development stage company
with no 1998 revenues. The company expects to begin commercial production of its
first-generation product in the second quarter of 1999 and its flat fingerprint
sensor in the second half of 1999. At March 22, 1999, Safeguard owns 27% of Who?
Vision's fully diluted stock.
XL Vision specializes in developing application-specific electronic imaging
solutions to meet specific customer needs and identifiable market needs. XL
Vision has refined its business model to invent, incubate, and spin out highly
differentiated, high-value imaging technology businesses. XL Vision's first spin
out company, ChromaVision Medical Systems (Nasdaq: CVSN), completed its initial
public offering as a Safeguard rights offering in 1997. XL Vision has also spun
out eMerge Vision Systems, Who? Vision Systems, and Integrated Visions. At March
22, 1999, Safeguard owns 55% of XL Vision's fully diluted stock.
Safeguard's ownership percentages in certain of the partnership companies
described above include shares which Safeguard has granted to certain of its
executives under its long term incentive plan. These grants are subject to
certain restrictions, and Safeguard continues to control the voting of these
shares until the restrictions lapse.
Venture Capital and Private Equity Funds
Safeguard also participates in managing seven venture capital and private equity
funds. These funds invest in early stage, rapidly growing and/or established
businesses, and have co-invested in certain of Safeguard's partnership
companies. The following table lists these funds. While Safeguard's focus is on
the information technology industry, the funds also invest in health care, life
sciences, service-related companies, technology companies in the energy
utilities markets, basic process industries, and later stage companies in
various industries. These funds made a total of 28 new investments in 1998 and
have a total of 104 companies in their portfolios at year end. Safeguard has
contributed a total of $41.8 million to these partnerships, and has received
total distributions of $28.1 million, including $12.3 million in 1998.
Technology Leaders I and Technology Leaders II are fully invested (including
reserves set aside for follow-on investments), and Radnor Venture Partners is
being closed out.
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Total Capital % Owned by Year
Name of Fund Commitments Safeguard(1) Established
- ------------ ----------- ------------ -----------
Technology Leaders I $ 61,000,000 4% 1992
Technology Leaders II 113,000,000 4% 1994
TL Ventures III 285,000,000 4% 1996
EnerTech Capital Partners 50,000,000 6% 1996
Safeguard International Fund 228,000,000 11% 1996
SCP Private Equity Partners 265,000,000 8% 1996
Pennsylvania Early Stage Partners 50,000,000 20% 1998
(1) Represents the percentage of the outstanding general and limited
partnership interests in each fund owned by Safeguard.
COMPUCOM
CompuCom is a leading provider of information technology products and technology
management services to large and medium sized businesses throughout the United
States. CompuCom helps Fortune 1000 companies manage information technology to
achieve their business goals by providing a wide range of services in
provisioning, support, and technology management. Products and technology
management services are sold through a direct sales force to over 6,000 business
customers nationwide. CompuCom's majority-owned subsidiary, ClientLink, offers
software application development services.
CompuCom is an authorized dealer of major distributed desktop computer products,
networking and related products, peripherals, and software for a number of
manufacturers, including Compaq Computer Corporation ("Compaq"), International
Business Machines Corporation ("IBM"), Hewlett-Packard Company ("HP"), Toshiba
America Information Systems, Intel Corporation, and Microsoft Corporation. To
further meet the needs of its customers, CompuCom provides a variety of services
including LAN/WAN project services, consulting, asset tracking, network
management, help desk, field engineering, configuration, software management,
distribution, and procurement utilizing network applications such as Novell
Netware, Windows NT, Windows 95 and Windows 98, and IBM OS/2 Warp.
CompuCom believes the key to improving its net revenue and net earnings
performance is the expansion of its higher margin services business, both
internally and through strategic acquisitions, as well as focusing on lowering
its cost structure through expense control and participation in programs
designed to increase inventory turns. CompuCom's target customers are becoming
increasingly dependent on information technology to compete effectively in
today's markets. As a result, the decision making process that organizations
face when planning, selecting and implementing technology solutions is becoming
more complex and requires many of these organizations to outsource the
management and support of their technology needs.
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CompuCom's product sales accounted for 87% of Safeguard's total net sales in
1998, compared to 86% in 1997 and 88% in 1996. CompuCom's services sales
accounted for 12% of Safeguard's total net sales in 1998 and 1997, compared to
8% in 1996. CompuCom's business tends to be subject to seasonal fluctuations,
with the highest revenue levels generally occurring in the fourth quarter.
Backlog is not considered to be a meaningful indicator of CompuCom's future
business prospects due to the short order fulfillment cycle. Large corporate
businesses accounted for the majority of CompuCom's net sales in 1998. However,
no one customer accounted for more than 10% of such sales.
CompuCom markets its product procurement, configuration, field engineering,
network management, help desk services, and technology management services
primarily through its direct sales force and service personnel. In late 1998,
CompuCom significantly restructured its operations by closing its physical
branch offices and moving to a virtual office model. The company also adopted a
plan to reduce its workforce by 10%. Sales and service representatives who
worked out of the branch offices continue to service customers in all of its
markets and the representatives access corporate information and support over
CompuCom's intranet and remote communications facilities.
CompuCom's customers generally require rapid fulfillment of product orders. To
meet these requirements and to assure itself of a continuous allotment of
products from its vendors, CompuCom maintains adequate levels of inventory
funded through credit facilities and vendor credit.
CompuCom provides product support to its customers primarily through inside
sales representatives ("ISRs") mostly based at its customer center, located in
Dallas, Texas. Each ISR works closely with CompuCom's direct sales
representatives. The primary goal of the customer center is to provide greater
support to CompuCom's customers while allowing CompuCom's direct sales force to
focus on soliciting new business and providing the necessary support for the
customers' more complex service needs. As of December 31, 1998, CompuCom
employed 335 full-time direct sales representatives and 400 customer center
personnel.
CompuCom configures and ships desktop products at its 300,000 square foot
distribution center in Paulsboro, NJ, its 104,000 square foot distribution
center in Stockton, CA, and its new 78,000 square foot center which is
co-located on the Compaq campus in Houston, TX. The company believes its
co-location arrangement with Compaq will further reduce its operating costs and
increase efficiency. The company is also beginning co-location programs with IBM
and Toshiba during the first half of 1999.
In order to remain profitable in the face of shrinking product gross margins,
CompuCom has continuously worked to improve its operating efficiency by
streamlining its business processes as evidenced by its recent restructuring and
its participation in co-location programs with its vendors. CompuCom is using
integrated enterprise-wide information systems to automate its operations,
including a corporate intranet for internal use and extranets to facilitate
eCommerce with its customers. CompuCom believes that this focus on business
process reengineering and
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technology-enhanced operations gives it one of the lowest operating cost
structures in its industry and provides a demonstration to its customers of the
benefits of its product and service offerings.
Product margins declined in 1998 compared to 1997 due primarily to heightened
competition from direct marketers and other resellers. CompuCom believes that
gross margins will continue to decline in 1999, and will be reactive to
industry-wide changes. Future profitability will depend on the ability to
effectively manage inventory in response to changes in suppliers price
protection and return programs, to retain and hire quality service personnel
while effectively managing the utilization of such personnel, to respond to
increased competition from its suppliers' direct selling initiatives, and to
continue to reduce operating expenses.
The computer reseller industry is characterized by intense competition,
primarily in the areas of price, product availability and breadth of product
line and service. CompuCom competes for potential clients, including national
accounts, with numerous resellers and distributors. Many established desktop
computer manufacturers (including some of the company's vendors), direct
marketers, systems integrators and resellers of distributed desktop or
networking products compete with the company in the configuration and
distribution of computer systems and equipment. In addition, direct marketers
have had a distinct pricing advantage over resellers such as CompuCom. In
response to the increased competition, particularly from direct marketers, a
number of the company's competitors have sought to increase their market share
through acquisitions. The company expects the consolidation in the industry will
continue in 1999. In order to keep pace, CompuCom expects to pursue additional
strategic acquisitions. To help combat the direct marketers' pricing advantage,
CompuCom and its major vendors are in the process of developing and implementing
strategies designed to reduce costs through reductions in inventory levels. In
the highly fragmented computer services business, CompuCom competes with several
larger competitors; other corporate resellers pursuing high-end service
opportunities, as well as smaller computer services companies. Some of these
competitors have financial, technical, manufacturing, sales, marketing and other
resources that are substantially greater than that of CompuCom. There can be no
assurance that CompuCom will be able to continue to compete successfully with
new or existing competition. If CompuCom uses its stock for acquisitions or if
some other dilutive event were to occur, Safeguard's voting interest in CompuCom
could be diluted below 50%, in which event Safeguard would no longer consolidate
CompuCom's financial results under current generally accepted accounting
principles. See "Management's Discussion and Analysis General" beginning on page
33 of Safeguard's Annual Report to Stockholders filed as part of Exhibit 13
hereto. CompuCom employed approximately 4,800 full-time employees as of December
31, 1998.
At March 22, 1999, Safeguard owns 56% of CompuCom's fully diluted stock.
TANGRAM
Tangram develops and markets asset tracking software and software distribution
solutions that enable automated enterprise-wide information system management.
The company markets to Fortune 1000 companies and their foreign equivalents and
to government agencies that are
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managing heterogeneous enterprises and mission-critical applications. Tangram's
primary product line is Asset Insight(R), an enterprise-wide asset tracking
solution that enables corporations to track current and historical information
about hardware, software and configuration changes and associate this
information with desktop users and departments across the enterprise. With this
information, decision makers can track changes in their hardware and software
assets, manage their Year 2000 risks, forward plan technology requirements
(including calculating the cost of software and hardware upgrades), optimize
end-user productivity, reduce total cost of asset ownership, identify missing
hardware components, and resolve desktop problems quickly.
Tangram markets Asset Insight through value added resellers, systems integrators
and other channel partners. Tangram markets and sells its other products and
services, including implementation of customized solutions incorporating its
AM:PM and other products, directly to its customers in North America and through
a network of independent distributors internationally.
Tangram spent $5.3 million for product development in 1998, compared to $5.0
million in 1997 and $3.4 million in 1996.
Because of its complexity, Asset Insight has a relatively long sales cycle.
Effective management of the sales process is critical to Tangram's future
success. In the broader market for asset management products and services,
competition is intense, and many of Tangram's actual and potential competitors
have substantially greater resources than Tangram and offer integrated products
providing broader asset management solutions. At March 22, 1999, Safeguard owns
57% of Tangram's fully diluted stock.
Other Segment Information
Export sales in each segment for the three year period ended December 31, 1998
were less than 5% of the segment's total sales in each of those years. Backlog
is not considered to be a meaningful indication of future business prospects for
any of the Company's operating segments.
OTHER INFORMATION
The operations of Safeguard and its partnership companies are subject to
environmental laws and regulations. Safeguard does not believe that expenditures
relating to those laws and regulations will have a material adverse effect on
the business, financial condition or results of operations of Safeguard.
EMPLOYEES
At December 31, 1998, Safeguard and its consolidated subsidiaries have
approximately 5,120 employees, of which approximately 94% are employed by
CompuCom. Safeguard believes relations with employees are good.
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RISK FACTORS REGARDING FORWARD-LOOKING STATEMENTS
Certain statements in this report describing the plans, goals, strategies,
intentions, and expectations of Safeguard or its partnership companies or
anticipated events, constitute what are sometimes termed forward-looking
statements. The following important factors could cause actual results to differ
materially from those in such forward-looking statements.
Competition to invest in or acquire successful emerging information technology
companies is substantial. The information technology industry is highly
competitive, characterized by rapid product development cycles, frequent price
reductions, and early product obsolescence, and is generally dominated by
companies with greater resources than Safeguard and its partnership companies.
In addition, there is an overall scarcity of available employees with
information technology skills, which could lead to increased costs of operations
and restrict internal growth.
Certain of Safeguard's partnership companies offer complex products or services
which have lengthy sales cycles, which makes sales forecasts difficult to make,
and can lead to substantial fluctuations in quarterly operating results.
Emerging technology companies often encounter obstacles and delays in developing
products, service offerings, and markets. If Safeguard's private partnership
companies encounter more delays and obstacles than anticipated, Safeguard's
ability to complete rights offerings when planned could be delayed.
Safeguard is dependent on the market for information technology companies in
general and for initial public offerings of those companies in particular. If
such markets were to become weak for an extended period of time, Safeguard's
ability to complete rights offerings when planned, and Safeguard's ability to
generate gains from sales of securities, could be materially adversely affected.
In addition, Safeguard's ability to borrow under its revolving credit facilities
could be adversely affected as availability under these facilities is determined
by the value of the publicly traded securities pledged by Safeguard as
collateral. The market for securities of Internet-related companies is extremely
volatile, and Safeguard's participation in Internet-related companies could
cause Safeguard's stock to become more volatile.
The impact that the Year 2000 issue will have on the information technology
industry over the next few years is a material uncertainty. Businesses and
government agencies which are clients of Safeguard's partnership companies could
reallocate part or all of their information systems budgets to address the Year
2000 issue, which could materially reduce the demand for the products and
services of Safeguard's partnership companies. In addition, Safeguard's and its
partnership companies' business operations could be materially adversely
affected if they do not timely complete any required remediation efforts or if
their vendors, business partners, or customers do not timely complete
remediation of any systems on which Safeguard or its partnership companies rely.
See also Item 7 - "Management's Discussion and Analysis of Financial Condition
and Results of Operations." In general, there is likely to be an extraordinary
amount of litigation regarding the Year 2000 issue over the next several years
and information technology providers could be attractive targets for such
litigation. This litigation could have a
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material adverse impact on Safeguard's and its partnership companies' operations
and financial conditions.
ITEM 1(d). FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND
EXPORT SALES
Safeguard does not believe that foreign or geographic area sales are material or
significant to an understanding of its business and operations during the
three-year period ended December 31, 1998. Where appropriate, information
concerning export sales of Safeguard's partnership companies is discussed in
Item 1(c) "Narrative Description of Business."
ITEM 1(e). EXECUTIVE OFFICERS
Information about Safeguard's executive officers can be found in Part III of
this report under "Item 10. Directors and Executive Officers of Registrant."
ITEM 2. PROPERTIES
Safeguard owns the office park in which its corporate headquarters and
administrative offices are located in Wayne, Pennsylvania. The headquarters
building is subject to a $3.6 million mortgage bearing interest at 9.75%, which
amortizes over a 30 year term and is callable by the lender at any time
beginning in 2002. The principal properties of CompuCom and Tangram consisted of
the following as of March 22, 1999:
OPERATING SEGMENT/LOCATION TYPE OF FACILITY LEASE EXPIRES
COMPUCOM
Dallas, TX Corporate/Operations *
Paulsboro, NJ Distribution Center 2001(1)
Stockton, CA Distribution Center 1999
Houston, TX Compaq co-location 2000 (2)
facility
TANGRAM
Cary, NC Office/Distribution 2004
(*) Owned facility.
(1) CompuCom has a cancellation option exercisable at any time after August
1999.
(2) Terminable by either party on 60 days notice.
CompuCom expects to complete a sale-leaseback transaction on its corporate and
operations facility in the first quarter of 1999.
In the opinion of management, the properties are in good condition and repair
and are adequate for the particular operations for which they are used.
CompuCom's corporate/operations facility
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in Dallas contains 250,000 square feet of office space in two buildings on 20
acres. The other facilities of the company generally are capable of supporting
increased activity without any significant capital expenditures.
ITEM 3. LEGAL PROCEEDINGS
Safeguard and its subsidiaries are involved in various claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
Safeguard's consolidated financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the fourth quarter of 1998.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Safeguard incorporates by reference the information contained under the caption
"Common Stock Data" on page 56 of its Annual Report to Stockholders for the year
ended December 31, 1998 which page is filed as part of Exhibit 13 hereto.
ITEM 6. SELECTED FINANCIAL DATA
Safeguard incorporates by reference the information contained under this caption
on page 33 of its Annual Report to Stockholders for the year ended December 31,
1998 which page is filed as part of Exhibit 13 hereto.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Safeguard incorporates by reference the information contained under this caption
on pages 33 through 39 of its Annual Report to Stockholders for the year ended
December 31, 1998 which pages are filed as part of Exhibit 13 hereto.
For the month of February 1999, CompuCom was out of compliance with one covenant
ratio of its existing receivables securitization facility. CompuCom does not
expect this violation to negatively impact negotiations relative to the
replacement securitization facility or to negatively impact its liquidity.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Safeguard is exposed to equity price risks on its securities in publicly traded
partnership companies, most of which we acquired as private companies and took
public through rights offerings. These securities are generally in companies in
the information technology industry sector. Many of the companies are considered
small capitalization stocks. As of December 31, 1998, we had not attempted to
reduce or eliminate our market exposure on these securities. A 20% decrease in
equity prices would result in an approximate $113 million decrease in the fair
value of our investments accounted for on the equity method or classified as
available-for-sale at the end of 1998. Approximately $190 million of the value
of these equity securities at the end of 1998 consisted of our holdings in
Cambridge. A 20% decrease in equity prices at the end of 1998 would result in an
approximate $29 million decrease in the fair value of our holdings in Tellabs,
which we acquired in the merger of Coherent into Tellabs. Our Tellabs shares are
classified as trading securities. Fluctuations in the market price of trading
securities are included in net earnings. In late March 1999, the Company
completed a hedging transaction to partially protect against possible declines
in the price of a portion of its Tellabs holdings.
Availability under Safeguard's bank credit facilities is determined by the
market value of the publicly traded partnership companies pledged as collateral.
At December 31, 1998, our ability to borrow would not be impacted unless equity
prices decreased more than 25%. A price decrease of 50% would reduce the
availability on our $200 million bank credit facilities by approximately $33
million. At December 31, 1998, $88.1 million was outstanding under the $200
million bank revolving credit facility.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Safeguard incorporates by reference the information on pages 40 through 56 of
its Annual Report to Stockholders for the year ended December 31, 1998 which
pages are filed as part of Exhibit 13 hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
EXECUTIVE OFFICERS:
The following persons were executive officers of the Registrant at March 22,
1999:
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OFFICER
NAME AGE SINCE POSITION
- ---- --- ------- --------
Warren V. Musser 72 1953 Chairman of the Board and
Chief Executive Officer
Harry Wallaesa (1) 48 1999 President and Chief Operating Officer
Edward R. Anderson (2) 52 1994 President and Chief Executive
Officer, CompuCom Systems
Jerry L. Johnson (3) 51 1995 Executive Vice President
Thomas C. Lynch (4) 56 1995 Executive Vice President and Chief
Operating Officer, CompuCom Systems
Michael W. Miles (5) 41 1992 Senior Vice President and Chief
Financial Officer
James A. Ounsworth(6) 56 1991 Senior Vice President, General
Counsel and Secretary
Stephen J. Andriole (7) 49 1997 Senior Technology Officer
(1) Mr. Wallaesa became President and Chief Operating Officer of Safeguard in
March 1999. Before joining Safeguard, Mr. Wallaesa served as President and
Chief Executive Officer of aligne incorporated, a strategic technology
management consulting firm which he co-founded in 1996. From 1985 through
1995, Mr. Wallaesa was the Chief Information Officer and Vice President of
management information systems at Campbell Soup Company, a global
manufacturer and marketer of high quality, branded convenience food
products.
(2) Mr. Anderson has served as President and Chief Executive Officer of
CompuCom Systems, Inc., a subsidiary of Safeguard, since January 1994 and
served as Chief Operating Officer from August 1993 through December 1993.
Prior to joining CompuCom, Mr. Anderson served from May 1988 to July 1993
as President and Chief Operating Officer of Computerland Corporation (now
known as Vanstar), a computer reseller.
(3) Mr. Johnson was promoted to Executive Vice President in March 1999. He
served as Senior Vice President from September 1995 until March 1999.
Prior to joining Safeguard, Mr. Johnson served at US West, a Regional Bell
Operating Company, from 1985 through 1995, most recently as Vice President
of Network Technology Services.
(4) Mr. Lynch joined CompuCom in October 1998. Prior to that time, Mr. Lynch
was Senior Vice President of Safeguard from 1995 through 1998. In 1995 Mr.
Lynch retired from the U.S. Navy as an Admiral after 31 years, including
serving as Superintendent of the U.S. Naval Academy from 1991 through 1994
and the Director of the Navy Staff 1994 through 1995.
(5) Mr. Miles was promoted to Senior Vice President in January 1998. He has
served as Vice President and Chief Financial Officer since January 1997
and has been with Safeguard
26
<PAGE>
since 1984 in various financial positions, including Vice President and
Corporate Controller.
(6) Mr. Ounsworth was promoted to Senior Vice President in November 1995. He
has served as Vice President, Secretary and General Counsel since December
1991. Prior to joining Safeguard, Mr. Ounsworth was a partner in the
Philadelphia law firm of Pepper, Hamilton & Scheetz, and before that he
was a nuclear engineer in the U.S. Navy.
(7) Dr. Andriole joined Safeguard in the Fall of 1997 from CIGNA Corporation,
where he was Senior Vice President for Technology Strategy & Chief
Technology Officer from 1995 to 1997. From 1990 to 1995, he was a
Professor of Information Systems & Computer & Electrical Engineering at
Drexel University. During the 1970s, Dr. Andriole was Director of
Cybernetics Technology at the Defense Advanced Research Projects Agency
(ARPA), the agency that developed much of the infrastructure for the
Internet.
DIRECTORS:
Safeguard incorporates by reference the information contained under the caption
"Election of Directors" in its definitive Proxy Statement relative to its May
20, 1999 annual meeting of stockholders, to be filed within 120 days after the
end of the year covered by this Form 10-K Report pursuant to Regulation 14A
under the Securities Exchange Act of l934, as amended.
DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K:
Safeguard incorporates by reference the information contained under the caption
"Section 16(a) Beneficial Ownership Reporting Compliance" in its definitive
Proxy Statement relative to its May 20, 1999 annual meeting of stockholders, to
be filed within 120 days after the end of the year covered by this Form 10-K
Report pursuant to Regulation 14A under the Securities Exchange Act of l934, as
amended.
ITEM 11. EXECUTIVE COMPENSATION
Safeguard incorporates by reference the information contained under the captions
"Board of Directors' --Additional Information" and "Executive Compensation and
Other Arrangements" in its definitive Proxy Statement relative to its May 20,
1999 annual meeting of stockholders, to be filed within 120 days after the end
of the year covered by this Form 10-K Report pursuant to Regulation 14A under
the Securities Exchange Act of l934, as amended.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Safeguard incorporates by reference the information contained under the caption
"Stock Ownership of Directors and Officers" in its definitive Proxy Statement
relative to its May 20,
27
<PAGE>
1999 annual meeting of stockholders, to be filed within 120 days after the end
of the year covered by this Form 10-K Report pursuant to Regulation 14A under
the Securities Exchange Act of l934, as amended.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Safeguard incorporates by reference the information contained under the caption
"Relationships and Related Transactions with Management and Others" in its
definitive Proxy Statement relative to its May 20, 1999 annual meeting of
stockholders, to be filed within 120 days after the end of the year covered by
this Form 10-K Report pursuant to Regulation 14A under the Securities Exchange
Act of l934, as amended.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following Financial Statements and Schedules are filed as part of this
report:
Consolidated Financial Statements Balance Sheets - December 31, 1998 and 1997
Operations - years ended December 31, 1998, 1997, and 1996
Cash Flows - years ended December 31, 1998, 1997, and 1996
Stockholders' Equity - years ended December 31, 1998, 1997, and 1996
Comprehensive Income - years ended December 31, 1998, 1997, and 1996
Notes to Consolidated Financial Statements Independent Auditors' Report
Statement of Management's Financial Responsibility
Quarterly Financial Data
Financial Statement Schedules
Independent Auditors' Report
Schedule I - Condensed Consolidated Financial Information of Registrant
Schedule II - Valuation and Qualifying Accounts
(b) Reports on Form 8-K
None.
(c) Exhibits
The following is a list of exhibits required by Item 601 of Regulation S-K filed
as part of this Report. Where so indicated by footnote, exhibits which were
previously filed are incorporated
28
<PAGE>
by reference. For exhibits incorporated by reference, the location of the
exhibit in the previous filing is indicated in parentheses.
EXHIBIT NO. EXHIBIT
- ----------- -------
3.1 Amended and Restated Articles of Incorporation of Safeguard
(20)(Exhibit 3.1)
3.2 By-laws of Safeguard, as amended (6)(Exhibit 3.2)
4.1** 1990 Stock Option Plan, as amended (20)(Exhibit 4.3)
4.2** Stock Option Plan for Non-Employee Directors (11) (Exhibit 4.8)
4.3** Safeguard Scientifics, Inc. Amended and Restated Stock Savings Plan
(14) (Exhibit 4.9)
4.4** First Amendment to Safeguard Scientifics, Inc. Stock Savings Plan
(20)(Exhibit 4.6)
4.5** Safeguard Scientifics, Inc. Stock Savings Plan Trust Agreement
(5)(Exhibit 4.2)
4.6 Trust Indenture Agreement dated February 1, 1996 (17) (Exhibit
10.34)
4.7 Purchase Agreement dated February 1, 1996 between Safeguard
Scientifics, Inc. and JP Morgan Securities, Inc. (17) (Exhibit
10.35)
10.1** Safeguard Scientifics Money Purchase Pension Plan (6)(Exhibit 10.3)
10.2** First Amendment to Safeguard Scientifics Money Purchase Pension
Plan (11) (Exhibit 10.2)
10.3** Second Amendment to Safeguard Scientifics Money Purchase Pension
Plan (14) (Exhibit 10.3)
10.4** Third Amendment to Safeguard Scientifics Money Purchase Pension
Plan (17) (Exhibit 10.4)
10.5** Safeguard Scientifics Money Purchase Pension Plan Trust Agreement
(6)(Exhibit 10.4)
10.6** Safeguard Management Incentive Compensation Plan (7)(Exhibit 10.3)
10.7** Safeguard Scientifics, Inc. Long Term Incentive Plan, as amended
and restated effective June 15, 1994 (14) (Exhibit 10.6)
10.8** Safeguard Scientifics, Inc. Deferred Compensation Plan (2)(Exhibit
10.12)
29
<PAGE>
10.9** Form of Promissory Notes dated February 12, 1997 given by certain
executives for advances by Safeguard of income tax withholdings on
restricted stock grants (20)(Exhibit 10.11)
10.10** Form of Amendment to Promissory Notes dated , 1999
(28)(Exhibit 10.10)
10.11 Asset Acquisition Agreement dated April 15, 1997 for the sale of
certain assets of Premier Solutions Ltd. to a subsidiary of Sungard
Data Systems Inc. (exhibits omitted) (21)(Exhibit 10.1)
10.12 Stock Exchange Agreement dated as of February 26, 1999 among
Safeguard Scientifics, Inc., aligne Incorporated, and the
shareholders of aligne Incorporated (exhibits and schedules
omitted)(28)(Exhibit 10.10)
10.13 Amended and Restated Credit Agreement, dated April 17, 1998, among
Safeguard Scientifics, Inc., Safeguard Scientifics (Delaware),
Inc., Safeguard Delaware, Inc. and PNC Bank, N.A. (exhibits
omitted)(25)(Exhibit 10.1)
10.14 Amended and Restated Master Security and Administration Agreement,
dated as of September 25, 1996, among CompuCom Systems, Inc.,
NationsBank of Texas, N.A., CSI Funding, Inc. and Enterprise
Funding Corporation (exhibits omitted) (19) (Exhibit 10.3)
10.15 Amendment No. 1 dated December 5, 1996 to Amended and Restated
Master Security Agreement among CompuCom Systems, Inc., NationsBank
of Texas, CSI Funding, Inc. and Enterprise Funding Corporation
(20)(exhibit 10.16)
10.16 Amended and Restated Credit Agreement, dated as of November 3,
1997, among CompuCom Systems, Inc., certain lenders party hereto,
and NationsBank of Texas, N.A., as administrative lender (exhibits
and schedules omitted) (24)(Exhibit 10.27)
10.17 Amendment No. 1 to Amended and Restated Credit Agreement, dated as
of June 26, 1998, among CompuCom Systems, Inc., certain lenders
party hereto, and NationsBank of Texas, N.A., as administrative
lender (exhibits omitted)(26)(Exhibit 10.2)
10.18 Amended and Restated Receivables Purchase Agreement, dated as of
November 3, 1997, between CompuCom Systems, Inc. and CSI Funding,
Inc. (exhibits omitted) (24)(Exhibit 10.28)
10.19 Amended and Restated Transfer and Administration Agreement, dated
as of November 3, 1997, among CSI Funding, Inc., CompuCom Systems,
Inc., Enterprise Funding Corporation and NationsBank, N.A.
(exhibits omitted) (24)(Exhibit 10.29)
30
<PAGE>
10.20** Executive Employment Agreement dated October 24, 1997 between
Edward Anderson and CompuCom Systems, Inc. (24)(Exhibit 10.32)
10.21** Employment Agreement Amendment dated February 19, 1999 between
Edward Anderson and CompuCom Systems, Inc. (28)(Exhibit 10.21)
10.22** Promissory Note dated February 12, 1997 from Edward Anderson to
CompuCom Systems, Inc. (20)(Exhibit 10.22)
10.23** First Amendment to Term Note dated February 19, 1999 from Edward
Anderson to CompuCom Systems, Inc. (28)(Exhibit 10.23)
10.24** Pledge Agreement dated August 31, 1994 between Edward Anderson and
CompuCom Systems, Inc. (14) (Exhibit 10.27)
10.25** Term Note dated October 22, 1998 from Edward Anderson to CompuCom
Systems, Inc. (28)(Exhibit 10.25)
10.26** Pledge Agreement dated October 22, 1998 from Edward Anderson to
CompuCom Systems, Inc. (28)(Exhibit 10.26)
10.27** Stock Option Grant Agreement between CompuCom Systems, Inc. and
Thomas C. Lynch, dated as of October 22, 1998 (27)(Exhibit 10.4)
10.28** Term Note dated December 23, 1998 from Thomas Lynch to CompuCom
Systems, Inc. (28)(Exhibit 10.28)
10.29** Pledge Agreement dated December 23, 1998 from Thomas Lynch to
CompuCom Systems, Inc. (28)(Exhibit 10.29)
10.30** Term Note dated December 23, 1998 from Thomas Lynch to Safeguard
Scientifics, Inc. (28)(Exhibit 10.30)
10.31** Security Agreement dated December 23, 1998 between Thomas Lynch and
Safeguard Scientifics, Inc. (28)(Exhibit 10.31)
10.32** Note Agreement dated October 6, 1998, between Safeguard Delaware,
Inc. and Donald R. Caldwell (27)(Exhibit 10.3)
11 Computation of Per Share Earnings * (included in Note 7 to the
Consolidated Financial Statements on page 50 of Safeguard's Annual
Report to Stockholders for year ended December 31, 1998, which page
is filed as part of Exhibit 13 hereto)
13 Pages 33 to 56 of Annual Report to Stockholders for year ended
December 31, 1998 *
31
<PAGE>
21 List of Subsidiaries (28)(Exhibit 21)
23.1 Consent of KPMG LLP, Independent auditors*
23.2 Consent and Report of PricewaterhouseCoopers LLP, Independent
auditors*
27 Financial Data Schedule for the year ended December 31, 1998*
99.1 Consolidated Financial Statements of Cambridge Technology
Partners (Massachusetts), Inc.*
- ----------
* Filed herewith.
** These exhibits relate to compensatory plans, contracts or arrangements in
which directors and/or executive officers of the registrant may
participate.
(1) Filed on March 30, 1981 as an exhibit to the Annual Report on Form 10-K
(No. 1-5620) and incorporated herein by reference.
(2) Filed on March 30, 1987 as an exhibit to Annual Report on Form 10-K (No.
1-5620) and incorporated herein by reference.
(5) Filed on December 13, 1991 as an exhibit to Form 8-K (No. 1-5620) and
incorporated herein by reference.
(6) Filed on March 30, 1992 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(7) Filed on March 31, 1993 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(11) Filed on March 30, 1994 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(14) Filed on March 30, 1995 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(17) Filed on April 1, 1996 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(18) Filed on May 15, 1996 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(19) Filed on November 12, 1996 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(20) Filed on March 31, 1997 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
32
<PAGE>
(21) Filed May 15, 1997 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(22) Filed August 14, 1997 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(23) Filed November 14, 1997 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(24) Filed March 31, 1998 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(25) Filed on May 15, 1998 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(26) Filed August 14, 1998 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(27) Filed November 16, 1998 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(28) Filed March 31, 1999 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
33
<PAGE>
(d) SEPARATE FINANCIAL STATEMENTS OF SUBSIDIARIES NOT CONSOLIDATED
Refer to Item 14(c) exhibit 99.1 for the consolidated financial
statements of Cambridge Technology Partners (Massachusetts), Inc.
as of December 31, 1998 and 1997 and for each of the three years
in the period ended December 31, 1998, which is filed as part of
this report.
FINANCIAL STATEMENT SCHEDULES
Independent Auditors' Report
The Board of Directors and Shareholders
Safeguard Scientifics, Inc.:
Under date of February 8, 1999, we reported on the consolidated
balance sheets of Safeguard Scientifics, Inc. and subsidiaries as of
December 31, 1998 and 1997, and the related consolidated statements of
operations, cash flows, shareholders' equity and comprehensive income
for each of the years in the three-year period ended
December 31, 1998, as contained in the 1998 annual report to
shareholders. These consolidated financial statements and our report
thereon are incorporated by reference in the annual report on Form
10-K/A for the year 1998. In connection with our audits of the
aforementioned consolidated financial statements, we also audited the
related consolidated financial statement schedules as listed in the
accompanying index. These financial statement schedules are the
responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statement schedules based on our
audits. We did not audit the 1998 and 1997 financial statements of a
nonsubsidiary investee. The financial statements of this investee were
audited by other auditors whose report has been furnished to us, and
our opinion, insofar as it relates to the amounts included for this
investee, is based solely on the report of the other auditor.
In our opinion, based on our audits and the report of the other
auditors, such financial statement schedules, when considered in
relation to the basic consolidated financial statements taken as a
whole, present fairly, in all material respects, the information set
forth therein.
/s/ KPMG LLP
Philadelphia, Pennsylvania
February 8, 1999
34
<PAGE>
Safeguard Scientifics, Inc.
Schedule I
Condensed Consolidated Balance Sheets
December 31, 1998 and 1997
(in thousands)
Assets
1998 1997
--------- ---------
Current Assets
Cash and cash equivalents $ 1,486 $ 680
Short-term investments 143,103 --
Notes and other receivables 27,783 6,157
Other current assets 1,497 4,873
--------- ---------
Total current assets 173,869 11,710
Property, Plant and Equipment, Net 24,455 13,142
Other Assets
Investments in unconsolidated subsidiaries and
affiliates 413,596 310,877
Notes and other receivables 22,069 21,669
Other 3,306 2,756
--------- ---------
Total other assets 438,971 335,302
========= =========
Total Assets $ 637,295 $ 360,154
========= =========
Liabilities and Shareholders' Equity
1998 1997
--------- ---------
Current Liabilities
Current debt obligations $ 866 $ 333
Accounts payable 383 888
Accrued expenses 79,575 17,304
--------- ---------
Total current liabilities 80,824 18,525
Long-Term Debt 123,115 29,689
Deferred Taxes 17,902 12,846
Other Liabilities 1,250 1,143
Convertible Subordinated Notes 71,345 90,881
Shareholders' Equity
Common stock 3,280 3,280
Additional paid-in capital 62,470 49,952
Retained earnings 261,594 151,471
Accumulated other comprehensive income 37,294 15,706
Treasury stock, at cost (21,779) (13,339)
--------- ---------
Total shareholders' equity 342,859 207,070
========= =========
Total Liabilities and Shareholders' Equity $ 637,295 $ 360,154
========= =========
See notes to condensed consolidated financial statements.
35
<PAGE>
Safeguard Scientifics, Inc.
Schedule I
Condensed Consolidated Statements of Operations
Years Ended December 31, 1998, 1997, and 1996
(in thousands except per share amounts)
1998 1997 1996
-------- -------- --------
Revenues
Net sales $ -- $ 15,982 $ 30,286
Securities and other gains, net 193,665 24,025 26,011
Other income 15,888 14,223 10,273
-------- -------- --------
Total revenues 209,553 54,230 66,570
Costs and Expenses
Cost of sales -- 10,908 19,223
Selling, general, and administrative 24,425 25,162 22,712
Depreciation and amortization 1,443 2,169 3,818
Interest 10,706 7,150 8,623
Equity in loss (income) of unconsolidated
subsidiaries and affiliates, net of taxes 1,846 (14,873) (12,345)
-------- -------- --------
Total costs and expenses 38,420 30,516 42,031
-------- -------- --------
Earnings Before Taxes on Income 171,133 23,714 24,539
Provision for taxes on income 61,010 2,213 4,612
-------- -------- --------
Net Earnings $110,123 $ 21,501 $ 19,927
======== ======== ========
Earnings Per Share
Basic $ 3.46 $ .69 $ .67
Diluted $ 3.22 $ .66 $ .61
Average Common Shares Outstanding
Basic 31,833 31,249 29,900
Diluted 34,914 31,996 31,348
See notes to condensed consolidated financial statements.
36
<PAGE>
Safeguard Scientifics, Inc.
Schedule I
Condensed Consolidated Statements of Cash Flows
Years Ended December 31, 1998, 1997, and 1996
(in thousands)
<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- ---------
<S> <C> <C> <C>
Operating Activities
Net earnings $ 110,123 $ 21,501 $ 19,927
Adjustments to reconcile net earnings to cash
provided (used) by operating activities
Depreciation and amortization 1,443 2,169 3,818
Deferred income taxes 41,447 (2,313) 109
Equity in loss (income) of unconsolidated
subsidiaries and affiliates, net of taxes 1,846 (14,873) (12,345)
Securities and other gains, net (193,665) (24,025) (26,011)
Cash provided (used) by changes in working capital items
Receivables (17,408) 3,349 (5,746)
Accounts payable, accrued expenses, and other 32,311 2,638 5,624
--------- -------- ---------
Cash (used) by operating activities (23,903) (11,554) (14,624)
Proceeds from securities and other gains, net 93,207 67,294 41,982
--------- -------- ---------
Cash provided by operating activities and securities
and other gains, net 69,304 55,740 27,358
Other Investing Activities
Investments and notes acquired, net (137,495) (80,518) (64,110)
Capital expenditures (3,142) (7,871) (5,985)
Other, net -- 3,408 (5,592)
--------- -------- ---------
Cash (used) by other investing activities (140,637) (84,981) (75,687)
Financing Activities
Net borrowings (repayments) on revolving credit facilities 85,907 22,200 (63,425)
Net borrowings on term debt 769 3,371 455
Issuance of Convertible Subordinated Notes, net -- -- 112,109
Repurchase of company common stock (18,672) (9,488) --
Issuance of company common stock 4,135 5,819 5,210
--------- -------- ---------
Cash provided by financing activities 72,139 21,902 54,349
--------- -------- ---------
Increase (Decrease) in Cash and Cash Equivalents 806 (7,339) 6,020
Cash and cash equivalents - beginning of year 680 8,019 1,999
--------- -------- ---------
Cash and Cash Equivalents - End of Year $ 1,486 $ 680 $ 8,019
========= ======== =========
</TABLE>
See notes to condensed consolidated financial statements.
37
<PAGE>
Notes to Condensed Consolidated Financial Statements
NOTE 1 - PRINCIPLES OF CONSOLIDATION
The Condensed Consolidated (also referred to as "Parent Company") Financial
Statements include the accounts of Safeguard Scientifics, Inc. (the Company) and
its wholly owned subsidiaries. These statements differ from the Consolidated
Financial Statements presented in the Company's Annual Report to Shareholders by
not consolidating the Company's less than wholly owned subsidiaries, primarily
CompuCom and Tangram, and instead treating these companies as if they were
accounted for on the equity method.
The Company sold its Pioneer Metal Finishing division (Pioneer) in mid-1997. The
Condensed Consolidated Statements of Operations include net sales and costs and
expenses of $16.0 million and $14.6 million, respectively, in 1997, and $28.6
million and $26.3 million, respectively, in 1996, related to Pioneer.
Subsequent to the sale of Pioneer, the Company's revenues consist of securities
and other gains and other income, which consists primarily of administrative
service fees charged to partnership companies and associated venture funds and
interest income generally derived from loans to partnership companies.
NOTE 2 - DEBT
1998 1997
--------- --------
(in thousands)
Revolving credit facilities $ 108,107 $ 22,200
Mortgage note, 9.75%, payable monthly through 2002 3,420 3,456
Mortgage notes, 6.1% to 7.8%, payable monthly through 2017 4,954 4,045
Mortgage note, 7.75%, payable monthly through 2021 6,239
Other 1,261 321
--------- --------
Total debt 123,981 30,022
Current debt obligations (866) (333)
--------- --------
Long-term debt $ 123,115 $ 29,689
========= ========
Aggregate maturities of long-term debt during future years are as follows (in
millions): $0.9 - 1999; $0.7 - 2000; $0.7 - 2001; $108.9 - 2002; $1.2 - 2003;
and $11.6 - thereafter.
Interest paid in 1998, 1997, and 1996 was $11.5 million, $6.9 million, and $6.3
million, respectively, of which $4.9 million, $5.8 million, and $3.4 million in
1998, 1997, and 1996, respectively, related to the Company's Convertible
Subordinated Notes, and $1.1 million in 1996 related to commercial real estate
debt.
38
<PAGE>
Safeguard Scientifics, Inc. and Subsidiaries
Schedule II
Valuation and Qualifying Accounts
(in thousands)
<TABLE>
<CAPTION>
Balance Additions
Beginning Charged to Balance
DESCRIPTION of Year Operations Deductions Other End of Year
- ----------- ------- ---------- ---------- ----- -----------
(1)
<S> <C> <C> <C> <C> <C>
Allowance for doubtful accounts
Year ended December 31, 1996 $ 2,644 $ 1,472 $ 995 $ (33) (2) $ 3,088
Year ended December 31, 1997 $ 3,088 $ 2,183 $ 1,829 $ (570) (3) $ 2,872
Year ended December 31, 1998 $ 2,872 $ 3,049 $ 1,350 $ 198 (4) $ 4,769
Inventory reserves
Year ended December 31, 1996 $ 9,524 $ 15,529 $ 16,119 $ 8,934
Year ended December 31, 1997 $ 8,934 $ 14,844 $ 13,854 $ 9,924
Year ended December 31, 1998 $ 9,924 $ 14,204 $ 16,326 $ 7,802
Investment reserves
Year ended December 31, 1996 $ 6,956 $ 4,461 $ 6,132 $ 802 $ 6,087
Year ended December 31, 1997 $ 6,087 $ 9,032 $ 6,701 $ 468 $ 8,886
Year ended December 31, 1998 $ 8,886 $ 31,773 $ 2,666 $ 37,993
Restructuring
Year ended December 31, 1998 $ - $ 16,437 $ - $ (2,349) (5) $ 14,088
</TABLE>
(1) Net write-offs.
(2) Sale of the Phoenix location of Pioneer Metal Finishing and the Commercial
Real Estate operations.
(3) Sale of Pioneer Metal Finishing and Premier Solutions Ltd.
(4) Acquisition of Dataflex.
(5) Payments against restructuring reserve.
39
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
Dated: March 16,2000 SAFEGUARD SCIENTIFICS, INC.
By: /s/ Warren V. Musser
------------------------------------
Warren V. Musser, Chairman and Chief
Executive Officer
<PAGE>
EXHIBIT INDEX
The following is a list of exhibits required by Item 601 of Regulation S-K filed
as part of this Report. Where so indicated by footnote, exhibits which were
previously filed are incorporated by reference. For exhibits incorporated by
reference, the location of the exhibit in the previous filing is indicated in
parentheses.
EXHIBIT
NO. EXHIBIT
- --- -------
3.1 Amended and Restated Articles of Incorporation of Safeguard
(20)(Exhibit 3.1)
3.2 By-laws of Safeguard, as amended (6)(Exhibit 3.2)
4.1** 1990 Stock Option Plan, as amended (20)(Exhibit 4.3)
4.2** Stock Option Plan for Non-Employee Directors (11) (Exhibit 4.8)
4.3** Safeguard Scientifics, Inc. Amended and Restated Stock Savings Plan
(14) (Exhibit 4.9)
4.4** First Amendment to Safeguard Scientifics, Inc. Stock Savings Plan
(20)(Exhibit 4.6)
4.5** Safeguard Scientifics, Inc. Stock Savings Plan Trust Agreement
(5)(Exhibit 4.2)
4.6 Trust Indenture Agreement dated February 1, 1996 (17) (Exhibit 10.34)
4.7 Purchase Agreement dated February 1, 1996 between Safeguard
Scientifics, Inc. and JP Morgan Securities, Inc. (17) (Exhibit 10.35)
10.1** Safeguard Scientifics Money Purchase Pension Plan (6)(Exhibit 10.3)
10.2** First Amendment to Safeguard Scientifics Money Purchase Pension Plan
(11) (Exhibit 10.2)
10.3** Second Amendment to Safeguard Scientifics Money Purchase Pension Plan
(14) (Exhibit 10.3)
10.4** Third Amendment to Safeguard Scientifics Money Purchase Pension Plan
(17) (Exhibit 10.4)
10.5** Safeguard Scientifics Money Purchase Pension Plan Trust Agreement
(6)(Exhibit 10.4)
10.6** Safeguard Management Incentive Compensation Plan (7)(Exhibit 10.3)
10.7** Safeguard Scientifics, Inc. Long Term Incentive Plan, as amended and
restated effective June 15, 1994 (14) (Exhibit 10.6)
<PAGE>
10.8** Safeguard Scientifics, Inc. Deferred Compensation Plan (2)(Exhibit
10.12)
10.9** Form of Promissory Notes dated February 12, 1997 given by certain
executives for advances by Safeguard of income tax withholdings on
restricted stock grants (20)(Exhibit 10.11)
10.10** Form of Amendment to Promissory Notes dated , 1999
(28)(Exhibit 10.10)
10.11 Asset Acquisition Agreement dated April 15, 1997 for the sale of
certain assets of Premier Solutions Ltd. to a subsidiary of Sungard
Data Systems Inc. (exhibits omitted) (21)(Exhibit 10.1)
10.12 Stock Exchange Agreement dated as of February 26, 1999 among Safeguard
Scientifics, Inc., aligne Incorporated, and the shareholders of aligne
Incorporated (exhibits and schedules omitted) (28)(Exhibit 10.10)
10.13 Amended and Restated Credit Agreement, dated April 17, 1998, among
Safeguard Scientifics, Inc., Safeguard Scientifics (Delaware), Inc.,
Safeguard Delaware, Inc. and PNC Bank, N.A. (exhibits
omitted)(25)(Exhibit 10.1)
10.14 Amended and Restated Master Security and Administration Agreement,
dated as of September 25, 1996, among CompuCom Systems, Inc.,
NationsBank of Texas, N.A., CSI Funding, Inc. and Enterprise Funding
Corporation (exhibits omitted) (19) (Exhibit 10.3)
10.15 Amendment No. 1 dated December 5, 1996 to Amended and Restated Master
Security Agreement among CompuCom Systems, Inc., NationsBank of Texas,
CSI Funding, Inc. and Enterprise Funding Corporation (20)(exhibit
10.16)
10.16 Amended and Restated Credit Agreement, dated as of November 3, 1997,
among CompuCom Systems, Inc., certain lenders party hereto, and
NationsBank of Texas, N.A., as administrative lender (exhibits and
schedules omitted) (24)(Exhibit 10.27)
10.17 Amendment No. 1 to Amended and Restated Credit Agreement, dated as of
June 26, 1998, among CompuCom Systems, Inc., certain lenders party
hereto, and NationsBank of Texas, N.A., as administrative lender
(exhibits omitted)(26)(Exhibit 10.2)
10.18 Amended and Restated Receivables Purchase Agreement, dated as of
November 3, 1997, between CompuCom Systems, Inc. and CSI Funding, Inc.
(exhibits omitted) (24)(Exhibit 10.28)
10.19 Amended and Restated Transfer and Administration Agreement, dated as
of November 3, 1997, among CSI Funding, Inc., CompuCom Systems, Inc.,
Enterprise Funding Corporation and NationsBank, N.A. (exhibits
omitted) (24)(Exhibit 10.29)
10.20** Executive Employment Agreement dated October 24, 1997 between Edward
Anderson and CompuCom Systems, Inc. (24)(Exhibit 10.32)
<PAGE>
10.21** Employment Agreement Amendment dated February 19, 1999 between Edward
Anderson and CompuCom Systems, Inc. (28)(Exhibit 10.21)
10.22** Promissory Note dated February 12, 1997 from Edward Anderson to
CompuCom Systems, Inc. (20)(Exhibit 10.22)
10.23** First Amendment to Term Note dated February 19, 1999 from Edward
Anderson to CompuCom Systems, Inc. (28)(Exhibit 10.23)
10.24** Pledge Agreement dated August 31, 1994 between Edward Anderson and
CompuCom Systems, Inc. (14) (Exhibit 10.27)
10.25** Term Note dated October 22, 1998 from Edward Anderson to CompuCom
Systems, Inc. (28)(Exhibit 10.25)
10.26** Pledge Agreement dated October 22, 1998 from Edward Anderson to
CompuCom Systems, Inc. (28)(Exhibit 10.26)
10.27** Stock Option Grant Agreement between CompuCom Systems, Inc. and Thomas
C. Lynch, dated as of October 22, 1998 (27)(Exhibit 10.4)
10.28** Term Note dated December 23, 1998 from Thomas Lynch to CompuCom
Systems, Inc. (28)(Exhibit 10.28)
10.29** Pledge Agreement dated December 23, 1998 from Thomas Lynch to CompuCom
Systems, Inc. (28)(Exhibit 10.29)
10.30** Term Note dated December 23, 1998 from Thomas Lynch to Safeguard
Scientifics, Inc. (28)(Exhibit 10.30)
10.31** Security Agreement dated December 23, 1998 between Thomas Lynch and
Safeguard Scientifics, Inc. (28)(Exhibit 10.31)
10.32** Note Agreement dated October 6, 1998, between Safeguard Delaware, Inc.
and Donald R. Caldwell (27)(Exhibit 10.3)
11 Computation of Per Share Earnings * (included in Note 7 to the
Consolidated Financial Statements on page 50 of Safeguard's Annual
Report to Stockholders for year ended December 31, 1998, which page is
filed as part of Exhibit 13 hereto)
13 Pages 33 to 56 of Annual Report to Stockholders for year ended
December 31, 1998 *
21 List of Subsidiaries (28)(Exhibit 21)
23.1 Consent of KPMG LLP, Independent auditors*
23.2 Consent and Report of PricewaterhouseCoopers LLP, Independent
accountants*
<PAGE>
27 Financial Data Schedule for the year ended December 31, 1998*
99.1 Consolidated Financial Statements of Cambridge Technology Partners
(Massachusetts), Inc.*
- ----------
* Filed herewith.
** These exhibits relate to compensatory plans, contracts or arrangements in
which directors and/or executive officers of the registrant may
participate.
(1) Filed on March 30, 1981 as an exhibit to the Annual Report on Form 10-K
(No. 1-5620) and incorporated herein by reference.
(2) Filed on March 30, 1987 as an exhibit to Annual Report on Form 10-K (No.
1-5620) and incorporated herein by reference.
(5) Filed on December 13, 1991 as an exhibit to Form 8-K (No. 1-5620) and
incorporated herein by reference.
(6) Filed on March 30, 1992 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(7) Filed on March 31, 1993 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(11) Filed on March 30, 1994 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(14) Filed on March 30, 1995 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(17) Filed on April 1, 1996 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(18) Filed on May 15, 1996 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(19) Filed on November 12, 1996 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(20) Filed on March 31, 1997 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(21) Filed May 15, 1997 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(22) Filed August 14, 1997 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(23) Filed November 14, 1997 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(24) Filed March 31, 1998 as an exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
(25) Filed on May 15, 1998 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
<PAGE>
(26) Filed August 14, 1998 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(27) Filed November 16, 1998 as an exhibit to Form 10-Q (No. 1-5620) and
incorporated herein by reference.
(28) Filed March 31, 1999 as a exhibit to Form 10-K (No. 1-5620) and
incorporated herein by reference.
<PAGE>
SELECTED FINANCIAL DATA
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
------------- ------------ ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net sales............................................. $2,275,143 $1,985,225 $2,062,809 $1,517,740 $1,412,026
Net earnings.......................................... 110,123(1) 21,501 19,927 18,263 15,740
Earnings per share
Basic............................................. 3.46(1) .69 .67 .63 .56
Diluted........................................... 3.22(1) .66 .61 .53 .47
Total assets.......................................... 1,068,690(2) 714,541(3) 936,070 742,874 617,155
Long-term debt, including current portion
CompuCom.......................................... 83,429 100,425(3) 239,946 123,461 137,310
Other............................................. 123,981 30,060 21,419 110,835 98,838
Convertible subordinated notes........................ 71,345 90,881 102,131 -- --
Shareholders' equity.................................. 342,859(1) 207,070 169,011 154,309 110,547
</TABLE>
No cash dividends have been declared in any of the years presented, and the
Company has no present intention to declare cash dividends.
(1) Increase relates primarily to net securities gains from Coherent/Tellabs
transactions (see Note 2 to the Consolidated Financial Statements).
(2) Increase relates primarily to recording the Company's investment in Tellabs
at fair value, increased investments, and increased assets at CompuCom resulting
from acquisitions in 1998 (see Notes 2 and 10 to the Consolidated Financial
Statements).
(3) Reflects the effect of $175 million in off-balance sheet financing at
CompuCom which reduced accounts receivable and long-term debt (see Note 3 to the
Consolidated Financial
Statements).
MANAGEMENT'S DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
Safeguard Scientifics, Inc. (the Company) develops and operates emerging
growth information technology companies. The Company's present emphasis is in
eCommerce, enterprise applications, and network infrastructure, all of which
are expected to benefit from the growing use of the Internet as a fundamental
business tool. The Company operates as a long-term partner, working closely
with its partnership companies to provide various operational and management
services to build value in preparation for public rights offerings and
beyond. The Company's partnership companies include privately held companies
and public companies that together form a community of shared resources. The
Company also assists in managing and working with several venture capital
funds. The Company's primary goal is to achieve superior returns for its
shareholders by bringing companies which it believes are ready for public
ownership to its shareholders through the rights offering process. This
process gives shareholders the opportunity to acquire direct ownership in
selected partnership companies at their initial public offering price. Not
all of the Company's private holdings are appropriate for this process;
therefore, the Company also considers mergers, sales, traditional initial
public offerings, and subscription offerings.
Consistent with its past approach, the Company plans to acquire
interests in early to mid-stage companies that can become leaders in their
respective markets. The Company is already active in the Internet through the
involvement of over 10 of its partnership companies, including Internet
Capital Group. Recognizing the growing importance of the Internet, the
Company sponsored the formation of Internet Capital in 1996 to focus
exclusively on owning, operating, and managing business-to-business eCommerce
companies. The Company owns approximately 26% of Internet Capital's
outstanding voting securities at December 31, 1998.
The Company feels the best way to build future value for its
shareholders is to be involved in Internet markets. As the Company acquires
interests in more Internet-related companies, it could experience increased
volatility in its earnings, as many early stage Internet companies have
operating losses. For several years, the Company has had a financial model of
exceeding the prior year's quarterly earnings per share (EPS) by $.01. This
was essentially accomplished through sales of shares of publicly traded
partnership companies. Given the volatility of the technology market,
especially Internet-related stocks, the Company will no longer sell shares of
publicly traded partnership companies solely to achieve a targeted EPS. As a
result, the Company's net earnings could fluctuate significantly from quarter
to quarter, depending on when the Company decides to sell those securities.
There can be no guarantee that the Company will report net earnings in each
period.
EFFECT OF VARIOUS ACCOUNTING METHODS ON THE
CONSOLIDATED FINANCIAL STATEMENTS
The net sales and related costs and expenses of a partnership company are
included in the Company's consolidated operating results if the Company owns
more than 50% of the outstanding voting securities of the partnership
company. Participation of share-holders other than the Company in the
earnings or losses of a more than 50% owned partnership company is reflected
in the caption "Minority interest" in the Consolidated Statements of
Operations. Minority interest adjusts consolidated net earnings to reflect
only the Company's share of the earnings or losses of the partnership
company. CompuCom Systems, Inc. and Tangram Enterprise Solutions, Inc. are
consolidated in 1998 and 1997. Premier Solutions Ltd. and Pioneer Metal
Finishing, which were sold in 1997, also were included
<PAGE>
in the Company's consolidated operating results through their
respective sale dates.
Partnership companies in which the Company owns 50% or less of the
outstanding voting securities, in which significant influence is exercised,
are accounted for on the equity method of accounting. Significant influence
is presumed at a 20% ownership level; however, the Company applies the equity
method for certain companies in which it owns less than 20% of the voting
interest when it exerts significant influence through representation on those
companies' Boards of Directors and other means. On the equity method of
accounting, a partnership company's revenues and related costs and expenses
are not included in the Company's consolidated operating results; however,
the Company's share of the earnings or losses of the partnership company is
reflected in the caption "Equity in losses (income) of affiliates" in the
Consolidated Statements of Operations.
The net effect of a partnership company's results of operations on the
Company's net earnings is the same under either consolidation accounting or
the equity method of accounting, as only the Company's share of the earnings
or losses of a partnership company is included in the Company's net earnings
in the Consolidated Statements of Operations.
Partnership companies not consolidated or accounted for on the equity
method are accounted for on the cost method of accounting under which the
Company's share of the earnings or losses of such companies is not included
in the Company's Consolidated Statements of Operations. However, the effect
of the change in market value of cost method investments classified as
trading securities is reflected in the Company's results of operations each
reporting period.
If the Company's ownership in any of the partnership companies changes
significantly, the Company's consolidated revenues and related costs and
expenses may fluctuate primarily due to the applicable accounting method used
for recognizing its participation in the operating results of that company.
As mentioned in Operations Overview, the Company's consolidated
revenues and related costs and expenses are significantly influenced by the
results of operations of CompuCom. At December 31, 1998, the Company owns
approximately 51% of CompuCom's outstanding common stock and owns preferred
stock which gives it 60% of the vote for CompuCom's directors.
CompuCom competes in the computer reseller industry which has been
undergoing significant transformation and consolidation. Several of
CompuCom's competitors have been growing through acquisitions and others have
been acquired. In addition, companies previously engaged in the retail
channel have begun to enter the corporate reseller market, heightening the
competition.
As a result, while growing internally, CompuCom is also looking to
strengthen its market share through acquisitions, including three
acquisitions which were completed in 1998. If CompuCom were to use its stock
for the acquisitions or if some other dilutive event were to occur, the
Company's voting interest in CompuCom could decrease below 50%. Under current
generally accepted accounting principles, the Company would cease
consolidating CompuCom's results and instead would account for its investment
in CompuCom on the equity method provided the Company maintained the ability
to exercise significant influence over CompuCom's ordinary course of
business. The Company's share of CompuCom's earnings on the equity method
versus consolidation would differ only to the extent that the Company's
ownership of CompuCom changed. However, the presentation of the Consolidated
Statements of Operations and Balance Sheets would change dramatically.
Note 14 to the Company's Consolidated Financial Statements summarizes
the Parent Company Statements of Operations and Balance Sheets of the Company
for the same periods presented in the Consolidated Financial Statements.
These statements differ from the Consolidated Financial Statements by
excluding the revenues, costs, expenses, assets, and liabilities of the
Company's less than wholly owned subsidiaries (primarily CompuCom and
Tangram) and instead treating these companies as if they were accounted for
on the equity method. The Company's share of the results of operations of
less than wholly owned subsidiaries is included in "Equity loss (income)" and
the carrying value of these companies is included in "Investments" in the
Parent Company Statements of Operations and Balance Sheets, respectively.
Although the Parent Company Statements of Operations and Balance Sheets
presented in Note 14 are accurate relative to the Company's historical
Consolidated Financial Statements, they are not necessarily indicative of
future Parent Company Statements of Operations and Balance Sheets.
OPERATIONS OVERVIEW
The Company's operations have been classified into the following business
segments: CompuCom, Tangram, general corporate operations, and other.
CompuCom's operations are further defined into two segments-sales of
distributed desktop computer products (product) and configuration, network
integration, and technology support (service). Tangram's operations include
the design, development, sale, and implementation of enterprise-wide asset
tracking and software management solutions. General corporate operations
consists of developing and operating partnership companies, most of which are
engaged in information technology businesses. Other primarily includes
Pioneer and Premier which were sold during 1997 and Commercial Real Estate
which was sold during 1996.
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED
DECEMBER 31, 1997
Net sales increased 15% to $2.3 billion in 1998 compared to $2.0 billion in
1997 as CompuCom experienced a 16% sales increase. The increase at CompuCom
was due primarily to a 17% product sales increase resulting from the
acquisitions of Computer Integration Corporation (CIC) and Dataflex
Corporation (the acquisitions) during the second quarter of 1998. Excluding
the acquisitions, CompuCom's product sales increased approximately 4% in
1998, and CompuCom sold 26% more desktop, laptop, and server units. However,
a decline in the average sales prices of these units as a result of
manufacturer price reductions lessened the impact of this unit growth on
sales. Although the trend of declining average sales prices continued to slow
in 1998 relative to 1997, CompuCom expects to be
<PAGE>
continually impacted by this trend in the short-term, as CompuCom must sell
more units to generate the same amount of product sales. CompuCom's service
sales increased 9% to $257.9 million in 1998 from $236.2 million in 1997,
which was primarily due to increases in field engineering, which is driven in
part by product unit sales volume and by the acquisitions. Excluding the
acquisitions, service sales increased approximately 5%. CompuCom represented
99% of the Company's total consolidated net sales in 1998.
The Company's overall gross margin was 13.3% in 1998 compared to 14.4%
in 1997. The decrease is primarily attributable to reduced gross margins at
CompuCom. CompuCom's product gross margin decreased to 9.8% in 1998 compared
to 10.4% in 1997. CompuCom attributes this to a decline in billed margins due
to heightened competition from other corporate resellers and direct
marketers. CompuCom expects to continue to experience declining product gross
margins in the short-term. CompuCom's service gross margin was 32.0% in 1998
compared to 35.7% in 1997. The decrease was primarily caused by lower billing
per engineer for CompuCom's service personnel, particularly in the systems
engineering group. CompuCom does not expect to see improvement in its service
gross margin percentage in the short-term.
Securities and other gains in 1998 include a $245.3 million gain on the
merger of Coherent Communications Systems Corporation and Tellabs, Inc.,
partially offset by a $48.6 million loss comprised of unrealized losses
resulting from the decline in the market price of Tellabs subsequent to the
merger and gains on the sales of Tellabs stock. Securities and other gains in
1998 also include the open market sales of a portion of the Company's
interest in Cambridge Technology Partners, the gain resulting from the merger
of Integrated Systems Consulting Group with First Consulting Group, and
distributions received from the Company's associated venture funds.
Securities and other gains in 1997 included the open market sales of a
portion of the Company's interest in Cambridge, the sale of shares of Diamond
Technology Partners and ChromaVision Medical Systems in rights offerings to
the Company's shareholders, and distributions received from the Company's
associated venture funds. The Company also recorded gains in 1997 from the
sale of Premier and Pioneer. Partially offsetting securities and other gains
in these years was a write-down of the Company's holdings in Sybase due to
the other than temporary decline in the market price of that stock, charges
incurred in the disposition of certain partnership companies, and provisions
for other investments and notes. Securities and other gains of varying
magnitude have been realized in recent years; prior gains are not
necessarily indicative of gains which may be realized in the future.
Equity in losses (income) of affiliates fluctuates with the Company's
ownership percentage and the operating results of partnership companies
accounted for on the equity method. In 1998, the Company discontinued
accounting for its investment in Coherent on the equity method of accounting
as a result of the Coherent/Tellabs merger. In addition, the Company recorded
its share of merger-related and other one-time charges at certain partnership
companies. Equity income decreased as a result of the above transactions as
well as increased operating losses at certain partnership companies,
partially offset by the continued strong overall performances at Cambridge
and Sanchez Computer Associates, and increased earnings at Internet Capital
resulting from securities sales. In 1998, the Company's public investments
accounted for on the equity method include Cambridge, ChromaVision, OAO
Technology Solutions (OAOT), Sanchez, and USDATA Corporation. The Company
expects certain of its partnership companies to continue to invest in their
products and services and to recognize operating losses. Additionally, the
Company expects to acquire interests in more Internet-related companies, and
many early stage Internet companies have operating losses. As a result,
equity losses of affiliates could increase significantly.
Cambridge reported 40% revenue growth in 1998 with earnings up 50%,
excluding business combination costs. At year end, approximately 50% of its
projects worldwide contained an Internet or interactive component. The
Company owns approximately 15% of Cambridge's common stock at December 31,
1998.
ChromaVision is making significant progress with clinical trials for its
Automated Cellular Imaging System (ACIS-TM-). ChromaVision submitted an
application to the FDA in November 1998 to use the ACIS-TM- for
Immunohistochemical (IHC) applications. Clearance from the FDA, which is
expected in the first quarter of 1999, would rapidly accelerate expansion of
the spectrum of clinical tests that can be performed on the ACIS-TM-
platform. The Company's increased losses primarily resulted from the
increased level of development and costs associated with the FDA application.
The Company owns approximately 26% of ChromaVision's common stock at
December 31, 1998.
OAOT initiated management and cost restructurings in 1998 which are
expected to result in annualized pretax savings in excess of $3 million.
Combined with two acquisitions in 1998, a $60 million IT staffing
augmentation services company and an Enterprise Resource Planning integrator,
OAOT is targeting higher margin service business in 1999. It also announced a
10-year contract for approximately $150 million with IBM Global Services to
provide application development and maintenance services in support of IBM's
application outsourcing contract with AT&T. The Company owns approximately
34% of OAOT's common stock at December 31, 1998.
Sanchez reported an 84% increase in earnings per share in 1998 with 53%
revenue growth. Sanchez also recently announced the formation of a dedicated
electronic banking service center through an agreement to purchase a banking
technology center near Pittsburgh. The new service offering, called
e-Profile.com, will allow leading financial institutions to launch new direct
banks from an operations and technology perspective in 30 to 90 days with
little or no up-front capital. The Company owns approximately 27% of
Sanchez's common stock at December 31, 1998.
USDATA announced its return to profitability in the fourth quarter of
1998 following 7 quarters of losses. USDATA also sold its hardware business
during 1998. The Company owns approximately 26% of USDATA's common stock at
December 31, 1998.
In October 1998, CompuCom's Board of Directors approved a restructuring
plan designed to reduce CompuCom's cost structure by approximately 1.25% to
1.5% of sales by closing branch facilities and reducing CompuCom's workforce
by approximately 10%. As a result, CompuCom recorded a restructuring charge
in the fourth quarter 1998 of $16.4 million (pretax), the effect of which is
approximately
<PAGE>
$8.1 million (pretax) to the Company's earnings, after recording minority
interest. The charge primarily consists of costs associated with the closing
of certain facilities and disposing of related fixed assets, as well as
employee severance and benefits related to the reduction in workforce.
CompuCom continues to maintain a local presence in all current markets
through the use of its virtual office strategy. As a result of its fourth
quarter 1998 restructuring, CompuCom expects to realize reductions in
operating expenses, primarily in selling and general and administrative
expenses, from its fourth quarter 1998 levels. These reductions may not
result in lower operating expenses in comparison to the respective period of
the prior year (see Note 5 to the Consolidated Financial Statements).
Selling and service expenses increased in absolute dollars and as a
percentage of sales in 1998 primarily due to increased expenses at CompuCom.
The increases at CompuCom were primarily due to an increase in the sales
force as a result of the CIC and Dataflex acquisitions, the hiring of
additional sales representatives, higher commission expense, growth in its
service business, and increased spending on training as a result of the
increase in the size of the engineering force.
General and administrative expenses increased in absolute dollars
primarily due to increased expenses at CompuCom and increased corporate
expenses incurred to support the growing activities of the partnership
companies. The increase was partially offset by the elimination of expenses
resulting from the sale of Pioneer in 1997. The increases at CompuCom were
primarily due to expenditures to broaden its eCommerce capabilities, costs
related to its ongoing campus recruiting program, and costs associated with
the integration of CIC and Dataflex. CompuCom's general and administrative
expenses are reported net of reimbursements by certain manufacturers for
specific training, promotional, and marketing programs. These reimbursements
offset the expenses incurred by CompuCom.
Depreciation and amortization increased primarily due to an increase at
CompuCom, which was partially offset by the elimination of depreciation and
amortization resulting from the sale of Premier and Pioneer in 1997. The
increase at CompuCom is associated with upgrading its hardware and software
and increased depreciation and amortization as a result of the acquisitions
completed during the first half of 1998. As a result of CompuCom's fourth
quarter 1998 restructuring, CompuCom expects to realize a slight decrease in
depreciation expense associated with the closing of branch facilities and
disposal of those related depreciable assets.
Interest and financing expenses increased in 1998 compared to 1997
primarily as a result of increased borrowings at CompuCom to fund the
acquisitions of CIC and Dataflex, and increased borrowings by the Company
primarily to fund interests in new or existing partnership companies,
partially offset by the elimination of interest due to the conversion of
$19.5 million of the Company's Convertible Subordinated Notes (Notes) into
the Company's Common Stock in 1998.
Minority interest decreased as a result of decreased earnings at
CompuCom, including its fourth quarter 1998 restructuring charge. Future
profitability at CompuCom will depend on its ability to effectively manage
inventory levels in response to changes in its major suppliers' price
protection and return programs, its ability to effectively manage the
utilization of service personnel, and its ability to respond to increased
competition from its suppliers' direct selling initiatives. It also depends
on CompuCom's ability to reduce operating expenses, demand for product,
competition, manufacturer product availability, effective utilization of
vendor programs, and its ability to implement its virtual office strategy as
part of its fourth quarter 1998 restructuring.
The effective tax rate decreased to 35.8% in 1998 compared to 40% for
1997 due to the realization of previously unrecorded tax benefits
attributable to the difference between the book basis and tax basis of
certain of the Company's investments as well as the application of lower tax
rates against realized investment gains.
The Company's net earnings increased significantly in 1998 compared to
1997 primarily due to higher securities and other gains related to
Coherent/Tellabs transactions, partially offset by decreased earnings at
CompuCom. Securities and other gains of varying magnitude have been realized
in recent years. The Company's net earnings could fluctuate significantly
from period to period, depending on when the Company decides to sell shares
of publicly traded partnership companies. There can be no guarantee that the
Company will report net earnings in each period.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED
DECEMBER 31, 1996
Net sales decreased 4% in 1997 compared to 1996 primarily attributable to
the sale of Premier and Pioneer during 1997 and decreased product sales at
CompuCom as CompuCom primarily focused on increasing earnings through growth
in its higher-margin service business in 1997. In addition, CompuCom believes
the decrease in product sales is also attributable to an increase in direct
marketers' market share and CompuCom's efforts during much of 1997 to reduce
the amount of low-margin product business. CompuCom's total sales decreased
2% for the year with service sales increasing 40% while product sales
decreased 6%. CompuCom represented 98% and 97% of the Company's total
consolidated net sales in 1997 and 1996, respectively.
The Company's overall gross margin was 14.4% in 1997 compared to 13.1%
for 1996. The increase is attributable to increased product margins at
CompuCom as well as increased service sales at CompuCom which generated
higher gross margins relative to product sales. Product margins increased to
10.4% in 1997 compared to 10.0% in 1996 primarily due to a reduction in the
relative volume of sales to some of CompuCom's larger customers, which
typically generate lower product margins, and an increase in the amount of
manufacturer-sponsored incentives in 1997 compared to 1996. Service gross
margin increased to 35.7% in 1997 from 33.3% in 1996 primarily due to
increased productivity of CompuCom's service engineers.
Securities and other gains in 1997 included the open market sales of a
portion of the Company's interest in Cambridge, the sale of shares of Diamond
and ChromaVision in rights offerings to the Company's shareholders, and
distributions received from the Company's associated venture funds. The
Company also recorded gains in 1997 from the sale of Premier and Pioneer.
Securities and other gains in 1996 included the open market sales of a
portion of the Company's interests in Coherent and Cambridge, and the sale of
shares of Integrated Systems
<PAGE>
and Sanchez in rights offerings to the Company's shareholders. Securities and
other gains in 1996 also included the sale of the Company's remaining
interest in Gandalf Technologies and the Company's share of CompuCom's gain
from the sale of substantially all of its holdings in PC Service Source.
Partially offsetting securities and other gains in these years was a
write-down of the Company's holdings in Sybase due to the other than
temporary decline in the market price of that stock, charges incurred in the
disposition of partnership companies, and provisions for other investments
and notes.
Increased equity income from most of the Company's public investments in
1997 was more than offset by the Company's share of losses at certain
private, early stage equity affiliates and increased amortization of the
excess of carrying value of equity affiliates over the Company's share of the
underlying net assets. The Company's public equity investments accounted for
on the equity method in 1997 included Cambridge, ChromaVision, Coherent,
OAOT, Sanchez, and USDATA.
Selling and service expenses increased in 1997 compared to 1996
primarily due to CompuCom's costs to manage and expand its growing service
business. General and administrative expenses, in absolute dollars and as a
percentage of sales, increased in 1997 compared to 1996 primarily due to
CompuCom's continued investment in its information system resources required
to broaden eCommerce capabilities and improve efficiency within its customer
center, Tangram's investment in workforce and research and development for
Asset Insight-TM-, and increased corporate expenses incurred to support the
growing activities of the partnership companies. These increases were
partially offset by the elimination of expenses resulting from the sale of
Premier and Pioneer in 1997.
Depreciation and amortization decreased in 1997 primarily due to the
sale of Premier and Pioneer in 1997 and the Company's commercial real estate
operations in 1996, partially offset by increased depreciation at CompuCom.
The increase at CompuCom is primarily associated with its new corporate
headquarters and operations campus and enhancements to CompuCom's information
systems.
Interest and financing expenses decreased slightly in l997 compared to
1996 primarily as a result of the conversion of approximately $24.2 million
of the Company's Notes in the fourth quarter of 1996 and the first quarter of
1997 into the Company's Common Stock and the elimination of interest
resulting from the sale of Premier and Pioneer in 1997 and the Company's
commercial real estate operations in 1996, partially offset by increased
borrowings by the Company. CompuCom's borrowing levels, including the
receivables securitization facility, were slightly higher in 1997 when
compared to 1996; however, this was offset by a lower effective rate for 1997.
LIQUIDITY AND CAPITAL RESOURCES
The Company has historically used its bank credit facility and proceeds from
sales of publicly traded partnership companies to fund its cash requirements.
In addition, in February 1996, the Company issued $115 million of 6%
Convertible Subordinated Notes due February 1, 2006. The Notes are
convertible into the Company's Common Stock at $28.985 per share. The Company
used approximately $67 million of the net proceeds to repay all of the
outstanding indebtedness under its bank revolving credit facility at that
date. Through March 1999, approximately $43.7 million of Notes have been
converted into 1,506,119 shares of the Company's Common Stock.
In April 1998, the Company increased the availability under its bank
revolving credit facility to $200 million from $150 million. Of the $200
million, $150 million matures in May 2002 and is secured by certain equity
securities the Company holds of its publicly traded partnership companies
(the Pledged Securities), including CompuCom. The value of these Pledged
Securities exceeds the total availability under the bank revolving credit
facility. The remaining $50 million is unsecured and matures in April 1999,
with availability limited to the lesser of $50 million or 10% of the value of
the Pledged Securities. The Company intends to renew the $50 million bank
revolving credit facility in 1999. There was $88.1 million outstanding under
the total facility at December 31, 1998.
The Company has revolving credit facilities with certain partnership
companies whereby the Company may borrow up to $20 million from these
partnership companies on a revolving basis at a rate that varies with the
Company's effective borrowing rate. At December 31, 1998, $20 million was
outstanding under these agreements.
During 1998, the Company invested approximately $48 million in seven new
partnership companies, including US Interactive, Kanbay, Pac-West Telecomm,
Integrated Visions, and Who? Vision. The Company invested approximately $73
million during 1998 in its existing private partnership companies and
associated venture funds. The Company also purchased approximately $20
million of shares of its publicly traded partnership companies, and
repurchased 765,000 shares of the Company's Common Stock in the open market
for approximately $19 million. The Company received approximately 3.5 million
shares of Tellabs in connection with the merger of Coherent with Tellabs and
received approximately 451,000 shares of First Consulting in connection with
the merger of Integrated Systems with First Consulting. During 1998, the
Company sold a portion of its interests in Cambridge and Tellabs for net
proceeds totaling $87 million.
Availability under the Company's revolving credit facilities, proceeds
from the sales from time to time of selected publicly traded partnership
companies, and other internal sources of cash flow are expected to be
sufficient to fund the Company's cash requirements through 1999, including
commitments to new or existing partnership companies, general corporate
requirements, and the repurchase of the Company's Common Stock from time to
time in the open market. The Company is contingently obligated for
approximately $30 million of guarantee commitments, and has committed capital
of approximately $100 million to various partnership companies, venture
funds, and private equity partnerships, to be funded over the next several
years.
Availability under the Company's bank credit facility is determined by
the market value of the publicly traded partnership companies pledged as
collateral. If the stock markets experience a significant decline,
availability under the credit facilities could be reduced significantly and
could have an adverse effect on the Company's ability to borrow under the
facilities. In addition, the Company's ability to raise proceeds from sales
of publicly traded partnership companies could also be adversely effected. As
a result, the Company's ability to acquire interests in new partnership compa-
<PAGE>
nies and support its existing partnership companies with additional funding
could be limited.
CompuCom maintains separate, independent financing arrangements, which
are non-recourse to the Company and are secured by certain assets of
CompuCom. During recent years, CompuCom has utilized operating earnings, bank
financing arrangements, and internally generated funds to fund its cash
requirements. CompuCom's liquidity has been negatively impacted by the
increase in the dollar volume of the rebate programs of its principal
suppliers. Under these programs, CompuCom is required to pay a higher initial
price for product and claim a rebate to reduce that price. The collection of
these rebates can take several months. Due to the increased volume of product
sold under these programs, CompuCom's initial price for the product is often
higher than the sales price CompuCom can obtain from its customers. At
December 31, 1998, these programs are a major factor in CompuCom's financing
needs.
CompuCom's financing arrangements consist of a $165 million working
capital facility (increased from $125 million in June 1998), a $175 million
receivables securitization facility, and a $25 million real estate loan
(collectively, the "credit agreements"). At December 31, 1998, approximately
$81.1 million was outstanding under the working capital facility and the real
estate loan, and the receivables securitization facility was fully utilized.
The working capital facility matures in November 2002 and the real estate
loan is due in quarterly installments beginning April 1999. The receivables
securitization facility expires on April 15, 1999.
At December 31, 1998, CompuCom was not in compliance with certain
financial covenants under the credit agreements. However, CompuCom received
an amendment related to such covenants from its lenders up to and including
April 15, 1999. CompuCom is currently negotiating a replacement receivables
securitization and working capital facility and expects to execute
agreements prior to April 15, 1999. Although these facilities are expected to
contain provisions that could result in lower interest rates as CompuCom's
financial performance improves, the initial interest rates are expected to be
higher than CompuCom's current effective interest rates. If CompuCom is not
successful in implementing the replacement facilities, its management
believes there are a number of viable alternatives to ensure continued
financing. CompuCom also expects to complete a sale/leaseback on its
headquarters building during the first quarter of 1999, with the proceeds
used to payoff the real estate loan and pay down a portion of the working
capital facility.
In 1998, CompuCom completed three business combinations for
approximately $49 million in cash. These business combinations were accounted
for as purchases.
Consolidated working capital increased to $252 million at December 31,
1998, compared to $228 million at December 31, 1997. The increase was
primarily due to the classification of the Company's Tellabs holdings as a
trading security following the Coherent/Tellabs merger in August 1998, as
well as an increase in accounts receivable at CompuCom as a result of two
acquisitions completed in the second quarter of 1998 which resulted in higher
sales in the fourth quarter of 1998 compared to the fourth quarter of 1997.
These increases were partially offset by an increase in accounts payable at
CompuCom resulting from the timing of product receipts and the mix of
vendors, and a decrease in inventory due to CompuCom's effort to reduce its
risk associated with changes in its suppliers price protection and return
programs and increase its inventory turns.
Cash flow provided by operating activities decreased in 1998 as
operating cash flow for 1997 included the effect of CompuCom's receivables
securitization facility in which $175 million of accounts receivable were
sold with the proceeds used to pay down long-term debt.
The Company has sold approximately 300,000 shares of Tellabs in the
first quarter through March 5, 1999, generating proceeds of approximately $24
million. The Company is considering certain hedging strategies to partially
protect against possible declines in the price of its Tellabs holdings.
The Company's operations are not capital intensive, and capital
expenditures in any year normally would not be significant in relation to the
overall financial position of the Company. Capital asset requirements are
generally funded through bank credit facilities, internally generated funds
or other financing sources. There were no material capital asset purchase
commitments at December 31, 1998.
YEAR 2000 READINESS DISCLOSURE
The Company is currently addressing the Year 2000 issue, which results from
the fact that many computer programs were previously written using two digits
rather than four to define the applicable year. Programs written in this way
may recognize a date ending in "00" as the year 1900 rather than the year
2000. This could result in a system failure or miscalculations causing
disruptions of operations. The Company has completed its assessment of its
computer information systems. The Company has replaced or is replacing during
the first quarter of 1999 all computer systems and software which were
determined to be non-compliant. These replacements were generally part of
the Company's program of regularly upgrading its computer systems, and the
Company has not incurred and does not expect to incur any material
extraordinary expense to remediate its systems. The Company will perform
testing and complete implementation of its computer systems during the second
quarter of 1999. The Company is in the process of surveying its vendors of
non-information systems including telecommunications and security systems,
and expects to complete remediation, if necessary, during 1999. If the
Company determines that its non-information systems are non-compliant and are
at risk to not be remedied in time, it will develop a contingency plan.
The Company has engaged in a regular program of surveying its
partnership companies regarding their Year 2000 readiness. The Company's most
significant consolidated subsidiary, CompuCom, has completed initial
assessment of its computer information systems, and plans to complete
remediation and testing by June 1999. Initial assessment and remediation of
CompuCom's non-information systems is currently expected to be completed
during the first quarter of 1999. CompuCom completed three business
acquisitions during 1998. CompuCom has integrated the operations of those
companies, including replacing their major information systems with
CompuCom's information systems. CompuCom has surveyed its vendors and
suppliers regarding their Year 2000 readiness, and has
<PAGE>
received confirmation of compliance for 85% of the systems currently in use.
CompuCom plans to upgrade or replace any systems which are not Year 2000
compliant during the second quarter of 1999. As a reseller of computer products,
CompuCom only passes through to its customers the applicable vendor's
warranties; it makes no warranties regarding Year 2000 compliance on any of the
products it resells. However, if one of CompuCom's major vendors or suppliers is
found to be Year 2000 non-compliant, CompuCom could experience a material loss
of revenues and earnings. CompuCom is currently developing a contingency plan to
operate in the event its computer systems or those of its vendors, suppliers, or
customers are not Year 2000 compliant. CompuCom currently anticipates that it
will spend approximately $1.4 million on Year 2000 compliance, of which
approximately $800,000 has been spent through December 31, 1998.
Almost all of the balance of the Company's partnership companies have
completed assessing their internal Year 2000 readiness, and the rest expect
to complete assessment in the first quarter of 1999. The partnership
companies are in varying stages of remediating and testing their internal
systems and assessing Year 2000 readiness of their vendors, business
partners, and customers. The partnership companies are also in varying stages
of developing contingency plans to operate in the event of a Year 2000
problem. Most of the partnership companies are in the business of providing
software products, information technology services, or outsourcing services.
Those partnership companies which produce software or products with embedded
programming believe that the current version of their products are Year 2000
compliant. Certain partnership companies are continuing to determine the
extent to which previously sold software products and services were
non-compliant. Some older companies may not be able to assess products sold
many years ago. The partnership companies generally have attempted to enter
into software license agreements and service agreements with their customers
that limit their liability, including for Year 2000 problems. Many of the
software companies' customers have maintenance agreements under which the
company will upgrade previously sold software to Year 2000 compliant
versions. They are generally encouraging their other customers to upgrade
older non-compliant versions to new compliant versions. The total cost and
time which will be incurred by the partnership companies on the Year 2000
readiness effort cannot presently be determined. There can be no assurance
that all necessary work will be completed in time, or that such costs will
not materially adversely impact one or more of such partnership companies. In
addition, required spending on the Year 2000 effort will cause customers of
most of the Company's partnership companies to reallocate at least part of
their information systems budgets. Although several partnership companies
have offerings which may be useful in such efforts, such reallocations could
materially adversely affect the results of operations of many partnership
companies.
SAFE HARBOR STATEMENT
Certain statements in this annual report describing the plans, goals,
strategies, intentions, forecasts, and expectations of the Company or its
partnership companies constitute what are sometimes termed "forward-looking
statements." The following important factors could cause actual results to
differ materially from those in such forward-looking statements.
The information technology industry is highly competitive,
characterized by rapid product development cycles, frequent price reductions,
and early product obsolescence, and is generally dominated by companies with
greater resources than the Company and its part-nership companies. Certain of
the Company's partnership companies offer complex products or services which
have lengthy sales cycles, which makes sales forecasts difficult to make, and
can lead to substantial fluctuations in quarterly operating results.
Emerging technology companies, including many of the Company's partnership
companies, often encounter obstacles and delays in developing products,
service offerings, and markets. Such delays and obstacles could affect the
Company's ability to complete rights offerings when planned.
Competition to invest in or acquire successful emerging information
technology companies is substantial, particularly in the areas the Company is
targeting. The Company may not be able to invest in companies in the targeted
areas at valuations it considers to be reasonable. The Company is dependent
on the financial market for information technology companies in general and
for initial public offerings of those companies in particular. If the current
uncertainty in those markets continues for an extended period of time, the
Company's ability to complete rights offerings when planned and the Company's
ability to generate gains from sales of publicly traded partnership companies
could be materially adversely affected. In addition, the Company's ability to
borrow under its revolving credit facilities could be adversely affected as
availability under these facilities is determined by the value of the
publicly traded securities pledged by the Company as collateral. As a result,
the Company's ability to acquire interests in new partnership companies and
support its existing partnership companies with additional funding could be
limited. The market for securities of Internet-related companies is extremely
volatile, and the Company's participation in Internet-related companies could
cause the Company's stock to become more volatile.
Clients of the Company's partnership companies could reallocate part or
all of their information systems budgets to address the Year 2000 issue,
which could materially reduce the demand for the products and services of the
Company's partnership companies. The Company's and its partnership companies'
business operations could be materially adversely affected if they or their
vendors, business partners, or customers do not timely complete any necessary
remediation efforts to their own systems and products. There is likely to be
an extraordinary amount of litigation regarding the Year 2000 issue over the
next several years, and information technology providers may be attractive
targets for such litigation. Such litigation could have a material adverse
impact on the Company's and its partnership companies' operations and
financial conditions.
<PAGE>
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
December 31 1998 1997
- ----------- ---------- ----------
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents.......................................................................... $ 6,257 $ 5,382
Short-term investments............................................................................. 143,103 --
Receivables less allowances ($4,769-1998; $2,872-1997)............................................. 296,093 187,385
Inventories........................................................................................ 138,551 198,053
Other current assets............................................................................... 5,006 6,459
- ----------- ---------- ----------
Total current assets............................................................................. 589,010 397,279
Property, Plant, and Equipment, Net.................................................................... 96,840 76,967
Other Assets
Investments........................................................................................ 288,336 185,111
Notes and other receivables........................................................................ 20,182 21,035
Excess of cost over net assets of businesses acquired, net......................................... 65,137 26,168
Other.............................................................................................. 9,185 7,981
- ----------- ---------- ----------
Total other assets............................................................................... 382,840 240,295
---------- ----------
Total Assets........................................................................................... $1,068,690 $ 714,541
---------- ----------
---------- ----------
Liabilities and Shareholders' Equity
Current Liabilities
Current debt obligations........................................................................... $ 2,366 $ 3,396
Accounts payable................................................................................... 161,700 74,025
Accrued expenses................................................................................... 172,953 91,857
---------- ----------
Total current liabilities........................................................................ 337,019 169,278
Long-Term Debt....................................................................................... 205,044 127,089
Deferred Taxes....................................................................................... 12,562 20,044
Minority Interest and Other.......................................................................... 99,861 100,179
Convertible Subordinated Notes....................................................................... 71,345 90,881
Shareholders' Equity
Common stock, par value $.10 per share
Authorized 100,000,000 shares; Issued 32,799,342 shares........................................... 3,280 3,280
Additional paid-in capital......................................................................... 62,470 49,952
Retained earnings.................................................................................. 261,594 151,471
Accumulated other comprehensive income............................................................. 37,294 15,706
Treasury stock, at cost (1,252,995 shares-1998; 1,563,626 shares-1997)............................. (21,779) (13,339)
---------- ----------
Total shareholders' equity....................................................................... 342,859 207,070
---------- ----------
Total Liabilities and Shareholders' Equity............................................................. $1,068,690 $ 714,541
---------- ----------
---------- ----------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ----------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Revenues
Net sales
Product....................................................................... $1,994,965 $1,724,220 $1,856,889
Service....................................................................... 280,178 261,005 205,920
---------- ---------- ----------
Total net sales................................................................. 2,275,143 1,985,225 2,062,809
Securities and other gains, net................................................. 193,665 26,857 30,373
Other income.................................................................... 14,691 12,932 8,646
---------- ---------- ----------
Total revenues.............................................................. 2,483,499 2,025,014 2,101,828
Costs and Expenses
Cost of sales-product........................................................... 1,787,370 1,534,310 1,655,893
Cost of sales-service........................................................... 185,561 164,882 137,065
Selling and service............................................................. 172,349 136,646 128,467
General and administrative...................................................... 96,647 87,538 84,235
Depreciation and amortization................................................... 21,738 18,132 20,645
Interest and financing.......................................................... 29,720 22,359 23,916
Equity in losses (income) of affiliates......................................... 2,083 (417) (1,539)
Restructuring................................................................... 16,437 -- --
---------- ---------- ----------
Total costs and expenses.................................................... 2,311,905 1,963,450 2,048,682
---------- ---------- ----------
Earnings Before Minority Interest and Taxes on Income............................. 171,594 61,564 53,146
Minority interest............................................................... (47) (25,727) (19,934)
---------- ---------- ----------
Earnings Before Taxes on Income................................................... 171,547 35,837 33,212
Provision for taxes on income................................................... 61,424 14,336 13,285
---------- ---------- ----------
Net Earnings...................................................................... $ 110,123 $ 21,501 $ 19,927
---------- ---------- ----------
Earnings Per Share
Basic........................................................................... $ 3.46 $ .69 $ .67
Diluted......................................................................... $ 3.22 $ .66 $ .61
Average Common Shares Outstanding
Basic........................................................................... 31,833 31,249 29,900
Diluted......................................................................... 34,914 31,996 31,348
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- ---------- --------- ----------
<S> <C> <C> <C>
Operating Activities
Net earnings.................................................................... $ 110,123 $ 21,501 $ 19,927
Adjustments to reconcile net earnings to cash provided (used) by
operating activities
Depreciation and amortization................................................. 21,738 18,132 20,645
Deferred income taxes......................................................... 28,909 (2,566) 1,910
Equity in losses (income) of affiliates....................................... 2,083 (417) (1,539)
Securities and other gains, net............................................... (193,665) (26,857) (30,373)
Minority interest, net........................................................ 28 15,436 11,960
Cash provided (used) by changes in working capital items
Receivables................................................................... (32,301) 210,578 (113,719)
Inventories................................................................... 68,840 35,498 (36,595)
Accounts payable, accrued expenses, and other................................. 69,313 (123,759) 38,454
---------- --------- ----------
Cash provided (used) by operating activities.................................... 75,068 147,546 (89,330)
Proceeds from securities and other gains, net................................... 94,838 71,318 53,350
---------- --------- ----------
Cash provided (used) by operating activities and
securities and other gains, net.................................................. 169,906 218,864 (35,980)
Other Investing Activities
Investments and notes acquired, net............................................. (137,375) (78,412) (59,270)
Business acquisitions, net of cash acquired..................................... (49,679) -- (6,937)
Capital expenditures............................................................ (17,582) (31,314) (49,984)
Other, net...................................................................... (1,988) 449 (14,197)
---------- --------- ----------
Cash used by other investing activities........................................... (206,624) (109,277) (130,388)
Financing Activities
Net borrowings (repayments) on revolving credit facilities...................... 52,754 (117,766) 27,131
Net (repayments) borrowings on term debt........................................ (2,269) (168) 24,165
Issuance of convertible subordinated notes, net................................. -- -- 112,109
Repurchase of Company common stock.............................................. (18,672) (9,488) --
Issuance of Company common stock................................................ 4,135 5,819 5,210
Issuance of subsidiary common stock............................................. 1,645 4,517 3,367
---------- --------- ----------
Cash provided (used) by financing activities...................................... 37,593 (117,086) 171,982
---------- --------- ----------
Increase (Decrease) in Cash and Cash Equivalents.................................. 875 (7,499) 5,614
Cash and cash equivalents-beginning of year....................................... 5,382 12,881 7,267
---------- --------- ----------
Cash and Cash Equivalents-End of Year............................................. $ 6,257 $ 5,382 $ 12,881
---------- --------- ----------
---------- --------- ----------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
Accumulated
Common Stock Additional Other Treasury Stock
-------------------- Paid-In Retained Comprehensive ---------------------
Shares Amount Capital Earnings Income Shares Amount
---------- ------ ---------- -------- ------------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Balance--December 31, 1995..................... 32,799,342 $3,280 $20,709 $110,043 $30,748 3,434,828 $(10,471)
Net earnings................................... 19,927
Stock options exercised, net................... 3,323 (759,011) 1,887
Conversion of convertible
subordinated notes............................ 11,364 (443,988) 1,419
Subsidiaries' equity transactions.............. 170
Other comprehensive loss....................... (23,388)
Balance--December 31, 1996..................... 32,799,342 3,280 35,566 129,970 7,360 2,231,829 (7,165)
Net earnings................................... 21,501
Stock options exercised, net................... 3,784 (670,649) 2,035
Repurchase of common stock..................... 390,577 (9,488)
Conversion of convertible
subordinated notes............................ 9,731 (388,131) 1,279
Subsidiaries' equity transactions.............. 871
Other comprehensive income..................... 8,346
Balance--December 31, 1997..................... 32,799,342 3,280 49,952 151,471 15,706 1,563,626 (13,339)
Net earnings................................... 110,123
Stock options exercised, net................... (66) (401,631) 4,201
Repurchase of common stock..................... 765,000 (18,672)
Conversion of convertible
subordinated notes............................ 13,189 (674,000) 6,031
Subsidiaries' equity transactions.............. (605)
Other comprehensive income..................... 21,588
Balance--December 31, 1998..................... 32,799,342 $3,280 $62,470 $261,594 $37,294 1,252,995 $(21,779)
</TABLE>
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- --------- -------- ---------
<S> <C> <C> <C>
Net Earnings....................................................... $110,123 $21,501 $ 19,927
--------- -------- ---------
Other Comprehensive Income (Loss), Before Taxes:
Unrealized holding gains (losses) on investments............... 43,676 10,706 (39,937)
Reclassification adjustments................................... (10,103) 1,940 4,500
Related Tax (Expense) Benefit:
Unrealized holding gains (losses) on investments............... (15,591) (3,640) 13,579
Reclassification adjustments................................... 3,606 (660) (1,530)
--------- -------- ---------
Other Comprehensive Income (Loss).................................. 21,588 8,346 (23,388)
--------- -------- ---------
Comprehensive Income (Loss)........................................ $131,711 $29,847 $ (3,461)
--------- -------- ---------
--------- -------- ---------
</TABLE>
See Notes to Consolidated Financial Statements.
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF THE COMPANY--Safeguard Scientifics, Inc. (the Company) is an
operating company that develops and operates partnership companies. Most of
the partnership companies are engaged in information technology businesses,
broadly defined to include all activities related to the acquisition,
processing, and dissemination of information and related technology and
services to improve business and personal productivity.
The most significant of the Company's partnership companies provides
computing and communications infrastructure services. This includes the
procurement and configuration of personal computers and servers as well as
application software development, implementation, and desktop/network
support services. They also provide IT strategy consultation. Almost half of
the partnership companies are involved with the Internet in aspects that
include the development of eCommerce models; the design, development,
hosting, and support of distributed eCommerce applications; and the provision
of security products and services to virtual enterprises. Many of the
Company's partnership companies operate in multiple vertical industries,
including healthcare, insurance, and financial services. The remaining
partnership companies are principally engaged in the development, sale, and
implementation of strategic business software, document management, and
multimedia and telecommunications technology and services. The Company also
has a robust incubation strategy which will increasingly focus on the
companies in the areas of eCommerce, enterprise applications, and network
infrastructure.
PRINCIPLES OF CONSOLIDATION--The Consolidated Financial Statements include
the accounts of the Company and its majority-owned subsidiaries, primarily
CompuCom Systems, Inc. and Tangram Enterprise Solutions, Inc. All significant
intercompany accounts and transactions have been eliminated. The effect of
adjustments to the Company's carrying values of these subsidiaries resulting
from the subsidiaries' underlying equity transactions is included in the
Company's Additional Paid-In Capital.
Investments in companies in which the Company owns 50% or less of the
outstanding voting securities, in which significant influence is exercised,
are accounted for on the equity method of accounting. Significant influence
is presumed at a 20% ownership level; however, the Company applies the equity
method for certain companies in which it owns less than 20% of the voting
interest when it exerts significant influence through representation on those
companies' Boards of Directors and other means. The amount by which the
Company's carrying value exceeds its share of the underlying net assets of
equity affiliates is amortized on a straightline basis which adjusts the
Company's share of the affiliates' earnings or losses.
All other investments are accounted for on the cost method. Certain cost
method investments are classified as available-for-sale and are recorded at
fair value, based on quoted market prices, with the unrealized gains or
losses, net of tax, included as a separate component of shareholders' equity.
The Company's investment in Tellabs, Inc. is classified as a trading security
and is reported at fair value, based on quoted market prices, with the net
gain or loss included in net earnings. All other investments are stated at
the lower of cost or net realizable value.
The Company continually evaluates investments for indications of
impairment based on the market value of each investment relative to cost,
financial condition, near-term prospects of the investment, and other
relative factors.
In 1997, the Company sold its Pioneer Metal Finishing division and all
of the assets of Premier Solutions Ltd. As a result, these entities are only
included in the Company's Consolidated Financial Statements through their
respective sale dates.
ACCOUNTING ESTIMATES--The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect amounts reported in the financial
statements and accompanying notes. Actual results could differ from those
estimates.
CASH AND CASH EQUIVALENTS--The Company considers all highly liquid
instruments with an original maturity of 90 days or less at the time of
purchase to be cash equivalents.
INVENTORIES, primarily finished goods, are stated at the lower of average
cost or market. The Company continually assesses the appropriateness of the
inventory valuations considering obsolete, slow-moving, and non-salable
inventory.
PROPERTY, PLANT, AND EQUIPMENT includes $75.2 million and $57.7 million of
land, buildings, and improvements and $65.1 million and $47.5 million of
machinery and equipment at December 31, 1998 and 1997, respectively.
Property, plant, and equipment are carried at cost less accumulated
depreciation and amortization of $43.5 million and $28.2 million at December
31, 1998 and 1997, respectively. The provision for depreciation and
amortization is based on the estimated useful lives of the assets (buildings
and improvements--3 to 40 years; machinery and equipment--3 to 12 years) and
is computed primarily on the straight-line method.
EXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED (goodwill) is amortized
on a straight-line basis primarily over 7 to 20 years. Accumulated
amortization at December 31, 1998 and 1997, was $29.1 million and $24.0
million, respectively. The Company continually evaluates goodwill for
indications of impairment based on the forecasted undiscounted cash flow from
the related business activity (including possible proceeds from a sale of the
business).
<PAGE>
RECEIVABLES SECURITIZATION--CompuCom has an agreement with a financial
institution that allows CompuCom to sell, on a revolving basis, an interest
in a portion of its accounts receivable. During 1997, the receivables
securitization facility was amended such that the sale is required to be
accounted for in accordance with Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" (SFAS 125), which requires these transactions
to be accounted for as a sale of receivables. Sales of receivables are
reflected as a reduction in "Receivables less allowances" on the Consolidated
Balance Sheets. CompuCom is retained as servicer of the receivables; however,
the cost to service the receivables is not material.
TAXES ON INCOME are reduced by allowable tax credits. Deferred taxes are
accounted for using the asset and liability method of accounting for income
taxes. Under this method, deferred taxes are recognized for the tax
consequences of "temporary differences" by applying enacted statutory tax
rates applicable to future years to differences between the financial
statement carrying amounts and the tax basis of existing assets and
liabilities.
FINANCIAL INSTRUMENTS--The Company's financial instruments, principally cash,
accounts receivable, accounts payable, and accrued expenses, are carried at
cost which approximates fair value due to the short-term maturity of these
instruments. The Company's long-term debt is carried at cost which
approximates fair value as the debt bears interest at rates approximating
current market rates. At December 31, 1998, the market value of the Company's
Convertible Subordinated Notes was approximately $72.8 million based on
quoted market prices.
EARNINGS PER SHARE (EPS) is computed on net earnings using the weighted
average number of common shares outstanding during each year. Dilutive EPS
includes common stock equivalents (unless anti-dilutive) which would arise
from the exercise of stock options and conversion of other convertible
securities and is adjusted, if applicable, for the effect on net earnings of
such transactions. Dilutive EPS calculations adjust net earnings for the
dilutive effect of common stock equivalents and convertible securities issued
by the Company's public subsidiary or equity affiliates.
REVENUE RECOGNITION--Product sales are generally recognized upon shipment
with provisions made for anticipated returns, which historically have not
been material. Service sales are generally recognized when the service is
rendered or ratably if performed over a service contract period.
VENDOR PROGRAMS--CompuCom receives volume incentives and rebates from certain
manufacturers related to sales of certain products which are recorded as a
reduction of cost of sales when earned. CompuCom also receives manufacturer
reimbursements for certain training, promotional, and marketing activities
that offset the expenses incurred by CompuCom.
STOCK-BASED COMPENSATION--The Company applies Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) for stock
options and other stock-based awards while disclosing pro forma net earnings
and net earnings per share as if the fair value method had been applied in
accordance with Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123).
COMPREHENSIVE INCOME--In 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130),
which requires companies to report and display comprehensive income and its
components in financial statements. Comprehensive income is the change in
equity of a business enterprise during a period from transactions and other
events and circumstances from non-owner sources. Excluding net earnings, the
Company's source of other comprehensive income is from net unrealized
appreciation on its investments classified as available-for-sale.
Reclassification adjustments result from the recognition in net earnings of
gains or losses that were included in comprehensive income in prior periods.
SEGMENT INFORMATION--At December 31, 1998, the Company adopted Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS 131), which requires companies to
present financial and descriptive segment information (see Note 15).
2. INVESTMENTS
SHORT-TERM INVESTMENTS
In August 1998, Coherent Communications Systems Corporation merged with
Tellabs. Prior to the merger, the Company owned 31% of Coherent and accounted
for its investment on the equity method. The Company received approximately
3.5 million shares of Tellabs in exchange for all of its Coherent shares and
recorded a pretax book gain of $245.3 million in 1998. At December 31, 1998,
the Company owns approximately 2.1 million shares of Tellabs.
The Company's investment in Tellabs is classified as a trading security
(classified as "Short-term investments" on the Consolidated Balance Sheets).
<PAGE>
NON-CURRENT INVESTMENTS
The following summarizes the Company's non-current investments (in
thousands). Investments are classified according to the applicable accounting
method at December 31, 1998. Market value reflects the price of publicly
traded securities at the close of business at the respective date. Unrealized
appreciation reflects the net excess of market value over carrying value of
publicly traded securities classified as available-for-sale. The table
excludes the Company's holdings in Tellabs (classified as "Short-term
investments" on the Consolidated Balance Sheets), which has a market value of
$143.1 million at December 31, 1998.
<TABLE>
<CAPTION>
December 31 1998 1997
- ----------- -------------------- ---------------------
Carrying Market Carrying Market
Value Value Value Value
--------- -------- ---------- --------
<S> <C> <C> <C> <C>
Equity Affiliates (voting %)
Cambridge Technology Partners (15%)........................... $ 35,248 $190,217 $ 24,679 $371,394
ChromaVision Medical Systems (26%)............................ 11,304 22,419 4,689 30,044
Coherent Communications Systems Corporation................... -- -- 14,799 135,008
OAO Technology Solutions (34%)................................ 16,472 16,551 13,887 43,716
Sanchez Computer Associates (27%)............................. 10,620 91,965 7,196 89,068
USDATA Corporation (26%)...................................... 7,053 5,545 7,194 13,325
Non-public companies.......................................... 23,784 18,453
-------- --------
104,481 90,897
Other
Diamond Technology Partners................................... 3,120 21,337 1,526 14,717
DocuCorp International........................................ 3,226 8,035 7,718 7,718(b)
First Consulting Group(a)..................................... 8,490 11,308 1,891 7,785
e4L (formerly National Media)................................. 2,035 32,299 2,035 1,563
Other public companies........................................ 10,388 11,648 13,358 18,541
Unrealized appreciation....................................... 57,368 23,796
Non-public companies.......................................... 99,228 43,890
-------- --------
$288,336 $185,111
</TABLE>
(a) First Consulting Group merged with Integrated Systems Consulting Group in
December 1998.
(b) The market value of DocuCorp equals its carrying value at December 31,
1997 since DocuCorp was not publicly traded until 1998.
The following summarized financial information for investees accounted for on
the equity method at December 31, 1998, has been compiled from the unaudited
financial statements of the respective investees and reflects certain
historical adjustments (in thousands):
Balance Sheets
<TABLE>
<CAPTION>
December 31 1998 1997
- ----------- -------- --------
<S> <C> <C>
Current assets................................. $453,829 $344,400
Non-current assets............................. 187,797 105,898
-------- --------
Total assets................................... $641,626 $450,298
-------- --------
-------- --------
Current liabilities............................ $198,683 $138,871
Non-current liabilities........................ 26,106 27,036
Shareholders' equity........................... 416,837 284,391
-------- --------
Total liabilities and
shareholders' equity.......................... $641,626 $450,298
-------- --------
-------- --------
</TABLE>
Results of Operations
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- -------- -------- --------
<S> <C> <C> <C>
Net Sales
Public companies............................... $792,320 $574,267 $394,816
Non-public companies:
MultiGen-Paradigm............................ 16,530 18,387 14,105
QuestOne..................................... 11,571 4,794 2,671
Other........................................ 21,633 18,616 --
-------- -------- --------
$842,054 $616,064 $411,592
-------- -------- --------
Net Income....................................... $ 7,503 $ 11,857 $ 12,267
-------- -------- --------
-------- -------- --------
</TABLE>
<PAGE>
The following summarized sales information for selected investments
accounted for on the cost method at December 31, 1998, has been compiled from
the unaudited financial statements of the respective companies and reflects
certain historical adjustments (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- -------- -------- --------
<S> <C> <C> <C>
Net Sales
Public companies................................ $121,471 $ 91,578 $ 65,999
Non-public companies:
Intellisource................................. 135,291 112,182 85,273
Kanbay........................................ 35,700 19,563 12,235
Pac-West Telecomm............................. 42,211 29,551 12,969
US Interactive................................ 16,645 13,095 4,455
Other......................................... 28,289 27,649 9,862
-------- -------- --------
$379,607 $293,618 $190,793
-------- -------- --------
-------- -------- --------
</TABLE>
Average cost is generally used to compute securities and other gains.
Pretax securities gains related to Coherent/Tellabs transactions for the year
ended December 31, 1998, were $196.7 million, which consists of the $245.3
million gain on the merger, partially offset by a $48.6 million loss
comprised of unrealized losses resulting from the decline in the market price
of Tellabs subsequent to the merger and gains on the sales of 1.4 million
shares of Tellabs stock (for net proceeds of $71.0 million). Fluctuations in
the price of Tellabs stock may have a significant impact on the Company's
future reported net earnings.
Securities and other gains in 1998 also include the open market sales of
a portion of the Company's interest in Cambridge, the gain resulting from the
merger of Integrated Systems with First Consulting, and distributions
received from the Company's associated venture funds. Securities and other
gains in 1997 included the open market sales of a portion of the Company's
interest in Cambridge, the sale of shares of Diamond and ChromaVision in
rights offerings to the Company's shareholders, and distributions received
from the Company's associated venture funds. The Company also recorded gains
in 1997 from the sale of Premier and Pioneer. Securities and other gains in
1996 included the open market sales of a portion of the Company's interest in
Cambridge and Coherent and the sale of shares of Sanchez in a rights offering
to the Company's shareholders. Partially offsetting securities and other
gains in each year was a write-down of the Company's holdings in Sybase due
to the other than temporary decline in the market price of that stock,
charges incurred in the disposition of partnership companies, and provisions
for other investments and notes receivable.
3. DEBT
The following is a summary of long-term debt (in thousands):
<TABLE>
<CAPTION>
December 31 1998 1997
- ----------- -------- --------
<S> <C> <C>
Parent Company and Other
Recourse Debt
Revolving credit facilities............................... $108,107 $ 22,200
Other..................................................... 15,874 7,822
-------- --------
123,981 30,022
Subsidiary Debt
(Non-Recourse to Parent)
CompuCom.................................................. 83,429 100,425
Other..................................................... -- 38
-------- --------
83,429 100,463
-------- --------
Total debt................................................ 207,410 130,485
Current debt obligations.................................. (2,366) (3,396)
-------- --------
Long-term debt............................................ $205,044 $127,089
-------- --------
-------- --------
</TABLE>
In April 1998, the Company increased the availability under its bank
revolving credit facility to $200 million from $150 million. Of the $200
million, $150 million matures in May 2002 and is secured by certain equity
securities the Company holds of its publicly traded partnership companies
(the Pledged Securities), including CompuCom. The remaining $50 million is
unsecured and matures in April 1999, with availability limited to the lesser
of $50 million or 10% of the value of the Pledged Securities. The Company
intends to renew the $50 million bank revolving credit facility in 1999. The
bank revolving credit facility bears interest at the prime rate and/or, at
the Company's option, at LIBOR (approximately 5.06% at December 31, 1998)
plus 1.25% and is subject to a commitment fee ranging from 0.2% to 0.3% on
the unused portion. At December 31, 1998, $88.1 million is outstanding under
the bank revolving credit facility. The Company borrowed a maximum of $123.2
million and $15.8 million during 1998 and 1997, respectively.
The Company had aggregate indebtedness of $20 million under revolving
credit facilities to certain partnership companies as of December 31, 1998.
These facilities are payable on demand and bear interest at the Company's
effective borrowing rate less .75%. The Company has the intent and ability,
if necessary, to repay these facilities with proceeds from its bank
revolving credit facility; accordingly, they are classified as long-term.
CompuCom has $365 million of separate, independent financing
arrangements which are secured by certain assets of CompuCom and consist of a
$165 million working capital facility, a $175 million receivables
securitization facility, and a $25 million real estate loan. In 1998,
CompuCom amended its working capital facility, increasing the availability to
$165 million from $125 million. The interest rates on the working capital
facility and the real estate loan are currently LIBOR plus 1.375%, subject to
adjustment based on certain performance criteria. There was $56.1 million and
$25.0 million outstanding under the working capital facility and the real
estate
<PAGE>
loan, respectively, at December 31, 1998. The working capital facility
matures in November 2002; the real estate loan is due in quarterly
installments beginning April 1999.
The interest rate applicable to CompuCom's receivables securitization
facility is based upon the bank's commercial paper rate (4.95% at December
31, 1998) plus 85 basis points. Discounts associated with the sale of
receivables totaled $10.8 million and $4.7 million for 1998 and 1997,
respectively, and are included in "Interest and financing" in the
Consolidated Statements of Operations. At December 31, 1998, $173.6 million
was outstanding under this facility. The receivables securitization facility
expires on April 15, 1999. CompuCom is currently negotiating a replacement
receivables securitization facility and expects to execute an agreement prior
to April 15, 1999.
The credit facilities of the Company and CompuCom generally require some
or all of the following: the maintenance of specified levels of tangible net
worth, debt to tangible net worth and net earnings, specified interest
coverage ratios, and limitations on the amount available for dividends,
capital expenditures, investments, and third party guarantees. At December
31, 1998, CompuCom was not in compliance with certain financial covenants
under its credit facilities. CompuCom received an amendment related to such
covenants from its lenders for periods up to and including April 15, 1999.
CompuCom is currently negotiating a replacement working capital facility and
expects to execute an agreement prior to April 15, 1999.
The aggregate net assets of subsidiaries which are restricted and
unavailable for dividends at December 31, 1998, is approximately $106 million.
Aggregate maturities of long-term debt during future years are (in
millions): $2.4-1999; $5.0-2000; $8.7-2001; $178.5-2002; $1.2-2003; and
$11.6-thereafter.
Interest paid in 1998, 1997, and 1996 was $31.5 million, $21.9 million,
and $22.0 million, respectively, of which $4.9 million, $5.8 million, and
$3.4 million in 1998, 1997, and 1996, respectively, related to the Company's
Convertible Subordinated Notes.
4. CONVERTIBLE SUBORDINATED NOTES
In February 1996, the Company issued $115 million of 6% Convertible
Subordinated Notes (Notes) due February 1, 2006. The Notes are convertible
into the Company's Common Stock at $28.985 per share. Interest is payable
semi-annually. The Notes are redeemable in whole or in part at the option of
the Company on or after February 2, 1999, for a maximum of 104% of face value
depending on the date of redemption and subject to certain restrictions.
In 1998, 1997, and 1996, approximately $19.5 million, $11.3 million, and
$12.9 million of notes, respectively, were converted into 674,000, 388,131,
and 443,988 shares, respectively, of the Company's Common Stock. The Company
recorded in shareholders' equity the principal amount of the converted notes
as well as forfeited interest and a proportionate share of the related
unamortized deferred charges.
5. RESTRUCTURING
In October 1998, CompuCom's Board of Directors approved a restructuring plan
designed to reduce CompuCom's cost structure by closing certain facilities
and reducing its workforce. As a result, CompuCom has recorded a
restructuring charge in the fourth quarter of 1998 in the amount of $16.4
million, the effect of which is approximately $8.1 million to the Company's
pretax earnings, after recording minority interest.
The restructuring charge of $16.4 million consists primarily of costs
associated with the closing of facilities and disposing of related fixed
assets as well as employee severance and benefits related to the reduction in
workforce. Of the total amount, approximately $2.4 million had been paid
through December 31, 1998. The remainder is included in "Accrued expenses" on
the Consolidated Balance Sheets. The following is a summary of the components
of the restructuring charge (in thousands):
<TABLE>
<CAPTION>
Expensed in Accrued at
1998 December 31, 1998
----------- -----------------
<S> <C> <C>
Lease termination costs........................... $ 7,259 $ 6,415
Employee severance and
related benefits................................ 3,804 2,986
Disposal of assets, net of
estimated proceeds.............................. 3,044 2,907
Other............................................. 2,330 1,780
----------- -----------------
$16,437 $14,088
----------- -----------------
----------- -----------------
</TABLE>
Severance is paid based on associates' years of service as well as their
level within the organization. The reduction in workforce includes 457
associates, of which two were executive officers.
The amount accrued at December 31, 1998, for lease termination costs is
the estimated cost for 65 facilities throughout the country to fulfill
CompuCom's obligations under signed lease contracts, to sublet certain
facilities, or to pay to terminate lease contracts before the end of their
terms. CompuCom has consulted with a professional real estate firm with
knowledge of market rent rates in all applicable markets where CompuCom has
space. Assumptions have been used for market rent rates and the estimated
amount of time to sublet certain facilities. Payments, net of proceeds
derived from subleases, are being charged against the accrual as incurred.
The amount accrued at December 31, 1998, for disposal of fixed assets
includes an estimate of proceeds to be received from the sale of those
assets. The assets primarily consist of furniture, fixtures, and computer
equipment associated with the facilities being closed.
Other restructuring charges primarily include amounts such as the
write-off of leasehold improvements, estimated legal expense, estimated costs
to ship fixed assets to CompuCom's headquarters in Dallas, and estimated
commissions to be paid to the real estate firm for subleasing activity.
As the majority of CompuCom's restructuring related charges in 1998 are
estimates and have not yet been paid, the actual amounts paid could differ
from those estimates. Any differences between the estimated amounts and
actual amounts paid will be reflected in operating expenses in future periods.
<PAGE>
6. INCOME TAXES
The provision for income taxes is comprised of the following (in thousands):
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- ------- -------- -------
<S> <C> <C> <C>
Current...................................... $32,515 $16,902 $11,375
Deferred..................................... 28,909 (2,566) 1,910
------- -------- -------
$61,424 $14,336 $13,285
------- -------- -------
State taxes on income included above......... $ 776 $ 2,235 $ 1,607
------- -------- -------
------- -------- -------
</TABLE>
Total income tax expense differed from the amounts computed by applying the
U.S. Federal income tax rate of 35% to earnings before income taxes as a
result of the following:
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- ------- ------- ------
<S> <C> <C> <C>
Statutory tax provision...................................... 35.0% 35.0% 35.0%
Increase (decrease) in taxes resulting from:
Non-deductible goodwill amortization....................... 0.9 3.4 4.1
Book/tax basis difference on securities sold............... (0.4) -- (0.9)
State taxes, net of federal tax benefit.................... 0.4 4.1 3.1
Income taxed at rates other than statutory rate............ (0.1) (2.5) (1.3)
------- ------- ------
35.8% 40.0% 40.0%
------- ------- ------
------- ------- ------
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the non-current deferred tax assets and deferred tax liabilities
are presented below (in thousands):
<TABLE>
<CAPTION>
December 31 1998 1997
- ----------- ------- --------
<S> <C> <C>
Deferred tax assets:
Subsidiary/investee carrying values..................... $ 3,656 $ 3,539
Accounts receivable allowances.......................... 1,227 1,034
Inventories, reserves and tax
capitalized costs..................................... 15,905 5,141
Other................................................... 15,865 2,522
------- --------
Gross deferred tax assets............................... 36,653 12,236
Less valuation allowance................................ (850) (1,600)
------- --------
Deferred tax assets..................................... 35,803 10,636
------- --------
Deferred tax liabilities:
Subsidiary/investee carrying values..................... (16,472) (11,522)
Accelerated depreciation................................ (3,252) (4,521)
Unrealized appreciation
on investments........................................ (20,075) (8,091)
Other................................................... (8,566) (6,546)
------- --------
Deferred tax liabilities................................ (48,365) (30,680)
------- --------
Net deferred tax liabilities............................ $(12,562) $(20,044)
------- --------
------- --------
</TABLE>
The above table excludes $48.4 million of current deferred tax
liabilities attributable to the difference between the book basis and tax
basis of the Company's investment in Tellabs, which is included in "Accrued
expenses" on the Consolidated Balance Sheets.
The valuation allowance relates to the uncertainty surrounding the
realization of tax benefits attributable to the difference between the book
basis and tax basis of certain of the Company's investments. Tax benefits
relating to changes in the valuation allowance for deferred tax assets are
reported as an income tax benefit in the Consolidated Statements of
Operations in the period recognized. Management believes it is more likely
than not that the remaining deferred tax assets will be realized through
future taxable earnings or implementation of tax planning strategies.
Income taxes paid were $9.8 million, $13.5 million, and $18.4 million in
1998, 1997, and 1996, respectively.
The Company has not recognized a deferred tax liability for the
difference between the book basis and tax basis of its investment in the
common stock of its subsidiaries (such difference relates primarily to
unremitted earnings of the subsidiaries), because the Company does not expect
this basis difference to become subject to tax at the parent level. The
Company believes it can implement certain tax strategies to recover its
investment in these subsidiaries tax-free.
<PAGE>
7. EARNINGS PER SHARE
The calculations of EPS were (in thousands except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- -------- ------- --------
<S> <C> <C> <C>
Basic:
Net earnings................................. $110,123 $21,501 $19,927
-------- ------- --------
Average common shares outstanding............ 31,833 31,249 29,900
-------- ------- --------
Basic EPS.................................... $ 3.46 $ .69 $ .67
-------- ------- --------
Diluted:
Net earnings................................. $110,123 $21,501 $19,927
Effect of: Public investees(a)............... (606) (328) (779)
Dilutive securities(b)............ 2,967 -- --
-------- ------- --------
Adjusted earnings............................ $112,484 $21,173 $19,148
-------- ------- --------
Average common shares outstanding............ 31,833 31,249 29,900
Effect of: Dilutive options.................. 554 747 1,448
Dilutive securities(b)............ 2,527 -- --
-------- ------- --------
Average number of common shares
assuming dilution.......................... 34,914 31,996 31,348
-------- ------- --------
Diluted EPS.................................. $ 3.22 $ .66 $ .61
-------- ------- --------
-------- ------- --------
</TABLE>
(a) Represents the dilutive effect of public investee common stock
equivalents and convertible securities.
(b) Represents the dilutive effect of the Company's 6% Convertible
Subordinated Notes for the year ended December 31, 1998. For the years
ended December 31, 1997 and 1996, the Convertible Subordinated Notes
were anti-dilutive; therefore, they do not impact the calculation of
diluted EPS in these years.
At December 31, 1998, 1997, and 1996, outstanding options to purchase
approximately 80,000, 502,000, and 91,000 shares of Common Stock at an
average price of $35.35, $32.56, and $35.07 per share were anti-dilutive and
are not included in the calculations of diluted EPS, because the options'
exercise price was greater than the average market price of common shares for
each respective period.
The Company repurchased $18.6 million and $9.8 million of its Common
Stock in the open market in 1998 and 1997, respectively, at an average price
of $24.33 in 1998 and $24.46 in 1997. The Company is authorized to purchase
up to an additional $18.4 million at December 31, 1998.
8. PREFERRED STOCK
Shares of Preferred Stock, par value $10 per share, are voting and are issuable
in one or more series with rights and preferences as to dividends, redemption,
liquidation, sinking funds, and conversion determined by the Board of Directors.
At December 31, 1998 and 1997, there were 55,423 shares authorized and none
outstanding.
9. STOCK-BASED COMPENSATION
Options may be granted to Company employees, directors, and consultants under
various stock option plans. Generally, outstanding options vest over periods not
exceeding four years after the date of grant and expire eight years after the
date of grant. To the extent allowable, all grants are incentive stock options.
All options granted under the plans to date have been at prices which have been
equal to the fair market value at the date of grant. At December 31, 1998, the
Company reserved approximately 2.1 million shares of Common Stock for possible
future issuance under its stock option plans. Several subsidiaries also maintain
stock option plans for their employees and directors.
<PAGE>
Option activity under the Company's plans is summarized below (in thousands
except per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
------------------ ------------------ ----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ -------- ------ ---------- ------ --------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year............................ 1,737 $17.58 2,078 $10.82 2,702 $ 7.11
Options granted............................................. 312 27.36 350 31.59 190 32.96
Options exercised........................................... (441) 6.12 (673) 4.56 (774) 2.86
Options canceled............................................ (11) 35.98 (18) 22.88 (40) 19.24
------ -------- ------ ---------- ------ --------
Outstanding at end of year.................................. 1,597 $22.09 1,737 $17.58 2,078 $10.82
------ -------- ------ ---------- ------ --------
------ -------- ------ ---------- ------ --------
Options exercisable at year-end............................. 863 867 1,150
Shares available for future grant........................... 506 807 1,139
------ -------- ------ ---------- ------ --------
------ -------- ------ ---------- ------ --------
</TABLE>
The following summarizes information about the Company's stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ----------------------------------------------------------------------------------------------- ---------------------------
Weighted Average Weighted Weighted
Range of Number Remaining Average Number Average
Exercise Outstanding Contractual Life Exercise Exercisable Exercise
Prices (in thousands) (in years) Price (in thousands) Price
- ---------------------------------------------- -------------- ----------------- --------- --------------- ---------
<S> <C> <C> <C> <C> <C>
$ 2.04 - $ 3.92................................ 222 2.12 $ 2.91 222 $ 2.91
4.31 - 5.75................................ 152 3.24 4.73 152 4.73
21.00 - 23.50................................ 425 4.88 22.62 314 22.61
26.13 - 29.25................................ 287 7.79 26.66 8 26.32
31.00 - 42.63................................ 511 6.52 32.56 167 32.77
------------- ----------------- --------- -------------- --------
$ 2.04 - $42.63................................ 1,597 5.39 $22.09 863 $16.38
------------- ----------------- --------- -------------- --------
------------- ----------------- --------- -------------- --------
</TABLE>
In February 1999, the Company's Board of Directors approved the 1999
Equity Compensation Plan, which will provide for the grant of stock options
to participating employees, directors, and consultants of the Company.
Initially, 3,000,000 shares will be reserved for issuance under the new plan,
which is subject to shareholder approval at the Company's Annual Meeting in
May 1999. In March 1999, the Company granted options to purchase 500,000
shares of the Company's Common Stock to its new president and chief operating
officer, including 100,000 options granted outside of existing stock option
plans. The option price is equal to the fair market value of the Company's
stock on the date of grant.
The Company, its subsidiaries, and its affiliates accounted for on the
equity method apply APB 25 and related interpretations in accounting for
stock option plans. Had compensation cost been recognized consistent with
SFAS 123, the Company's consolidated net earnings and earnings per share
would have been reduced to the pro forma amounts indicated below (in
thousands except per share amounts):
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- -------- ------- -------
<S> <C> <C> <C> <C>
Consolidated net earnings As reported $110,123 $21,501 $19,927
Pro forma $ 99,411 $17,314 $15,986
Earnings per share
Basic As reported $ 3.46 $ .69 $ .67
Pro forma $ 3.12 $ .55 $ .53
Diluted As reported $ 3.22 $ .66 $ .61
Pro forma $ 2.92 $ .53 $ .48
Per share weighted average fair value of
stock options issued on date of grant $ 13.14 $ 14.97 $ 14.64
</TABLE>
<PAGE>
The following range of assumptions were used by the Company, its
subsidiaries, and its affiliates accounted for on the equity method to
determine the fair value of stock options granted in 1998, 1997, and 1996
using the Black-Scholes option-pricing model:
<TABLE>
<CAPTION>
Subsidiaries and
Company Affiliates
------------ -----------------
<S> <C> <C>
Dividend yield...................... 0% 0%
Expected volatility................. 40% to 48% 30% to 75%
Average expected
option life........................ 5 years 3.5 to 6 years
Risk-free interest rate............ 4.4% to 6.8% 4.2% to 7.1%
</TABLE>
The full impact of calculating compensation cost for stock options under
SFAS 123 is not reflected in the pro forma consolidated net earnings amounts
presented above, because compensation cost is reflected over an option's
vesting period and compensation cost for options granted prior to January 1,
1995 is not considered.
10. BUSINESS COMBINATIONS
In 1998, CompuCom completed three business combinations for approximately $49
million in cash. These business combinations were accounted for as purchases
and, accordingly, the consolidated financial statements reflect the operations
of the acquired entities since the respective acquisition dates. CompuCom has
not completed the final allocation of the purchase price for these acquisitions;
accordingly, the amount of goodwill could be adjusted once the allocation is
finalized.
11. RELATED PARTY TRANSACTIONS
In 1998, the Company loaned an officer and director of the Company $500,000
evidenced by a term note receivable. Interest on the note accrues at the rate of
4.33% per annum. The note was fully repaid in March 1999.
In 1998, CompuCom loaned two officers and directors $796,875 and $2.0
million evidenced by term notes receivable. Interest on the notes accrue at
rates of 4.3% and 5.1% per annum, respectively. Principal on the notes is due
on December 31, 2001, and October 22, 2003, respectively. The loan proceeds
were used to exercise stock options. In January 1999, the Company loaned an
officer of CompuCom $806,078 to exercise CompuCom stock options. Interest on
the note accrues at a rate of 4.3% per annum, and principal on the note is
due on December 31, 2001.
As discussed in Note 3, the Company had aggregate indebtedness of $20
million under revolving credit facilities to certain partnership companies as
of December 31, 1998.
12. LEASES
The Company and its subsidiaries conduct a portion of its operations in leased
facilities and leases machinery and equipment under leases expiring at various
dates to 2004.
Future minimum lease payments under non-cancelable operating leases with
initial or remaining terms of one year or more at December 31, 1998, are (in
millions): $4.6-1999; $3.7-2000; $2.4-2001; $0.8-2002; $0.6-2003; and
$0.6-thereafter.
Total rental expense under operating leases was $11.7 million, $10.2
million, and $14.5 million in 1998, 1997, and 1996, respectively.
13. COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are involved in various claims and legal
actions arising in the ordinary course of business. In the opinion of
management, the ultimate disposition of these matters will not have a material
adverse effect on the Company's consolidated financial position or results of
operations.
In connection with interests in certain partnership companies, the
Company is contingently obligated for approximately $30 million of guarantee
commitments. In addition, it has committed capital of approximately $100
million to various partnership companies, venture funds, and private equity
partnerships, to be funded over the next several years.
14. PARENT COMPANY FINANCIAL INFORMATION
Condensed Financial Information is provided to reflect the results of
operations and financial position of the "Parent Company," or the Company
without the effect of consolidating its less than wholly owned subsidiaries.
The Company presents complete Condensed Financial Information in Schedule I
to its Form 10-K.
The following summarizes the Parent Company Balance Sheets of Safeguard
Scientifics, Inc. and its wholly owned subsidiaries (in thousands). These
Parent Company Balance Sheets differ from the Consolidated Balance Sheets due
to the exclusion of the assets and liabilities of the Company's less than
wholly owned subsidiaries, primarily CompuCom and Tangram, with carrying
values of these companies included in "Investments."
<TABLE>
<CAPTION>
Balance Sheets
December 31 1998 1997
- --------------- -------- ---------
<S> <C> <C>
Assets
Short-term investments............................. $143,103 $ --
Other current assets............................... 30,766 11,710
Investments........................................ 413,596 310,877
Other.............................................. 49,830 37,567
-------- ---------
Total assets......................................... $637,295 $360,154
-------- ---------
-------- ---------
Liabilities and Shareholders' Equity
Current liabilities................................ $ 80,824 $ 18,525
Long-term debt..................................... 123,115 29,689
Other liabilities.................................. 19,152 13,989
Convertible subordinated notes..................... 71,345 90,881
Shareholders' equity............................... 342,859 207,070
-------- ---------
Total liabilities and
shareholders' equity................................ $637,295 $360,154
-------- ---------
-------- ---------
</TABLE>
<PAGE>
The following summarizes the Parent Company's investments in less than
wholly owned subsidiaries (in thousands). Market value reflects the price of
publicly traded securities at the close of business on December 31 of each
year. The table excludes the Company's holdings in Tellabs (classified as
"Short-term investments" on the Consolidated Balance Sheets), which has a
market value of $143.1 million at December 31, 1998.
<TABLE>
<CAPTION>
December 31 1998 1997
- ----------- -------------------- -------------------
Carrying Market Carrying Market
Value Value Value Value
--------- -------- --------- --------
<S> <C> <C> <C> <C>
CompuCom................................ $121,832 $ 98,538 $122,613 $211,504
Tangram................................. 3,428 41,795 3,153 68,570
Cambridge............................... 35,248 190,217 24,679 371,394
Coherent................................ -- -- 14,799 135,008
Other public............................ 130,076 221,107 83,290 226,477
Other................................... 123,012 62,343
--------- --------
$413,596 $310,877
</TABLE>
The market value of the Company's holdings in CompuCom increased to
approximately $122 million at March 1, 1999.
The following summarizes the Parent Company Statements of Operations of
Safeguard Scientifics, Inc. and its wholly owned subsidiaries (in thousands).
These Parent Company Statements of Operations differ from the Consolidated
Statements of Operations by excluding the revenues and related costs and
expenses of the Company's less than wholly owned subsidiaries, primarily
CompuCom and Tangram, with the Company's share of the earnings or losses of
these companies reflected in the caption "Equity loss (income)." 1997
included net sales and cost of sales and operating expenses of $16.0 million
and $14.6 million, respectively, related to Pioneer which was sold in
mid-1997.
<TABLE>
<CAPTION>
Statements of Operations
Year Ended December 31 1998 1997 1996
- ---------------------- --------- -------- --------
<S> <C> <C> <C>
Revenues
Net sales.................................... $ -- $ 15,982 $ 30,286
Securities and other gains, net.............. 193,665 24,025 26,011
Other income................................. 15,888 14,223 10,273
--------- -------- --------
Total revenues............................ 209,553 54,230 66,570
--------- -------- --------
Costs and Expenses
Cost of sales and operating expenses......... 36,574 45,389 54,376
Equity loss (income)......................... 1,846 (14,873) (12,345)
--------- -------- --------
Total costs and expenses.................. 38,420 30,516 42,031
--------- -------- --------
Earnings Before Taxes on Income................ 171,133 23,714 24,539
Provision for taxes on income................ 61,010 2,213 4,612
--------- -------- --------
Net Earnings................................... $110,123 $ 21,501 $ 19,927
--------- -------- --------
--------- -------- --------
</TABLE>
<PAGE>
15. OPERATING SEGMENTS
In 1998, the Company adopted SFAS 131, which requires the reporting of
operating segments using the "management approach" versus the "industry
approach" previously required. The Company's reportable segments consist of
CompuCom, Tangram, general corporate operations, and other. CompuCom's
operations are defined into two segments--sales of distributed desktop
computer products (product) and configuration, network integration, and
technology support (service). Tangram's operations include the design,
development, sale, and implementation of enterprise-wide asset tracking and
software management solutions. General corporate operations consists of
developing and operating partnership companies, most of which are engaged in
information technology businesses. Other includes Pioneer and Premier which
were sold during 1997, Commercial Real Estate which was sold during 1996, and
other reconciling items.
The following summarizes information related to the Company's segments
(in thousands). All significant intersegment activity has been eliminated.
Assets are the owned or allocated assets used by each operating segment.
<TABLE>
<CAPTION>
Year Ended December 31 1998 1997 1996
- ---------------------- ---------- ---------- ----------
<S> <C> <C> <C>
Net Sales
CompuCom
Product....................................... $1,980,578 $1,699,268 $1,816,504
Service....................................... 273,887 250,534 178,686
---------- ---------- ----------
2,254,465 1,949,802 1,995,190
Tangram......................................... 20,678 14,074 11,142
Other........................................... -- 21,349 56,477
---------- ---------- ----------
$2,275,143 $1,985,225 $2,062,809
---------- ---------- ----------
---------- ---------- ----------
Gross Margin(a)
CompuCom
Product....................................... $ 193,727 $ 176,234 $ 180,851
Service....................................... 90,233 91,311 60,112
---------- ---------- ----------
283,960 267,545 240,963
Tangram......................................... 18,252 12,123 8,733
Other........................................... -- 6,365 20,155
---------- ---------- ----------
$ 302,212 $ 286,033 $ 269,851
---------- ---------- ----------
---------- ---------- ----------
Operating Profit (Loss)
CompuCom
Product....................................... $ 17,852 $ 38,073 $ 55,545
Service....................................... 17,995 28,860 159
---------- ---------- ----------
35,847 66,933 55,704
Interest and financing, net................... (18,742) (14,947) (14,764)
Restructuring................................. (16,437) -- --
---------- ---------- ----------
668 51,986 40,940
---------- ---------- ----------
Tangram......................................... 1,764 (2,256) (625)
---------- ---------- ----------
General Corporate
Securities and other gains, net............... 193,665 26,857 30,373
Equity in (losses) income of affiliates....... (2,083) 417 1,539
Interest and financing, net................... (10,978) (7,412) (9,152)
General corporate expense, net................ (10,345) (9,612) (8,661)
Minority interest............................. (47) (25,727) (19,934)
---------- ---------- ----------
170,212 (15,477) (5,835)
---------- ---------- ----------
Other........................................... (1,097) 1,584 (1,268)
---------- ---------- ----------
Earnings Before Taxes on Income................. $ 171,547 $ 35,837 $ 33,212
---------- ---------- ----------
---------- ---------- ----------
Total Assets
CompuCom
Product....................................... $ 339,778 $ 323,970 $ 542,970
Service....................................... 212,403 146,812 157,803
---------- ---------- ----------
552,181 470,782 700,773
Tangram......................................... 15,170 14,077 12,946
General Corporate............................... 501,339 229,682 172,781
Other........................................... -- -- 49,570
---------- ---------- ----------
$1,068,690 $ 714,541 $ 936,070
---------- ---------- ----------
---------- ---------- ----------
</TABLE>
(a) Total gross margin reconciles to the Consolidated Statements of
Operations by subtracting cost of sales from net sales.
<PAGE>
Independent Auditors' Report
The Board of Directors and Shareholders
Safeguard Scientifics, Inc.:
We have audited the accompanying consolidated balance sheets of
Safeguard Scientifics, Inc. and subsidiaries as of December 31, 1998 and
1997, and the related consolidated statements of operations, cash flows,
shareholders' equity, and comprehensive income for each of the years in the
three year period ended December 31, 1998. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits. We did not audit the financial statements of
a nonsubsidiary investee. The Company's ownership interest in this investee
at December 31, 1998 and 1997, was $35.2 million and $24.7 million,
respectively, and its equity in earnings of this investee was $7.9 million
and $5.1 million for the years ended December 31, 1998 and 1997,
respectively. The financial statements of this investee were audited by other
auditors whose report have been furnished to us, and our opinion, insofar as
it relates to the amounts included for this investee, is based solely on the
report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits and the report
of the other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Safeguard
Scientifics, Inc. and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three year period ended December 31, 1998, in conformity with generally
accepted accounting principles.
KPMG LLP
Philadelphia, Pennsylvania
February 8, 1999
Statement of Management's
Financial Responsibility
Management has prepared and is responsible for the integrity and
objectivity of the consolidated financial statements and related financial
information in this Annual Report. The statements are prepared in conformity
with generally accepted accounting principles. The financial statements
reflect management's informed judgment and estimation as to the effect of
events and transactions that are accounted for or disclosed.
Management maintains a system of internal control at each business unit.
This system, which undergoes continual evaluation, is designed to provide
reasonable assurance that assets are safeguarded and records are adequate for
the preparation of reliable financial data. In determining the extent of the
system of internal control, management recognizes that the cost should not
exceed the benefits derived. The evaluation of these factors requires
estimates and judgment by management.
KPMG LLP is engaged to render an opinion as to whether management's
financial statements present fairly, in all material respects, Safeguard
Scientifics, Inc.'s financial condition and operating results in accordance
with generally accepted accounting principles. The scope of their engagement
included a review of the internal control system, tests of the accounting
records, and other auditing procedures to the extent deemed necessary to
render their opinion on the financial statements. Their report is presented
above.
The Audit Committee of the Board of Directors meets with the
independent auditors and management to satisfy itself that they are
properly discharging their responsibilities. The auditors have direct
access to the Audit Committee.
Safeguard Scientifics, Inc.
/s/ Michael W. Miles
- ----------------------------
Michael W. Miles
Senior Vice President and Chief Financial Officer
<PAGE>
QUARTERLY FINANCIAL DATA
The following table presents unaudited supplementary quarterly financial data
for the years ended December 31, 1998 and 1997 (in thousands, except per
share data):
<TABLE>
<CAPTION>
Quarters Ended
-----------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
--------- --------- ----------- ----------
<S> <C> <C> <C> <C>
1998
Net Sales................................................. $441,898 $602,534 $609,053 $621,658
After-tax Operating Earnings (Losses)(1).................. 2,214 2,885 (5,130) (14,137)
After-tax Securities and Other Gains, Net................. 4,711 5,228 65,154(2) 49,228(2)
Net Earnings.............................................. 5,060 6,026 59,242(2) 39,795(2)
Earnings Per Share
Basic................................................. .16 .19 1.85 1.26
Diluted............................................... .15 .18 1.71 1.18
1997
Net Sales................................................. $447,576 $502,706 $505,312 $529,631
After-tax Operating Earnings(1)........................... 2,559 5,437 5,476 7,351
After-tax Securities and Other Gains, Net................. 4,321 4,103 4,010 3,680
Net Earnings.............................................. 4,492 5,636 5,265 6,108
Earnings Per Share
Basic................................................. .14 .18 .17 .20
Diluted............................................... .14 .17 .16 .19
</TABLE>
(1) Before securities and other gains and minority interest.
(2) Increase relates primarily to net securities gains from Coherent/Tellabs
transactions (see Note 2 to the Consolidated Financial Statements).
Net securities and other gains of varying magnitude have been realized in
recent years; prior gains are not necessarily indicative of gains which may
be realized in the future.
Earnings per share calculations for each of the quarters are based on the
weighted average number of shares outstanding in each period. Diluted
earnings per share calculations adjust net earnings for the dilutive effect
of public investee common stock equivalents and convertible securities. The
Company's Convertible Subordinated Notes were dilutive for the quarters ended
September 30 and December 31, 1998, but were anti-dilutive for all other
periods presented. Therefore, the sum of the quarters may not necessarily
equal the year to date earnings per share.
COMMON STOCK DATA
The Company's Common Stock is listed on the New York Stock Exchange (Symbol:
SFE). As of March 1, 1999, there were approximately 25,000 beneficial holders
of the Company's Common Stock. The high and low sale prices reported within
each quarter for the years ended December 31, 1998 and 1997, are as follows:
<TABLE>
<CAPTION>
1998 1997
--------------- ---------------
High Low High Low
------- ------ ------ ------
<S> <C> <C> <C> <C>
First Quarter............................ $38.44 $30.13 $32.63 $16.88
Second Quarter........................... 45.38 34.63 33.00 19.75
Third Quarter............................ 41.44 23.50 32.06 25.00
Fourth Quarter........................... 31.75 17.13 36.50 27.50
</TABLE>
The high and low sale prices reported in 1999 through March 1 were $47.25 and
$27.50, respectively, and the last sale price reported on March 1, 1999, was
$37.06. No cash dividends have been declared in any of the years presented,
and the Company has no present intention to declare cash dividends.
<PAGE>
Exhibit 23.1
Consent of Independent Auditors
The Board of Directors
Safeguard Scientifics, Inc.:
We consent to incorporation by reference in the Registration Statements (No.
33-41853, No. 33-48579, No. 33-48462, No. 2-72362, No. 33-72559 and No.
33-72560) on Form S-8 of Safeguard Scientifics, Inc. of our report dated
February 8, 1999, relating to the consolidated balance sheets of Safeguard
Scientifics, Inc. and subsidiaries as of December 31, 1998 and 1997, the
related consolidated statements of operations, cash flows, shareholders'
equity and comprehensive income for each of the years in the three-year
period ended December 31, 1998 and related schedules, which reports are
included or incorporated by reference in the December 31, 1998 annual report
on Form 10-K/A of Safeguard Scientifics, Inc. Our report makes reference to
other auditors who audited the 1998 and 1997 financial statements of an
investee and our opinion, insofar as it relates to the investee, is based
solely on the report of the other auditors.
/s/ KPMG LLP
Philadelphia, Pennsylvania
March 16, 2000
<PAGE>
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Registration
Statements of Safeguard Scientifics, Inc. on Form S-8 (File Nos. 33-41853,
33-48579, 33-48462, 2-72362, 33-72559 and 33-72560) of our report dated
February 2, 1999, except for Note R as to which the date is March 29, 1999,
on our audits of the consolidated financial statements of Cambridge
Technology Partners (Massachusetts), Inc. as of December 31, 1998 and 1997,
and for each of the three years in the period ended December 31, 1998, which
report is included in the December 31, 1998 annual report of Safeguard
Scientifics, Inc. on Form 10-K/A.
/s/ PricewaterhouseCoopers LLP
Boston, Massachusetts
March 16,2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTIANS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND THE CONSOLIDATED
STATEMENT OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998, AND IS QUALIFIED
IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 6,257
<SECURITIES> 143,103
<RECEIVABLES> 300,862
<ALLOWANCES> 4,769
<INVENTORY> 138,551
<CURRENT-ASSETS> 589,010
<PP&E> 140,332
<DEPRECIATION> 43,492
<TOTAL-ASSETS> 1,068,690
<CURRENT-LIABILITIES> 337,019
<BONDS> 276,389
0
0
<COMMON> 3,280
<OTHER-SE> 339,579
<TOTAL-LIABILITY-AND-EQUITY> 1,068,690
<SALES> 1,994,965
<TOTAL-REVENUES> 2,483,499
<CGS> 1,787,370
<TOTAL-COSTS> 1,972,931
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,049
<INTEREST-EXPENSE> 29,720
<INCOME-PRETAX> 173,677
<INCOME-TAX> 61,424
<INCOME-CONTINUING> 110,123
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 110,123
<EPS-BASIC> 3.46
<EPS-DILUTED> 3.22
</TABLE>
<PAGE>
CAMBRIDGE TECHNOLOGY PARTNERS (MASSACHUSETTS), INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Accountants F-2
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997, and 1996 F-4
Consolidated Statements of Stockholders' Equity for
the Years Ended December 31, 1998, 1997, and 1996 F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997, and 1996 F-6
Notes to Consolidated Financial Statements F-7
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Cambridge Technology Partners (Massachusetts), Inc.:
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, stockholders' equity and cash flows
present fairly, in all material respects, the financial position of Cambridge
Technology Partners (Massachusetts), Inc. (the "Company") at December 31, 1998
and December 31, 1997, and the results of its operations and its cash flows for
each of the three years in the period ended December 31, 1998, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Boston, Massachusetts
February 2, 1999, except for Note R,
as to which the date
is March 29, 1999
F-2
<PAGE>
CAMBRIDGE TECHNOLOGY PARTNERS (MASSACHUSETTS), INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1998 1997
--------- ---------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 80,051 $ 39,649
Investments held to maturity 24,918 15,824
Accounts receivable, less allowance of $4,550 and $2,757
at December 31, 1998 and 1997, respectively 133,583 105,206
Unbilled revenue on contracts 10,964 9,048
Deferred income taxes 2,179 950
Prepaid expenses and other current assets 33,284 27,878
-------- --------
Total current assets 284,979 198,555
Property and equipment, net 48,255 36,027
Other assets 16,786 5,745
Goodwill, net 1,186 2,094
-------- --------
Total assets $351,206 $242,421
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 15,804 $ 19,134
Accrued expenses 49,603 40,018
Deferred revenue 10,861 9,502
Income taxes payable 30,635 19,361
Obligations under capital leases, current 147 207
Other current liabilities - 2,032
-------- --------
Total current liabilities 107,050 90,254
Obligations under capital leases 197 377
Deferred income taxes 1,809 923
Commitments and contingencies
Stockholders' equity:
Common stock, $.01 par value, authorized 250,000,000 and
120,000,000 shares at December 31, 1998 and 1997,
respectively; issued and outstanding 58,856,401
and 56,649,420 shares at December 31, 1998 and 1997,
respectively 589 567
Additional paid-in capital 115,662 75,400
Retained earnings 127,551 77,361
Accumulated other comprehensive loss (1,652) (2,461)
-------- --------
Total stockholders' equity 242,150 150,867
-------- --------
Total liabilities and stockholders' equity $351,206 $242,421
======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
<PAGE>
CAMBRIDGE TECHNOLOGY PARTNERS (MASSACHUSETTS), INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
Net revenues $612,041 $438,329 $294,527
Costs and expenses:
Project personnel 272,263 203,928 138,706
General and administration 66,454 47,445 34,239
Sales and marketing 56,947 40,668 25,270
Other costs 126,970 84,582 55,544
Business combination costs 8,400 4,760 1,195
-------- -------- --------
Total operating expenses 531,034 381,383 254,954
-------- -------- --------
Income from operations 81,007 56,946 39,573
Other income (expense):
Interest income 2,432 2,135 1,009
Interest expense (199) (311) (132)
Gain on equity investments 798 188 -
Foreign exchange loss (934) (122) (141)
-------- -------- --------
Income before income taxes 83,104 58,836 40,309
Provision for income taxes 31,164 25,054 16,317
-------- -------- --------
Net income $ 51,940 $ 33,782 $ 23,992
======== ======== ========
Basic net income per share $.90 $.62 $.46
======== ======== ========
Diluted net income per share $.83 $.55 $.40
======== ======== ========
Weighted average number of
common shares outstanding 58,079 54,632 52,054
======== ======== ========
Weighted average number of common and
common equivalent shares outstanding 63,301 60,775 59,573
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
<PAGE>
CAMBRIDGE TECHNOLOGY PARTNERS (MASSACHUSETTS), INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands, except share data)
<TABLE>
<CAPTION>
ADDITIONAL
NUMBER OF PAR PAID-IN
SHARES VALUE CAPITAL
----------- --------- ------------
<S> <C> <C> <C>
Balance, December 31, 1995 21,099,186 $ 212 $ 28,121
Comprehensive Income:
Net income - - -
Other comprehensive income:
Foreign currency translation adjustment - - -
Total comprehensive income
Excercise of stock options 1,776,193 18 8,297
Tax benefit related to stock option exercises - - 10,555
Shares issued under employee stock purchase plan 124,123 1 2,070
Issuance of Ramos stock under restricted stock plan - - 5
Shares to effect stock split 30,368,134 303 (303)
Accretion of Peter Chadwick preferred stock - - 787
Dividend distribution (Peter Chadwick) - - -
Dividend distribution (NatSoft) - - -
----------- ----------- ----------
Balance, December 31, 1996 53,367,636 534 49,532
Comprehensive Income:
Net income - - -
Other comprehensive income:
Foreign currency translation adjustment - - -
Total comprehensive income
Exercise of stock options 2,170,050 22 12,779
Tax benefit related to stock option exercises - - 5,807
Shares issued under employee stock purchase plan 211,734 2 4,934
Exercise of stock warrants 900,000 9 1,791
Foreign currency translation adjustment
Accretion of Peter Chadwick preferred stock - - 557
Dividend distribution (Peter Chadwick) - - -
Dividend distribution (Excell) - - -
----------- --------- ----------
Balance, December 31, 1997 56,649,420 567 75,400
Comprehensive Income:
Net income - - -
Other comprehensive income:
Foreign currency translation adjustment - - -
Unrealized gain on investment, net of taxes - - -
Other comprehensive income
Total comprehensive income
Exercise of stock options 1,975,616 20 18,656
Tax benefit related to stock option exercises - - 12,238
Shares issued under employee stock purchase plan 231,365 2 7,618
Excell conversion to C Corporation - - 1,750
----------- --------- ----------
Balance, December 31, 1998 58,856,401 $ 589 $ 115,662
=========== ========= ==========
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE RETAINED
INCOME (LOSS) EARNINGS TOTAL
------------- ------------- ------------
<S> <C> <C> <C>
Balance, December 31, 1995 $ 260 $27,414 $ 56,007
Comprehensive Income:
Net income - 23,992 23,992
Other comprehensive income:
Foreign currency translation adjustment (135) - (135)
----------
Total comprehensive income 23,857
Excercise of stock options - - 8,315
Tax benefit related to stock option exercises - - 10,555
Shares issued under employee stock purchase plan - - 2,071
Issuance of Ramos stock under restricted stock plan - - 5
Shares to effect stock split - - -
Accretion of Peter Chadwick preferred stock - (787) -
Dividend distribution (Peter Chadwick) - (1,999) (1,999)
Dividend distribution (NatSoft) - (15) (15)
---------- ---------- ----------
Balance, December 31, 1996 125 48,605 98,796
Comprehensive Income:
Net income - 33,782 33,782
Other comprehensive income:
Foreign currency translation adjustment (2,586) - (2,586)
- ----------
Total comprehensive income 31,196
Exercise of stock options - - 12,801
Tax benefit related to stock option exercises - - 5,807
Shares issued under employee stock purchase plan - - 4,936
Exercise of stock warrants - - 1,800
Foreign currency translation adjustment
Accretion of Peter Chadwick preferred stock - (557) -
Dividend distribution (Peter Chadwick) - (4,085) (4,085)
Dividend distribution (Excell) - (384) (384)
---------- ---------- ----------
Balance, December 31, 1997 (2,461) 77,361 150,867
Comprehensive Income:
Net income - 51,940 51,940
Other comprehensive income:
Foreign currency translation adjustment (446) - (446)
Unrealized gain on investment, net of taxes 1,255 - 1,255
----------
Other comprehensive income 809
----------
Total comprehensive income 52,749
Exercise of stock options - - 18,676
Tax benefit related to stock option exercises - - 12,238
Shares issued under employee stock purchase plan - - 7,620
Excell conversion to C Corporation - (1,750) -
--------- --------- ----------
Balance, December 31, 1998 $ (1,652) $127,551 $242,150
========= ========= ==========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
F-5
<PAGE>
CAMBRIDGE TECHNOLOGY PARTNERS (MASSACHUSETTS), INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-----------------------------------
1998 1997 1996
---------- --------- ----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 51,940 $ 33,782 $ 23,992
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization 12,846 8,762 6,795
Tax benefit from exercise of stock options 12,238 5,807 10,555
Unrealized gain on investment in Cambridge
Technology Capital Fund (798) - -
Benefit for deferred income taxes (1,096) (337) (566)
Changes in assets and liabilities:
Increase in accounts receivable (27,574) (45,346) (21,733)
Increase in unbilled revenue on contracts (1,880) (4,756) (1,422)
Increase in prepaid expenses and other current assets (5,214) (10,533) (9,355)
Increase in other assets (6,689) (2,346) (1,829)
(Decrease)/increase in accounts payable (3,422) 6,483 5,429
Increase in accrued expenses 8,331 13,680 8,721
Increase in deferred revenue 1,359 4,217 2,371
Increase in income taxes payable 11,165 12,741 2,211
Other, net - 1,129 124
-------- -------- --------
Net cash provided by operating activities 51,206 23,283 25,293
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment (24,048) (23,089) (13,282)
Purchase of investments held to maturity (32,288) (18,261) (18,467)
Maturity of investments held to maturity 23,194 15,164 14,284
Investment in Cambridge Technology Capital Fund (1,589) (300) -
-------- -------- --------
Net cash used in investing activities (34,731) (26,486) (17,465)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments under credit arrangements, net - - (325)
Issuance of common stock, net of issuance costs - - 5
Proceeds from long-term loan arrangement - 875 12
Repayment of long-term debt and capital leases (1,013) (250) (271)
Dividend distributions (1,193) (3,340) (2,014)
Proceeds from employee stock purchase plan 7,620 4,936 2,071
Proceeds from exercise of stock options 18,676 12,801 8,315
Proceeds from exercise of warrants - 1,800 -
-------- -------- --------
Net cash provided by financing activities 24,090 16,822 7,793
-------- -------- --------
Effect of foreign exchange rate changes on cash (163) (426) (341)
Net increase in cash and cash equivalents 40,402 13,193 15,280
Cash and cash equivalents at beginning of period 39,649 26,456 11,176
-------- -------- --------
Cash and cash equivalents at end of period $ 80,051 $ 39,649 $ 26,456
======== ======== ========
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
F-6
<PAGE>
CAMBRIDGE TECHNOLOGY PARTNERS (MASSACHUSETTS), INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. Summary of Significant Accounting Policies
BUSINESS DESCRIPTION
Cambridge Technology Partners (Massachusetts), Inc. (the "Company") is an
international management consulting and systems integration firm. Founded in
1991, the Company combines management consulting, internet solutions, custom and
package software deployment, network services, and training to rapidly deliver
end-to-end business solutions for "Global 1000" organizations worldwide. The
Company provides the majority of its services on a fixed-time, fixed-price model
with client involvement at all stages of the process. In performing its
services, the Company brings together key client users, executives, and IT
professionals in interactive sessions to achieve consensus on the business case,
strategic objectives, and functionality of a business solution. In many cases,
the Company employs a rapid development methodology that features an iterative
approach.
BASIS OF REPORTING
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All intercompany accounts and
balances have been eliminated in consolidation. On August 31, 1998, the Company
acquired all of the outstanding capital stock of Excell Data Corporation
("Excell"). The acquisition of Excell was accounted for using the pooling of
interests method of accounting (see Note B). All prior period historical
consolidated financial statements presented herein have been restated to include
the financial position, results of operations, and cash flows of Excell. Certain
prior period amounts have been reclassified to conform with current period
presentation.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consist of cash and highly liquid investments with
maturities of three months or less from the date of purchase and whose carrying
amount approximates market value due to the short maturity of the investments.
INVESTMENTS
The Company has the positive intent and ability to hold its short-term
investments to maturity. These investments are classified as investments held to
maturity and mature within one year from the date of purchase. At December 31,
1998 and 1997, the Company held investment grade municipal bonds of $24.9
million and $15.8 million, respectively, which are reported at amortized cost
that approximates market value.
Marketable equity securities are classified as available for sale within other
assets and are recorded at fair value. At December 31, 1998, the Company had
marketable securities at fair value of $2.1 million with a cost of $96,000 and
an unrealized gain of $1.3 million, net of taxes.
F-7
<PAGE>
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Repairs and maintenance costs are
charged to operations when incurred, while betterments are capitalized.
Depreciation is computed using the straight-line method based on the estimated
useful lives of the assets, which range from three to fifteen years for
equipment, furniture and fixtures, leasehold improvements, motor vehicles, and
software and other depreciable assets. Buildings are being depreciated over an
estimated useful life of forty years. Upon retirement or disposal, the cost of
the asset disposed of and the related accumulated depreciation is removed from
the accounts and any gain or loss is reflected in income.
INTANGIBLE ASSETS
Goodwill of approximately $4.8 million, related to the acquisition of IOS Group
AB (now CTP Scandinavia) in February 1994, is being amortized over six years on
a straight-line basis. The Company recorded amortization expense of $798,000 for
each of the years ended December 31, 1998, 1997, and 1996. As of December 31,
1998 and 1997, the accumulated amortization was $3.9 million and $3.1 million,
respectively. The carrying value of goodwill is subject to periodic review of
realizability.
REVENUE RECOGNITION
The Company operates in one industry segment, the design, development, and
implementation of business solutions. Revenues derived from any software
maintenance and support services are immaterial to the consolidated financial
statements of the Company. Revenues from software design, development, and
implementation contracts are recognized primarily on the percentage of
completion method. The cumulative impact of any revision in estimates of the
percent complete is reflected in the period in which the changes become known.
Losses on projects in progress are recognized when known. Revenues from
management consulting and package software evaluation and implementation
services are recognized as the service is provided, principally on a time and
materials basis. Net revenues exclude reimbursable expenses charged to clients.
Deferred revenue consists of amounts received or billed in advance of services
to be provided. Unbilled revenue represents amounts recognized based on services
performed in advance of billings in accordance with contract terms.
EARNINGS PER SHARE
The Company adopted Statement of Financial Accounting Standard No. 128,
"Earnings per Share," ("SFAS 128") beginning with the year ended December 31,
1997, which includes retroactively restating earnings per share ("EPS") for all
prior periods for which EPS data is presented. SFAS 128 requires the
presentation of basic and diluted EPS. Basic EPS is computed by dividing net
income available to common stockholders by the weighted average number of common
shares outstanding for the period. Diluted EPS is computed using the weighted
average number of common shares outstanding plus the dilutive effect of common
stock equivalents (using the treasury stock method).
F-8
<PAGE>
TRANSLATION OF FOREIGN CURRENCIES AND FOREIGN EXCHANGE TRANSACTIONS
For non-U.S. operations, the functional currency is the applicable local
currency. The translation of the functional currencies into U.S. dollars is
performed for balance sheet accounts using current exchange rates in effect
at the balance sheet date and for revenue and expense accounts using average
rates of exchange prevailing during the reporting period. Adjustments
resulting from the translation of foreign currency financial statements are
accumulated in a separate component of stockholders' equity until the entity
is sold or substantially liquidated. Gains or losses resulting from foreign
currency transactions are included in the results of operations.
FOREIGN EXCHANGE CONTRACTS
The Company maintains foreign exchange contracts to mitigate the risk of changes
in foreign exchange rates associated with intercompany balances. The contracts
generally have maturities of one month. The impact of exchange rate movements on
contracts is recorded in other income in the period in which the exchange rates
change, generally consistent with the term of the contract. As of December, 31,
1998 and 1997, the Company held foreign exchange forward contracts of
approximately $9.4 million and $4.1 million, respectively, and there were no
related deferred gains and losses. The Company does not hold foreign exchange
contracts for trading purposes.
CONCENTRATION OF CREDIT RISK
The Company provides its services primarily to Global 1000 companies. The
Company performs ongoing credit evaluations of its major customers and maintains
reserves for potential credit losses. Such losses have been immaterial and have
been within management's expectation. No single customer accounted for 5% or
more of total net revenues for the years ended 1998, 1997, and 1996.
The Company may be exposed to credit-related losses in the event of
nonperformance by counterparties to hedging instruments. The counterparties to
these contracts are major financial institutions. The Company continually
monitors its positions and credit ratings of its counterparties and limits the
amount of contracts it enters into with any one party.
RISKS AND UNCERTAINTIES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to provide estimates and assumptions
that affect the amounts reported in the financial statements and the related
footnotes. Actual results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
The Company has adopted Statement of Financial Accounting Standards No. 130,
"Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 requires the
presentation of comprehensive income and its components. Comprehensive income
presents a measure of all changes in equity that result from recognized
transactions and other economic events during the period other than transactions
with stockholders. SFAS 130 requires restatement of all prior period financial
statements presented and is effective for the periods beginning after December
15, 1997. The
F-9
<PAGE>
Company has elected to disclose the components of other comprehensive income and
total comprehensive income, net of taxes, in the Consolidated Statements of
Stockholders' Equity.
The Company has adopted Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information" ("SFAS
131"), which is effective for fiscal years beginning after December 15, 1997.
Interim reporting disclosures are not required in the first year of adoption.
SFAS 131 specifies revised guidelines for determining an entity's operating
segments and the type and level of financial information to be disclosed (see
Note P).
In March 1998, Statement of Position 98-1, "Accounting for the Cost of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"), was issued. SOP
98-1 provides guidance on applying generally accepted accounting principles in
addressing whether and under what conditions the costs of internal-use software
should be capitalized. SOP 98-1 is effective for transactions entered into in
fiscal years beginning after December 15, 1998, however earlier adoption is
encouraged. The Company adopted the guidelines of SOP 98-1 as of January 1, 1998
and the impact on the operating results for the year ended December 31, 1998 was
immaterial.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for all fiscal
quarters of all fiscal years beginning after June 15, 1999 (January 1, 2000 for
the Company). SFAS 133 requires that all derivative instruments be recorded on
the balance sheet at their fair value. Changes in the fair value of derivatives
are recorded for each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge transaction
and, if it is, the type of hedge transaction. The Company is currently
determining the impact of the adoption of SFAS 133 on the Company's results of
operations and financial position.
B. ACQUISITIONS
In August 1998, the Company acquired all of the outstanding capital stock of
Excell. This acquisition was accomplished through a merger of the Company's
acquisition subsidiary and Excell in an exchange of 1,680,416 shares of the
Company's common stock for all outstanding shares of capital stock of Excell.
The acquisition has been accounted for using the pooling of interests method of
accounting. Founded in 1991, Excell had approximately 510 employees at the time
of the acquisition, and had locations in Bellevue, Washington, Portland, Oregon,
and Denver, Colorado. Transaction costs related to this acquisition which
consist primarily of investment banking fees, accounting fees, legal fees and
business integration costs were approximately $1.7 million and are included in
business combination costs in the accompanying Consolidated Statements of
Operations (also see Note G - "Excell Phantom Stock Plan").
In November 1997, the Company acquired all of the outstanding capital stock of
Peter Chadwick Holdings Limited ("Peter Chadwick"). This acquisition was
accomplished through an exchange of 3,255,731 shares of the Company's common
stock for all outstanding shares of capital stock and options to purchase
ordinary shares of Peter Chadwick. The acquisition has been accounted for using
the pooling of interests method of accounting. Founded in 1987 and based in the
F-10
<PAGE>
United Kingdom, Peter Chadwick specialized in change implementation strategies
and performance improvement programs. Peter Chadwick had offices in the United
Kingdom, Germany, Holland, France, and the U.S. and had approximately 325
employees at the time of the acquisition. Peter Chadwick was renamed Cambridge
Management Consulting Holdings Limited in July 1998.
In November 1996, the Company acquired all the outstanding capital stock of
Ramos & Associates, Inc. ("Ramos"). This acquisition was accomplished through a
merger of the Company's acquisition subsidiary and Ramos in an exchange of
1,175,119 shares of the Company's common stock for all outstanding shares of
capital stock of Ramos. Ramos, founded in 1991 and based in San Ramon,
California, specialized in the Enterprise Resource Planning service market. The
acquisition has been accounted for using the pooling of interests method of
accounting. Ramos was renamed Cambridge Technology Partners - Enterprise
Resource Solutions, Inc. ("ERS") in March 1997.
In October 1996, the Company acquired all the outstanding capital stock of
NatSoft S.A. ("NatSoft"), a Swiss-based information technology consulting and
software implementation firm. This acquisition was accomplished through an
exchange of 271,714 shares of the Company's common stock for all outstanding
shares of capital stock of NatSoft. This acquisition established the Company's
entry into the Swiss market and provided the Company with a pool of
multi-lingual professionals who can support projects in Southern Europe. The
acquisition of NatSoft has been accounted for using the pooling of interests
method of accounting. In March 1997, NatSoft was renamed Cambridge Technology
Partners Switzerland, S.A ("Cambridge-Switzerland").
The accompanying consolidated financial statements of the Company have been
prepared to give retroactive effect to the acquisitions of Excell, Peter
Chadwick, Ramos, and NatSoft in accordance with the pooling of interests
requirements. All prior period historical consolidated financial statements
presented herein have been restated to include the financial position, results
of operations, and cash flows of these acquisitions. Costs related to these
acquisitions have been charged to business combination costs in the consolidated
statements of operations for the period in which the transaction was
consummated.
The following information presents certain statement of operations data (in
thousands) of the Company, NatSoft, Ramos, Peter Chadwick, and Excell for the
periods prior to the acquisitions. NatSoft and Ramos information are presented
through September 30, 1996, which represents the interim period end nearest to
the date of these acquisitions. Peter Chadwick and Excell information are
presented through September 30, 1997 and June 30, 1998, respectively, which
represent the interim period ends nearest to the dates of these acquisitions.
F-11
<PAGE>
<TABLE>
<CAPTION>
Cambridge
Technology Peter Combined
Partners NatSoft Ramos Chadwick Excell Total
---------- --------- --------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Net revenues for the:
Nine months ended
September 30, 1996 $ 141,862 $ 8,046 $ 17,497 $ 26,384 $ 15,635 $ 209,424
Year ended
December 31, 1996 $ 236,554 $ 36,324 $ 21,649 $ 294,527
Nine months ended
September 30, 1997 $ 250,501 $ 36,841 $ 22,217 $ 309,559
Year ended
December 31, 1997 $ 406,672 $ 31,657 $ 438,329
Six months ended
June 30, 1998 $ 238,018 $ 18,588 $ 256,606
Net income for the:
Nine months ended
September 30, 1996 $ 14,042 $ 163 $ 853 $ 2,049 $ 408 $ 17,515
Year ended
December 31, 1996 $ 21,100 $ 2,925 $ (33) $ 23,992
Nine months ended
September 30, 1997 $ 24,623 $ 2,365 $ 962 $ 27,950
Year ended
December 31, 1997 $ 32,929 $ 853 $ 33,782
Six months ended
June 30, 1998 $ 41,798 $ 397 $ 42,195
</TABLE>
C. ACCOUNTS RECEIVABLE
Accounts receivable consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Contracts in process $ 78,767 $ 69,995
Completed contracts 59,366 37,968
-------- --------
138,133 107,963
Less: Allowance for doubtful accounts 4,550 2,757
-------- --------
$133,583 $105,206
======== ========
</TABLE>
In accordance with state government practices, a governmental client withheld a
percentage of invoiced receivables as retention until final review of completed
projects. At December 31, 1998 and 1997, this retention receivable totaled $2.4
million and was included in other assets. The Company does not include client
reimbursable expenses or other non-trade receivables as a component of net
revenues. At December 31, 1998 and 1997, approximately $19.2 million and $14.0
million, respectively, of client reimbursable expenses and other non-trade
receivables are included in prepaid expenses and other current assets.
F-12
<PAGE>
D. PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Equipment $ 54,591 $ 38,121
Furniture and fixtures 11,693 8,618
Leasehold improvements 11,312 7,611
Motor vehicles 880 1,137
Software and other 2,849 1,501
-------- --------
Total cost 81,325 56,988
Less accumulated depreciation 33,070 20,961
-------- --------
$ 48,255 $ 36,027
======== ========
</TABLE>
Depreciation expense for 1998, 1997, and 1996 was $11.9 million, $7.2 million,
and $5.8 million, respectively.
E. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
------------------
1998 1997
-------- --------
<S> <C> <C>
Accrued payroll and payroll related expenses $ 20,776 $ 21,106
Other accrued expenses 22,959 15,864
Accrued value added tax 5,868 3,048
-------- --------
$ 49,603 $ 40,018
======== ========
</TABLE>
In April 1997, Peter Chadwick acquired the assets of a training facility located
in the United Kingdom for $1.9 million (see Note B). Peter Chadwick entered into
a Loan Agreement with National Westminister Bank (the "Loan Agreement") to
finance this acquisition. As of December 31, 1997, the principal amount due
under the Loan Agreement was $823,000. Interest payments, at a rate of 2% above
the Bank of England base rate (7.25% at December 31, 1997), were payable in
monthly installments. A balloon payment for the entire outstanding balance was
due in 2005. This amount is included in other current liabilities in the
accompanying consolidated balance sheet at December 31, 1997. In the first
quarter of 1998, the Company repaid the outstanding amount of approximately
$823,000 and terminated the Loan Agreement.
F-13
<PAGE>
F. REVOLVING CREDIT FACILITY
In September 1998, the Company obtained a $50.0 million unsecured senior
revolving credit facility (the "Facility") through a syndication arrangement
committed equally by The Chase Manhattan Bank ("Chase") and Fleet National Bank
("Fleet Bank"). The Facility expires on September 10, 2001 and replaces the
Company's previously maintained $20.0 million revolving credit facility that
expired on June 30, 1998. The Facility is administered by Chase and carries a
commitment fee, payable quarterly in arrears, calculated based on the unused
portion of the Facility and a price grid as set forth in the credit agreement.
The Facility permits the Company to elect any of three possible interest rate
formulas as defined in the credit agreement. Interest is payable in arrears
based on an interest period determined by the interest rate elected by the
Company. The Facility requires, among other things, the Company to maintain
certain financial ratios, including debt service coverage, debt to capital, and
net worth. For the year ended December 31, 1998, the Company was in compliance
with these financial ratio requirements. As of December 31, 1998, the Company
had no balance outstanding under the Facility.
G. STOCKHOLDERS' EQUITY AND OTHER STOCK-RELATED INFORMATION
AUTHORIZED SHARES
On May 13, 1998, the stockholders of the Company voted to amend to the Company's
corporate charter to increase the number of authorized shares of common stock
from 120 million shares to 250 million shares.
STOCK SPLIT
In March 1996, the Board of Directors approved a three-for-one stock split of
the Company's common stock and an amendment to the Company's corporate charter
to increase authorized common stock from 30 million to 120 million shares.
Following stockholder approval in May 1996, the stock split was completed on
June 19, 1996, in the form of a 200% stock dividend to stockholders of record on
May 29, 1996. All references in the consolidated financial statements and the
related notes to applicable share and per share data, stock option data, and
market prices per share of the Company's common stock, for all periods
presented, have been retroactively restated to reflect the stock split.
STOCK OPTION PLANS
Under the Company's amended 1991 Stock Option Plan (the "1991 Option Plan"), the
Company may grant incentive stock options to employees and nonqualified stock
options to employees, directors, officers, and other key individuals. The
Management Resource Committee (the "MRC") of the Board of Directors administers
the 1991 Option Plan, subject to approval by the Board of Directors with respect
to certain matters. Options granted under the 1991 Option Plan prior to 1997
generally vest ratably over a 48 month period and expire ten years from the date
of grant. Options granted under the 1991 Option Plan in 1997 and thereafter
generally vest ratably over a 48 month period and expire in installments five to
eight years from the date of grant. At December 31, 1998, 1997, and 1996,
options to purchase 4,725,224, 4,063,342, and 4,014,783 shares, respectively,
were exercisable under the 1991 Option Plan. In December 1996 and 1997,
F-14
<PAGE>
the Company's Board of Directors amended the 1991 Option Plan, with subsequent
stockholder approval, to increase the number of shares of common stock
authorized for issuance under the 1991 Option Plan from 15 million to 19 million
in 1996, and from 19 million to 23 million in 1997.
During 1995, the Company established the 1995 Non-employee Director Stock Option
Plan ("Non-employee Director Option Plan"). The Non-employee Director Option
Plan authorizes the grant of nonqualified options for up to 150,000 shares of
the Company's common stock. Each member of the Company's Board of Directors who
was neither (I) an employee nor an officer of the Company or Safeguard
Scientific, Inc. ("Safeguard") nor (II) an affiliate of Technology Leaders II
L.P. or any related entity, and was serving on the Company's Board of Directors
on March 21, 1995, was granted an option to purchase 30,000 shares of the
Company's common stock. Each person who is neither (I) an employee nor an
officer of the Company or Safeguard nor (II) an affiliate of Technology Leaders
II L.P. or any related entity, and who is first elected to the Board of
Directors after March 21, 1995, is automatically granted, on the date of such
election without further action by the Board of Directors, an option to purchase
30,000 shares of the Company's common stock. Options granted under the
Non-employee Director Option Plan generally vest ratably over a 48 month period
and expire ten years from the date of grant. At December 31, 1998, 1997 and
1996, options to purchase 95,136, 73,121, and 43,122 shares, respectively, were
exercisable under the Non-employee Director Option Plan.
In November 1997, the Board of Directors adopted the 1997 Stock Option Plan (the
"1997 Option Plan") under which the Company may grant nonqualified stock options
to purchase up to 450,000 shares of common stock to employees (other than
officers) and consultants of the Company. The MRC administers the 1997 Option
Plan, subject to approval by the Board of Directors with respect to certain
matters. Options granted under the 1997 Option Plan generally vest ratably over
a 48 month period and expire in installments five to eight years from the date
of grant. At December 31, 1998 and 1997, options to purchase 34,773 and zero
shares, respectively, were exercisable under the 1997 Option Plan.
In October 1998, the Board of Directors adopted the 1998 Stock Option Plan (the
"1998 Option Plan") under which the Company may grant nonqualified stock options
to purchase up to five million shares of the Company's common stock to employees
of the Company and other key individuals other than members of the Board of
Directors or officers of the Company. The MRC administers the 1998 Option Plan.
Unless otherwise provided by the MRC at the time of grant, options granted under
the 1998 Option Plan vest ratably over a 48 month period and expire four years
from the last vesting date in each year. At December 31, 1998, options to
purchase 31,732 shares were exercisable under the 1998 Option Plan.
F-15
<PAGE>
Stock option activity under the Company's stock option plans is summarized as
follows:
<TABLE>
<CAPTION>
Weighted Average
Option Exercise Price
Shares Per Share
---------- ------------------
<S> <C> <C>
Outstanding at December 31, 1995 11,354,211 $ 7.48
Granted 2,922,675 25.71
Exercised 2,660,679 3.18
Canceled 902,252 10.97
---------- -------
Outstanding at December 31, 1996 10,713,955 13.27
Granted 6,281,988 29.89
Exercised 2,170,050 5.86
Canceled 2,768,753 26.31
---------- -------
Outstanding at December 31, 1997 12,057,140 20.16
Granted 12,189,805 22.14
Exercised 1,975,616 9.39
Canceled 6,919,605 33.65
---------- -------
Outstanding at December 31, 1998 15,351,724 $ 17.39
========== =======
</TABLE>
In October of 1998, in order to re-establish the incentive nature of outstanding
stock options with exercise prices greater than the then current fair market
value of the Company's common stock, the Company offered to holders of
outstanding stock options granted on or after April 24, 1997 the opportunity to
exchange those options for options covering an equivalent number of shares with
an exercise price of $15.50 per share, the then current fair market value. The
Chief Executive Officer and directors of the Company were not eligible to
participate in the exchange. The table above reflects the cancellation and
re-issuance of options to purchase 5,236,670 shares of common stock in 1998 in
connection with the option exchange. The new options vest in accordance with the
vesting schedule of the options they replaced, but cannot be exercised until
October 15, 1999, in the case of the Company's executive vice presidents, senior
vice presidents, vice presidents and associate vice presidents, and until April
15, 1999, in the case of all other employees who participated in the option
exchange.
The above table also reflects the cancellation and re-issuance of options to
purchase 2,051,286 shares of common stock in 1997 under the 1991 Option Plan.
These re-issued options were granted in April 1997 at fair market value in
exchange for options granted from October 1996 through March 1997 with exercise
prices above April 1997 fair market values. Vesting schedules for these options
re-started at April 1997 and option lives were shortened compared to the
original grants.
F-16
<PAGE>
The following summarizes information about the Company's stock options
outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- ----------------------------------------------------------- -----------------------
Weighted Average Weighted Weighted
Number Remaining Average Number Average
Range of Outstanding Contractual Exercise Exercisable Exercise
Exercise Price at 12/31/98 Life Price at 12/31/98 Price
- --------------- ----------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C>
$ .16 - $ 1.34 328,648 3.3 Years $ .62 328,648 $ .62
1.67 - 6.32 1,176,227 5.4 Years $ 5.64 1,176,227 $ 5.64
10.00 - 17.30 8,941,973 6.5 Years $ 15.45 2,634,841 $ 15.27
22.50 - 29.13 4,129,610 6.7 Years $ 22.81 547,759 $ 25.46
33.00 - 36.00 695,585 6.6 Years $ 34.95 197,890 $ 34.86
46.06 - 49.60 79,681 7.2 Years $ 48.82 1,500 $ 47.18
- --------------- ---------- --------- -------- --------- --------
$ .16 - $49.60 15,351,724 6.4 Years $ 17.39 4,886,865 $ 13.59
=============== ========== ========= ======== ========= ========
</TABLE>
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees", and related interpretations in accounting for its
option plans. Accordingly, no compensation expense has been recognized. Had
compensation expense for the Company's stock option plans and employee stock
purchase plan been determined based on the fair value at the grant date for
awards under these plans consistent with the methodology proscribed under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("SFAS 123"), the Company's consolidated net income and net income
per share would have been reduced to the pro forma amounts indicated as follows
for the years ended December 31, 1998, 1997, and 1996 (in thousands except per
share data):
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
As reported net income $51,940 $33,782 $23,992
Pro forma net income for SFAS 123 $24,133 $27,092 $18,692
Net income per share:
As reported basic net income per share $ .90 $ .62 $ .46
Pro forma basic net income per
share for SFAS 123 $ .42 $ .50 $ .36
As reported diluted net income per share $ .83 $ .55 $ .40
Pro forma diluted net income per
share for SFAS 123 $ .38 $ .45 $ .31
</TABLE>
F-17
<PAGE>
The following assumptions were used by the Company to determine the fair value
of stock options granted using the Black-Scholes options-pricing model:
<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- --------
<S> <C> <C> <C>
Expected volatility 52% 45% 45%
Average expected option life 4 Years 5 Years 5 Years
Average expected life for employee
stock purchase plan shares .5 Year .5 Year .5 Year
Risk-free interest rate 4.5% 6.2% 6.2%
Dividend yield 0% 0% 0%
</TABLE>
The weighted average fair value of options granted under the stock option plans
was $8.80 in 1998, $12.59 in 1997, and $12.25 in 1996. The weighted average fair
value of shares issued under the employee stock purchase plan was was $13.40 in
1998, $4.81 in 1997, and $2.64 in 1996. The pro forma expense amounts assume
that the fair value assigned to the option grants was amortized over the vesting
period of the options, which is approximately four years, while the fair value
assigned to grants under the Employee Stock Purchase Plan was recognized in full
at the various dates of grant.
EMPLOYEE STOCK PURCHASE PLAN
On December 14, 1994, the Board of Directors adopted the Company's 1994 Employee
Stock Purchase Plan (the "Stock Purchase Plan"), which was subsequently approved
by stockholders at the annual meeting of stockholders in May 1995. The Company
has authorized 1,500,000 shares of the Company's common stock for purchases
under the Stock Purchase Plan. The Stock Purchase Plan permits eligible
employees to purchase shares of common stock, subject to limitations provided by
Section 423(b) of the Internal Revenue Code, through accumulated payroll
deductions. Each participating employee may purchase up to 1,500 shares per
payment period and purchases by any one employee may not exceed $25,000 in fair
market value of the stock purchased in any one year. The purchases are made
twice per year at a price equal to the lesser of (i) 85% of the average market
price of the Company' common stock on the first business day of the payment
period and (ii) 85% of the average market price of the Company's common stock on
the last day of the payment period. Annual payment periods consist of two
six-month periods, January 15 through July 14 and July 15 through January 14.
For the years ended December 31, 1998, 1997, and 1996, 231,365, 211,734, and
124,123 shares of common stock, respectively, were issued under the Stock
Purchase Plan.
PREFERRED STOCK
The Company's certificate of incorporation was amended and restated, in December
1992, to increase the number of authorized shares of capital stock to include
two million shares of preferred stock, par value $.01 per share, in one or more
series. The Board of Directors is authorized, subject to certain limitations
prescribed by law, to fix or alter the designations, preferences, rights and any
qualifications, limitations or restrictions of the shares of each such series.
The Company has not issued and, except pursuant to the preferred stock purchase
rights
F-18
<PAGE>
described in the Rights Plan section of this note, has no present plans to issue
any shares of preferred stock.
WARRANTS
In December 1992, the Company issued warrants to Safeguard Scientifics, Inc. for
the purchase of 900,000 shares of common stock at a price of $2.00 per share.
The warrants were exercisable for a five-year period from the date of issuance.
In December 1997, all warrants were exercised for common stock.
DIVIDENDS
The Facility prohibits the Company from paying any dividends or making any
distributions either in cash or in kind on any class of its capital stock
without prior consent of Chase as administrator of the Facility (see Note F).
The Company currently intends to retain future earnings for use in its business
and, therefore, does not expect to pay dividends in the foreseeable future.
Dividend distributions made by Peter Chadwick were made in accordance with the
Peter Chadwick shareholder agreements in effect prior to the acquisition, and
amounted to $1.2 million, $3.0 million, and $2.0 million for the years ended
December 31, 1998, 1997 and 1996, respectively. At December 31, 1997, the $1.2
million of dividend distribution paid in the first quarter of 1998 was included
in other current liabilities reflecting Peter Chadwick's dividend obligations up
to the date of acquisition in accordance with the Peter Chadwick shareholder
agreements in effect prior to the acquisition.
Dividend distributions made by Excell prior to the acquisition were principally
for reimbursement of income tax liabilities of its former stockholders due to
Excell's S-Corporation tax status prior to the acquisition.
RIGHTS PLAN
On June 23, 1997, the Board of Directors of the Company approved and adopted a
Rights Plan pursuant to a Rights Agreement which was amended on September 30,
1998, and in connection therewith, declared a dividend of one preferred stock
purchase right for each outstanding share of the Company's common stock, which
dividend was paid on July 3, 1997 to holders of record of the Company at the
close of business on July 3, 1997. One preferred stock purchase right is also
attached to each share of the Company's common stock issued after July 3, 1997.
The rights are not presently transferable separate from the share of common
stock with respect to which they were issued. The rights are subject to
adjustment and become exercisable upon the occurrence of certain events
described in the Rights Agreement. In general, the Company is entitled to redeem
the rights at $.01 per right. The rights will expire on June 23, 2007, unless
earlier redeemed or exchanged. As part of the Rights Plan, the Company
designated 100,000 shares of its preferred stock as Series A Junior
Participating Preferred Stock and reserved such shares for issuance upon
exercise of the rights.
EXCELL PHANTOM STOCK PLAN
Excell maintained a 1996 Class I Phantom Stock Plan ("Phantom Plan") under which
Excell granted nonqualified phantom stock units to qualifying employees. The
Phantom Plan entitled a
F-19
<PAGE>
holder to surrender the units for cash equal to the defined per-unit amount
derived from net income of Excell over the holding period of the units. The
Phantom Plan also provided for a five-year vesting period along with other
restrictions regarding redemption. The Phantom Plan also contained provisions
related to payments to holders of units based on a defined market value if
Excell was sold or a major change in ownership (collectively a "change in
control") occurred, as defined under the Phantom Plan agreement. The acquisition
of Excell by the Company qualified as a change in control under the Phantom
Plan. As a result, upon consummation of the acquisition, the Company recorded a
charge to operations of $6.7 million for the year ended December 31, 1998, which
is included in business combination costs, representing amounts owed to Phantom
Plan participants as of the closing date of the Excell acquisition. In
accordance with the Phantom Plan, as a result of the acquisition, the Phantom
Plan was terminated.
H. LEASE COMMITMENTS
On June 4, 1992, the Company entered into, among other building and equipment
leases, a lease for a building in Cambridge, Massachusetts, that houses its
Northeast operations and corporate departments. The building is owned by a
trust, the sole beneficiary of which is the Chairman of the Board of Directors
of the Company. The initial lease term expires in August 2007, and is renewable
for two additional five-year terms. The lease provides for rent increases, which
began in September 1995, based upon increases in the Consumer Price Index-Urban
Wage Earners and Clerical Workers, U.S. City Average, All Items.
In January 1998, the Company entered into an agreement with Boston Properties
Limited Partnership ("Boston Properties") to lease a building to be constructed
and developed by Boston Properties. This approximately 177,000 square foot
building, which is located in Cambridge, Massachusetts, will house the Company's
Northeast operations, new employee training facility, and corporate departments.
The lease agreement is for a ten-year period, which is expected to commence in
June 1999. The Company's current facility in Cambridge, Massachusetts, which
houses part of the Company's Northeast operations and corporate functions, is
expected to be subleased through its remaining lease term. The Company's lease
for its Allston, Massachusetts facility, which houses the remainder of the
Company's Northeast operations, will be terminated effective June 30, 1999.
F-20
<PAGE>
Minimum future lease commitments under noncancelable operating leases for
buildings and equipment in effect at December 31, 1998, are presented as follows
(in thousands):
<TABLE>
<S> <C>
1999 $ 18,247
2000 18,272
2001 16,924
2002 15,076
2003 13,218
Thereafter 42,464
---------
Total minimum lease payments $ 124,201
=========
</TABLE>
For the years ended December 31, 1998, 1997, and 1996, rental expense under all
leases was approximately $15.6 million, $11.0 million, and $6.6 million,
respectively, of which approximately $814,000, $765,000, and $785,000,
respectively, were paid to the trust described above.
I. OTHER COSTS
Other costs consist of the following (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Facility costs and related expenses $ 58,881 $ 43,920 $ 31,846
Non-billable project expenses 34,597 19,080 11,818
Non-billable staff costs 21,412 15,479 7,473
Education and training 12,080 6,103 4,407
-------- -------- --------
$126,970 $ 84,582 $ 55,544
======== ======== ========
</TABLE>
F-21
<PAGE>
J. INCOME TAXES
The components of income before income taxes and the related provision for
income taxes for the years ended December 31, 1998, 1997, and 1996 are presented
below (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Income before income taxes:
Domestic $ 57,071 $ 49,340 $ 33,220
Foreign 26,033 9,496 7,089
-------- -------- --------
$ 83,104 $ 58,836 $ 40,309
======== ======== ========
Provision for income taxes:
Current:
Federal $ 19,955 $ 17,769 $ 10,430
Foreign 9,682 3,881 3,420
State 2,623 3,741 3,033
-------- -------- --------
32,260 25,391 16,883
Deferred:
Federal (1,009) (308) (311)
Foreign - 10 (207)
State (87) (39) (48)
-------- -------- --------
(1,096) (337) (566)
-------- -------- --------
Total $ 31,164 $ 25,054 $ 16,317
======== ======== ========
</TABLE>
The Company's deferred tax assets and (liabilities) are comprised of the
following as of December 31, 1998 and 1997 (in thousands):
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Bad debt reserves $ 838 $ 442
Vacation accrual 631 177
Fixed asset depreciation (485) (923)
Cash to accrual adjustments (1,174) (476)
Unrealized gain on investment (1,033) -
Other accruals 1,593 807
-------- --------
$ 370 $ 27
======== ========
</TABLE>
Included in unrealized gain on investment is a deferred tax liability of
$753,000 related to an increase in the basis of an investment recorded as part
of comprehensive income reflected in the Consolidated Statements of
Stockholders' Equity. In accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes", this deferred tax liability
amount is not included in the provision for income taxes.
F-22
<PAGE>
The table below reconciles the expected U.S. federal statutory income tax rate
to the recorded income tax rate:
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
U.S. statutory tax rate 35.0% 35.0% 35.0%
State income taxes, net of
federal income tax benefit 2.3 5.0 5.5
Goodwill amortization 0.3 0.4 0.7
Non-taxable S-Corporation income (0.5) (0.6) -
Other, net (0.4) (0.9) (0.7)
----- ----- -----
Effective tax rate before non-
deductible pooling costs 36.7 38.9 40.5
Non-deductible pooling costs 0.8 3.7 -
----- ----- -----
Effective tax rate 37.5% 42.6% 40.5%
===== ===== =====
</TABLE>
During the period from April 1, 1996 through August 31, 1998 (the date of the
Company's acquisition of Excell), Excell elected to be treated as an
S-Corporation for income tax reporting purposes. Under this election, Excell's
individual stockholders are deemed to have received a pro rata distribution of
taxable income of Excell (whether or not an actual distribution was made), which
is included in each stockholder's taxable income. Accordingly, Excell did not
provide for income taxes during the period from April 1, 1996 through August 31,
1998. Excell's S-Corporation tax reporting status was terminated on the date of
acquisition and therefore, the undistributed earnings of Excell, as of the date
of acquisition, were reclassified to additional paid-in-capital as of August 31,
1998. Pro forma net income per share data is presented below to reflect the pro
forma increase to historical income taxes related to Excell as if Excell was a
C-Corporation for tax reporting purposes during those periods.
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Pro forma data (unaudited):
Historical income before income taxes $ 83,104 $ 58,836 $ 40,309
Provision for income taxes:
Historical income taxes 31,164 25,054 16,317
Pro forma increase to historical income taxes 195 437 64
-------- -------- --------
Pro forma net income $ 51,745 $ 33,345 $ 23,928
======== ======== ========
Pro forma basic net income per share $ .90 $ .62 $ .46
======== ======== ========
Pro forma diluted net income per share $ .83 $ .55 $ .40
======== ======== ========
</TABLE>
F-23
<PAGE>
K. NET INCOME PER SHARE
The following table presents the calculation of per share earnings for the years
ended December 31, 1998, 1997, and 1996 (see Note A) (in thousands except per
share data):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- ---------
<S> <C> <C> <C>
Net income $ 51,940 $ 33,782 $ 23,992
======== ======== =========
Basic:
Weighted average common shares outstanding 58,079 54,632 52,054
======== ======== =========
Net income per common share $ .90 $ .62 $ .46
======== ======== =========
Diluted:
Weighted average common shares outstanding 58,079 54,632 52,054
Dilutive effects of stock options and warrants 5,222 6,143 7,519
-------- -------- ---------
Weighted average common and common
equivalent shares outstanding 63,301 60,775 59,573
======== ======== =========
Net income per common and common
equivalent share $ .83 $ .55 $ .40
======== ======== =========
</TABLE>
L. EMPLOYEE BENEFIT PLANS
In 1992, the Company established a savings and profit-sharing plan (the "401(k)
Plan") covering substantially all of the Company's employees. The 401(k) Plan is
qualified under Section 401(a) of the Internal Revenue Code of 1986, as amended.
The Company may elect to make contributions under the 401(k) Plan. Starting in
1994, the Company elected to make matching contributions based on a percentage
of employees' contributions, subject to limitations as defined in the 401(k)
Plan. Company matching contributions made under the 401(k) Plan amounted to $2.3
million, $1.3 million, and $845,000 in 1998, 1997, and 1996, respectively.
Cambridge-Switzerland sponsors a defined contribution retirement plan (the
"Switzerland Plan") for its employees. Under the Switzerland Plan, employees can
contribute between 5% to 11% of salary depending on age and other factors. All
employee contributions are matched by Cambridge-Switzerland. Employer matching
contributions amounted to $225,000, $188,000, and $202,000 for the years ended
December 31, 1998, 1997, and 1996, respectively.
In 1992, ERS established a savings and profit-sharing plan (the "ERS
Profit-sharing Plan") covering substantially all of ERS' employees. The ERS
Profit-sharing Plan was qualified under Section 401(a) of the Internal Revenue
Code of 1986, as amended. ERS could elect to make contributions under the ERS
Profit-sharing Plan. ERS elected to make matching contributions based on a
percentage of employees' contributions. The Company completed the rollover of
assets held under the ERS Profit-sharing Plan to the 401(k) Plan in January
1998. ERS' matching
F-24
<PAGE>
contributions amounted to $538,000 and $455,000 for the years ended December 31,
1997 and 1996, respectively.
In November 1995, Peter Chadwick Limited Employee Trust (the "Trust") was formed
for the purpose of providing benefits to Peter Chadwick employees and
facilitating the acquisition of Peter Chadwick shares by, or for the benefit of,
employees. The Trust is controlled by an independent trustee and, accordingly,
the Trust is not reflected in the consolidated financial statements. As a result
of the acquisition of Peter Chadwick, the trustees terminated the Trust.
Excell maintains a qualified deferred compensation plan under Section 401(a) of
the Internal Revenue Code of 1986, as amended. Under this plan, employees may
elect to defer a portion of their compensation subject to Internal Revenue Code
defined limitations. Employees are eligible to participate in the plan after
they have worked for Excell for 90 days. Excell did not provide any matching
based on employee contributions.
In December 1997, the MRC and the Board of Directors approved a Deferred
Compensation Plan for executive officers and all vice presidents of the Company.
Under the Deferred Compensation Plan, eligible employees may defer either 5% or
10% of eligible cash bonus compensation, beginning with bonus compensation for
1998, which amount the Company will match on a 100% basis. Deferrals and
matching amounts are credited to an unfunded account maintained on the books of
the Company and treated as notionally invested in common stock of the Company,
based on the average of the closing prices of such stock over the ten business
days immediately preceding the crediting date. The matching portion vests in 25%
installments on each of the next four anniversaries of the date the match was
credited to the account, provided that the participant has been continuously
employed since the crediting date. With certain exceptions, the vested portion
of a participant's account will be paid in a single payment upon termination of
employment. As the Company did not, generally, pay any cash bonuses to employees
eligible to participate in the Deferred Compensation Plan in 1998, there was no
participation in the plan, or Company contributions, for 1998.
M. COMMITMENTS AND CONTINGENCIES
On November 18, 1998, certain of the former shareholders of Excell filed a
lawsuit against the Company in the United States District Court for the District
of Massachusetts. The complaint alleges breach of contract, violation of federal
securities laws, common law fraud, and negligent misrepresentation in connection
with the Excell acquisition and seeks unspecified damages. The Company believes
that the plaintiffs' claims are without merit and intends to vigorously defend
the lawsuit. In February 1999, the Company filed a counterclaim alleging breach
of contract.
The Company is involved in litigation and various other legal matters, which
have arisen in the ordinary course of business. The Company does not believe
that the ultimate resolution of any existing matter will have a material adverse
effect on its financial condition, results of operations, or cash flows.
F-25
<PAGE>
N. CAMBRIDGE TECHNOLOGY CAPITAL FUND I L.P.
Cambridge Technology Capital Fund I L.P. (the "Fund") was formed in October 1997
as a limited partnership with committed capital of approximately $25.3 million.
The Fund is intended to invest in expansion-stage, private companies providing
products and services within areas of the Company's strategic expertise. A
wholly owned subsidiary of the Company acts as the sole general partner of the
Fund's general partner. The Company's investment in the Fund is accounted for
using the equity method of accounting. The Company's capital commitment to the
Fund is approximately $6.0 million. No more than two-thirds of the Fund's
committed capital may be called before October 1999 without approval of the
Fund's partners. The balance of the Fund's capital has been provided by
institutional investors and directors and employees of the Company. For the
years ended December 31, 1998 and 1997, the Company's investment in the Fund
amounted to approximately $1.6 million and $300,000, respectively. The Company's
investment in the Fund resulted in a net gain of approximately $798,000 for the
year ended December 31, 1998.
O. SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information are presented as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Cash paid during the year for:
Interest $ 199 $ 232 $ 107
Income taxes 11,171 5,503 4,505
</TABLE>
P. OPERATING SEGMENT AND GEOGRAPHIC INFORMATION
In the fourth quarter of 1998, the Company has adopted Statement of Financial
Accounting Standard No. 131, "Disclosure About Segments of an Enterprise and
Related Information". The Company is managed in two operating segments: North
America and International. North America provides systems integration and
consulting services in the United States and Canada while International provides
systems integration and consulting services outside of North America. In 1999,
the Company will operate under a service line structure.
F-26
<PAGE>
The Company evaluates each segment's performance based on net revenues and
income from operations. Corporate net revenue, depreciation/amortization
expense, and income from operations has been allocated to each segment based on
the proportionate operating income of each segment. Total corporate assets and
fixed asset additions have been included in North America.
Information about the Company's operating segments is presented as follows (in
thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net revenues:
North America $421,741 $309,531 $199,017
International 190,300 128,798 95,510
-------- -------- --------
Consolidated $612,041 $438,329 $294,527
======== ======== ========
Depreciation and amortization:
North America $ 9,386 $ 6,547 $ 4,756
International 3,460 2,215 2,039
-------- -------- --------
Consolidated $ 12,846 $ 8,762 $ 6,795
======== ======== ========
Income from operations:
North America $ 63,217 $ 49,661 $ 33,062
International 17,790 7,285 6,511
-------- -------- --------
Consolidated $ 81,007 $ 56,946 $ 39,573
======== ======== ========
Fixed asset additions:
North America $ 18,082 $ 17,745 $ 9,703
International 5,966 5,344 3,579
-------- -------- --------
Consolidated $ 24,048 $ 23,089 $ 13,282
======== ======== ========
Total assets :
North America $257,617 $185,845 $108,872
International 93,589 56,576 41,716
-------- -------- --------
Consolidated $351,206 $242,421 $150,588
======== ======== ========
</TABLE>
F-27
<PAGE>
Geographic information of the Company is as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------- -------- --------
<S> <C> <C> <C>
Net revenues:
North America $421,608 $307,512 $198,959
Europe 172,650 121,630 93,578
Latin America 11,795 8,852 1,990
Pacific Rim 5,988 335 -
-------- -------- --------
Consolidated $612,041 $438,329 $294,527
======== ======== ========
Income (loss) from operations:
North America $ 54,184 $ 46,150 $ 29,875
Europe 28,402 13,470 10,526
Latin America (1,778) (827) (828)
Pacific Rim 199 (1,847) -
-------- -------- --------
Consolidated $ 81,007 $ 56,946 $ 39,573
======== ======== ========
Total long-lived assets:
North America $ 53,683 $ 34,176 $ 20,937
Europe 11,158 9,336 5,869
Latin America 1,249 322 338
Pacific Rim 606 32 -
-------- -------- --------
Consolidated $ 66,696 $ 43,866 $ 27,144
======== ======== ========
</TABLE>
Net revenues to external customers are based on the location of the customer.
North American operations consist of services provided in the United States and
Canada. European operations consist of services provided primarily in the United
Kingdom, the Netherlands, Switzerland, Sweden, Norway, Ireland, Germany, France,
and Austria, which have similar business environments. Latin American operations
consist of services provided primarily in Mexico, Puerto Rico, Brazil, and
Venezuela. Pacific Rim operations consist of services provided primarily in
Japan, Australia, and India. There are no intraenterprise sales for the periods
presented. Corporate net revenue, income from operations and long-lived assets
have been included in North America. No customer of the Company accounted for 5%
or more of the Company's net revenues for any of the periods presented.
F-28
<PAGE>
Q. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The following table presents unaudited quarterly financial information for the
years ended 1998 and 1997 (in thousands, except per share data):
<TABLE>
<CAPTION>
Quarters Ended
-----------------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
----------------- ------------------- ------------------- -------------------
1998 1997 1998 1997 1998 1997 1998 1997
-------- ------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues $142,223 $88,498 $156,578 $104,032 $153,074 $117,029 $160,166 $128,770
Income from operations 20,117 13,008 22,078 15,103 13,831 16,570 24,981 12,265
Income before income taxes 20,529 13,263 22,577 15,736 14,821 17,085 25,177 12,752
Net income 12,480 7,893 13,534 9,605 9,675 10,452 16,251 5,832
Basic net income per share .22 .15 .23 .18 .17 .19 .28 .10
Diluted net income per share .20 .13 .21 .16 .16 .17 .26 .09
</TABLE>
R. SUBSEQUENT EVENT
On March 22, 1999 and March 29, 1999, certain stockholders of the Company filed
class action lawsuits against the Company and certain of the Company's officers
in the United States District Court for the District of Massachusetts. The suits
allege misrepresentations and omissions regarding the Company's future growth
prospects and progress of the Company's reorganization in violation of federal
securities laws. The suits seek unspecified damages. The Company believes that
the plaintiffs' claims are without merit and intends to vigorously defend the
lawsuits.
F-29
