-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LYPKlRou6w3WNZyAjCLWmsDV2FUpuhuYiRUPb9ZrkSGQnbola1rLUoPB+8h0X+io i/GX7KRJXBoVu19HuEckFQ== 0000813895-99-000016.txt : 19990923 0000813895-99-000016.hdr.sgml : 19990923 ACCESSION NUMBER: 0000813895-99-000016 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981003 FILED AS OF DATE: 19990922 FILER: COMPANY DATA: COMPANY CONFORMED NAME: THERMO POWER CORP CENTRAL INDEX KEY: 0000813895 STANDARD INDUSTRIAL CLASSIFICATION: AIR COND & WARM AIR HEATING EQUIP & COMM & INDL REFRIG EQUIP [3585] IRS NUMBER: 042891371 STATE OF INCORPORATION: MA FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 001-10573 FILM NUMBER: 99715326 BUSINESS ADDRESS: STREET 1: 45 FIRST AVENUE STREET 2: PO BOX 9046 CITY: WALTHAM STATE: MA ZIP: 02454-9046 BUSINESS PHONE: 6176221000 MAIL ADDRESS: STREET 1: 81 WYMAN STREET CITY: WALTHAM STATE: MA ZIP: 02254 FORMER COMPANY: FORMER CONFORMED NAME: TECOGEN INC DATE OF NAME CHANGE: 19920703 10-K/A 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------------------------------------------------- AMENDMENT NO. 3 ON FORM 10-K/A (mark one) [ X ] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended October 3, 1998 [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 1-10573 THERMO POWER CORPORATION (Exact name of Registrant as specified in its charter) Massachusetts 04-2891371 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 81 Wyman Street, P.O. Box 9046 Waltham, Massachusetts 02454-9046 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (781) 622-1000 Securities registered pursuant to Section 12(b) of theAct: Title of each class Name of exchange on which registered Common Stock, $.10 par value American 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, and (2) has been subject to the filing requirements for at least 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 the Registrant's knowledge, in definitive proxy or information statements incorporated by reference into Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the voting stock held by nonaffiliates of the Registrant as of October 30, 1998, was approximately $18,451,000. As of October 30, 1998, the Registrant had 11,830,163 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Annual Report to Shareholders for the fiscal year ended October 3, 1998, are incorporated by reference into Parts I and II. FORM 10-K/A THERMO POWER CORPORATION Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a, d) Financial Statements and Schedules Financial Statement Schedules filed herewith: Schedule II: Valuation and Qualifying Accounts. See attached. (c) Exhibits 13 Annual Report to Shareholders for the Fiscal Year Ended October 3, 1998 (only these portions incorporated herein by reference). 23 Consent of Arthur Andersen LLP. Attached is Exhibit 13 and Schedule II of the Registrant's Form 10-K for the year ended October 3, 1998. The Registrant's financial statements have been amended principally to modify disclosures concerning certain restructuring actions and other subsequent events. This amended information replaces the corresponding information filed originally in the Form 10-K. 2 FORM 10-K/A 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 by the undersigned, thereunto duly authorized. Date: September 22, 1999 THERMO POWER CORPORATION By: /s/ J. Timothy Corcoran J. Timothy Corcoran President and Chief Executive Officer 3 Report of Independent Public Accountants To the Shareholders and Board of Directors of Thermo Power Corporation: We have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in Thermo Power Corporation's Annual Report to Shareholders incorporated by reference in this Amendment No. 3 on Form 10-K/A, and have issued our report thereon dated November 9, 1998 (except with respect to certain matters discussed in Notes 4 and 15, as to which the date is July 3, 1999). Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Item 14 on page 2 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states in all material respects the consolidated financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. Arthur Andersen LLP Boston, Massachusetts November 9, 1998 4
SCHEDULE II FORM 10-K/A THERMO POWER CORPORATION Valuation and Qualifying Accounts (In thousands) Balance at Provision Beginning Charged Accounts Balance of to Accounts Written at End Description Year Expense Recovered Off Other (a) of Year - ----------------------------------- ---------- ------------- ----------- ---------- ----------- ----------- Allowance for Doubtful Accounts Year Ended October 3, 1998 $ 757 $ 200 $ 208 $ (491) $ 9,625 $10,299 Year Ended September 27, 1997 $ 589 $ 252 $ 3 $ (87) $ - $ 757 Year Ended September 28, 1996 $ 530 $ 191 $ 26 $ (158) $ - $ 589 Description Balance at Established Activity Balance Beginning as Cost of Charged at End of Year Acquisitions to Reserve Other (c) of Year - ----------------------------------- ---------- ------------- ----------- ---------- ----------- Accrued Acquisition Expenses (b) Year Ended October 3, 1998 $ 33 $ 7,364 $ (5,311) $ - $ 2,086 Year Ended September 27, 1997 $ 519 $ - $ (7) $ (479) $ 33 Year Ended September 28, 1996 $ 680 $ - $ (109) $ (52) $ 519 Description Balance at Provision Activity Balance Beginning Charged to Charged to at End of Year Expense Reserve Other of Year - ----------------------------------- ---------- ------------- ----------- ---------- ----------- Reserve for Discontinued Operations (d) Year Ended October 3, 1998 $ - $ 993 $ - $ - $ 993 (a) Includes allowances of businesses acquired and discontinued during the year as described in Notes 3 and 4, respectively, to Consolidated Financial Statements in the Registrant's Fiscal 1998 Annual Report to Shareholders and the effect of foreign currency translation. (b) The nature of activity in this account is described in Note 3 to Consolidated Financial Statements in the Registrant's Fiscal 1998 Annual Report to Shareholders. (c) Represents reductions of cost in excess of net assets of acquired companies for accrued acquisition expenses no longer considered necessary. (d) The nature of activity in this account is described in Note 4 to Consolidated Financial Statements in the Registrant's Fiscal 1998 Annual Report to Shareholders.
EX-13 2 Exhibit 13 Thermo Power Corporation Consolidated Financial Statements Fiscal Year 1998
Thermo Power Corporation 1998 Financial Statements Consolidated Statement of Income Year Ended ----------------------------- (In thousands except per share amounts) Oct. 3, Sept. 27, Sept. 28, 1998 1997 1996 - --------------------------------------------------------------------------- ---------- --------- ---------- Revenues (Notes 7 and 12) $ 245,692 $ 91,881 $ 93,058 --------- -------- --------- Costs and Operating Expenses: Cost of revenues 172,055 72,725 74,289 Selling, general, and administrative expenses (Note 7) 50,801 14,265 13,874 Research and development expenses 7,921 1,929 2,633 --------- -------- --------- 230,777 88,919 90,796 --------- -------- --------- Operating Income 14,915 2,962 2,262 Interest Income (includes $257 from related parties in fiscal 1,930 1,829 1,714 1998; Note 3) Interest Expense (includes $8,146 to related party in fiscal 1998; (8,998) (18) (26) Note 10) Gain on Sale of Investments, Net (includes $53 and $469 on sale of 11 53 208 related-party investments in fiscal 1997 and 1996; Notes 2 and 7) --------- -------- --------- Income from Continuing Operations Before Income Taxes and Minority 7,858 4,826 4,158 Interest Provision for Income Taxes (Note 6) 4,082 2,223 1,772 Minority Interest Expense 423 312 312 --------- -------- --------- Income from Continuing Operations 3,353 2,291 2,074 Loss from Discontinued Operations (net of benefit for income taxes (381) (187) (1,189) of $215, $105, and $669; Note 4) Provision for Loss on Disposal of Discontinued Operations (net of (636) - - benefit for income taxes of $357; Note 4) --------- -------- --------- Net Income $ 2,336 $ 2,104 $ 885 ========= ======== ========= Earnings per Share from Continuing Operations (Note 13) Basic $ .28 $ .19 $ .17 ========= ======== ========= Diluted $ .28 $ .19 $ .16 ========= ======== ========= Basic and Diluted Earnings per Share (Note 13) $ .20 $ .17 $ .07 ========= ======== ========= Weighted Average Shares (Note 13) Basic 11,838 12,212 12,466 ========= ======== ========= Diluted 11,908 12,218 12,707 ========= ======== ========= The accompanying notes are an integral part of these consolidated financial statements. 2 Thermo Power Corporation 1998 Financial Statements Consolidated Balance Sheet (In thousands) Oct. 3, Sept. 27, 1998 1997 - -------------------------------------------------------------------------------------- ---------- --------- Assets Current Assets: Cash and cash equivalents (includes $11,459 and $17,994 under repurchase $ 22,240 $ 19,347 agreement with parent company; Note 15) Available-for-sale investments, at quoted market value (amortized cost of 4,018 9,171 $4,017 and $9,129; Notes 2 and 7) Accounts receivable, less allowances of $10,299 and $757 52,098 21,012 Unbilled contract costs and fees 10,718 4,856 Inventories 43,984 19,884 Prepaid income taxes (Note 6) 11,205 3,118 Net assets of discontinued operations (Note 4) 8,525 - Other current assets 2,421 219 Due from parent company and affiliated companies 732 - --------- --------- 155,941 77,607 --------- --------- Rental Assets, at Cost, Net 10,118 10,276 --------- --------- Property, Plant, and Equipment, at Cost, Net 24,871 10,591 --------- --------- Long-term Available-for-sale Investments, at Quoted Market Value - 2,200 (amortized cost of $2,301 in fiscal 1997; Notes 2 and 3) --------- --------- Other Assets 4,976 236 --------- --------- Cost in Excess of Net Assets of Acquired Companies (Note 3) 155,729 7,082 --------- --------- $ 351,635 $ 107,992 ========= ========= 3 Thermo Power Corporation 1998 Financial Statements Consolidated Balance Sheet (continued) (In thousands except share amounts) Oct. 3, Sept. 27, 1998 1997 ----------------------------------------------------------------------------------- ---------- --------- Liabilities and Shareholders' Investment Current Liabilities: Current maturities of long-term obligations (Note 10) $ 396 $ - Accounts payable 30,899 9,622 Accrued payroll and employee benefits 7,885 3,133 Billings in excess of contract costs and fees 8,517 1,353 Accrued income taxes 10,048 1,620 Accrued warranty costs 6,293 3,435 Common stock of subsidiary subject to redemption ($18,450 redemption 18,372 - value) Accrued costs for acquired contracts (Note 3) 8,906 - Accrued acquisition expenses (Note 3) 2,086 33 Other accrued expenses (Note 4) 26,777 3,207 Due to parent company and affiliated companies - 496 --------- --------- 120,179 22,899 --------- --------- Deferred Income Taxes (Note 6) 1,093 114 --------- --------- Long-term Obligations (Note 10) 160,499 252 --------- --------- Commitments (Notes 7 and 8) Common Stock of Subsidiary Subject to Redemption ($18,450 redemption value) - 18,059 --------- --------- Shareholders' Investment (Notes 5 and 9): Common stock, $.10 par value, 30,000,000 shares authorized; 12,493,371 1,249 1,249 shares issued Capital in excess of par value 55,401 55,283 Retained earnings 16,147 13,811 Treasury stock at cost, 663,208 and 578,124 shares (4,600) (3,636) Net unrealized gain (loss) on available-for-sale investments (Note 2) 1 (39) Cumulative translation adjustment 1,666 - --------- --------- 69,864 66,668 --------- --------- $ 351,635 $ 107,992 ========= ========= The accompanying notes are an integral part of these consolidated financial statements.
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Thermo Power Corporation 1998 Financial Statements Consolidated Statement of Cash Flows Year Ended ------------------------------- (In thousands) Oct. 3, Sept. 27, Sept. 28, 1998 1997 1996 - ------------------------------------------------------------------------- ---------- ----------- --------- Operating Activities Net income $ 2,336 $ 2,104 $ 885 Adjustments to reconcile net income to income from continuing operations: Loss from discontinued operations (Note 4) 381 187 1,189 Provision for loss on disposal of discontinued operations (Note 4) 636 - - --------- --------- --------- Income from continuing operations 3,353 2,291 2,074 Adjustments to reconcile income from continuing operations to net cash provided by operating activities of continuing operations: Depreciation and amortization 10,477 2,837 2,738 Provision for losses on accounts receivable 200 207 185 Minority interest expense 423 312 312 Deferred income tax expense (benefit) (371) (403) 372 Other noncash items 112 (184) (262) Changes in current accounts, excluding the effects of acquisitions, dispositions, and discontinued operations: Accounts receivable 5,018 (2,600) (498) Inventories 1,008 695 (685) Unbilled contract costs and fees (2,660) 2,254 (766) Other current assets (1,466) 55 226 Accounts payable (3,717) (3,743) 2,512 Other current liabilities (8,778) 2,728 82 --------- --------- --------- Net cash provided by continuing operations 3,599 4,449 6,290 Net cash provided by (used in) discontinued operations 5,662 (2,241) 920 --------- --------- --------- Net cash provided by operating activities 9,261 2,208 7,210 --------- --------- --------- Investing Activities Acquisitions, net of cash acquired (Note 3) (156,815) - (860) Proceeds from sale of acquired business to related party (Note 3) 19,117 - - Proceeds from sale of acquired business (Note 3) 1,075 - - Purchases of available-for-sale investments - (11,301) (5,000) Proceeds from sale and maturities of available-for-sale investments 5,011 6,000 8,982 Proceeds from sale of related-party investments (Notes 2 and 7) - 262 852 Purchases of property, plant, and equipment (6,159) (1,778) (2,384) Proceeds from sale of property, plant, and equipment 2,179 - - Increase in rental assets (2,872) (3,191) (4,849) Proceeds from sale of rental assets 1,239 1,522 2,268 Other - (2) 140 --------- --------- --------- Net cash used in continuing operations (137,225) (8,488) (851) Net cash used in discontinued operations (144) (630) (329) --------- --------- --------- Net cash used in investing activities $(137,369) $ (9,118) $ (1,180) --------- --------- --------- 5 Thermo Power Corporation 1998 Financial Statements Consolidated Statement of Cash Flows (continued) Year Ended -------------------------------- (In thousands) Oct. 3, Sept. 27, Sept. 28, 1998 1997 1996 - ------------------------------------------------------------------------- ---------- ----------- --------- Financing Activities Issuance of long-term obligation to parent company (Note 10) $ 160,000 $ - $ - Decrease in short-term obligations (Note 10) (28,274) - - Purchases of Company common stock (1,380) (3,613) - Net proceeds from issuance of Company common stock 534 71 377 Repayment of long-term obligations (162) (53) (59) ---------- --------- --------- Net cash provided by (used in) financing activities 130,718 (3,595) 318 of continuing operations --------- --------- --------- Exchange Rate Effect on Cash 283 - - --------- ---------- --------- Increase (Decrease) in Cash and Cash Equivalents 2,893 (10,505) 6,348 Cash and Cash Equivalents at Beginning of Year 19,347 29,852 23,504 --------- ---------- --------- Cash and Cash Equivalents at End of Year $ 22,240 $ 19,347 $ 29,852 ========= ========== ========= Cash Paid For Interest $ 8,370 $ 18 $ 26 Income taxes $ (1,368) $ 445 $ 894 Noncash Activities Fair value of assets of acquired companies $ 298,141 $ - $ 860 Cash paid for acquired companies (172,412) - (860) Cash paid in prior year for acquired company (2,301) - - --------- ---------- --------- Liabilities assumed of acquired companies $ 123,428 $ - $ - ========= ========== ========= The accompanying notes are an integral part of these consolidated financial statements.
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Thermo Power Corporation 1998 Financial Statements Consolidated Statement of Shareholders' Investment Year Ended --------------------------- (In thousands) Oct. 3, Sept. 27, Sept. 28, 1998 1997 1996 - ---------------------------------------------------------------------------- ---------- --------- -------- Common Stock, $.10 Par Value Balance at beginning of year $ 1,249 $ 1,249 $ 1,248 Issuance of stock under employees' and directors' stock plans - - 1 -------- -------- -------- Balance at end of year 1,249 1,249 1,249 -------- -------- -------- Capital in Excess of Par Value Balance at beginning of year 55,283 54,448 53,898 Issuance of stock under employees' and directors' stock plans 118 71 58 Tax benefit related to employees' and directors' stock plans (Note 6) - 764 492 -------- -------- -------- Balance at end of year 55,401 55,283 54,448 -------- -------- -------- Retained Earnings Balance at beginning of year 13,811 11,707 10,822 Net income 2,336 2,104 885 -------- -------- -------- Balance at end of year 16,147 13,811 11,707 -------- -------- -------- Treasury Stock Balance at beginning of year (3,636) (23) (341) Purchases of Company common stock (1,380) (3,613) - Issuance of stock under employees' and directors' stock plans 416 - 318 -------- -------- -------- Balance at end of year (4,600) (3,636) (23) -------- -------- -------- Net Unrealized Gain (Loss) on Available-for-sale Investments Balance at beginning of year (39) (13) 198 Change in net unrealized gain (loss) on available-for-sale investments 40 (26) (211) (Note 2) -------- -------- -------- Balance at end of year 1 (39) (13) -------- -------- -------- Cumulative Translation Adjustment Balance at beginning of year - - - Translation adjustment 1,666 - - -------- -------- -------- Balance at end of year 1,666 - - -------- -------- -------- Total Shareholders' Investment $ 69,864 $ 66,668 $ 67,368 ======== ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 7 Thermo Power Corporation 1998 Financial Statements Notes to Consolidated Financial Statements 1. Nature of Operations and Summary of Significant Accounting Policies Nature of Operations Thermo Power Corporation (the Company) manufactures, markets, and services intelligent traffic-control systems and related products, industrial refrigeration equipment, and commercial cooling and cogeneration systems. The Company also conducts research and development on advanced power and pollution-control technologies, and offers propane-powered lighting products as well as lighting products for the automotive, sporting goods, and marine markets. Relationship with Thermo Electron Corporation The Company was incorporated on June 6, 1985, as a wholly owned subsidiary of Thermo Electron Corporation. As of October 3, 1998, Thermo Electron owned 9,300,806 shares of the Company's common stock, representing 79% of such stock outstanding. On August 12, 1998, Thermo Electron announced a proposed reorganization involving certain of Thermo Electron's subsidiaries, including the Company. As part of this reorganization, Thermo Electron announced that the Company may be taken private and become a wholly owned subsidiary of Thermo Electron (Note 15). Principles of Consolidation The accompanying financial statements include the accounts of the Company, its wholly owned subsidiaries, and its 78%-owned privately held subsidiary, ThermoLyte Corporation (Note 15). All material intercompany accounts and transactions have been eliminated. Fiscal Year The Company has adopted a fiscal year ending the Saturday nearest September 30. References to fiscal 1998, 1997, and 1996 are for the fiscal years ended October 3, 1998, September 27, 1997, and September 28, 1996, respectively. Fiscal 1998 included 53 weeks; 1997 and 1996 each included 52 weeks. Revenue Recognition The Company recognizes revenues upon shipment of its products or upon completion of services it renders, and recognizes rental revenues on a straight-line basis over the term of the rental contract. The Company provides a reserve for its estimate of warranty costs at the time of shipment. In addition, revenues and profits on substantially all contracts are recognized using the percentage-of-completion method. Revenues recorded under the percentage-of-completion method, including revenues from research and development contracts, were $83,773,000, $60,590,000, and $57,842,000 in fiscal 1998, 1997, and 1996, respectively. The percentage of completion is determined by relating the actual costs incurred to date to management's estimate of total costs to be incurred on each contract. If a loss is indicated on any contract in process, a provision is made currently for the entire loss. The Company's contracts generally provide for billing of customers upon the attainment of certain milestones specified in each contract. Revenues earned on contracts in process in excess of billings are classified as unbilled contract costs and fees, and amounts billed in excess of revenues are classified as billings in excess of contract costs and fees in the accompanying balance sheet. There are no significant amounts included in the accompanying balance sheet that are not expected to be recovered from existing contracts at current contract values or that are not expected to be collected within one year, including amounts that are billed but not paid under retainage provisions. Research and Development Arrangements The Company has research and development arrangements with the natural gas industry and various government agencies. Revenues in the accompanying statement of income include $4,220,000, $4,688,000, and $5,836,000 and cost of revenues include $3,874,000, $3,776,000, and $4,475,000 related to these arrangements in fiscal 1998, 1997, and 1996, respectively. The Company is required to pay royalties for any technologies developed or products 8 1. Nature of Operations and Summary of Significant Accounting Policies (continued) commercialized under several of these arrangements. Selling, general, and administrative expenses in the accompanying statement of income include royalty expense related to these arrangements of $41,000, $65,000, and $71,000 in fiscal 1998, 1997, and 1996, respectively. Stock-based Compensation Plans The Company applies Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock-based compensation plans (Note 5). Accordingly, no accounting recognition is given to stock options granted at fair market value until they are exercised. Upon exercise, net proceeds, including tax benefits realized, are credited to equity. Income Taxes In accordance with Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes," the Company recognizes deferred income taxes based on the expected future tax consequences of differences between the financial statement basis and the tax basis of assets and liabilities calculated using enacted tax rates in effect for the year in which the differences are expected to be reflected in the tax return. Earnings per Share During the first quarter of fiscal 1998, the Company adopted SFAS No. 128, "Earnings per Share" (Note 13). As a result, all previously reported earnings per share have been restated; however, basic and diluted earnings per share equal the Company's previously reported earnings per share for the fiscal 1997 and 1996 periods. Basic earnings per share have been computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted earnings per share have been computed assuming the exercise of stock options and their related income tax effect. Cash and Cash Equivalents At fiscal year-end 1998 and 1997, $11,459,000 and $17,994,000, respectively, of the Company's cash equivalents were invested in a repurchase agreement with Thermo Electron. Under this agreement, the Company in effect lends excess cash to Thermo Electron, which Thermo Electron collateralizes with investments principally consisting of corporate notes, U.S. government-agency securities, commercial paper, money market funds, and other marketable securities, in the amount of at least 103% of such obligation. The Company's funds subject to the repurchase agreement are readily convertible into cash by the Company. The repurchase agreement earns a rate based on the 90-day Commercial Paper Composite Rate plus 25 basis points, set at the beginning of each quarter (Note 15). Cash equivalents are carried at cost, which approximates market value. The Company's cash equivalents also include $8,270,000 of money market fund investments of the Company's foreign subsidiaries at October 3, 1998. Inventories Inventories are stated at the lower of cost (on a first-in, first-out basis) or market value and include materials, labor, and manufacturing overhead. The components of inventories are as follows: (In thousands) 1998 1997 - ---------------------------------------------------------------------------------------- -------- -------- Raw Materials and Supplies $21,549 $ 17,570 Work in Process 14,422 1,077 Finished Goods 8,013 1,237 ------- -------- $43,984 $ 19,884 ======= ======== 9 1. Nature of Operations and Summary of Significant Accounting Policies (continued) Rental Assets The costs of additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. The Company provides for depreciation on rental assets over an estimated useful life of seven years. Accumulated depreciation was $4,766,000 and $3,369,000 at fiscal year-end 1998 and 1997, respectively. Property, Plant, and Equipment The costs of additions and improvements are capitalized, while maintenance and repairs are charged to expense as incurred. The Company provides for depreciation and amortization using the straight-line method over the estimated useful lives of the property as follows: buildings, 20 to 50 years; machinery and equipment, 2 to 12 years; and leasehold improvements, the shorter of the term of the lease or the life of the asset. Property, plant, and equipment consists of the following: (In thousands) 1998 1997 - ---------------------------------------------------------------------------------------- -------- -------- Land $ 2,595 $ 252 Buildings 7,782 5,731 Machinery, Equipment, and Leasehold Improvements 24,056 13,654 ------- -------- 34,433 19,637 Less: Accumulated Depreciation and Amortization 9,562 9,046 ------- -------- $24,871 $ 10,591 ======= ======== Other Assets Other assets in the accompanying fiscal 1998 balance sheet consists primarily of acquired technology and other intangibles, including the cost of acquired patents, that are being amortized over their estimated useful lives, primarily 15 years. Accumulated amortization was $314,000 at fiscal year-end 1998. Cost in Excess of Net Assets of Acquired Companies The excess of cost over the fair value of net assets of acquired companies is amortized using the straight-line method over periods of 25 to 40 years. Accumulated amortization was $4,280,000 and $710,000 at fiscal year-end 1998 and 1997, respectively. The Company assesses the future useful life of this asset whenever events or changes in circumstances indicate that the current useful life has diminished. The Company considers the future undiscounted cash flows of the acquired companies in assessing the recoverability of this asset. If impairment has occurred, any excess of carrying value over fair value is recorded as a loss. Common Stock of Subsidiary Subject to Redemption In March 1995, ThermoLyte sold 1,845,000 units, each unit consisting of one share of ThermoLyte common stock, $.001 par value, and one redemption right, at $10.00 per unit, for net proceeds of $17,253,000. Holders of the common stock purchased in the offering have the option to require ThermoLyte to redeem in December 1998 or December 1999 any or all of their shares at $10.00 per share (Note 15). The redemption rights are guaranteed on a subordinated basis by Thermo Electron. The Company has agreed to reimburse Thermo Electron in the event Thermo Electron is required to make a payment under the guarantee. The difference between the redemption value and the original carrying amount of common stock of subsidiary subject to redemption is accreted using the straight-line method over the period ending December 1998, which corresponds to the first redemption period. The accretion is charged to minority interest expense in the accompanying statement of income. 10 1. Nature of Operations and Summary of Significant Accounting Policies (continued) Foreign Currency All assets and liabilities of the Company's foreign subsidiaries are translated at year-end exchange rates, and revenues and expenses are translated at average exchange rates for the year, in accordance with SFAS No. 52, "Foreign Currency Translation." Resulting translation adjustments are reflected as a separate component of shareholders' investment titled "Cumulative translation adjustment." Foreign currency transaction gains and losses in fiscal 1998 are included in the accompanying statement of income and are not material. The Company had no foreign subsidiaries in fiscal 1997 and 1996. Forward Contracts The Company uses short-term forward foreign exchange contracts to manage certain exposures to foreign currencies. The Company enters into forward foreign exchange contracts to hedge certain firm purchase and sale commitments denominated in currencies other than its subsidiaries' local currencies. These contracts principally hedge transactions denominated in Dutch guilders. The purpose of the Company's foreign currency hedging activities is to protect the Company's local currency cash flows related to these commitments from fluctuations in foreign exchange rates. Gains and losses arising from forward foreign exchange contracts are recognized as offsets to gains and losses resulting from the transactions being hedged. The Company does not enter into speculative foreign currency agreements. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Presentation Certain amounts in fiscal 1997 and 1996 have been reclassified to conform to the presentation in the fiscal 1998 financial statements. In addition, the results of operations of the Company's Engine segment have been classified as discontinued operations as a result of the Company's decision to divest this business (Note 4). 2. Available-for-sale Investments The Company's debt and marketable equity securities are considered available-for-sale investments in the accompanying balance sheet and are carried at market value, with the difference between cost and market value, net of related tax effects, recorded as a component of shareholders' investment titled "Net unrealized gain (loss) on available-for-sale investments."
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2. Available-for-sale Investments (continued) The aggregate market value, cost basis, and gross unrealized gains and losses of short- and long-term available-for-sale investments by major security type are as follows: (In thousands) Gross Gross Market Cost Unrealized Unrealized Value Basis Gains Losses - -------------------------------------------------- ------------- ------------- ------------- ------------- 1998 Corporate Bonds $ 4,002 $ 4,001 $ 1 $ - Other 16 16 - - ------- ------- ------- ------- $ 4,018 $ 4,017 $ 1 $ - ======= ======= ======= ======= 1997 Government-agency Securities $ 5,008 $ 4,982 $ 26 $ - Corporate Bonds 4,068 4,052 16 - Other 2,295 2,396 - (101) ------- ------- ------- ------- $11,371 $11,430 $ 42 $ (101) ======= ======= ======= ======= Short-term available-for-sale investments in the accompanying fiscal 1998 balance sheet represent debt securities with contractual maturities of less than one year. The cost of available-for-sale investments that were sold was based on specific identification in determining realized gains and losses recorded in the accompanying statement of income. Gain on sale of investments, net, in the accompanying fiscal 1998 and 1997 statement of income resulted from gross realized gains relating to the sale of available-for-sale investments. Gain on sale of investments, net, in the accompanying fiscal 1996 statement of income resulted from gross realized gains of $469,000 and gross realized losses of $18,000 relating to the sale of available-for-sale investments, and a write-down of other investments of $243,000. In fiscal 1998, Peek plc ordinary shares acquired in fiscal 1997, purchased for $2,301,000, were reclassified from long-term available-for-sale investments and were included in the purchase price for Peek (Note 3). 3. Acquisitions and Dispositions On November 6, 1997, the Company declared unconditional in all respects its cash tender offer for the outstanding ordinary shares of Peek. The aggregate cost to acquire all outstanding Peek ordinary shares, including related expenses, was $166,736,000. The purchase price includes $2,301,000 that was paid for shares acquired in fiscal 1997, classified as long-term available-for-sale investments in the accompanying fiscal 1997 balance sheet. The Company made final payments for the Peek ordinary shares outstanding in the second quarter of fiscal 1998. To finance the Peek acquisition, the Company borrowed $160,000,000 from Thermo Electron (Notes 10 and 15). The cost of this acquisition exceeded the estimated fair value of the acquired net assets by $147,884,000, which is being amortized over 40 years. Peek develops, manufactures, markets, installs, and services equipment to monitor and regulate traffic flow in cities and towns around the world. Subsequent to Peek's acquisition by the Company, the Company sold its Measurement business to ONIX Systems Inc., a majority-owned subsidiary of Thermo Instrument Systems Inc., effective November 6, 1997, for $19,117,000 in cash. Thermo Instrument is a majority-owned subsidiary of Thermo Electron. The components of the sales price for the Measurement business consisted of the net tangible book value of the Measurement business, cost in excess of net assets of acquired company, and the estimated tax liability relating to the sale. The cost in excess of net assets of acquired company was determined based upon a percentage of the Company's total cost in excess of net 12 3. Acquisitions and Dispositions (continued) assets of acquired company associated with its acquisition of Peek, based on the 1997 revenues of the Measurement business relative to Peek's total 1997 consolidated revenues. The Measurement business developed and marketed field measurement products. During fiscal 1998, the Company also sold the stock of Peek Fleetlogic B.V. for $1,075,000 in cash. The purchase price approximated the book value of the net assets of Fleetlogic and the Company recorded no gain or loss on the sale. As a result of the Company's planned divestiture of this business, its operating losses were recorded as a reduction of previously established accrued acquisition expenses. In addition, in March 1998, the Company acquired the assets, subject to certain liabilities, of Traffic Control Technology, Inc. for $1,299,000 in cash and, in July 1998, ThermoLyte acquired the outstanding stock of Optronics, Inc. for $6,662,000 in cash, including the repayment of $1,184,000 of debt. The Optronics acquisition is subject to a post-closing adjustment. The cost of Traffic Control Technology exceeded the estimated fair value of the acquired net assets by $750,000 and the cost of Optronics exceeded the estimated fair value of the acquired net assets by $3,132,000. These amounts are being amortized over 25 years. Traffic Control Technology is a manufacturer of traffic control equipment and Optronics is a manufacturer of lighting products for the automotive, sporting goods, and marine markets. These acquisitions have been accounted for using the purchase method of accounting, and their results have been included in the accompanying financial statements from their respective dates of acquisition. Allocation of the purchase price for these acquisitions was based on estimates of the fair value of the net assets acquired, and for Optronics, is subject to adjustment upon finalization of the purchase price allocation. The Company has no information that indicates the final purchase price allocation will differ materially from the preliminary estimates. In the first quarter of fiscal 1996, the Company acquired the thermoelectric cooling module business of ThermoTrex Corporation, a majority-owned subsidiary of Thermo Electron, for $860,000, which was the net book value of the business acquired. Because the Company and the thermoelectric cooling module business were deemed for accounting purposes to be under control of their common majority owner, Thermo Electron, the transaction has been accounted for at historical cost in a manner similar to a pooling of interests. The results of the thermoelectric cooling module business have been included in the accompanying financial statements from the date of acquisition. Based on unaudited data, the following table presents selected financial information for the Company and Peek on a pro forma basis, assuming the companies had been combined since the beginning of fiscal 1997. The results of Peek exclude the results of businesses sold by Peek prior to its acquisition by the Company and Peek's Measurement business, which was sold to ONIX. The effect of the acquisitions not included in the pro forma data was not material to the Company's results of operations.
(In thousands except per share amounts) 1998 1997 - -------------------------------------------------------------------------------------- ---------- --------- Revenues $ 263,778 $ 286,533 Income (Loss) from Continuing Operations 2,693 (20,441) Net Income (Loss) 1,676 (20,628) Basic and Diluted Earnings (Loss) per Share from Continuing Operations .23 (1.67) Basic and Diluted Earnings (Loss) per Share .14 (1.69) The pro forma results are not necessarily indicative of future operations or the actual results that would have occurred had the acquisition of Peek been made at the beginning of fiscal 1997. 13 3. Acquisitions and Dispositions (continued) Following the acquisition of Peek, the Company undertook a broad restructuring of Peek's business. This included severance of 87 employees at Peek, including closure of its former corporate headquarters in London and termination of most of the staff there. In addition, the Company decided to sell or close several businesses. Peek's Fleetlogic BV subsidiary, a Netherlands-based developer, manufacturer, and distributor of "in vehicle" traffic information systems was sold in August 1998. Signal Control Corporation, an Oregon-based manufacturer of an earlier generation traffic controller was closed in December 1998. In addition, Peek's operations in Hong Kong were closed in August 1998 and operations in Thailand were scaled back to complete outstanding contracts. The Company has abandoned leased facilities in Oregon, Florida, London, and Hong Kong as a result of decisions to exit certain operations of Peek. During fiscal 1998, the Company expended $3.9 million for severance and $1.4 million of lease costs for abandoned facilities, principally in connection with the actions described above. The lease costs paid in fiscal 1998 primarily related to Peek's former London headquarters. At October 3, 1998, the Company had accrued additional costs which will require future outlays of cash of $0.6 million for severance which will be paid in fiscal 1999. In addition, the Company had accrued $1.4 million for abandoned facilities, principally for an Oregon facility that requires payments through 2006, in the event that the Company's efforts to sublease or buyout the arrangement prove unsuccessful. The severance and lease costs were accounted for in accordance with Emerging Issues Task Force Pronouncement (EITF) 95-3 and are detailed in the table that follows. The Company finalized its plan for restructuring Peek in fiscal 1998 and all substantive actions were completed in early fiscal 1999. In addition, the Company acquired certain loss contracts as a result of the Peek acquisition. The loss contracts relate principally to work in Hong Kong and Signal Control Corporation, which were exited in calendar 1998, and in Thailand. The Company is currently in the process of completing contracts in Thailand assumed at the date of acquisition. The timing of completion is dependent on the completion of certain aspects of Thailand's infrastructure performed by third parties and ongoing negotiations with the customer. In connection with these contracts, in the allocation of purchase price for the Peek acquisition, the Company recorded $13.6 million of liability as a cost of the acquisition. This amount includes $8.0 million for liability assumed at acquisition for liquidated damages and performance bond obligations related to these contracts. The balance of the costs, $5.6 million, represents estimated losses to complete contracts outstanding at the date of acquisition, of which $4.1 million had been accrued by Peek prior to its acquisition. During fiscal 1998, the Company made cash expenditures of $4.7 million associated with these contracts and expects future expenditures of $8.9 million, primarily through the first half of fiscal 2000.
14
3. Acquisitions and Dispositions (continued) A summary of the changes in accrued acquisition expenses follows: Abandonment of Excess (In thousands) Facilities Severance Other Total - --------------------------------- -------------- -------------- ------------- -------------- -------------- Balance at September 30, 1995 $ 458 $ - $ 222 $ 680 Usage - - (109) (109) Decrease due to finalization (52) - - (52) of restructuring plans, recorded as a decrease in cost in excess of net assets of acquired companies -------- ------- -------- -------- Balance at September 28, 1996 406 - 113 519 Usage - - (7) (7) Decrease due to finalization (406) - (73) (479) of restructuring plans, recorded as a decrease in cost in excess of net assets of acquired companies -------- ------- -------- -------- Balance at September 27, 1997 - - 33 33 Reserves established 2,791 4,573 - 7,364 Usage (1,366) (3,934) (11) (5,311) -------- ------- -------- -------- Balance at October 3, 1998 $ 1,425 $ 639 $ 22 $ 2,086 ======== ======= ======== ======== 4. Discontinued Operations In September 1998, the Company adopted a plan to divest its Engines segment, which consists of its Crusader Engines division. In accordance with the provisions of APB No. 30 concerning reporting the effect of disposal of a segment of a business, the Company has classified the fiscal 1998 results of operations of the Engines segment, and the results for all prior periods presented, as discontinued in the accompanying statement of income. Revenues from the Engines segment were $24,723,000, $30,801,000, and $29,265,000 in fiscal 1998, 1997, and 1996, respectively. In addition, the net assets of the Engines segment have been classified as net assets of discontinued operations in the accompanying fiscal 1998 balance sheet, and primarily consist of inventories, accounts receivable, and machinery and equipment, net of certain current liabilities, principally accounts payable. The net assets of the Engines segment at fiscal year-end 1997 totaled $14,043,000. In December 1998, the Company completed the sale of the industrial and marine engine product lines of its Crusader Engines division to two unrelated third parties. Such sale represents a complete divestiture of the Engines segment. The aggregate sales price for the two product lines consists of $6,393,000 in cash, the assumption of certain liabilities of the Crusader Engines division, and a receivable of $1,035,000. The receivable is due in December 1999 and is secured by an irrevocable letter of credit. The Company retained liability for certain warranty obligations of this business. The Company does not expect that this obligation or other costs associated with winding down this business will materially affect its results of operations or cash flows. 15 4. Discontinued Operations (continued) In fiscal 1998, the Company provided $636,000, net of a tax benefit of $357,000, for the estimated loss on disposal of discontinued operations. This amount includes $448,000, net of a tax benefit of $252,000, for estimated losses from operations of discontinued operations through the expected date of disposition. During the first nine months of fiscal 1999, the unaudited activity recorded to the reserve was as follows: the reserve was increased by a pretax gain on the sale of the net assets of the industrial and marine engine product lines of $508,000 and was reduced by pretax operating losses of discontinued operations of $645,000. The unaudited remaining reserve on July 3, 1999, was $896,000, primarily representing continuing warranty obligations and a reserve for estimated losses from operations as the Company winds down this business, following its divestiture. The tax effect on these items was recorded as an adjustment to accrued income taxes. The reserve for estimated losses on disposal of the Engines segment is included in other accrued expenses in the accompanying and fiscal 1998 balance sheets. The Engines segment had unaudited revenues through the date of disposition and an unaudited net loss for the first nine months of fiscal 1999 of $2,695,000 and $413,000, respectively. The net loss of the Engines segment for the first nine months of 1999 was recorded as a reduction of previously established reserves as discussed above. The unaudited revenues and net loss from the Engines segment for the first nine months of fiscal 1998 were $17,993,000 and $338,000, respectively. 5. Employee Benefit Plans Stock-based Compensation Plans Stock Option Plans The Company has stock-based compensation plans for its key employees, directors, and others. The Company's equity incentive plan permits the grant of a variety of stock and stock-based awards as determined by the human resources committee of the Company's Board of Directors (the Board Committee), including restricted stock, stock options, stock bonus shares, or performance-based shares. To date, only nonqualified stock options have been awarded under these plans. The option recipients and the terms of options granted under these plans are determined by the Board Committee. Generally, options granted to date are exercisable immediately, but are subject to certain transfer restrictions and the right of the Company to repurchase shares issued upon exercise of the options at the exercise price, upon certain events. The restrictions and repurchase rights generally lapse ratably over periods ranging from one to ten years after the first anniversary of the grant date, depending on the term of the option, which may range from three to twelve years. Nonqualified stock options may be granted at any price determined by the Board Committee, although incentive stock options must be granted at not less than the fair market value of the Company's stock on the date of grant. To date, all options have been granted at fair market value. The Company also has a directors' stock option plan that provides for the grant of stock options in the Company and its majority-owned subsidiary to outside directors pursuant to a formula approved by the Company's shareholders. Options in the Company awarded under this plan are exercisable six months after the date of grant and expire three or seven years after the date of grant. In addition to the Company's stock-based compensation plans, certain officers and key employees may also participate in the stock-based compensation plans of Thermo Electron.
16 5. Employee Benefit Plans (continued)
A summary of the Company's stock option information is as follows: 1998 1997 1996 ------------------ ------------------ ----------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Price Price Price Number Number Number of of of (Shares in thousands) Shares Shares Shares - ---------------------------------------------- -------- ---------- -------- ---------- --------- --------- Options Outstanding, Beginning of Year 1,283 $ 9.32 1,342 $ 9.35 1,406 $9.24 Granted 550 11.30 68 8.07 12 13.07 Exercised (56) 8.40 (1) 5.45 (40) 6.76 Forfeited (223) 11.32 (126) 9.03 (36) 8.98 ---- ----- ----- Options Outstanding, End of Year 1,554 9.77 1,283 $ 9.32 1,342 $9.35 ===== ====== ===== ====== ===== ===== Options Exercisable 1,554 9.77 1,283 $ 9.32 1,342 $9.35 ===== ====== ===== ====== ===== ===== Options Available for Grant 226 49 75 ==== ===== =====
A summary of the status of the Company's stock options at October 3, 1998, is as follows: Options Outstanding and Exercisable ----------------------------------------------------- Range of Exercise Prices Number Weighted Weighted of Average Average Shares Remaining Exercise (In thousands) Contractual Life Price - ---------------------------------------------- ------------------- ------------------- ------------------- $ 6.40 - $ 8.34 109 1.9 years $ 7.58 8.35 - 10.27 930 5.9 years 9.13 10.28 - 12.21 508 6.4 years 11.34 12.22 - 14.15 7 3.2 years 13.77 ---- $ 6.40 - $14.15 1,554 5.8 years $ 9.77 ===== Employee Stock Purchase Program Substantially all of the Company's full-time employees are eligible to participate in an employee stock purchase program sponsored by the Company and Thermo Electron. Under this program, shares of the Company's and Thermo Electron's common stock can be purchased at the end of a 12-month period at 95% of the fair market value at the beginning of the period, and the shares purchased are subject to a six-month resale restriction. Beginning in November 1998, shares of the Company's and Thermo Electron's common stock can be purchased at 85% of the lower of the fair market value at the beginning or end of the period, and the shares purchased will be subject to a one-year resale restriction. Shares are purchased through payroll deductions of up to 10% of each participating employee's gross wages. During fiscal 1998, 1997, and 1996, the Company issued 7,835 shares, 4,622 shares, and 18,012 shares, respectively, of its common stock under this program. 17
5. Employee Benefit Plans (continued) Pro Forma Stock-based Compensation Expense In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-based Compensation," which sets forth a fair-value based method of recognizing stock-based compensation expense. As permitted by SFAS No. 123, the Company has elected to continue to apply APB No. 25 to account for its stock-based compensation plans. Had compensation cost for awards after fiscal 1995 under the Company's stock-based compensation plans been determined based on the fair value at the grant dates consistent with the method set forth under SFAS No. 123, the effect on the Company's net income and earnings per share would have been as follows: (In thousands except per share amounts) 1998 1997 1996 - ----------------------------------------------------------------------- ----------- ----------- ---------- Income from Continuing Operations: As reported $3,353 $2,291 $2,074 Pro forma 2,900 2,085 1,904 Basic Earnings per Share from Continuing Operations: As reported .28 .19 .17 Pro forma .24 .17 .15 Diluted Earnings per Share from Continuing Operations: As reported .28 .19 .16 Pro forma .24 .17 .15 Net Income: As reported $2,336 $2,104 $ 885 Pro forma 1,866 1,883 708 Basic and Diluted Earnings per Share: As reported .20 .17 .07 Pro forma .16 .15 .06 Because the method prescribed by SFAS No. 123 has not been applied to options granted prior to October 1, 1995, the resulting pro forma compensation expense may not be representative of the amount to be expected in future years. Compensation expense for options granted is reflected over the vesting period; therefore, future pro forma compensation expense may be greater as additional options are granted. The weighted average fair value per share of options granted was $4.86, $3.45, and $4.83 in fiscal 1998, 1997, and 1996, respectively. The fair value of each option grant was estimated on the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions: 1998 1997 1996 - ----------------------------------------------------------------------- ----------- ----------- ---------- Volatility 41% 43% 43% Risk-free Interest Rate 5.5% 6.0% 5.7% Expected Life of Options 4.8 years 4.2 years 3.3 years 18 5. Employee Benefit Plans (continued) The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option-pricing models require the input of highly subjective assumptions including expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. 401(k) Savings Plan The majority of the Company's domestic subsidiaries participate in Thermo Electron's 401(k) savings plan. Contributions to the 401(k) savings plan are made by both the employee and the Company. Company contributions are based upon the level of employee contributions. For this plan, the Company contributed and charged to expense $979,000, $666,000, and $674,000 in fiscal 1998, 1997, and 1996, respectively. Other Retirement Plans In addition, the majority of the Company's foreign subsidiaries offer defined contribution plans. Company contributions to these plans are based on formulas determined by the Company. For these plans, the Company contributed and charged to expense $1,094,000 in fiscal 1998. No such plans existed prior to fiscal 1998. 6. Income Taxes The components of income from continuing operations before income taxes and minority interest are as follows: (In thousands) 1998 1997 1996 - ----------------------------------------------------------------------- ----------- ----------- ---------- Domestic $(2,695) $ 4,826 $ 4,158 Foreign 10,553 - - ------- ------- ------- $ 7,858 $ 4,826 $ 4,158 ======= ======= ======= The components of the provision for income taxes for continuing operations are as follows: (In thousands) 1998 1997 1996 - ----------------------------------------------------------------------- ----------- ----------- ---------- Currently Payable (Refundable): Federal $ (404) $ 2,159 $ 1,268 Foreign 4,690 - - State 167 467 132 ------- ------- ------- 4,453 2,626 1,400 ------- ------- ------- Deferred (Prepaid), Net: Federal (312) (316) 305 Foreign - - - State (59) (87) 67 ------- ------- ------- (371) (403) 372 ------- ------- ------- $ 4,082 $ 2,223 $ 1,772 ======= ======= ======= 19 6. Income Taxes (continued) The total provision (benefit) for income taxes included in the accompanying statement of income was as follows: (In thousands) 1998 1997 1996 - ----------------------------------------------------------------------- ----------- ----------- ---------- Continuing Operations $ 4,082 $ 2,223 $ 1,772 Discontinued Operations (572) (105) (669) ------- ------- ------- $ 3,510 $ 2,118 $ 1,103 ======= ======= ======= The Company receives a tax deduction upon exercise of nonqualified stock options by employees for the difference between the exercise price and the market price of the Company's common stock on the date of exercise. The provision for income taxes that is currently payable does not reflect $764,000 and $492,000 of such benefits that have been allocated to capital in excess of par value in fiscal 1997 and 1996, respectively. The provision for income taxes from continuing operations in the accompanying statement of income differs from the provision calculated by applying the statutory federal income tax rate of 34% to income from continuing operations before income taxes and minority interest due to the following: (In thousands) 1998 1997 1996 - ----------------------------------------------------------------------- ----------- ----------- ---------- Provision for Income Taxes at Statutory Rate $ 2,672 $ 1,641 $ 1,414 Increases (Decreases) Resulting from: State income taxes, net of federal benefit 71 251 131 Amortization of cost in excess of net assets of acquired 1,287 67 72 companies Foreign tax rate and tax law differential (21) - - Losses not benefited 194 258 214 Other (121) 6 (59) ------- ------- ------- $ 4,082 $ 2,223 $ 1,772 ======= ======= ======= Prepaid and deferred income taxes in the accompanying balance sheet consist of the following: (In thousands) 1998 1997 - ----------------------------------------------------------------------------------- ----------- ---------- Prepaid (Deferred) Income Taxes: Tax loss carryforwards $34,137 $ 444 Reserves and accruals 11,659 2,449 Inventory basis difference 1,205 807 Other 5,588 (114) ------- ------- 52,589 3,586 Less: Valuation allowance 42,477 582 ------- ------- $10,112 $ 3,004 ======= ======= 20 6. Income Taxes (continued) The valuation allowance primarily relates to uncertainty surrounding the realization of certain tax assets, including $85 million of foreign capital loss carryforwards and $8 million of federal and state operating loss carryforwards at October 3, 1998. The foreign capital loss carryforwards do not expire. The realization of the federal and state operating loss carryforwards is limited to the future income of certain subsidiaries, and expire from fiscal 1999 through 2013. Any future tax benefits realized on $41,473,000 of the valuation allowance will be used to reduce cost in excess of net assets of acquired companies. The increase in the valuation allowance in fiscal 1998 resulted primarily from preacquisition losses of Peek, acquired November 1997. A provision has not been made for U.S. or additional foreign taxes on $5.9 million of undistributed earnings of foreign subsidiaries that could be subject to taxation if remitted to the U.S. because the Company currently plans to keep these amounts permanently reinvested overseas. 7. Related-party Transactions Corporate Services Agreement The Company and Thermo Electron have a corporate services agreement under which Thermo Electron's corporate staff provides certain administrative services, including certain legal advice and services, risk management, certain employee benefit administration, tax advice and preparation of tax returns, centralized cash management, and certain financial and other services, for which the Company pays Thermo Electron annually an amount equal to 0.8% of the Company's revenues. In calendar 1997 and 1996, the Company paid an amount equal to 1.0% of the Company's revenues. Prior to January 1996, the Company paid an annual fee equal to 1.2% of the Company's revenues. The annual fee is reviewed and adjusted annually by mutual agreement of the parties. For these services, the Company was charged $2,277,000, $1,210,000, and $1,262,000 in fiscal 1998, 1997, and 1996, respectively, including amounts charged relating to discontinued operations. Management believes that the service fee charged by Thermo Electron is reasonable and that such fees are representative of the expenses the Company would have incurred on a stand-alone basis. The corporate services agreement is renewed annually but can be terminated upon 30 days' prior notice by the Company or upon the Company's withdrawal from the Thermo Electron Corporate Charter (the Thermo Electron Corporate Charter defines the relationships among Thermo Electron and its majority-owned subsidiaries). For additional items such as employee benefit plans, insurance coverage, and other identifiable costs, Thermo Electron charges the Company based upon costs attributable to the Company. Long-term Obligations During fiscal 1998, the Company borrowed $160.0 million from Thermo Electron to finance its acquisition of Peek (Note 10). Revenues The Company sells products in the ordinary course of business to certain subsidiaries of Thermo Electron. Sales of such products to related parties totaled $66,000, $423,000, and $104,000 in fiscal 1998, 1997, and 1996, respectively. Other Services The Company provides contract administration, data processing, and other services to certain companies affiliated with Thermo Electron. The Company is reimbursed for costs incurred based on actual usage. For these services, the Company was reimbursed $127,000, $105,000, and $167,000 in fiscal 1998, 1997, and 1996, respectively. 21 7. Related-party Transactions (continued) Leases The Company leases an office and laboratory facility from Thermo Electron under an agreement expiring in 2002. The accompanying statement of income includes expenses from this operating lease of $326,000 in fiscal 1998, and $170,000 in fiscal 1997 and 1996. The future minimum payments due under this operating lease as of October 3, 1998, are $326,000 per year through fiscal 2002. Total future minimum lease payments are $1,304,000. During fiscal 1998, the Company sublet office and manufacturing space in the United Kingdom to ONIX pursuant to an arrangement whereby the Company charges ONIX its allocated share of occupancy expenses. Pursuant to this arrangement, the Company recorded $166,000 in fiscal 1998 as a reduction in selling, general, and administrative expenses. Repurchase Agreement The Company invests excess cash in a repurchase agreement with Thermo Electron as discussed in Note 1. Other Transactions In May 1997, the Company sold 420,000 shares of common stock of The Randers Killam Group Inc. to Thermo TerraTech Inc., a majority-owned subsidiary of Thermo Electron, for proceeds of $262,000, resulting in a gain of $53,000. In February 1996, the Company sold $365,000 principal amount of 6.5% subordinated convertible debentures to an unrelated party for net proceeds of $490,000, resulting in a gain of $125,000. The debentures were issued by Thermo TerraTech. In December 1995, the Company sold 10,969 shares of Thermo Electron common stock to an unrelated party for net proceeds of $362,000, resulting in a gain of $344,000. 8. Commitments Commitments In addition to the lease described in Note 7, the Company leases equipment and manufacturing, service, and office facilities under various operating leases. The accompanying statement of income includes expenses from operating leases of $4,107,000, $1,219,000, and $1,166,000 in fiscal 1998, 1997, and 1996, respectively. Future minimum payments due under noncancellable operating leases as of October 3, 1998, are $2,102,000 in fiscal 1999; $1,777,000 in fiscal 2000; $1,257,000 in fiscal 2001; $1,027,000 in fiscal 2002; $1,020,000 in fiscal 2003; and $2,568,000 in fiscal 2004 and thereafter. Total future minimum lease payments are $9,751,000. Future minimum rental income to be received under noncancellable operating leases as of October 3, 1998, is $392,000 in fiscal 1999. 9. Common Stock At October 3, 1998, the Company had reserved 1,928,775 unissued shares of its common stock for possible issuance under stock-based compensation plans. 10. Short- and Long-term Obligations Short-term Obligations As of October 3, 1998, the Company's foreign subsidiaries had unused lines of credit totaling approximately $12.0 million. Borrowings under the lines of credit generally bear interest at variable rates and are payable on demand. During fiscal 1998, the Company repaid $28,407,000 of short-term obligations assumed in connection with the Peek acquisition. 22 10. Short- and Long-term Obligations (continued) Long-term Obligations To finance the acquisition of Peek, the Company borrowed $160,000,000 from Thermo Electron pursuant to a promissory note due November 1999, and bearing interest at the 90-day Commercial Paper Composite Rate plus 25 basis points, set at the beginning of each quarter, which was 5.73% at October 3, 1998 (Note 15). The Company assumed a $250,000 mortgage loan in connection with its acquisition of Optronics. The loan bears interest at a fixed rate of 6% and matures in fiscal 2007. In addition, at October 3, 1998, long-term obligations include a $222,000 mortgage loan which matures in fiscal 2001. The interest rate on this loan is 75% of the prime rate, which was 6.38% at fiscal year-end 1998 and 1997. These obligations are secured by property with a net book value of $4,969,000. The annual requirements for long-term obligations are as follows: (In thousands) - -------------------------------------------------------------------------------------- ---------- --------- 1999 $ 70 2000 160,073 2001 154 2002 25 2003 25 Thereafter 125 -------- $160,472 ======== In addition, in connection with its acquisition of Peek, the Company assumed capital lease obligations. The carrying amount of the property leased is $0.5 million, which is included in property, plant, and equipment in the accompanying balance sheet. The future minimum lease payments under the lease obligation are as follows: (In thousands) - -------------------------------------------------------------------------------------- ---------- --------- 1999 $ 332 2000 65 2001 42 2002 30 -------- 469 Less: Amount Representing Interest 46 -------- Present Value of Minimum Lease Payments 423 Less: Current Portion 326 -------- Long-term Capital Lease Obligation $ 97 ======== See Note 11 for information pertaining to the fair value of the Company's long-term obligations. 23 11. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash and cash equivalents, available-for-sale investments, accounts receivable, current maturities of long-term obligations, accounts payable, common stock of subsidiary subject to redemption, due to/from parent company and affiliated companies, long-term obligations, and forward foreign exchange contracts. The carrying amounts of these financial instruments, with the exception of available-for-sale investments, long-term obligations, and forward foreign exchange contracts, approximate fair value due to their short-term nature. Available-for-sale investments are carried at fair value in the accompanying balance sheet. The fair values were determined based on quoted market prices. See Note 2 for fair value information pertaining to these financial instruments. The carrying amounts of the Company's long-term obligations, which approximate fair value, were $160,499,000 and $252,000 at fiscal year-end 1998 and 1997, respectively. The fair value of the Company's long-term obligations was determined based on borrowing rates available to the Company at the respective year-ends. The Company had forward foreign exchange contracts of $942,000 outstanding at October 3, 1998. The fair value of such contracts was approximately $9,000, which represents the amount the Company would pay upon termination of the contract, taking into account the change in foreign exchange rates. 12. Business Segment and Geographical Information, and Concentrations of Risk The Company's continuing operations are divided into three segments. Through the Company's Peek subsidiary, acquired November 1997, the Traffic Control segment develops, manufactures, markets, installs, and services equipment to monitor and regulate traffic flow in cities and towns around the world. The Industrial Refrigeration Systems segment develops, manufactures, markets, services, and rents industrial refrigeration and commercial cooling equipment. The Cooling and Cogeneration Systems segment develops, manufactures, markets, and services gas cooling and cogeneration systems, conducts research and development on advanced power and pollution-control technologies, is developing and commercializing a family of propane-powered lighting products, and offers automotive, sporting goods, and marine lighting products. The results of operations of the Engines segment have been classified as discontinued operations as a result of the Company's decision to divest this business (Note 4). 24
12. Business Segment and Geographical Information, and Concentrations of Risk (continued) Information for fiscal 1998, 1997, and 1996, with respect to the Company's business segments, is shown in the following table. (In thousands) 1998 1997 1996 - --------------------------------------------------------------------------- ---------- --------- ----------- Business Segment Information Revenues: Traffic Control $ 152,368 $ - $ - Industrial Refrigeration Systems 76,160 74,843 73,312 Cooling and Cogeneration Systems 17,678 17,819 20,477 Intersegment sales elimination (a) (514) (781) (731) --------- -------- --------- $ 245,692 $ 91,881 $ 93,058 ========= ======== ========= Income from Continuing Operations Before Income Taxes and Minority Interest: Traffic Control $ 11,635 $ - $ - Industrial Refrigeration Systems 6,782 5,331 4,403 Cooling and Cogeneration Systems (269) (647) 122 Corporate (b) (3,233) (1,722) (2,263) --------- -------- --------- Total operating income 14,915 2,962 2,262 Interest and other income (expense), net (7,057) 1,864 1,896 --------- -------- --------- $ 7,858 $ 4,826 $ 4,158 ========= ======== ========= Identifiable Assets: Traffic Control $ 261,671 $ - $ - Industrial Refrigeration Systems 51,895 52,157 52,707 Cooling and Cogeneration Systems 21,254 22,178 22,953 Corporate (c) 8,290 17,129 21,134 Discontinued operations (d) 8,525 16,528 13,917 --------- -------- --------- $ 351,635 $107,992 $ 110,711 ========= ======== ========= Depreciation and Amortization: Traffic Control $ 6,949 $ - $ - Industrial Refrigeration Systems 3,111 2,606 2,501 Cooling and Cogeneration Systems 341 198 214 Corporate 76 33 23 --------- -------- --------- $ 10,477 $ 2,837 $ 2,738 ========= ======== ========= Capital Expenditures: Traffic Control $ 4,204 $ - $ - Industrial Refrigeration Systems 3,974 4,558 6,959 Cooling and Cogeneration Systems 559 382 240 Corporate 294 29 34 --------- -------- --------- $ 9,031 $ 4,969 $ 7,233 ========= ======== ========= 25 12. Business Segment and Geographical Information, and Concentrations of Risk (continued) (In thousands) 1998 1997 1996 - --------------------------------------------------------------------------- ---------- --------- ---------- Geographical Information Revenues: United States $ 137,250 $ 91,881 $ 93,058 The Netherlands 42,468 - - United Kingdom 40,024 - - Other Europe 31,364 - - Other 1,677 - - Transfers among geographic areas (a) (7,091) - - --------- -------- --------- $ 245,692 $ 91,881 $ 93,058 ========= ======== ========= Income from Continuing Operations Before Income Taxes and Minority Interest: United States $ 6,959 $ 4,684 $ 4,525 The Netherlands 9,292 - - United Kingdom (1,201) - - Other Europe 3,172 - - Other (74) - - Corporate (b) (3,233) (1,722) (2,263) --------- -------- --------- Total operating income 14,915 2,962 2,262 Interest and other income (expense), net (7,057) 1,864 1,896 --------- -------- --------- $ 7,858 $ 4,826 $ 4,158 ========= ======== ========= Identifiable Assets: United States $ 139,148 $ 74,335 $ 75,660 The Netherlands 68,623 - - United Kingdom 75,102 - - Other Europe 47,995 - - Other 3,952 - - Corporate (c) 8,290 17,129 21,134 Discontinued operations (d) 8,525 16,528 13,917 --------- -------- --------- $ 351,635 $107,992 $ 110,711 ========= ======== ========= Export Revenues Included in United States Revenue Above (e): Asia $ 10,626 $ 16,430 $ 7,821 Other 8,183 4,271 6,054 --------- -------- --------- $ 18,809 $ 20,701 $ 13,875 ========= ======== ========= (a) Intersegment sales and transfers among geographic areas are accounted for at prices that are representative of transactions with unaffiliated parties. (b) Primarily corporate general and administrative expenses. (c) Primarily cash, cash equivalents, and available-for-sale investments. (d) Net of liabilities at October 3, 1998. (e) In general, export revenues are denominated in U.S. dollars. 26 12. Business Segment and Geographical Information, and Concentrations of Risk (continued) Sales to governmental entities accounted for 26% of the Company's total revenues in fiscal 1998, of which 92% related to sales to foreign governmental entities. Sales to governmental entities related principally to the Traffic Control segment and represented 39% of its revenues in fiscal 1998. In addition, a significant portion of the Traffic Control segment's revenues are generated by sales to distributors whose customers are governmental entities. A decrease in sales to governmental entities could have an adverse effect on the Company's business and future results of operations. 13. Earnings per Share Basic and diluted earnings per share were calculated as follows: (In thousands except per share amounts) 1998 1997 1996 - -------------------------------------------------------------------------- ---------- ---------- --------- Income from Continuing Operations $ 3,353 $ 2,291 $ 2,074 Loss from Discontinued Operations (381) (187) (1,189) Provision for Loss on Disposal of Discontinued Operations (636) - - ------- ------- ------- Net Income $ 2,336 $ 2,104 $ 885 ------- ------- ------- Basic Weighted Average Shares 11,838 12,212 12,466 ------- ------- ------- Basic Earnings (Loss) per Share: Continuing operations $ .28 $ .19 $ .17 Discontinued operations (.08) (.02) (.10) ------- ------- ------- $ .20 $ .17 $ .07 ======= ======= ======= Diluted Weighted Average Shares 11,838 12,212 12,466 Effect of Stock Options 70 6 241 ------- ------- ------- Weighted Average Shares, as Adjusted 11,908 12,218 12,707 ------- ------- ------- Diluted Earnings (Loss) per Share: Continuing operations $ .28 $ .19 $ .16 Discontinued operations (.08) (.02) (.09) ------- ------- ------- $ .20 $ .17 $ .07 ======= ======= ======= The computation of diluted earnings per share excludes the effect of assuming the exercise of certain stock options because the effect would be antidilutive. As of October 3, 1998, there were 1,336,499 such options outstanding, with exercise prices ranging from $8.92 to $14.15 per share.
27
14. Unaudited Quarterly Information (In thousands except per share amounts) 1998 First (a) Second Third Fourth (b) - --------------------------------------------------------------- ---------- ---------- ---------- ---------- Revenues $58,696 $62,005 $58,345 $ $ 66,646 Gross Profit 17,913 16,231 19,020 20,473 Income (Loss) from Continuing Operations 1,280 (1,134) 1,350 1,857 Net Income (Loss) 1,055 (1,288) 1,391 1,178 Basic and Diluted Earnings (Loss) per Share from .11 (.10) .11 .16 Continuing Operations Basic and Diluted Earnings (Loss) per Share .09 (.11) .12 .10 1997 First Second Third Fourth - --------------------------------------------------------------- ---------- ---------- ---------- ---------- Revenues $23,547 $21,322 $24,919 $ 22,093 Gross Profit 4,092 4,673 4,976 5,415 Income from Continuing Operations 325 388 633 945 Net Income 4 375 716 1,009 Basic and Diluted Earnings per Share from Continuing .03 .03 .05 .08 Operations Basic and Diluted Earnings per Share - .03 .06 .08 (a) Reflects the November 1997 acquisition of Peek plc and borrowings to finance such acquisition. (b) Reflects provision for loss on disposal of discontinued operations, net of tax, of $636,000. 15. Subsequent Events Proposed Merger On May 5, 1999, the Company entered into a definitive agreement and plan of merger with Thermo Electron, under which Thermo Electron would acquire all of the outstanding shares of Company common stock held by minority shareholders. The Board of Directors of the Company unanimously approved the merger agreement based on a recommendation by a special committee of the Board of Directors, consisting solely of outside directors of the Company. Under the terms of the merger agreement, the Company would become a wholly owned subsidiary of Thermo Electron. Each issued and outstanding share of Company common stock not already owned by Thermo Electron would be converted into the right to receive $12.00 in cash. Following the merger, the Company's common stock would cease to be publicly traded. The completion of this merger is subject to, among other things, shareholder approval of the merger agreement. Thermo Electron intends to vote all of its shares of common stock of the Company in favor of approval of the merger agreement and, therefore, approval of the merger agreement is assured. This merger is expected to be completed by the beginning of the fourth quarter of calendar 1999. Option Exchange In November 1998, the Company's employees, excluding its officers and directors, were offered the opportunity to exchange previously granted options to purchase shares of Company common stock for an amount of options equal to half of the number of options previously held, exercisable at a price equal to the fair market value at the time of the exchange offer. Holders of options to acquire 179,085 shares at a weighted average exercise price of $11.08 elected to 28 15. Subsequent Events (continued) participate in this exchange and, as a result, received options to purchase 89,543 shares of Company common stock at $8.09 per share. The other terms of the new options are the same as the exchanged options except that the holders may not sell shares purchased pursuant to such new options for six months from the exchange date. Redemption of ThermoLyte Common Stock In December 1998, holders of 1,707,000 shares of ThermoLyte common stock redeemed their shares for $10.00 per share in cash or an aggregate of $17,070,000. Subsequent to such redemption, 138,000 redeemable shares of ThermoLyte common stock remained outstanding and are redeemable in December 1999 at $10.00 per share. The Company's ownership of ThermoLyte increased to 98% as a result of such redemption. Promissory Note Refinancing The Company's $160.0 million promissory note to Thermo Electron is due in November 1999. In February 1999, Thermo Electron issued a commitment letter to the Company pursuant to which Thermo Electron has agreed to refinance the promissory note at the option of the Company, on its maturity date, with the net proceeds from its October 1998 offering of 7.625% Notes due 2008, and other available cash. In accordance with the commitment letter, the new promissory note from the Company to Thermo Electron would be due in 2008 and bear interest at a rate of 7.625%. Restructuring Actions During the third quarter of fiscal 1999, the Company undertook certain restructuring actions, which included a decision by the Cooling and Cogeneration Systems segment to divest its ThermoLyte Corporation subsidiary, as well as a decision by the Traffic Control segment to outsource certain manufacturing and warranty functions and reduce staffing levels, and a decision by the Industrial Refrigeration Systems segment to reduce staffing levels. In addition, the Traffic Control segment wrote down certain assets at Peek's sales and service subsidiaries located in Malaysia and Croatia that have become impaired due to business conditions in those regions. In connection with these actions, the Company recorded restructuring and related costs of $12,633,000, including $8,913,000 of restructuring costs, inventory provisions of $2,988,000, costs for outsourcing certain warranty repairs of $483,000, and a provision for uncollectible accounts receivable of $249,000. Of the restructuring and related costs of $12,633,000, $7,916,000, $4,662,000, and $55,000 were recorded by the Traffic Control, Cooling and Cogeneration Systems, and Industrial Refrigeration Systems segments, respectively. Restructuring costs include $4,079,000 for the write-off of cost in excess of net assets of acquired companies, of which $2,911,000 was to reduce the carrying value of ThermoLyte to the estimated proceeds from its sale and $1,168,000 was to reduce the carrying value of Peek's subsidiaries located in Malaysia and Croatia due to projected undiscounted cash flows from their operations being insufficient to recover the Company's investment. In addition, restructuring costs include $2,040,000 of severance costs for approximately 63 employees across all functions; $1,550,000 for the write-down of certain fixed assets, principally at operations being exited; and $1,244,000 for lease costs at facilities being abandoned. Provisions for severance and leases were accounted for in accordance with EITF 94-3. Inventory provisions represent a write-down of inventories to estimated salvage value and consist of $1,826,000 for raw materials for product lines being outsourced, $1,042,000 for a discontinued product line, and $120,000 for inventories at Malaysia and Croatia. Unaudited revenues and operating losses for ThermoLyte, excluding restructuring and related costs, were $9,822,000 and $103,000, respectively, for the first nine months of fiscal 1999, and $3,065,000 and $1,361,000, respectively, for fiscal 1998. The Company is actively seeking a buyer for ThermoLyte's principal operations and expects to complete a transaction in the next twelve months, although there can be no assurance that this will occur. 29 15. Subsequent Events (continued) During the second quarter of fiscal 1999, the Company recorded restructuring costs of $701,000 related to actions taken at its Peek subsidiary. The restructuring costs, which were accounted for in accordance with EITF 94-3, consisted of $389,000 related to severance costs for approximately 70 employees across all functions, $222,000 for lease costs at facilities being abandoned in connection with the consolidation of facilities, and an asset write-down of $90,000 related to the consolidation of such facilities. The Company expects to incur additional restructuring costs totaling approximately $2.5 million, principally at the Traffic Control segment, through December 1999 for costs that will be recorded when incurred, such as additional severance and fees associated with outsourcing certain product lines. Completion of the Company's restructuring plans is expected to occur by December 1999. As of July 3, 1999, the Company had terminated 49 employees of the 133 employees for whom severance had been provided in the first nine months of fiscal 1999. A summary of the changes in accrued restructuring costs is as follows:
Severance Abandonment of Excess (In thousands) Facilities Total - --------------------------------------------------------------- -------------- ------------- ------------- (Unaudited) Balance at October 3, 1998 $ - $ - $ - Provision charged to expense 2,430 1,465 3,895 Usage (246) (28) (274) Currency translation (58) (38) (96) ------ ----- ------ Balance at July 3, 1999 $2,126 $1,399 $3,525 ====== ====== ====== Cash Management Arrangement Effective June 1, 1999, the Company and Thermo Electron commenced use of a new domestic cash management arrangement (Note 1). Under the new arrangement, amounts advanced to Thermo Electron by the Company for domestic cash management purposes bear interest at the 30-day Dealer Commercial Paper Rate plus 50 basis points, set at the beginning of each month. Thermo Electron is contractually required to maintain cash, cash equivalents, and/or immediately available bank lines of credit equal to at least 50% of all funds invested under this cash management arrangement by all Thermo Electron subsidiaries other than wholly owned subsidiaries. The Company has the contractual right to withdraw its funds invested in the cash management arrangement upon 30 days' prior notice. The Company will report amounts invested in this arrangement as "advance to affiliate" in its balance sheet beginning in the third quarter of fiscal 1999. In addition, under the new domestic cash management arrangement, amounts borrowed from Thermo Electron by the Company for domestic cash management purposes bear interest at the 30-day Dealer Commercial Paper Rate plus 150 basis points, set at the beginning of each month. The Company will report amounts borrowed under this arrangement as "notes payable and current maturities of long-term obligations" in its balance sheet beginning in the third quarter of fiscal 1999. 30 Report of Independent Public Accountants To the Shareholders and Board of Directors of Thermo Power Corporation: We have audited the accompanying consolidated balance sheet of Thermo Power Corporation (a Massachusetts corporation and 79%-owned subsidiary of Thermo Electron Corporation) and subsidiaries as of October 3, 1998, and September 27, 1997, and the related consolidated statements of income, shareholders' investment, and cash flows for each of the three years in the period ended October 3, 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 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 consolidated 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 provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Thermo Power Corporation and subsidiaries as of October 3, 1998, and September 27, 1997, and the results of their operations and their cash flows for each of the three years in the period ended October 3, 1998, in conformity with generally accepted accounting principles. Arthur Andersen LLP Boston, Massachusetts November 9, 1998 (except with respect to certain matters discussed in Notes 4 and 15, as to which the date is July 3, 1999) 31 Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-looking statements, within the meaning of Section 21E of the Securities Exchange Act of 1934, are made throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words "believes," "anticipates," "plans," "expects," "seeks," "estimates," and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause the results of the Company to differ materially from those indicated by such forward-looking statements, including those detailed immediately after this Management's Discussion and Analysis of Financial Condition and Results of Operation under the heading "Forward-looking Statements." Overview The Company's continuing operations are divided into three segments: Traffic Control, Industrial Refrigeration Systems, and Cooling and Cogeneration Systems. Through the Company's Peek subsidiary, acquired November 1997, the Traffic Control segment develops, manufactures, markets, installs, and services equipment to monitor and regulate traffic flow in cities and towns around the world. Peek offers a wide range of products, including hardware, such as vehicle detectors, counters, classifiers, traffic signals and controllers, video cameras, and variable message signs, as well as traffic management systems that integrate these products to ease roadway congestion, improve safety, and collect data. Traffic management systems include variable message systems to advise drivers of accidents and other roadway hazards, traffic signal-timing systems that adapt continuously to changing conditions to minimize delays, parking guidance systems, and public transportation-management systems that give buses priority at intersections. The Company also offers high-resolution video equipment to aid police officers in capturing the information necessary to charge individuals with motor vehicle violations such as speeding and red light violations. Sales to governmental entities accounted for 26% of the Company's total revenues in fiscal 1998, of which 92% related to sales to foreign governmental entities. Sales to governmental entities related principally to the Traffic Control segment and represented 39% of its revenues in fiscal 1998. In addition, a significant portion of the Traffic Control segment's revenues are generated by sales to distributors whose customers are governmental entities. A decrease in sales to governmental entities could have an adverse effect on the Company's business and future results of operations. The quarterly revenues and income of the Traffic Control segment fluctuate significantly based on funding patterns of governmental entities and seasonality. As a result of these factors, Peek has historically experienced higher sales and income in the first and third fiscal quarters and lower sales and income in the second and fourth fiscal quarters. Additionally, a portion of the Traffic Control segment's revenues result from the sale of large systems, the timing of which can lead to variability in the Company's quarterly revenues and income. In fiscal 1998, approximately 44% of the Company's revenues originated outside the U.S., principally in Europe, and approximately 8% of the Company's revenues were exports from the U.S. Foreign divisions and subsidiaries principally sell in their local currencies and generally seek to charge their customers in the same currency as their operating costs. However, the Company's financial performance and competitive position can be affected by currency exchange rate fluctuations affecting the relationship between the U.S. dollar and foreign currencies. The Company seeks to reduce its exposure to currency fluctuations through the use of forward contracts. Since the operations of the Traffic Control segment are conducted principally in Europe, the Company's operating results could be adversely affected by capital spending levels and economic conditions in Europe. In addition, on January 1, 1999, several member countries of the European Union established fixed conversion rates between their existing sovereign currencies, and adopted the Euro as their new common currency. As of that date, the Euro traded on currency exchanges although the legacy currencies will remain legal tender in the participating countries through 2001. Based on its current assessment, the Company does not expect that the transition to the Euro will materially affect its results of operations or cash flows. 32 Overview (continued) Through the Company's FES division, the Industrial Refrigeration Systems segment supplies standard and custom-designed industrial refrigeration systems used primarily by the food-processing, chemical, petrochemical, and pharmaceutical industries. NuTemp, Inc. is a supplier of rental cooling and industrial refrigeration equipment. The Company also offers custom-made and remanufactured equipment for sale. NuTemp's industrial refrigeration equipment is used primarily in the food-processing, chemical, petrochemical, and pharmaceutical industries, and its commercial cooling equipment is used primarily in institutions and commercial buildings, as well as by service contractors. The demand for NuTemp's equipment is highest in the summer months and can be adversely affected by cool summer weather. The Cooling and Cogeneration Systems segment consists of the Company's Tecogen division and the Company's ThermoLyte Corporation subsidiary. Tecogen develops, markets, and services preassembled cooling and cogeneration systems fueled principally by natural gas for sale to a wide range of commercial, institutional, industrial, and multi-unit residential users. Certain large-capacity cooling systems are manufactured for Tecogen by FES. Tecogen also conducts research and development on natural gas-engine technology, applications of thermal energy, and pollution-control technologies. ThermoLyte is developing and commercializing various propane-powered lighting products. In July 1998, ThermoLyte acquired the outstanding stock of Optronics, Inc. Optronics makes over 400 lighting and associated products, including tail-lights and turn-signal lights for trailers, portable lights for fishing and hunting, and docking lights, and serves the automotive, sporting goods, and marine markets. In connection with restructuring actions commenced during the third quarter of fiscal 1999, the Company had decided to divest its ThermoLyte subsidiary (Note 15). Unaudited revenues and operating losses for ThermoLyte, excluding restructuring and related costs, were $9.8 million and $0.1 million, respectively, for the first nine months of fiscal 1999, and $3.1 million and $1.4 million, respectively, for fiscal 1998. Results of Operations Fiscal 1998 Compared With Fiscal 1997 Total revenues increased to $245.7 million in fiscal 1998 from $91.9 million in fiscal 1997, primarily due to the acquisition of Peek in November 1997, which contributed $152.4 million of revenues in fiscal 1998. Industrial Refrigeration Systems segment revenues increased to $76.2 million in fiscal 1998 from $74.8 million in fiscal 1997, primarily due to increased demand at FES. Cooling and Cogeneration Systems segment revenues were relatively unchanged at $17.7 million in fiscal 1998 and $17.8 million in fiscal 1997. A decrease in revenues from gas-fueled cooling systems was substantially offset by the inclusion of $2.3 million of revenues from Optronics, acquired in July 1998. Peek's backlog decreased to $50.7 million at October 3, 1998, from $64.4 million at the date of acquisition, excluding backlog of businesses sold and divested. The $13.7 million decrease in backlog occurred principally in the Netherlands and United Kingdom, and was primarily due to a decrease in orders from foreign governmental entities as a result of a reduction in funding allocated by those entities to traffic control projects. The decrease in backlog at Peek was substantially offset by an aggregate increase in backlog at the Company's other businesses totaling $12.2 million. The gross profit margin increased to 30% in fiscal 1998 from 21% in fiscal 1997, primarily due to a 34% gross profit margin at Peek. The gross profit margin for the Industrial Refrigeration Systems segment increased to 23% in fiscal 1998 from 21% in fiscal 1997, primarily due to manufacturing efficiencies and lower warranty expenses at FES, and an increase in higher-margin rental revenues at NuTemp. The gross profit margin for the Cooling and Cogeneration Systems segment increased to 21% in fiscal 1998 from 19% in fiscal 1997, primarily due to the inclusion of higher-margin revenues at Optronics. 33 Fiscal 1998 Compared With Fiscal 1997 (continued) Selling, general, and administrative expenses as a percentage of revenues increased to 21% in fiscal 1998 from 16% in fiscal 1997, principally due to amortization expense related to the excess cost over acquired net assets of Peek and relatively higher selling, general, and administrative expenses as a percentage of revenues at Peek. Research and development expenses increased to $7.9 million in fiscal 1998 from $1.9 million in fiscal 1997, due to the inclusion of $6.4 million of research and development expenses at Peek. Interest income increased to $1.9 million in fiscal 1998 from $1.8 million in fiscal 1997, principally due to an increase in average invested balances. Interest expense increased by $9.0 million in fiscal 1998 due to borrowings from Thermo Electron to finance the acquisition of Peek (Note 10) and the inclusion of $0.8 million of interest expense at Peek. The effective tax rate increased to 52% in fiscal 1998 from 46% in fiscal 1997. The effective tax rate for fiscal 1998 exceeded the statutory federal income tax rate primarily due to the impact of nondeductible amortization of cost in excess of net assets of acquired companies on the Company's pretax income. The effective tax rate for fiscal 1997 exceeded the statutory federal income tax rate primarily due to an increase in the valuation allowance for net operating loss carryforwards and other tax assets of the Company's ThermoLyte subsidiary, and the impact of state income taxes. The effective tax rate increased from fiscal 1997 to fiscal 1998 principally due to the relative impact of nondeductible amortization of cost in excess of net assets of acquired companies relating to the Peek acquisition. Minority interest expense increased to $0.4 million in fiscal 1998 from $0.3 million in fiscal 1997 due to minority interest expense on Peek's earnings relating to Peek shares tendered after November 6, 1997, through January 16, 1998. As of January 16, 1998, the Company had acquired all of the Peek outstanding ordinary shares. In accordance with the provisions of Accounting Principles Board Opinion No. 30 concerning reporting the effect of disposal of a segment of a business, the results of operations of the Engines segment have been classified as discontinued operations as a result of the Company's decision to divest this business (Note 4). The loss from discontinued operations was $0.4 million in fiscal 1998 and $0.2 million in fiscal 1997. In addition, in fiscal 1998, the Company provided $0.6 million, net of tax, for the estimated loss on disposal of discontinued operations, which includes a provision for estimated losses from operations through the expected date of disposition. The Company retained liability for certain warranty obligations of this business. The Company does not expect that this obligation or other costs associated with winding down this business will materially affect its results of operations or cash flows. The Company completed the divestiture of the Engines segment in December 1998 in the form of a sale of the assets of the segment's two product lines. Fiscal 1997 Compared With Fiscal 1996 Total revenues were $91.9 million in fiscal 1997 and $93.1 million in fiscal 1996. Industrial Refrigeration Systems segment revenues increased to $74.8 million in fiscal 1997 from $73.3 million in fiscal 1996, primarily due to greater demand for custom-designed industrial refrigeration packages and product services at FES and, to a lesser extent, increased demand for rental equipment at NuTemp. These improvements were offset in part by a decrease in demand for standard industrial refrigeration packages at FES. Cooling and Cogeneration Systems segment revenues were $17.8 million in fiscal 1997, compared with $20.5 million in fiscal 1996. Decreased revenues from sponsored research and development, gas-fueled cooling systems, and thermoelectric devices were offset in part by increased service revenues in fiscal 1997. The gross profit margin increased to 21% in fiscal 1997 from 20% in fiscal 1996. The gross profit margin for the Industrial Refrigeration Systems segment increased to 21% in fiscal 1997 from 20% in fiscal 1996, primarily due to higher margins at FES, resulting from lower warranty expenses, manufacturing efficiencies, and a decrease in the cost of a major component, and higher margins at NuTemp resulting from increased revenues. FES experienced a cost increase for a major component in fiscal 1996, for which the Company had begun receiving deliveries from an additional supplier at a lower cost. The gross profit margin for the Cooling and Cogeneration Systems segment decreased to 19% in fiscal 1997 from 22% in fiscal 1996, primarily due to lower revenues and higher warranty expenses for gas-fueled cooling systems. 34 Fiscal 1997 Compared With Fiscal 1996 (continued) Selling, general, and administrative expenses as a percentage of revenues increased to 16% in fiscal 1997 from 15% in fiscal 1996, primarily due to an increase in marketing expenses associated with the introduction of the Company's propane-powered lighting products. Research and development expenses decreased to $1.9 million in fiscal 1997 from $2.6 million in fiscal 1996, primarily due to lower spending on natural gas-engine products and propane-powered lighting products, primarily due to the completion of a phase of development efforts for these products. Net gain on sale of investments in fiscal 1996 primarily represents a gain of $344,000 relating to the sale of the Company's remaining investment in Thermo Electron common stock and a gain of $125,000 relating to the sale of the Company's remaining investment in subordinated convertible debentures issued by Thermo TerraTech, a majority-owned subsidiary of Thermo Electron (Note 7). These gains were largely offset by a write-down of other investments. The effective tax rate increased to 46% in fiscal 1997 from 43% in fiscal 1996. These rates exceeded the statutory federal income tax rate primarily due to the impact of an increase, in both periods, in the valuation allowance for net operating loss carryforwards and other tax assets of the Company's ThermoLyte subsidiary, and the impact of state income taxes. The effective tax rate increased in fiscal 1997 from fiscal 1996 primarily due to the larger impact of the increase in the valuation allowance on ThermoLyte tax assets relative to income for continuing operations. The loss from discontinued operations decreased to $0.2 million in fiscal 1997 from $1.2 million in fiscal 1996, principally as a result of increased revenues from lift-truck and TecoDrive(R) engine sales and margin improvement as a result of a reduction in warranty expenses and lower overhead expenses, resulting primarily from the consolidation of facilities. Liquidity and Capital Resources Consolidated working capital was $35.8 million at October 3, 1998, compared with $54.7 million at September 27, 1997. Included in working capital are cash, cash equivalents, and available-for-sale investments of $26.3 million at October 3, 1998, compared with $28.5 million at September 27, 1997. Of the $26.3 million balance at October 3, 1998, $7.1 million was held by ThermoLyte, and the remainder was held by the Company and its wholly owned subsidiaries. At October 3, 1998, $8.3 million of the Company's cash and cash equivalents was held by its foreign subsidiaries. While this cash can be used outside of the United States, repatriation of this cash into the United States would be subject to a United States tax. Additionally, working capital at October 3, 1998, was reduced by common stock of subsidiary subject to redemption of $18.4 million, which represents ThermoLyte's common stock and is redeemable at the option of the holder in December 1998 or December 1999, for a total redemption value of $18.5 million. In December 1998, holders of 1,707,000 shares of ThermoLyte common stock redeemed their shares for $10.00 per share in cash, for an aggregate price of $17,070,000 (Note 15). During fiscal 1998, $9.3 million of cash was provided by operating activities, which consisted of $3.6 million provided by continuing operations and $5.7 million provided by discontinued operations. Cash provided by continuing operations was reduced by a decrease in accounts payable of $3.7 million, principally at Peek due to the timing of payments, and a decrease in other current liabilities of $8.8 million, principally at Peek due to a reduction in accrued costs for acquired contracts and accrued acquisition expenses (Note 3). Cash flow provided by continuing operations was improved by a decrease in accounts receivable of $5.0 million, primarily due to a decrease at Peek, as well as the timing of billings on percentage-of-completion contracts. In addition, $5.7 million of cash was provided by discontinued operations principally as a result of efforts to reduce working capital at that business. During fiscal 1998, the primary investing activities, excluding available-for-sale investments activity, included acquisitions for $156.8 million in cash, net of cash acquired, and dispositions for $20.2 million in cash (Note 3). The Company also expended $9.0 million for purchases of property, plant, and equipment and rental assets, and received $3.4 million in proceeds from the sale of property, plant, and equipment and rental assets. In fiscal 1999, the Company expects to make capital expenditures for the purchase of property, plant, and equipment and rental assets of 35 Liquidity and Capital Resources (continued) approximately $9 million. In addition, in connection with certain restructuring actions undertaken during fiscal 1999, the Company expects to incur cash expenditures of approximately $3.6 million during the remainder of fiscal 1999 and $3.1 million during fiscal 2000. In December 1998, the Company completed the sale of its industrial and marine engine product lines of its Crusader Engines division, classified as discontinued operations in the accompanying financial statements, for $6.4 million in cash, the assumption of certain liabilities, and a receivable of $1.0 million (Note 4). The receivable is due in December 1999 and is secured by an irrevocable letter of credit. The aggregate sales price is subject to certain post-closing adjustments. In addition, in December 1998, the Company acquired the assets, subject to certain liabilities, of Linne Trafiksystem AB, a subsidiary of LinneData, for approximately $1.6 million in cash. The purchase price is subject to a post-closing adjustment. Linne Trafiksystem is located in Sweden and develops specialized public transportation systems. The Company's financing activities, all of which related to continuing operations, provided $130.7 million of cash in fiscal 1998. The Company borrowed $160.0 million from Thermo Electron to finance the acquisition of Peek and used $28.3 million to fund a decrease in short-term borrowings (Note 10). In addition, the Company expended $1.4 million of cash to purchase its common stock pursuant to an authorization by its Board of Directors. At October 3, 1998, the Company has no remaining authorizations to purchase Company common stock. Following the acquisition of Peek, the Company undertook a broad restructuring of Peek's business. This included severance of 87 employees at Peek, including closure of its former corporate headquarters in London and termination of most of the staff there. In addition, the Company decided to sell or close several businesses. Peek's Fleetlogic BV subsidiary, a Netherlands-based developer, manufacturer, and distributor of "in vehicle" traffic information systems was sold in August 1998. Signal Control Corporation, an Oregon-based manufacturer of an earlier generation traffic controller was closed in December 1998. In addition, Peek's operations in Hong Kong were closed in August 1998 and operations in Thailand were scaled back to complete outstanding contracts. The Company has abandoned leased facilities in Oregon, Florida, London, and Hong Kong as a result of decisions to exit certain operations of Peek. During fiscal 1998, the Company expended $3.9 million for severance and $1.4 million of lease costs for abandoned facilities, principally in connection with the actions described above. The lease costs paid in fiscal 1998 primarily related to Peek's former London headquarters. At October 3, 1998, the Company had accrued additional costs which will require future outlays of cash of $0.6 million for severance which will be paid in fiscal 1999. In addition, the Company had accrued $1.4 million for abandoned facilities, principally for an Oregon facility that requires payments through 2006, in the event that the Company's efforts to sublease or buyout the arrangement prove unsuccessful. The Company finalized its plan for restructuring Peek in fiscal 1998 and all substantive actions were completed in early fiscal 1999. The accounting for this restructuring was in accordance with Emerging Issues Task Force Pronouncement 95-3. In addition, the Company acquired certain loss contracts as a result of the Peek acquisition. The loss contracts relate principally to work in Hong Kong and Signal Control Corporation, which were exited in calendar 1998, and Thailand. The Company is currently in the process of completing contracts in Thailand assumed at the date of acquisition. The timing of completion is dependent on the completion of certain aspects of Thailand's infrastructure performed by third parties and ongoing negotiations with the customer. In connection with these contracts, in the allocation of purchase price for the Peek acquisition, the Company recorded $13.6 million of liability as a cost of the acquisition. This amount includes $8.0 million for liability assumed at acquisition for liquidated damages and performance bond obligations related to these contracts. The balance of the costs, $5.6 million, represents estimated losses to complete contracts outstanding at the date of acquisition, of which $4.1 million had been accrued by Peek prior to its acquisition. During fiscal 1998, the Company made cash expenditures of $4.7 million associated with these contracts and expects future expenditures of $8.9 million, primarily through the first half of fiscal 2000. 36 Liquidity and Capital Resources (continued) The Company's $160.0 million promissory note to Thermo Electron is due in November 1999. Subsequent to fiscal year-end 1998, Thermo Electron issued a commitment letter to the Company pursuant to which Thermo Electron has agreed to refinance the promissory note at the option of the Company, on its maturity date, with the net proceeds from its October 1998 offering of 7.625% Notes due 2008, and other available cash (Note 15). In accordance with the commitment letter, the new promissory note from the Company to Thermo Electron would be due in 2008 and bear interest at a rate of 7.625%. The Company's Board of Directors has authorized additional borrowings of up to $10 million from Thermo Electron to fund working capital requirements. The Company believes its existing resources, together with the funding expected from Thermo Electron as described above, are sufficient to meet the capital requirements of its existing operations for the foreseeable future. Market Risk The Company is exposed to market risk from changes in foreign currency exchange rates and interest rates which could affect its future results of operations and financial condition. The Company manages its exposure to these risks through its regular operating and financing activities. Additionally, the Company uses short-term forward contracts to manage certain exposures to foreign currencies. The Company enters into forward foreign exchange contracts to hedge firm purchase and sale commitments denominated in currencies other than its subsidiaries' local currencies. The Company does not engage in extensive foreign currency hedging activities; however, the purpose of the Company's foreign currency hedging activities is to protect the Company's local currency cash flows related to these commitments from fluctuations in foreign exchange rates. The Company's forward foreign exchange contracts principally hedge transactions denominated in Dutch guilders. Gains and losses arising from forward contracts are recognized as offsets to gains and losses resulting from the transactions being hedged. The Company does not enter into speculative foreign currency agreements. Foreign Currency Exchange Rates The fair value of forward foreign exchange contracts is sensitive to changes in foreign currency exchange rates. The fair value of forward foreign exchange contracts is the estimated amount that the Company would pay or receive upon termination of the contract, taking into account the change in foreign exchange rates. A 10% depreciation in fiscal year-end 1998 foreign currency exchange rates related to the Company's contracts would result in an increase in the unrealized loss on forward foreign exchange contracts of $0.1 million. Since the Company uses forward foreign exchange contracts as hedges of firm purchase and sale commitments, the unrealized gain or loss on forward foreign currency exchange contracts resulting from changes in foreign currency exchange rates would be offset by a corresponding change in the fair value of the hedged item. The Company generally views its investment in foreign subsidiaries with a functional currency other than the Company's reporting currency as long-term. The Company's investment in foreign subsidiaries is sensitive to fluctuations in foreign currency exchange rates. The functional currencies of the Company's foreign subsidiaries are principally denominated in British pounds sterling, Dutch guilders, Swiss francs, Norwegian kroner, Danish kroner, and Finnish markkaa. The effect of a change in foreign exchange rates on the Company's net investment in foreign subsidiaries is recorded as a separate component of shareholders' investment. A 10% depreciation in 1998 functional currencies, relative to the U.S. dollar, would result in a $7.1 million reduction of shareholders' investment. 37 Market Risk (continued) Interest Rates The Company's cash and cash equivalents and certain long-term obligations are sensitive to changes in interest rates. Interest rate changes would result in a change in interest income and expense due to the difference between the current interest rates on these financial instruments and the variable rate that these financial instruments may adjust to in the future. A 10% increase in fiscal year-end 1998 interest rates would result in a negative impact of $0.5 million on the Company's net income. Year 2000 The following constitutes a "Year 2000 Readiness Disclosure" under Year 2000 Information and Readiness Disclosure Act. The Company continues to assess the potential impact of the year 2000 date recognition issue on the Company's internal business systems, products, and operations. The Company's year 2000 initiatives include (i) testing and upgrading significant information technology systems and facilities; (ii) testing and developing upgrades, if necessary, for the Company's current products and certain discontinued products; (iii) assessing the year 2000 readiness of its key suppliers and vendors to determine their year 2000 compliance status; and (iv) developing a contingency plan. The Company's State of Readiness The Company has implemented a compliance program to ensure that its critical information technology systems and non-information technology systems will be ready for the year 2000. The first phase of the program, testing and evaluating the Company's critical information technology systems and non-information technology systems for year 2000 compliance, has largely been completed. During phase one, the Company tested and evaluated its significant computer systems, software applications, and related equipment for year 2000 compliance. The Company also evaluated the potential year 2000 impact on its critical non-information technology systems, which efforts included testing the year 2000 readiness of its manufacturing, utility, and telecommunications systems at its critical facilities. The Company is currently in phase two of its program, during which any material noncompliant information technology systems or non-information technology systems that were identified during phase one are prioritized and remediated. Based on its evaluations, the Company does not believe it is required to make any material upgrades to its critical non-information technology systems. The Company is currently upgrading or replacing its material noncompliant information technology systems, and this process was approximately 80% complete as of July 3, 1999. The Company expects that all of its material information technology systems and critical non-information technology systems will be year 2000 compliant by October 1999. The Company has also implemented a compliance program to test and evaluate the year 2000 readiness of the material products that it currently manufactures and sells. The Company believes that all of such material products are year 2000 compliant. However, as many of the Company's products are complex, interact with or incorporate third-party products, and operate on computer systems that are not under the Company's control, there can be no assurance that the Company has identified all of the year 2000 problems with its current products. The Company believes that certain of its older products, which it no longer manufactures or sells, may not be year 2000 compliant. The Company is continuing to test and evaluate such products. The Company is focusing its efforts on products that are still under warranty, early in their expected life, and/or may pose a safety risk. The Company is offering upgrades and/or identifying potential solutions where reasonably practicable. The Company also identified and assessed the year 2000 readiness of key suppliers and vendors that are believed to be significant to the Company's business operations. As part of this effort, the Company developed and distributed questionnaires relating to year 2000 compliance to its significant suppliers and vendors. To date, no significant supplier or vendor has indicated that it believes its business operations will be materially disrupted by the year 2000 issue. The Company has substantially completed the majority of its assessment of third-party risk. 38 Year 2000 (continued) Contingency Plan The Company is developing a contingency plan that will allow its primary business operations to continue despite disruptions due to year 2000 problems. This plan may include identifying and securing other suppliers, increasing inventories, and modifying production facilities and schedules. As the Company continues to evaluate the year 2000 readiness of its business systems and facilities, products, and significant suppliers and vendors, it will modify and adjust its contingency plan as may be required. The Company expects to complete its contingency plan by October 1999. Estimated Costs to Address the Company's Year 2000 Issues The Company had incurred expenses to third parties (external costs) related to year 2000 issues of approximately $1.4 million as of July 3, 1999, and the total external costs of year 2000 remediation are expected to be approximately $1.9 million. Of the external costs incurred as of July 3, 1999, approximately $0.7 million had been spent on testing and upgrading information technology systems, which represents approximately 25% of the Company's total information technology budget. In addition, as of July 3, 1999, $0.6 million had spent on testing and upgrading products and $0.1 million had been spent to test and upgrade facilities. Year 2000 costs were funded from working capital. All internal costs and related external costs, other than capital additions, related to year 2000 remediation have been and will continue to be expensed as incurred. The Company does not track the internal costs incurred for its year 2000 compliance project. Such costs are principally the related payroll costs for its information systems group. Reasonably Likely Worst Case Scenario At this point in time, the Company is not able to determine the most reasonably likely worst case scenario to result from the year 2000 issue. One possible worst case scenario would be that certain of the Company's material suppliers or vendors experience business disruptions due to the year 2000 issue and would be unable to provide materials and services to the Company on time. The Company's operations could be delayed or temporarily shut down, and it could be unable to meet its obligations to customers in a timely fashion. The Company's business, operations, and financial condition could be adversely affected in amounts that cannot be reasonably estimated at this time. If the Company believes that any of its key suppliers or vendors may not be year 2000 compliant, it will seek to identify and secure other suppliers or vendors as part of its contingency plan. Risks of the Company's Year 2000 Issues While the Company is attempting to minimize any negative consequences arising from the year 2000 issue, there can be no assurance that year 2000 problems will not have a material adverse impact on the Company's business, operations, or financial condition. While the Company expects that upgrades to its internal business systems will be completed in a timely fashion, there can be no assurance that the Company will not encounter unexpected costs or delays. Despite its efforts to ensure that its material current products are year 2000 compliant, the Company may see an increase in warranty and other claims, especially those related to Company products that incorporate, or operate using, third party software or hardware. In addition, certain of the Company's older products, which it no longer manufactures or sells, may not be year 2000 compliant, which may expose the Company to claims. As discussed above, if any of the Company's material suppliers or vendors experience business disruptions due to year 2000 issues, the Company might also be materially adversely affected. If any countries in which the Company operates experience significant year 2000 disruption, the Company could also be materially adversely affected. There is expected to be a significant amount of litigation relating to the year 2000 issue and there can be no assurance that the Company will not incur material costs in defending or bringing lawsuits. In addition, if any year 2000 issues are identified, there can be no assurance that the Company will be able to retain qualified personnel to remedy such issues. Any unexpected costs or delays arising from the year 2000 issue could have a material adverse impact on the Company's business, operations, and financial condition in amounts that cannot be reasonably estimated at this time. 39 Forward-looking Statements In connection with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company wishes to caution readers that the following important factors, among others, in some cases have affected, and in the future could affect, the Company's actual results and could cause its actual results in fiscal 1999 and beyond to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company. Reliance on Sales to Governmental Entities. Sales to governmental entities accounted for 26% of the Company's total revenues in fiscal 1998, of which 92% related to sales to foreign governmental entities. Sales to governmental entities related principally to the Traffic Control segment and represented 39% of its revenues in fiscal 1998. In addition, a significant portion of the Company's revenues in the Traffic Control segment are generated by sales to distributors whose customers are governmental entities. The Company continues to focus its marketing of its Traffic Control segment's products and services on various governmental entities, including the U.S. Federal Highway Administration and comparable overseas agencies, regional counties of governments, state and city traffic engineers, public transit authorities, public toll operators, law enforcement agencies, and tunnel and bridge authorities. Any decrease in purchases by these government bodies, including, without limitation, decreases as the result of a shift in priorities or overall budgeting limitations, could have an adverse effect on the Company's business, financial condition, and results of operations. Sales of the Company's Traffic Control segment's products and services in the United States are largely dependent on federal funding of transportation projects, such as appropriations and allocations to states under the Transportation Equity Act for the 21st Century. Contracts with governmental entities often permit the purchaser to cancel the agreement at any time. Cancellation of a significant contract could also result in a material adverse effect on the Company's business and future results of operations. Customized Contracts. A significant portion of the Company's contracts for traffic control systems require the development and integration of customized products for a fixed fee. Due to the complexity of the Company's traffic control systems, the Company may experience delays from time to time in developing, manufacturing, and installing such systems. In addition, the Company may incur substantial unanticipated costs that cannot be passed on to the customer. The Company's inability to deliver customized systems in a timely manner and within budget could result in a material adverse affect on the Company' business, financial condition, and results of operations. Competition. The market for traffic products and services is extremely competitive, and the Company expects that competition will continue to increase. The Company believes that the principal competitive factors in the traffic industry are price, functionality, reliability, service and support, and vendor and product reputation. The Company believes that its ability to compete successfully will depend on a number of factors both within and outside its control, including the pricing policies of its competitors and suppliers, the timing and quality of products introduced by the Company and others, the Company's ability to maintain a strong reputation in the traffic industry, and industry and general economic trends. In the traffic market, the Company currently competes with companies with greater financial resources and name recognition. The introduction by one of these competitors or a new competitor of a technologically superior product would have a material adverse effect on the Company's business, financial condition, and results of operations. There can be no assurance that the Company will be able to compete successfully with existing or new competitors. The Company encounters and expects to continue to encounter intense competition for the sale of its cooling and cogeneration products. The Company's products are subject to competition from absorption air conditioning systems and electric motor-driven vapor compressor systems, as well as other natural gas-fueled, engine-driven cooling systems. Although the Company has a proprietary position with respect to certain features of its products, the core technologies relating to its cooling and cogeneration products are mature and available to other companies. A number of companies, including companies with greater financial resources than those of the Company, offer products that compete with those offered by the Company, and there can be no assurance that other companies will not develop competitive products. In addition, electric utility pricing programs provide competition for the Company's cooling and cogeneration products. 40 The Company's sale of industrial refrigeration systems is subject to intense competition. The industrial refrigeration market is mature, highly fragmented, and extremely dependent on close customer contacts. There can be no assurance that the Company will be able to continue to successfully compete in the worldwide industrial refrigeration market, which is characterized by strong local manufacturers. Dependence on New Products. A substantial portion of the Company's revenues are derived from the sale of electronics and associated hardware and software for the traffic industry, as well as from providing integration services for such electronics, hardware, and software, through the Company's Peek subsidiary. A substantial portion of the Company's efforts, particularly its product development and marketing efforts, is now focused on the traffic market. Prior to the Peek acquisition, the Company had no prior experience in the traffic industry, and there can be no assurance that the Company will be able to successfully market and sell Peek's products and services. The Company's future success will depend significantly on its ability to develop, introduce, and integrate new products in the traffic market and to continue to improve the performance, features, and reliability of Peek's current products. In order for Peek to achieve the level of profitability desired by the Company, the Company must successfully reduce Peek's expenses and improve market penetration. No assurance can be given that the Company will be successful in this regard. Any failure or inability of the Company's traffic products to perform substantially as anticipated or to achieve market acceptance would have a material adverse effect on the Company's business, financial condition, and results of operations. Risks Associated with International Operations. The Company intends to continue to expand its presence in international markets. In fiscal 1998, approximately 44% of the Company's revenues originated outside the United States, principally in Europe, and approximately 8% of the Company's revenues were exports from the United States International revenues are subject to a number of risks, including the following: fluctuations in exchange rates may affect product demand and adversely affect the profitability in U.S. dollars of products and services provided by the Company in foreign markets where payment for the Company's products and services is made in the local currency; agreements may be difficult to enforce and receivables difficult to collect through a foreign country's legal system; foreign customers may have longer payment cycles; foreign countries may impose additional withholding taxes or otherwise tax the Company's foreign income, impose tariffs, or adopt other restrictions on foreign trade; United States export licenses, if required, may be difficult to obtain; the protection of intellectual property in foreign countries may be more difficult to enforce. There can be no assurance that any of these factors will not have a material adverse impact on the Company's business, financial condition and results of operations. In addition, on January 1, 1999, several member countries of the European Union established fixed conversion rates between their existing sovereign currencies, and adopted the Euro as their new common currency. As of that date, the Euro traded on currency exchanges although the legacy currencies will remain legal tender in the participating countries through 2001. Based on its current assessment, the Company does not expect that the transition to the Euro will materially affect its results of operations or cash flows. The Company had planned to expand its traffic control business in Asia. However, Asia is currently experiencing a severe economic crisis, which has been characterized by sharply reduced economic activity and liquidity, highly volatile foreign currency exchange and interests rates, and unstable stock markets. In fiscal 1998, the Company discontinued certain operations located in Asia. The economic crisis in Asia may adversely affect the Company's ability to expand its Traffic Control business. Ability to Manage Change. In November 1997, the Company acquired Peek, a public company in the United Kingdom, which had, as of July 3, 1999, approximately 1,000 employees located principally in Europe and the United States, and had revenues in fiscal 1998, from the date of its acquisition, and in the first nine months of fiscal 1999, of $152.4 million and $119.6 million, respectively. This acquisition has resulted in new and increased responsibilities for the Company's administrative, operational, development, and financial personnel. In order to manage the Company's changing business, Peek's management and other employees must be assimilated into the Company's existing 41 operations. There can be no assurance that the Company will be successful in retaining Peek's key employees and integrating them into the Company. The Company's success depends to a significant extent on the ability of its officers and key employees to operate effectively, both independently and as a group, and this ability may be impeded by the Company's rapid geographic expansion, potential disruption of the Company's business, and diversion of management's attention from other business concerns due to the Peek acquisition. In addition, there can be no assurance that the Company's systems, procedures, and controls will be adequate to support the significant expansion of the Company's operations. Any failure of the Company's management to manage change effectively could have a material adverse effect on the Company's business, financial condition, and results of operations. Significant Quarterly Fluctuations in Operating Results. The quarterly revenues and income of the Company's Traffic Control segment fluctuate significantly based on funding patterns of governmental entities as well as seasonality. As a result of these factors, Peek has historically experienced higher sales and income in the first and third fiscal quarters and lower sales and income in the second and fourth fiscal quarters. A portion of the Traffic Control segment's revenues result from the sale of large systems, the timing of which can lead to variability in the Company's quarterly revenues and income. In addition, the demand for the Company's NuTemp subsidiary's equipment is typically highest in the summer period and can be adversely affected by cool summer weather. Dependence of Markets on Government Regulation. The Public Utility Regulatory Policies Act of 1978 (PURPA) and state laws and regulations implementing PURPA prohibit discrimination by electric utilities against cogeneration providers and require utilities to purchase co-generated electricity under certain conditions. Under these regulations, certain classes of facilities are exempt from the provisions of the Public Utility Holding Company Act, as well as many state laws and regulations regarding the setting of electricity rates and the financial and organizational regulation of electric utilities, and certain provisions of the Federal Power Act. Because the Company's current customers typically do not sell power to electric utilities, the Company does not rely to a significant extent on the provisions of PURPA that require utilities to purchase electricity from cogeneration providers. However, recent bills in Congress have proposed amendments to, and in some cases, the repeal of, certain of these laws or regulations. Any such amendment or repeal could have a material adverse effect on the Company's cogeneration business. Importance of Energy Prices. The cost savings that result from use of the Company's packaged cooling and cogeneration systems are directly related to the retail price of electricity. Given prevailing rate structures, demand for the Company's cooling and cogeneration systems has been less than anticipated. Although the Company believes that increases in demand, as well as potential increases in the cost of fuel, will lead to eventual increases in electricity rates, there can be no assurance that electricity prices will increase in the future. The economic benefits of the Company's natural gas engine products and packaged cooling and cogeneration systems are also affected by the cost of natural gas. A significant increase in the relative cost of natural gas could also have a material adverse effect on the sale of certain of the Company's products. Incentives for Cooling Systems. Purchasers of the Company's Tecochill(R) cooling systems often receive investment incentives for the purchase of Tecochill equipment from gas utilities or state or municipal governments. Although the Company has no reason to believe these incentives will be discontinued, elimination of these incentives could have a material adverse effect on sales of the Company's Tecochill systems. Risks Associated with Protection, Defense and Use of Intellectual Property, and Ownership of Technology Rights. The Company holds several patents relating to various aspects of its products. Proprietary rights relating to the Company's products are protected from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents or are maintained in confidence as trade secrets. There can be no assurance that patents will be issued from any pending or future patent applications owned by or licensed to the Company or that the claims allowed under any issued patents will be sufficiently broad to protect the Company's technology and, in the absence of 42 patent protection, the Company may be vulnerable to competitors who attempt to copy the Company's products or gain access to its trade secrets and know-how. Proceedings initiated by the Company to protect its proprietary rights could result in substantial costs to the Company. There can be no assurance that competitors of the Company will not initiate litigation to challenge the validity of the Company's patents, or that they will not use their resources to design comparable products that do not infringe the Company's patents. There may also be pending or issued patents held by parties not affiliated with the Company that relate to the Company's products or technologies. The Company may need to acquire licenses to, or contest the validity of, any such patents. There can be no assurance that any license required under any such patent would be made available on acceptable terms or that the Company would prevail in any such contest. The Company could incur substantial costs in defending itself in suits brought against it or in suits in which the Company may assert its patent rights against others. If the outcome of any such litigation is unfavorable to the Company, the Company's business and results of operations could be materially adversely affected. In addition, the Company relies on trade secrets and proprietary know-how which it seeks to protect, in part, by confidentiality agreements with its collaborators, employees, and consultants. There can be no assurance that these agreements will not be breached, that the Company would have adequate remedies for any breach, or that the Company's trade secrets will not otherwise become known or be independently developed by competitors. In addition, a significant percentage of the Company's research and development is sponsored by third parties. Sponsors of these programs generally own the rights to technology that is developed as a result of the Company's work under the programs. These rights could limit the Company's ability to commercialize any technological breakthroughs made in the course of such work. Potential Impact of Year 2000 on Processing of Date-sensitive Information. While the Company is attempting to minimize any negative consequences arising from the year 2000 issue, there can be no assurance that year 2000 problems will not have a material adverse impact on the Company's business, operations, or financial condition. While the Company expects that upgrades to its internal business systems will be completed in a timely fashion, there can be no assurance that the Company will not encounter unexpected costs or delays. Despite its efforts to ensure that its material current products are year 2000 compliant, the Company may see an increase in warranty and other claims, especially those related to Company products that incorporate, or operate using, third party software or hardware. In addition, certain of the Company's older products, which it no longer manufactures or sells, may not be year 2000 compliant, which may expose the Company to claims. As discussed above, if any of the Company's material suppliers or vendors experience business disruptions due to year 2000 issues, the Company might also be materially adversely affected. If any countries in which the Company operates experience significant year 2000 disruption, the Company could also be materially adversely affected. There is expected to be a significant amount of litigation relating to the year 2000 issue and there can be no assurance that the Company will not incur material costs in defending or bringing lawsuits. In addition, if any year 2000 issues are identified, there can be no assurance that the Company will be able to retain qualified personnel to remedy such issues. Any unexpected costs or delays arising from the year 2000 issue could have a material adverse impact on the Company's business, operations, and financial condition in amounts that cannot be reasonably estimated at this time. Risks Associated with Cash Management Arrangement with the Parent Company. Effective June 1, 1999, the Company began participating in a cash management arrangement with its parent company, Thermo Electron. Under this cash management arrangement, the Company lends its excess cash to Thermo Electron on an unsecured basis. The Company has the contractual right to withdraw its funds invested in the cash management arrangement upon 30 days' prior notice. Thermo Electron is contractually required to maintain cash, cash equivalents, and/or immediately available bank lines of credit equal to at least 50% of all funds invested under the cash management arrangement by all Thermo Electron subsidiaries other than wholly owned subsidiaries. The funds are held on an unsecured basis and therefore are subject to the credit risk of Thermo Electron. The Company's ability to receive its cash upon notice of withdrawal could be adversely affected if participants in the cash management arrangement demand withdrawal of their funds in an aggregate amount in excess of the 50% reserve required to be maintained by Thermo Electron. In the 43 event of a bankruptcy of Thermo Electron, the Company would be treated as an unsecured creditor and its rights to receive funds from the bankruptcy estate would be subordinated to secured creditors and would be treated on a pari passu basis with all other unsecured creditors. Further, all cash withdrawn by the Company from the cash management arrangement within one year before the bankruptcy would be subject to rescission. The inability of Thermo Electron to return the Company's cash on a timely basis or at all could have a material adverse effect on the Company's results of operations and financial position.
44
Selected Financial Information (In thousands except per share amounts) 1998 (a) 1997 1996 1995 (b) 1994 - --------------------------------------------------- ---------- ---------- ----------- ---------- --------- Statement of Income Data Revenues $245,692 $ 91,881 $ 93,058 $ 79,113 $ 69,833 Income from Continuing Operations 3,353 2,291 2,074 4,447 3,199 Net Income 2,336 2,104 885 4,188 3,248 Earnings per Share from Continuing Operations: Basic .28 .19 .17 .36 .26 Diluted .28 .19 .16 .35 .26 Earnings per Share: Basic .20 .17 .07 .34 .26 Diluted .20 .17 .07 .33 .26 Balance Sheet Data Working Capital (c) $ 35,762 $ 54,708 $ 57,719 $ 60,140 $ 43,143 Total Assets 351,635 107,922 110,711 108,417 82,621 Long-term Obligations 160,499 252 305 364 344 Common Stock of Subsidiary Subject to Redemption - 18,059 17,747 17,435 - Shareholders' Investment 69,864 66,668 67,368 65,825 60,475 (a) Reflects the November 1997 acquisition of Peek plc and borrowings to finance such acquisition. (b) Reflects the net proceeds from the private placement of shares of ThermoLyte Corporation in March 1995. (c) In fiscal 1998, includes common stock of subsidiary subject to redemption, redeemable in December 1998 or December 1999. 45
Common Stock Market Information The Company's common stock is traded on the American Stock Exchange under the symbol THP. The following table sets forth the high and low sale prices of the Company's common stock for fiscal 1998 and 1997, as reported in the consolidated transaction reporting system. 1998 1997 ------------------- ----------------- Quarter High Low High Low - --------------------------------------------------------------- ---------- ---------- ---------- ---------- First $10 1/4 $ 7 1/4 $11 1/4 $ 7 3/4 Second 12 1/8 8 1/2 9 1/4 6 1/8 Third 11 9/16 10 1/4 7 5 1/2 Fourth 11 1/4 7 5/8 9 7/8 5 5/8 As of October 30, 1998, the Company had 392 holders of record of its common stock. This does not include holdings in street or nominee names. The closing market price on the American Stock Exchange for the Company's common stock on October 30, 1998, was $7 1/2 per share. Shareholder Services Shareholders of Thermo Power Corporation who desire information about the Company are invited to contact the Investor Relations Department, Thermo Power Corporation, 81 Wyman Street, P.O. Box 9046, Waltham, Massachusetts 02454-9046, (781) 622-1111. A mailing list is maintained to enable shareholders whose stock is held in street name, and other interested individuals, to receive quarterly reports, annual reports, and press releases as quickly as possible. Distribution of printed quarterly reports is limited to the second quarter only. All material is available from Thermo Electron's Internet site (http://www.thermo.com/subsid/thp1.html). Stock Transfer Agent American Stock Transfer & Trust Company is the stock transfer agent and maintains shareholder activity records. The agent will respond to questions on issuance of stock certificates, change of ownership, lost stock certificates, and change of address. For these and similar matters, please direct inquiries to: American Stock Transfer & Trust Company Shareholder Services Department 40 Wall Street, 46th Floor New York, New York 10005 (718) 921-8200 Dividend Policy The Company has never paid cash dividends and does not expect to pay cash dividends in the foreseeable future because its policy has been to use earnings to finance expansion and growth. Payment of dividends will rest within the discretion of the Board of Directors and will depend upon, among other factors, the Company's earnings, capital requirements, and financial condition. Form 10-K Report A copy of the Annual Report on Form 10-K for the fiscal year ended October 3, 1998, as amended, as filed with the Securities and Exchange Commission, may be obtained at no charge by writing to the Investor Relations Department, Thermo Power Corporation, 81 Wyman Street, P.O. Box 9046, Waltham, Massachusetts 02454-9046. Annual Meeting The annual meeting of shareholders was held on Wednesday, March 10, 1999, at 10:00 a.m. at Thermo Electron Corporation, 81 Wyman Street, Waltham, Massachusetts.
EX-23 3 Exhibit 23 Consent of Independent Public Accountants As independent public accountants, we hereby consent to the incorporation by reference of our reports dated November 9, 1998 (except with respect to certain matters discussed in Notes 4 and 15, as to which the date is July 3, 1999), included in or incorporated by reference into Thermo Power Corporation's Annual Report on Form 10-K for the year ended October 3, 1998, into the Company's previously filed Registration Statements as follows: Registration Statement No. 33-19061 on Form S-8, Registration Statement No. 33-19062 on Form S-8, Registration Statement No. 33-25051 on Form S-8, Registration Statement No. 33-52814 on Form S-8, Registration Statement No. 33-87674 on Form S-8, Registration Statement No. 33-87686 on Form S-8, Registration Statement No. 33-87692 on Form S-8, and Registration Statement No. 33-65273 on Form S-8. Arthur Andersen LLP Boston, Massachusetts September 21, 1999 -----END PRIVACY-ENHANCED MESSAGE-----