Why did Thermo Electron's earnings decline in 1998 even though revenue grew?

Revenue rose 9% to $3.87 billion, but operating income fell 18% to $331.3 million. Contributing factors included $44.5 million in restructuring and nonrecurring costs, $8.6 million in inventory write-downs, lower demand in Asia and the semiconductor industry, losses at ThermoLase's spa business, and a smaller gain on subsidiary stock issuances ($51.8 million versus $80.1 million). The effective tax rate also rose, partly due to a $6.9 million tax asset write-off and a valuation allowance at ThermoLase.

How important are gains from subsidiary stock sales to the company's earnings?

They have been substantial in several periods. The company records a gain when a majority-owned subsidiary sells stock to outside investors at a price above book value. These gains were $51.8 million in 1998, $80.1 million in 1997, and $126.6 million in 1996. The filing explicitly states there is no assurance such transactions will occur in the future, so investors should not treat these gains as recurring operating earnings.

What is the proposed reorganization, and what does it mean for shareholders?

The company plans to reduce its majority-owned public subsidiaries from 23 to 16 by consolidating businesses and taking some entities private, including Thermedics Detection, Thermo Sentron, ThermoSpectra, and Thermo Power. The stated goals are better competitive positioning and larger public floats for the remaining subsidiaries. Each transaction is subject to conditions such as price agreements, board approvals, and fairness opinions, and some may not close. Public shareholders of the taken-private companies would receive cash.

How strong is the company's balance sheet and financing position?

Shareholders' investment rose to $2.25 billion, and the company held $1.64 billion in cash and available-for-sale investments at year-end, of which $1.24 billion sat in majority-owned subsidiaries. Long-term obligations increased to $2.03 billion, mainly convertible debentures. The company also has put options that could require it to buy back about 5 million shares for $73.8 million. Because the parent's access to subsidiary cash is subject to minority shareholder fiduciary duties and tax considerations, some consolidated cash may not be readily available to the parent.

What are the main risks to watch in Thermo Electron's businesses?

Key risks include: Thermo Ecotek's California plants shifting to avoided-cost pricing in 1999-2000, with possible losses and a possible $3-5 million Woodland impairment; uncertainty over the New Hampshire PSNH settlement, which could affect the Company's New Hampshire plants; the FDA's pending review of Trex Medical's digital mammography system; the ongoing ThermoLase spa restructuring; patent litigation involving ThermoQuest's Finnigan subsidiary; and exposure to Asian economic instability and semiconductor cyclicality. The company also cited Year 2000 readiness as a risk, with about $13 million in expected external remediation costs.

TMO 10-K FY1999 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 23, 1999. Cited figures are marked; the original filing is the authoritative source.

Thermo Electron Corporation's (NYSE: TMO) 10-K for fiscal 1998 (year ended January 2, 1999) shows a company that grew revenue but saw profits fall sharply.

Revenue rose 9% to $3,867.6 million^a, yet net income fell 24% to $181.9 million and diluted EPS dropped to $1.07 from $1.41. Operating income fell to $331.3 million from $405.8 million, reflecting $44.5 million of restructuring costs, $8.6 million of inventory write-downs, and weakness in Asian and semiconductor-related demand. The decline in gains from subsidiary stock issuances (down to $51.8 million from $80.1 million) and a higher effective tax rate also weighed on earnings.

Investors should note that the company's structure, which spins out majority-owned public subsidiaries, has historically generated large non-operating gains that may not recur. The balance sheet remains substantial, with $6.3 billion^b in total assets, $1.64 billion in cash and available-for-sale investments, and shareholders' investment of $2.25 billion. Long-term obligations rose to $2.03 billion, largely subordinated convertible debentures, and the company issued $150 million of 7 5/8% senior notes and $250 million of 4% convertible debentures during the year.

Management also disclosed a proposed reorganization that would reduce the number of majority-owned public subsidiaries from 23 to 16, and it announced a planned CEO transition to Richard F. Syron effective June 1, 1999. The February 1999 acquisition of Spectra-Physics for about $355 million^c adds to the company's measurement and detection portfolio.

Several risks deserve attention. Thermo Ecotek's California power contracts move to avoided-cost pricing in 1999-2000, which management expects to materially reduce that unit's profitability. ThermoLase's spa business is loss-making and under review, and the Trex Medical mammography system faces FDA uncertainty.

The company's stock fell to a closing price of $16^d 5/8 on January 29, 1999, from a 1998 high of $44 1/4. The filing also notes that the company has never paid cash dividends and that a portion of consolidated cash is held by majority-owned subsidiaries and may not be readily available to the parent.

02—Key points

Key Highlights

Revenue grew 9% to $3,867.6 million, driven by acquisitions in Measurement and Detection and Energy and Environment, but organic demand weakened in Asia and the semiconductor sector.
Net income fell 24% to $181.9 million; diluted EPS declined to $1.07 from $1.41, with operating income down 18% to $331.3 million.
Gains on issuance of subsidiary stock fell to $51.8 million from $80.1 million, reducing a historically significant source of earnings.
Restructuring and nonrecurring charges totaled $44.5 million, plus $8.6 million of inventory write-downs, concentrated at Thermo Instrument, ThermoLase, and Thermo TerraTech.
Total assets of $6.33 billion, cash and investments of $1.64 billion, and long-term obligations of $2.03 billion, which rose after $150 million in senior notes and $250 million in convertible debentures were issued.
Proposed reorganization would cut majority-owned public subsidiaries from 23 to 16, and the company announced CEO succession to Richard F. Syron effective June 1, 1999.
Thermo Ecotek faces a significant earnings drop as California fixed-rate power contracts convert to lower avoided-cost pricing in 1999-2000.

03—Questions

Frequently Asked Questions

Why did Thermo Electron's earnings decline in 1998 even though revenue grew?
Revenue rose 9% to $3.87 billion, but operating income fell 18% to $331.3 million. Contributing factors included $44.5 million in restructuring and nonrecurring costs, $8.6 million in inventory write-downs, lower demand in Asia and the semiconductor industry, losses at ThermoLase's spa business, and a smaller gain on subsidiary stock issuances ($51.8 million versus $80.1 million). The effective tax rate also rose, partly due to a $6.9 million tax asset write-off and a valuation allowance at ThermoLase.
How important are gains from subsidiary stock sales to the company's earnings?
They have been substantial in several periods. The company records a gain when a majority-owned subsidiary sells stock to outside investors at a price above book value. These gains were $51.8 million in 1998, $80.1 million in 1997, and $126.6 million in 1996. The filing explicitly states there is no assurance such transactions will occur in the future, so investors should not treat these gains as recurring operating earnings.
What is the proposed reorganization, and what does it mean for shareholders?
The company plans to reduce its majority-owned public subsidiaries from 23 to 16 by consolidating businesses and taking some entities private, including Thermedics Detection, Thermo Sentron, ThermoSpectra, and Thermo Power. The stated goals are better competitive positioning and larger public floats for the remaining subsidiaries. Each transaction is subject to conditions such as price agreements, board approvals, and fairness opinions, and some may not close. Public shareholders of the taken-private companies would receive cash.
How strong is the company's balance sheet and financing position?
Shareholders' investment rose to $2.25 billion, and the company held $1.64 billion in cash and available-for-sale investments at year-end, of which $1.24 billion sat in majority-owned subsidiaries. Long-term obligations increased to $2.03 billion, mainly convertible debentures. The company also has put options that could require it to buy back about 5 million shares for $73.8 million. Because the parent's access to subsidiary cash is subject to minority shareholder fiduciary duties and tax considerations, some consolidated cash may not be readily available to the parent.
What are the main risks to watch in Thermo Electron's businesses?
Key risks include: Thermo Ecotek's California plants shifting to avoided-cost pricing in 1999-2000, with possible losses and a possible $3-5 million Woodland impairment; uncertainty over the New Hampshire PSNH settlement, which could affect the Company's New Hampshire plants; the FDA's pending review of Trex Medical's digital mammography system; the ongoing ThermoLase spa restructuring; patent litigation involving ThermoQuest's Finnigan subsidiary; and exposure to Asian economic instability and semiconductor cyclicality. The company also cited Year 2000 readiness as a risk, with about $13 million in expected external remediation costs.

04—Continue

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