SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2003
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 1-7211
IONICS, INCORPORATED
(Exact name of registrant as specified in its charter)
Massachusetts 04-2068530
(State or other jurisdiction (IRS Employer Identification Number)
of incorporation or organization)
65 Grove Street
Watertown, Massachusetts 02472-2882
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 926-2500
Former name, former address and former fiscal year,
if changed since last report: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
At October 31, 2003 the Company had 17,763,811 shares of Common Stock, par value
$1.00 per share, outstanding.
-0-
IONICS, INCORPORATED
FORM 10-Q
FOR QUARTER ENDED September 30, 2003
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements 2
Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2003 and 2002 2
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002 3
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2003 and 2002 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk 35
Item 4. Controls and Procedures 35
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 37
Item 6. Exhibits and Reports on Form 8-K 37
SIGNATURES 38
EXHIBIT INDEX 39
-1-
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
IONICS, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
---------- ---------- --------- ---------
Revenues:
Equipment Business Group $ 39,272 $ 41,438 $ 109,386 $ 112,430
Ultrapure Water Group 26,662 25,169 75,526 75,354
Consumer Water Group 6,447 6,558 17,880 18,739
Instrument Business Group 7,112 6,990 21,671 20,344
Affiliated companies 11,135 3,330 35,918 9,022
---------- ---------- --------- ---------
90,628 83,485 260,381 235,889
---------- ---------- --------- ---------
Costs and expenses:
Cost of sales of Equipment Business Group 34,970 31,491 86,987 83,667
Cost of sales of Ultrapure Water Group 21,561 20,038 58,427 57,649
Cost of sales of Consumer Water Group 4,492 3,198 9,521 8,444
Cost of sales of Instrument Business Group 3,027 2,983 9,150 8,320
Cost of sales to affiliated companies 9,575 2,978 30,958 8,294
Research and development 1,784 1,617 5,515 4,832
Selling, general and administrative 24,732 21,209 69,752 62,179
Restructuring and impairment of long-lived assets 4,997 - 4,997 -
Impairments of goodwill 12,731 - 12,731 -
---------- ---------- --------- ---------
117,869 83,514 288,038 233,385
---------- ---------- --------- ---------
(Loss) income from operations (27,241) (29) (27,657) 2,504
Interest income 679 807 2,221 2,668
Interest expense (254) (338) (741) (1,274)
Equity income (loss) 43 722 (2,800) 2,396
---------- ---------- --------- ---------
(Loss) income from continuing operations before gain (26,773) 1,162 (28,977) 6,294
sale, income tax and minority interest expense
Gain on sale of Aqua Cool 457 - 457 -
Income tax (benefit) expense (8,260) 492 (9,076) 2,584
---------- ---------- --------- ---------
(Loss) income from continuing operations before
minority interest expense (18,056) 670 (19,444) 3,710
Minority interest expense 249 283 634 708
---------- ---------- --------- ---------
(Loss) income from continuing operations (18,305) 387 (20,078) 3,002
Discontinued operations:
(Loss) income from operations (558) (46) (4,745) 164
(Loss) on disposal (5,502) - (5,502) -
Income tax (benefit) expense (2,333) (18) (3,945) 63
---------- ---------- --------- ---------
(Loss) income from discontinued operations, net of tax (3,727) (28) (6,302) 101
---------- ---------- --------- ---------
Net (loss) income $ (22,032) $ 359 $ (26,380) $ 3,103
========== ========== ========= =========
Basic and diluted (loss) earnings per share
from continuing operations $ (1.03) $ 0.02 $ (1.14) $ 0.17
Basic and diluted (loss) earnings per share
from discontinued operations (0.21) (0.00) (0.36) 0.01
---------- ---------- --------- ---------
Basic and diluted net (loss) earnings per share $ (1.24) $ 0.02 $ (1.50) $ 0.18
========== ========== ========= =========
Shares used in basic (loss) earnings per share calculations 17,699 17,552 17,607 17,537
========== ========== ========= =========
Shares used in diluted (loss) earnings per share calculations 17,699 17,597 17,607 17,694
========== ========== ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
-2-
IONICS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands, except share and par value amounts)
September 30, December 31,
2003 2002
-------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 130,208 $ 136,044
Restricted cash - 4,250
Short-term investments 1,055 958
Accounts receivable, net 82,432 92,715
Notes receivable 6,626 6,645
Receivables from affiliated companies 28,680 23,642
Inventories:
Raw materials 14,690 17,706
Work in process 5,811 6,607
Finished goods 5,643 6,363
-------------- --------------
26,144 30,676
Deferred income taxes 17,820 14,664
Other current assets 14,496 11,795
Assets from discontinued operations 9,044 20,637
-------------- --------------
Total current assets 316,505 342,026
Receivables from affiliated companies, long-term 19,490 11,740
Notes receivable, long-term 26,631 24,718
Investments in affiliated companies 19,918 22,618
Property, plant and equipment:
Land 5,663 5,527
Buildings 42,330 40,179
Machinery and equipment 275,726 259,471
Other, including furniture, fixtures and vehicles 36,272 31,742
-------------- --------------
359,991 336,919
Less accumulated depreciation 188,313 170,124
-------------- --------------
171,678 166,795
Goodwill 7,485 20,118
Deferred income taxes, long-term 17,244 12,591
Other assets 12,433 7,407
-------------- --------------
Total assets $ 591,384 $ 608,013
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term debt $ 5,677 $ 4,134
Accounts payable 28,141 35,678
Deferred revenue and advances from affiliated companies 7,833 4,308
Income taxes payable 26,226 25,692
Other current liabilities 48,383 43,870
Liabilities from discontinued operations 1,246 486
-------------- --------------
Total current liabilities 117,506 114,168
Long-term debt and notes payable 8,797 9,670
Deferred income taxes 32,294 35,337
Deferred revenue from affiliated companies 4,011 4,662
Other liabilities 4,870 6,023
Commitments and contingencies
Stockholders' equity:
Common stock, par value $1.00, authorized
shares: 55,000,000 at September 30, 2003 and December 31, 2002;
issued: 17,736,011 at September 30, 2003 and 17,555,046 at
December 31, 2002 17,736 17,555
Additional paid-in capital 193,921 190,417
Retained earnings 220,729 247,109
Accumulated other comprehensive loss (8,480) (16,928)
-------------- --------------
Total stockholders' equity 423,906 438,153
-------------- --------------
Total liabilities and stockholders' equity $ 591,384 $ 608,013
============== ==============
The accompanying notes are an integral part of these consolidated financial
statements.
-3-
IONICS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine months ended
September 30,
------------------------------
2003 2002
-------------- -------------
Operating activities:
Net (loss) income $ (26,380) $ 3,103
Less: (Loss) income from discontinued operations (2,918) 101
Loss on disposal of discontinued operations (3,384) -
-------------- -------------
(Loss) income from continuing operations (20,078) 3,002
Adjustments to reconcile (loss) income from continuing operations
to net cash provided by (used in) operating activities:
Depreciation 18,446 16,183
Amortization of intangibles 426 227
Impairment of long-lived assets 2,499 -
Impairment of goodwill 12,731 -
Provision for losses on accounts and notes receivable 3,199 791
Equity in losses (earnings) of affiliates 2,800 (2,396)
Changes in assets and liabilities:
Notes receivable (610) (5,251)
Accounts receivable 11,624 36,654
Receivables from affiliated companies (14,386) (25,720)
Inventories 5,758 (2,135)
Other current assets (2,200) 3,927
Investments in affiliated companies 1,116 3,937
Deferred income taxes (8,491) (3,038)
Accounts payable and accrued expenses (7,798) (17,146)
Customer deposits 1,377 10,493
Deferred revenue and advances from affiliated companies 2,869 402
Income taxes payable (3,999) (25,637)
Other (3,206) (869)
-------------- -------------
Net cash provided by (used in) operating activities 2,077 (6,576)
-------------- -------------
Investing activities:
Additions to property, plant and equipment (18,345) (24,350)
Disposals of property, plant and equipment 281 1,782
Additional investments in affiliates (1,575) -
Acquisitions, net of cash acquired (7,092) (1,035)
Sales of short-term investments 12 90
-------------- -------------
Net cash used in investing activities (26,719) (23,513)
-------------- -------------
Financing activities:
Restricted cash 4,250 -
Principal payments on current debt (4,662) (73,764)
Proceeds from borrowings of current debt 5,135 61,068
Principal payments on long-term debt (864) (727)
Proceeds from borrowings of long-term debt - 1,334
Proceeds from issuance of common stock - 60
Proceeds from issuance of stock under stock option plans 3,377 1,661
-------------- -------------
Net cash provided by (used in) financing activities 7,236 (10,368)
-------------- -------------
Effect of exchange rate changes on cash 5,519 4,362
-------------- -------------
Net cash used in continuing operations (11,887) (36,095)
Net cash provided by discontinued operations 6,051 1,762
-------------- -------------
Net change in cash and cash equivalents (5,836) (34,333)
Cash and cash equivalents at beginning of period 136,044 178,283
-------------- -------------
Cash and cash equivalents at end of period $ 130,208 $ 143,950
============== =============
The accompanying notes are an integral part of these consolidated financial
statements.
-4-
IONICS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying consolidated quarterly financial statements of Ionics,
Incorporated (the "Company") are unaudited; however, in the opinion of the
management of the Company, all adjustments have been made that are necessary for
a fair statement of the Company's consolidated financial position, results of
operations and cash flows for each period presented. The consolidated results of
operations for the interim periods are not necessarily indicative of the results
of operations to be expected for the full year or any future period.
The accompanying financial statements have been prepared with the assumption
that users of the interim financial information have either read or have access
to the Company's financial statements for the year ended December 31, 2002.
Accordingly, footnote disclosures that would substantially duplicate the
disclosures contained in the Company's audited financial statements as of and
for the year ended December 31, 2002 have been omitted from these financial
statements. These financial statements have been prepared in accordance with the
instructions to Form 10-Q and the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
instructions, rules and regulations. These financial statements should be read
in conjunction with the Company's 2002 Annual Report as filed on Form 10-K (the
"2002 Form 10-K") with the Securities and Exchange Commission.
Certain prior year amounts have been reclassified to conform to the current year
presentations with no impact on net income.
2. Stock Plans
Options for the purchase of the Company stock are granted to officers, directors
and key employees under various stock option agreements. The Company applies the
recognition and measurement provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees," and related interpretations
in accounting for its stock-based compensation plans. Accordingly, for options
with an exercise price less than the fair market value of the stock at the date
of grant, if any, stock-based compensation is measured as the difference between
the option exercise price and fair market value of the stock at the date of
grant and is charged to operations over the expected period of benefit to the
Company. For the three and nine months ended September 30, 2003 and 2002, no
stock-based compensation expense is reflected in net income.
-5-
The following table illustrates the pro forma effect on net (loss) income and
basic and diluted (loss) earnings per share if the Company had applied the fair
value method of accounting for stock options and other equity instruments as
defined by Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation."
For the three months ended
(Amounts in thousands, except per share amounts) September 30,
-------------------------
2003 2002
------------ -----------
(Loss) income from continuing operations, as reported $ (18,305) $ 387
Loss from discontinued operations, net, as reported (3,727) (28)
------------ -----------
Net (loss) income, as reported $ (22,032) $ 359
Less: Stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects (1,277) (717)
------------ -----------
Pro forma net loss $ (23,309) $ (358)
============ ===========
(Loss) earnings per basic share from continuing operations, as reported $ (1.03) $ 0.02
Loss per basic share from discontinued operations, net, as reported (0.21) -
------------ -----------
Net (loss) earnings per basic share, as reported $ (1.24) $ 0.02
============ ===========
Net loss per basic share, pro forma $ (1.32) $ (0.02)
============ ===========
(Loss) earnings per diluted share from continuing operations, as reported $ (1.03) $ 0.02
Loss per diluted share from discontinued operations, net, as reported (0.21) -
------------ -----------
Net (loss) earnings per diluted share, as reported $ (1.24) $ 0.02
============ ===========
Net loss per diluted share, pro forma $ (1.32) $ (0.02)
============ ===========
For the nine months ended
(Amounts in thousands, except per share amounts) September 30,
-------------------------
2003 2002
------------ -----------
(Loss) income from continuing operations, as reported $ (20,078) $ 3,002
(Loss) income from discontinued operations, net, as reported (6,302) 101
------------ -----------
Net (loss) income, as reported $ (26,380) $ 3,103
Less: Stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects (3,698) (1,883)
------------ -----------
Pro forma net (loss) income $ (30,078) $ 1,220
============ ===========
(Loss) earnings per basic share from continuing operations, as reported $ (1.14) $ 0.17
(Loss) earnings per basic share from discontinued operations, net, as reported (0.36) 0.01
------------ -----------
Net (loss) earnings per basic share, as reported $ (1.50) $ 0.18
============ ===========
Net (loss) earnings per basic share, pro forma $ (1.71) $ 0.07
============ ===========
(Loss) earnings per diluted share from continuing operations, as reported $ (1.14) $ 0.17
(Loss) earnings per diluted share from discontinued operations, net, as reported (0.36) 0.01
------------ -----------
Net (loss) earnings per diluted share, as reported $ (1.50) $ 0.18
============ ===========
Net (loss) earnings per diluted share, pro forma $ (1.71) $ 0.07
============ ===========
Since the options vest over several years and because additional option grants
are expected to be made in future years, the pro forma results are not
representative of the pro forma results for future periods.
The fair value of each option granted during the first nine months of 2003 and
2002 is estimated on the date of grant using the Black-Scholes option-pricing
model with the following assumptions:
For the three months ended For the nine months ended
September 30, September 30,
------------------------- -------------------------
2003 2002 2003 2002
---------- ------------ ------------ -----------
Expected term (years) 6 6 6 6
Volatility 41.4 42.2 41.4 42.2
Risk-free interest rate (zero coupon U.S. treasury note) 3.77% 3.61% 3.42% 3.68%
Dividend yield None None None None
-6-
3. Discontinued Operations
On August 14, 2003, the Company's management and Board of Directors approved a
plan of disposition to sell its consumer chemical business, the Elite Consumer
Products division in Ludlow, MA, which is part of the Company's Consumer Water
Group segment. Accordingly, the Company's consolidated financial statements and
notes reflect this business as a discontinued operation in accordance with
Financial Accounting Standards Board Statement No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets."
The loss from discontinued operations of $3.7 million, or $6.1 million on a
pre-tax basis, recorded in the three months ended September 30, 2003 includes
losses from operations of $0.6 million and an estimated loss on disposal of $5.5
million, reflecting asset impairment charges to write down the carrying value of
these assets to their estimated fair value less costs to sell. The Company
expects to complete the sale within the next twelve months. The loss from
discontinued operations of $6.3 million, or $10.2 million on a pre-tax basis,
recorded for the nine months ended September 30, 2003, includes losses from
operations of $4.7 million and an estimated loss on disposal of $5.5 million,
which includes an asset impairment charge of $4.0 million recorded during the
second quarter attributable to certain sodium hypochlorite manufacturing
equipment.
The summary of operating results from discontinued operations is as follows:
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2003 2003 2003 2002
------------ ------------ ------------ ------------
Net sales $ 4,564 $ 3,302 $ 13,952 $ 10,400
Gross margin (1,729) 91 (1,581) 731
============ ============ ============ ============
(Loss) income from discontinued operations,
before income tax $ (558) $ (46) $ (4,745) $ 164
Income tax (benefit) expense (215) (18) (1,827) 63
------------ ------------ ------------ ------------
(Loss) income from discontinued operations,
net of tax $ (343) $ (28) $ (2,918) $ 101
Loss on disposal of discontinued operations,
net of tax 3,384 - 3,384 -
------------ ------------ ------------ ------------
(Loss) income from discontinued operations,
net of tax $ (3,727) $ (28) $ (6,302) $ 101
============ ============ ============ ============
Assets and liabilities from discontinued operations at September 30, 2003 and
December 31, 2002 consisted of the following:
September 30, December 31,
2003 2002
------------------ ---------------
Current assets $ 4,486 $ 7,351
Non-current assets 4,558 13,286
----------------- ---------------
Assets from discontinued operations $ 9,044 $ 20,637
================== ===============
Liabilities from discontinued operations $ 1,246 $ 486
================== ===============
Current assets include cash and cash equivalents, accounts and notes receivable,
inventory and other current assets. Non-current assets include property, plant
and equipment, intangible assets and other assets. Liabilities consist of
accounts payable and accrued expenses.
-7-
4. Restructuring and Impairment of Long-Lived Assets
On September 3, 2003, the Company announced a restructuring plan intended to
improve financial performance through a realignment of the Company's management
structure, a reduction in personnel, and the consolidation of certain
operations. The program will consolidate the Company's sales, engineering,
manufacturing and accounting functions, which are currently spread among
numerous reporting entities, into several regional centers in the United States,
Europe and Asia. The Company also announced plans to eventually consolidate the
Equipment Business Group segment ("EBG") and the Ultrapure Water Group segment
("UWG") into a single business group and plans to divest the Elite Consumer
Products division in Ludlow, MA, and shut down operations at the Company's
Ionics Watertec facility in Australia and its European Home Water activities.
As a result of the above decisions, the Company recorded restructuring charges
of approximately $2.5 million in the third quarter of 2003 relating to employee
severance costs for the elimination of approximately 150 positions. At September
30, 2003, substantially all of the employees whose employment was terminated as
a result of these restructuring activities had left the Company. At September
30, 2003, the Company has approximately $1.6 million accrued for restructuring
costs associated with employee severance arrangements and expects the remainder
of the payments to be made during the fourth quarter of 2003.
During the third quarter of 2003, the Company recorded an impairment charge
relating to production equipment within the EBG segment that it had previously
expected to operate for a manufacturer of lactic acid in the food industry under
a build-own-operate contract. During the third quarter, the Company's customer
began the process of filing for bankruptcy protection. Accordingly, the Company
recorded a pre-tax asset impairment charge of approximately $2.5 million
associated with the remaining carrying value of the equipment as the Company
does not expect to recover the asset or receive any future payments.
5. Goodwill and Intangible Assets
Impairment of Goodwill
SFAS No. 142, "Goodwill and Other Intangible Assets," provides that goodwill of
a reporting unit be tested for impairment on an annual basis and between annual
tests in certain circumstances including a significant adverse change in the
business outlook. During the third quarter of 2003, as a result of significant
changes in business outlook which resulted in the Company's restructuring
program, the Company conducted an interim impairment test of the goodwill
related to certain of its reporting units as of September 30, 2003. Based upon
its preliminary assessment, the Company concluded that the carrying value of the
assets and liabilities associated with its RCC, Ahlfinger and Separatech
reporting units exceeded their fair value and accordingly recorded a $12.7
million goodwill impairment charge ($6.8 million at RCC, $3.7 million at
Ahlfinger and $2.2 million at Separatech). The impairment charge, representing
the entire goodwill balance for these reporting units, was estimated by
comparing the implied fair value of the goodwill associated with these reporting
units to their carrying values. Adjustments, if any, arising from the
finalization of the reporting units' valuation for purposes of goodwill
impairment testing will be recorded during the fourth quarter of 2003. The fair
value of the reporting units was estimated utilizing the expected present value
of future cash flows.
-8-
Goodwill
The changes in the carrying amount of goodwill for the nine months ended
September 30, 2003 and 2002 are as follows:
Equipment Ultrapure Consumer Instrument
Business Business Water Business
Dollars in thousands Group Group Group Group Corporate Total
----------------------------------------------------------------------------
Balance December 31, 2001 $ 11,360 $ 7,054 $ 541 $ - $ - $ 18,955
-
Cumulative translation adjustment/other 159 5 321 - - 485
- ----------------------------------------------------------------------------------------------------------------------
Balance September 30, 2002 $ 11,519 $ 7,059 $ 862 $ - $ - $ 19,440
============================================================================
Balance December 31, 2002 $ 11,623 $ 7,633 $ 862 $ - $ - $ 20,118
Impairment losses (8,981) (3,750) - - - (12,731)
Cumulative translation adjustment/other 199 (101) - - - 98
- ----------------------------------------------------------------------------------------------------------------------
Balance September 30, 2003 $ 2,841 $ 3,782 $ 862 $ - $ - $ 7,485
============================================================================
Intangible Assets
The Company's intangible assets are included in other assets in the Consolidated
Balance Sheets and consist principally of patents, trademarks and customer
lists. At September 30, 2003 and 2002, the gross carrying value of intangible
assets was approximately $8.3 million and $2.7 million, respectively, and the
accumulated amortization was $1.2 million and $0.6 million, respectively. The
increase in intangible assets during the third quarter of 2003 primarily
reflects the acquired intangible assets of CoolerSmart, LLC (see Note 14), which
are primarily being amortized over a period of eight years. Substantially all of
the Company's intangible assets are amortized on a straight-line basis over
various periods ranging up to 20 years. Amortization expense for intangible
assets is estimated to be approximately $0.8 million in 2003, $1.1 million in
2004 and 2005, $1.0 million in 2006 and $0.8 million in 2007.
6. Equity Income (Loss) in Affiliated Companies
The Company accounts for investments in affiliates that represent 20% to 50%
ownership of the equity securities of the affiliate under the equity method of
accounting. Under the equity method, the Company records its proportionate share
of the earnings or losses of the affiliates in equity income (loss). With
respect to the Company's investment in the Desalination Company of Trinidad and
Tobago Ltd. ("Desalcott"), in recognition of the fact that the Company has
provided all of the cash equity funding for Desalcott, the Company has concluded
that it would not be appropriate to recognize equity method losses based solely
on its ownership interest in Desalcott. The Company holds 200 ordinary shares of
Desalcott, representing a 40% ownership interest. The Company also loaned $10
million to Hafeez Karamath Engineering Services, Ltd. ("HKES"), the founder of
Desalcott and promoter of the Trinidad desalination project, to enable HKES to
acquire 200 ordinary shares of Desalcott and thereby raise its existing equity
interest in Desalcott from 100 to 300 ordinary shares. As a result, the Company
currently owns a 40% equity interest in Desalcott, and HKES currently owns a 60%
equity interest in Desalcott. In addition, the Company made a $10 million loan
to Desalcott in the third quarter of 2003 as an additional source of long-term
financing. Accordingly, based on its aggregate economic interests in Desalcott,
the Company records 100% of any net loss reported by Desalcott and 40% of any
net income reported by Desalcott. In periods in which Desalcott has an
accumulated loss (as opposed to retained earnings), the Company records 100% of
any net income of Desalcott up to the amount of Desalcott's accumulated loss,
and 40% of any net income reported thereafter by Desalcott.
7. Income Taxes
For the nine months ended September 30, 2003, the Company recorded an income tax
benefit of $9.1 million on a consolidated pre-tax loss from continuing
operations before minority interest expense of $28.5 million, yielding an annual
effective tax rate of 31.8%. For the nine months ended September 30, 2002, the
Company recorded income tax expense of $2.6 million on consolidated pre-tax
income from continuing operations before minority interest of $6.3 million,
yielding an annual effective tax rate of 41.1%. The change in the effective tax
rate for the nine months ended September 30, 2003 compared to the nine months
ended September 30, 2002 resulted from changes in the overall level of
-9-
consolidated pre-tax profit and the geographic mix of expected losses in several
foreign subsidiaries for which the Company may not be able to realize future tax
benefits.
The Company estimates income taxes in each of the jurisdictions in which it
operates and involves an assessment of permanent and temporary differences
resulting from differing treatment of items for tax and book accounting
purposes. Temporary differences result in deferred tax assets and liabilities,
which are included within the consolidated balance sheet. The Company must also
assess the likelihood that any deferred tax assets will be recovered, and must
establish a valuation allowance to the extent that it believes that it is more
likely than not any deferred tax asset will not be utilized from future taxable
income. Although realizability is not assured, based on the weight of available
evidence, the Company believes it is more likely than not that all remaining
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable is subject to change based on future events, including
generating taxable income in future periods. The Company will continue to assess
the need for the valuation allowance at each balance sheet date based on all
available evidence. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term, and the amount could be material, if
the Company does not generate sufficient taxable income in future periods.
8. Commitments and Contingencies
Litigation
The Company, its Chief Financial Officer and its former Chief Executive Officer
have been named as defendants in a class action lawsuit captioned Jerome Deckler
v. Ionics, Inc., et al., filed in the U.S. District Court, District of
Massachusetts in March 2003. An amended complaint was filed in August 2003.
Plaintiff alleges violations of the federal securities laws relating to the
restatement of the Company's financial statements for the first and second
quarters of 2002, announced in November 2002, and are seeking an unspecified
amount of compensatory damages and their costs and expenses, including legal
fees. The Company believes the allegations in the lawsuit are without merit and
intends vigorously to defend the litigation. While the Company believes that the
litigation will have no material adverse impact on its financial condition,
results of operations or cash flows, the litigation process is inherently
uncertain and the Company can make no assurances as to the ultimate outcome of
this matter.
The Company was notified in 1992 that it is a potentially responsible party
(PRP) at a Superfund Site, Solvent Recovery Services of New England in
Southington, Connecticut. Ionics' share of assessments to date for site work and
administrative costs totals approximately $78,000. The United States
Environmental Protection Agency ("EPA") has not yet issued a decision regarding
clean-up methods and costs. However, based upon the large number of PRPs
identified, the Company's small volumetric ranking (approximately 0.5%) and the
identities of the larger PRPs, the Company believes that its liability in this
matter will not have a material effect on the Company's financial position,
results of operations or cash flows.
In 2002, Sievers Instruments, Inc. ("Sievers"), a wholly owned subsidiary of the
Company, filed a patent infringement suit in the United States District Court
for the District of Colorado against Anatel Corporation and against Anatel's
acquiring company, Hach Company ("Anatel"). The suit alleges that Anatel's
manufacture and sale of its Model 643 organic carbon analyzer unlawfully copied
and interfered with sales of Sievers' TOC 400 total organic carbon analyzer in
that the Model 643 infringes certain claims of Sievers' U.S. patents No.
5,976,468 and No. 6,271,043. The suit further asserts that the continuing sale
of calibration standards by Anatel constitutes infringement. The defendants have
raised certain defenses, withdrawn the accused product from the market, and
introduced a redesigned analyzer. Defendants have asked the Court to rule that
their redesigned analyzer does not infringe, and the Court has not yet issued
its decision.
The Company is involved in the normal course of its business in various other
litigation matters, some of which are in the pre-trial discovery stages. The
Company believes that none of the other pending matters will have an outcome
material to the Company's financial position, results of operations or cash
flows.
Other Commitments and Contingencies
From time to time, the Company enters into joint ventures with respect to
specific projects, including the projects in Trinidad, Kuwait and Israel
described below. Each joint venture arrangement is independently negotiated
based on the specific facts and circumstances of the project, the purpose of the
joint venture company related to the project, as well as the rights and
obligations of the other joint venture partners. Generally, the Company has
structured its project joint ventures so that the Company's obligation to
provide funding to the underlying project or to the joint venture entity is
limited to its proportional capital contribution, which can take the form of
equity or subordinated debt. Except in situations that are negotiated with a
specific joint venture entity as discussed below, the Company has no other
-10-
commitment to provide for the joint venture's working capital or other cash
needs. In addition, the joint venture entity typically obtains third-party debt
financing for a substantial portion of the project's total capital requirements.
In these situations, the Company is typically not responsible for the repayment
of the indebtedness incurred by the joint venture entity. In connection with
certain joint venture projects, the Company may also enter into contracts for
the supply and installation of the Company's equipment during the construction
of the project, for the operation and maintenance of the facility once it begins
operation, or both. These commercial arrangements do not require the Company to
commit to any funding for working capital or any other requirements of the joint
venture company. As a result, the Company's exposure with respect to its joint
ventures is typically limited to its debt and equity investments in the joint
venture entity, the fulfillment of any contractual obligations it has to the
joint venture entity and the accounts receivable owing to the Company from the
joint venture entity.
Trinidad
In 2000, the Company acquired 200 ordinary shares of Desalination Company of
Trinidad and Tobago Ltd. ("Desalcott"), for $10 million and loaned $10 million
to Hafeez Karamath Engineering Services Ltd. ("HKES"), the founder of Desalcott
and promoter of the Trinidad desalination project, to enable HKES to acquire an
additional 200 ordinary shares of Desalcott. Prior to those investments, HKES
owned 100 ordinary shares of Desalcott. As a result, the Company currently owns
a 40% equity interest in Desalcott, and HKES currently owns a 60% equity
interest in Desalcott. In the second quarter of 2002, construction was completed
on the first four (out of five) phases of the Trinidad desalination facility
owned by Desalcott, and the facility commenced water deliveries to its customer,
the Water and Sewerage Authority of Trinidad and Tobago.
The Company's $10 million loan to HKES is included in notes receivable,
long-term in the Company's Consolidated Balance Sheets. The loan bears interest
at a rate equal to 2% above the London Interbank Offered Rate (LIBOR), with
interest payable (subject to availability of funds) starting October 25, 2002
and every six months thereafter and at maturity. Prior to maturity, accrued
interest (as well as principal payments) is payable only to the extent dividends
or other distributions are paid by Desalcott on the ordinary shares of Desalcott
owned by HKES and pledged to the Company. Principal repayment is due in 14 equal
installments commencing on April 25, 2004 and continuing semiannually
thereafter. The loan matures and is payable in full on April 25, 2011. The loan
is secured by a security interest in the shares of Desalcott owned by HKES and
purchased with the borrowed funds, which is subordinate to the security interest
in those shares in favor of the Trinidad bank that provided the financing for
Desalcott. In addition, any dividends or other distributions paid by Desalcott
to HKES on the pledged shares must be applied to loan payments to the Company.
In 2000, Desalcott entered into a "bridge loan" agreement with a Trinidad bank
providing $60 million in construction financing. Effective November 8, 2001, the
loan agreement was amended to increase maximum borrowings to $79.9 million. The
bridge loan of $79.9 million and the $20 million equity provided to Desalcott
did not provide sufficient funds to pay all of Desalcott's obligations in
completing construction and commissioning of the project prior to receipt of
long-term financing in the second quarter of 2003. Consequently, included in
Desalcott's obligations at March 31, 2003 was approximately $30.1 million
payable to the Company's Trinidad subsidiary for equipment and services
purchased in connection with the construction of the facility. However,
Desalcott disputed certain amounts payable under the construction contract. In
June 2003, Desalcott and the Company's Trinidad subsidiary resolved their
dispute under the construction contract, and reached agreement as to the final
amount owing to the Company for completion of the first four phases of the
project. As a result of this agreement, the Company will not realize
approximately $2.7 million of the deferred profit on the construction project,
and therefore reduced the related accounts receivable and deferred revenue
balances by $2.7 million each.
In June 2003, Desalcott entered into a long-term loan agreement with the
Trinidad bank that had provided the bridge loan. In connection with the funding
of the loan, Desalcott paid the Company's Trinidad subsidiary approximately $12
million of outstanding accounts receivable under the construction contract in
July 2003. In addition, pursuant to a previous commitment made by the Company,
the Company, effective July 31, 2003, converted an additional $10 million of
amounts owing under the construction contract into a loan to Desalcott as an
additional source of long-term project financing. That loan has a seven-year
term, and is payable in 28 quarterly payments of principal and interest. The
interest rate is fixed at two percent above the interest rate payable by
Desalcott on the U.S. dollar portion of its borrowings under its long-term loan
agreement with the Trinidadian bank (the initial annual rate on the U.S. dollar
portion was 8 1/2%). In the event of a default by Desalcott, Desalcott's
obligation to the Company is subordinated to Desalcott's obligations to the
Trinidad bank.
-11-
As a result of the settlement of the construction contract dispute described
above and Desalcott's $12 million payment to the Company's Trinidad subsidiary,
together with the conversion of an additional $10 million of accounts receivable
into a long-term note receivable as described above, the remaining amount due to
the Company's Trinidad subsidiary from Desalcott for construction work on the
first four phases of the project is approximately $6 million. This amount will
be partially paid out of Desalcott's future cash flow from operations over a
period of time estimated to be two years, and the balance from funds available
from long-term financing proceeds upon completion by the Company of certain
"punch list" items. In addition, Desalcott and the Company agreed that the
Company's Trinidad subsidiary would complete the last phase (phase 5) of the
project (which will increase water production capacity by approximately 9%) for
a fixed price of $7.7 million. Work on phase 5 has commenced and is expected to
be completed in the second quarter of 2004.
Kuwait
During 2001, the Company acquired a 25% equity interest in a Kuwaiti project
company, Utilities Development Company W.L.L. ("UDC"), which was awarded a
concession agreement by an agency of the Kuwaiti government for the
construction, ownership and operation of a wastewater reuse facility in Kuwait.
During the second quarter of 2002, UDC entered into agreements for the long-term
financing of the project, and construction of the project commenced. At
September 30, 2003, the Company had invested a total of $8.3 million as equity
and subordinated debt in UDC. The Company has commitments to make additional
equity investments or issue additional subordinated debt to UDC of approximately
$7.3 million over the next two years. In addition, a total of $18.8 million in
performance bonds have been issued on behalf of the Company's Italian subsidiary
in connection with the project.
Israel
In 2001, the Company entered into agreements with an Israeli cooperative society
and an Israeli corporation for the establishment of Magan Desalination Ltd.
("MDL") as an Israeli project company in which the Company has a 49% equity
interest. During the second quarter of 2003, the Israeli cooperative society and
the Company acquired the ownership interest of the Israeli corporation in MDL.
On June 17, 2003, MDL finalized a concession contract originally entered into in
August 2002 with a state-sponsored water company for the construction, ownership
and operation of a brackish water desalination facility in Israel. In June 2003,
MDL obtained $8 million of debt financing for the project from an Israeli bank,
and the Company has guaranteed repayment of 49% of the loan amount in the form
of a bank letter of guarantee. In July 2003, the Company through its Israeli
subsidiary made an equity investment of $1.5 million in MDL for its 49% equity
interest. This project is scheduled to be completed in the first half of 2004.
In January 2002, the Company entered into agreements with two Israeli
corporations giving the Company the right to a one-third ownership interest in
an Israeli project company, Carmel Desalination Ltd. ("CDL"). On October 28,
2002, CDL was awarded a concession agreement by the Israeli Water Desalination
Agency ("WDA") (established by the Ministry of Finance and the Ministry of
Infrastructure) for the construction, ownership and operation of a major
seawater desalination facility in Israel. At December 31, 2002, the Company made
an equity investment of $0.2 million in CDL. Additionally, at September 30, 2003
the Company had deferred costs of approximately $0.6 million relating to the
engineering design and development work on the project. If CDL obtains long-term
project financing, the Company has committed to make additional equity
investments to CDL of approximately $9.7 million. The timing and amount of such
investments will depend upon the terms of the long-term financing agreement. The
terms of the concession agreement originally required that long-term financing
be obtained by April 2003. CDL was granted an extension to August 20, 2003 and a
request for a further extension to obtain such financing has been submitted to
the WDA for approval. Although the Company currently anticipates that CDL will
obtain long-term financing for the project, if CDL is unable to obtain such
financing, the Company would expense its deferred costs relating to the
construction project and its investment in CDL (estimated to be approximately
$0.8 million by the time of the closing of the long-term financing).
Additionally, the Company could incur its one-third proportionate share ($2.5
million) of liability under a $7.5 million performance bond issued on behalf of
CDL. In August 2003, the Company entered into an agreement with the two other
equity participants in CDL, which would permit one of them to withdraw from the
project subject to the approval of the WDA. Should the withdrawal of the partner
be approved by the WDA, the Company's equity interest in CDL would increase from
one-third to 50%, proportionately increasing its obligation under the
performance bond, as well as increasing its required equity investment in the
project to approximately $15 million.
In August 2003, a 50/50 joint venture between the Company and an Israeli
engineering corporation was selected by Mekorot, the Israeli state-sponsored
water company, to design, supply and construct a 123,000 cubic meter per day
(32.5 million gallons per day) seawater desalination facility in Ashdod, Israel.
-12-
The estimated amount of the equipment supply and construction contract to be
negotiated and entered into with respect to the project is approximately $95
million, and it is estimated that the plant will require approximately two years
to complete. The joint venture submitted a $5 million bid bond with its
proposal, and the Company would be responsible for 50% of this amount if a
demand were made on the bid bond. It is currently anticipated that the parties
will sign a final form of contract in the first quarter of 2004, at which time
the joint venture will replace the bid bond with a performance bond in the
principal amount of 10% of the contract value.
Guarantees and Indemnifications
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others an
interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB
Interpretation No. 34" ("FIN 45"). FIN 45 requires that a guarantor recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken by issuing the guarantee and additional disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees it has issued. The accounting requirements
for the initial recognition of guarantees became applicable on a prospective
basis for guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for all guarantees outstanding, regardless of when
they were issued or modified as of December 15, 2002. The adoption of FIN 45 did
not have a material effect on the Company's consolidated financial statements.
The following is a summary of the Company's agreements that have determined to
be within the scope of FIN 45.
Under its By-laws, the Company has an obligation to indemnify its directors and
officers to the extent legally permissible against liabilities reasonably
incurred in connection with any action in which such individual may be involved
by reason of such individual being or having been a director or officer of the
Company. The Company has obtained director and officer liability insurance
policies that may limit its exposure and enable it to recover a portion of any
future amounts paid. As a result of this insurance policy coverage, the
estimated fair value of this indemnification is not material. This obligation to
indemnify its directors and officers is grandfathered under the provisions of
FIN 45 as it existed prior to December 31, 2002. Accordingly, the Company has
not recorded any liabilities for these obligations as of September 30, 2003.
In the normal course of business, the Company issues letters of credit to
customers, vendors and lending institutions as guarantees for payment,
performance or both under various commercial contracts into which it enters. Bid
bonds are also sometimes obtained by the Company as security for the Company's
commitment to proceed with a project if it is the successful bidder. Performance
bonds are typically issued for the benefit of the Company's customers as
financial security for the completion or performance by the Company of its
contractual obligations under certain commercial contracts. In the past, the
Company has not incurred significant liabilities or expenses as a result of the
use of these instruments. Approximately $110.6 million of these instruments were
outstanding at September 30, 2003. Based on the Company's experience with
respect to letters of credit, bid bonds and performance bonds, the Company
believes the estimated fair value of the instruments entered into during the
first nine months of 2003 is not material. Accordingly, the Company has not
recorded any liabilities for these instruments as of September 30, 2003.
As part of past acquisitions and divestitures of businesses or assets, the
Company made a variety of warranties and indemnifications to the sellers and
purchasers that are typical for such transactions. The Company only provides
such warranties or indemnifications after considering the economics of the
transaction and the liquidity and credit risk of the other party in the
transaction. Typically, certain of the warranties and the indemnifications
expire after a defined period of time following the transaction, but others may
survive indefinitely. The warranty and indemnification obligations noted above
were grandfathered under the provisions of FIN 45 as they were in effect prior
to December 31, 2002. In addition, the Company has not made any similar warranty
or indemnification obligations during the first nine months of 2003.
Accordingly, the Company has not recorded any liabilities for these obligations
as of September 30, 2003.
On November 1, 2003, the Company guaranteed repayment, up to its 43%
proportional equity interest, of a $10 million bank line of credit extended to
Toray Membrane America, Inc., a joint venture affiliated company engaged in
membrane manufacture. The Company's guaranty will expire on December 3, 2003,
and it is anticipated that the Company will reissue or extend its guaranty at
that time.
-13-
Warranty Obligations
The Company's products generally include warranty obligations and the related
estimated costs are included in cost of sales when revenue is recognized. While
the Company engages in extensive product quality programs and processes, the
Company's estimated costs to satisfy its warranty obligations are based upon
historical product failure rates and the costs incurred in correcting such
product failures. If actual product failure rates or the costs associated with
fixing such product failures differ from historical rates, adjustments to the
warranty obligations may be required in the period in which determined. The
changes in accrued warranty obligations for the nine months ended September 30,
2003 are as follows:
(Amounts in thousands)
For the nine months ended
September 30,
2003
-------------
Balance at December 31, 2002 $ 1,067
Accruals for warranties issued during the period 1,212
Accruals related to pre-existing warranties 198
Settlements made (in cash or in kind) during the period (1,195)
-------------
Balance at September 30, 2003 $ 1,282
=============
9. Earnings Per Share (EPS)
The effect of dilutive stock options excludes those stock options for which the
impact was antidilutive based on the exercise price of the options. The number
of options that were antidilutive for the three and nine months ended September
30, 2002 were 1,824,017 and 1,444,467, respectively. All options outstanding are
antidilutive for the three and nine months ended September 30, 2003 based on the
Company's net loss.
(Amounts in thousands, except per share amounts)
For the three months ended September 30,
-------------------------------------------------------------------------------------------
2003 2002
---------------------------------------------- -----------------------------------------
(Loss) Income (Loss) Income
from Continuing Per Share from Continuing Per Share
Operations Shares Amount Operations Shares Amount
---------- ------ ------ ---------- ------ ------
Basic EPS
(Loss) income from continuing
operations available to
common stockholders $ (18,305) 17,699 $ (1.03) $ 387 17,552 $ 0.02
Effect of dilutive
stock options - - - - 45 -
-------------- ------------ ------------ ------------ ------------- ----------
Diluted EPS $ (18,305) 17,699 $ (1.03) $ 387 17,597 0.02
============== ============ ============ ============ ============= ==========
For the nine months ended September 30,
-------------------------------------------------------------------------------------------
2003 2002
---------------------------------------------- -----------------------------------------
(Loss) Income (Loss) Income
from Continuing Per Share from Continuing Per Share
Operations Shares Amount Operations Shares Amount
-------------- ------------ ------------ ------------ ------------- ----------
Basic EPS
(Loss) income from continuing
operations available to
common stockholders $ (20,078) 17,607 $ (1.14) $ 3,002 17,537 $ 0.17
Effect of dilutive
stock options - - - - 157 -
-------------- ------------ ------------ ------------ ------------- ----------
Diluted EPS $ (20,078) 17,607 $ (1.14) $ 3,002 17,694 $ 0.17
============== ============ ============ ============ ============= ==========
-14-
10. Comprehensive (Loss) Income
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income," which
establishes standards for the reporting and display of comprehensive income and
its components. The table below sets forth comprehensive income (loss) as
defined by SFAS No. 130 for the three and nine month periods ended September 30,
2003 and 2002.
(Amounts in thousands)
Three months ended Nine months ended
September 30, September 30,
-------------------------------- -------------------------------
2003 2002 2003 2002
(as restated) (as restated)
-------------- ---------------- -------------- -------------
Net (loss) income $ (22,032) $ 359 $ (26,380) $ 3,103
Other comprehensive income,
net of tax:
Change in value of foreign exchange
contracts designated as cash flow hedges (6) - 480 -
Translation adjustments 875 1,848 7,968 6,324
-------------- ------------ -------------- -------------
Comprehensive (loss) ncome $ (21,163) $ 2,207 $ (17,932) $ 9,427
============== ============ ============== =============
11. Segment Information
The Company has four reportable segments corresponding to a "business group"
structure. The following table summarizes the Company's operations by the four
business group segments and "Corporate." Corporate includes legal and research
and development expenses not allocated to the business groups, certain corporate
administrative and insurance costs, foreign exchange gains and losses on
corporate assets, as well as the elimination of intersegment transfers.
For the three months ended September 30, 2003
----------------------------------------------------
Equipment Ultrapure Consumer Instrument
Business Water Water Business
Group Group Group Group Corporate Total
-------- ------- ------- -------- --------- -----
(Amounts in thousands)
Revenue - unaffiliated $ 39,272 $ 26,662 $ 6,447 $ 7,112 $ - $ 79,493
Revenue - affiliated 10,997 - 76 62 - 11,135
Inter-segment transfers 1,656 383 44 557 (2,640) -
Gross profit - unaffiliat 4,302 5,101 1,955 4,085 - 15,443
Gross profit - affiliated 1,491 - 38 31 - 1,560
Restructuring and impairment
of long-lived assets 3,450 875 77 - 595 4,997
Impairment of goodwill 8,981 3,750 - - - 12,731
Equity (loss) income (181) - 210 - 14 43
(Loss) income from continuing
operations before interest, gain
on sale, income tax and minority
interest expense (17,060) (6,006) (3,198) 875 (1,809) (27,198)
Interest income 679
Interest expense (254)
(Loss) from continuing operations
before gain on sale, income tax
and minority interest expense (26,773)
-15-
For the three months ended September 30, 2002
----------------------------------------------------
Equipment Ultrapure Consumer Instrument
Business Water Water Business
Group Group Group Group Corporate Total
-------- ------- ------- -------- ---------- ------
(Amounts in thousands)
Revenue - unaffiliated $ 41,437 $ 25,169 $ 6,559 $ 6,990 $ - $ 80,155
Revenue - affiliated 3,252 - 9 69 - 3,330
Inter-segment transfers 349 269 - 530 (1,148) -
Gross profit - unaffiliat 9,945 5,131 3,361 4,007 - 22,444
Gross profit - affiliated 315 - 4 34 - 353
Equity income (loss) 330 - 222 - 170 722
Income (loss) from continuing
operations before interest, income
taxes and minority interest expense 1,656 (887) (783) 1,018 (311) 693
Interest income 807
Interest expense (338)
Income from continuing operations
before income taxes and minority
interest expense 1,162
For the nine months ended September 30, 2003
----------------------------------------------------
Equipment Ultrapure Consumer Instrument
Business Water Water Business
Group Group Group Group Corporate Total
-------- ------- ------- -------- ---------- ------
(Amounts in thousands)
Revenue - unaffiliated $ 109,386 $ 75,526 $ 17,880 $ 21,671 $ - $ 224,463
Revenue - affiliated 35,609 - 168 141 - 35,918
Inter-segment transfers 5,601 1,100 48 1,670 (8,419) -
Gross profit - unaffiliated 22,399 17,099 8,359 2,521 - 60,378
Gross profit - affiliated 4,799 - 91 70 - 4,960
Restructuring and impairment
of long-lived assets 3,450 875 77 - 595 4,997
Impairment of goodwill 8,981 3,750 - - - 12,731
Equity (loss) income (3,118) - 608 - (290) (2,800)
(Loss) income from continuing
operations before interest, gain
on sale, income tax and minority
interest expense (16,124) (6,184) (4,103) 2,454 (6,500) (30,457)
Interest income 2,221
Interest expense (741)
(Loss) from continuing operations
before gain on sale, income tax
and minority interest expense (28,977)
Identifiable assets 293,391 131,503 101,701 33,512 11,359 571,466
Investment in affiliated companies 15,630 - 2,482 - 1,806 19,918
Goodwill 2,841 3,782 862 - - 7,485
Other intangible assets 1,027 826 4,964 324 - 7,141
For the nine months ended September 30, 2002
----------------------------------------------------
Equipment Ultrapure Consumer Instrument
Business Water Water Business
Group Group Group Group Corporate Total
-------- ------- ------- -------- ---------- ------
(Amounts in thousands)
Revenue - unaffiliated $ 112,430 $ 75,354 $ 18,739 $ 20,344 $ - $ 226,867
Revenue - affiliated 8,646 - 12 364 - 9,022
Inter-segment transfers 3,901 580 - 1,642 (6,123) -
Gross profit - unaffiliated 28,763 17,705 10,295 12,024 - 68,787
Gross profit - affiliated 540 - 6 182 - 728
Equity income (loss) 1,675 7 725 - (11) 2,396
Income (loss) from continuing
operations before interest, income
taxes and minority interest expense 5,979 (1,603) (3,740) 3,032 1,232 4,900
Interest income 2,668
Interest expense (1,274)
Income (loss) from continuing
operations before interest, income
taxes and minority interest expense 6,294
Identifiable assets 321,550 139,705 52,256 30,198 36,340 580,049
Investment in affiliated companies 17,236 - 2,829 - 2,580 22,645
Goodwill 11,519 7,059 862 - - 19,440
Other intangible assets 957 767 95 300 - 2,119
-16-
12. Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
143, "Accounting for Obligations Associated with the Retirement of Long-Lived
Assets." SFAS No. 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS No. 143 is
effective for financial statements for fiscal years beginning after June 15,
2002. The adoption of SFAS No. 143 did not have a material impact on the
Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities." SFAS 146 addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that were previously accounted
for under Emerging Issues Task Force ("EITF") No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurrent in a Restructuring)." The scope of SFAS 146
also includes costs related to terminating a contract that is not a capital
lease and termination benefits that employees who are involuntarily terminated
receive under the terms of a one-time benefit arrangement that is not an ongoing
benefit arrangement or an individual deferred compensation contract. The Company
applied the provisions of SFAS 146 effective for exit or disposal activities
initiated during the quarter ended September 30, 2003. The adoption of SFAS 146
changes, on a prospective basis, the timing of recording restructuring charges
from the commitment date to when a liability is determined to have been
incurred.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" which amended SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based compensation. It also amends the disclosure
provisions to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The provisions of SFAS No. 148 are to be applied to
financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS No. 148 did not have an impact on the Company's financial
position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51" (FIN 46). This
interpretation addresses the consolidation of certain variable interest entities
(VIEs) for which a controlling financial interest exists. FIN 46 applies
immediately to financial interests obtained in VIEs after January 31, 2003. It
applies in the first fiscal year or interim period beginning after September 15,
2003, to VIEs in which a financial interest was obtained before February 1,
2003. FIN 46 may be applied prospectively with a cumulative-effect adjustment or
by restating previously issued financial statements with a cumulative-effect
adjustment as of the beginning of the first year restated. The Company has a
financial interest in certain entities that may be considered VIEs under FIN 46.
The Company is currently evaluating the impact of FIN 46 on its Investments in
Affiliated Companies, and if the Company determines that it has a controlling
financial interest in any of these entities, consolidation may be required. The
ultimate effect of adopting FIN 46 on the Company's financial position or
results of operations has not yet been determined.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the accounting guidance on (1) derivative instruments, including
certain derivative instruments embedded in other contracts, and (2) hedging
activities that fall within the scope of SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No. 133
and certain other existing pronouncements to provide for more consistent
reporting of contracts that are derivatives in their entirety or that contain
embedded derivatives that warrant separate accounting. SFAS No. 149 is effective
(1) for contracts entered into or modified after June 30, 2003, with certain
exceptions, and (2) for hedging relationships designated after June 30, 2003.
The guidance is to be applied prospectively. The adoption of this pronouncement
did not have any material impact on the Company's financial position or results
of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS No.150").
This accounting standard establishes standards for classifying and measuring
certain financial instruments with characteristics of both liabilities and
-17-
equity. It requires that certain financial instruments that were previously
classified as equity now be classified as a liability. This accounting standard
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise at the beginning of the first interim period beginning after
June 15, 2003. The adoption of this pronouncement did not have any impact on the
Company's financial position or results of operations.
In May, 2003 the EITF reached a consensus on EITF Issue No. 01-8, Determining
Whether an Arrangement Contains a Lease ("EITF 01-8"). Arrangements or contracts
that traditionally were not viewed as leases may contain features that would
require them to be accounted for under SFAS No. 13, Accounting for Leases. EITF
01-8 is effective July 1, 2003. The adoption of EITF 01-8 did not have an impact
on the Company's financial position or results of operations.
In May 2003, the FASB Emerging Issues Task Force finalized Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables" ("EITF 00-21").
EITF 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it will perform multiple revenue-generating activities.
EITF 00-21 establishes three principles: (a) revenue arrangements with multiple
deliverables should be divided into separate units of accounting; (b)
arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values; and (c) revenue recognition
criteria should be considered separately for separate units of accounting. EITF
00-21 is effective for all arrangements entered into in fiscal periods beginning
after June 15, 2003. The adoption of this pronouncement did not have any
material impact on the Company's financial position or results of operations.
13. Derivative Financial Instruments and Hedging Activity
On December 31, 2002, the Company entered into a series of U.S. dollar/euro
forward foreign exchange contracts with the intent of offsetting the foreign
exchange risk associated with the forecasted revenues related to an ongoing
project. At September 30, 2003, the notional amount of outstanding forward
foreign exchange contracts to exchange U.S. dollars for euros, which were
designated as forecasted cash flow hedging instruments, was $8.3 million. The
fair values of the forward contracts, based upon dealer quotations, are recorded
as components of other current assets or other current liabilities, depending
upon the amount of the valuation. At September 30, 2003, the fair value of these
forward contracts of $0.5 million was recorded as a component of other current
assets. The net unrealized gain of $0.5 million on the forward contracts that
qualified as cash-flow hedging instruments was included in accumulated other
comprehensive income. The Company expects these instruments to affect earnings
over the next eighteen months. To the extent that any portion of the hedge is
determined to be ineffective, the related gain or loss is required to be
included in income currently. For the nine months ended September 30, 2003, the
Company recognized a gain of approximately $0.1 million related to the
ineffective portion of its forecasted cash flow hedge.
At September 30, 2003, the Company had also entered into U.S. dollar/Taiwan
dollar foreign forward exchange contracts to hedge the balance sheet exposure
related to an intercompany loan. At September 30, 2003, the notional amount of
outstanding forward contracts to exchange Taiwan dollars for U.S. dollars, which
were designated as fair value hedging instruments, was $1.5 million. The fair
values of these forward contracts, based upon dealer quotations, are recorded as
components of other current assets or current liabilities, depending on the
amount of the valuation. At September 30, 2003, the fair value of these hedging
instruments, which was immaterial, was recorded as a component of other current
assets. The net unrealized loss on the instruments, which was immaterial, was
recorded in selling, general and administrative expenses.
14. Acquisitions and Divestures
Acquisitions
On July 29, 2003, the Company completed the acquisition of substantially all of
the assets of CoolerSmart LLC ("CoolerSmart"), a limited liability company in
the business of leasing point-of-use "bottleless" water coolers to commercial
customers, primarily in the mid-Atlantic region of the United States for
approximately $7 million in cash, subject to future adjustments based on changes
from the represented net asset value and number of active customer accounts.
This acquisition allows the Company to enter the domestic point-of-use
"bottleless" water cooler market. This acquisition has been accounted for under
the purchase method of accounting and the provisions of SFAS No. 141 and,
accordingly, the purchase price has been allocated to the assets acquired based
on their estimated fair values at the date of acquisition. The assets acquired
consist primarily of coolers, customer contracts, motor vehicles, accounts
receivable, and other tangible and intangible assets. The Company also assumed
certain liabilities of CoolerSmart incurred in the ordinary course of business.
The purchase price has been allocated to current assets of $0.5 million,
tangible long-lived assets of $2.5 million and identifiable intangible assets of
$5.0 million, based on estimated fair market values of those assets and assumed
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liabilities of $0.9 million. The weighted average amortization period for the
acquired intangibles is approximately eight years. The results of operations of
CoolerSmart have been included in the Company's statement of operations in the
Consumer Water Group segment from the date of acquisition. Pro forma results of
operations have not been presented, as the effect of this acquisition on the
financial statements was not material to the Company's results of operations.
Divestures
On December 31, 2001, the Company completed the sale of its Aqua Cool Pure
Bottled Water operations in the United States, United Kingdom and France to
affiliates of Perrier-Vittel S.A., a subsidiary of Nestle S.A. ("Nestle"). The
purchase price set forth in the divestiture agreement was approximately $220
million, of which $10 million was deposited in escrow pursuant to the terms of
the divestiture agreement. The amount of the purchase price was subject to
adjustment based on the final number of customers and working capital levels of
the transferred businesses, in each case as determined in accordance with the
divestiture agreement. As of December 31, 2001, the Company's accrued
liabilities included estimates of loss contingencies of approximately $17
million, representing management's best estimate of the Company's liability for
final adjustments to the purchase price based on the number of qualifying
customers. Prior to the date of the audit report issued by the Company's
independent auditors and the filing of the Company's financial statements for
the year ended December 31, 2002, the Company and Nestle reached agreement as to
the amount of purchase price adjustments and other claims made by Nestle.
Pursuant to that agreement, the $10 million held in escrow (plus accumulated
interest) was delivered to Nestle and the Company paid Nestle an additional $2.9
million in cash as of March 31, 2003. Because that agreement provided additional
evidence with respect to conditions that existed at the date of the balance
sheet and provided for the ultimate resolution of the loss contingency estimate,
the Company recorded a $14.1 million reduction in the accrued liabilities
referenced above in the fourth quarter of 2002, reflecting the final agreement
as to the number of qualifying customers and the settlement of other claims. In
addition, the Company recorded a $3.4 million charge related to bonuses for
management and certain other employees, and a $2.5 million charge for
incremental transaction costs. The $3.4 million bonus amount had not been
recorded prior to the fourth quarter of 2002 because the bonus payments related
directly to the Aqua Cool sale were contingent upon the final resolution of the
purchase price adjustments, and could not be determined until the purchase price
adjustments had been finally determined. The net result of these items was the
recognition of approximately $8.2 million of pre-tax gain in the fourth quarter
of 2002. After finalization of transaction and employee compensation costs, the
Company recorded an additional pretax gain of $0.5 million in the third quarter
of 2003.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the consolidated financial
statements and the related notes thereto included elsewhere in this Form 10-Q
and the audited consolidated financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in our Annual Report on Form 10-K for the year ended
December 31, 2002, which has been filed with the Securities and Exchange
Commission.
The Company's critical accounting policies and estimates remain as described in
the Annual Report on Form 10-K for the year ended December 31, 2002. These
policies and estimates include the following clarification of the Company's
accounting for its equity method income and loss on its equity investment in
Desalination Company of Trinidad and Tobago Ltd. ("Desalcott"). With respect to
the Company's investment in Desalcott, in recognition of the fact that the
Company has provided all of the cash equity funding for Desalcott, the Company
has concluded that it would not be appropriate to recognize equity method losses
based solely on its ownership interest in Desalcott. The Company holds 200
ordinary shares of Desalcott, representing a 40% ownership interest. The Company
also loaned $10 million to Hafeez Karamath Engineering Services, Ltd. ("HKES"),
the founder of Desalcott and promoter of the Trinidad desalination project, to
enable HKES to acquire 200 ordinary shares of Desalcott and thereby raise its
existing equity interest in Desalcott from 100 to 300 ordinary shares. As a
result, the Company currently owns a 40% equity interest in Desalcott, and HKES
currently owns a 60% equity interest in Desalcott. In addition, the Company made
a $10 million loan to Desalcott in the third quarter of 2003 as an additional
source of long-term financing. Accordingly, based on its aggregate economic
interests in Desalcott, the Company records 100% of any net loss reported by
Desalcott and 40% of any net income reported by Desalcott. In periods in which
Desalcott has an accumulated loss (as opposed to retained earnings), the Company
records 100% of any net income of Desalcott up to the amount of Desalcott's
accumulated loss, and 40% of any net income reported thereafter by Desalcott.
The following discussion and analysis describes material changes in the
Company's financial condition since December 31, 2002. The analysis of results
of operations compares the three- and nine-month periods ended September 30,
2003 with the comparable periods of the prior fiscal year.
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Overview
The Company is a leading water purification company engaged worldwide in the
supply of water and related activities and the supply of water treatment
equipment through the use of proprietary separations technologies and systems.
The Company's products and services are used by the Company or its customers to
desalt brackish water and seawater, recycle and reclaim process water and
wastewater, to treat water in the home, to manufacture and supply water
treatment chemicals and ultrapure water, to process food products, and to
measure levels of waterborne contaminants and pollutants. The Company's
customers include industrial companies, consumers, municipalities and other
governmental entities and utilities. The following discussion and analysis of
financial condition and results of operations refers to the activities of the
Company's four business groups, which comprise the Company's reportable
operating segments. These groups are the Equipment Business Group (EBG),
Ultrapure Water Group (UWG), Consumer Water Group (CWG) and Instrument Business
Group (IBG). Within the existing business group structure, the Company has
instituted a matrix-type organization which became effective at the beginning of
2002. Within each business group, the Company has begun to focus on "centers of
excellence," which represent the application of treatment or separation
technologies contained in The Ionics Toolbox(R) to solve certain application
problems. These centers of excellence include desalination, reuse, surface
water, microelectronics, pharmaceuticals and instruments, among others, and each
represents a range of technology solutions to solve a related applications
problem. The Company utilizes its water treatment and liquids separation
expertise by employing its own proprietary products and other commodity products
in the best integrated combination to solve customers' application problems.
The EBG segment provides products and services for seawater and brackish water
desalination, water reuse and recycle, surface water treatment, and zero liquid
discharge. Significant factors influencing the desalination market include
worldwide water shortages, the need for better quality water in many parts of
the world, and the reduced cost of operating modern desalination facilities.
These factors have driven a trend toward larger plants, and toward the purchase
of water supply and operating and maintenance contracts. Trends impacting the
water reuse and recycle market are similar, with membrane technology becoming
proven in reuse and recycling applications. The surface water market has been
influenced primarily by regulatory pressures to reduce contaminants in water
supplies. The use of membrane technology is also becoming more accepted in
surface water applications. The zero liquid discharge market, which consists of
equipment and services for the minimization of liquid waste through such
techniques as evaporation, concentration and crystallization, has been
influenced by regulatory pressures on utilities to eliminate discharge of
process water. The Company believes that it is positioned to be able to compete
successfully in these applications, although it frequently faces substantially
larger competitors.
The UWG segment provides equipment and services for the microelectronics, power,
pharmaceutical, and other industries, where high quality ultrapure (i.e. very
highly purified) water is required for use in production processes, and is
critical to ultimate product quality and yield. The UWG segment has historically
been heavily reliant upon the microelectronics industry, and the continued
softness in that industry has adversely impacted both revenue and profitability.
The UWG segment has been pursuing applications in other markets, such as power,
pharmaceuticals and flat panel display, to lessen its reliance upon the
microelectronics market. The UWG segment has recently begun to engage in water
reuse projects for industrial applications. During the third quarter of 2003, as
part of the Company's restructuring plan, the Company decided to shut down
operations of its Australian subsidiary, Watertec.
The CWG segment provides home water units for the treatment of residential
water. In July 2003, the CWG segment significantly expanded its pilot activities
in the point-of-use "bottleless" water cooler market through the acquisition of
CoolerSmart, LLC (see Note 14 to Notes to Consolidated Financial Statements).
Prior to the divestiture of the Aqua Cool Pure Bottled Water business in the
U.S., U.K. and France on December 31, 2001, it was also engaged in the home and
office delivery market for bottled water. Trends in the consumer water market
include increased consumer awareness of and the need for improved water quality,
and reduced confidence in the quality of existing water supplies. During the
third quarter of 2003, as part of the Company's restructuring plan, the Company
announced plans to divest the Elite Consumer Products division in Ludlow, MA,
and shut down operations of its European Home Water business.
The IBG segment manufactures and sells instruments and related products for the
measurement of impurities in water. The segment serves the pharmaceutical,
microelectronics and power markets where the measurement of water quality,
including levels and types of contaminants in process water, is critical to
production processes. The IBG segment has established a strong position in the
pharmaceutical industry, providing products and services that facilitate
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compliance with both domestic and foreign regulatory requirements. Like the UWG
segment, the performance of the IBG segment has been impacted by the downturn in
the microelectronics industry, although to a lesser extent than the UWG segment.
The EBG and UWG segments have historically supplied equipment and related
membranes. Starting in the mid-1980's, these groups also began to own and
operate facilities that sell desalted or otherwise treated water directly to
customers under water supply agreements. The revenues and cost of sales
associated with equipment sales are recorded in the revenue and cost of sales
lines on the Company's Consolidated Statement of Operations in the periods in
which the revenues are realized. Equipment contracts are generally accounted for
under the percentage completion accounting method, and the period of time over
which costs are incurred and revenues are realized may vary between six months
and two years, depending on the nature and amount of equipment being supplied.
For water supply agreements, with respect to smaller projects, of which the
Company is the sole owner, the initial cost of the equipment becomes part of the
Company's depreciable fixed asset base, and the revenues and cost of sales
recorded by the Company are those that are associated with the supply of water
under the water supply agreement. These contracts typically vary in length
between 5 and 15 years.
The EBG segment pursues large-scale, long-term water treatment projects,
typically through joint venture project companies in which the Company will hold
a minority ownership interest. Such project companies are formed to own and
operate larger scale desalination, reuse, or other projects in which the Company
may participate in several ways, including: having an ownership interest
(typically a minority interest) in the project company; selling the
desalination, reuse, or other treatment system to the project company; and
providing operating and maintenance services to the project company once the
project facility commences operations. These projects often exceed $100 million
in total cost and may involve multiple equity participants in the project
company. The Company's participation in major projects through a minority
interest in a project company structure generally mitigates the risks of
engaging in such activities, and also provides the Company with potential
long-term equity income from such investments, because these project companies
typically enter into long-term concession agreements with their customers.
On September 3, 2003, the Company announced a restructuring plan intended to
improve financial performance through a realignment of the Company's management
structure, a reduction in personnel, and the consolidation of certain
operations. The program will consolidate the Company's sales, engineering,
manufacturing and accounting functions, which are currently spread among
numerous reporting entities, into several regional centers in the United States,
Europe and Asia. The Company also announced plans to eventually consolidate the
EBG segment and the UWG segment into a single business group and plans to divest
the Elite Consumer Products division in Ludlow, MA, and shut down operations at
the Company's Ionics Watertec facility in Australia and its European Home Water
activities.
Results of Operations
Comparison of the Three Months Ended September 30, 2003 with the Three Months
Ended September 30, 2002
The Company reported consolidated revenues of $90.6 million and a net loss of
$22.0 million for the third quarter of 2003, compared to consolidated revenues
of $83.5 million and net income of $0.4 million for the third quarter of 2002.
Results of the Company's Elite Consumer Products division in Ludlow, MA have
been reclassified to discontinued operations in the Consolidated Statements of
Operations for all periods presented.
Revenues
Total revenues of $90.6 million for the third quarter of 2003 increased $7.1
million, or 8.6%, from revenues of $83.5 million for the third quarter of 2002.
EBG revenues of $39.3 million in the third quarter of 2003 decreased $2.2
million, or 5.2%, compared to revenues of $41.4 million in the third quarter of
2002. The decrease in revenues was primarily attributable to the absence of
revenues in 2003 from several desalination equipment projects that were
completed during the third quarter of 2002 by the Company's Italian subsidiary.
UWG revenues of $26.7 million for the third quarter of 2003 increased $1.5
million, or 5.9%, compared to revenues of $25.2 million for the third quarter of
2002. The increase was primarily attributable to increased revenues from the
Company's Elite Australia division as a result of a warmer-than-expected season,
which caused increased demand for the Company's bulk hypochlorite product.
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CWG revenues of $6.4 million for the third quarter of 2003 decreased $0.1
million, or 1.7%, compared to revenues of $6.6 million for the third quarter of
2003. Revenue for the third quarter of 2003 included $0.7 million associated
with the Company's CoolerSmart point-of-use business, which was acquired in July
2003. Also, results associated with the Company's Elite Consumer Products
division in Ludlow, MA, have been reclassified to discontinued operations for
all periods presented.
IBG revenues of $7.1 million in the third quarter of 2003 increased $0.1
million, or 1.7%, compared to revenues of $7.0 million in the second quarter of
2002.
Revenues from sales to affiliated companies of $11.1 million in the third
quarter of 2003 increased $7.8 million compared to revenues from affiliated
companies of $3.3 million in the third quarter of 2002. The increase in revenues
from affiliated companies primarily resulted from the sale of capital equipment
to the Company's Kuwait joint venture company, Utilities Development Company
W.L.L. ("UDC"), for the Kuwait wastewater treatment project.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or "build, own and operate"
(BOO) contracts. The Company believes that the remaining duration on its
existing sale of equipment contracts ranges from less than one year to three
years and the remaining duration on its existing BOO contracts ranges from one
year to 25 years. The time to completion of any of these contracts, however, is
subject to a number of variables, including the nature and provisions of the
contract and the industry being served. Historically, as contracts are
completed, the Company has entered into new contracts with the same or other
customers. In the past, the completion of any one particular contract has not
had a material effect on the Company's business, results of operations or cash
flows.
Cost of Sales
The Company's total cost of sales as a percentage of total revenue was 81.2% in
the third quarter of 2003 compared to cost of sales as a percentage of total
revenue of 72.7% for the third quarter of 2002. Accordingly, the resulting gross
margin decreased to 18.8% in the third quarter of 2003 compared to 27.3% in the
third quarter of 2002.
EBG's cost of sales as a percentage of revenue increased to 89.0% in the third
quarter of 2003 from 76.0% in the third quarter of 2002. The increase in cost of
sales as a percentage of revenue related primarily to $4.8 million of costs
recorded during the third quarter of 2003 to retrofit certain components of the
Company's demineralization systems.
UWG's cost of sales as a percentage of revenue increased to 80.9% in the third
quarter of 2003 from 79.6% in the third quarter of 2002. The increase in cost of
sales as a percentage of revenue primarily reflects the write-off of inventory
as a result of the Company's decision to shut down operations in its Watertec
business in Australia.
CWG's cost of sales as a percentage of revenue increased to 69.7% in the third
quarter of 2003 from 48.8% in the third quarter of 2002. The increase in the
2003 cost of sales as a percentage of revenue primarily reflects the write-off
of $1.7 million of inventory as a result of the Company's decision to shut down
operations in its European Home Water business.
IBG's cost of sales as a percentage of revenue remained flat at 42.6% in the
third quarter of 2003 in comparison to 42.7% in the third quarter of 2002.
Cost of sales to affiliated companies as a percentage of revenue decreased to
86.0% in the third quarter of 2003 from 89.4% in the third quarter of 2002. The
decrease in the third quarter of 2003 was primarily due to lower revenues from
sales to the Company's affiliate, Desalination Company of Trinidad and Tobago
Ltd. ("Desalcott"). All intercompany profit on sales to Desalcott has been
deferred. The decrease in costs of sales as a percentage of revenues was also
due to the increase in equipment sales to UDC, for which the Company defers
intercompany profit equal to its 25% equity ownership in UDC.
Operating Expenses
Research and development expenses increased 10.3% or $0.2 million during the
third quarter of 2003 compared to the third quarter of 2002. The Company
currently expects to continue to invest in new products and technologies at
approximately the same level as in prior quarters.
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Selling, general and administrative expenses increased $3.5 million to $24.7
million in the third quarter of 2003 from $21.2 million in the third quarter of
2002. The increase in selling, general and administrative costs in the third
quarter of 2003 compared to the third quarter of 2002 was attributable to
several factors, including increased pension costs of approximately $0.4 million
due to plan amendments and changes in plan assumptions, and increased
professional services fees of approximately $0.8 million. The Company also
incurred charges of approximately $0.8 million for the write-down of a
receivable that is currently in litigation, as well as incremental bad debt
expense of $0.4 million associated with the Company's decision to shut down
operations of the European Home Water business and $0.3 million of bad debt
expense associated with the shutdown of operations of the Company's Watertec
business in Australia.
Restructuring and Impairment of Long-Lived Assets On September 3, 2003, the
Company announced a restructuring plan intended to improve financial performance
through a realignment of the Company's management structure, a reduction in
personnel, and the consolidation of certain operations. The program will
consolidate the Company's sales, engineering, manufacturing and accounting
functions, which are currently spread among numerous reporting entities, into
several regional centers in the United States, Europe and Asia. The Company also
announced plans to eventually consolidate the Equipment Business Group segment
("EBG") and the Ultrapure Water Group segment ("UWG") into a single business
group and plans to divest the Elite Consumer Products division in Ludlow, MA,
and shut down operations at the Company's Ionics Watertec facility in Australia
and its European Home Water activities.
As a result of the above decisions, the Company recorded restructuring charges
of approximately $2.5 million in the third quarter of 2003 relating to employee
severance costs for the elimination of approximately 150 positions. At September
30, 2003, substantially all of the employees whose employment was terminated as
a result of these restructuring activities had left the Company. At September
30, 2003, the Company has approximately $1.6 million accrued for restructuring
costs associated with employee severance arrangements and expects the remainder
of the payments to be made during the fourth quarter of 2003.
During the third quarter of 2003, the Company recorded an impairment charge
relating to production equipment within the EBG segment that it had previously
expected to operate for a manufacturer of lactic acid in the food industry under
a build-own-operate contract. During the third quarter, the Company's customer
began the process of filing for bankruptcy protection. Accordingly, the Company
recorded a pre-tax asset impairment charge of approximately $2.5 million
associated with the remaining carrying value of the equipment as the Company
does not expect to recover the asset or receive any future payments.
Impairment of Goodwill
SFAS No. 142, "Goodwill and Other Intangible Assets," provides that goodwill of
a reporting unit be tested for impairment on an annual basis and between annual
tests in certain circumstances including a significant adverse change in the
business outlook. During the third quarter of 2003, as a result of significant
changes in business outlook which resulted in the Company's restructuring
program, the Company conducted an interim impairment test of the goodwill
related to certain of its reporting units as of September 30, 2003. Based upon
its preliminary assessment, the Company concluded that the carrying value of the
assets and liabilities associated with its RCC, Ahlfinger and Separatech
reporting units exceeded their fair value and accordingly recorded a $12.7
million goodwill impairment charge ($6.8 million at RCC, $3.7 million at
Ahlfinger and $2.2 million at Separatech). The impairment charge, representing
the entire goodwill balance for these reporting units, was estimated by
comparing the implied fair value of the goodwill associated with these reporting
units to their carrying values. Adjustments, if any, arising from the
finalization of the reporting units' valuation for purposes of goodwill
impairment testing will be recorded during the fourth quarter of 2003. The fair
value of the reporting units was estimated utilizing the expected present value
of future cash flows.
Interest Income and Interest Expense
Interest income totaled $0.7 million in the third quarter of 2003 compared to
$0.8 million in the third quarter 2002. Interest expense was $0.3 million in the
third quarter of 2003 compared to $0.3 million in the third quarter of 2002.
Equity (Loss) Income
Equity income from affiliated companies totaled $43,000 in the third quarter of
2003 compared to equity income in the third quarter of 2002 of $0.7 million. The
Company's equity income is derived primarily from its 20% equity interest in a
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Mexican joint venture company, its 40% equity interest in Desalcott, its equity
interests in several joint ventures in the Middle East, and to a lesser extent
from its other equity investments in affiliated companies. The decrease in
equity income in the third quarter of 2003 compared to the third quarter of 2002
was primarily related to increased losses reported by Desalcott.
Gain on Sale of Aqua Cool
On December 31, 2001, the Company completed the sale of its Aqua Cool Pure
Bottled Water operations in the United States, United Kingdom and France to
affiliates of Perrier-Vittel S.A., a subsidiary of Nestle S.A. ("Nestle"). The
purchase price set forth in the divestiture agreement was approximately $220
million, of which $10 million was deposited in escrow pursuant to the terms of
the divestiture agreement. The amount of the purchase price was subject to
adjustment based on the final number of customers and working capital levels of
the transferred businesses, in each case as determined in accordance with the
divestiture agreement. As of December 31, 2001, the Company's accrued
liabilities included estimates of loss contingencies of approximately $17
million, representing management's best estimate of the Company's liability for
final adjustments to the purchase price based on the number of qualifying
customers. Prior to the date of the audit report issued by the Company's
independent auditors and the filing of the Company's financial statements for
the year ended December 31, 2002, the Company and Nestle reached agreement as to
the amount of purchase price adjustments and other claims made by Nestle.
Pursuant to that agreement, the $10 million held in escrow (plus accumulated
interest) was delivered to Nestle and the Company paid Nestle an additional $2.9
million in cash as of March 31, 2003. Because that agreement provided additional
evidence with respect to conditions that existed at the date of the balance
sheet and provided for the ultimate resolution of the loss contingency estimate,
the Company recorded a $14.1 million reduction in the accrued liabilities
referenced above in the fourth quarter of 2002, reflecting the final agreement
as to the number of qualifying customers and the settlement of other claims. In
addition, the Company recorded a $3.4 million charge related to bonuses for
management and certain other employees, and a $2.5 million charge for
incremental transaction costs. The $3.4 million bonus amount had not been
recorded prior to the fourth quarter of 2002 because the bonus payments related
directly to the Aqua Cool sale were contingent upon the final resolution of the
purchase price adjustments, and could not be determined until the purchase price
adjustments had been finally determined. The net result of these items was the
recognition of approximately $8.2 million of pre-tax gain in the fourth quarter
of 2002. After finalization of transaction and employee compensation costs, the
Company recorded an additional pretax gain of $0.5 million in the third quarter
of 2003.
Income Tax (Benefit) Expense
For the three months ended September 30, 2003, the Company recorded an income
tax benefit of $8.3 million on a consolidated pre-tax loss from continuing
operations before minority interest expense of $26.3 million, yielding an
effective tax rate of 31.4%. For the three months ended September 30, 2002, the
Company recorded income tax expense of $0.5 million on consolidated pre-tax
income from continuing operations before minority interest of $1.2 million,
yielding an effective tax rate of 42.3%. The change in the effective tax rate
for the quarter ended September 30, 2003 compared to the quarter ended September
30, 2002 resulted from changes in the overall level of consolidated pre-tax
profit and the geographic mix of anticipated losses in several foreign
subsidiaries, for which the Company may not be able to realize future tax
benefits.
The Company estimates income taxes in each of the jurisdictions in which it
operates and involves an assessment of permanent and temporary differences
resulting from differing treatment of items for tax and book accounting
purposes. Temporary differences result in deferred tax assets and liabilities,
which are included within the consolidated balance sheet. The Company must also
assess the likelihood that any deferred tax assets will be recovered, and must
establish a valuation allowance to the extent that it believes that it is more
likely than not any deferred tax asset will not be utilized from future taxable
income. Although realizability is not assured, based on the weight of available
evidence, the Company believes it is more likely than not that all remaining
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable is subject to change based on future events, including
generating taxable income in future periods. The Company will continue to assess
the need for the valuation allowance at each balance sheet date based on all
available evidence. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term, and the amount could be material, if
the Company does not generate sufficient taxable income in future periods.
Discontinued Operations On August 14, 2003, the Company's management and Board
of Directors approved a plan of disposition to sell its consumer chemical
business, the Elite Consumer Products division in Ludlow, MA, which is part of
the Company's Consumer Water Group segment. Accordingly, the Company's
consolidated financial statements and notes reflect this business as a
discontinued operation in accordance with Financial Accounting Standards Board
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets."
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The loss from discontinued operations of $3.7 million, or $6.1 million on a
pre-tax basis, recorded in the three months ended September 30, 2003 includes
losses from operations of $0.6 million and an estimated loss on disposal of $5.5
million, reflecting asset impairment charges to write down the carrying value of
these assets to their estimated fair value less costs to sell. The Company
expects to complete the sale within the next twelve months. The loss from
discontinued operations of $6.3 million, or $10.2 million on a pre-tax basis,
recorded for the nine months ended September 30, 2003, includes losses from
operations of $4.7 million and an estimated loss on disposal of $5.5 million,
which includes an asset impairment charge of $4.0 million recorded during the
second quarter attributable to certain sodium hypochlorite manufacturing
equipment.
Net (Loss) Income
The Company's net loss amounted to $22.0 million in the third quarter of 2003
compared to net income of $0.4 million for the third quarter of 2002.
Comparison of the Nine Months Ended September 30, 2003 with the Nine Months
Ended September 30, 2002
The Company reported consolidated revenues of $260.4 million and a net loss of
$26.4 million for the first nine months of 2003 compared to consolidated
revenues of $235.9 million and net income of $3.1 million for the first nine
months of 2002. Results for the Company's majority-owned Malaysian subsidiary,
Enersave, are included in the results for 2002 through the date the subsidiary
was divested in May 2002. Results of the Company's Elite Consumer Products
division in Ludlow, MA, have been reclassified to discontinued operations in the
income statement for all periods presented.
Revenues
Total revenues of $260.4 million for the first nine months of 2003 increased
$24.5 million, or 10.4%, from revenues of $235.9 million for the first nine
months of 2002. Revenues during the first nine months of 2002 included $4.2
million of revenues from the Company's majority owned subsidiary, Enersave,
which was divested in May 2002.
EBG revenues of $109.4 million for the first nine months of 2003 decreased $3.0
million, or 2.7%, compared to revenues of $112.4 million for the first nine
months of 2002. The decrease in revenues was primarily attributable to reduced
revenues from the zero liquid discharge equipment business. This decrease was
partially offset by new sales of capital equipment to several municipalities for
surface water applications.
UWG revenues of $75.5 million for the first nine months of 2003 increased $0.2
million, or 0.2%, compared to revenues of $75.4 million for the first nine
months of 2002. Revenues were primarily impacted by the absence of revenues from
the Company's Enersave subsidiary, which was divested in May 2002, offset by the
growth in UWG's operations in Asia and Australia.
CWG revenues of $17.9 million for the first nine months of 2003 decreased $0.9
million, or 4.6%, compared to revenues of $18.7 million for the first nine
months of 2002. Results associated with the Company's Elite Consumer Products
division in Ludlow, MA, have been reclassified to discontinued operations for
all periods presented (see Note 3).
IBG revenues of $21.7 million for the first nine months of 2003 increased $1.3
million, or 6.5%, compared to revenues of $20.3 million for the first nine
months of 2002. The increase in revenues primarily results from increased sales
to the pharmaceutical industry as well as continued growth in sales of
consumable products and instrument services.
Revenues from sales to affiliated companies of $35.9 million for the first nine
months of 2003 increased $26.9 million compared to revenues from affiliated
companies of $9.0 million for the first nine months of 2002. The increase in
revenues from affiliated companies primarily resulted from the sale of capital
equipment to the Company's Kuwait joint venture company, UDC, for the Kuwait
wastewater treatment project.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or "build, own and operate"
(BOO) contracts. The Company believes that the remaining duration on its
existing sale of equipment contracts ranges from less than one year to three
years and the remaining duration on its existing BOO contracts ranges from one
year to 25 years. The time to completion of any of these contracts, however, is
subject to a number of variables, including the nature and provisions of the
contract and the industry being served. Historically, as contracts are
completed, the Company has entered into new contracts with the same or other
customers. In the past, the completion of any one particular contract has not
had a material effect on the Company's business, results of operations or cash
flows.
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Cost of Sales
The Company's total cost of sales as a percentage of total revenue was 74.9% for
the first nine months of 2003 compared to cost of sales as a percentage of total
revenue of 70.5% for the first nine months of 2002. Accordingly, total gross
margin decreased to 25.1% for the first nine months of 2003 compared to 29.5%
for the first nine months of 2002. Cost of sales as a percentage of total
revenue increased for the first nine months of 2003 compared to the first nine
months of 2002 for all four of the Company's business segments.
EBG's cost of sales as a percentage of revenue increased to 79.5% for the first
nine months of 2003 from 74.4% for the first nine months of 2002. The increase
in cost of sales as a percentage of revenue related primarily to the Company's
decision to retrofit certain components of the Company's demineralization
systems at an estimated cost of $4.8 million. Additionally, the increase in cost
of sales as a percentage of revenue relates to cost overruns associated with
several projects ($0.5 million) as well as legal costs associated with contract
disputes concerning two completed zero liquid discharge projects ($0.5 million).
UWG's cost of sales as a percentage of revenue increased to 77.4% for the first
nine months of 2003 from 76.5% for the first nine months of 2002. The increase
in cost of sales as a percentage of revenue primarily reflects the write-off of
inventory as a result of the Company's decision to shut down operations of its
Watertec business in Australia.
CWG's cost of sales as a percentage of revenue increased to 53.2% for the first
nine months of 2003 from 45.1% for the first nine months of 2002. The increase
in the 2003 cost of sales as a percentage of revenue compared to the 2002 figure
was primarily attributable to the write-off of inventory as a result of the
Company's decision to shut down operations in its European Home Water business.
IBG's cost of sales as a percentage of revenue increased to 42.2% for the first
nine months of 2003 from 40.9% for the first nine months of 2002. The increase
in cost of sales as a percentage of revenue was primarily associated with the
expansion of the field service force and expanded production capacity for
consumable products.
Cost of sales to affiliated companies as a percentage of revenue decreased to
86.2% for the first nine months of 2003 from 91.9% for the first nine months of
2002. The decrease in the cost of sales for the first nine months of 2003 was
primarily due to lower revenues from sales to Desalcott for which all
intercompany profit on sales to Desalcott has been deferred. The decrease in
costs of sales as a percentage of revenues was also due to the increase in
equipment sales to UDC, for which the Company defers intercompany profit equal
to its 25% equity ownership in UDC.
Operating Expenses
Research and development expenses increased 15.1% or $0.7 million during the
first nine months of 2003 compared to the first nine months of 2002. The Company
currently expects to continue to invest in new products and technologies at
approximately the same level as in prior quarters.
Selling, general and administrative expenses increased $7.6 million to $69.8
million for the first nine months of 2003 from $62.2 million for the first nine
months of 2002. The increase in selling, general, and administrative costs for
the first nine months of 2003 compared to the first nine months of 2002 is
attributable to several factors. The Company recorded increased professional
fees of $2.1 million during the first nine months of 2003. The Company also
recorded increased bad debt expense of approximately $2.4 million primarily
relating to charges incurred of $0.8 million for the write-down of a receivable
that is currently in litigation, as well as incremental bad debt expense of $0.4
million associated with the Company's decision to shut down operations of the
European Home Water business and $0.3 million of bad debt expense associated
with the Company's decision to shutdown operations of the Company's Watertec
business in Australia. The Company also incurred increased pension costs of
approximately $1.7 million due to plan amendments and changes in plan
assumptions as well as post-retirement obligations of $0.9 million incurred in
connection with the announced retirement of the Company's former Chief Executive
Officer.
Restructuring and Impairment of Long-Lived Assets
On September 3, 2003, the Company announced a restructuring plan intended to
improve financial performance through a realignment of the Company's management
structure, a reduction in personnel, and the consolidation of certain
operations. The program will consolidate the Company's sales, engineering,
manufacturing and accounting functions, which are currently spread among
numerous reporting entities, into several regional centers in the United States,
Europe and Asia. The Company also announced plans to eventually consolidate the
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Equipment Business Group segment ("EBG") and the Ultrapure Water Group segment
("UWG") into a single business group and plans to divest the Elite Consumer
Products division in Ludlow, MA, and shut down operations at the Company's
Ionics Watertec facility in Australia and its European Home Water activities.
As a result of the above decisions, the Company recorded restructuring charges
of approximately $2.5 million in the third quarter of 2003 relating to employee
severance costs for the elimination of approximately 150 positions. At September
30, 2003, substantially all of the employees whose employment was terminated as
a result of these restructuring activities had left the Company. At September
30, 2003, the Company has approximately $1.6 million accrued for restructuring
costs associated with employee severance arrangements and expects the remainder
of the payments to be made during the fourth quarter of 2003.
During the third quarter of 2003, the Company recorded an impairment charge
relating to production equipment within the EBG segment that it had previously
expected to operate for a manufacturer of lactic acid in the food industry under
a build-own-operate contract. During the third quarter, the Company's customer
began the process of filing for bankruptcy protection. Accordingly, the Company
recorded a pre-tax asset impairment charge of approximately $2.5 million
associated with the remaining carrying value of the equipment as the Company
does not expect to recover the asset or receive any future payments.
Impairment of Goodwill
SFAS No. 142, "Goodwill and Other Intangible Assets," provides that goodwill of
a reporting unit be tested for impairment on an annual basis and between annual
tests in certain circumstances including a significant adverse change in the
business outlook. During the third quarter of 2003, as a result of significant
changes in business outlook which resulted in the Company's restructuring
program, the Company conducted an interim impairment test of the goodwill
related to certain of its reporting units as of September 30, 2003. Based upon
its preliminary assessment, the Company concluded that the carrying value of the
assets and liabilities associated with its RCC, Ahlfinger and Separatech
reporting units exceeded their fair value and accordingly recorded a $12.7
million goodwill impairment charge ($6.8 million at RCC, $3.7 million at
Ahlfinger and $2.2 million at Separatech). The impairment charge, representing
the entire goodwill balance for these reporting units, was estimated by
comparing the implied fair value of the goodwill associated with these reporting
units to their carrying values. Adjustments, if any, arising from the
finalization of the reporting units' valuation for purposes of goodwill
impairment testing will be recorded during the fourth quarter of 2003. The fair
value of the reporting units was estimated utilizing the expected present value
of future cash flows.
Interest Income and Interest Expense
Interest income totaled $2.2 million for the first nine months of 2003 compared
to $2.7 million for the first nine months of 2002. Interest expense was $0.7
million for the first nine months of 2003 compared to $1.3 million for the first
nine months of 2002.
Equity (Loss) Income
Equity losses in affiliated companies totaled to $2.8 million for the first nine
months of 2003 compared to equity income of $2.4 million for the first nine
months of 2002. The Company's equity income is derived primarily from its 20%
equity interest in a Mexican joint venture company, its 40% equity interest in
Desalcott, its equity interests in several joint ventures in the Middle East,
and to a lesser extent from its other equity investments in affiliated
companies. The decrease in equity income of $5.2 million for the first nine
months of 2003 compared to the first nine months of 2002 was primarily related
to increased losses reported by Desalcott. Desalcott's losses were primarily a
result of management fees and costs associated with the close of long-term
financing and the settlement of the construction contract dispute (see Note 8),
as well as development costs associated with investigating potential new
projects in Trinidad.
Gain on Sale of Aqua Cool
On December 31, 2001, the Company completed the sale of its Aqua Cool Pure
Bottled Water operations in the United States, United Kingdom and France to
affiliates of Perrier-Vittel S.A., a subsidiary of Nestle S.A. ("Nestle"). The
purchase price set forth in the divestiture agreement was approximately $220
million, of which $10 million was deposited in escrow pursuant to the terms of
the divestiture agreement. The amount of the purchase price was subject to
adjustment based on the final number of customers and working capital levels of
the transferred businesses, in each case as determined in accordance with the
divestiture agreement. As of December 31, 2001, the Company's accrued
liabilities included estimates of loss contingencies of approximately $17
million, representing management's best estimate of the Company's liability for
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final adjustments to the purchase price based on the number of qualifying
customers. Prior to the date of the audit report issued by the Company's
independent auditors and the filing of the Company's financial statements for
the year ended December 31, 2002, the Company and Nestle reached agreement as to
the amount of purchase price adjustments and other claims made by Nestle.
Pursuant to that agreement, the $10 million held in escrow (plus accumulated
interest) was delivered to Nestle and the Company paid Nestle an additional $2.9
million in cash as of March 31, 2003. Because that agreement provided additional
evidence with respect to conditions that existed at the date of the balance
sheet and provided for the ultimate resolution of the loss contingency estimate,
the Company recorded a $14.1 million reduction in the accrued liabilities
referenced above in the fourth quarter of 2002, reflecting the final agreement
as to the number of qualifying customers and the settlement of other claims. In
addition, the Company recorded a $3.4 million charge related to bonuses for
management and certain other employees, and a $2.5 million charge for
incremental transaction costs. The $3.4 million bonus amount had not been
recorded prior to the fourth quarter of 2002 because the bonus payments related
directly to the Aqua Cool sale were contingent upon the final resolution of the
purchase price adjustments, and could not be determined until the purchase price
adjustments had been finally determined. The net result of these items was the
recognition of approximately $8.2 million of pre-tax gain in the fourth quarter
of 2002. After finalization of transaction and employee compensation costs, the
Company recorded an additional pretax gain of $0.5 million in the third quarter
of 2003.
Income Tax (Benefit) Expense
For the nine months ended September 30, 2003, the Company recorded an income tax
benefit of $9.1 million on a consolidated pre-tax loss from continuing
operations before minority interest expense of $28.5 million, yielding an annual
effective tax rate of 31.8%. For the nine months ended September 30, 2002, the
Company recorded income tax expense of $2.6 million on consolidated pre-tax
income from continuing operations before minority interest of $6.3 million,
yielding an annual effective tax rate of 41.1%. The change in the effective tax
rate for the nine months ended September 30, 2003 compared to the nine months
ended September 30, 2002 resulted from changes in the overall level of
consolidated pre-tax profit and the geographic mix of expected losses in several
foreign subsidiaries for which the Company may not be able to realize future tax
benefits.
The Company estimates income taxes in each of the jurisdictions in which it
operates and involves an assessment of permanent and temporary differences
resulting from differing treatment of items for tax and book accounting
purposes. Temporary differences result in deferred tax assets and liabilities,
which are included within the consolidated balance sheet. The Company must also
assess the likelihood that any deferred tax assets will be recovered, and must
establish a valuation allowance to the extent that it believes that it is more
likely than not any deferred tax asset will not be utilized from future taxable
income. Although realizability is not assured, based on the weight of available
evidence, the Company believes it is more likely than not that all remaining
deferred tax assets will be realized. The amount of the deferred tax asset
considered realizable is subject to change based on future events, including
generating taxable income in future periods. The Company will continue to assess
the need for the valuation allowance at each balance sheet date based on all
available evidence. The amount of the deferred tax asset considered realizable,
however, could be reduced in the near term, and the amount could be material, if
the Company does not generate sufficient taxable income in future periods.
Discontinued Operations On August 14, 2003, the Company's management and Board
of Directors approved a plan of disposition to sell its consumer chemical
business, the Elite Consumer Products division in Ludlow, MA, which is part of
the Company's Consumer Water Group segment. Accordingly, the Company's
consolidated financial statements and notes reflect this business as a
discontinued operation in accordance with Financial Accounting Standards Board
Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets."
The loss from discontinued operations of $3.7 million, or $6.1 million on a
pre-tax basis, recorded in the three months ended September 30, 2003 includes
losses from operations of $0.6 million and an estimated loss on disposal of $5.5
million, reflecting asset impairment charges to write down the carrying value of
these assets to their estimated fair value less costs to sell. The Company
expects to complete the sale within the next twelve months. The loss from
discontinued operations of $6.3 million, or $10.2 million on a pre-tax basis,
recorded for the nine months ended September 30, 2003, includes losses from
operations of $4.7 million and an estimated loss on disposal of $5.5 million,
which includes an asset impairment charge of $4.0 million recorded during the
second quarter attributable to certain sodium hypochlorite manufacturing
equipment.
Net (Loss) Income
The Company's net loss amounted to $26.4 million for the first nine months of
2003, compared to net income of $3.1 million for the first nine months of 2002.
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Financial Condition
Net working capital decreased $28.9 million during the first nine months of
2003, while the Company's current ratio, defined as current assets divided by
current liabilities, of 2.7 at September 30, 2003 decreased from 3.0 at December
31, 2002.
At September 30, 2003, the Company had total assets of $591.4 million, compared
to total assets of $608.0 million at December 31, 2002. Cash, cash equivalents
and restricted cash decreased $10.1 million during the first nine months of
2003, primarily reflecting payments of current accounts payable and funding
requirements of the Kuwait wastewater project. At December 31, 2002, the Company
had $4.3 million in restricted cash, reflecting advance payments for work to be
performed on the Kuwait wastewater treatment facility, the restrictions on which
expired during the first quarter of 2003.
Net cash provided by operating activities amounted to $2.1 million during the
first nine months of 2003. The primary sources provided by operating cash flow
during the first nine months of 2003 was the reduction of accounts receivable of
$11.6 million, depreciation and amortization charges of $18.9 million, provision
for losses on accounts and notes receivable of $3.2 million, and impairment of
long-lived assets of $2.5 million. These sources of operating cash were offset
by uses for increased affiliate accounts receivable of $14.4 million, primarily
from continuing work on the Kuwait wastewater project, reductions of deferred
income taxes of $8.5 million, and payments made on accounts payable of $7.8
million.
Net cash used in investing activities amounted to $26.7 million during the first
nine months of 2003, reflecting additions to property, plant and equipment,
primarily related to investments made in the UWG segment for a build, own, and
operate facility in the power industry. The Company currently expects to invest
a proportionate amount in property, plant and equipment during the fourth
quarter of 2003 as compared with the prior quarters of 2003. Also, during the
third quarter of 2003, the Company purchased substantially all of the assets of
CoolerSmart, LLC, a limited liability company in the business of leasing
point-of-use "bottleless" water coolers, for approximately $7 million.
Net cash provided by financing activities totaled $7.2 million during the first
nine months of 2003, primarily reflecting the expiration of the restriction on
the use of cash that existed at December 31, 2002.
Other Commitments and Contingencies
From time to time, the Company enters into joint ventures with respect to
specific projects, including the projects in Trinidad, Kuwait and Israel
described below. Each joint venture arrangement is independently negotiated
based on the specific facts and circumstances of the project, the purpose of the
joint venture company related to the project, as well as the rights and
obligations of the other joint venture partners. Generally, the Company has
structured its project joint ventures so that the Company's obligation to
provide funding to the underlying project or to the joint venture entity is
limited to its proportional capital contribution, which can take the form of
equity or subordinated debt. Except in situations that are negotiated with a
specific joint venture entity as discussed below, the Company has no other
commitment to provide for the joint venture's working capital or other cash
needs. In addition, the joint venture entity typically obtains third-party debt
financing for a substantial portion of the project's total capital requirements.
In these situations, the Company is typically not responsible for the repayment
of the indebtedness incurred by the joint venture entity. In connection with
certain joint venture projects, the Company may also enter into contracts for
the supply and installation of the Company's equipment during the construction
of the project, for the operation and maintenance of the facility once it begins
operation, or both. These commercial arrangements do not require the Company to
commit to any funding for working capital or any other requirements of the joint
venture company. As a result, the Company's exposure with respect to its joint
ventures is typically limited to its debt and equity investments in the joint
venture entity, the fulfillment of any contractual obligations it has to the
joint venture entity and the accounts receivable owing to the Company from the
joint venture entity.
Trinidad
In 2000, the Company acquired 200 ordinary shares of Desalination Company of
Trinidad and Tobago Ltd. ("Desalcott"), for $10 million and loaned $10 million
to Hafeez Karamath Engineering Services Ltd. ("HKES"), the founder of Desalcott
and promoter of the Trinidad desalination project, to enable HKES to acquire an
additional 200 ordinary shares of Desalcott. Prior to those investments, HKES
owned 100 ordinary shares of Desalcott. As a result, the Company currently owns
a 40% equity interest in Desalcott, and HKES currently owns a 60% equity
interest in Desalcott. In the second quarter of 2002, construction was completed
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on the first four (out of five) phases of the Trinidad desalination facility
owned by Desalcott, and the facility commenced water deliveries to its customer,
the Water and Sewerage Authority of Trinidad and Tobago.
The Company's $10 million loan to HKES is included in notes receivable,
long-term in the Company's Consolidated Balance Sheets. The loan bears interest
at a rate equal to 2% above the London Interbank Offered Rate (LIBOR), with
interest payable (subject to availability of funds) starting October 25, 2002
and every six months thereafter and at maturity. Prior to maturity, accrued
interest (as well as principal payments) is payable only to the extent dividends
or other distributions are paid by Desalcott on the ordinary shares of Desalcott
owned by HKES and pledged to the Company. Principal repayment is due in 14 equal
installments commencing on April 25, 2004 and continuing semiannually
thereafter. The loan matures and is payable in full on April 25, 2011. The loan
is secured by a security interest in the shares of Desalcott owned by HKES and
purchased with the borrowed funds, which is subordinate to the security interest
in those shares in favor of the Trinidad bank that provided the financing for
Desalcott. In addition, any dividends or other distributions paid by Desalcott
to HKES on the pledged shares must be applied to loan payments to the Company.
In 2000, Desalcott entered into a "bridge loan" agreement with a Trinidad bank
providing $60 million in construction financing. Effective November 8, 2001, the
loan agreement was amended to increase maximum borrowings to $79.9 million. The
bridge loan of $79.9 million and the $20 million equity provided to Desalcott
did not provide sufficient funds to pay all of Desalcott's obligations in
completing construction and commissioning of the project prior to receipt of
long-term financing in the second quarter of 2003. Consequently, included in
Desalcott's obligations at March 31, 2003 was approximately $30.1 million
payable to the Company's Trinidad subsidiary for equipment and services
purchased in connection with the construction of the facility. However,
Desalcott disputed certain amounts payable under the construction contract. In
June 2003, Desalcott and the Company's Trinidad subsidiary resolved their
dispute under the construction contract, and reached agreement as to the final
amount owing to the Company for completion of the first four phases of the
project. As a result of this agreement, the Company will not realize
approximately $2.7 million of the deferred profit on the construction project,
and therefore reduced the related accounts receivable and deferred revenue
balances by $2.7 million each.
In June 2003, Desalcott entered into a long-term loan agreement with the
Trinidad bank that had provided the bridge loan. In connection with the funding
of the loan, Desalcott paid the Company's Trinidad subsidiary approximately $12
million of outstanding accounts receivable under the construction contract in
July 2003. In addition, pursuant to a previous commitment made by the Company,
the Company, effective July 31, 2003, converted an additional $10 million of
amounts owing under the construction contract into a loan to Desalcott as an
additional source of long-term project financing. That loan has a seven-year
term, and is payable in 28 quarterly payments of principal and interest. The
interest rate is fixed at two percent above the interest rate payable by
Desalcott on the U.S. dollar portion of its borrowings under its long-term loan
agreement with the Trinidadian bank (the initial annual rate on the U.S. dollar
portion was 8 1/2%). In the event of a default by Desalcott, Desalcott's
obligation to the Company is subordinated to Desalcott's obligations to the
Trinidad bank.
As a result of the settlement of the construction contract dispute described
above and Desalcott's $12 million payment to the Company's Trinidad subsidiary,
together with the conversion of an additional $10 million of accounts receivable
into a long-term note receivable as described above, the remaining amount due to
the Company's Trinidad subsidiary from Desalcott for construction work on the
first four phases of the project is approximately $6 million. This amount will
be partially paid out of Desalcott's future cash flow from operations over a
period of time estimated to be two years, and the balance from funds available
from long-term financing proceeds upon completion by the Company of certain
"punch list" items. In addition, Desalcott and the Company agreed that the
Company's Trinidad subsidiary would complete the last phase (phase 5) of the
project (which will increase water production capacity by approximately 9%) for
a fixed price of $7.7 million. Work on phase 5 has commenced and is expected to
be completed in the second quarter of 2004.
Kuwait
During 2001, the Company acquired a 25% equity interest in a Kuwaiti project
company, Utilities Development Company W.L.L. ("UDC"), which was awarded a
concession agreement by an agency of the Kuwaiti government for the
construction, ownership and operation of a wastewater reuse facility in Kuwait.
During the second quarter of 2002, UDC entered into agreements for the long-term
financing of the project, and construction of the project commenced. At
September 30, 2003, the Company had invested a total of $8.3 million as equity
and subordinated debt in UDC. The Company has commitments to make additional
equity investments or issue additional subordinated debt to UDC of approximately
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$7.3 million over the next two years. In addition, a total of $18.8 million in
performance bonds have been issued on behalf of the Company's Italian subsidiary
in connection with the project.
Israel
In 2001, the Company entered into agreements with an Israeli cooperative society
and an Israeli corporation for the establishment of Magan Desalination Ltd.
("MDL") as an Israeli project company in which the Company has a 49% equity
interest. During the second quarter of 2003, the Israeli cooperative society and
the Company acquired the ownership interest of the Israeli corporation in MDL.
On June 17, 2003, MDL finalized a concession contract originally entered into in
August 2002 with a state-sponsored water company for the construction, ownership
and operation of a brackish water desalination facility in Israel. In June 2003,
MDL obtained $8 million of debt financing for the project from an Israeli bank,
and the Company has guaranteed repayment of 49% of the loan amount in the form
of a bank letter of guarantee. In July 2003, the Company through its Israeli
subsidiary made an equity investment of $1.5 million in MDL for its 49% equity
interest. This project is scheduled to be completed in the first half of 2004.
In January 2002, the Company entered into agreements with two Israeli
corporations giving the Company the right to a one-third ownership interest in
an Israeli project company, Carmel Desalination Ltd. ("CDL"). On October 28,
2002, CDL was awarded a concession agreement by the Israeli Water Desalination
Agency ("WDA") (established by the Ministry of Finance and the Ministry of
Infrastructure) for the construction, ownership and operation of a major
seawater desalination facility in Israel. At December 31, 2002, the Company made
an equity investment of $0.2 million in CDL. Additionally, at September 30, 2003
the Company had deferred costs of approximately $0.6 million relating to the
engineering design and development work on the project. If CDL obtains long-term
project financing, the Company has committed to make additional equity
investments to CDL of approximately $9.7 million. The timing and amount of such
investments will depend upon the terms of the long-term financing agreement. The
terms of the concession agreement originally required that long-term financing
be obtained by April 2003. CDL was granted an extension to August 20, 2003 and a
request for a further extension to obtain such financing has been submitted to
the WDA for approval. Although the Company currently anticipates that CDL will
obtain long-term financing for the project, if CDL is unable to obtain such
financing, the Company would expense its deferred costs relating to the
construction project and its investment in CDL (estimated to be approximately
$0.8 million by the time of the closing of the long-term financing).
Additionally, the Company could incur its one-third proportionate share ($2.5
million) of liability under a $7.5 million performance bond issued on behalf of
CDL. In August 2003, the Company entered into an agreement with the two other
equity participants in CDL, which would permit one of them to withdraw from the
project subject to the approval of the WDA. Should the withdrawal of the partner
be approved by the WDA, the Company's equity interest in CDL would increase from
one-third to 50%, proportionately increasing its obligation under the
performance bond, as well as increasing its required equity investment in the
project to approximately $15 million.
In August 2003, a 50/50 joint venture between the Company and an Israeli
engineering corporation was selected by Mekorot, the Israeli state-sponsored
water company, to design, supply and construct a 123,000 cubic meter per day
(32.5 million gallons per day) seawater desalination facility in Ashdod, Israel.
The estimated amount of the equipment supply and construction contract to be
negotiated and entered into with respect to the project is approximately $95
million, and it is estimated that the plant will require approximately two years
to complete. The joint venture submitted a $5 million bid bond with its
proposal, and the Company would be responsible for 50% of this amount if a
demand were made on the bid bond. It is currently anticipated that the parties
will sign a final form of contract in the first quarter of 2004, at which time
the joint venture will replace the bid bond with a performance bond in the
principal amount of 10% of the contract value.
Algeria
On October 18, 2003 the Algerian Energy Company (AEC) publicly declared the
Company as the selected bidder for a twenty-five year seawater desalination
build-own-operate (BOO) project. The Company and AEC intend to form a joint
project company to finance, build and operate the plant, and it is currently
anticipated that the Company will have a majority interest in the project
company. It is currently contemplated that the projected $225 million capital
investment will be financed by a combination of equity and non-recourse debt.
The take-or-pay water supply contract will be guaranteed by Sonatrach, the
Algerian national energy company.
The desalination plant, to be located near Algiers, will have a capacity of
200,000 cubic meters per day (53 million gallons per day) of drinking water. It
is estimated that construction will take approximately two years after
completion of debt financing. The plant will be the largest membrane
desalination facility in Africa and one of the largest in the world.
-31-
The Company will design and supply the seawater reverse osmosis desalination
system, and operate the facility over the 25-year contract period. In accordance
with Company policy, the project will not be booked into backlog until a firm
commitment for debt financing is obtained and the final water sales contract is
completed. These activities are expected to take approximately 6 to 8 months.
Guarantees and Indemnifications
In November 2002, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 45 "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others an
interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB
Interpretation No. 34" ("FIN 45"). FIN 45 requires that a guarantor recognize,
at the inception of a guarantee, a liability for the fair value of the
obligation undertaken by issuing the guarantee and additional disclosures to be
made by a guarantor in its interim and annual financial statements about its
obligations under certain guarantees it has issued. The accounting requirements
for the initial recognition of guarantees became applicable on a prospective
basis for guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for all guarantees outstanding, regardless of when
they were issued or modified as of December 15, 2002. The adoption of FIN 45 did
not have a material effect on the Company's consolidated financial statements.
The following is a summary of the Company's agreements that have determined to
be within the scope of FIN 45.
Under its By-laws, the Company has an obligation to indemnify its directors and
officers to the extent legally permissible against liabilities reasonably
incurred in connection with any action in which such individual may be involved
by reason of such individual being or having been a director or officer of the
Company. The Company has obtained director and officer liability insurance
policies that may limit its exposure and enable it to recover a portion of any
future amounts paid. As a result of this insurance policy coverage, the
estimated fair value of this indemnification is not material. This obligation to
indemnify its directors and officers is grandfathered under the provisions of
FIN 45 as it existed prior to December 31, 2002. Accordingly, the Company has
not recorded any liabilities for these obligations as of September 30, 2003.
As part of past acquisitions and divestitures of businesses or assets, the
Company made a variety of warranties and indemnifications to the sellers and
purchasers that are typical for such transactions. The Company only provides
such warranties or indemnifications after considering the economics of the
transaction and the liquidity and credit risk of the other party in the
transaction. Typically, certain of the warranties and the indemnifications
expire after a defined period of time following the transaction, but others may
survive indefinitely. The warranty and indemnification obligations noted above
were grandfathered under the provisions of FIN 45 as they were in effect prior
to December 31, 2002. In addition, the Company has not made any similar warranty
or indemnification obligations during the first nine months of 2003.
Accordingly, the Company has not recorded any liabilities for these obligations
as of September 30, 2003.
On November 1, 2003, the Company guaranteed repayment, up to its 43%
proportional equity interest, of a $10 million bank line of credit extended to
Toray Membrane America, Inc., a joint venture affiliated company engaged in
membrane manufacture. The Company's guaranty will expire on December 3, 2003,
and it is anticipated that the Company will reissue or extend its guaranty at
that time.
In April 2003, the Company reinstated and amended its domestic unsecured working
capital credit facility with Fleet Bank. The terms of the facility, which
expires on April 30, 2004, are substantially the same as that of the expired
facility, except that at the request of the Company the maximum borrowings under
the facility were reduced from $30.0 million to $15.0 million. Loans against the
facility bear interest at the Prime Rate or LIBOR plus 1.25%, at the discretion
of the Company. The facility includes certain financial covenants relating to
liquidity levels, capital expenditures and consolidated tangible net worth, and
at September 30, 2003 the Company is in compliance. The Company also maintains
several foreign lines of credit. The Company may borrow a total of $23.0 million
under its domestic and international unsecured credit facilities. At September
30, 2003, the Company's total borrowings under all its existing credit
facilities was $4.2 million.
In addition, the Company has facilities in place with its banks and insurance
carriers under which letters of credit and bonds are issued from time to time
under commercial transactions for the benefit of customers and other parties
with whom the Company does business. In the normal course of business, the
Company issues letters of credit to customers, vendors and lending institutions
as guarantees for payment, performance or both under various commercial
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contracts into which it enters. Bid bonds are also sometimes obtained by the
Company as security for the Company's commitment to proceed with a project if it
is the successful bidder. Performance bonds are typically issued for the benefit
of the Company's customers as financial security for the completion or
performance by the Company of its contractual obligations under certain
commercial contracts. In the past, the Company has not incurred significant
liabilities or expenses as a result of the use of these instruments.
Approximately $110.6 million of these instruments were outstanding at September
30, 2003. Based on the Company's experience with respect to letters of credit,
bid bonds and performance bonds, the Company believes the estimated fair value
of the instruments entered into during the first nine months of 2003 is not
material. Accordingly, the Company has not recorded any liabilities for these
instruments as of September 30, 2003.
The Company believes that its future capital requirements will depend on a
number of factors, including the amount of cash generated from operations and
its capital commitments to new "own and operate" projects, either directly or
through joint ventures, that the Company may be successful in obtaining. The
Company believes that its existing cash and cash equivalents, cash generated
from operations, lines of credit and foreign exchange facilities will be
sufficient to fund its capital expenditures, working capital requirements and
contractual obligations and commitments beyond the next twelve months, based on
its current business plans and projections.
Recent Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
143, "Accounting for Obligations Associated with the Retirement of Long-Lived
Assets." SFAS No. 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS No. 143 is
effective for financial statements for fiscal years beginning after June 15,
2002. The adoption of SFAS No. 143 did not have a material impact on the
Company's financial position or results of operations.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Exit or Disposal
Activities." SFAS 146 addresses significant issues regarding the recognition,
measurement and reporting of costs that are associated with exit and disposal
activities, including restructuring activities that were previously accounted
for under Emerging Issues Task Force ("EITF") No. 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurrent in a Restructuring)." The scope of SFAS 146
also includes costs related to terminating a contract that is not a capital
lease and termination benefits that employees who are involuntarily terminated
receive under the terms of a one-time benefit arrangement that is not an ongoing
benefit arrangement or an individual deferred compensation contract. The Company
applied the provisions of SFAS 146 effective for exit or disposal activities
initiated during the quarter ended September 30, 2003. The adoption of SFAS 146
changes, on a prospective basis, the timing of recording restructuring charges
from the commitment date to when a liability is determined to have been
incurred.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" which amended SFAS No. 123,
"Accounting for Stock-Based Compensation." SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value based method of
accounting for stock-based compensation. It also amends the disclosure
provisions to require prominent disclosure about the effects on reported net
income of an entity's accounting policy decisions with respect to stock-based
employee compensation. The provisions of SFAS No. 148 are to be applied to
financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS No. 148 did not have an impact on the Company's financial
position or results of operations.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities, an interpretation of ARB No. 51" (FIN 46). This
interpretation addresses the consolidation of certain variable interest entities
(VIEs) for which a controlling financial interest exists. FIN 46 applies
immediately to financial interests obtained in VIEs after January 31, 2003. It
applies in the first fiscal year or interim period beginning after September 15,
2003, to VIEs in which a financial interest was obtained before February 1,
2003. FIN 46 may be applied prospectively with a cumulative-effect adjustment or
by restating previously issued financial statements with a cumulative-effect
adjustment as of the beginning of the first year restated. The Company has a
financial interest in certain entities that may be considered VIEs under FIN 46.
The Company is currently evaluating the impact of FIN 46 on its Investments in
Affiliated Companies, and if the Company determines that it has a controlling
financial interest in any of these entities, consolidation may be required. The
ultimate effect of adopting FIN 46 on the Company's financial position or
results of operations has not yet been determined.
-33-
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS No. 149 amends and
clarifies the accounting guidance on (1) derivative instruments, including
certain derivative instruments embedded in other contracts, and (2) hedging
activities that fall within the scope of SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities." SFAS No. 149 amends SFAS No. 133
and certain other existing pronouncements to provide for more consistent
reporting of contracts that are derivatives in their entirety or that contain
embedded derivatives that warrant separate accounting. SFAS No. 149 is effective
(1) for contracts entered into or modified after June 30, 2003, with certain
exceptions, and (2) for hedging relationships designated after June 30, 2003.
The guidance is to be applied prospectively. The adoption of this pronouncement
did not have any material impact on the Company's financial position or results
of operations.
In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity ("SFAS No.150").
This accounting standard establishes standards for classifying and measuring
certain financial instruments with characteristics of both liabilities and
equity. It requires that certain financial instruments that were previously
classified as equity now be classified as a liability. This accounting standard
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise at the beginning of the first interim period beginning after
June 15, 2003. The adoption of this pronouncement did not have any impact on the
Company's financial position or results of operations.
In May, 2003 the EITF reached a consensus on EITF Issue No. 01-8, Determining
Whether an Arrangement Contains a Lease ("EITF 01-8"). Arrangements or contracts
that traditionally were not viewed as leases may contain features that would
require them to be accounted for under SFAS No. 13, Accounting for Leases. EITF
01-8 is effective July 1, 2003. The adoption of EITF 01-8 did not have an impact
on the Company's financial position or results of operations.
In May 2003, the FASB Emerging Issues Task Force finalized Issue No. 00-21,
"Accounting for Revenue Arrangements with Multiple Deliverables" ("EITF 00-21").
EITF 00-21 addresses certain aspects of the accounting by a vendor for
arrangements under which it will perform multiple revenue-generating activities.
EITF 00-21 establishes three principles: (a) revenue arrangements with multiple
deliverables should be divided into separate units of accounting; (b)
arrangement consideration should be allocated among the separate units of
accounting based on their relative fair values; and (c) revenue recognition
criteria should be considered separately for separate units of accounting. EITF
00-21 is effective for all arrangements entered into in fiscal periods beginning
after June 15, 2003. The adoption of this pronouncement did not have any
material impact on the Company's financial position or results of operations.
Forward-Looking Information
Safe Harbor Statement under Private Securities Litigation Reform Act of 1995
Certain statements contained in this report, including, without limitation,
statements regarding expectations as to the Company's future results of
operations, statements in the "Notes to the Consolidated Financial Statements"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" constitute forward-looking statements. Such statements are based on
management's current views and assumptions and are neither promises nor
guarantees but involve risks, uncertainties and other factors that could cause
actual results to differ materially from management's current expectations as
described in such forward-looking statements. Among these factors are the
matters described under "Risks and Uncertainties" contained in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section of the Company's Annual Report on Form 10-K for the year ended December
31, 2002, as well as overall economic and business conditions; competitive
factors, such as acceptance of new products and pricing pressures and
competition from companies larger than the Company; risk of nonpayment of
accounts receivable, including those from affiliated companies; risks associated
with the recently announced restructuring program; risks associated with foreign
operations; risks associated with joint venture entities, including their
respective abilities to arrange for necessary long-term project financing; risks
involved in litigation; regulations and laws affecting business in each of the
Company's markets; market risk factors, as described below under "Quantitative
And Qualitative Disclosures About Market Risk"; fluctuations in the Company's
quarterly results; and other risks and uncertainties described from time to time
in the Company's filings with the Securities and Exchange Commission. Readers
should not place undue reliance on any such forward looking statements, which
speak only as of the date they are made, and the Company disclaims any
obligation to update, supplement or modify such statements in the event the
facts, circumstances or assumptions underlying the statements change, or
otherwise.
-36-
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Derivative Instruments
The Company enters into foreign exchange contracts including forwards, options
and swaps. The Company's policy is to enter into such contracts only for the
purpose of managing exposures and not for speculative purposes. The Company
holds a series of U.S. dollar/euro forward contracts that were executed to
offset the foreign exchange risk associated with forecasted revenues related to
an ongoing project. As of September 30, 2003, the notional amount of the
contracts was $8.3 million. The fair value of the forward contracts, which was
$0.5 million at September 30, 2003, is recorded in the "Other current assets"
section of the Consolidated Balance Sheets. End of period changes in the market
value of the forward contracts that qualify as cash flow hedging contracts are
recorded as a component of "Accumulated other comprehensive loss" in the
"Stockholders' equity" section of the Consolidated Balance Sheets.
The Company also maintains foreign exchange forward contracts to hedge the
balance sheet exposure related to an intercompany loan. At September 30, 2003,
the fair value of the forward contracts, which was immaterial, was recorded in
the "Other current assets" section of the Consolidated Balance Sheets. The end
of period change in the fair market value of the contracts, which was
immaterial, was recorded in "Selling, general and administrative" expenses. At
September 30, 2003, a hypothetical change of 10% in exchange rates would change
the fair value of the Company's portfolio of foreign exchange contracts by
approximately $1.0 million.
Market Risk
The Company's primary market risk exposures are in the areas of interest rate
risk and foreign currency exchange rate risk. The Company's investment portfolio
of cash equivalents is subject to interest rate risk fluctuations, but the
Company believes the risk is not material due to the short-term nature of these
investments. At September 30, 2003, the Company had $5.7 million of short-term
debt and $8.8 million of long-term debt outstanding. The major portion of this
debt has fixed interest rates and is not subject to risk arising from interest
rate variability. A hypothetical increase of 10% in interest rates for a
one-year period would result in additional interest expense that would not be
material in the aggregate. The Company's net foreign exchange currency gain was
$1.2 million and $1.7 million for the nine months ended September 30, 2003 and
2002, respectively. The Company's exposure to foreign currency exchange rate
fluctuations is mitigated by the fact that the operations of its international
subsidiaries are primarily conducted in their respective local currencies. Also,
in certain situations, the Company enters into foreign exchange contracts to
mitigate the impact of foreign exchange fluctuations.
Item 4. Controls and Procedures
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
Company's "disclosure controls and procedures" as of September 30, 2003. The
Securities and Exchange Commission ("SEC") defines "disclosure controls and
procedures" as a company's controls and procedures that are designed to ensure
that information required to be disclosed by the company in the reports it files
or submits under the Securities Exchange Act of 1934 (the "Exchange Act") is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. Based on their evaluation of the Company's
disclosure controls and procedures, the Company's Chief Executive Officer
(principal executive officer) and Chief Financial Officer (principal financial
officer) concluded that the Company's disclosure controls and procedures as of
September 30, 2003 were effective to provide reasonable assurances that
information required to be disclosed by the Company in the reports it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the SEC's rules and forms.
During the third quarter of 2003, the Company implemented the following measures
designed to address the deficiencies and material control weaknesses previously
identified by the Company's independent auditors in connection with the audit of
the 2002 financial statements:
o Conducted a Controllers Conference on September 16 and 17, 2003 for the
Company's segment and divisional controllers and corporate accounting
staff which addressed the key roles and responsibilities of the
controller function, the requirements of the Sarbanes Oxley Act, and
reviewed the Company's Financial Reporting Manual, including a review
of key policies and procedures.
o Commenced the process of eliminating and consolidating the number of
reporting entities in an effort to simplify the Company's reporting
structure.
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Other than these measures, there were no changes in our internal control over
financial reporting during the third quarter ended September 30, 2003 that have
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
-36-
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
The Company, its Chief Financial Officer, and its former Chief Executive Officer
have been named as defendants in a class action lawsuit captioned Jerome Deckler
v. Ionics, Inc., et al., filed in the U.S. District Court, District of
Massachusetts, in March 2003. The complaint was amended in August 2003.
Plaintiffs allege violations of the federal securities laws relating to the
restatement of the Company's financial statements for the first and second
quarters of 2002, announced in November 2002, and are seeking an unspecified
amount of compensatory damages and their costs and expenses, including legal
fees. The Company believes that the allegations in the lawsuit are without merit
and intends vigorously to defend the litigation. While the Company believes that
the litigation will have no material adverse impact on its financial condition,
results of operations or cash flows, the litigation process is inherently
uncertain and the Company can make no assurances as to the ultimate outcome of
this matter.
The litigation captioned Aerocrine AB v. Ionics, Inc. and Sievers Instruments,
Inc., first reported in the Company's quarterly report for the period ended June
30, 2003, was settled in August 2003. The Company and its subsidiary, Sievers
Instruments, Inc., entered into a non-exclusive license agreement with the
plaintiff, the impact of which the Company believes will not be material.
Item 6. Exhibits and Reports on Form 8-K
a) Exhibits
Exhibit No. Description
10.1 Employment Agreement dated as of August 28, 2003 between the
Company and John F. Curtis.
10.2 Inducement Non-Qualified Stock Option Agreement dated as of
August 28, 2003 between the Company
and John F. Curtis (filed as Exhibit 4.3 to
Registration Statement No. 333-108904 on Form S-8 effective
September 18, 2003).*
10.3 Loan Agreement dated as of July 31, 2003
between the Desalination Company of Trinidad
and Tobago Limited and Ionics Ventures Ltd.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of Chief Financial Officer.
32.1 Section 1350 Certification of Chief Executive Officer.
32.2 Section 1350 Certification of Chief Financial Officer.
---------------------
* Incorporated herein by reference.
b) Reports on Form 8-K
One report on Form 8-K was filed by the Company with the Securities and
Exchange Commission during the three-month period ended September 30,
2003. This report, filed on August 1, 2003, reported under Item 7 and
Item 12 of Form 8-K, the issuance by the Company of a press release
reporting financial results for the second quarter of 2003, ended June
30, 2003. A copy of the financial results press release was filed as
Exhibit 99 to the Form 8-K.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
IONICS, INCORPORATED
Date: November 13, 2003 By: /s/Douglas R. Brown
-------------------------------------
Douglas R. Brown
President and Chief Executive Officer
(duly authorized officer)
Date: November 13, 2003 By: /s/Daniel M. Kuzmak
-------------------------------------
Daniel M. Kuzmak
Vice President and Chief Financial Officer
(principal financial officer)
-38-
EXHIBIT INDEX
Exhibit No. Description
10.1 Employment Agreement dated as of August 28, 2003 between the
Company and John F. Curtis.
10.2 Inducement Non-Qualified Stock Option Agreement dated as of
August 28, 2003 between the Company and John F. Curtis (filed
as Exhibit 4.3 to Registration Statement No. 333-108904 on Form
S-8 effective September 18, 2003).
10.3 Loan Agreement dated as of July 31, 2003 between the
Desalination Company of Trinidad and Tobago Limited and
Ionics Ventures Ltd.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer.
31.2 Rule 13a-14(a) Certification of Chief Financial Officer.
32.1 Section 1350 Certification of Chief Executive Officer.
32.2 Section 1350 Certification of Chief Financial Officer.