UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: DECEMBER 31, 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 of incorporation) (IRS Employer Identification Number)
65 GROVE STREET 02472-2882
WATERTOWN, MASSACHUSETTS (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (617)926-2500
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $1.00 PAR VALUE
Name of each exchange on which registered: NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [ ]
The aggregate market value of the Common Stock of the registrant held by
non-affiliates as of June 30, 2003 was $386,822,853 (17,292,014 shares at $22.37
per share).
As of March 1, 2004, 22,578,284 shares of Common Stock, $1.00 par value, were
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant intends to file a definitive proxy statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December 31,
2003. Portions of such proxy statement are incorporated by reference into Item 5
and Part III of this Annual Report on Form 10-K.
IONICS, INCORPORATED
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
PART I.................................................................................................... 3
ITEM 1. BUSINESS.................................................................................. 3
ITEM 2. PROPERTIES................................................................................ 13
ITEM 3. LEGAL PROCEEDINGS......................................................................... 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................... 16
PART II................................................................................................... 16
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..................... 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA...................................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..... 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK................................. 50
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................. 51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...... 92
ITEM 9A. CONTROLS AND PROCEDURES................................................................... 92
PART III.................................................................................................. 92
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................ 92
ITEM 11. EXECUTIVE COMPENSATION.................................................................... 92
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................ 92
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................ 93
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.................................................... 93
PART IV................................................................................................... 93
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.......................... 93
SIGNATURES................................................................................................ 99
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................................................ 51
2
PART I
Except for historical information, the matters discussed in this Annual Report
on Form 10-K are forward-looking statements that involve risks and
uncertainties. The Company makes such forward-looking statements under the
provision of the "Safe Harbor" section of the Private Securities Litigation
Reform Act of 1995. Actual future results may vary materially from those
projected, anticipated, or indicated in any forward-looking statements as a
result of certain risk factors. Readers should pay particular attention to the
considerations described in the section of this report entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risks
and Uncertainties and Forward Looking Information." Readers should also
carefully review the risk factors described in the other documents that we file
from time to time with the Securities and Exchange Commission. In this Annual
Report on Form 10-K, the words "anticipates," "believes," "expects," "intends,"
"future," "could," and similar words or expressions (as well as other words or
expressions referencing future events, conditions or circumstances) identify
forward-looking statements.
ITEM 1. BUSINESS
GENERAL
Ionics, Incorporated ("Ionics" or the "Company") is a global leader in the
supply of water purification and wastewater treatment equipment and services.
Ionics' products and services are used by the Company or its customers to desalt
brackish water and seawater, treat, recycle and reclaim process water and waste
water, treat water for residential and commercial applications, manufacture and
supply disinfection chemicals and process food products. The Company is also a
leader in supplying zero liquid discharge systems, in providing ultrapure water
systems for the power and microelectronics industries, and in the measurement
and analysis of water impurities. With the acquisition of Ecolochem, Inc., and
its affiliated companies (the Ecolochem Group) on February 13, 2004, the Company
has also become a leader in the provision of mobile water treatment. The Company
has over 50 years of experience in the design, installation, operation and
maintenance of water and waste water treatment systems. The Company's customers
include industrial companies, consumers, resorts, municipalities and other
governmental entities and utilities. Unless the context indicates otherwise, the
terms "Ionics" and "Company" as used herein includes Ionics, Incorporated and
all its subsidiaries.
Over fifty years ago, the Company pioneered the development of the ion-exchange
membrane and the electrodialysis process. Since that time, the Company has
expanded its separations technology base to include a number of membrane and
non-membrane-based separations processes. These separations processes include
electrodialysis reversal (EDR), reverse osmosis (RO), ultrafiltration (UF),
microfiltration (MF), electrodeionization (EDI), electrolysis, ion exchange,
carbon adsorption, and thermal processes such as evaporation and
crystallization.
The Company's business activities are reported in four business group segments,
which the Company put into place in 1998. The business group structure is based
upon defined areas of management responsibility with respect to markets,
applications and products. The Company believes that each business group segment
comprises and represents a class of similar products or product lines used in
particular water treatment applications. These business group segments are the
Equipment Business Group, Ultrapure Water Group, Consumer Water Group, and
Instrument Business Group. In 2003, these segments accounted for approximately
41.5%, 29.5%, 6.1% and 8.6%, respectively, of the Company's total revenues. See
Note 18 to the Consolidated Financial Statements for additional information
regarding the Company's four business segments (sales to affiliated companies
accounted for the remaining 14.3%). On December 31, 2001, the Company sold its
Aqua Cool Pure Bottled Water division, constituting the major portion of the
assets of the Consumer Water Group. Approximately 48.4% of the Company's 2003
revenues were derived from foreign sales or operations.
In the first quarter of 2004, the Company completed the acquisition of
Ecolochem, Inc. and its affiliated companies. Ecolochem, a privately held
company headquartered in Norfolk, Virginia is a leading provider of emergency,
short and long-term mobile water treatment services to the power, petrochemical
and other industries. The acquisition significantly increases the Company's
ability to offer extensive outsourced water services to its customer base and
adds significantly to the Company's recurring revenue base.
The Company is changing its operating structure starting in the first quarter of
2004. The Company plans to restructure its organization into three business
groups - water systems, instruments and consumer. The water systems group will
be further classified into equipment sales and operations. Equipment sales will
reflect all of the Company's capital equipment and related sales, including
spare parts and the operations group will include all of its recurring revenue
activities including regeneration, operating plants, disinfection chemicals and
other related products. The consumer group will continue to include its existing
3
activities. The instrument group will also continue its existing activities, and
will be credited with all instrument sales made by the Company (the Equipment
Business Group and Ultrapure Water Group were previously credited with
instrument sales made by their own organizations).
The Company was incorporated in Massachusetts in 1948. The Company's principal
executive officers are located at 65 Grove Street, Watertown, Massachusetts,
02472.
INFORMATION ABOUT BUSINESS SEGMENTS
EQUIPMENT BUSINESS GROUP
The Equipment Business Group accounted for approximately 41.5% of revenues in
2003. This segment provides technologies, treatment systems and services for
seawater desalination, surface water treatment, brackish water desalination, and
wastewater reuse and recycle. In addition, this segment includes the Company's
custom fabrication and food processing activities.
Desalination and Related Water Treatment Equipment and Processes
Opportunities for the sale of desalination equipment for seawater and brackish
water have been driven by population growth, increased industrial demands and
decreasing availability of quality water from existing sources. Less than 1% of
the water on the planet is fresh and usable, while 97% of the world's water is
seawater and over 2% is locked in the polar ice caps.
The Company sells a wide spectrum of products and systems to serve this market
utilizing technologies including EDR, ion exchange, EDI, RO, UF, ozonation and
carbon adsorption. Depending on the customers' needs, the Company provides
standardized versions of systems utilizing one or more of the technologies
mentioned, or can supply complete turnkey plants that may include standardized
models as well as peripheral water treatment equipment, complete engineering
services, process and equipment design, project engineering, commissioning,
operator training and field service.
As an example of the Company's activities in this market during 2003, the
Company completed the fabrication and installation of a 6.2 million gallon per
day (MGD) EDR system at Mason City, Iowa. This $3.9 million system is scheduled
to commence operations and to be commissioned in 2004 for the treatment of a
municipal groundwater supply.
The Company has also been participating in a growing market for surface water
treatment equipment as municipalities are being required to meet increasingly
stringent regulations for ensuring safe drinking water quality. For example, in
late 2001 the Company received an order for equipment from the City of
Minneapolis for the sale of UF based water treatment equipment to treat surface
water used by the city for drinking water. The plant is expected to commence
operations in 2004.
In 2003, the Company had completed 50% of the fabrication and assembly of a 15
MGD UF drinking water system to treat water from the Rio Grande River for Eagle
Pass, Texas. This $4.6 million system will be completed in the first half of
2004, with installation and commissioning scheduled for the second half of 2004.
Wastewater Treatment Equipment and Processes
The market for treatment, recycle and reuse of industrial and municipal
wastewaters has shown significant growth as the world-wide demand for water
increases and regulations limiting waste discharges to the environment continue
to mount.
Industrial Wastewater Treatment
The Company designs, engineers and constructs customized systems for industrial
wastewater customers which may include conventional treatment systems, as well
as advanced membrane separation technologies such as EDR, EDI, RO, UF and MF.
Typical industrial customers are power stations, chemical and petrochemical
plants, manufacturers and a variety of other industrial applications.
For "zero liquid discharge" applications the Company designs, engineers and
constructs brine concentrators, evaporators and crystallizers which are used to
clean, recover and recycle wastewaters. Such systems may also incorporate EDR
membrane systems as preconcentrators and EDI membrane systems for further
treatment of wastewater.
4
As an example of the Company's activities in the zero liquid discharge market,
in 2003 the Company began the design and procurement of a zero-liquid-discharge
(ZLD) system for the joint venture between Saudi Arabian Texaco and Kuwait Oil
Company. This $5.0 million system is scheduled for delivery in late 2004. The
equipment will be used to treat and reclaim produced water generated from crude
oil extraction.
Municipal Wastewater Treatment
The Company also provides custom and packaged sewage treatment systems for
municipalities and advanced membrane systems that treat waste from conventional
sewage treatment plants so that the treated wastewater can be recycled and
revised for irrigation and process water needs.
As an example of the Company's activities in membrane based water treatment,
during 2002, Utilities Development Company W.L.L. (UDC), a Kuwaiti project
company in which the Company has a 25% ownership interest, commenced activities
under a contract to construct, own and operate the largest membrane based water
reuse facility in the world. The Company is also serving as a membrane equipment
supplier to UDC under an $85 million supply contract awarded in 2002.
Construction on the Kuwait facility began in 2003 with completion scheduled for
late 2004 and start-up in 2005. For further discussion regarding UDC, see Item 7
of this Annual Report on Form 10-K under the caption "Financial Condition" and
Note 9 to the Consolidated Financial Statements contained in Item 8 of this
Annual Report on Form 10-K.
Water Supply for Drinking and Industrial Use
Ionics' position as a seller of purified or treated water has evolved from its
traditional role as a supplier of water treatment equipment. In certain
situations, opportunities are available for the Company to supply the water
itself through the ownership and operation of the water purification facility.
In these situations, the Company is responsible for the financing, construction,
operation and maintenance of the water treatment facilities. For large-scale
water treatment projects, the Company's business model has been to participate
in such projects through joint ventures in which the Company typically holds an
equity interest.
As an example, the Company and the Algerian Energy Company (AEC), its local
partner, have formed Hamma Water Desalination Ltd. (HWD) as the special purpose
company for the execution of a 200,000 cubic meter per day seawater RO
build-own-operate (BOO) contract. HWD was selected on October 17, 2003 for this
25 year project. HWD is in the process of arranging non-recourse debt financing
for the project.
Ionics, through a wholly-owned subsidiary, owns and operates an EDR facility
with capacity to treat 5.5 million gallons per day of brackish water and an RO
seawater facility with capacity to treat 3.6 million gallons per day on Grand
Canary Island, Spain. Under long-term supply contracts, the Company sells the
desalted water from both facilities to the local water utility for distribution.
Ionics, through its local subsidiary, Ionics Water Resources, Ltd., owns 49% of
Magan Desalination Ltd., a special purpose company established to finance,
design, build, operate and maintain a 23,000 cubic meters per day brackish water
desalination plant that will produce and sell potable water to the local water
authority in Israel. At the end of 2003, the plant was 85% complete with
start-up and commissioning scheduled for the second quarter of 2004.
In 2003, construction was started on the fifth and final stage of what the
Company believes is the largest membrane-based seawater desalination plant in
the Western Hemisphere, which is located in Trinidad. The seawater reverse
osmosis (SWRO) desalination plant provides the Water and Sewerage Authority of
Trinidad and Tobago (WASA) and the industries of the Point Lisas Industrial
Estate with a high quality water supply for industrial requirements. This
project is owned and operated by a joint venture between the Company (which has
a 40% equity ownership interest in the venture) and its local partner, Hafeez
Karamath Engineering Services Ltd. The plant began to produce and deliver water
during 2002 and has a current design capacity of 26.4 million gallons per day,
which will be expanded to 28.7 million gallons per day when Phase 5 is completed
and commences operations in 2004. For further discussion regarding the Trinidad
project, see Item 7 of this Annual Report on Form 10-K under the caption
"Financial Condition" and Note 9 to the Consolidated Financial Statements
contained in Item 8 of this Annual Report on Form 10-K.
The Company also owns and operates more than 40 desalination plants on a number
of Caribbean islands, which provide drinking water to hotels, resorts and
governmental entities. Drinking water on these islands is usually supplied
pursuant to water supply contracts with terms ranging up to ten years. On the
island of Barbados, a 7.9 million gallon per day brackish water RO plant is
5
providing fresh potable drinking water to about one-fifth of the island's
population. Desalinated water is being provided to the Barbados Water Authority
on a build, own, operate (BOO) basis by a consolidated joint venture (in which
the Company has a controlling ownership interest) between Ionics and its local
partner, Williams Industries.
The Equipment Business Group also carries out the following business activities:
Fabricated Products
At its Bridgeville and Canonsburg, Pennsylvania facilities, the Company
fabricates products for industrial and defense-related applications.
Food Processing
Under an agreement with a major U.S. dairy cooperative, the Company oversees
whey-processing activities at a plant owned by the cooperative and earns revenue
based on the production of demineralized whey for its services. Included in the
equipment being utilized at this plant is its Electromat(R) electrodialysis
system.
ULTRAPURE WATER GROUP
The Ultrapure Water Group accounted for approximately 29.5% of the Company's
2003 revenues. This segment provides equipment and other related products for
specialized industrial users of ultrapure water, such as companies in the
microelectronics, power, chemical and life sciences industries. Ultrapure water
is purified by a series of processes to the degree that remaining impurities are
measured in parts per billion or trillion. The microelectronics industry has
historically been a significant source of the revenues of the Ultrapure Water
Group and the downturn in the microelectronics industry in recent years has
negatively affected the performance of the Ultrapure Water Group.
Ultrapure Water Equipment
The demand for technologically advanced ultrapure water equipment and systems
has increased as the industries which use ultrapure water have become more
knowledgeable about their quality requirements and as such requirements have
become more stringent. Ultrapure water needs are particularly important in the
microelectronics, power, chemical and life sciences industries. The
semiconductor industry in particular has increasingly demanded higher purity
water as the circuits on silicon wafers have become more densely packed.
The Company supplies sophisticated ultrapure water systems, which utilize a
combination of ion-exchange, EDI, RO and UF technologies. These systems are
either trailer-mounted or land-based and vary from standardized modules to large
multi-million dollar systems, depending on the customer's requirements.
The Company continues to pursue customers in the developing microelectronics
market in the Far East. For example, during 2003 the Company received a $6.0
million order in connection with a project for Seagate Technology International
in Singapore and a $4.0 million order from Chungwa Picture Tube (CPT) in Taiwan
for the supply of ultrapure water systems for their manufacturing operations.
Ultrapure Water Supply
In industries such as microelectronics, power, chemical and life sciences,
ultrapure water is critical to product volume, quality and yield. Depending on
the composition and quantity of the impurities to be removed or treated, any one
of several membrane separations methods can be utilized to provide ultrapure
water to the customer. Ionics has pioneered the application of three membrane
technologies (EDR, RO and UF) combined together in a mobile system called the
"triple membrane" trailer (TMT) for use in the commercial processing of
ultrapure water. Ionics provides ultrapure water services and the production and
sale of ultrapure water from trailer-mounted units at customer sites.
6
The Company's EDI technology is becoming increasingly utilized in the production
of ultrapure water. EDI is a continuous, electrically driven, membrane-based
water purification process, which produces ultrapure water without the use of
strong chemical regenerants, such as sulfuric acid and caustic soda, which are
commonly required. The Company's TMT-II trailers utilize a combination of EDI,
RO and UF technologies and represent what the Company believes to be the most
advanced technology used in the commercial processing of ultrapure water.
As an example of the Company's activities in this area in 2003, the Company
completed a project to supply 2,700 gallons per minute of ultrapure water to a
large cogeneration utility in the Philadelphia area. The Company has a ten year
"own and operate" contract for this ultrapure water supply that utilizes EDI as
one of the key treatment technologies.
One of the Company's important ultrapure water activities is ion-exchange
regeneration, which is conducted at four U.S. locations and two foreign
locations. The Company also provides system sanitization and high-flow
deionization at customer sites. As a result of the acquisition of the Ecolochem
Group in February 2004, the Company now operates six additional ion-exchange
resin regeneration sites in the U.S. and one in England.
The Company has been expanding its ultrapure water activities in the Asian
market. The Company established an ultrapure water sales, service and
regeneration facility in Singapore in 1998, opened an office in Taiwan in 1999,
commenced operation of the first resin regeneration facility in Taiwan in 2002,
and established a subsidiary in China in 2002 for the manufacture of water
systems to serve the China market and for export.
Chemical Supply
The Company uses its Cloromat(R) electrolytic membrane-based technology to
produce sodium hypochlorite and related chlor-alkali chemicals for industrial,
commercial and other non-consumer applications. These activities are carried out
by the Company's wholly owned Australian subsidiary, Elite Chemicals Pty. Ltd.
(Elite), and the Company's wholly-owned Mexican subsidiary, Ionics Acapulco Ltd.
(until 2002, this activity had been included in the Equipment Business Group).
CONSUMER WATER GROUP
This business group segment accounted for approximately 6.1% of the Company's
2003 revenues and currently serves the home water purification and point-of-use
commercial water cooler markets. During 2003, the Company made a decision to
sell its Elite Consumer Products division, located in Ludlow, Massachusetts, and
accordingly the results for that division are reflected as a discontinued
operation for all periods presented. On January 31, 2004, the Company completed
the sale of its Elite Consumer Products division for approximately $5.2 million.
On December 31, 2001, the Company completed the sale of its Aqua Cool Pure
Bottled Water business conducted in the United States, United Kingdom, and
France to affiliates of Perrier Vittel S.A., a subsidiary of Nestle S.A. In this
transaction, the Company received total proceeds of approximately $207 million,
following finalization of contractual purchase price adjustments in the first
quarter of 2003. See Note 17 to the Consolidated Financial Statements contained
in Item 8 of this Annual Report on Form 10-K. The Company retains equity
ownership interests in certain joint venture entities in Bahrain, Kuwait and
Saudi Arabia which are engaged in the bottled water business.
Home Water Purification Systems
Point-of-Entry Home Water Purifiers
Ionics' point-of-entry water products include ion-exchange water conditioners to
"soften" hard water and chemicals and media for filtration and treatment. The
Company sells its products, under the General Ionics and other brand names,
through both independent distributorships and wholly owned sales and service
dealerships.
7
Point-of-Use Home Water Purifiers
The Company participates in the "point-of-use" ("POU") market for over- and
under-the-sink water purifiers through the sale of RO and activated carbon-based
filtering devices and through the manufacture and sale of HYgene(R), a
proprietary, EPA-registered, silver-impregnated activated carbon filtering
medium. The Company incorporates HYgene(R), which is designed to prevent
bacterial build-up while providing the capability of removing undesirable tastes
and odors from the water supply, into its own bacteriostatic water conditioners
and also sells HYgene(R) to manufacturers of household point-of-use water
filters.
Point-of-Use Water Coolers
In 2003, the Company acquired the assets and business of CoolerSmart, LLC, a
U.S. company primarily providing point-of-use water coolers to commercial
customers. A point-of-use (POU) cooler provides water treatment systems within
the cooler and therefore eliminates the need for providing bottles of water from
an external service. The Company believes this offers businesses an economical
alternative option to conventional bottled water coolers.
During the fourth quarter of 2003, the Company's management and Board of
Directors approved a plan of disposition to sell its European POU cooler
business in the United Kingdom and Ireland. Accordingly, the results for the
European POU business have been reflected as a discontinued operation for all
periods presented.
Other Products
The Company's Elite Consumer Products division operated a facility in Ludlow,
Massachusetts to produce and distribute bleach-based products for the consumer
market, and methanol-based automobile windshield wash solution. In January 2004,
the Company completed the sale of the assets of this business group.
INSTRUMENT BUSINESS GROUP
The Company's Instrument Business Group accounted for approximately 8.6% of the
Company's 2003 revenues. This segment designs and manufactures analytical
instruments that serve the pharmaceutical, microelectronic, chemical, power
generation, environmental, municipal water, food and beverage, and medical
research industries. The Instrument Business Group derives more than 40% of its
revenues from service, consumables, spare parts, and training products from its
installed base of more than 8,000 units. During 2000, the Ionics Instrument
Division, which was located in Watertown, Massachusetts, was moved and
consolidated with Ionics Sievers Instruments, located in Boulder, Colorado. This
business group also includes Ionics Agar Environmental, located in Herzlia,
Israel. The Company is a leading manufacturer of instruments that measure total
organic carbon (TOC) across the water "spectrum" from ultrapure water to
wastewater. The Sievers(R) Model 400ES TOC analyzer, introduced at the end of
2001, is designed specifically to comply with United States Pharmacopoeia (USP)
and European Pharmacopoeia (EP) requirements for determining water quality in
the pharmaceutical industry. The Instrument Business Group offers TOC analyzers
sensitive to the parts-per-trillion range, designed specifically for ultrapure
water measurement in the semiconductor and power generation industries. In 2001,
the Company introduced the first on-line boron analyzer designed specifically
for continuous measurement of trace boron contamination, a capability
particularly important in the semiconductor and power industries. In addition to
the Sievers product line, the Instrument Business Group offers a full line of
TOC monitors for process water and wastewater applications, as well as other
instruments.
In 2002, the Company introduced enhancements to its Model 400ES TOC Analyzer
that facilitates pharmaceutical company compliance with FDA electronic
record-keeping requirements. Additionally, the Company expanded its consumables
and service business capability with a new range of products and services, and
an expanded production facility for the manufacture of calibration standards for
its pharmaceutical customers.
The Company's Ionics Agar Environmental division, acquired in 1999, offers a
line of instruments for the detection of thin layers of oil on water. The
Company's Leakwise(R) oil-on-water detection systems are used by a range of
industries from oil refining to power generation. In 2002, the Company
introduced its Leakwise ID-227WL wireless system for remote sensing and
satellite/cellular communication of environmental oil spills.
8
OTHER INFORMATION CONCERNING THE BUSINESS OF THE COMPANY
Foreign Operations
The Company has significant operations outside the United States. The Company's
sales to customers in foreign countries primarily involve desalination systems,
ultrapure water systems, water and wastewater treatment systems, Cloromat
systems, instruments and related products and services. The Company believes
that this geographic diversity provides stability to its operations and revenue
streams to offset geographic economic trends and offers it an opportunity to
expand into new markets for its products. The Company conducts operations
outside the United States directly or through its wholly-owned subsidiaries
located in Australia, China, Bermuda, several countries in the Caribbean,
England, France, Ireland, Israel, Italy, Korea, Mexico, Singapore, Spain and
Taiwan as well as through a majority-owned subsidiary in Algeria. In addition,
the Company also conducts operations outside the United States through
affiliated companies and joint venture relationships in the Caribbean (including
Trinidad), Bahrain, Israel, Japan, Kuwait, Mexico and Saudi Arabia. In addition,
the Company recently became a majority owner of an Algerian project company
which is currently seeking financing for the construction of a large seawater
desalination plant in Algeria. See "Water Supply for Drinking and Industrial
Use" in this Item 1. Of these affiliated company and joint venture operations,
the Company believes that the Kuwait, Trinidad and Mexico ventures are material
to its business on a consolidated basis.
Revenues from operations outside the United States totaled $131.2 million in
2003, $121.2 million in 2002, and $146.1 million in 2001, accounting for
approximately 37.8%, 38.0% and 32.6%, respectively, of the Company's total
revenues. The Company's Italian subsidiary contributed approximately 17.1% of
the Company's total revenues in 2003. No single country outside the United
States contributed more than 10% of the Company's total revenues in 2002 and
2001.
For a discussion of risks attendant to the Company's foreign operations, see
Item 7 of this Annual Report on Form 10-K. In addition, further geographical and
financial information concerning the Company's foreign operations appears in the
Notes of the Company's Consolidated Financial Statements included in Item 8 of
this Annual Report on Form 10-K.
Raw Materials and Sources of Supply
All raw materials and parts and supplies essential to the business of the
Company can normally be obtained from more than one source. The Company produces
the membranes required for its equipment and systems that use the ED, EDR and
EDI processes. Membranes used for the MF, UF and RO processes are at times also
purchased from third-party suppliers and are normally available from multiple
sources. During 2000, the Company formed a joint venture with Toray Industries,
Inc. and Mitsui & Co. to manufacture and market RO membrane modules for the
desalination of seawater and brackish water using Toray's proprietary RO
manufacturing technology. Ionics has a 43% interest in the joint venture
company, Toray Membrane America, Inc. (TMA). In 2001, TMA commenced the
manufacture of RO membrane modules in space leased from the Company in
Watertown, MA.
Patents and Trademarks
The Company believes that its products, know-how, servicing network and
marketing skills are more significant to its business than trademarks or patent
protection of its technology. Nevertheless, the Company has a policy of applying
for patents both in the United States and abroad on inventions made in the
course of its research and development work for which a commercial use is
considered likely. The Company owns numerous United States and foreign patents
and trademarks and has issued licenses thereunder, and currently has additional
pending patent applications. Of the approximately 92 outstanding U.S. patents
held by the Company, a substantial portion involve membranes, membrane
technology and related separations processes such as ED and EDR, RO, UF, EDI and
instrumentation technology. The Company does not believe that any of its
individual patents or groups of related patents, nor any of its trademarks, is
of sufficient importance that its termination or abandonment, or the
cancellation of licenses extending rights thereunder, would have a material
adverse effect on the Company.
Seasonality
The activities of the Company's businesses are generally not seasonal in nature.
The operations of the Ecolochem Group do tend to fluctuate when periods of
severe hot weather or cold weather result in increased demand for mobile water
treatment services for power plants.
9
Customers
The nature of the Company's business is such that it frequently has in progress
large contracts with one or more customers for specific projects. In 2003, the
Company's Italian subsidiary contributed approximately 12% of the Company's
total revenue in connection with sales to the Company's Kuwait joint venture
company. There is no other customer whose purchases accounted for 10% or more of
the revenues of any business segment and whose loss the Company believes would
have a material adverse effect on the Company and its subsidiaries taken as a
whole.
Backlog
The Company's backlog of firm orders was $330.0 million at December 31, 2003 and
$377.2 million at December 31, 2002. The majority of the Company's backlog
related to the Equipment Business Group. For multi-year contracts, the Company
includes in reported backlog the revenues associated with the first five years
of the contract at inception. In years two, three and four, the Company includes
in reported backlog revenues associated with four years, three years and two
years, respectively, for the contract. Thereafter, the Company includes in
backlog up to one year of revenue. The Company expects to fill approximately 38%
of its December 31, 2003 backlog during 2004. The Company does not believe that
there are any seasonal aspects to its backlog figures.
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 equipment sale 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.
Government Contracts
The Company does not believe that any of its sales under U.S. Government
contracts or subcontracts during 2003 are subject to renegotiation. The Company
has not had adjustments to its negotiated contract prices, nor are any
proceedings pending for such adjustments.
Competition
The Company experiences competition from a variety of sources with respect to
virtually all of its products, systems and services, however the Company knows
of no single entity that competes with it across the full range of its products
and services. Competition in the markets served by the Company is based on a
number of factors, which may include price, technology, applications experience,
know-how, availability of financing, reputation, product warranties,
reliability, service and distribution. The Company is unable to state with
certainty its relative market position in all aspects of its business. Many of
its competitors have financial and other resources greater than those of the
Company.
With respect to the Company's Equipment Business Group, there are a number of
companies, including several sizable chemical companies that manufacture and
sell membranes, but not water treatment equipment. There are numerous smaller
companies, primarily fabricators, that sell water treatment and desalination
equipment, but which generally do not have proprietary membrane technology. A
limited number of companies, some of which are larger than the Company,
manufacture both membranes and water treatment equipment. The Company has
numerous competitors in its conventional water treatment, instrument and
fabricated products business lines.
In 2002, the International Desalination Association released a report providing
data regarding the manufacturers of desalination equipment. According to the
report, which covered land-based water desalination plants delivered or under
construction as of December 31, 2001, with a capacity to produce 100 cubic
meters (approximately 25,000 gallons) or more of fresh water daily, the Company
ranked first in terms of the number of such plants sold from 1992 to 2001,
having sold more than the next three manufacturers combined. In addition, the
report indicated that the Company ranked first in the total capacity of such
plants sold.
With respect to the Ultrapure Water Group business segment, the Company competes
with suppliers of ultrapure water services and with other manufacturers of
membrane-related equipment on an international, national and regional basis.
10
With respect to the Company's Consumer Water Group business segment, most of the
Company's competitors in point-of-entry and point-of-use products for use in the
home or office are small assemblers, serving local or regional markets. However,
there are also several large companies competing nationally in these markets.
Research and Development
The Company's research and development activities are directed toward developing
new products for use in water and wastewater purification, processing and
measurement, and separations technology. The Company's research and development
expenses were approximately $7.4 million in 2003, $6.5 million in 2002, and $6.4
million in 2001.
Environmental Matters
The Company complies with federal, state and local government rules and
regulations relating to the discharge of materials into the environment or
otherwise relating to the protection of the environment. 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 ("SRS
Site"). Ionics' share of assessments to date for site work and administrative
costs totals approximately $82,000. 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 or its financial position, results of operations
or cash flows.
The Company has never had a product liability claim grounded in environmental
liability, and believes that the nature of its products and business makes such
a claim unlikely.
Employees
The Company and its consolidated subsidiaries employ approximately 2,350 persons
on a full-time basis, including the employees of the Ecolochem Group. None of
the Company's employees are represented by unions or have entered into workplace
agreements with the Company, except for the employees of the Company's
Australian subsidiary and certain employees of the Company's Spanish subsidiary.
The Company considers its relations with its employees to be good.
11
Executive Officers of the Company
The names, ages and positions of the Company's Executive Officers are as
follows:
Age as of
Name March 1, 2004 Positions Presently Held
---- ------------- ------------------------
Douglas R. Brown 49 President since April 1, 2003; Chief Executive Officer since July 1,
2003; Director since 1996
Edward J. Cichon 49 Vice President, Equipment Business Group, since July 1998
Alan M. Crosby 51 Vice President, Consumer Water Group since March 2000; previously Vice
President and General Manager, Elite Consumer Products;
and Vice President, Operations
John F. Curtis 53 Vice President, Strategy and Operations since August 28, 2003;
Treasurer since February 9, 2004
Lyman B. Dickerson 59 Vice President, Water Systems Division since February 17, 2004
Anthony Di Paola 37 Vice President and Corporate Controller since May 2000
Stephen Korn 58 Vice President, General Counsel and Clerk since September 1989
Daniel M. Kuzmak 51 Vice President, Finance and Chief Financial Officer since January 2001
William J. McMahon 48 Vice President, Ultrapure Water Group, since November 2000
Michael W. Routh 56 Vice President, Instrument Business Group since April 2000
There are no family relationships between any of the officers or directors.
Executive officers of the Company are appointed each year at the meeting of
directors held on the date of the annual meeting of shareholders. There are no
arrangements or understandings pursuant to which any executive officer was
selected.
Except for Messrs. Brown, Curtis, Dickerson, Di Paola, Kuzmak, McMahon and
Routh, all of the current executive officers have been employed by the Company
in various capacities for more than five years.
Prior to joining the Company on April 1, 2003, Mr. Brown had served as President
and Chief Executive Officer of Advent International Corp., a private investment
firm, from January 1996 through December 2002.
Prior to joining the Company on August 28, 2003, Mr. Curtis was employed for
over 30 years by Ernst & Young LLP, in various capacities, most recently as the
partner-in-charge of that firm's Venture Capital Advisory Group, Europe, and as
senior advisory partner.
Prior to the Company's acquisition of the Ecolochem Group on February 13, 2004,
Mr. Dickerson served as President and Chief Executive Officer of Ecolochem, Inc.
for over 30 years.
Mr. Di Paola served in various finance and accounting positions with
Thyssen-Dover Elevator Company North America from 1997 until he joined the
Company, including as Corporate Controller from 1998 to 2000. Prior to 1997, he
served as Assistant Controller for Vector Health Systems, Incorporated.
Mr. Kuzmak joined the Company after 15 years with ABB and its U.S. subsidiary,
including serving as Chief Financial Officer of ABB Inc. (US) from 1998 to 2000,
and Vice President, Finance of ABB Nuclear Operations and ABB Nuclear Business
from 1995 to 1998.
12
Mr. McMahon served as President and Chief Executive Officer of Stone &
Webster/Sonat Energy Resources LLC from 1998 until he joined the Company;
President of Stone & Webster Energy Services from 1997 to 1998; and General
Manager/Environmental Systems of DB Riley Consolidated, Inc. from 1995 to 1997.
Mr. Routh served as President of the Baird Division of Thermo Instrument
Systems, Inc. from 1995 to 1997, and General Manager of the Spectroscopy
Division of BioRad Laboratories, Inc., from 1998 to March, 2000.
Available Information
The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and amendments to those reports are available,
without charge, on our website at www.ionics.com, as soon as reasonably
practicable after they are filed (or furnished) electronically with the
Securities and Exchange Commission.
The Company's Corporate Governance Guidelines and the charters for the Company's
Audit, Compensation, and Nominating and Corporate Governance Committees are
posted on the Company's website (www.ionics.com) under the "About Ionics -
Governance" section and address a number of governance items, such as Board size
and membership criteria; director responsibilities; change in director status;
retirement of directors; director compensation; lead independent director;
committees; executive sessions of independent directors; Board access to
management and others; director orientation and continuing education; management
succession; annual performance evaluation of the Board; and stockholder
communications to the Board. Copies of the these corporate governance documents
may be obtained, at no cost, by writing or telephoning Stephen Korn, Clerk,
Ionics, Incorporated, 65 Grove Street, Watertown, MA 02472-2882, telephone (617)
673-4450.
The public may read and copy any materials the Company files with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. The
public may also order information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding registrants that file electronically with the SEC
(http://www.sec.gov).
ITEM 2. PROPERTIES
The Company's executive offices are located in a Company-owned facility at 65
Grove Street, Watertown, Massachusetts. Manufacturing, assembly, engineering and
other operations are carried out in a number of domestic and international
locations. The following table provides certain information as to the Company's
principal general offices and manufacturing facilities:
13
BUSINESS SEGMENT APPROXIMATE SQUARE
LOCATION UTILIZING THE LOCATION PROPERTY INTEREST FEET OF FLOOR SPACE
-------- ---------------------- ----------------- -------------------
Watertown, MA* Equipment Business Group Owned** 134,000
(headquarters) Instrument Business Group
Consumer Water Group
Ultrapure Water Group
Watertown, MA Equipment Business Group Owned** 27,000
Bridgeville, PA Equipment Business Group Owned** 77,000
Consumer Water Group
Canonsburg, PA Equipment Business Group Leased 88,000
Fontenay Sous Bois, France Equipment Business Group Leased 17,000
San Jose, CA Ultrapure Water Group Owned** 66,000
Boulder, CO Instrument Business Group Leased 74,000
Pico Rivera, CA Ultrapure Water Group Owned** 68,000
Phoenix, AZ Ultrapure Water Group Owned** 34,000
Brisbane, Australia Equipment Business Group Owned 38,000
Brisbane, Australia Ultrapure Water Group Leased 62,000
Bellevue, WA Equipment Business Group Leased 28,000
Montgomeryville, PA Ultrapure Water Group Leased 20,000
Milan, Italy Equipment Business Group Leased 18,000
Dallas, TX Ultrapure Water Group Owned** 12,000
Singapore Ultrapure Water Group Leased 9,000
East Hartford, CT+ Owned** 23,400
Fontana, CA+ Owned** 13,500
Baytown, TX+ Owned** 48,000
Miami, FL+ Owned** 22,600
Norfolk, VA+ Owned** 62,000
St. Peters, MO+ Owned** 47,000
Peterborough, England, UK+ Owned 83,000
--------------------
* Approximately 22,000 square feet of this facility are leased to a joint
venture entity engaged in membrane manufacture.
** Subject to a mortgage held by UBS AG, Stamford Branch, as Collateral
Agent for the Lenders pursuant to the Credit Agreement dated as of
February 13, 2004 by and among the Company as borrower; certain of its
domestic subsidiaries as
14
guarantors; UBS Securities LLC as Lead Arranger, Sole Bookmanager and
Documentation Agent; Fleet Securities, Inc. and Bank of America, N.A.
as Syndication Agents; Wachovia Bank, N.A. and General Electric Capital
Corporation as Co-Documentation Agents; UBS A.G., Stamford Branch as
Administrative Agent and Collateral Agent; UBS Loan Finance LLC as
Swingline Lender; HSBC Bank USA as Issuing Bank; and the lender parties
thereto.
+ Owned by Ecolochem, Inc. or related companies, acquired by the Company
on February 13, 2004. These facilities will be utilized by the
Company's newly constituted Water Systems division.
The Company also owns or leases smaller facilities in which its business
segments conduct business. The Company considers the business facilities that it
utilizes to be adequate for their intended business purpose.
ITEM 3. LEGAL PROCEEDINGS
On December 16, 2003, Ionics Iberica, S.A., the Company's wholly-owned Spanish
subsidiary (Iberica) brought suit in Palencia, Spain against Intersuero, S.A.
Iberica is seeking the return of certain membrane-based production equipment
which Iberica had supplied under a lease agreement to Intersuero (which had
begun insolvency proceedings), or payment of 2.8 million Euros or $3.5 million
plus interest for the equipment. On February 17, 2004 Intersuero filed an answer
and counterclaim, alleging that the equipment did not perform to specifications,
and seeking 15.8 million Euros or $19.9 million in damages, lost profits,
interests and costs. The Company believes Intersuero's allegations to be without
merit and will defend itself vigorously in this matter. While the Company
believes that this litigation should 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, its former Chief Executive Officer, and its Chief Financial 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. 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 other material misrepresentations and omissions concerning the Company's
financial results. The plaintiffs 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, which is in the early discovery stage. The
Company had filed a motion to dismiss the lawsuit, but the Court did not grant
the motion. 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 $82,000. 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 or its 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.
15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the New York Stock Exchange under the
symbol ION. As of March 11, 2004, there were approximately 1,000 shareholders of
record. No cash dividends were paid in either 2003 or 2002 pursuant to the
Company's current policy to retain earnings for use in its business. The Company
currently intends to continue to retain future earnings, if any, for use in its
business and does not expect to pay any cash dividends in the foreseeable
future.
In addition, the Company's ability to pay dividends is restricted by certain
contractual provisions in the Credit Agreement dated as of February 13, 2004 by
and among the Company as borrower; certain of its domestic subsidiaries as
guarantors; UBS Securities LLC as Lead Arranger, Sole Bookmanager and
Documentation Agent; Fleet Securities, Inc. and Bank of America, N.A. as
Syndication Agents; Wachovia Bank, N.A. and General Electric Capital Corporation
as Co-Documentation Agents; UBS A.G. Stamford Branch as Administrative Agent and
Collateral Agent; UBS Loan Finance LLC as Swingline Lender; HSBC Bank USA as
Issuing Bank; and the lender parties thereto, which is attached hereto as
Exhibit 10.28.
During the period January 1, 2002 to December 31, 2003, the range of high and
low sales prices of the common stock for each quarterly period was as follows:
COMMON STOCK PRICE RANGE
2003 HIGH LOW
---- ---- ---
First Quarter $ 24.60 $ 15.70
Second Quarter 24.82 15.96
Third Quarter 28.37 20.04
Fourth Quarter 33.25 24.23
2002 HIGH LOW
---- ---- ---
First Quarter $ 33.90 $ 28.86
Second Quarter 32.22 24.00
Third Quarter 25.21 18.90
Fourth Quarter 25.15 17.64
The information referenced by this item with respect to the Company's
stockholder-approved plans and non-stockholder-approved plans is hereby
incorporated by reference from the Company's definitive Proxy Statement for the
2004 Annual Meeting under the caption "Equity Compensation Plan Information."
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data for each of the five years
ended December 31, 2003, 2002, 2001, 2000 and 1999 are derived from the
Company's Consolidated Financial Statements. This data should be read in
conjunction with the Company's audited financial statements and related notes,
and with Item 7 of this Annual Report on Form 10-K.
CONSOLIDATED STATEMENT OF OPERATIONS DATA
For the years ended December 31,
Dollars in Thousands -----------------------------------------------------------------------------------
Except Per Share Amounts 2003 % 2002 % 2001 % 2000 % 1999 %
------------------------ -------- ----- --------- ----- --------- ----- --------- ----- -------- -----
Revenues $347,407 100.0 $ 318,884 100.0 $ 448,049 100.0 $ 458,058 100.0 $343,184 100.0
(Loss) income from continuing operations
before income taxes, minority interest,
and gain on sale of Aqua Cool (44,333) (12.8) 3,779 1.2 (16,772) (3.7) (682) (0.1) 27,818 8.1
(Loss) income from continuing operations* (33,268) (9.6) 5,504 1.7 44,613 10.0 (922) (0.2) 18,511 5.4
(Loss) earnings from continuing operations
per basic share (1.88) 0.31 2.61 (0.04) 1.16
(Loss) earnings from continuing operations
per diluted share (1.88) 0.31 2.59 (0.04) 1.14
* Includes a pre-tax gain on the sale of the Aqua Cool Pure Bottled Water
business of $0.5 million, $8.2 million and $102.8 million in 2003, 2002 and
2001, respectively.
16
CONSOLIDATED BALANCE SHEET DATA
December 31,
--------------------------------------------------------------
Dollars in Thousands 2003 2002 2001 2000 1999
-------------------- ---------- ---------- ---------- ---------- ----------
Current assets $ 315,818 $ 341,364 $ 392,144 $ 264,976 $ 207,677
Current liabilities 118,092 114,168 156,866 173,363 99,475
---------- ---------- ---------- ---------- ----------
Working capital 197,726 227,196 235,278 91,613 108,202
Total assets 591,977 603,593 633,313 585,813 500,906
Long-term debt and notes payable 8,889 9,670 10,126 10,911 8,351
Stockholders' equity 416,165 438,153 423,353 356,861 361,852
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
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). See Note 18 to the Consolidated Financial Statements contained in
Item 8 of Part II of this Annual Report on Form 10-K for additional information
regarding its four business segments. The Company is planning a change in its
operating structure starting in the first quarter of 2004. The Company plans to
restructure its organization into three business groups - water systems,
instruments and consumer. The water systems group will consist of equipment
sales and operations, and include the operations of the Ecolochem Group, which
was acquired in February 2004. Equipment sales will reflect all of the Company's
capital equipment and related sales and spare parts, and the operations group
will include recurring revenue from regeneration, operating plants, disinfection
chemicals and other related products. The consumer and instrument groups will
continue to include their existing activities.
The EBG segment provides products and services for seawater and brackish water
desalination, water reuse and recycling, 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 recycling 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 discharges 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,
and pharmaceutical 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.
17
The CWG segment provides home water units for the treatment of residential water
and point-of-use "bottleless" water coolers. 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. The CWG segment also produced bleach-based cleaning products and
automobile windshield wash solution in its Elite Consumer Products division,
which was reclassified as a discontinued operation in 2003 and sold in January
2004. 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.
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
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-1980s, 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 Statements of Operations in the periods in which the
revenues are realized. Equipment contracts are generally accounted for under the
percentage of 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.
In the EBG segment, which more recently has begun to pursue large-scale,
long-term water treatment projects, the Company's business model typically has
been to participate in such projects through joint venture project companies in
which the Company will hold an 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 an
interest in a project company structure 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 the customer entity.
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 consolidate the EBG and UWG
segments into a single business group, to divest the Elite Consumer Products
division in Ludlow, MA, and shut down operations at the Company's Ionics
Watertec facility in Australia. Additionally, during the fourth quarter of 2003,
the Company decided to divest its European POU cooler business.
As a result of the above decisions, the Company recorded restructuring charges
of approximately $2.8 million during 2003 relating primarily to employee
severance costs for the elimination of approximately 160 positions. The Company
expects to realize a reduction of approximately $15.4 million in operating
expenses in 2004 as a result of the restructuring initiatives undertaken in the
third and fourth quarters of 2003.
18
During 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 was part of the Company's Consumer Water Group,
and its European POU cooler business, which sells point-of-use "bottleless"
water coolers in Ireland and the U.K. Accordingly, the Company's Consolidated
Financial Statements and Notes have been reclassified to reflect these
businesses as discontinued operations in accordance with Financial Accounting
Standards Board Statement No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," for all periods presented. (Loss) income from discontinued
operations was ($11.5) million, ($0.7) million and $0.1 million in 2003, 2002
and 2001, respectively.
During 2003, the Company recorded an impairment charge relating to production
equipment within the EBG segment that it had previously expected to lease to a
manufacturer of lactic acid in the food industry. During the second half of 2003
the Company's customer, Intersuero, began the process of filing for insolvency
protection. Accordingly, the Company recorded an 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 in respect to the asset. This matter is currently in litigation.
See Item 3, Legal Proceedings. Additionally, as a result of the Company's
restructuring plan, the Company ceased or reduced manufacturing operations at
various locations resulting in the impairment of manufacturing equipment
totaling approximately $1.0 million. The Company also recorded an impairment
charge of $0.6 million associated with its decision to abandon a plan to
increase manufacturing capacity in a plant located in Italy.
During the third quarter of 2003, as a result of significant changes in the
business climate 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. Based upon this assessment, the Company concluded that
goodwill associated with several reporting units exceeded their fair value and
accordingly recorded a $12.7 million impairment charge.
In the third quarter of 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 POU "bottleless" water coolers to
commercial customers, primarily in the mid-Atlantic region of the United States
for approximately $7 million in cash. This acquisition allows the Company to
enter the domestic POU "bottleless" water cooler market.
In the first quarter of 2004, the Company completed the acquisition of the
Ecolochem Group. The Ecolochem Group, privately held companies headquartered in
Norfolk, Virginia, are a leading provider of emergency, short and long-term
mobile water treatment services to the power, petrochemical and other
industries. The acquisition significantly increases the Company's ability to
offer extensive outsourced water services to its customer base and adds
significantly to the Company's recurring revenue base. The Ecolochem Group,
which will be included in the Water Systems Division in the Company's proposed
new reporting structure for 2004, offers three broad categories of water
treatment offerings: emergency, supplemental and extended term outsourcing.
Emergency. Mobile emergency water treatment responds to unplanned
requests by customers to fulfill their short-term treated water needs.
Periodically, a customer may require a temporary supply of demineralized water
as a result of unpredictable events, such as breakdowns at its water treatment
facilities, extreme temperature and weather conditions, periods of high
production demand or deterioration in the quality of the raw water supply. In
those situations, the customer is often faced with the decision whether to shut
down its facility, reduce production levels or find an alternative water
treatment service. To address these needs, the Ecolochem Group offers mobile
emergency water treatment services provided by mobile units or trailers with the
equipment needed to produce water treated to the customer's specifications. Once
a customer contacts its centralized dispatch center, the Ecolochem Group's
standard procedure requires the prompt dispatch of a mobile unit to the
customer's site. For these services, customers pay fees for the delivery and use
of the mobile units.
Supplemental. Supplemental product offerings address customers'
interim, but planned, water treatment needs, provided with advance notice, to
customers for a variety of reasons, including planned outages (such as scheduled
overhauls or inspections) of their own water treatment facilities, start-up
procedures for the construction of new plants, temporary production requirements
(such as specialty batch processing) and other anticipated increases in demand
for treated water. The typical term of a supplemental services contract is less
than 12 months. The Ecolochem Group also uses its mobile water treatment fleet
to provide these services. For these services, customers pay fees for the
transportation and use of the mobile units.
Extended Term Outsourcing. Extended term outsourcing, or customer
facility-based services, supply customers with long-term on-site water treatment
solutions. The term of a typical extended term contract is five to ten years,
but may range from as short as 12 months to 15 years or more. The Ecolochem
Group retains ownership of the equipment and often operates and maintains the
water treatment system. The technology used in outsourcing is identical to that
used in the mobile services, and although installed at the customer's site, the
equipment is substantially similar to that used in mobile services. This
equipment
19
similarity allows the Ecolochem Group to back-up, with its mobile fleet, any
outsourced installations that are shut down for upgrading or repair or that
requires additional capacity. For these services, customers pay both a fixed fee
based on the cost of the equipment provided and a variable fee based on the
volume of water treated.
Other Activities. The Ecolochem Group also resells both ion-exchange
resins and reverse osmosis membranes. Often, it will provide temporary mobile
services during the replacement and installation of resins or membranes at the
customer's plant. The Ecolochem Group also provides off-site ion exchange resin
regeneration and reclamation services for customer-owned resins. It also
supplies water softening and filtration treatment equipment to residential and
light industrial customers in Southeast Virginia.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's Discussion and Analysis of Financial Condition and Results of
Operations is based on the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of consolidated financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent liabilities. On an ongoing basis, the Company evaluates
its accounting policies and estimates, including those related to revenue
recognition, allowance for doubtful accounts, investments in affiliated
entities, goodwill and other long-lived assets, income taxes, pension plans,
loss contingencies and derivative instruments. The Company bases its estimates
on historical experience and other relevant information and on appropriate
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions. The Company's significant accounting policies are described in Note
1 to the Consolidated Financial Statements included in Item 8 of this Annual
Report on Form 10-K. The Company has identified the policies discussed below as
critical to understanding its business and its results of operations.
Revenue Recognition
For certain contracts involving customized equipment eligible for contract
accounting under American Institute of Certified Public Accountants ("AICPA")
Statement of Position No. 81-1, "Accounting for Performance of Construction-Type
and Certain Construction-Type Contracts" (SOP 81-1), revenue is recognized using
the percentage of completion accounting method based upon an efforts-expended
method. The nature of these contracts and the types of products and services
provided are considered in determining the proper accounting for a given
contract. Long-term, fixed-price and cost plus fixed-fee contracts are recorded
on a percentage of completion basis using the cost-to-cost method of accounting
where revenue is recognized based on the ratio of costs incurred to estimated
total costs at completion. The Company follows this method since reasonably
dependable estimates of the costs of the total contract can be made. As a
general rule, sales and profits are recognized earlier under the cost-to-cost
method of percentage of completion accounting compared to the completed contract
method. Contract accounting requires significant judgment relative to assessing
risks, estimating contract costs and making related assumptions regarding
schedules and technical issues. Due to the size and nature of the Company's
long-term contracts, the estimation of cost at completion is complicated and
subject to numerous variables. Contract costs include material, labor,
subcontracting and other related costs. Assumptions must be made relative to the
length of time to complete the contract. With respect to contract change orders,
claims or similar items, judgment must be used in estimating related amounts and
assessing the potential for realization. Such amounts are only included in the
contract value when they can be reliably estimated and realization is reasonably
assured, generally upon receipt of a customer-approved change order. Given the
significance of the judgments and estimation processes described above, it is
likely that materially different amounts could be recorded if different
assumptions were used or if underlying circumstances were to change. The Company
closely monitors compliance and consistency of application of its critical
accounting policies related to contract accounting. In addition, reviews of the
status of contracts are performed through periodic contract status and
performance reviews. In all cases, changes to total estimated costs and
anticipated losses, if any, are recognized in the period in which determined.
For contracts involving the sale of equipment to a joint venture or other
unconsolidated affiliated entity in which the Company has an ownership interest,
the extent of revenue and profit recognized while the contract is being
performed varies based on the level of equity interest held by the Company.
Generally, when the Company's equity ownership in the affiliated customer is
less than 20% and accounts for such interest on a cost basis, no revenue or
profit is eliminated as the contract is being performed. When the Company's
equity ownership is between 20% and 50%, provided that the Company does not
exercise effective control over the affiliated entity, the Company recognizes
revenue as the contract is being performed but eliminates a portion of the
profit equal to the Company's equity ownership percentage in the entity. The
portion of the profit eliminated is accounted for as a reduction in
20
the Company's carrying amount of the investment in the affiliated company. After
construction has been completed and commercial operations have commenced, the
resulting eliminated intercompany profit is amortized as a basis difference into
equity income over the estimated useful life of the equipment owned by the
affiliated entity. When the Company's equity ownership exceeds 50%, or in
instances where the Company effectively controls the affiliated entity, no
revenue or profit is recognized on the sale of equipment as the contract is
executed, and all of the profit on the contract is eliminated.
With respect to the Company's sale of equipment to Desalcott (the project
company) in connection with the Trinidad project where the Company is a 40%
equity owner of Desalcott, since the Company is considered to have provided all
of the cash equity funding for the project either directly or through a loan to
the Company's local majority partner, equipment revenue earned has been
recognized to the extent of costs incurred as the contract is executed; however,
all of the profit has been eliminated.
The "Revenues: Affiliated companies" and "Cost of sales to affiliated companies"
included in the Statements of Operations reflect the revenue and costs recorded
from the sales of equipment to joint ventures or other unconsolidated entities.
Revenue is recognized in accordance with SOP 81-1 or with Securities and
Exchange Commission's Staff Accounting Bulletin No. 104, "Revenue Recognition"
(SAB 104), as appropriate, less the amount of intercompany profit eliminated
equal to the Company's ownership interest in the affiliated companies.
Eliminated intercompany profit, as described above, is amortized as a basis
difference into equity income over the useful life of the equipment placed in
service by the affiliated company (e.g. 23 years for the Trinidad project, and
27 years for the Kuwait project).
In addition to the construction and sale of customized equipment to its
customers, the Company also enters into water and other concession agreements
under which the Company "owns and operates" desalination or water treatment
facilities to produce and supply water to its customers. Under these contracts,
where the Company remains the owner of the facility or equipment, revenue and
profit is recognized as water quantities are sold to the customer (or,
alternatively, pursuant to a "take or pay" arrangement if minimum quantities are
not purchased). More specifically, the revenue derived from these contracts is
generally recognized based on actual meter readings and agreed-upon rates in
effect during the term of the contract. The constructed equipment is capitalized
by the Company, included in property, plant and equipment, and amortized to cost
of sales over the shorter of the estimated useful life of the equipment or the
contract term.
For sales of standard products and equipment not governed by SOP 81-1, such as
the sale of instruments and consumer water products, the Company follows the
guidance provided by SAB 104. The Company does not recognize revenue unless
there is persuasive evidence of an arrangement, title and risk of loss has
passed to the customer, delivery has occurred or the services have been
rendered, the sales price is fixed or determinable and collection of the related
receivable is reasonably assured. It is the Company's policy to require an
arrangement with its customers, either in the form of a written contract or
purchase order containing all of the terms and conditions governing the
arrangement, prior to the recognition of revenue. Title and risk of loss
generally pass to the customer at the time of delivery of the product to a
common carrier. At the time of the transaction, the Company assesses whether the
sale price is fixed or determinable and whether or not collection is reasonably
assured. If the sales price is not deemed to be fixed or determinable, revenue
is recognized as the amounts become due from the customer. The Company does not
generally offer a right of return on its products and the products are generally
not subject to customer acceptance rights. The Company assesses collectibility
based on a number of factors, including past transaction and collection history
with a customer and the credit-worthiness of the customer. The Company performs
ongoing credit evaluations of its customers' financial condition but generally
does not require collateral from its customers. If the Company determines that
collectibility of the sales price is not reasonably assured, revenue is deferred
until such time as collection becomes reasonably assured, which is generally
upon receipt of payment from the customer. The Company includes shipping and
handling costs in revenue and cost of sales.
The Company provides lease financing to consumers for the purchase of certain
home water treatment systems. Prior to entering into the lease agreement, the
Company evaluates the creditworthiness of its customer and generally
collateralizes the lease receivable with a security interest in the customer's
personal residence. At the time the lease transaction is consummated, the
Company recognizes revenue for the full amount of the sales value of the
equipment and records a lease receivable on its balance sheet. Finance income is
recognized as revenue by the Company over the term of the lease based on the
interest rate stated in the lease. The Company evaluates the collectibility at
point of sale of its lease receivables based on its historical loss experience
and assessment of prospective risk, and does so through ongoing reviews of its
receivables portfolio.
The Company provides support services to customers primarily through service
contracts, and the Company typically recognizes support service revenue ratably
over the term of the service contract or as services are rendered.
21
The Company also rents equipment to customers under short-term rental
agreements. The Company generally invoices customers monthly and recognizes
revenue over the rental period based on amounts billed. The rental equipment is
capitalized and depreciated to cost of sales over its estimated useful life.
The Company's products are generally subject to warranty, and related costs are
provided for in cost of sales when revenue is recognized. While the Company
engages in extensive product quality programs and processes, the Company's
warranty obligation is based upon historical product failure rates and costs
incurred in correcting a product failure. If actual product failure rates or the
costs associated with fixing failures differ from historical rates, adjustments
to the warranty liability may be required in the period in which determined.
Allowance for Doubtful Accounts
The Company evaluates the adequacy of its allowance for doubtful accounts on an
ongoing basis through detailed reviews of its accounts and notes receivables.
Estimates are used in determining the Company's allowance for doubtful accounts
and are based on historical collection experience, current trends including
prevailing economic conditions and adverse events that may affect a customer's
ability to repay, aging of accounts and notes receivable by category, and other
factors such as the financial condition of large customers. This evaluation is
inherently subjective because estimates may be revised in the future as more
information becomes available about outstanding accounts. Allowance for doubtful
accounts are established through a charge to operations included in selling,
general and administrative expenses.
Investments in Affiliated Companies
The Company consolidates the balance sheet and results of operations of all
wholly and majority owned subsidiaries and controlled affiliates. The Company
also holds minority investments in certain private companies having
complementary or strategic operations in different geographical locations around
the world. These investments are included in investments in affiliates and
include investments accounted for under the equity method of accounting. Under
the equity method of accounting, which generally applies to investments that
represent a 20% to 50% ownership of the equity securities of the affiliates, the
Company's proportionate share of the earnings or losses based on its ownership
interest of the affiliates is included in equity income. The Company records
equity losses in excess of the carrying amount of the investment when it
guarantees obligations or is otherwise committed to provide further financial
support to the affiliate. 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. Realization of the
Company's investments in equity securities may be affected by the affiliate's
ability to obtain adequate funding and execute its business plans, general
market conditions, industry considerations specific to the affiliate's business,
and other factors. The inability of an affiliate to obtain future funding or
successfully execute its business plan could adversely affect the Company's
earnings in the periods affected by those events. Future adverse changes in
market conditions or poor operating results of underlying investments could
result in a write-down or in an inability to recover the carrying value of an
equity investment that may not be reflected in an investment's current carrying
value, thereby possibly requiring an impairment charge in the future. The
Company records an impairment charge when it believes an investment has
experienced a decline in fair value that is other-than-temporary.
Goodwill and Other Long-Lived Assets
The Company assesses the potential impairment of identifiable intangibles and
other long-lived assets whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. Factors that could indicate an
impairment include significant underperformance of the asset as compared to
historical or projected future operating results, significant changes in the
actual or intended future use of the asset, or the strategy for its overall
business and significant negative industry or economic trends. When the Company
determines that the carrying value of intangible and other long-lived assets may
not be recoverable, the related estimated future undiscounted cash flows
expected to result from the use of the asset and its eventual disposition are
compared to the carrying amount of the asset. If the sum of the estimated future
cash flows is less than the carrying amount, the
22
Company records an impairment charge based on the estimated discounted future
cash flows using a discount rate determined by Company management to be
commensurate with the associated risks.
On January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other Intangible
Assets" (SFAS 142). In accordance with SFAS 142, amortization of goodwill was
discontinued as of January 1, 2002. Goodwill represents the excess acquisition
cost over the fair value of the net assets acquired in the purchase of various
entities. Prior to the adoption of SFAS 142, goodwill was amortized on a
straight-line basis over its estimated useful life, which generally was a period
ranging from 10 to 40 years. The Company evaluates the recoverability of
goodwill annually as of December 31, or more frequently if events or changes in
circumstances warrant, such as material adverse changes in the business climate
indicate that the carrying value of an asset might be impaired. Goodwill is
considered to be impaired when the net book value of a reporting unit exceeds
its estimated fair value. Fair values are estimated using a discounted cash flow
methodology. Discounted cash flows are based on the businesses' strategic plans
and management's best estimate of revenue growth and profit margin by each
reporting unit. During the third quarter of 2003, as a result of significant
changes in the business climate, 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. Based upon this assessment, the
Company concluded that goodwill associated with several reporting units exceeded
their fair value and accordingly recorded a $12.7 million impairment charge. The
impairment charge represented the entire goodwill balance for these reporting
units.
Income Taxes
The Company estimates its income tax liability in each jurisdiction in which it
operates based on an assessment of permanent and temporary differences resulting
from differing treatment of items for tax and financial reporting purposes.
Temporary differences result in deferred tax assets and liabilities, which are
included within the Consolidated Balance Sheets. The Company assesses the
likelihood that deferred tax assets will be recovered, and establishes a
valuation allowance to the extent that it believes that it is more likely than
not any deferred tax asset will not be realized. All available evidence, both
positive and negative, is considered in the determination of recording a
valuation allowance. The Company considers future taxable income and ongoing tax
planning strategies when assessing the need for a valuation allowance. Negative
evidence that would suggest the need for a valuation allowance consists of the
Company's recent cumulative operating losses that were attributable to
unprofitable businesses.
The positive evidence consists of the Company's current initiative to realign
its businesses to operate more efficiently. In addition, the Company recently
acquired the Ecolochem Group, which has strong historical earnings. The Company
believes that future taxable income will be sufficient to realize the deferred
tax benefit of the net deferred tax assets. In the event that it is determined
that the Company's financial projections of pre tax profits change and it
becomes more likely than not that the net deferred tax assets will not be
realized, an adjustment to the net deferred tax assets will be made and will
result in a charge to income in the period such determination is made. The net
deferred tax asset amount as of December 31, 2003 is $6.3 million.
Taxable income in future periods significantly different from that projected may
cause adjustments to the valuation allowance that could materially increase or
decrease future income tax expense. At any time, the Company's income tax
expense can also be impacted by changes in tax laws, or by administrative
actions or court rulings. 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.
The Company has taken positions in its worldwide corporate income tax filings
based on careful interpretations of global statutes, rules, regulations and
court decisions that may be applied and interpreted differently by a taxing
authority. These taxing authorities may or may not challenge the Company's
application and interpretation of a wide body of tax jurisprudence. During 2004
and the beginning of 2005, the Company expects that several matters relating to
interpretations made regarding tax positions taken by the Company could be
resolved either through the completion of the examination by taxing authorities
or by the passage of the statute of limitations for review. Although the final
determination of these matters cannot presently be determined, the Company
believes that an unfavorable settlement of any particular matter would likely
require the use of cash while a favorable resolution would likely result in a
reduction in the Company's effective tax rate in the period of resolution. While
the Company believes its accrued income tax liabilities are adequate, the
resolution of certain of these matters could have a material impact on the
Company's results of operations, financial condition or cash flows.
23
The Company has elected not to provide tax on certain undistributed earnings of
its foreign subsidiaries which it considers to be permanently reinvested. The
cumulative amount of such unprovided U.S. taxes was approximately $10.5 million,
$9.7 million and $8.2 million as of December 31, 2003, 2002 and 2001,
respectively.
Pension Plans
The Company has a qualified defined benefit pension plan covering most of its
domestic employees. The Company's calculation of pension expense is sensitive to
changes in several key economic assumptions and in the demographics of its
workforce. The Company's pension income or expense for the plan is computed
using actuarial valuations. The assumptions made by the Company relate to
financial market and other economic conditions. Changes in key economic
indicators can result in changes in the assumptions the Company uses. The
assumptions made at year-end used to estimate pension income or expense for the
following year are the discount rate and the expected long-term rate of return
on plan assets. The discount rate states the expected future cash flows
necessary to satisfy the pension obligations at a present value. The Company
uses judgment in selecting these assumptions giving consideration to current
market conditions, future market trends, changes in interest rates and equity
market performance. The Company also considers factors such as the timing and
amounts of expected contributions to the plans and benefit payments to plan
participants. The Company's selection of a discount rate represents the market
rate of return on high-quality fixed income investments. A lower discount rate
would increase the present value of the pension obligation and increase pension
expense.
During 2003, the Company's review of market trends, actual returns on plan
assets, and other factors resulted in maintaining the expected long-term rate of
return on plan assets at 7.0% for its December 31, 2003 actuarial calculations.
This rate is applied to a calculated value of plan assets which results in an
amount that is included in pension income or expense in 2004. The Company
reduced the discount rate assumption from 6.5% to 6.0% at December 31, 2003.
During the fourth quarter of 2003, the Company's Board of Directors approved
amendments to the defined benefit pension plan and to the Supplemental Executive
Retirement Plan ("SERP") to cease accepting new participants after December 31,
2003 and to freeze benefit accruals as of March 31, 2004. The amendments to
these plans resulted in the recognition of a curtailment loss of approximately
$5.5 million in the fourth quarter of 2003.
During 2003 and 2002, the Company recorded an adjustment in the stockholders'
equity section of its Consolidated Balance Sheets to reflect a minimum pension
liability for its pension plan. This adjustment is determined by comparing the
accumulated benefit obligation (ABO) for the plan to the fair value of the
plan's assets. The amount by which the ABO exceeds the fair value of the plan
assets, after adjusting for previously recorded accrued or prepaid pension cost
for the plan, must be recorded as a minimum pension liability, with a
corresponding increase in an intangible asset, if appropriate, and a reduction
to stockholders' equity, consistent with SFAS 87. The after-tax adjustment
related to the Company's recording a minimum pension liability in 2003 did not
impact earnings, but reduced stockholders' equity by $0.5 million. This
adjustment is computed each year at December 31 and could potentially reverse in
the future if financial markets improve and interest rates increase, or could
potentially increase if financial market performance and interest rates continue
to decline.
Loss Contingencies
The Company is subject to certain claims and litigation including proceedings
under government laws and regulations and commercial disputes relating to its
operations, including ordinary routine litigation incidental to its business.
(See "Note 9. Commitments and Contingencies to the Consolidated Financial
Statements"). Management reviews and determines which liabilities, if any;
arising from these claims and litigations could have a material adverse effect
on the Company's consolidated financial position, liquidity or results of
operations. Management assesses the likelihood of any adverse judgments or
outcomes as well as potential ranges of probable losses. Loss contingency
liabilities are recorded for these contingencies based on careful analysis of
each matter with the assistance of outside counsel when it is probable that a
liability has been incurred and the amount of the loss is reasonably estimable.
These liabilities may change in the future due to new developments relating to
each matter or changes in approach such as a change in settlement strategy.
Derivative Instruments
All derivative instruments are stated at fair value on the Consolidated Balance
Sheets. The Company conducts business in a number of foreign countries, with
certain transactions denominated in local currencies. The Company hedges certain
foreign currency exposures to minimize the effect of exchange rate fluctuations
on certain monetary assets and anticipated cash flows denominated in foreign
currencies. The terms of the currency instruments used for hedging purposes are
consistent with the timing of the transactions being hedged. The Company does
not use derivative financial instruments for trading or speculative purposes.
24
The Company enters into foreign currency forward contracts to hedge its
exposures associated with certain forecasted revenue transactions. These
derivative instruments, which are designated as foreign currency cash flow
hedges and generally mature within two years or less. All outstanding
derivatives are recognized on the Consolidated Balance Sheets at fair value and
changes in their fair value are recorded in accumulated other comprehensive
income (loss) until the underlying forecasted transaction occurs. Once the
underlying forecasted transaction is realized, the gain or loss from the
derivative designated as a hedge of the transaction is reclassified from
accumulated other comprehensive income (loss) to the statement of operations in
the related revenue caption. In the event the underlying forecasted transaction
does not occur, the amount recorded in accumulated other comprehensive income
(loss) will be reclassified to selling, general and administrative expense in
the Consolidated Statements of Operations in the then-current period. No amounts
were reclassified from accumulated other comprehensive income (loss) to selling,
general and administrative expense during 2003, 2002 or 2001.
The Company also enters into foreign exchange forward contracts to hedge its
exposures associated with foreign-currency denominated assets and liabilities.
These derivative instruments are designated as foreign currency fair value
hedges. The derivatives are recognized on the Consolidated Balance Sheets at
fair value and period-end changes in fair value are recorded in selling, general
and administrative expense in the Consolidated Statements of Operations.
Since the Company is using foreign exchange derivative contracts to hedge
foreign exchange exposures, the changes in the value of the derivatives are
highly effective in offsetting changes in the cash flows of the hedged item.
Hedge effectiveness is assessed on a quarterly basis. Any ineffective portion of
the derivatives designated as cash flow hedges is recognized in current earnings
in selling, general and administrative expense. The ineffective portion of the
derivatives consists of discounts or premiums on forward contracts and gains or
losses associated with differences between actual and forecasted amounts. In any
instance in which the designated hedged item matures, is terminated, or, in the
case of an anticipated transaction, is deemed unlikely to occur, the related
derivative contract is closed and any gain or loss is immediately recognized in
the Consolidated Statements of Operations in selling, general and administrative
expense. For the year ended December 31, 2003, the Company recognized a gain of
approximately $0.1 million related to the ineffective portion of its forecasted
cash flow hedge.
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED DECEMBER 31, 2003 AND DECEMBER 31, 2002
The Company reported consolidated revenues of $347.4 million and a net loss of
$44.8 million in 2003, compared to consolidated revenues of $318.9 million and
net income of $4.8 million in 2002. During 2003, as part of the Company's
restructuring plan, the Company approved plans to divest its Elite Consumer
Products division and its European Point of Use cooler ("POU") business.
Accordingly, results for the Company's Elite Consumer Products division and
European POU business, which are part of the Consumer Water Group, have been
reclassified to discontinued operations in the Consolidated Statements of
Operations for all periods presented. Results for 2002 included the partial year
operations of the Company's majority-owned Malaysian subsidiary, Ionics Enersave
("Enersave") which was divested in May 2002. In addition, in the third quarter
of 2003, the Company completed the acquisition of substantially all of the
assets of CoolerSmart LLC, a limited liability company in the business of
leasing POU "bottleless" water coolers.
Revenues
Total Company revenues of $347.4 million for 2003 increased $28.5 million or
8.9% from revenues of $318.9 million for 2002. The decreased revenue in EBG and
CWG were primarily offset by increased revenue from affiliated companies.
Included in 2002 are $4.2 million of revenues from partial year results of
Enersave, which was divested in May 2002.
25
The following table reflects the revenues of the Company's four business
segments and sales to affiliated companies for the years ended December 31, 2003
and 2002:
For the years ended December 31,
-------------------------------- Percentage
(Dollars in thousands) 2003 2002 Dollar Change Change
---------- ---------- ------------- ----------
Revenues
Equipment Business Group $ 144,043 $ 154,378 $ (10,335) (6.7)%
Ultrapure Water Group 102,600 102,407 193 0.2%
Consumer Water Group 21,216 22,190 (974) (4.4)%
Instrument Business Group 29,807 27,741 2,066 7.4%
Affiliated companies 49,741 12,168 37,573 308.8%
---------- ---------- ---------- -----
$ 347,407 $ 318,884 $ 28,523 8.9%
========== ========== ========== =====
EBG revenues of $144.0 million in 2003 decreased $10.3 million, or 6.7%,
compared to revenues of $154.4 million in 2002. The decrease in revenues is
primarily attributable to reduced revenues from the Zero Liquid Discharge
("ZLD") business of $13.5 million, primarily as a result of the Company's
business strategy to not pursue the civil construction scope on ZLD projects.
This decrease was partially offset by increases in EBG's water supply business
in the Caribbean ($3.6 million), as well as new sales of capital equipment to
several municipalities for surface water applications.
UWG revenues of $102.6 million in 2003 increased $0.2 million, or 0.2%, compared
to revenues of $102.4 million for 2002. Revenues for 2002 included $4.2 million
from Enersave, which was divested in May 2002. Excluding Enersave revenue from
2002, UWG revenue increased $4.4 million or 4.5% in 2003 compared to 2002. The
increase in revenues is primarily attributable to increased revenues in
Australia ($4.5 million) and Asia ($4.6 million), offset by lower revenues from
domestic operations ($5.3 million).
CWG revenues totaled $21.2 million in 2003 compared to revenues of $22.2 million
in 2002, representing a decrease of $1.0 million or 4.4%. Results for the
Company's Elite Consumer Products division in Ludlow, MA, as well as the
Company's European POU divisions, have been reclassified to discontinued
operations for all periods presented.
IBG revenues of $29.8 million in 2003 increased $2.1 million, or 7.4%, compared
to revenues of $27.7 million in 2002. The increase in revenues primarily
resulted from increased sales to the pharmaceutical industry as a result of
legislative regulations as well as continued growth in sales of consumable
products and instrument services.
Revenues from sales to affiliated companies of $49.7 million in 2003 increased
$37.6 million or 308.8% compared to revenues from affiliated companies of $12.2
million in 2002. The increase in revenues from sales to 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.
26
Cost of Sales
The following table reflects cost of sales of the Company's four business
segments and cost of sales to affiliated companies for the years ended December
31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Cost of Sales
Equipment Business Group $ 113,779 79.0% $ 114,251 74.0%
Ultrapure Water Group 80,159 78.1% 78,423 76.6%
Consumer Water Group 9,878 46.6% 9,889 44.6%
Instrument Business Group 12,317 41.3% 11,719 42.2%
Affiliated companies 43,639 87.7% 10,965 90.1%
---------- ---- ---------- ----
$ 259,772 74.8% $ 225,247 70.6%
========== ==== ========== ====
The Company's total cost of sales as a percentage of revenue was 74.8% in 2003
and 70.6% in 2002. The resulting gross margin decreased to 25.2% in 2003 from to
29.4% in 2002. Cost of sales as a percentage of revenue increased in the EBG,
UWG and CWG segments and decreased for the IBG segment and for affiliated
companies.
EBG's cost of sales as a percentage of revenue increased to 79.0% in 2003 from
74.0% in 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 approximately $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 settlements of contract disputes concerning two completed zero liquid
discharge projects ($0.5 million).
UWG's cost of sales as a percentage of revenue increased to 78.1% in 2003 from
76.6% in 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 ($0.8
million). Additionally, the Company wrote off inventory of approximately $0.5
million relating to its decision to cease manufacturing in certain domestic
locations.
CWG's cost of sales as a percentage of revenue increased to 46.6% in 2003 from
44.6% in 2002. The increase in the 2003 cost of sales as a percentage of revenue
was primarily attributable to the write-off of inventory as a result of the
Company's decision to shut down the operations of its European Home Water
business.
IBG's cost of sales as a percentage of revenue decreased to 41.3% in 2003 from
42.2% in 2002, equally reflecting increased sales of higher margin instruments
and consumable products along with increased absorption of manufacturing
overhead, as a result of higher sales volume.
Cost of sales to affiliated companies as a percentage of revenue decreased to
87.7% in 2003 from 90.1% in 2002. The decrease in the cost of sales for 2003 was
primarily due to lower revenues from sales to Desalination Company of Trinidad
and Tobago Ltd. ("Desalcott"), because all profit on sales to Desalcott has been
eliminated. 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 eliminates
intercompany profit equal to its 25% equity ownership in UDC.
27
Operating Expenses
The following table compares the Company's operating expenses for the years
ended December 31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Operating expenses
Research and development expenses $ 7,449 2.1% $ 6,462 2.0%
---------- ---- ---------- ----
Selling, general and administrative $ 99,754 28.7% $ 89,078 27.9%
---------- ---- ---------- ----
Research and development expenses consist primarily of personnel costs and costs
associated with the development of new products and the enhancement of existing
products for the EBG, UWG and IBG segments. Research and development expenses
increased 15.3%, or $1.0 million, during 2003 compared to 2002. The Company
currently expects to continue to invest in new products, processes and
technologies at the same level as in prior years.
Selling, general and administrative expenses increased $10.7 million during 2003
to $99.8 million from $89.1 million during 2002. The increase in selling,
general, and administrative costs during 2003 compared to 2002 is attributable
to several factors. The Company recorded a $5.4 million loss associated with its
decision in the fourth quarter of 2003 to curtail the Company's defined benefit
plan and SERP in early 2004. 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 retirement of the Company's former Chief Executive Officer.
The Company also incurred increased professional service fees of approximately
$2.1 million in 2003 as well as approximately $1.2 million in costs associated
with its decision to implement a Company-wide enterprise resource planning
("ERP") system.
Restructuring and Impairment of Long-Lived Assets
The following table compares the Company's expenses relating to restructuring
and impairment of long-lived assets for the years ended December 31, 2003 and
2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Restructuring and impairment of
long-lived assets
Restructuring $ 2,723 0.8% $ - 0.0%
---------- --- ---------- ---
Impairment of long-lived assets $ 4,330 1.2% $ - 0.0%
---------- --- ---------- ---
During the third quarter of 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 consolidate the EBG and UWG
into a single business group, divest the Elite Consumer Products division in
Ludlow, MA, and shut down operations at the Company's Ionics Watertec facility
in Australia as well as the Company's European Home Water activities (the sale
of home water conditioners in Ireland and the U.K.). Additionally, during the
fourth quarter of 2003, the Company decided to divest its European POU business,
which engaged in the sale of POU "bottleless" coolers in Ireland and the U.K.
As a result of these decisions, the Company recorded restructuring charges of
approximately $2.8 million during 2003 relating primarily to employee severance
costs for the elimination of approximately 160 positions primarily in the EBG
and UWG segments. During 2003, substantially all of the employees whose
employment was terminated as a result of these restructuring activities left the
Company. Additionally, at December 31, 2003, the Company has approximately $0.9
million accrued for
28
restructuring costs associated with employee severance arrangements and expects
the remainder of the payments to be made during the first half of 2004. The
Company expects to realize a reduction of approximately $15.4 million in
operating expenses in 2004 as a result of the actions taken in the third and
fourth quarters of 2003.
During 2003, the Company recorded an impairment charge relating to production
equipment within the EBG segment that it had previously expected to lease to a
manufacturer of lactic acid in the food industry in Spain. During the second
half of 2003 the Company's customer, Intersuero, began the process of filing for
insolvency protection. Accordingly, the Company recorded an 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 in respect to the asset. This matter is currently in litigation.
See Item 3, Legal Proceedings. Additionally, as a result of the Company's
restructuring plan, the Company ceased or reduced manufacturing operations at
various locations resulting in the impairment of manufacturing equipment
totaling approximately $1.2 million. The Company also recorded an impairment
charge of approximately $0.6 million associated with its decision to abandon a
plan to increase manufacturing capacity in a plant located in Italy.
Impairment of Goodwill
The following table compares the Company's expenses relating to impairment of
goodwill for the years ended December 31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Impairment of goodwill $ 12,731 3.7% $ - 0.0%
---------- --- ---------- ---
During the third quarter of 2003, as a result of significant changes in the
business climate for several reporting units 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. Based upon this assessment,
the Company concluded that goodwill associated with its Ionics RCC, Ionics
Ahlfinger and Separations Technology business units exceeded their fair value
and accordingly recorded a $12.7 million impairment charge ($6.8 million at
Ionics RCC, $3.7 million at Ionics Ahlfinger and $2.2 million at Separations
Technology). The impairment charge represented the entire goodwill balance for
these reporting units.
Interest Income and Interest Expense
The following table compares the Company's interest income and interest expense
for the years ended December 31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Interest Income $ 3,091 0.9% $ 3,411 1.1%
---------- --- ---------- ---
Interest Expense $ 908 0.3% $ 1,172 0.4%
---------- --- ---------- ---
Interest income totaled $3.1 million in 2003 and $3.4 million in 2002. Interest
expense, net of capitalized interest of $0.1 million, was $0.9 million in 2003.
Interest expense, net of capitalized interest of $0.3 million, was $1.2 million
in 2002.
29
Equity (Loss) Income
The Company's proportionate share of the earnings and losses of affiliated
companies in which it holds a minority equity interest is included in equity
income. The following table compares the Company's equity (loss) income relating
to the results of its minority equity investments for the years ended December
31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Equity (loss) income $ (7,164) (2.1)% $ 3,443 1.1%
---------- ---- ---------- ---
Equity loss amounted to $7.2 million in 2003 compared to equity income of $3.4
million in 2002. The Company's equity (loss) income is derived primarily from
its 20% equity interest in a Mexican joint venture company which owns two water
treatment plants in Mexico, its 40% equity interest in Desalcott, its 43%
ownership in Toray Membrane America, Inc. (TMA), a membrane manufacturer, its
equity interests in several joint ventures in the Middle East which engage in
bottled water distribution, and to a lesser extent from its other equity
investments in affiliated companies. The decrease in equity income of $10.6
million primarily relates to losses reported by TMA and Desalcott. TMA losses
primarily resulted from the impairment of certain of its membrane manufacturing
equipment during the fourth quarter of 2003. Desalcott's losses were primarily
the result of management fees and costs associated with the close of long-term
financing and settlement of a construction contract dispute between the Company
and Desalcott.
Gain on Sale of Aqua Cool
The following table compares the Company's gain on sale of its Aqua Cool
Business for the years ended December 31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Gain on sale of Aqua Cool $ 457 0.1% $ 8,160 2.6%
---------- --- ---------- ---
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
adjustments 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.
30
Income Tax (Benefit) Expense
The following table compares the Company's income tax (benefit) expense and
effective tax rates for the years ended December 31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Effective Tax Effective Tax
(Dollars in thousands) 2003 Rate 2002 Rate
---------- ------------- ---------- -------------
Income tax (benefit) expense $ (11,533) (26.3)% $ 5,466 45.8%
---------- ----- ---------- ----
For the year ended December 31, 2003, the Company recorded an income tax benefit
of $11.5 million on a consolidated pre-tax loss from continuing operations
before minority interest expense of $43.9 million, yielding an annual effective
tax rate of 26.3%. For the year ended December 31, 2002, the Company recorded
income tax expense of $5.5 million on consolidated pre-tax income from
continuing operations before minority interest of $11.9 million, yielding an
annual effective tax rate of 45.8%. The change in the effective tax rate for
2003 compared to 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 continually assesses the realizability of its deferred tax asset.
The deferred tax asset may be reduced by a valuation allowance, if based on the
weight of available evidence; it is more likely than not that some portion or
all of the recorded deferred tax assets will not be realized in future periods.
All available evidence, both positive and negative, is considered in the
determination of recording a valuation allowance. The Company considers future
taxable income and ongoing tax planning strategies when assessing the need for a
valuation allowance. Negative evidence that would suggest the need for a
valuation allowance consists of the Company's recent cumulative operating losses
that were attributable to unprofitable businesses.
The positive evidence consists of the Company's current initiative to realign
its businesses to operate more efficiently. In addition, the Company recently
acquired the Ecolochem Group, which has strong historical earnings. The Company
believes that future taxable income will be sufficient to realize the deferred
tax benefit of the net deferred tax assets. In the event that it is determined
that the Company's financial projections of pre tax profits change and it
becomes more likely than not that the net deferred tax assets will not be
realized, an adjustment to the net deferred tax assets will be made and will
result in a charge to income in the period such determination is made. The net
deferred tax asset amount as of December 31, 2003 is $6.3 million.
Discontinued Operations
In the third quarter of 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 was part of the Company's
Consumer Water Group. Additionally, during the fourth quarter of 2003, the
Company's management and Board of Directors approved a plan of disposition to
sell its European POU cooler business, which sells point-of-use "bottleless"
water coolers in Ireland and the U.K. Accordingly, the Company's Consolidated
Financial Statements and Notes have been reclassified to reflect these
businesses as discontinued operations in accordance with Financial Accounting
Standards Board Statement No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets."
The following table compares the Company's results of discontinued operations
for the years ended December 31, 2003 and 2002:
For the years ended December 31,
-----------------------------------
(Dollars in thousands) 2003 2002
----------- -----------
Discontinued Operations
Loss from operations $ (9,410) $ (1,270)
Loss on disposal (7,667) -
Income tax benefit 5,575 558
---------- ----------
Loss from discontinued operations, net of tax $ (11,502) $ (712)
========== ==========
The loss from discontinued operations of $11.5 million, or $17.1 million on a
pre-tax basis, in 2003 includes pre-tax losses from
31
operations of $9.4 million, which includes an asset impairment charge of $4.0
million recorded during the second quarter attributable to certain sodium
hypochlorite manufacturing equipment. The estimated loss on disposal of $7.7
million reflects asset impairment charges to write down the carrying value of
these assets to their estimated fair value less costs to sell. In early 2004,
the Company completed the sale of the Elite Consumer Products division for
approximately $5.2 million and expects to complete the sale of the European POU
business in 2004.
Net (Loss) Income
The following table compares the Company's net (loss) income and percentage of
revenues for the years ended December 31, 2003 and 2002:
For the years ended December 31,
-------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Net (loss) income $ (44,770) (12.9)% $ 4,792 1.5%
---------- ----- ---------- ---
Net loss amounted to $44.8 million in 2003 compared to net income of $4.8
million for 2002.
COMPARISON OF YEARS ENDED DECEMBER 31, 2002 AND DECEMBER 31, 2001
The Company reported consolidated revenues of $318.9 million and net income of
$4.8 million in 2002, compared to consolidated revenues of $448.0 million and
net income of $44.7 million in 2001. During 2003, as part of the Company's
restructuring plan, the Company approved plans to divest its Elite Consumer
Products division and its European POU business. Accordingly, results for the
Company's Elite Consumer Products division and European POU business, which were
part of the Consumer Water Group, have been reclassified to discontinued
operations in the Consolidated Statements of Operations for all periods
presented. Results for 2001 included the operations of the Aqua Cool Pure
Bottled Water business ("Aqua Cool Business"), which was divested on December
31, 2001, as well as the results of the Company's majority-owned Malaysian
subsidiary, Enersave, which was divested in May 2002.
Revenues
The following table reflects the revenues of the Company's four business
segments and sales to affiliated companies for the years ended December 31, 2002
and 2001:
For the years ended December 31,
-------------------------------- Percentage
(Dollars in thousands) 2002 2001 Dollar Change Change
---------- ---------- ------------- ----------
Revenues
Equipment Business Group $ 154,378 $ 161,565 $ (7,187) (4.4)%
Ultrapure Water Group 102,407 133,605 (31,198) (23.4)%
Consumer Water Group 22,190 105,065 (82,875) (78.9)%
Instrument Business Group 27,741 26,595 1,146 4.3 %
Affiliated companies 12,168 21,219 (9,051) (42.7)%
---------- ---------- ---------- -----
$ 318,884 $ 448,049 $ (129,165) (28.8)%
========== ========== ========== =====
Total Company revenues of $318.9 million for 2002 decreased $129.2 million, or
28.8%, from revenues of $448.0 million for 2001. The 2001 revenues of the Aqua
Cool Business represented $76.2 million, or 59.0% of the decrease, and the
revenues of the Company's majority-owned Malaysian subsidiary represented $14.8
million, or 11.5% of the decrease.
EBG revenues of $154.4 million in 2002 decreased $7.2 million, or 4.4%, compared
to revenues of $161.6 million in 2001. The decrease in revenues is primarily
attributable to reduced revenues from the Zero Liquid Discharge ("ZLD")
business, primarily as a result of the Company's business strategy to not pursue
the civil construction scope on ZLD projects.
32
UWG revenues of $102.4 million decreased $31.2 million, or 23.4%, compared to
revenues of $133.6 million for 2001. The revenues associated with Enersave,
which was divested in May 2002, amounted to $19.0 million in 2001 and $4.2
million in 2002, and accordingly represented 47.4% of the revenue decrease. The
additional decrease in revenues relates primarily to the continued downturn in
the microelectronics sector.
CWG revenues totaled $22.2 million in 2002 compared to revenues of $105.1
million in 2001, representing a decrease of $82.9 million or 78.9%. The 2001
revenues of the Aqua Cool Business of $76.2 million represented 91.9% of the
decrease in revenues. CWG revenue levels were also adversely impacted by lower
demand for home water treatment equipment as a result of the general downturn in
the domestic economy.
IBG revenues of $27.7 million in 2002 increased $1.1 million, or 4.3%, compared
to revenues of $26.6 million in 2001. The increase in revenues equally resulted
from increased sales volume to the pharmaceutical industry driven by regulatory
requirements in that industry, as well as continued growth in recurring sales of
the Company's after-market products.
Revenues from sales to affiliated companies of $12.2 million in 2002 decreased
$9.1 million or 42.7% compared to revenues from affiliated companies of $21.2
million in 2001. The decrease in revenues from affiliated companies primarily
resulted from lower equipment sales to the Trinidad joint venture company,
Desalcott, as a result of the substantial completion of the first four out of
the five construction phases of the desalination facility in early 2002. The
decrease was partially offset by an increase in sales of equipment in the second
half of 2002 to the Kuwaiti joint venture company, UDC, for the Kuwait reuse
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 following table reflects cost of sales of the Company's four business
segments and cost of sales to affiliated companies for the years ended December
31, 2002 and 2001:
For the years ended December 31,
-------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
---------- ------------- ---------- -------------
Cost of Sales
Equipment Business Group $ 114,251 74.0% $ 126,757 78.5%
Ultrapure Water Group 78,423 76.6% 107,148 80.2%
Consumer Water Group 9,889 44.6% 56,971 54.2%
Instrument Business Group 11,719 42.2% 12,756 48.0%
Affiliated companies 10,965 90.1% 20,677 97.4%
---------- ---- ---------- ----
$ 225,247 70.6% $ 324,309 72.4%
========== ==== ========== ====
The Company's total cost of sales as a percentage of revenue was 70.6% in 2002
and 72.4% in 2001. The resulting gross margin increased to 29.4% in 2002
compared to 27.6% in 2001. Cost of sales as a percentage of revenue decreased in
all segments.
EBG's cost of sales as a percentage of revenue decreased to 74.0% in 2002 from
78.5% in 2001. The improvement in cost of sales as a percentage of revenue from
2001 to 2002 related to the elimination of losses incurred on the civil
construction portion of ZLD projects that were incurred in 2001.
UWG's cost of sales as a percentage of revenue decreased to 76.6% in 2002 from
80.2% in 2001. The decrease in cost of goods sold as a percentage of revenue
primarily reflects the elimination of losses associated with projects in
Australia, improved operating results in the group's Asian operations, and the
reduction of losses associated with Enersave, which was divested in May 2002.
33
CWG's cost of sales as a percentage of revenue decreased to 44.6% in 2002 from
54.2% in 2001. The decrease in the cost of sales as a percentage of revenue was
primarily attributable to the divestiture of the Company's Aqua Cool Business.
IBG's cost of sales as a percentage of revenue decreased to 42.2% in 2002 from
48.0% in 2001, primarily reflecting increased sales of higher margin instruments
and consumable products along with increased absorption of manufacturing
overhead, as a result of higher sales volume.
Cost of sales to affiliated companies as a percentage of revenue decreased to
90.1% in 2002 from 97.4% in 2001. The decrease in 2002 was primarily due to
lower revenues from sales to Desalcott, where all profit on sales to Desalcott
is being eliminated, and the increase in equipment sales to UDC, where the
Company eliminates profit equal to its 25% equity ownership in UDC.
Operating Expenses
The following table compares the Company's operating expenses for the years
ended December 31, 2002 and 2001:
For the years ended December 31,
---------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
---------- ------------- ---------- -------------
Operating expenses
Research and development expenses $ 6,462 2.0% $ 6,420 1.4%
---------- ---- ---------- ----
Selling, general and administrative expenses $ 89,078 27.9% $ 119,019 26.6%
---------- ---- ---------- ----
Research and development expenses as a percentage of revenue increased slightly
during 2002 compared to 2001. The Company currently expects to continue to
invest in new products and technologies at approximately the same level as in
prior years.
Selling, general and administrative expenses decreased $29.9 million to $89.1
million in 2002 from $119.0 million in 2001. The elimination of 2001 selling,
general and administrative expenses resulted from the divestiture of the Aqua
Cool Business on December 31, 2001, as well as the divestiture of Enersave in
the second quarter of 2002, and the cessation of goodwill amortization amounting
to approximately $40.2 million. These decreases in 2002 selling, general and
administrative expenses were partially offset by increased operating expenses
associated with the Company's European operations, primarily in France, higher
than normal professional service fees related primarily to the Company's
restatement of its interim financial statements for the first and second
quarters of 2002, increased provisions for doubtful accounts, and other general
increases.
Restructuring and Impairment of Long-Lived Assets
The following table compares the Company's expenses relating to impairment of
long-lived assets for the years ended December 31, 2002 and 2001:
For the years ended December 31,
---------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
---------- ------------- ---------- -------------
Impairment of long-lived assets $ - $ - $ 1,300 0.3%
---------- ------------- ---------- ---
In 2001, the Company wrote down approximately $1.3 million of impaired
long-lived assets in order to reduce the carrying value of assets held for sale
related to the divestiture of Enersave. The Company began negotiations to sell
its 55% interest in Enersave to the minority shareholders in late 2001. In early
2002, the Company had signed a term sheet for the disposition of its interest in
Enersave and the sale was completed in May 2002. Accordingly, at December 31,
2001, the Company recorded an impairment charge of approximately $9.2 million,
representing the difference between the Company's 55% ownership interest in the
net asset value of Enersave (principally property, plant and equipment, and
goodwill) and the anticipated net proceeds from the sale of the Company's
interest in the subsidiary of approximately $1.0 million.
34
Impairment of Goodwill
The following table compares the Company's expenses relating to impairment of
goodwill for the years ended December 31, 2002 and 2001:
For the years ended December 31,
-----------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
------- ------------- -------- -------------
Impairment of goodwill $ - - $ 11,016 2.5%
------- ------------- -------- -------------
During 2001, the Company wrote down approximately $11.0 million of goodwill. Of
this amount, $7.8 million related to the Company's divestiture of Enersave, and
the remaining $3.2 million related to previous acquisitions.
Interest Income and Interest Expense
The following table compares the Company's interest and interest expense for the
years ended December 31, 2002 and 2001:
For the years ended December 31,
-----------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
------- ------------- -------- -------------
Interest Income $ 3,411 1.1% $ 1,013 0.2%
------- ------------- -------- -------------
Interest Expense $ 1,172 0.4% $ 5,166 1.2%
------- ------------- -------- -------------
Interest income totaled $3.4 million in 2002 and $1.0 million in 2001. Interest
expense, net of capitalized interest of $0.3 million, was $1.2 million in 2002
and $5.2 million in 2001. The increase in interest income in 2002 compared to
2001 reflects the investment of proceeds resulting from the divestiture of the
Aqua Cool Business on December 31, 2001. Additionally, a portion of the proceeds
from the disposition of the Aqua Cool Business was utilized to reduce domestic
short-term borrowings, which resulted in lower interest expense of $1.2 million
in 2002 compared to $5.2 million in 2001.
Equity Income
The Company's proportionate share of the earnings and losses of affiliated
companies in which it holds a minority equity interest is included in equity
income for the years ended December 31, 2002 and 2001.
For the years ended December 31,
-----------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
------- ------------- -------- -------------
Equity income $ 3,443 1.1% $ 1,396 0.3%
------- ------------- -------- -------------
Equity income amounted to $3.4 million in 2002 and $1.4 million in 2001. The
Company's equity income is derived primarily from its 20% equity interest in a
Mexican joint venture company, which owns two water treatment plants in Mexico,
its 40% equity interest in Desalcott, its equity interests in several joint
ventures in the Middle East which engage in bottled water distribution, and to a
lesser extent from its other equity investments in affiliated companies.
35
Gain on Sale of Aqua Cool
The following table compares the Company's gain on sale of Aqua Cool for the
years ended December 31, 2002 and 2001:
For the years ended December 31,
-----------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
------- ------------- -------- -------------
Gain on sale of Aqua Cool $ 8,160 2.6% $102,834 23.0%
------- ------------- -------- -------------
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
adjustments 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.
Income Tax Expense
The following table compares the Company's income tax expense and effective tax
rates for the years ended December 31, 2002 and 2001:
For the years ended December 31,
----------------------------------------------------
Effective Tax Effective Tax
(Dollars in thousands) 2002 Rate 2001 Rate
------- ------------- -------- -------------
Income tax expense $ 5,466 45.8% $ 42,186 49.0%
------- ------------- -------- -------------
The Company's effective tax rate for 2002 was 45.8% compared to 49.0% in 2001.
The Company's 2002 tax rate was primarily affected by losses in certain of its
foreign subsidiaries for which the Company may not be able to realize future tax
benefits. The 2001 tax rate was primarily impacted by the gain on the sale of
the Company's Aqua Cool Business, which included non-deductible goodwill, as
well as significant losses incurred by Enersave that were not benefited since
realization of those benefits was not likely.
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 was part of the Company's Consumer Water
Group segment. Additionally, during the fourth quarter of 2003, the Company's
management and Board of Directors approved a plan of disposition to sell its
European POU business. Accordingly, the Company's Consolidated Financial
Statements and Notes have been reclassified to reflect these businesses as
discontinued operations for all periods presented.
36
The following table compares the Company's results of discontinued operations
for the years ended December 31, 2002 and 2001:
For the years ended December 31,
-------------------------------
(Dollars in thousands) 2002 2001
---- ----
Discontinued Operations
(Loss) income from operations $(1,270) $ 141
Income tax benefit (expense) 558 (53)
------- -------
(Loss) income from discontinued operations, net of tax $ (712) $ 88
======= =======
The loss from discontinued operations of $0.7 million, or $1.3 million on a
pre-tax basis in 2002 includes the Elite Consumer Products division and the
European POU business. In 2001, income from discontinued operations was $0.1
million on a net tax and pre-tax basis.
Net Income
The following table compares the Company's net income and net income as a
percentage of sales for the years ended December 31, 2002 and 2001:
For the years ended December 31,
--------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2002 Sales 2001 Sales
---- ----- ---- -----
Net income $ 4,792 1.5% $ 44,701 10.0%
========== === ========== ====
Net income amounted to $4.8 million in 2002 compared to $44.7 million for 2001.
Net income in 2002 and 2001 included pre-tax gains of $8.2 million and $102.8
million, respectively, from the sale of the Company's Aqua Cool Business.
FINANCIAL CONDITION
The following table compares the Company's net working capital and current ratio
for the years ended December 31, 2003 and 2002:
For the years ended December 31,
----------------------------------------
(Dollars in thousands) 2003 2002 Change
---- ---- ------
Total current assets $315,818 $341,364 $(25,546)
Total current liabilities 118,092 114,168 3,924
-------- -------- --------
Net working capital $197,726 $227,196 $(29,470)
-------- -------- --------
Current ratio 2.7 3.0 (0.3)
-------- -------- --------
Net working capital decreased $29.5 million during 2003, while the Company's
current ratio, defined as current assets divided by current liabilities, of 2.7
at December 31, 2003 decreased from 3.0 at December 31, 2002.
At December 31, 2003, the Company had total assets of $592.0 million, compared
to total assets of $603.6 million at December 31, 2002. Cash, cash equivalents
and restricted cash decreased $6.5 million during 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.
37
Net cash provided by operating activities amounted to $4.5 million during 2003.
The primary sources of operating cash flow in 2003 included the loss from
continuing operations, adjusted to exclude the effects of non-cash items of
$15.7 million, accounts receivable of $9.6 million and inventory of $6.6
million. These sources of operating cash were offset by uses for increased
affiliate accounts receivable of $8.5 million, primarily from continuing work on
the Kuwait wastewater project and reductions of accounts payable and accrued
expenses of $9.1 million.
Net cash used in investing activities amounted to $29.0 million during 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 similar amount in
property, plant and equipment during 2004. 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 POU "bottleless" water
coolers, for approximately $7.1 million.
Net cash provided by financing activities totaled $11.0 million during 2003,
reflecting the expiration of the restriction on the use of cash that existed at
December 31, 2002 and proceeds from stock option plans.
Borrowings and Lines of Credit
At December 31, 2003, the Company maintained two primary domestic credit
facilities, including a $15 million unsecured credit line with Fleet Bank for
working capital and a $25 million unsecured credit line with HSBC Bank USA for
the issuance of letters of credit. Borrowings under the Fleet Bank facility bore
interest equal to a base rate (generally the Prime Rate) or LIBOR plus a margin
of 1.25%, at the Company's option. Letters of credit issued under the HSBC Bank
USA facility bore interest at a rate of .825%. The terms of the facilities
included financial covenants relating to liquidity, leverage, net worth and
capital expenditures. At December 31, 2003, the Company was in compliance with
all covenants. The Company had no borrowings against the Fleet Bank line of
credit at December 31, 2003 or December 31, 2002. The Company had outstanding
letters of credit under the HSBC Bank USA facility of $16.7 million at December
31, 2003 and $9.3 million at December 31, 2002. In February 2004, the Company
terminated its unsecured domestic credit lines with Fleet Bank and HSBC Bank
USA.
At December 31, 2003, the Company also maintained other international unsecured
lines of credit, under which the Company could borrow up to an aggregate of $8.8
million in working capital and issue letters of credit or letters of guarantee
up to an aggregate of $40.9 million. The Company had outstanding borrowings of
$4.8 million and $2.9 million and outstanding letters of credit and letters of
guarantee of $27.6 million and $29.0 million at December 31, 2003 and December
31, 2002, respectively.
On February 13, 2004, the Company acquired the stock and membership interests of
the Ecolochem Group from the shareholders and members of the Ecolochem Group for
an aggregate purchase price of $222.0 million (which includes $12.8 million to
be paid in the event that the Company makes a Section 338(h)(10) election with
respect to the acquired assets of the Ecolochem Group) and 4,652,648 shares of
the Company's common stock. The cash portion of the consideration was financed
with the Company's available cash resources and proceeds from new $255 million
senior secured credit facilities. In connection with the acquisition of the
Ecolochem Group (see Note 21), the Company obtained $255 million of senior
secured credit facilities with a syndication of lenders led by UBS, Fleet Bank
and Bank of America. Proceeds from the facilities were used to fund the
acquisition, pay certain fees and expenses, provide for ongoing working capital
and support the issuance of letters of credit. The facilities consist of a $175
million 7-year term loan and an $80 million 6-year revolving credit facility.
Borrowings under the facilities bear interest equal to a base rate (generally
the Prime Rate) plus a specified margin or LIBOR plus a specified margin, at the
Company's option; the specified margins are a function of the Company's leverage
ratio. Interest on outstanding borrowings is payable quarterly. The facilities
are collateralized by the assets of the Company and its domestic subsidiaries
and by 65% of the equity of the Company's international and its subsidiaries.
The terms of the facilities include financial covenants relating to fixed charge
coverage, interest coverage, leverage ratio and capital expenditures, the most
restrictive of which are anticipated to be the leverage ratio and limitations on
capital spending. The terms of the new credit facilities contain provisions that
limit the Company's ability to incur additional indebtedness in the future and
place other restrictions on the Company's business. In connection with the
execution of the new credit facility, the Company entered into interest rate
swap agreements that fix the Company's LIBOR rate on approximately 60% of the
outstanding balance of the term loan at 3.1175%. The swap agreements expire in
2010.
38
The Company has three project finance loans for its controlled affiliate in
Barbados. These loans are payable in equal quarterly installments over a ten
year period that began in 2000, and bear interest at rates ranging from LIBOR +
2.0% (3.09% at December 31, 2003) to 8.75%. The controlled affiliate had
outstanding borrowings of $6.4 million and $7.4 million against these loans at
December 31, 2003 and December 31, 2002, respectively. The Company also has
project financing loans for its controlled affiliate in Italy. The loans have a
ten-year maturity and bear interest at EURIBOR plus a specified margin. The
controlled affiliate had outstanding borrowings of EUR 3.0 million ($3.8
million) and EUR 3.4 million ($3.5 million) against these loans at December 31,
2003 and December 31, 2002, respectively.
Maturities of all cash borrowings outstanding for the five years ended December
31, 2004 through December 2008 are approximately $6.3 million, $1.5 million,
$1.6 million, $1.6 million, $1.7 million, and $2.5 million thereafter,
respectively. The weighted average interest rate on all borrowings was 6% at
both December 31, 2003 and 2002.
Off Balance Sheet Arrangements
From time to time, the Company enters into joint ventures with respect to
specific projects, including the projects in Trinidad, Kuwait, Israel and
Algeria 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
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.
39
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. This settlement had no impact on the Company's Statement of Operations.
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 relating to phases 1 through 4. 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 December
31, 2003, the Company had invested a total of $9.7 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 $7.6
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. Construction of the wastewater reuse facility is
underway and is expected to be completed in 2005.
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. During the second quarter of 2003, the
Israeli cooperative society and the Company acquired the ownership interest of
the Israeli corporation in MDL, resulting in the Company's holding a 49% equity
interest 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 $8.0 million of debt financing
for the project from an Israeli bank, and the Company has guaranteed repayment
of 49% of the loan amount during the construction period 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.
Construction of 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 December 31, 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 initially granted an extension to August 20,
2003 and a further extension to April 1, 2004 was granted by the WDA. If CDL is
40
unable to obtain such financing, the Company would expense its deferred costs
relating to the construction project and its investment in CDL of approximately
$0.8 million. 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, 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 project has been delayed because of the restructuring of Mekorot. 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 third 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.
Other Joint Venture Arrangements
Algeria
In October 2003, the Company and Algerian Energy Company (AEC) were selected for
a 25-year seawater desalination build-own-operate project. Sonatrach, the
national energy company, will guarantee the water supply contract. The Company
and AEC have formed a joint project company, Hamma Water Desalination S.p.A.
(HWD), with Ionics owning 70%. The projected $220 million capital investment
will be financed by a combination of equity and non-recourse debt. At December
31, 2003, the Company made an equity investment of $0.2 million in HWD and had
deferred costs of approximately $0.3 million relating to the engineering design
and development work on the project. If HWD obtains long-term project financing,
the Company has committed to make additional equity investments to HWD of
approximately $46.2 million. Terms of the contract require that long-term
project financing be obtained by June 30, 2004. If HWD is unable to obtain such
financing, the Company would expense its deferred costs relating to the
construction project and its investment in HWD. Additionally, the Company could
incur liability under a $1.0 million performance bond issued by the Company to
the customer.
41
Contractual Obligations and Other Commercial Commitments
The following table summarizes the Company's known contractual and contingent
obligations to make potential future payments or other consideration pursuant to
certain contracts as of December 31, 2003, as well as an estimate of the timing
in which these obligations are expected to be satisfied. 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. These instruments are not reflected on the
Company's balance sheet as a liability because they will not result in a
liability to the Company unless the Company fails to perform the contractual
obligations which are secured by the corresponding instrument. In the past, the
Company has not incurred significant liabilities or expenses as a result of the
use of these instruments.
LESS 1-3 4-5 AFTER 5
(Dollars in Thousands) THAN 1 YEAR YEARS YEARS YEARS TOTAL
---------------------- ----------- -------- -------- -------- --------
Notes Payable and
Current Portion of Long-Term Debt $ 6,282 $ 3,113 $ 3,288 $ 2,483 $ 15,166
Letters of Credit, Letters of Guarantee 24,514 17,133 1,905 707 44,259
Performance and Bid Bonds 38,600 10,570 40 8,000 57,210
----------- -------- -------- -------- --------
Total Letters of Credit, Letters of Guarantee and Bonds $ 63,114 $ 27,703 $ 1,945 $ 8,707 $101,469
Future Minimum Payments Due Under Operating Leases 6,597 5,906 1,077 73 13,653
Other 1,500 1,500 - - 3,000
----------- -------- -------- -------- --------
TOTAL CONTRACTUAL OBLIGATIONS $ 77,493 $ 38,222 $ 6,310 $ 11,263 $133,288
=========== ======== ======== ======== ========
The Company has also issued approximately $30.2 million of committed purchase
orders to third-party vendors and affiliated companies which will be settled
during 2004. 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 at least through 2005.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 143,
"Accounting for Obligations Associated with the Retirement of Long-Lived
Assets." SFAS 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS 143 is effective
for financial statements for fiscal years beginning after June 15, 2002. The
adoption of SFAS 143 did not have a material impact on the Company's financial
position or results of operations.
In June 2002, the FASB issued SFAS 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 Incurred 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
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. The Company applied the provisions of SFAS 146 effective
for employment termination benefits and exit or disposal activities during the
quarter ended September 30, 2003.
42
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" which amended SFAS 123, "Accounting
for Stock-Based Compensation." SFAS 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 148 are to be applied to financial
statements for fiscal years ending after December 15, 2002. The adoption of SFAS
148 did not have an impact on the Company's financial position or results of
operations.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities" and, in December 2003, issued a revision to that interpretation. FIN
No. 46R replaces FIN No. 46 and addresses consolidation by business enterprises
of variable interest entities that possess certain characteristics. A variable
interest entity (VIE) is defined as (a) an ownership, contractual or monetary
interest in an entity where the ability to influence financial decisions is not
proportional to the investment interest, or (b) an entity lacking the invested
capital sufficient to fund future activities without the support of a third
party. FIN No. 46R establishes standards for determining under what
circumstances VIEs should be consolidated with their primary beneficiary,
including those to which the usual condition for consolidation does not apply.
The Company will adopt FIN No. 46R in the first quarter of 2004.
The Company continues to evaluate the impact of FIN 46R on its financial
condition and results of operations. Based on the Company's preliminary analysis
of the impact of FIN 46R, the Company believes that it is reasonably possible
that the Company will be required to consolidate its Desalcott equity investment
when the consolidation requirements become effective in the first quarter ending
March 31, 2004. The Company believes it holds a majority of the related
financial risks, despite the Company's lack of voting control over Desalcott. As
of December 31, 2003, Desalcott had net assets of approximately $14.1 million.
For the year ended December 31, 2003, Desalcott had revenues of approximately
$27.2 million and a net loss of approximately $4.9 million. As a result of the
adoption of FIN 46R, the Company may be required to include an additional $156.7
million in assets and $142.5 million in liabilities in its consolidated balance
sheet. The Company's maximum exposure to losses, however, as a result of its
involvement with Desalcott is $38.3 million, consisting of its investment in
Desalcott of $3.7 million, amounts due from Desalcott of $23.2 million and
amounts due from HKES of $11.7 million (see Note 9).
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS 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 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 149 amends SFAS 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 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 an impact on the
Company's financial position or results of operations.
In May 2003, the FASB issued Statement of Financial Accounting Standards 150,
"Accounting For Certain Financial Instruments with Characteristics of Both
Liabilities and Equity" (SFAS 150), which establishes standards for how an
issuer of financial instruments classifies and measures certain financial
instruments with characteristics of both liabilities and equity. SFAS 150 is
effective for financial instruments entered into or modified after May 31, 2003.
In November 2003, the FASB deferred the classification and measurement
provisions for certain mandatorily redeemable non-controlling interests for an
indefinite period of time. The adoption of SFAS 150 did not have an impact on
the Company's financial position or operating results.
In May 2003 the EITF reached a consensus on EITF Issue No. 01-8, "Determining
Whether an Arrangement Contains a Lease." Arrangements or contracts that
traditionally were not viewed as leases may contain features that would require
them to be accounted for under SFAS 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.
43
In May 2003, the EITF 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 an impact on the Company's financial position or
results of operations.
RISKS AND UNCERTAINTIES
The Company's results of operations may fluctuate significantly on a quarterly
basis.
The Company's quarterly operating results may vary significantly from quarter to
quarter, depending on a number of factors including:
- the introduction and market acceptance of new products and new
variations of existing products;
- the activities of competitors;
- our ability to control expenses;
- variations in the timing of orders and subsequent shipments;
- length of approval processes or market tests;
- changes in our mix of products;
- disruption in our sources of supply;
- personnel changes;
- changes in our capital spending;
- unforeseeable or unavoidable delays in large-scale customer
projects;
- higher interest rates; and
- general economic conditions.
The anticipated benefits of acquiring Ecolochem, Inc. and its affiliated
companies (the "Ecolochem Group") may not be realized.
The Company acquired the Ecolochem Group with the expectation that the
acquisition would result in various benefits including, among other things,
enhanced revenue, profits, market presence, cost savings and operating
efficiencies. We expect that the acquisition will enhance our position in the
water treatment services market through the combination of our technologies,
products, services and customer contacts with those of the Ecolochem Group, and
will enable us to broaden our customer base in the electric power and
petrochemical industries. If our business or the Ecolochem Group's business
fails to meet the demands of the marketplace, customer acceptance of our
products and services could decline, which would have an adverse effect on our
results of operations and financial condition. We may not realize any of these
benefits and the acquisition may result in the deterioration or loss of
significant business. Costs incurred and potential liabilities assumed in
connection with the acquisition, including pending and threatened disputes,
litigation and environmental liabilities, could have a material adverse effect
on our business, financial condition and operating results.
In addition, we may not achieve the anticipated benefits as rapidly as, or to
the extent, anticipated by certain financial or industry analysts, or other
analysts may not perceive the same benefits to the acquisition as we do. If
these risks materialize, our stock price could be adversely affected.
The Company's restructuring program may not result in the intended financial
performance improvements.
On September 3, 2003, we announced a restructuring program intended to improve
our financial performance through a realignment of our management structure, a
reduction in personnel, and the consolidation of certain operations. The program
when fully carried out would result in the elimination of approximately 200
positions, or approximately 10% of our workforce, and is anticipated to result
in annual personnel savings of approximately $14 million and annual facilities
savings of approximately $1.4 million. In connection with the restructuring
program, we anticipate incurring charges for severance costs, facilities
shutdown and relocation costs, and reporting process improvement costs totaling
approximately $11 million, as well as goodwill impairment and other long-lived
asset impairment charges.
44
A number of the planned restructuring actions have been taken, and others have
yet to be implemented. We may not be able to complete the implementation of the
restructuring program to the extent and according to the timetable presently
expected. The cost savings we realized from the restructuring may be less than
anticipated, and the overall restructuring costs we incur may be greater than
anticipated. Consequently, the overall impact of the restructuring on our
profitability may differ from our original estimate.
The Company may have difficulty and incur substantial costs integrating the
Ecolochem Group.
Integrating the Ecolochem Group will be a complex, time-consuming and expensive
process. Before the acquisition of the Ecolochem Group, Ionics and the Ecolochem
Group operated independently, each with its own business, products, customers,
employees, culture and systems, including data management and financial systems.
Additionally, we are currently in the process of restructuring our business and
operations. We may face substantial difficulties, costs and delays in
integrating the Ecolochem Group, which may include:
- perceived adverse changes in product or service offerings or
customer service standards, whether or not these changes do, in
fact, occur;
- costs and delays in implementing common information and other
systems and procedures and costs and delays caused by
communication difficulties;
- potential difficulty in applying our accounting controls and
procedures to the members of the Ecolochem Group, which have
operated as independent private companies;
- charges to earnings resulting from the application of purchase
accounting to the acquisition;
- diversion of management resources;
- potential incompatibility of business cultures;
- potential losses of management and other key employees due to
perceived uncertainty in career opportunities, compensation
levels and benefits;
- the retention of existing customers of each company;
- reduction or loss of customer orders due to the potential for
market confusion, hesitation and delay; and
- coordinating infrastructure operations in a rapid and efficient
manner.
We will seek to combine certain operations and functions using common
information and communication systems, operating procedures, financial controls
and human resource practices, including training, professional development and
benefit programs. We may be unsuccessful, or experience delays, in implementing
the integration of these systems and processes.
Any one or all of these factors may cause increased operating costs, worse than
anticipated financial performance or the loss of customers and employees. Many
of these factors are outside our control. The failure to timely and efficiently
integrate the Ecolochem Group could have a material adverse effect on our
business, financial condition and operating results. In addition, the
differences between the business cultures could present significant obstacles to
timely, cost-effective integration of the Ecolochem Group.
The Company may have difficulty establishing appropriate controls and procedures
on a timely basis with respect to the Ecolochem Group's financial reporting as
our subsidiaries.
We have been implementing a number of measures and procedures to ensure that our
disclosure controls and procedures and internal controls over financial
reporting are effective. The acquisition of the Ecolochem Group will add
significant business units to our operations, which, prior to the acquisition,
were operated as private businesses and were not subject to the various
reporting obligations imposed on publicly traded companies. We will be required
to establish appropriate controls and procedures in accordance with our policies
and procedures with respect to the Ecolochem Group's financial reporting.
Failure to establish those controls and procedures in a timely manner, or any
failure of those controls and procedures once established, could adversely
impact our public disclosures regarding our business, financial condition or
operating results, which may adversely impact the price of our common stock.
The debt the Company incurred in connection with the acquisition of the
Ecolochem Group will create financial and operating risks that could limit its
operating flexibility and growth.
As a result of the acquisition of the Ecolochem Group, we incurred substantial
additional debt. The terms of the new credit facilities contain provisions that
limit our ability to incur additional indebtedness in the future and place other
restrictions on our
45
business. We may not be able to repay any current or future debt on a timely
basis, depending on our future operating results. We will be required to devote
increased amounts of our cash flow to service indebtedness incurred in
connection with the acquisition or incurred in the future. This could require us
to modify, delay or abandon our capital expenditures and other investments
necessary to implement our business plan.
A portion of this debt, as well as other short-term and long-term borrowings,
will be subject to variable interest rates tied to prime rates or other indices.
We will be subject to the risk that interest rates may increase significantly
and increase the cost of our debt.
The success of the Company's strategic plan to grow sales and develop
relationships internationally may be limited by risks related to conducting
business in international markets.
Although both the Company and the Ecolochem Group have experience marketing and
distributing their products and services and developing strategic relations in
Europe and other foreign markets, part of our strategy will be to increase sales
and build additional relationships in Europe and other foreign markets. Risks
inherent in marketing, selling and developing relationships in European and
other foreign markets include those associated with:
- Economic conditions in those markets, including fluctuations in
the relative values of the U.S. dollar and foreign currencies;
- Taxes and fees imposed by foreign governments that may increase
the cost of products and services; and
- Laws and regulations imposed by individual countries and by the
European Union and other governmental bodies.
The Company has only limited protection for its proprietary technology.
We rely on a combination of patent, trademark and trade secret laws and
restrictions on disclosure to protect our intellectual property rights. Our
success depends in part on our ability to obtain new patents and licenses and to
preserve other intellectual property rights covering our products. We intend to
continue to seek patents on our inventions when appropriate. The process of
seeking patent protection can be time consuming and expensive and we cannot
assure you that any new patent applications will be approved, that any patents
that may issue will protect our intellectual property or that any issued patents
will not be challenged by third parties or will be sufficient in scope or
strength to provide meaningful protection or any commercial advantage to us.
Other parties may independently develop similar or competing technology or
design around any patents that may be issued to us. We cannot be certain that
the steps we have taken will prevent the misappropriation of our intellectual
property, particularly in foreign countries where the laws may not protect our
proprietary rights as fully as in the United States.
The Company may become subject to infringement claims.
Although we do not believe that our products infringe the proprietary rights of
any third parties, we have in the past been subject to infringement claims and
third parties might assert infringement claims against us or our customers in
the future. Furthermore, we may initiate claims or litigation against third
parties for infringement of our proprietary rights or to establish the validity
of our proprietary rights. Litigation, either as plaintiff or defendant, would
cause us to incur substantial costs and divert management resources from
productive tasks. Any litigation, regardless of the outcome, could harm our
business.
If it appears necessary or desirable, we may seek licenses to intellectual
property that we are allegedly infringing. We may not be able to obtain licenses
on acceptable terms. The failure to obtain necessary licenses or other rights
could harm our business.
The Company has many competitors and may not be able to compete effectively.
We experience competition from a variety of sources with respect to virtually
all of our products, although we do not know of any single entity that competes
with us across the full range of our products, systems and services. Competition
in the markets that we serve is based on a number of factors, including price,
technology, applications experience, know-how, availability of financing,
reputation, product warranties, reliability, service and distribution. Many of
our current and potential competitors have greater name recognition and
substantially greater financial, marketing and other resources than we do. These
greater resources could, for example, allow our competitors to develop
technology, products and services superior to our own. As a result, we may not
be able to compete effectively with current or future competitors.
46
The Company may not be able to develop the new products or acquire the rights to
new products necessary to remain competitive.
The water purification industry is characterized by ongoing technological
developments and changing customer requirements. As a result, our success and
continued growth depend, in part, on our ability to develop or acquire rights to
and successfully introduce into the marketplace enhancements of existing
products or new products that incorporate technological advances, meet customer
requirements and respond to products developed by our competition. There can be
no assurance that we will be successful in developing or acquiring such rights
to products on a timely basis or that such products will adequately address the
changing needs of the marketplace.
The Company may not be able to adapt to changes in technology and government
regulation fast enough to remain competitive.
The water purification industry is characterized by changing technology,
competitively imposed process standards and regulatory requirements, each of
which influences the demand for our products and services. Changes in
legislative, regulatory or industrial requirements may render certain of our
purification products and processes obsolete. Acceptance of new products may
also be affected by the adoption of new government regulations requiring
stricter standards. Our ability to anticipate changes in technology and
regulatory standards and to develop and introduce new and enhanced products
successfully on a timely basis will be a significant factor in our ability to
grow and to remain competitive. There can be no assurance that we will be able
to achieve the technological advances that may be necessary for us to remain
competitive or that certain of our products will not become obsolete. In
addition, we are subject to the risks generally associated with new product
introductions and applications, including lack of market acceptance, delays in
development, or failure of products to operate properly.
A portion of the Company's sales is dependent upon customers' spending cycles
for capital equipment.
The sale of capital equipment within the water purification industry is cyclical
and influenced by various economic factors including interest rates and general
fluctuations of the business cycle. Our Equipment Business Group and our
Ultrapure Water Group each derive a significant portion of its revenue from the
sale of capital equipment. While we sell capital equipment to customers in
diverse industries and in domestic and international markets, cyclicality of
capital equipment sales and general economic conditions could have an adverse
effect on our revenues and profitability.
The acquisition of the Ecolochem Group may result in a loss of customers,
strategic partners and suppliers.
The acquisition of the Ecolochem Group may have the effect of disrupting
customer relationships. Some of our customers or potential customers and those
of the Ecolochem Group may delay or alter buying patterns as they evaluate the
likelihood of successful integration of the Ecolochem Group's business following
the acquisition. Other customers may seek alternative sources of products or
services due to, among other reasons, a desire not to do business with us or
perceived concerns that we may not continue to support certain products or
services. In addition, by increasing the breadth of our business, the
acquisition may make it more difficult for us to enter into relationships with
customers and strategic partners, some of whom may view us as a more direct
competitor than we were prior to the acquisition. Therefore, we could experience
some customer attrition as a result of the acquisition.
Difficulties in integrating operations could also result in the loss of
strategic partners and suppliers and potential disputes or litigation with
customers, strategic partners, suppliers, resellers or others. There can be no
assurance that any steps by management to counter such potential increased
customer, strategic partner or supplier attrition will be effective.
Failure by management to control customer, strategic partner and supplier
attrition could have a material adverse effect on our business, financial
condition and operating results.
The results of operations of the Ecolochem Group tend to fluctuate because of
the weather conditions that affect its customers.
Demand for the mobile water treatment services offered by the Ecolochem Group
tends to increase during periods of severe hot or cold weather resulting in
increased revenues and earnings. The absence of severe weather may adversely
impact the revenue and operating results of the Ecolochem Group.
47
The Company must comply with significant environmental regulations, which can be
difficult and expensive.
The Company is subject to a variety of federal, state and local governmental
regulations related to the use, storage, discharge and disposal of toxic,
volatile or otherwise hazardous chemicals used in our manufacturing processes.
Although we believe that our activities conform to presently applicable
environmental regulations, the failure to comply with present or future
regulations could result in fines being imposed on us, suspension of production
or a cessation of operations. Any failure by us to control the use of, or
adequately restrict the discharge of, hazardous substances, or otherwise comply
with environmental regulations, could subject us to significant future
liabilities. In addition, we cannot assure you that past use or disposal of
environmentally sensitive materials in conformity with then existing
environmental laws and regulations will not result in remediation or other
significant liabilities under current or future environmental laws or
regulations.
The Company depends on key personnel, the loss of whom could harm its business.
We have been and are presently dependent upon the continued efforts of our
senior management team, including Douglas R. Brown, our President and Chief
Executive Officer. The loss of the services of Mr. Brown or any other members of
our senior management team could have a material adverse effect on our ability
to achieve our objectives.
The loss of our key personnel, including those of the Ecolochem Group, could
adversely affect our ability to manage our business. We believe that the
continued service of our executive officers and the executive officers of the
Ecolochem Group will be important to our future growth and competitiveness. Our
employees and those of the Ecolochem Group are entitled to voluntarily terminate
their relationship with us or with the Ecolochem Group, typically without any,
or with only minimal, advance notice. The process of finding additional trained
personnel to carry out our strategy could be lengthy, costly and disruptive. We
might not be able to retain the services of all of our or the Ecolochem Group's
key employees or a sufficient number of them to execute our plans. In addition,
we might not be able to continue to attract new employees as required.
The loss of the services of any member of our or the Ecolochem Group's
management team, or of any other key employee, could divert management's time
and attention, increase our expenses and adversely affect our ability to conduct
our business efficiently.
If the Company is unable to continue to hire and retain skilled technical and
scientific personnel, then it will have trouble developing products.
Our success depends largely upon the continued service of our management and
scientific staff and our ability to attract, retain and motivate highly skilled
scientific, management and marketing personnel. We face significant competition
for such personnel from other companies, research and academic institutions,
government and other organizations who may better be able to attract such
personnel. The loss of key personnel or our inability to hire and retain
personnel who have technical and scientific backgrounds could materially
adversely affect our product development efforts and our business.
If certain intangible assets acquired in the acquisition of the Ecolochem Group
subsequently become impaired, the Company may be required to write off, or
reduce the value of, those intangible assets, which would adversely impact its
financial results during the periods in which they occur.
We currently expect to record approximately $182.9 million of goodwill and $73
million of other intangible assets in connection with the acquisition of the
Ecolochem Group. Goodwill associated with the acquisition will be required to be
tested at least annually for impairment. Other intangible assets will be
amortized over their estimated useful lives. If the goodwill or other intangible
assets are deemed to be impaired in the future, we will be required to reduce
the value of those assets or to write them off completely, which would reduce
our reported financial results during the periods in which such determination is
made. If we are required to write down or write off all or a portion of those
assets, or if financial analysts or investors believe we may be required to take
such action in the future, the prices at which our common stock trades may be
adversely affected.
The Company may not derive any income tax benefits from the tax election which
it currently intends to make.
We may elect to make, with the former shareholders of Ecolochem, Inc. and
Ecolochem International, Inc., an election under Section 338(h)(10) of the
Internal Revenue Code of 1986, as amended (the "Code"), with respect to the
acquisition of Ecolochem, Inc., Ecolochem International, Inc. or both. If a
valid election is made under Section 338(h)(10) of the Code, we will generally
be able to treat the acquisition of the stock of any company with respect to
which such election is made as an asset acquisition. As a result, after the
acquisition, the assets of such company will have a tax basis generally equal to
the cash and other property paid for
48
the stock of such company plus any liabilities of such company that are assumed
in the transaction.
The principal tax advantage of making an election under Section 338(h)(10) of
the Code is that our new subsidiary or subsidiaries, as the case may be, will be
able to depreciate or amortize the new federal income tax basis of depreciable
or amortizable assets over time periods specified in the Code. For intangible
assets, that time period is generally 15 years. Currently, we intend to make an
election under Section 338(h)(10) of the Code only with respect to Ecolochem,
Inc., but we may decide to make an election under Section 338(h)(10) of the Code
with respect to Ecolochem International, Inc. If we make a Section 338(h)(10)
election, we will be required to pay significant additional amounts to certain
of the former owners of the Ecolochem Group.
The Company will be subject to significant influence by the former owners of the
Ecolochem Group.
The former owners of the Ecolochem Group beneficially own approximately 19.5% of
our common stock. As a result, they have a strong influence on matters requiring
approval by our stockholders, such as the election of directors and most
corporate actions, including mergers and acquisitions. In addition, the former
owners of the Ecolochem Group are entitled to designate two members of our Board
of Directors. These directors will have the opportunity to participate in all
matters brought before the Board of Directors. Moreover, Mr. Lyman Dickerson,
the President of Ecolochem, Inc., will have the opportunity to become the
Chairman of our Board of Directors pursuant to the terms of the Stockholders
Agreement entered into in connection with the acquisition of the Ecolochem
Group. Collectively, these arrangements will allow the former owners of the
Ecolochem Group to have significant participation in matters affecting us.
Failure of any of the members of the Ecolochem Group to be a "pass-through"
entity for United States federal and other tax purposes could increase the
Company's cost of the acquisition.
The owners of the Ecolochem Group have represented in the purchase agreement
that each of the members of the Ecolochem Group is a "pass-through" entity for
United States federal income tax purposes. Specifically, the owners of the
Ecolochem Group have represented that each of Ecolochem and Ecolochem
International, Inc. is a "Subchapter S Corporation" under the Code, and that
each of Moson Holdings, LLC and Ecolochem S.A.R.L. is treated as a "partnership"
under the Code for federal tax purposes. Accordingly, except in limited
circumstances, the Ecolochem Group does not, and has not for a substantial
period, paid income taxes at the entity level either to the United States or to
many state and local jurisdictions (with certain exceptions). If it were
ultimately determined that any member of the Ecolochem Group was not a valid
pass-through entity for tax purposes, that entity could be subject to tax,
penalties, additions to tax and interest for prior periods. The owners of the
Ecolochem Group are required to indemnify us for any taxes attributable to
periods prior to the acquisition, but there can be no assurance that any such
amount will actually be paid. Any significant tax, penalties, additions to tax
and interest for prior periods which we pay and for which we are not indemnified
by the owners of the Ecolochem Group could have a material adverse effect on our
business, financial condition and operating results.
FORWARD-LOOKING INFORMATION
Safe Harbor Statement under Private Securities Litigation Reform Act of 1995
Certain statements contained in this Annual Report on Form 10-K, 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 this Item, 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 the integration of the Company's
operations with those of the Ecolochem Group; 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.
49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
DERIVATIVE INSTRUMENTS
In certain instances, 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. During 2003 and 2002, the Company entered into a series of
U.S. dollar/euro forward contracts with the intent to hedge the foreign exchange
risk associated with forecasted cash flows relating to an ongoing project. The
fair market value of the contracts are recorded in either "Current assets" or
"Current liabilities" section of the Consolidated Balance Sheets. End-of-period
changes in the market value of the contracts are recorded as a component of
"Other comprehensive income" in the Stockholders' equity section of the
Consolidated Balance Sheets. At December 31, 2003, the notional amount of the
outstanding foreign currency forward contracts to sell U.S. dollars to hedge
these currency exposures was $6.2 million. A hypothetical change of 10% in
exchange rates would change the fair value by approximately $0.6 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 December 31, 2003, the Company had $6.3 million of short-term
debt and $8.9 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
$1.0 million in 2003 compared with a gain of $2.8 million in 2002 and a loss of
$0.6 million in 2001. 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.
50
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
IONICS, INCORPORATED
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page
-----
Report of Independent Auditors 52
Financial Statements:
Consolidated Statements of Operations for the Years Ended December 31, 2003, 2002 and 2001 53
Consolidated Balance Sheets at December 31, 2003 and 2002 54
Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001 55
Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2003, 2002 and 2001 56
Notes to Consolidated Financial Statements 57
Supporting Financial Statement Schedule:
Schedule II - Valuation and Qualifying Accounts 91
51
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of Ionics, Incorporated:
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Ionics, Incorporated and its subsidiaries at December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America. In addition, in our opinion,
the financial statement schedule listed in the accompanying index presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements. These financial
statements and financial statement schedule are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements and financial statement schedule based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
As discussed in Note 1 to the consolidated financial statements, the Company
changed the manner in which it accounts for discontinued operations as of
January 1, 2002 upon adoption of Statement of Financial Accounting Standards No.
144, "Accounting for the Impairment of Long-Lived Assets." Also, as discussed in
Note 1 to the consolidated financial statements, the Company changed the manner
in which it accounts for goodwill as of January 1, 2002 upon adoption of
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets."
/s/PricewaterhouseCoopers LLP
---------------------------------
PricewaterhouseCoopers LLP
Boston, Massachusetts
March 12, 2004
52
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31
Amounts in Thousands, Except per Share Amounts 2003 2002 2001
------------------------------------------------------ --------- --------- ---------
Revenues:
Equipment Business Group $ 144,043 $ 154,378 $ 161,565
Ultrapure Water Group 102,600 102,407 133,605
Consumer Water Group 21,216 22,190 105,065
Instrument Business Group 29,807 27,741 26,595
Affiliated companies 49,741 12,168 21,219
--------- --------- ---------
347,407 318,884 448,049
--------- --------- ---------
Costs and expenses:
Cost of sales of Equipment Business Group 113,779 114,251 126,757
Cost of sales of Ultrapure Water Group 80,159 78,423 107,148
Cost of sales of Consumer Water Group 9,878 9,889 56,971
Cost of sales of Instrument Business Group 12,317 11,719 12,756
Cost of sales to affiliated companies 43,639 10,965 20,677
Research and development 7,449 6,462 6,420
Selling, general and administrative 99,754 89,078 119,019
Restructuring and impairment of long-lived assets 7,053 - 1,300
Impairments of goodwill 12,731 - 11,016
--------- --------- ---------
386,759 320,787 462,064
--------- --------- ---------
Loss from continuing operations (39,352) (1,903) (14,015)
Interest income 3,091 3,411 1,013
Interest expense (908) (1,172) (5,166)
Equity (loss) income (7,164) 3,443 1,396
--------- --------- ---------
(Loss) income from continuing operations before income
taxes, minority interest and gain on sale of Aqua Cool (44,333) 3,779 (16,772)
Gain on sale of Aqua Cool 457 8,160 102,834
Income tax benefit (expense) 11,533 (5,466) (42,186)
--------- --------- ---------
(Loss) income from continuing operations before
minority interest (32,343) 6,473 43,876
Minority interest in earnings (losses) 925 969 (737)
--------- --------- ---------
(Loss) income from continuing operations (33,268) 5,504 44,613
Discontinued operations:
(Loss) income from operations (9,410) (1,270) 141
Loss on disposal (7,667) - -
Income tax benefit (expense) 5,575 558 (53)
--------- --------- ---------
(Loss) income from discontinued operations, net of tax (11,502) (712) 88
--------- --------- ---------
Net (loss) income $ (44,770) $ 4,792 $ 44,701
========= ========= =========
Basic (loss) earnings per share from continuing operations $ (1.88) $ 0.31 $ 2.61
Basic (loss) earnings per share from discontinued operations (0.65) (0.04) 0.01
--------- --------- ---------
(Loss) earnings per basic share $ (2.53) $ 0.27 $ 2.61
========= ========= =========
Diluted (loss) earnings per share from continuing operations $ (1.88) $ 0.31 $ 2.59
Diluted (loss) earnings per share from discontinued operations (0.65) (0.04) 0.01
--------- --------- ---------
(Loss) earnings per diluted share $ (2.53) $ 0.27 $ 2.59
========= ========= =========
Shares used in basic (loss) earnings per share calculations 17,674 17,541 17,106
Shares used in diluted (loss) earnings per share calculations 17,674 17,671 17,246
The accompanying notes are an integral part of these consolidated financial
statements.
53
CONSOLIDATED BALANCE SHEETS
At December 31
Dollars in Thousands, Except Share Amounts 2003 2002
----------------------------------------------------- --------- ---------
Assets
Current assets:
Cash and cash equivalents $ 133,815 $ 136,044
Restricted cash - 4,250
Short-term investments - 958
Notes receivable, current 6,365 6,662
Accounts receivable, net 87,415 94,841
Receivables from affiliated companies 22,140 23,642
Inventories 24,716 29,833
Deferred income taxes 13,585 14,099
Assets from discontinued operations 7,466 18,470
Other current assets 20,316 12,565
--------- ---------
Total current assets 315,818 341,364
--------- ---------
Receivables from affiliated companies, long-term 20,915 11,740
Notes receivable, long-term 28,408 24,718
Investments in affiliated companies 14,362 18,198
Property, plant and equipment, net 171,785 167,456
Goodwill 7,695 20,118
Deferred income taxes, long-term 21,305 12,591
Other assets 11,689 7,408
--------- ---------
Total assets $ 591,977 $ 603,593
========= =========
Liabilities and Stockholders' Equity
Current liabilities:
Notes payable and current portion of long-term debt $ 6,276 $ 4,134
Accounts payable 28,279 36,039
Billings in advance from affiliated companies 3,629 4,308
Income taxes payable 32,840 25,692
Liabilities from discontinued operations 396 227
Other current liabilities 46,672 43,768
--------- ---------
Total current liabilities 118,092 114,168
--------- ---------
Long-term debt and notes payable 8,889 9,670
Deferred income taxes 30,979 35,337
Accumulated losses in investments in affiliated companies 5,068 242
Other liabilities 12,784 6,023
Commitments and contingencies
Stockholders' equity:
Common stock, par value $1, authorized shares: 55,000,000
in 2003 and 2002; issued and outstanding: 17,898,486 in
2003 and 17,555,046 in 2002 17,898 17,555
Additional paid-in capital 198,285 190,417
Retained earnings 202,339 247,109
Accumulated other comprehensive loss (2,357) (16,928)
--------- ---------
Total stockholders' equity 416,165 438,153
--------- ---------
Total liabilities and stockholders' equity $ 591,977 $ 603,593
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
54
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31
Dollars in Thousands 2003 2002 2001
--------------------------------------------------------------- --------- --------- ---------
OPERATING ACTIVITIES:
Net (loss) income $ (44,770) $ 4,792 $ 44,701
Less: (loss) income from discontinued operations (6,336) (712) 88
Less: loss on disposal of discontinued operations (5,166) - -
--------- --------- ---------
(Loss) Income from continuing operations (33,268) 5,504 44,613
Adjustments to reconcile net (loss) income from
continuing operations to net cash provided by (used in)
operating activities:
Depreciation 25,017 22,383 31,988
Amortization of other intangibles 778 191 146
Amortization of goodwill - - 2,787
Impairment of long-lived assets 4,330 - 1,300
Impairment of goodwill 12,731 - 11,015
Gain on Sale of Aqua Cool Business (457) (8,160) (102,834)
Provision for losses on accounts and notes receivable 5,302 4,641 4,632
Equity in loss (earnings) of affiliates 7,164 (3,443) (1,396)
Deferred income tax expense (benefit) (8,636) 1,459 (5,690)
Changes in assets and liabilities,
net of effects of businesses acquired:
Notes receivable (2,618) (4,516) (6,538)
Accounts receivable 9,579 15,838 22,202
Receivables from affiliated companies (8,746) (8,917) (23,933)
Inventories 6,643 (1,310) (3,148)
Other current assets (7,002) (1,116) 3,547
Investments in affiliated companies 1,975 4,861 782
Deferred income taxes (8,853) 2,250 (7,844)
Accounts payable and accrued expenses (9,055) (13,691) (8,294)
Deferred revenue from affiliates (4,319) 5,493 3,360
Accrued expenses for affiliated companies 3,247 - -
Customer deposits (131) 1,363 (2,682)
Income taxes payable 7,425 (22,496) 51,425
Accumulated losses in investments in affiliated companies 4,826 242 -
Other (1,405) (1,572) (5,536)
--------- --------- ---------
Net cash provided by (used in) operating activities 4,527 (996) 9,902
INVESTING ACTIVITIES:
Additions to property, plant and equipment (23,429) (32,739) (39,155)
Disposals of property, plant and equipment 1,353 1,836 1,567
Additional investments in affiliated companies (1,536) (230) (4,799)
Acquisitions of businesses, net of cash acquired (7,092) (1,035) -
Proceeds from sale of Aqua Cool Business - - 210,476
Sales (purchases) of short-term investments 1,684 (836) 413
--------- --------- ---------
Net cash (used in) provided by investing activities (29,020) (33,004) 168,502
FINANCING ACTIVITIES:
Restricted cash 4,250 (4,250) -
Principal payments on current debt (553) (73,678) (171,343)
Proceeds from borrowings of current debt 1,680 62,846 116,476
Principal payments on long-term debt (1,487) (989) (1,390)
Proceeds from borrowings of long-term debt - 553 1,294
Proceeds from issuance of common stock - - 21,814
Proceeds from issuance of stock under stock option plans 7,159 1,661 4,990
--------- --------- ---------
Net cash provided by (used in) financing activities 11,049 (13,857) (28,159)
Effect of exchange rate changes on cash 9,871 5,962 (520)
Net cash (used in) provided by continuing operations (3,573) (41,895) 149,725
Net cash provided by (used in) discontinued operations 1,344 (344) 3,061
Cash and cash equivalents at end of prior year 136,044 178,283 25,497
--------- --------- ---------
Cash and cash equivalents at end of current year $ 133,815 $ 136,044 $ 178,283
========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
55
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Accumulated
Common Stock Additional Other Total
------------------------ Paid-In Retained Comprehensive Stockholders'
Dollars in Thousands Shares Par Value Capital Earnings (Loss) Income Equity
------------------------------------------ ---------- ----------- ----------- ----------- ------------- -------------
Balance at December 31, 2000 16,369,029 $ 16,369 $ 162,114 $ 197,616 $ (19,238) $ 356,861
Comprehensive income:
Net income - - - 44,701 - 44,701
Other comprehensive income, net of tax:
Translation adjustments, (tax $974) - - - - (4,112) (4,112)
Minimum pension liability
adjustment, (tax $1,009) - - - - (1,646) (1,646)
-------------
Total comprehensive income 38,943
-------------
Stock options exercised 228,650 229 4,761 - - 4,990
Tax benefit of stock option activity - - 641 - - 641
Shares issued to directors 4,326 4 100 - - 104
Shares issued for private placement 875,000 875 20,939 - - 21,814
---------- ----------- ----------- ----------- ------------- -------------
Balance at December 31, 2001 17,477,005 17,477 188,555 242,317 (24,996) 423,353
Comprehensive income:
Net income - - - 4,792 - 4,792
Other comprehensive income, net of tax:
Translation adjustments, (tax $2,195) - - - - 9,844 9,844
Minimum pension liability
adjustment, (tax $1,089) - - - - (1,776) (1,776)
-------------
Total comprehensive income 12,860
-------------
Stock options exercised 72,937 73 1,588 - - 1,661
Tax benefit of stock option activity - - 159 - - 159
Shares issued to directors 5,104 5 115 - - 120
---------- ----------- ----------- ----------- ------------- -------------
Balance at December 31, 2002 17,555,046 17,555 190,417 247,109 (16,928) 438,153
Comprehensive Loss:
Net loss - - - (44,770) - (44,770)
Other comprehensive income, net of tax:
Changes in value of foreign exchange
contracts designated as cash
flow hedges - - - - 1,044 1,044
Translation Adjustments, (tax $5,389) - - - - 14,036 14,036
Minimum pension liability
adjustment, (tax $312) - - - - (509) (509)
-------------
Total comprehensive loss (30,199)
-------------
Stock options exercised, net 340,230 340 6,819 - - 7,159
Tax benefit of stock option activity - - 977 - - 977
Shares issued to directors 3,210 3 72 - - 75
---------- ----------- ----------- ----------- ------------- -------------
Balance at December 31, 2003 17,898,486 $ 17,898 $ 198,285 $ 202,339 $ (2,357) $ 416,165
========== =========== =========== =========== ============= =============
The accompanying notes are an integral part of these consolidated financial
statements.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
The Company is involved worldwide in the manufacture and sale of membranes,
equipment for the purification, concentration, treatment and analysis of water
and wastewater, in the supply of purified water, food and chemical products, and
in the sale of home water purification equipment. Principal markets include the
United States, Europe and Asia, as well as other international markets.
Basis of Presentation
The Company consolidates the financial statements of all wholly owned and
majority owned subsidiaries and controlled affiliates. All intercompany accounts
and transactions have been eliminated. Certain prior year amounts have been
reclassified to conform to the current year presentation with no impact on net
income. During the third quarter ended September 30, 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 was part of the Company's Consumer Water Group (CWG) segment. In addition,
during the fourth quarter ended December 31, 2003, the Company's management and
Board of Directors approved a plan of disposition to sell its European
"point-of-use" business, located in the United Kingdom and Ireland, which was
also part of the Company's CWG segment. Accordingly, the Company's Consolidated
Financial Statements and Notes have been reclassified to reflect these
businesses as discontinued operations in accordance with Financial Accounting
Standards Board Statement No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." The Company's consolidated results of operations include the
operating results of CoolerSmart LLC, since the date of its acquisition.
As part of the Company's adoption of a matrix business organization effective
January 1, 2002, results associated with the Company's trailer leasing and
non-consumer bleach based chemical supply businesses are included in the
Ultrapure Water Group (UWG) segment, rather than the Equipment Business Group
(EBG) segment where they had historically been presented. Segment information
for all periods has been presented to reflect these changes. (See Note 18).
Revenue Recognition
For certain contracts involving customized equipment eligible for contract
accounting under American Institute of Certified Public Accountants ("AICPA")
Statement of Position No. 81-1, "Accounting for Performance of Construction-Type
and Certain Construction-Type Contracts" (SOP 81-1), revenue is recognized using
the percentage of completion accounting method based upon an efforts-expended
method. The nature of these contracts and the types of products and services
provided are considered in determining the proper accounting for a given
contract. Long-term, fixed-price and cost plus fixed-fee contracts are recorded
on a percentage of completion basis using the cost-to-cost method of accounting
where revenue is recognized based on the ratio of costs incurred to estimated
total costs at completion. The Company follows this method since reasonably
dependable estimates of the costs of the total contract can be made. As a
general rule, sales and profits are recognized earlier under the cost-to-cost
method of percentage of completion accounting compared to the completed contract
method. Contract accounting requires significant judgment relative to assessing
risks, estimating contract costs and making related assumptions regarding
schedules and technical issues. Due to the size and nature of the Company's
long-term contracts, the estimation of cost at completion is complicated and
subject to numerous variables. Contract costs include material, labor,
subcontracting and other related costs. Assumptions must be made relative to the
length of time to complete the contract. With respect to contract change orders,
claims or similar items, judgment must be used in estimating related amounts and
assessing the potential for realization. Such amounts are only included in the
contract value when they can be reliably estimated and realization is reasonably
assured, generally upon receipt of a customer-approved change order. Given the
significance of the judgments and estimation processes described above, it is
likely that materially different amounts could be recorded if different
assumptions were used or if underlying circumstances were to change. The Company
closely monitors compliance and consistency of application of its critical
accounting policies related to contract accounting. In addition, reviews of the
status of contracts are performed through periodic contract status and
performance reviews. In all cases, changes to total estimated costs and
anticipated losses, if any, are recognized in the period in which determined.
For contracts involving the sale of equipment to a joint venture or other
unconsolidated affiliated entity in which the Company has an ownership interest,
the extent of revenue and profit recognized while the contract is being
performed varies based on the level of equity interest held by the Company.
Generally, when the Company's equity ownership in the affiliated customer is
less than 20% and accounts for such interest on a cost basis, no revenue or
profit is eliminated as the contract is being performed. When the Company's
equity ownership is between 20% and 50%, provided that the Company does not
exercise effective control over the
57
affiliated entity, the Company recognizes revenue as the contract is being
performed but eliminates a portion of the profit equal to the Company's equity
ownership percentage in the entity. The portion of the profit eliminated is
accounted for as a reduction in the Company's carrying amount of the investment
in the affiliated company. After construction has been completed and commercial
operations have commenced, the resulting eliminated intercompany profit is
amortized as a basis difference into equity income over the estimated useful
life of the equipment owned by the affiliated entity. When the Company's equity
ownership exceeds 50%, or in instances where the Company effectively controls
the affiliated entity, no revenue or profit is recognized on the sale of
equipment as the contract is executed, and all of the profit on the contract is
eliminated.
With respect to the Company's sale of equipment to Desalcott (the project
company) in connection with the Trinidad project where the Company is a 40%
equity owner of Desalcott, since the Company is considered to have provided all
of the cash equity funding for the project either directly or through a loan to
the Company's local majority partner, equipment revenue earned has been
recognized to the extent of costs incurred as the contract is executed; however,
all of the profit has been eliminated.
The "Revenues: affiliated companies" and "Cost of sales to affiliated companies"
included in the Statement of Operations reflect the revenue and costs recorded
from the sales of equipment to joint ventures or other unconsolidated entities.
Revenue is recognized in accordance with SOP 81-1 or with Securities and
Exchange Commission's Staff Accounting Bulletin No. 104, "Revenue Recognition"
(SAB 104), as appropriate, less the amount of intercompany profit eliminated
equal to the Company's ownership interest in the affiliated companies.
Eliminated intercompany profit, as described above, is amortized as a basis
difference into equity income over the useful life of the equipment placed in
service by the affiliated company (e.g., 23 years for the Trinidad project, and
27 years for the Kuwait project).
In addition to the construction and sale of customized equipment to its
customers, the Company also enters into water and other concession agreements
under which the Company "owns and operates" desalination or water treatment
facilities to produce and supply water to its customers. Under these contracts,
where the Company remains the owner of the facility or equipment, revenue and
profit is recognized as water quantities are sold to the customer (or,
alternatively, pursuant to a "take or pay" arrangement if minimum quantities are
not purchased). More specifically, the revenue derived from these contracts is
generally recognized based on actual meter readings and agreed-upon rates in
effect during the term of the contract. The constructed equipment is capitalized
by the Company, included in property, plant and equipment, and amortized to cost
of sales over the shorter of the estimated useful life of the equipment or the
contract term.
For sales of standard products and equipment not governed by SOP 81-1, such as
the sale of instruments and consumer water products, the Company follows the
guidance provided by SAB 104. The Company does not recognize revenue unless
there is persuasive evidence of an arrangement, title and risk of loss has
passed to the customer, delivery has occurred or the services have been
rendered, the sales price is fixed or determinable and collection of the related
receivable is reasonably assured. It is the Company's policy to require an
arrangement with its customers, either in the form of a written contract or
purchase order containing all of the terms and conditions governing the
arrangement, prior to the recognition of revenue. Title and risk of loss
generally pass to the customer at the time of delivery of the product to a
common carrier. At the time of the transaction, the Company assesses whether the
sale price is fixed or determinable and whether or not collection is reasonably
assured. If the sales price is not deemed to be fixed or determinable, revenue
is recognized as the amounts become due from the customer. The Company does not
generally offer a right of return on its products and the products are generally
not subject to customer acceptance rights. The Company assesses collectibility
based on a number of factors, including past transaction and collection history
with a customer and the credit-worthiness of the customer. The Company performs
ongoing credit evaluations of its customers' financial condition but generally
does not require collateral from its customers. If the Company determines that
collectibility of the sales price is not reasonably assured, revenue is deferred
until such time as collection becomes reasonably assured, which is generally
upon receipt of payment from the customer. The Company includes shipping and
handling costs in revenue and cost of sales.
The Company provides lease financing to consumers for the purchase of certain
home water treatment systems. Prior to entering into the lease agreement, the
Company evaluates the creditworthiness of its customer and generally
collateralizes the lease receivable with a security interest in the customer's
personal residence. At the time the lease transaction is consummated, the
Company recognizes revenue for the full amount of the sales value of the
equipment and records a lease receivable on its balance sheet. Finance income is
recognized as revenue by the Company over the term of the lease based on the
interest rate stated in the lease. The Company evaluates the collectibility at
point of sale of its lease receivables based on its historical loss experience
and assessment of prospective risk, and does so through ongoing reviews of its
receivables portfolio.
58
The Company provides support services to customers primarily through service
contracts, and the Company typically recognizes support service revenue ratably
over the term of the service contract or as services are rendered.
The Company also rents equipment to customers under short-term rental
agreements. The Company generally invoices customers monthly and recognizes
revenue over the rental period based on amounts billed. The rental equipment is
capitalized and depreciated to cost of sales over its estimated useful life.
Accounting for Stock-Based Compensation
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, any difference between the option price and the fair market value
of the stock at the date of grant is charged to operations over the expected
period of benefit to the Company. During 2003, 2002 and 2001, no stock-based
compensation expense has been recorded in net income as all options granted
under those plans had an exercise price equal to or greater than the market
value of the underlying common stock on the date of grant.
The following table illustrates the pro forma effect on net (loss) income and
(loss) earnings per share if the Company had applied the fair value method of
accounting for stock options and other equity instruments defined by SFAS 123,
"Accounting for Stock-Based Compensation," as amended by SFAS 148 "Accounting
for Stock-Based Compensation-Transition and Disclosure." The effect of applying
SFAS 123 in the pro forma disclosure are not indicative of future awards, which
are anticipated.
(Amounts in thousands, except per share amounts) 2003 2002 2001
---------- ---------- ----------
(Loss) income from continuing operations, as reported $ (33,268) $ 5,504 $ 44,613
(Loss) income from discontinued operations, as reported (11,502) (712) 88
---------- ---------- ----------
Net (loss) income, as reported $ (44,770) $ 4,792 $ 44,701
Less: Stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects 4,527 2,652 2,596
---------- ---------- ----------
Pro forma net (loss) income $ (49,297) $ 2,140 $ 42,105
========== ========== ==========
(Loss) earnings per basic share from continuing operations,
as reported $ (1.88) $ 0.31 $ 2.61
(Loss) earnings per basic share from discontinued
operations, as reported (0.65) (0.04) 0.01
---------- ---------- ----------
(Loss) earnings per basic share, as reported $ (2.53) $ 0.27 $ 2.61
========== ========== ==========
(Loss) earnings per basic share, pro forma $ (2.79) $ 0.12 $ 2.46
========== ========== ==========
(Loss) earnings per diluted share from continuing operations,
as reported $ (1.88) $ 0.31 $ 2.59
(Loss) earnings per diluted share from discontinued
operations, as reported (0.65) (0.04) 0.01
---------- ---------- ----------
(Loss) earnings per diluted share, as reported $ (2.53) $ 0.27 $ 2.59
========== ========== ==========
(Loss) earnings per diluted share, pro forma $ (2.79) $ 0.12 $ 2.44
========== ========== ==========
59
The weighted average fair value of options granted were $8.03, $9.95 and $11.08
per option during 2003, 2002 and 2001, respectively. The fair value of each
option granted during 2003, 2002 and 2001 was estimated on the date of grant
using the Black-Scholes option-pricing model with the following assumptions:
2003 2002 2001
---------- ---------- ----------
Expected term (years) 6.0 6.0 5.0
Volatility 41.0% 42.2% 38.6%
Risk-free interest rate (zero coupon U.S. treasury note) 3.4% 3.7% 4.9%
Dividend yield NONE None None
Cash Equivalents
Short-term investments with an original maturity of 90 days or less from the
date of acquisition are classified as cash equivalents.
Restricted Cash
At December 31, 2003, no restrictions on cash existed. At December 31, 2002, the
Company had $4.3 million in restricted cash. This amount represented cash
received from a customer that was pledged to decrease the banking fees
associated with a letter of credit the Company issued against an advance payment
it received for work to be performed on the Kuwait wastewater treatment facility
project.
Investments
Management determines the appropriate classification of its investment in debt
securities at the time of purchase. Debt securities which the Company has the
ability and positive intent to hold to maturity are classified accordingly and
carried at amortized cost. The Company is not involved in activities classified
as the trading of investments.
Allowance for Doubtful Accounts
The Company evaluates the adequacy of its allowance for doubtful accounts on an
ongoing basis through detailed reviews of its accounts and notes receivables.
Estimates are used in determining the Company's allowance for doubtful accounts
and are based on historical collection experience, current trends including
prevailing economic conditions and adverse events that may affect a customer's
ability to repay, aging of accounts and notes receivable by category, and other
factors such as the financial condition of large customers. This evaluation is
inherently subjective and estimates may be revised in the future as more
information becomes available. Allowance for doubtful accounts are established
through a charge to operations included in selling, general and administrative
expenses.
Notes Receivable
Notes receivable have been reported at their estimated net realizable value. The
allowance for uncollectible notes receivable totaled $1.2 million and $0.7
million at December 31, 2003 and 2002, respectively. This allowance is comprised
of the principal and accrued finance income amounts due on the notes. The
Company suspends the accrual of finance income on the notes receivable when the
collection of the notes receivable principal balance is doubtful, due to the
fact that the finance income is no longer considered collectible.
Inventories
Inventories are carried at the lower of cost (first-in, first-out basis) or
market.
Investments in Affiliated Companies
The Company holds minority investments in certain private companies having
complementary or strategic operations in different geographical locations around
the world. These investments are included in investments in affiliates and
include investments accounted for under the equity method of accounting. Under
the equity method of accounting, which generally applies to investments that
represent a 20% to 50% ownership of the equity securities of the affiliates, the
Company's proportionate share of the earnings or losses based on its ownership
interest of the affiliates is included in equity income. The Company records
equity losses in excess of the carrying amount of the investment when it
guarantees obligations or is otherwise committed to provide further financial
support to the affiliate. 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
60
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. Realization of the Company's investments in equity
securities may be affected by the affiliate's ability to obtain adequate funding
and execute its business plans, general market conditions, industry
considerations specific to the affiliate's business, and other factors. The
inability of an affiliate to obtain future funding or successfully execute its
business plan could adversely affect the Company's earnings in the periods
affected by those events. Future adverse changes in market conditions or poor
operating results of underlying investments could result in a write-down or in
an inability to recover the carrying value of an equity investment that may not
be reflected in an investment's current carrying value, thereby possibly
requiring an impairment charge resulting in an other than temporary loss in the
future. The Company records an impairment charge when it believes an investment
has experienced a decline in fair value that is other-than-temporary.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Maintenance and repair costs
are expensed as incurred. Significant additions and improvements are capitalized
and depreciated. When an asset is retired or sold, any resulting gain or loss is
included in the results of operations. Interest payments on debt capitalized as
property, plant and equipment amounted to $0.1 million, $0.3 million, and $0.1
million in 2003, 2002 and 2001, respectively. In general, depreciation is
computed on a straight-line basis over the expected useful lives of the assets,
as follows:
CLASSIFICATION DEPRECIATION LIVES
-------------- ------------------
Buildings and improvements 10 - 40 years
Machinery and equipment, including supply equipment 3 - 25 years
Other 3 - 12 years
In certain situations, depreciation is computed based on the units of production
method.
The Company's policy is to depreciate processing plants, other than leased
equipment, over the shorter of their useful lives or the term of the
corresponding supply contracts.
Impairment of Long-Lived Assets
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS 144). The Company assesses the potential impairment of
identifiable intangibles and other long-lived assets whenever events or changes
in circumstances indicate that the carrying value may not be recoverable.
Factors that could indicate an impairment include significant underperformance
of the asset as compared to historical or projected future operating results,
significant changes in the actual or intended future use of the asset, or the
strategy for its overall business and significant negative industry or economic
trends. When the Company determines that the carrying value of intangible and
other long-lived assets may not be recoverable, the related estimated future
undiscounted cash flows expected to result from the use of the asset and its
eventual disposition are compared to the carrying amount of the asset. If the
sum of the estimated future cash flows is less than the carrying amount, the
Company records an impairment charge based on the estimated discounted future
cash flows using a discount rate determined by Company management to be
commensurate with the associated risks.
Goodwill
On January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other Intangible
Assets" (SFAS 142). In accordance with SFAS 142, amortization of goodwill was
discontinued as of January 1, 2002. Goodwill represents the excess acquisition
cost over the fair value of the net assets acquired in the purchase of various
entities. Prior to the adoption of SFAS 142, goodwill was amortized on a
straight-line basis over its estimated useful life, which generally was a period
ranging from 10 to 40 years. The Company evaluates the recoverability of
goodwill annually on December 31, or more frequently if events or changes in
circumstances, such as, material adverse changes in the business climate
indicate that the carrying value of an asset might be impaired. Goodwill is
considered to be impaired when the net book value of a reporting unit exceeds
its estimated fair value. Fair values are estimated using a discounted cash flow
methodology. Discounted cash flows are based on the businesses' strategic plans
and management's best estimate of revenue growth and profit margin by each
reporting unit.
61
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. The
Company estimates costs to satisfy its warranty obligations based upon
historical product failure rates and the estimated costs to correct 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 accrued
warranty obligation is included in other current liabilities. The changes in
accrued warranty obligations for the years ended December 31, 2003 and 2002 are
as follows:
Dollars in thousands 2003 2002
-------------------- --------- ---------
Balance at end of prior year $ 1,067 $ 844
Accruals for warranties issued during the period 1,331 1,373
Accruals related to pre-existing warranties 294 18
Settlements made (in cash or in kind) during the period (1,519) (1,168)
--------- ---------
Balance at end of year $ 1,173 $ 1,067
========= =========
In addition to warranty obligations, the Company recorded a $4.8 million charge
in the third quarter of 2003 to retrofit certain components of the Company's
demineralization systems.
Research and Development
All research and development costs are expensed as incurred and consist
primarily of personnel costs and costs associated with the development of new
products and the enhancement of existing products for the EBG, UWG and IBG
segments.
Income Taxes
The Company estimates its income tax liability in each jurisdiction in which it
operates based on an assessment of permanent and temporary differences resulting
from differing treatment of items for tax and financial reporting purposes.
Temporary differences result in deferred tax assets and liabilities, which are
included within the Consolidated Balance Sheets. The Company assesses the
likelihood that deferred tax assets will be recovered, and establish a valuation
allowance to the extent that it believes that it is more likely than not any
deferred tax asset will not be realized. To the extent the Company has
established a valuation allowance; income tax expense is recorded in the
Company's Consolidated Statements of Operations. Taxable income in future
periods significantly different from that projected may cause adjustments to the
valuation allowance that could materially increase or decrease future income tax
expense.
The Company has elected not to provide tax on certain undistributed earnings of
its foreign subsidiaries which it considers to be permanently reinvested. The
cumulative amount of such unprovided U.S. taxes was approximately $10.5 million,
$9.7 million and $8.2 million as of December 31, 2003, 2002 and 2001,
respectively.
Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net (loss) income
available to common shareholders by the weighted-average number of common shares
outstanding during the reporting period. Diluted (loss) earnings per share is
computed by dividing net (loss) income available to common shareholders by the
weighted-average number of common shares outstanding while giving effect to all
potentially dilutive common shares that were outstanding during the period
calculated using the treasury stock method which determines the additional
common shares that are issuable upon the exercise of outstanding stock options.
Comprehensive Income (Loss)
The Company reports comprehensive income (loss) in the Statements of
Stockholders' Equity. For 2003, total comprehensive loss was $30.2 million and
consisted of net loss, changes in fair values of foreign exchange contracts
designated as cash flow hedges, foreign currency translation adjustments and
minimum pension liability adjustment, net of tax effects. In 2002 and 2001,
comprehensive income was $12.9 million and $38.9 million, respectively,
consisting primarily of net income and translation adjustments, net of tax
effects.
Accumulated other comprehensive (loss) income amounted to ($2.4) million and
($16.9) million at December 31, 2003 and 2002, respectively. At December 31,
2003, it consisted on cumulative translation adjustments, minimum pension
liability and changes in value of foreign exchange contracts designated as cash
flow hedges. At December 31, 2002, accumulated other comprehensive
62
(loss) income was comprised of cumulative translation adjustments and minimum
pension liability. The cumulative translation adjustments were $0.5 million and
($13.5) million at December 31, 2003 and 2002, respectively. The minimum pension
liability component of other comprehensive (loss) income was ($3.9) million and
($3.4) million at December 31, 2003 and 2002, respectively. The change in the
value of foreign exchange contracts designated as cash flow hedges was $1.0
million at December 31, 2003.
Foreign Exchange
Assets and liabilities of foreign affiliates and subsidiaries, for which the
local currency is the functional currency, are translated into U.S. dollars at
year-end exchange rates, and the related statements of operations are translated
at average exchange rates during the year. Translation gains and losses are
accumulated net of income tax as a separate component of stockholders' equity.
Some transactions of the Company and its subsidiaries are made in currencies
different from their functional currency. Foreign currency gains (losses) on
these transactions or balances are recorded in selling, general and
administrative expense when incurred. Net foreign currency transaction gains
(losses) included in income before income taxes and minority interest totaled
$1.0 million, $2.8 million and $(0.6) million for 2003, 2002 and 2001,
respectively.
Derivative Instruments
The Company adopted SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," as amended by SFAS 137 and SFAS 138 in the first quarter of 2001.
All derivatives are stated at fair value on the balance sheets. The Company
conducts business in a number of foreign countries where transactions are
denominated in local foreign currencies. The Company hedges certain foreign
currency exposures to minimize the effect of exchange rate fluctuations on
certain monetary assets and anticipated cash flows denominated in foreign
currencies. The terms of currency instruments used for hedging purposes are
consistent with the timing of the transactions being hedged. The Company does
not use derivative financial instruments for trading or speculative purposes.
The Company enters into foreign currency forward contracts to hedge its
exposures associated with certain forecasted revenue transactions. These
derivative instruments, which are designated as foreign currency cash flow
hedges, generally mature within two years or less. All outstanding derivatives
are recognized on the balance sheet at fair value and changes in their fair
value are recorded in accumulated other comprehensive income (loss) until the
underlying forecasted transaction occurs. Once the underlying forecasted
transaction is realized, the gain or loss from the derivative designated as a
hedge of the transaction is reclassified from accumulated other comprehensive
income (loss) to the statement of operations in the related revenue caption. In
the event the underlying forecasted transaction does not occur, the amount
recorded in accumulated other comprehensive income (loss) will be reclassified
to selling, general and administrative expense in the statement of operations in
the then-current period. For the year ended December 31, 2003, the Company
recognized a gain of approximately $0.1 million related to the ineffective
portion of its forecasted cash flow hedge. No amounts were reclassified from
accumulated other comprehensive income (loss) to selling, general and
administrative expense during 2002 or 2001.
The Company also enters into foreign exchange forward contracts to hedge its
exposures associated with foreign currency denominated assets and liabilities.
These derivative instruments are designated as foreign currency fair value
hedges. The derivatives are recognized on the Consolidated Balance Sheets at
fair value and period-end changes in fair value are recorded in selling, general
and administrative expense in the Consolidated Statement of Operations.
Since the Company is using foreign exchange derivative contracts to hedge
foreign exchange exposures, the changes in the value of the derivatives are
highly effective in offsetting changes in the cash flows of the hedged item.
Hedge effectiveness is assessed on a quarterly basis. Any ineffective portion of
the derivatives designated as cash flow hedges is recognized in current earnings
in "Selling, general and administrative expense." The ineffective portion of the
derivatives consists of discounts or premiums on forward contracts and gains or
losses associated with differences between actual and forecasted amounts. In any
instance in which the designated hedged item matures, is terminated, or, in the
case of an anticipated transaction, is deemed unlikely to occur, the related
derivative contract is closed and any gain or loss is immediately recognized in
the Statement of Operations in selling, general and administrative expense.
Use of Estimates
The preparation of financial statements, in conformity with generally accepted
accounting principles in the United States of America, requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
63
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued SFAS 143,
"Accounting for Obligations Associated with the Retirement of Long-Lived
Assets." SFAS 143 provides the accounting requirements for retirement
obligations associated with tangible long-lived assets. SFAS 143 is effective
for financial statements for fiscal years beginning after June 15, 2002. The
adoption of SFAS 143 did not have a material impact on the Company's financial
position or results of operations.
In June 2002, the FASB issued SFAS 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 Incurred 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
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. The Company applied the provisions of SFAS 146 effective
for employment termination benefits and exit or disposal activities during the
quarter ended September 30, 2003.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" which amended SFAS 123, "Accounting
for Stock-Based Compensation." SFAS 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 148 are to be applied to financial
statements for fiscal years ending after December 15, 2002. The adoption of SFAS
148 did not have an impact on the Company's financial position or results of
operations.
In January 2003, the FASB issued FIN No. 46, "Consolidation of Variable Interest
Entities" and, in December 2003, issued a revision to that interpretation. FIN
No. 46R replaces FIN No. 46 and addresses consolidation by business enterprises
of variable interest entities that possess certain characteristics. A variable
interest entity (VIE) is defined as (a) an ownership, contractual or monetary
interest in an entity where the ability to influence financial decisions is not
proportional to the investment interest, or (b) an entity lacking the invested
capital sufficient to fund future activities without the support of a third
party. FIN No. 46R establishes standards for determining under what
circumstances VIEs should be consolidated with their primary beneficiary,
including those to which the usual condition for consolidation does not apply.
The Company will adopt FIN No. 46R in the first quarter of 2004.
The Company continues to evaluate the impact of FIN 46R on its financial
condition and results of operations. Based on the Company's preliminary analysis
of the impact of FIN 46R, the Company believes that it is reasonably possible
that the Company will be required to consolidate its Desalcott equity investment
when the consolidation requirements become effective in the first quarter ending
March 31, 2004. The Company believes it holds a majority of the related
financial risks, despite the Company's lack of voting control over Desalcott. As
of December 31, 2003, Desalcott had net assets of approximately $14.1 million.
For the year ended December 31, 2003, Desalcott had revenues of approximately
$27.2 million and a net loss of approximately $4.9 million. As a result of the
adoption of FIN 46R, the Company may be required to include an additional $156.7
million in assets and $142.5 million in liabilities in its consolidated balance
sheet. The Company's maximum exposure to losses, however, as a result of its
involvement with Desalcott is $38.3 million, consisting of its investment in
Desalcott of $3.7 million, amounts due from Desalcott of $23.2 million and
amounts due from HKES of $11.7 million (see Note 9).
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities." SFAS 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 133, "Accounting for Derivative Instruments
and Hedging Activities." SFAS 149 amends SFAS 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 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 an impact on the
Company's financial position or results of operations.
64
In May 2003, the FASB issued Statement of Financial Accounting Standards 150,
"Accounting For Certain Financial Instruments with Characteristics of Both
Liabilities and Equity" (SFAS 150), which establishes standards for how an
issuer of financial instruments classifies and measures certain financial
instruments with characteristics of both liabilities and equity. SFAS 150 is
effective for financial instruments entered into or modified after May 31, 2003.
In November 2003, the FASB deferred the classification and measurement
provisions for certain mandatorily redeemable non-controlling interests for an
indefinite period of time. The adoption of SFAS 150 did not have an impact on
the Company's financial position or operating results.
In May 2003 the EITF reached a consensus on EITF Issue No. 01-8, "Determining
Whether an Arrangement Contains a Lease." Arrangements or contracts that
traditionally were not viewed as leases may contain features that would require
them to be accounted for under SFAS 13, "Accounting for Leases." EITF 01-8 was
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 EITF 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 an impact on the Company's financial position or
results of operations.
NOTE 2. CONSOLIDATED BALANCE SHEET DETAILS
Dollars in Thousands 2003 2002
-------------------- ------------ ------------
Raw materials $ 15,269 $ 17,706
Work in process 5,621 6,608
Finished goods 3,826 5,519
------------ ------------
Inventories $ 24,716 $ 29,833
============ ============
Land $ 6,297 $ 6,077
Buildings 43,070 41,388
Machinery and equipment 279,997 259,202
Other, (includes furniture,
fixtures and vehicles) 35,677 30,838
------------ ------------
365,041 337,505
Accumulated depreciation (193,256) (170,049)
------------ ------------
Property, plant and equipment, net $ 171,785 $ 167,456
============ ============
Customer deposits $ 4,531 $ 4,114
Accrued expenses 42,141 39,654
------------ ------------
Other current liabilities $ 46,672 $ 43,768
============ ============
Benefit plan liabilities $ 7,745 $ 3,123
Other liabilities 5,039 2,900
------------ ------------
Other liabilities $ 12,784 $ 6,023
------------ ------------
65
NOTE 3. SUPPLEMENTAL SCHEDULE OF CASH FLOW INFORMATION
Dollars in Thousands 2003 2002 2001
-------------------- -------- --------- ---------
Cash payments for interest
and income taxes:
Interest $ 803 $ 1,520 $ 6,093
Taxes $ 2,447 $ 21,503 $ 1,865
NOTE 4. ACCOUNTS RECEIVABLE
Dollars in Thousands 2003 2002
-------------------- --------- ----------
Billed receivables $ 67,556 $ 79,389
Unbilled receivables 28,913 21,530
Less: Allowance for doubtful accounts (9,054) (6,078)
--------- ----------
Accounts receivable, net $ 87,415 $ 94,841
========= ==========
Unbilled receivables represent the excess of revenues recognized on percentage
of completion contracts over amounts billed. These amounts will become billable
as the Company achieves certain contractual milestones. Substantially all of the
unbilled amounts at December 31, 2003 are expected to be billed during 2004.
Billed receivables include retainage amounts of $2.4 million and $4.4 million at
December 31, 2003 and 2002, respectively. Approximately 50% of the retainage
amounts are expected to be collected during 2004.
NOTE 5. INVESTMENTS IN AFFILIATED COMPANIES
The Company's investments in the following affiliates are accounted for under
the equity method. The principal business activities of these foreign affiliates
involve the production, sale and distribution of treated or bottled water, the
sale of membranes, equipment and replacement parts, and the ownership and
operation of water treatment facilities.
OWNERSHIP
AFFILIATE PERCENTAGE
--------- ----------
Aqua Cool Kuwait - Kuwait 49%
Aqua Cool Saudi Arabia - Saudi Arabia 40%
Aqua Design Ltd. - Cayman Islands 39%
Carmel Desalination Ltd. - Israel 33%
Desalination Company of Trinidad and Tobago Ltd. - Trinidad 40%
Grupo Empresarial de Mejoramiento Ambiental, S. de R.L.
de C.V. - Mexico 20%
Jalal-Ionics - Bahrain 40%
Magan Desalination Ltd. - Israel 49%
Toray Membrane America, Inc. - Massachusetts, USA 43%
UTE El Reventon - Spain 50%
UTE Tamaino - Spain 50%
Utilities Development Company, W.L.L. - Kuwait 25%
Watlington Waterworks, Ltd. - Bermuda 26%
Yuasa-Ionics Co., Ltd. - Japan 50%
66
The Company's percentage ownership interest in affiliates may vary from its
interest in the earnings of such affiliate.
Activity in investments in affiliated companies:
Dollars in Thousands 2003 2002 2001
-------------------- --------- --------- --------
Investments at end
of prior year $ 18,198 $ 20,434 $ 18,310
Equity (loss) income (7,164) 3,443 1,396
Distributions received (1,848) (3,734) (1,511)
Cumulative translation adjustments and other (348) (344) 804
Change in accumulated losses 4,826 242 -
Elimination of intercompany profits (48) (1,298) (3,364)
Reclassification of Trinidad investment (790) - -
Reclassification to long-term notes receivable from UDC - (775) -
Additional investments 1,536 230 4,799
-------- --------- --------
Investments at end of current year $ 14,362 $ 18,198 $ 20,434
======== ========= ========
At December 31, 2003 and 2002, the Company's equity in the net assets of its
affiliates was $13.8 million and $20.6 million, respectively. The difference
between the carrying amount and the underlying equity in net assets is being
amortized into equity over the estimated useful life of the related intangible
asset.
At December 31, 2003 and 2002, the Company's accumulated loss in investments in
affiliates of $5.1 million and $0.2 million, respectively, primarily relates to
the Company's investment in Toray Membrane America, Inc. ("TMA"). As a result of
$8.8 million of asset impairment charges recorded at TMA during 2003, the
Company has recorded a liability of $2.3 million representing the Company's
share of TMA's equity losses in excess of the Company's investment in TMA. This
liability has been recorded based on the current expectation that the Company
will continue to support TMA.
The elimination of intercompany profits on the sale of equipment to an
affiliated company in which the Company has an ownership interest represents a
basis difference, which will be amortized into equity income in future periods.
The Trinidad investment reclassification adjustment in 2003 relates to the
reclassification of affiliate revenue and interest income earned by the Company
from the Company's Desalcott affiliate which is included in equity income while
the corresponding asset resides in the affiliate accounts receivable balance
(rather than in the investment in affiliate balance). The Utilities Development
Company ("UDC") reclassification adjustment in 2002 relates to the determination
in 2002 that the Company's investments in UDC were finalized as loans rather
than an equity investment in UDC.
Toray Membrane America, Inc. ("TMA") was formed in 2000. TMA was incorporated to
engage in the manufacture and sale of membrane elements and certain types of
membrane finished products. During 2003, the Company recognized $4.6 million of
equity method loss based on its ownership interest in TMA, including the
Company's portion of the asset impairment charges for certain membrane
manufacturing equipment. As a result, the Company has recorded an accumulated
loss in excess of its equity investment of $2.3 million at December 31, 2003.
The Company's equity investment was $2.3 million at December 31, 2002. The
liability balance at December 31, 2003 is included in "Accumulated losses in
investments in affiliated companies," while the investment balance at December
31, 2002 is included in "Investments in affiliated companies" in the
Consolidated Balance Sheets. During 2003 and 2002, no dividends were received.
67
Summarized financial information of TMA is presented as follows (dollars in
thousands):
December 31,
---------------------------
2003 2002
--------- ---------
Current assets $ 8,778 $ 4,944
Non-current assets 6,765 15,295
--------- ---------
Total assets $ 15,543 $ 20,239
========= =========
Current liabilities $ 20,839 $ 9,932
Non-current liabilities - 5,000
--------- ---------
Total liabilities $ 20,839 $ 14,932
========= =========
Years ended December 31,
-----------------------------------
2003 2002 2001
----------- -------- --------
Sales $ 7,206 $ 3,667 $ 1,594
Cost of sales 6,654 2,778 1,319
Impairment of long-lived assets 8,592 - -
Operating loss (9,664) (652) (831)
Loss before income taxes (10,602) (728) (810)
Net loss (10,602) (728) (810)
Desalination Company of Trinidad and Tobago Ltd. ("Desalcott") was formed in
2000 to build, own and operate a desalination facility in Trinidad. The facility
supplies water to the Water and Sewerage Authority of Trinidad and Tobago.
During 2003, the Company recognized $4.9 million of equity loss that reflects
100% of Desalcott's net loss for the year. The carrying value of the Company's
equity investment in Desalcott was approximately $3.7 million and $7.1 million,
respectively, at December 31, 2003 and 2002. In the Company's Consolidated
Balance Sheets at December 31, 2003 and 2002, the investment balance is included
in "Investment in affiliated companies."
Summarized financial information of Desalcott is presented as follows (dollars
in thousands):
December 31,
---------------------------
2003 2002
---------- ----------
Current assets $ 32,771 $ 14,044
Non-current assets 123,904 126,321
---------- ----------
Total assets $ 156,675 $ 140,365
========== ==========
Current liabilities $ 24,735 $ 11,772
Non-current liabilities 117,811 109,631
---------- ----------
Total liabilities $ 142,546 $ 121,403
========== ==========
Years ended December 31,
--------------------------------------
2003 2002 2001
---------- ---------- -------
Sales $ 27,220 $ 18,804 $ -
Cost of sales 14,216 9,240 264
Operating (loss) income (3,868) 615 (295)
(Loss) income before income taxes (3,868) 615 (295)
Net loss (4,867) (1,118) (295)
Grupo Empresarial de Mejoramiento Ambiental, S. de R.L. de C.V. ("GEMA") was
formed in 1991. GEMA was incorporated to design and construct wastewater
treatment plants and provide wastewater collection, treatment, conduction and
distribution services. The carrying value of the Company's investment in GEMA
was approximately $3.6 million and $3.8 million, at
68
December 31, 2003 and 2002, respectively, and is included in "Investments in
affiliated companies" in the Consolidated Balance Sheets. During 2003 and 2002,
the Company received $1.4 million and $2.2 million, respectively, of cash
dividends from GEMA.
Summarized financial information of GEMA is presented as follows (dollars in
thousands):
December 31,
-------------------------
2003 2002
--------- ---------
Current assets $ 16,133 $ 16,375
Non-current assets 29,045 37,428
--------- ---------
Total assets $ 45,178 $ 53,803
========= =========
Current liabilities $ 8,851 $ 10,288
Non-current liabilities 18,296 24,381
--------- ---------
Total liabilities $ 27,147 $ 34,669
========= =========
Years ended December 31,
-----------------------------
2003 2002 2001
-------- ------- --------
Sales $ 35,666 $38,803 $ 35,800
Cost of sales 14,405 13,586 12,960
Operating income 16,576 20,370 17,817
Income before income taxes 13,655 14,743 15,954
Net income 7,646 9,910 11,227
NOTE 6. DISCONTINUED OPERATIONS
In August 2003, the Company's management and Board of Directors approved the
plan to sell its consumer chemical business, the Elite Consumer Products
division in Ludlow, MA, which was part of the Company's Consumer Water Group
segment. In addition, during the fourth quarter of 2003, the Company's
management and Board of Directors approved a plan of disposition to sell its
European POU cooler business, located in the United Kingdom and Ireland, which
was also part of the Company's Consumer Water Group segment. Accordingly, the
Company's financial statements and notes reflect these businesses as
discontinued operations in accordance with Financial Accounting Standards Board
Statement 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
The net loss from discontinued operations for the Elite Consumer Products
division for the year ended December 31, 2003 was $7.0 million, or $11.5 million
on a pre-tax basis, includes losses from operations of $3.6 million and loss on
disposal of $3.4 million. The loss on disposal reflects impairment charges to
write down the carrying value of assets to their estimated fair value less costs
to sell, and charges related to the abandonment of a plan to commence
bleach-manufacturing operations in Elkton, Maryland. In February 2004, the
Company completed the sale of the Elite Consumer Products division for
approximately $5.2 million.
The net loss from discontinued operations for the POU business in the U.K. for
the year ended December 31, 2003 was $2.4 million or $3.5 million on a pre-tax
basis. The total net loss includes losses from operations of $1.9 million and
loss on disposal of $473,000. The loss on disposal reflects impairment charges
to write down the carrying value of assets to their estimated fair value less
costs to sell. The Company expects to complete the sale of the POU business
during 2004.
The net loss from discontinued operations for the POU business in Ireland for
the year ended December 31, 2003 was $2.1 million. The total net loss includes
losses from operations of $780,000 and loss on disposal of $1.3 million. The
loss on disposal reflects impairment charges to write down the carrying value of
assets to their estimated fair value less costs to sell.
The Company's financial statements have been reclassified to reflect these
entities as discontinued operations for all periods presented. The operating
results of the discontinued operations are summarized below which exclude
general corporate overhead previously allocated to each entity.
69
(Dollars in thousands)
For the years ended December 31,
--------------------------------
2003 2002 2001
----------- ---------- ----------
Net sales $ 20,961 $ 16,488 $ 18,683
Gross margin (2,309) 1,486 1,712
========== ========= =========
(Loss) income from discontinued operations,
before income tax (17,077) (1,270) 141
Income tax benefit (expense) 5,575 558 (53)
---------- --------- ---------
(Loss) income from discontinued
operations, net of tax (6,336) (712) 88
Loss on disposal of discontinued operations,
net of tax (5,166) - -
---------- --------- ---------
(Loss) income from discontinued operations,
net of tax $ (11,502) $ (712) $ 88
========== ========= =========
At December 31, 2003, the combined assets and liabilities of discontinued
operations consisted of the following:
(Dollars in thousands)
December 31, December 31,
2003 2002
------------ ------------
Current assets $ 2,709 $ 5,846
Non-current assets 4,757 12,624
-------- --------
Assets from discontinued operations $ 7,466 $ 18,470
======== ========
Liabilities from discontinued operations $ 396 $ 227
======== ========
NOTE 7. RESTRUCTURING AND IMPAIRMENT OF LONG-LIVED ASSETS
During the third quarter of 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. As a result of these decisions, the Company recorded
restructuring charges of approximately $2.8 million during 2003 relating
primarily to employee severance costs for the elimination of approximately 160
positions. During 2003, substantially all of the employees whose employment was
terminated as a result of these restructuring activities left the Company.
Additionally, at December 31, 2003, the Company has approximately $0.9 million
accrued for restructuring costs associated with employee severance arrangements
and expects the remainder of the payments to be made during the first half of
2004. Additionally, as a result of the Company's restructuring plan, the Company
ceased or reduced manufacturing operations at various locations resulting in the
impairment of manufacturing equipment totaling approximately $1.2 million. The
Company also recorded an impairment charge of approximately $0.6 million
associated with its decision to abandon a plan to increase manufacturing
capacity in a plant located in Italy.
During 2003, the Company recorded an impairment charge relating to production
equipment within the EBG segment that it had previously expected to lease to a
manufacturer of lactic acid in the food industry in Spain. During the second
half of 2003 the Company's customer began the process of filing for insolvency
protection. Accordingly, the Company recorded an impairment charge of
approximately $2.5 million associated with the remaining carrying value of the
equipment as the Company does not
70
expect to recover the asset or receive any future payments for the asset. This
matter is currently in litigation. (See Note 9.)
During 2001, the Company recorded charges of $1.3 million for impairment of
long-lived assets held for sale related to the Company's divestiture of its
majority-owned Malaysian subsidiary, Ionics Enersave Sdn. Bhd. (Enersave). The
Company began negotiations to sell its interest in Enersave to the minority
shareholders in late 2001. In early 2002, the Company had signed a term sheet
for the disposition and the sale was completed in May 2002. Accordingly, at
December 31, 2001, the Company recorded an impairment charge of approximately
$9.2 million, representing the difference between the Company's 55% ownership
interest in the net asset value of Enersave (principally property, plant and
equipment, and goodwill) and the net proceeds from the sale of the Company's
interest in subsidiary of approximately $1.0 million.
NOTE 8. GOODWILL AND INTANGIBLE ASSETS
During the third quarter of 2003, as a result of significant changes in the
business climate which resulted in the Company's restructuring program, the
Company conducted interim impairment tests of the goodwill related to certain
reporting units. Based upon its preliminary assessment, the Company determined
that the carrying value of the net assets associated with its Ionics RCC, Ionics
Ahlfinger and Separations Technology reporting units exceeded their fair value
and accordingly recorded a $12.7 million goodwill impairment charge ($6.8
million for Ionics RCC, $3.7 million for Ionics Ahlfinger and $2.2 million for
Separations Technology). The impairment charge, representing the entire goodwill
balance for these reporting units, was estimated by comparing the implied fair
values of the goodwill associated with these reporting units to their carrying
values. No adjustment arose from the completion of the final assessment of the
reporting units' valuation. during the fourth quarter of 2003
During 2001, the Company wrote down approximately $11.0 million of goodwill. Of
this amount, $7.8 million related to the Company's divestiture of Enersave, and
the remaining $3.2 million related to other previous acquisitions.
The following tables reflect the adjustments to selected consolidated financial
information to present pro forma amounts which exclude amortization of goodwill:
For the year ended
December 31,
------------------
(Amounts in thousands, except per share amounts) 2001
-----------------
Reported income from continuing operations $ 44,613
Goodwill amortization, net of tax 2,188
-----------------
Adjusted income from continuing operations $ 46,801
=================
Reported basic earnings from continuing operations per share $ 2.61
Goodwill amortization, net of tax 0.13
-----------------
Adjusted basic earnings from continuing operations per share $ 2.74
=================
Reported diluted earnings from continuing operations per share $ 2.59
Goodwill amortization, net of tax 0.13
-----------------
Adjusted diluted earnings from continuing operations per share $ 2.72
=================
71
The changes in the carrying amount of goodwill for the years ended December 31,
2003 and 2002 are as follows:
Equipment Ultrapure Consumer Instrument
Business Business Water Business
Dollars in thousands Group Group Group Group Corporate Total
------------- --------- ------ ---------- --------- ----------
Balance at December 31, 2001 $ 11,360 $ 7,054 $ 541 $ - $ - $ 18,955
Goodwill acquired during the year - 597 - - - 597
Cumulative translation adjustment/other 263 (18) 321 - - 566
------------- -------- ------ --------- --------- ----------
BALANCE AT DECEMBER 31, 2002 $ 11,623 $ 7,633 $ 862 $ - $ - $ 20,118
IMPAIRMENTS OF GOODWILL (8,981) (3,750) - - - (12,731)
CUMULATIVE TRANSLATION ADJUSTMENT/OTHER 351 (43) - - - 308
------------- -------- ------ --------- --------- ----------
BALANCE AT DECEMBER 31, 2003 $ 2,993 $ 3,840 $ 862 $ - $ - $ 7,695
============= ======== ====== ========= ========= ==========
The Company's intangible assets consist of acquired patents, trademarks and
customer lists. At December 31, 2003 and 2002, the gross carrying value of
intangible assets was approximately $7.9 million and $3.3 million, respectively,
and the accumulated amortization was $1.5 million and $1.0 million,
respectively. Amortization expense for intangible assets is estimated to be
approximately $0.9 million in 2004 through 2006 and $0.8 million in 2007 and
2008.
NOTE 9. COMMITMENTS AND CONTINGENCIES
Litigation
On December 16, 2003, Ionics Iberica, S.A., the Company's wholly-owned Spanish
subsidiary (Iberica) brought suit in Palencia, Spain against Intersuero, S.A.
Iberica is seeking the return of certain membrane-based production equipment
which Iberica had supplied under a lease agreement to Intersuero (which had
begun insolvency proceedings, or payment of 2.8 million Euros or $3.5 million
plus interest for the equipment. On February 17, 2004 Intersuero filed an answer
and counterclaim, alleging that the equipment did not perform to specifications
and seeking 15.8 million Euros or $19.9 million in damages, lost profits,
interests and costs. The Company believes Intersuero's allegations to be without
merit and will defend itself vigorously in this matter. While the Company
believes that this litigation should 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, its former Chief Executive Officer and its Chief Financial 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. 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 other material misrepresentations and omissions concerning the Company's
financial results. The plaintiffs 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, which is in the early discovery stage. The
Company had filed a motion to dismiss the lawsuit, but the Court did not grant
the motion. 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 $82,000. 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 or its 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
72
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, Israel and
Algeria 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
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. This settlement had no impact on the Company's Statements of
Operations.
73
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 Trinidad 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 relating to phases 1 through 4. 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 December
31, 2003, the Company had invested a total of $9.7 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 $7.6
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. Construction of the wastewater reuse facility is
underway and is expected to be completed in 2005.
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. During the second quarter of 2003, the
Israeli cooperative society and the Company acquired the ownership interest of
the Israeli corporation in MDL, resulting in the Company's holding a 49% equity
interest 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 $8.0 million of debt financing
for the project from an Israeli bank, and the Company has guaranteed repayment
of 49% of the loan amount during the construction period 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.
Construction of 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 December 31, 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 initially granted an extension to August 20,
2003 and a further extension to April 1, 2004 was granted by the WDA. 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 of approximately
$0.8 million. 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.
74
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 project has been delayed because of the restructuring of Mekorot. 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 third 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
In October 2003, the Company and Algerian Energy Company (AEC) were selected for
a 25-year seawater desalination build-own-operate project. Sonatrach, the
national energy company, will guarantee the water supply contract. The Company
and AEC have formed a joint project company, Hamma Water Desalination S.p.A.
(HWD), with Ionics owning 70%. The projected $220 million capital investment
will be financed by a combination of equity and non- recourse debt. At December
31, 2003, the Company made an equity investment of $0.2 million in HWD and had
deferred costs of approximately $0.3 million relating to the engineering design
and development work on the project. If HWD obtains long-term project financing,
the Company has committed to make additional equity investments to HWD of
approximately $46.2 million. Terms of the contract require that long-term
project financing be obtained by June 30, 2004. If HWD is unable to obtain such
financing, the Company would expense its deferred costs relating to the
construction project and its investment in HWD. Additionally, the Company could
incur liability under a $1.0 million performance bond issued by the Company to
the customer.
Guarantees and Indemnifications
In the fourth quarter of 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 5, 57, and 107 and rescission of FASB
Interpretation 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 were determined to
be within the scope of FIN 45.
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 in the form of bank guarantees are sometimes 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 $101.5 million of these
instruments were outstanding at December 31, 2003. Based on the Company's
experience with respect to letters of credit and these bid bonds and performance
bonds, the Company believes the estimated fair value of the instruments entered
into during 2003 is not material. Accordingly, the Company has not recorded any
liabilities for these instruments as of December 31, 2003. Approximately 53% of
the guarantees outstanding at December 31, 2003 are scheduled to expire in 2004.
These instruments were executed with creditworthy institutions.
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 2003. Accordingly, the Company has not
recorded any liabilities for these obligations as of December 31, 2003.
75
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 expired on December 3, 2003.
NOTE 10. LONG-TERM DEBT AND NOTES PAYABLES
Dollars in thousands 2003 2002
-------------------- -------- --------
Borrowings outstanding $ 15,165 $ 13,804
Less: Installments due within one year 6,276 4,134
-------- --------
Long-term debt and notes payable $ 8,889 $ 9,670
======== ========
At December 31, 2003, the Company maintained two primary domestic credit
facilities, including a $15 million credit line with Fleet Bank for working
capital and a $25 million credit line with HSBC Bank USA for the issuance of
letters of credit. Borrowings under the Fleet Bank facility bore interest equal
to a base rate (generally the Prime Rate) or LIBOR plus a margin of 1.25%, at
the Company's option. Letters of credit issued under the HSBC Bank USA facility
bore interest at a rate of .825%. The terms of the facilities included financial
covenants relating to liquidity, leverage, net worth and capital expenditures.
At December 31, 2003, the Company was in compliance with all covenants. The
Company had no borrowings against the Fleet Bank line of credit at December 31,
2003 or December 31, 2002. The Company had outstanding letters of credit under
the HSBC Bank USA facility of $16.7 million at December 31, 2003 and $9.3
million at December 31, 2002. In February 2004, the Company terminated its
unsecured domestic credit lines with Fleet Bank and HSBC Bank USA.
At December 31, 2003, the Company also maintained other international lines of
credit, under which the Company could borrow up to an aggregate of $8.8 million
in working capital and issue letters of credit or letters of guarantee up to an
aggregate of $40.9 million. The Company had outstanding borrowings of $4.8
million and $2.9 million and outstanding letters of credit and letters of
guarantee of $27.6 million and $29.0 million at December 31, 2003 and December
31, 2002, respectively.
On February 13, 2004, the Company acquired the stock and membership interests of
the Ecolochem Group from the shareholders and members of the Ecolochem Group for
an aggregate purchase price of $222.0 million in cash (which includes $12.8
million to be paid in the event that the Company makes a Section 338(h)(10)
election with respect to the acquired assets of the Ecolochem Group) and
4,652,648 shares of the Company's common stock. The cash portion of the
consideration was financed with the Company's available cash resources and
proceeds from new $255 million senior credit facilities. In connection with
the acquisition of the Ecolochem Group (see Note 21), the Company obtained $255
million of senior credit facilities with a syndication of lenders led by UBS,
Fleet Bank and Bank of America. Proceeds from the facilities were used to fund
the acquisition, pay certain fees and expenses, provide for ongoing working
capital and support the issuance of letters of credit. The facilities consist of
a $175 million 7-year term loan and an $80 million 6-year revolving credit
facility. Borrowings under the facilities bear interest equal to a base rate
(generally the Prime Rate) plus a specified margin or LIBOR plus a specified
margin, at the Company's option; the specified margins are a function of the
Company's leverage ratio. Interest on outstanding borrowings is payable
quarterly. The facilities are collateralized by the assets of Ionics,
Incorporated and of its domestic subsidiaries and by 65% of the equity of the
Company's international subsidiaries. The terms of the facilities include
financial covenants relating to fixed charge coverage, interest coverage,
leverage ratio and capital expenditures, the most restrictive of which are
anticipated to be the leverage ratio and limitations on capital spending. The
terms of the new credit facilities contain provisions that limit the Company's
ability to incur additional indebtedness in the future and place other
restrictions on the Company's business. In connection with the execution of the
new credit facility, the Company entered into interest rate swap agreements that
fix the Company's LIBOR rate on approximately 60% of the outstanding balance of
the term loan at 3.1175%. The swap agreements expire in 2010.
The Company has three project finance loans for its controlled affiliate in
Barbados. These loans are payable in equal quarterly installments over a ten
year period that began in 2000, and bear interest at rates ranging from LIBOR +
2.0% (3.09% at December 31, 2003) to 8.75%. The controlled affiliate had
outstanding borrowings of $6.4 million and $7.4 million against these loans at
December 31, 2003 and December 31, 2002, respectively. The Company also has
project financing loans for its controlled affiliate in Italy. The loans have a
ten-year maturity and bear interest at EURIBOR plus a specified margin. The
controlled affiliate had outstanding borrowings of EUR 3.0 million ($3.8
million) and EUR 3.4 million ($3.5 million) against these loans at December 31,
2003 and December 31, 2002, respectively.
Maturities of all cash borrowings outstanding for the five years ended December
31, 2004 through December 2008 are approximately $6.3 million, $1.5 million,
$1.6 million, $1.6 million, $1.7 million, and $2.5 million thereafter,
respectively. The weighted average interest rate on all borrowings was 6% at
both December 31, 2003 and 2002.
76
NOTE 11. INCOME TAXES
The components of domestic and foreign income from continuing operations before
income taxes and minority interest were as follows:
Dollars in Thousands 2003 2002 2001
-------------------- ---- ---- ----
U.S. $ (49,527) $ 654 $ 4,155
Non-U.S. 5,651 11,285 81,907
---------- ---------- ----------
(Loss) income before income tax
expense and minority interest $ (43,876) $ 11,939 $ 86,062
========== ========== ==========
Income tax benefit (expense) consisted of the following:
Dollars in Thousands 2003 2002 2001
-------------------- ---- ---- ----
Federal $ 2,651 $ (115) $ (7,916)
Foreign 526 (3,658) (37,246)
State (280) (234) (2,714)
---------- ---------- ----------
Current benefit (expense) 2,897 (4,007) (47,876)
---------- ---------- ----------
Federal 9,762 (1,071) (605)
Foreign (2,322) (156) 6,316
State 1,196 (232) (21)
---------- ---------- ----------
Deferred benefit (expense) 8,636 (1,459) 5,690
---------- ---------- ----------
Income tax benefit (expense) $ 11,533 $ (5,466) $ (42,186)
========== ========== ==========
Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. At December 31, 2003 and
2002, deferred income tax assets and liabilities were as follows:
2003 2002 2003 2002
---------- ---------- ----------- -----------
Deferred Deferred
Deferred Deferred Tax Tax
Dollars in Thousands Tax Assets Tax Assets Liabilities Liabilities
-------------------- ---------- ---------- ----------- -----------
Depreciation $ - $ - $ 10,242 $ 12,628
Amortization 2,310 - - 1,670
Inventory valuation 996 1,382 - -
Bad debt reserves 2,532 1,384 - -
Accrued expenses 3,508 2,108 - -
Profit on sales to foreign subsidiaries 348 726 - -
U.S. tax on unrepatriated earnings - - 14,583 13,358
Alternative minimum tax credits 4,171 3,370 - -
Foreign withholding taxes on
undistributed earnings - - 1,593 1,594
Foreign deferred taxes 540 4,881 1,733 1,160
Tax effect of currency translation loss 5,111 277 -
Net operating loss carryforwards 14,765 4,209 - -
Foreign tax credit carryforwards 3,224 - - -
Capitalized research and development 1,867 - - -
Minimum pension liability 2,409 2,098 - -
Miscellaneous 5,654 7,824 2,551 5,674
---------- ---------- ----------- -----------
42,324 33,093 30,979 36,084
Valuation allowance (5,025) (3,739) - -
---------- ---------- ----------- -----------
Deferred income taxes $ 37,299 $ 29,354 $ 30,979 $ 36,084
========== ========== =========== ===========
77
The United States federal statutory corporate tax rate is reconciled to the
Company's effective tax rate as follows:
2003 2002 2001
---- ---- ----
U.S. Federal statutory rate (35.0)% 35.0% 35.0%
Foreign sales corporation/ETI exclusion (1.0) (3.2) (0.7)
Goodwill 1.8 - 6.6
State income taxes, net of
federal tax benefit (2.3) 3.2 2.1
Foreign rate differential 0.2 (7.0) (3.6)
U.S. tax on non-permanently reinvested
foreign earnings 2.6 4.7 4.3
Net change in valuation allowance 3.0 10.1 5.3
Non-deductible equity loss 3.7 1.2 -
Non-deductible charges 0.3 1.2 0.2
Other, net 0.4 0.6 (0.2)
----- ---- ----
Effective tax rate (benefit) (26.3)% 45.8% 49.0%
===== ==== ====
At December 31, 2003, the Company has total federal, state and foreign unused
tax loss carryforwards of $82 million, some of which expire beginning in 2004.
Because of the uncertainty of the realization of the tax benefits of losses
incurred in certain foreign jurisdictions, the Company has established $4.8
million as a valuation allowance at December 31, 2003. Also at December 31,
2003, the Company had $3.2 million of foreign tax credit carryforwards which
expire beginning in 2006. Because of the uncertainty of the realization of the
tax benefit of certain of these credits, the Company has established $0.2
million as a valuation allowance at December 31, 2003. $2.4 million of deferred
tax benefit related to the minimum pension liability adjustment recorded in
other comprehensive income has been included in other assets at December 31,
2003.
The Company continually assesses the realizability of its deferred tax asset.
The deferred tax asset may be reduced by a valuation allowance, if based on the
weight of available evidence; it is more likely than not that some portion or
all of the recorded deferred tax assets will not be realized in future periods.
All available evidence, both positive and negative, is considered in the
determination of recording a valuation allowance. The Company considers future
taxable income and ongoing tax planning strategies when assessing the need for a
valuation allowance. Negative evidence that would suggest the need for a
valuation allowance consists of the Company's recent cumulative operating losses
that were attributable to unprofitable businesses.
The positive evidence consists of the Company's current initiative to realign
its businesses to operate more efficiently. In addition, the Company recently
acquired the Ecolochem Group, which has strong historical earnings. The Company
believes that future taxable income will be sufficient to realize the deferred
tax benefit of the net deferred tax assets. In the event that it is determined
that the Company's financial projections of pretax profits change and it becomes
more likely than not that the net deferred tax assets will not be realized, an
adjustment to the net deferred tax assets will be made and will result in a
charge to income in the period such determination is made. The net deferred tax
asset amount at December 31, 2003 is $6.3 million.
Under the provisions of the Internal Revenue Code, certain substantial changes
in the Company's ownership may limit the amount of net operating loss and tax
credit carryforwards which could be utilized annually to offset future taxable
income and taxes payable. The amount of this annual limitation is determined
based upon the Company's value prior to an ownership change.
The Company has elected not to provide tax on certain undistributed earnings of
its foreign subsidiaries which it considers to be permanently reinvested. The
cumulative amount of such unprovided taxes was approximately $10.5 million, $9.7
million and $8.2 million as of December 31, 2003, 2002 and 2001, respectively.
NOTE 12. STOCKHOLDERS' EQUITY
Stock Option Plans
Under the Company's 1997 Amended and Restated Stock Incentive Plan ("1997
Plan"), incentive stock options, non-qualified stock options, long-term
performance awards, and, after Stockholders approval on February 11, 2004,
shares of restricted stock may be awarded to officers and other key employees
and to consultants. At December 31, 2003 and 2002, there were 891,023 and
775,323 shares, respectively, reserved for issuance of additional options under
the 1997 Plan. Options granted under the 1997 Plan
78
have a term of ten years and vest over a five-year period, except that options
become fully vested if an option holder retires after reaching age 65. Only
non-qualified stock options have been granted under the 1997 Plan. On December
31, 2003, options for 2,102,517 shares of common stock were outstanding under
the 1997 Plan. On February 11, 2004, the stockholders approved (i) the
reservation of an additional 1,200,000 shares of common stock for issuance under
the 1997 Plan, and (ii) the issuance of up to 1,000,000 shares of restricted
stock under the 1997 Plan.
Under the Company's 1986 Stock Option Plan for Non-Employee Directors ("1986
Plan"), which expired on December 31, 2003, options were granted at a price not
less than the fair market value of the stock at the date of grant. The options
become fully exercisable after a six-month period, are exercisable only during
certain "window" periods, and have a term of ten years and one day. As of
December 31, 2003 and 2002, no shares were reserved for issuance of additional
options under the 1986 Plan. Options for 92,500 shares of common stock were
outstanding under the 1986 Plan on December 31, 2003.
In the first quarter of 2003, the Company adopted the 2003 Non-Employee
Directors Stock Option Plan ("2003 Plan") to replace the expired 1986 Plan. The
2003 Plan was approved by the Company's stockholders at the 2003 annual meeting.
Under the 2003 Plan, options are granted at a price not less than the fair
market value of the stock at the date of grant. The options become fully
exercisable after a six month period and have a term of ten years. At December
31, 2003 and 2002, there were 172,000 and 200,000 shares, respectively, reserved
for issuance of additional options under the 2003 Plan. Options for 28,000
shares of common stock were outstanding under the 2003 Plan at December 31,
2003.
The Company has adopted a restricted stock plan ("1994 Plan") under which shares
of common stock may be granted to officers and other key employees of the
Company. Restrictions on the sale of such common stock typically lapse over a
five-year vesting period. No shares were granted under the 1994 Plan in 2003 or
2002. As of December 31, 2003, a total of 280,178 shares remain reserved for
issuance under the 1994 Plan, which will expire in August 2004.
On April 1, 2003, Douglas R. Brown, who became President of the Company on April
1, 2003 and Chief Executive Officer of the Company on July 1, 2003, was awarded
an inducement non-qualified stock option ("Inducement Option") for 500,000
shares of common stock. On August 28, 2003, John J. Curtis, who became Vice
President, Strategy and Operations of the Company on August 28, 2003, was
awarded an inducement non-qualified stock option ("Inducement Option") for
200,000 shares of common stock.
Mr. Brown's Inducement Option represents a grant of 500,000 non-qualified stock
options, of which 125,000 vested immediately and the remainder will vest in
125,000 option increments on April 1, 2004, 2005 and 2006, respectively. The
option exercise price is $16.16 per share, the last sale price on the New York
Stock Exchange on April 1, 2003, Mr. Brown's first day of employment. Upon a
voluntary termination of employment by Mr. Brown, any unvested options would be
forfeited, and all vested options would remain exercisable over the remainder of
the ten year term of the Inducement Option. In the event Mr. Brown's employment
were terminated involuntarily (other than for cause), any unvested options will
be forfeited (Mr. Brown's employment would be deemed to continue for 18 months
beyond his termination date solely for vesting purposes), and all vested options
will remain exercisable over the remainder of the ten-year term. In the event
that Mr. Brown's employment were to be terminated involuntarily for cause, all
options, vested and unvested, would be forfeited upon the termination of his
employment.
In the event of Mr. Brown's death or permanent disability while employed by the
Company, his employment would be deemed to continue for 18 months for vesting
purposes only, and all vested options will remain exercisable over the remainder
of the ten-year term.
The Inducement Option is transferable by Mr. Brown only to certain immediate
family members or to a trust or other entity for the exclusive benefit of his
immediate family members.
The Inducement Option granted to Mr. Curtis contains substantially identical
terms as the Inducement Option granted to Mr. Brown, except that (i) the
exercise price is $22.00 per share and (ii) the Inducement Option represents a
grant of 200,000 non-qualified stock options, of which 50,000 vested immediately
and the remainder will vest in 50,000 option increments on August 28, 2004, 2005
and 2006, respectively.
On August 19, 1998, the Company adopted the 1998 Non-Employee Directors' Fee
Plan ("Fee Plan"). The Fee Plan permits non-employee directors to elect to
receive payment of their annual retainer fee in common stock instead of cash.
The valuation of the common stock is based on the last reported sales price of
the common stock on the New York Stock Exchange on the trading date next
preceding the date of the Board meeting at which payment will be made. Annual
retainer fees are paid in two equal
79
installments during the year. A total of 80,213 and 83,423 shares were reserved
for issuance under the Fee Plan as of December 31, 2003 and 2002, respectively.
A summary of the status of the Company's stock option plans as of December 31,
2003, 2002 and 2001 and changes during the years then ended is presented below:
2003 2002 2001
--------------------- --------------------- --------------------
WEIGHTED Weighted Weighted
AVERAGE Average Average
EXERCISE Exercise Exercise
Options in Thousands OPTIONS PRICE Options Price Options Price
-------------------- ------- -------- ------- ----- ------- --------
Outstanding at end of prior year 3,503 $ 27.21 2,889 $ 28.77 3,226 $ 28.38
Granted 736 17.90 790 21.54 65 26.94
Exercised (409) 21.98 (73) 22.91 (229) 21.84
Canceled (155) 30.58 (103) 29.87 (173) 30.22
----- -------- ----- -------- ----- --------
Outstanding at end of current year 3,675 $ 25.78 3,503 $ 27.21 2,889 $ 28.77
Options exercisable at year-end 2,229 $ 29.27 2,085 $ 30.24 1,873 $ 30.88
The weighted average fair value of options granted were $8.03, $9.95 and $11.08
per option during 2003, 2002 and 2001, respectively.
The following table summarizes the information about stock options outstanding
at December 31, 2003:
OPTIONS IN THOUSANDS OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------- ------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
RANGE OF NUMBER CONTRACT EXERCISE NUMBER EXERCISE
EXERCISE PRICES OUTSTANDING YEARS PRICE EXERCISABLE PRICE
--------------- ----------- ----- ----- ----------- -----
$ 16.16-$ 18.90 530,000 9.3 $ 16.31 153,000 $ 16.66
$ 21.06-$ 23.74 1,520,000 7.8 21.55 519,000 $ 21.74
$ 24.24-$ 26.50 319,000 2 24.51 303,000 $ 24.47
$ 27.06-$ 27.88 59,000 3.6 27.56 43,000 $ 27.56
$ 28.00-$ 29.88 704,000 4.8 29.46 681,000 $ 29.46
$ 30.00-$ 33.81 35,000 6.5 31.86 22,000 $ 32.34
$ 42.38-$ 48.18 508,000 2.8 43.39 508,000 $ 43.39
--------------- --------- --- -------- --------- --------
$ 16.16-$ 48.18 3,675,000 6.2 $ 25.78 2,229,000 $ 29.27
Other Plans
The Company has a Section 401(k) stock savings plan under which 1,050,000 shares
have been registered with the Securities and Exchange Commission for purchase on
behalf of employees. Shares are normally acquired for the plan in the open
market. Through December 31, 2003, no shares had been issued under the plan.
The Company has adopted a Renewed Rights Plan designed to protect stockholders
against abusive takeover tactics. Each share of common stock now carries one
right. Each right entitles the holder to purchase from the Company one share of
common stock (or in certain circumstances, to receive cash, property or other
securities of the Company) at a purchase price of $175 subject to adjustment. In
certain circumstances, rights become exercisable for common stock (or a
combination of cash, property or other securities of the Company) worth twice
the exercise price of the right. The rights are not exercisable until the
occurrence of certain events as defined in the Renewed Rights Plan. The rights
may be redeemed by the Company at $.01 per right at any time unless certain
events occur. Unless redeemed earlier, the rights, which have no voting power,
expire on August 19, 2007.
80
NOTE 13. EARNINGS PER SHARE CALCULATIONS (EPS)
Dollars and shares in thousands,
Except per share amounts FOR THE YEAR ENDED 2003 For the Year Ended 2002 For the Year Ended 2001
-------------------------------- ------------------------------ ------------------------------ -----------------------------
NET Net Net
INCOME Income Income
FROM from from
CONTINUING PER SHARE Continuing Per Share Continuing Per Share
OPERATIONS SHARES AMOUNT Operations Shares Amount Operations Shares Amount
---------- ------ --------- ---------- ------ --------- ---------- ------ ---------
Basic EPS
Income (loss) from continuing
operations available to
common stockholders $ (33,268) 17,674 $ (1.88) $ 5,504 17,541 $ 0.31 $ 44,613 17,106 $ 2.61
Effect of dilutive stock
options - - - - 130 - - 140 (0.02)
---------- ------ -------- ---------- ------ ------- ---------- ------ -------
Diluted EPS $ (33,268) 17,674 $ (1.88) $ 5,504 17,671 $ 0.31 $ 44,613 17,246 $ 2.59
========== ====== ======== ========== ====== ======= ========== ====== =======
The effect of dilutive stock options excludes those stock options for which the
impact would have been antidilutive based on the exercise price of the options.
The number of options that were antidilutive at December 31, 2003, 2002 and 2001
were 562,000, 1,818,000 and 608,750, respectively. The number of options that
were antidilutive at December 31, 2003 include 117,000 shares whose dilutive
effect was included as a result of the Company's net loss.
NOTE 14. OPERATING LEASES
The Company leases equipment, primarily for industrial water purification to
customers through operating leases. The original cost of this equipment was
$128.4 million and $114.7 million at December 31, 2003 and 2002, respectively.
The accumulated depreciation for such equipment was $61.4 million and $51.4
million at December 31, 2003 and 2002, respectively. The bottled water coolers
were sold on December 31, 2001 as part of the sale of the Company's bottled
water business.
At December 31, 2003, future minimum rentals receivable under non-cancelable
operating leases in the years 2004 through 2008 and later were approximately
$38.1 million, $32.2 million, $28.9 million, $27.1 million, $25.4 million and
$111.7 million, respectively.
The Company leases facilities and personal property under various operating
leases. Future minimum payments due under lease arrangements are as follows:
$6.6 million in 2004, $3.0 million in 2005, $1.7 million in 2006, $1.2 million
in 2007, $0.7 million in 2008 and $0.5 million thereafter. Rent expense under
these leases was approximately $5.4 million, $4.2 million and $7.0 million for
2003, 2002 and 2001, respectively.
NOTE 15. PROFIT SHARING AND PENSION PLANS
The Company has a contributory profit-sharing plan (defined contribution plan)
which covers employees of the Company who are members of the Fabricated Products
Group of the Bridgeville division. The Company contributions to the defined
contribution plan are made from the group's pre-tax profits, may vary from 8% to
15% of participants' compensation, and are allocated to participants' accounts
in proportion to each participant's respective compensation. Company
contributions were $460,000, $446,000 and $375,000 in 2003, 2002 and 2001,
respectively.
The Company also has a contributory defined benefit pension plan ("Retirement
Plan") for all other domestic employees. Benefits are based on years of service
and the employee's average compensation. The Company's funding policy is to
contribute annually an amount that can be deducted for federal income tax
purposes. In 2002, the Board of Directors approved a "prior period update" to
January 1, 1996, so that the base monthly salary for participants in the
Retirement Plan at each January 1 prior to January 1, 1996 is deemed to be the
same as it was on January 1, 1996.
In 1996, the Company's Board of Directors adopted a Supplemental Executive
Retirement Plan for officers and key employees of the Company ("SERP"). The
purpose of the SERP is to permit officers and other key employees whose base
salary exceeds the maximum pay upon which retirement benefits may be accrued in
any year to accrue retirement benefits on base salary in excess of that amount,
equivalent to the benefits that would have been accrued under the Retirement
Plan if base salary levels over that amount could be taken into account in
calculating benefits under the Retirement Plan. The Company recognized expense
of $0.8 million and $0.1 million in 2003 and 2002, respectively, under the SERP.
No expense was recognized in 2001. The liability
81
accrued as of December 31, 2003 and 2002 related to the Plan was $5.5 million
and $0.5 million, respectively. The SERP is administered by the Compensation
Committee of the Board of Directors.
On December 30, 2003, the Board of Directors authorized the closing of the
Retirement Plan and SERP to new participants, effective January 1, 2004. On
February 13, 2004, the Company notified the participants in these plans that no
further benefits would accrue after March 31, 2004. The effect of the
resolutions required the recognition of curtailment losses of $1.3 million and
$4.1 million for the Retirement Plan and SERP, respectively, for the year ending
December 31, 2003. The curtailment losses were recorded in "Selling, general and
administrative expenses" in the Consolidated Statement of Operations.
The Company uses a December 31 measurement date in the determination of net
periodic benefit costs, benefit obligations and the value of plan assets. The
following table sets forth the funded status and amounts recognized in the
Company's Balance Sheets at December 31, 2003 and 2002 for all defined benefit
plans:
Dollars in Thousands 2003 2002
-------------------- ---- ----
Change in Benefit Obligation:
Benefit obligation as of prior year-end $ 29,065 $ 24,807
Service cost 1,768 1,446
Interest cost 1,967 1,397
Assumption changes 201 1,868
Actuarial loss 1,788 822
Benefits paid (767) (1,275)
Amendments 1,163 -
Curtailment (3,684) -
-------- --------
Projected benefit obligation $ 31,501 $ 29,065
======== ========
Change in Plan Assets:
Fair value of plan assets as of prior year-end $ 15,665 $ 14,297
Actual return on plan assets 2,684 (124)
Company contributions 4,711 2,890
Expenses paid (47) (123)
Benefits paid (767) (1,275)
-------- --------
Fair value of plan assets $ 22,246 $ 15,665
======== ========
Funded Status:
Funded status as of year-end $ (9,255) $(13,400)
Unrecognized transition asset - (44)
Unrecognized prior service cost - 4,918
Unrecognized net actuarial loss 6,284 9,930
Intangible asset - (267)
Accumulated other comprehensive loss (6,342) (5,782)
-------- --------
Accrued benefit cost $ (9,313) $ (4,645)
======== ========
The Company's investment strategy with respect to Plan assets is to maintain a
portfolio of various mutual fund investments. These investments are generally
split between debt and equity securities. The strategy is based primarily on an
analysis of historical returns. The expected rate of return on Plan assets
utilized for determination of the Plan's funded status and amounts recognized in
the Company's balance sheet and the expense of the defined benefit plan was 7.0%
for the years ended December 31, 2003 and 2002 and 9.0% in 2001. The utilized
rates of return were developed through, among other things, analysis of
historical market returns for the plans' investment classes and current market
conditions.
82
Net periodic benefit cost consisted of the following:
Dollars in Thousands 2003 2002 2001
-------------------- ---- ---- ----
Components of Net Periodic Benefit Cost:
Service cost $ 1,768 $ 1,446 $ 1,285
Interest cost 1,967 1,397 1,206
Expected return on plan assets (1,193) (1,372) (1,309)
Amortization of transition asset (44) (53) (53)
Amortization of prior service cost 545 33 37
Curtailment loss 5,454 - -
Recognized net actuarial loss 588 356 141
--------- --------- ---------
Net periodic benefit cost $ 9,085 $ 1,807 $ 1,307
========= ========= =========
The accumulated benefit obligation for these plans was $31.4 million at December
31, 2003 and $25.1 million at December 31, 2002. Certain information for these
plans with accumulated benefit obligations in excess of plan assets follows:
DECEMBER 31,
Dollars in Thousands 2003 2002
-------------------- ---- ----
Projected benefit obligation $ 31,501 $ 29,065
Accumulated benefit obligation 31,417 25,119
Fair value of plan assets 22,246 15,665
Weighted-average assumptions used
to determine benefit obligations at
December 31,
2003 2002
---- ----
Discount Rate 6.0% 6.5%
Rate of compensation increase 5.0% 5.0%
Weighted-average assumptions used
to determine net periodic benefit cost
for years ended December 31,
Discount Rate 6.5% 6.5%
Rate of compensation increase 5.0% 5.0%
The Company expects to contribute $3.0 million to its pension plan in 2004.
Expected benefit payments, which reflect expected future service cost through
March 31, 2004, are expected to be paid as follows:
PENSION
Dollars in Thousands BENEFITS
-------------------- --------
2004 $ 747
2005 860
2006 963
2007 1,089
2008 1,166
Years 2009-2013 7,089
83
The Ionics Section 401(k) Stock Savings Plan is available to substantially all
U.S. employees of the Company. Employees may contribute from 1% to 12% of
compensation subject to certain limits. The Company matches 50% of employee
contributions allocated to the Company's common stock up to 6% of their salary.
The Company recognized expense of $0.6 million, $0.7 million and $0.7 million in
2003, 2002 and 2001, respectively, under this plan.
The Company generally does not provide post-retirement health care benefits to
its employees or any other post-retirement benefits other than those described.
However, in connection with the retirement of Arthur L. Goldstein, Chief
Executive Officer until July 1, 2003, Mr. Goldstein and his wife were granted
lifetime medical and dental benefits (at the same level he had as a Company
employee) following his retirement at December 31, 2003. In addition, the Board
of Directors in February 2002 authorized the establishment of a Medicare
Supplemental Plan for corporate officers who retire from service with the
Company at age 65 or older after at least 20 years of employment.
NOTE 16. FINANCIAL INSTRUMENTS
Foreign Exchange Contracts
During 2003 and 2002, the Company entered into a series of U.S. dollar/euro
forward contracts with the intent of offsetting the foreign exchange risk
associated with forecasted cash flows related to an ongoing project. The fair
market value of the contracts are recorded in either the current assets or
current liabilities section of the Consolidated Balance Sheets. End of period
changes in the market value of the contracts are recorded as a component of
other comprehensive income (loss) in the "Stockholders' Equity" section of the
Consolidated Balance Sheets.
At December 31, 2003, the Company also held a foreign exchange contract to hedge
the balance sheet exposure related to an intercompany loan. The fair market
value of the contract, which was immaterial, is included in the "Other current
assets" section of the Consolidated Balance Sheets. The end of period change in
the fair market value of the contract which was immaterial, was recorded in
income in "Selling, general and administrative" expenses.
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash equivalents,
investments, trade accounts receivable and notes receivable. The credit risk of
cash equivalents and investments is low as the funds are primarily invested in
money market investments and in Spanish Government securities. The Company's
concentrations of credit risk with respect to trade accounts receivable and
notes receivable is considered low. The Company's customer base is spread across
many different industries and geographies, and the Company obtains guarantees or
letters of credit for many of its foreign orders.
Fair Value of Financial Instruments
The carrying amounts of cash equivalents, investments, accounts payable and
accrued expenses closely approximate their fair values as these items have
relatively short maturities and are highly liquid. Based on market information,
the carrying amounts of notes receivable and debt approximate their fair values.
Investments in Marketable Securities
Realized gains and losses from the sale of debt and equity securities during
fiscal 2003 and 2002 were not significant.
Long-term investments, maturing in 2004 and 2005, which the Company intends to
hold to maturity have been recorded at a net cost of $1.9 million and $1.5
million at December 31, 2003 and 2002, respectively. At December 31, 2002, the
Company also had short-term investments of $1.0 million which the Company held
to maturity. The Company had no short-term investments at December 31, 2003. The
cost of these investments approximates fair value.
NOTE 17. ACQUISITIONS AND DIVESTITURES
Acquisitions
In the third quarter of 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. 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 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,
84
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 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.
Divestitures
In May 2002, the Company completed its planned divestiture of its 55% equity
interest in a Malaysian affiliate, which had previously been treated as "held
for sale" and included in "Other small current assets" at December 31, 2001.
Included in the Company's first half results were revenues of $4.2 million and a
$0.4 million pre-tax loss resulting from Malaysian operations. For the second
quarter of 2002, revenues totaled $1.6 million and pre-tax profit amounted to
$0.2 million, including a gain of approximately $0.7 million on the same of the
Company's equity interest in the Malaysian subsidiary, which is included in
"Selling, general and administrative" expenses.
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.
NOTE 18. SEGMENT INFORMATION
In 1998, the Company adopted SFAS 131, "Disclosures about Segments of an
Enterprise and Related Information." Since 1998, the Company has been reporting
four "business group" segments corresponding to a "business group" structure put
into place in the latter part of 1998. These segments are summarized as follows:
Equipment Business Group - The EBG engages in the following activities:
- Manufacture and sale of water purification and treatment
equipment and processes from components to turnkey plants,
including:
- Membrane-based equipment for seawater or brackish water
desalination;
- Membrane-based equipment for surface water treatment;
- Equipment for wastewater treatment, including membrane-based
equipment; brine concentrators, crystallizers and evaporators
(zero liquid discharge (ZLD) equipment); and traditional
wastewater treatment equipment.
85
- Supply of water for drinking and industrial use through
ownership and/or operation of desalination or other water
treatment facilities.
- Fabrication of specialty metal components for industrial and
defense-related applications.
- Provision of food processing services through oversight for
customers of whey-processing activities using the Company's
membrane-based systems.
Ultrapure Water Group - The UWG engages in the following activities:
- Manufacture and sale of equipment, from components to turnkey
systems, utilizing various membrane-based and other
technologies for the production of ultrapure (very highly
purified) water to customers in various industries including
microelectronics, pharmaceuticals and power generation.
- Production and sale of ultrapure and high quality process
water through ownership and/or operation of ultrapure water
facilities.
- Production of sodium hypochlorite and related chlor-alkali
chemicals for industrial, municipal, commercial and other
non-consumer applications (prior to 2002, this activity was
part of EBG).
- Leasing of trailer-based ultrapure water equipment (prior to
2002, this activity was part of the EBG).
- Regeneration of ion-exchange resin for industrial customers.
Consumer Water Group - Until December 31, 2001, the largest business group
within the CWG was the Company's Aqua Cool Pure Bottled Water division, which
engaged in the U.S., U.K. and France in the production of purified drinking
water and water deliveries in five-gallon bottles to homes and offices. This
business was sold on December 31, 2001 to subsidiaries of Perrier-Vittel, S.A.
The Company retains equity ownership interests in certain joint ventures in the
bottled water business in Saudi Arabia, Kuwait and Bahrain. The CWG continues to
engage in the following activities:
- Manufacture and sale of "point-of-entry" home water treatment
equipment, including ion-exchange water conditioners to
"soften" hard water and bacteriostatic treatment equipment,
and related chemicals and media for filtration and treatment.
- Manufacture and sale of "point-of-use" over- and
under-the-sink water purifiers.
- Sale and lease of "point-of-use" bottleless drinking water
coolers.
- Provision of consumer finance services in connection with the
sale of home water treatment equipment.
Instrument Business Group - The IBG engages in the following activities:
- Manufacture and sale of laboratory and on-line instruments for
the measurement of impurities in water ranging in quality from
ultrapure process water to wastewater, including:
- Total organic carbon (TOC) analyzers;
- On-line boron analyzers;
- Instruments for the measurement of other water-borne
contaminants, including total carbon, sulfur, nitric oxide,
and total oxygen demand, and;
- Instruments for the detection of thin layers of oil on water.
86
Geographic Areas
Revenues are reflected in the country from which the sales are made. Long-lived
assets include all long-term assets except for notes receivable. No foreign
country's revenues from sales to unaffiliated customers or long-lived assets
were material.
Included in the United States segment are export sales of approximately 12%, 11%
and 19% for 2003, 2002 and 2001, respectively. Including these U.S. export
sales, the percentages of total revenues attributable to activities outside the
U.S. were 48%, 40% and 44% in 2003, 2002 and 2001, respectively.
Information about the Company's operations by geographic area follows:
UNITED
DOLLARS IN THOUSANDS STATES INTERNATIONAL TOTAL
-------------------- ------ ------------- -----
2003
Revenue - unaffiliated customers $ 209,575 $ 88,091 $ 297,666
Revenue - affiliated companies 6,663 43,078 49,741
---------- ---------- ----------
Total revenue 216,238 131,169 347,407
Long-lived assets 172,946 53,890 226,836
---------- ---------- ----------
2002
Revenue - unaffiliated customers $ 191,435 $ 115,281 $ 306,716
Revenue - affiliated companies 6,263 5,905 12,168
---------- ---------- ----------
Total Revenue 197,698 121,186 318,884
Long-lived assets 141,988 83,783 225,771
---------- ---------- ----------
2001
Revenue - unaffiliated customers $ 281,117 $ 145,713 $ 426,830
Revenue - affiliated companies 20,826 393 21,219
---------- ---------- ----------
Total Revenue 301,943 146,106 448,049
Long-lived assets 132,445 85,514 217,959
---------- ---------- ----------
The Company's Italian subsidiary accounted for approximately 17% of the
Company's total revenues in 2003. No single country outside the United States
contributed more than 10% in 2002 or 2001 of the Company's total revenues.
Additional information about the Company's business segments is set forth in the
following table:
87
Equipment Ultrapure Consumer Instrument
Business Water Water Business
Dollars in Thousands Group Group Group Group Corporate Total
-------------------- ---------- ---------- ---------- ---------- ---------- ----------
2003
Revenue - unaffiliated customers $ 144,043 $ 102,600 $ 21,216 $ 29,807 $ - $ 297,666
Revenue - affiliated companies 49,408 - 150 183 - 49,741
Inter-segment transfers 6,867 1,309 73 2,539 (10,988) -
Gross profit - unaffiliated 30,264 22,441 11,338 17,490 - 81,533
Gross profit - affiliated 5,935 - 75 92 - 6,102
Restructuring and impairment of long-lived assets 3,049 1,280 2,724 - - 7,053
Impairments of goodwill 8,981 3,750 - - - 12,731
Equity (loss) income (3,704) - 807 - (4,267) (7,164)
(Loss) earnings before interest, tax, minority
interest, and gain on sale (18,206) (8,351) (3,788) 3,955 (20,126) (46,516)
Interest income - - - - - 3,091
Interest expense - - - - - (908)
Loss before income taxes, minority interest
and gain on sale - - - - - (44,333)
Identifiable assets 353,906 127,824 99,412 35,568 (39,095) 577,615
Investments in affiliated companies 11,573 - 2,789 - - 14,362
Goodwill 2,992 3,841 862 - - 7,695
Other intangible assets 557 803 4,765 298 - 6,423
Depreciation and amortization 9,882 13,799 778 1,008 328 25,795
Capital expenditures 7,463 12,907 153 572 2,334 23,429
========== ========== ========== ========== ========== ==========
2002
Revenue - unaffiliated customers $ 154,378 $ 102,407 $ 22,190 $ 27,741 $ - $ 306,716
Revenue - affiliated companies 11,695 - 74 399 - 12,168
Inter-segment transfers 2,521 2,743 - 1,568 (6,832) -
Gross profit - unaffiliated 40,127 23,984 12,301 16,022 - 92,434
Gross profit - affiliated 967 - 37 199 - 1,203
Equity income (loss) 2,638 7 953 - (155) 3,443
Earnings (loss) before interest, tax, minority
interest, and gain on sale 4,731 (2,171) (3,096) 3,920 (1,844) 1,540
Interest income - - - - - 3,411
Interest expense - - - - - (1,172)
Income before income taxes, minority interest
and gain on sale - - - - - 3,779
Identifiable assets 297,948 139,383 106,328 30,729 11,007 585,395
Investments in affiliated companies 15,865 - 2,333 - - 18,198
Goodwill 11,623 7,633 862 - - 20,118
Other intangible assets 1,009 740 - 279 - 2,028
Depreciation and amortization 8,843 12,132 333 971 295 22,574
Capital expenditures 13,382 17,250 578 1,037 492 32,739
========== ========== ========== ========== ========== ==========
2001
Revenue - unaffiliated customers $ 161,565 $ 133,605 $ 105,065 $ 26,595 $ - $ 426,830
Revenue - affiliated companies 20,571 - 203 445 - 21,219
Inter-segment transfers 2,521 2,743 - 1,568 (6,832) -
Gross profit - unaffiliated 34,808 26,457 48,094 13,839 - 123,198
Gross profit - affiliated 217 - 102 223 - 542
Impairment of long-lived assets - 1,300 - - - 1,300
Impairments of goodwill - 9,222 - 1,794 - 11,016
Equity income (loss) 1,441 68 (57) - (56) 1,396
Earnings (loss) before interest, tax, minority
interest, and gain on sale 4,161 (5,490) (1,707) 942 (10,525) (12,619)
Interest income - - - - - 1,013
Interest expense - - - - - (5,166)
Loss before income taxes, minority interest
and gain on sale - - - - - (16,772)
Identifiable assets 292,409 126,943 49,453 25,641 118,433 612,879
Investments in affiliated companies 17,619 - 2,815 - - 20,434
Goodwill 11,360 7,054 541 - - 18,955
Other intangible assets 823 23 - 305 - 1,151
Depreciation and amortization 8,510 12,567 12,562 997 285 34,921
Capital expenditures 9,612 16,135 11,642 1,015 751 39,155
========== ========== ========== ========== ========== ==========
88
Segment Realignment
During the first quarter of 2004, the Company will realign its business
structure and begin reporting new business segments. This segment realignment
will combine most of its existing Equipment Business Group and Ultrapure Water
Group into a new reporting group called Water Systems. The Instrument Business
Group will continue with its existing activities and will also combine global
instrument sales by all business units. The Consumer Water Group will continue
to remain a reporting group as previously constituted. A Corporate Group will
also be utilized to capture all corporate overhead not specifically assignable
to the other business groups.
Water Systems will be comprised of two operating segments, Equipment Sales and
Operations. Most of the existing Equipment Business Group and Ultrapure Water
Group will be combined within Water Systems, as will the Ecolochem Group. (See
Note 20).
The Consumer Water Group operations will remain unchanged, except to the extent
that operations have been discontinued or shutdowns within the Group have
occurred.
The Instrument Business Group operations will remain unchanged except that the
Group will be credited with instrument sales activity previously reported by the
Equipment Business Group and Ultrapure Water Group.
The Corporate Group will be utilized as a new reporting group and is expected to
comprise all corporate overhead not specifically attributable to an identified
reporting group.
NOTE. 19. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
(Loss) (Loss)
Earnings Earnings
from from
(Loss) Continuing Continuing
Income Operations Operations
Dollars in Thousands from Per Per
Except Per Gross Continuing Basic Diluted
Share Amounts Revenues Profit Operations Share Share
-------------------- -------- -------- -------- ---------- ----------
2003
First Quarter $ 82,590 $ 24,771 $ 953 $ 0.05 $ 0.05
Second Quarter 85,920 23,197 (1,909) (0.11) (0.11)
Third Quarter 89,861 17,106 (17,551) (0.99) (0.99)
Fourth Quarter 89,036 22,561 (14,761) (0.83) (0.83)
-------- -------- -------- -------- --------
$347,407 $ 87,635 $(33,268) $ (1.88) $ (1.88)
======== ======== ======== ======== ========
Earnings Earnings
from from
Continuing Continuing
Income Operations Operations
Dollars in Thousands from Per Per
Except Per Gross Continuing Basic Diluted
Share Amounts Revenues Profit Operations Share Share
-------------------- -------- -------- -------- ---------- ----------
2002
First Quarter $ 75,900 $ 22,423 $ 1,813 $ 0.10 $ 0.10
Second Quarter 76,173 24,119 1,528 0.09 0.09
Third Quarter 82,742 22,303 300 0.02 0.02
Fourth Quarter 84,069 24,792 1,863 0.10 0.10
-------- -------- -------- -------- --------
$318,884 $ 93,637 $ 5,504 $ 0.31 $ 0.31
======== ======== ======== ======== ========
NOTE 20. SUBSEQUENT EVENT
On February 13, 2004, the Company acquired all of the outstanding shares of
capital stock and ownership interest of Ecolochem, Inc. and its affiliated
companies ("Ecolochem Group"). The Ecolochem Group, privately held companies
headquartered in Norfolk, Virginia, constitutes a leading provider of emergency,
short and long-term mobile water treatment services to the power, petrochemical
and other industries.
The aggregate purchase price was $361.9 million, consisting of $222.0 million in
cash, which includes $12.8 million to be paid (in the event the Company makes a
Section 338(h)(10) election with respect to the acquired assets of the Ecolochem
Group), and 4.65 million shares of common stock valued at $139.9 million. The
cash portion of the purchase price consideration was financed with the Company's
available cash resources and proceeds from new $255 million senior
collateralized credit facilities.
89
The following table summarizes the preliminary estimated fair values of the
assets acquired and liabilities assumed at the date of acquisition. The Company
is in the process of finalizing the valuation of certain tangible and intangible
assets and, accordingly, the allocation of the purchase price is subject to
adjustment.
Current assets $ 42.7
Property, plant and equipment 100.9
Intangible assets 73.0
Goodwill 182.9
Other assets 6.0
--------
Total assets acquired $ 405.5
--------
Current liabilities $ 12.1
Other liabilities 18.5
--------
Total liabilities assumed 30.6
--------
Total purchase price including acquisition costs $ 374.9
========
Of the $73.0 million of acquired intangible assets, the following table reflects
the allocation of the acquired intangible assets and related estimates of useful
lives:
Contractual relationships $ 56.7 12-year estimated economic consumption life
Technology and know-how 11.5 10-year estimated useful life
Non-compete agreements 0.7 3-year estimated useful life
Trade names and trademarks 2.4 9-year estimated useful life
Discharge permits 1.7 Indefinite life
-------
$ 73.0
=======
90
IONICS, INCORPORATED
SCHEDULE - VALUATION AND QUALIFYING ACCOUNTS
Additions Additions
Balance at charged to due to
end of costs and acquired Balance at
prior year expenses businesses Deductions(a) end of year
----------- ----------- ---------- ------------- -----------
Allowance for doubtful
accounts receivable and
notes receivable:
Years ended:
December 31, 2003 $ 6,785,000 $ 5,302,000 $ 185,000 $ 2,013,000 $10,259,000
=========== =========== ========== ============= ===========
December 31, 2002 $ 4,769,000 $ 4,641,000 $ - $ 2,625,000 $ 6,785,000
=========== =========== ========== ============= ===========
December 31, 2001 $ 5,250,000 $ 4,632,000 $ - $ 5,113,000 $ 4,769,000
=========== =========== ========== ============= ===========
(a) Deductions result primarily from the write-off of accounts.
91
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There are no disagreements with the Company's accountants on accounting and
financial disclosure.
ITEM 9A. 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 December 31, 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
December 31, 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.
There were no changes in the Company's internal control over financial reporting
during the fourth quarter ended December 31, 2003 that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting. The Company has undertaken a review of its internal
control over financial reporting to ensure that it will meet the requirements of
Section 404 of the Sarbanes-Oxley Act of 2002. In connection with this review,
the Company has made and will continue to make changes that enhance the
effectiveness of its internal controls.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information referenced by this item with respect to directors is hereby
incorporated by reference from the Company's definitive Proxy Statement for the
2004 Annual Meeting under the caption "Explanation of Agenda for the Meeting -
Proposal 1. Election of Directors." Information about compliance with Section
16(a) of the Securities Exchange Act of 1934 is incorporated by reference from
the Company's definitive Proxy Statement for the 2004 Annual Meeting under the
caption "Section 16(a) Beneficial Ownership Reporting Compliance." The balance
of the response to this item is contained in the discussion entitled "Executive
Officers of the Registrant" in Part I, Item 1 of this Annual Report on Form
10-K.
The Company has adopted a Code of Ethics that applies to all its employees,
including its Chief Executive Officer, Chief Financial Officer and Corporate
Controller. The Board of Directors ratified and adopted the Code of Ethics of
March 11, 2004. The Code of Ethics is attached hereto as Exhibit 14.0 and is
available on our website at www.ionics.com under the "About Ionics -Governance"
section. The Company will promptly disclose any substantive amendments to its
Code of Ethics as well as all waivers granted to directors or executive
officers. Such disclosures will be made on our website at www.ionics.com under
the "About Ionics -Governance" section as prescribed by the Securities and
Exchange Commission.
The remainder of the responses to this item are contained in the discussion
entitled "Executive Officers of the Registrant" in Part I, Item 1 of this Annual
Report on Form 10-K.
ITEM 11. EXECUTIVE COMPENSATION
The information referenced by this item is incorporated by reference from the
Company's definitive Proxy Statement for the 2004 Annual Meeting under the
caption "Executive Compensation and Other Information."
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information referenced by this item is incorporated by reference from the
Company's definitive Proxy Statement for the 2004 Annual Meeting under the
captions "Equity Compensation Plan Information" and "Security Ownership of
Certain Beneficial Owners and Management."
92
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information referenced by this item is incorporated by reference from the
Company's definitive Proxy Statement for the 2004 Annual Meeting under Footnote
3 to the "Summary Compensation Table," and under the captions "Certain
Relationships and Related Transactions," "Executive Compensation and Other
Information" and "Compensation Committee Interlocks and Insider Participation."
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information referenced by this item is incorporated by reference from the
Company's definitive Proxy Statement for the 2004 Annual Meeting under the
caption "Independent Auditors' Fees and Services."
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
See Index to Financial Statements and Financial Statement Schedule
included in Item 8.
2. Financial Statement Schedule
See Index to Financial Statements and Financial Statement Schedule
included in Item 8. All other Financial Statement Schedules have been
omitted because they are either not applicable or the required
information is included in the Consolidated Financial Statements or
notes thereto.
3. Exhibits
EXHIBIT NO. DESCRIPTION
----------- -----------
3.0 Articles of Organization and By-Laws
3.1 Restated Articles of Organization filed April 16, 1986 (filed as
Exhibit 3.1 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997). *
3.1(a) Amendment to Restated Articles of Organization filed June 19, 1987
(filed as Exhibit 3.1(a) to the Company's Annual Report on Form
10-K for the year ended December 31, 1997). *
3.1(b) Amendment to Restated Articles of Organization filed May 13, 1988
(filed as Exhibit 3.1(b) to Registration Statement No. 33-38290 on
Form S-2 effective January 24, 1991). *
3.1(c) Amendment to Restated Articles of Organization filed May 8, 1992
(filed as Exhibit 3.1 to the Company's Quarterly Report on Form
10-Q for the quarterly period ending June 30, 1996). *
3.1(d) Amendment to Restated Articles of Organization filed May 8, 1998
(filed as Exhibit 3.1(a) to the Company's Quarterly Report on Form
10-Q for the quarterly period ending March 31, 1998). *
3.1(e) Amendment to Restated Articles of Organization filed February 13,
2004. +
93
3.2 By-Laws, as amended through February 13, 2004. +
4.0 Instruments defining the rights of security holders, including indentures
4.1 Renewed Rights Agreement dated as of August 19, 1997 between the
Company and Equiserve Trust Company as successor Rights Agent
(filed as Exhibit 1 to the Company's Current Report on Form 8-K
dated August 27, 1997). *
4.2 Amendment No. 1 dated as of November 17, 2003 to the Renewed
Rights Agreement dated August 19, 1997 between the Company and
Equiserve Trust Company as Rights Agent (filed as Exhibit 4.1 to
the Company's Current Report on Form 8-K filed November 26, 2003). *
4.3 Form of Common Stock Certificate (filed as Exhibit 4.2 to the
Company's Annual Report on Form 10-K for the year ended December
31, 1997). *
10.0 Material Contracts
10.1 1979 Stock Option Plan, as amended through March 27, 2003 (filed
as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2003). *
10.2 1986 Stock Option Plan for Non-Employee Directors, as amended
through February 26, 2002 (filed as Exhibit 10.2 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001). *
10.3 Amended and Restated 1997 Stock Incentive Plan, as amended through
March 11, 2004. +
10.4 Ionics, Incorporated Supplemental Executive Retirement Plan
effective as of January 1, 1996 (filed as Exhibit 10.10 to the
Company's Annual Report on Form 10-K dated December 31, 1997). *
10.5 First Amendment to Ionics, Incorporated Supplemental Executive
Retirement Plan, effective April 1, 2003 (filed as Exhibit 10.3 to
the Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2003). *
10.6 1994 Restricted Stock Plan (filed as Exhibit 10.12 to the
Company's Annual Report on Form 10-K dated March 30, 1995). *
10.7 1998 Non-Employee Directors Fee Plan (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly period
ending September 30, 1998). *
10.8 Ionics, Incorporated 2003 Non-Employee Directors Stock Option Plan
(filed as Exhibit 10.5 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2003). *
94
10.9 Form of Stock Option Agreement issued pursuant to the Ionics,
Incorporated 2003 Non-Employee Directors Stock Option Plan (filed
as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2003). *
10.10 Form of Employee Retention Agreement dated February 24, 1998
between the Company and certain officers of the Company and its
subsidiaries (filed as Exhibit 10.9 to the Company's Annual Report
on Form 10-K dated December 31, 1997). *
10.11 Master Agreement dated as of November 30, 2001 by and between the
Company and The Perrier Group of America, Inc. (filed as Exhibit
2.1 to the Company's Current Report on Form 8-K dated January 15,
2002). *
10.12 Second Amendment and Waiver to Third Amended and Restated
Revolving Credit Agreement dated as of March 28, 2002 between the
Company and Fleet National Bank (filed as Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the year ended December
31, 2001). *
10.13 Third Amendment and Waiver to Third Amended and Restated Revolving
Credit Agreement between the Company and Fleet National Bank dated
as of April 14, 2003 (filed as Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31,
2003). *
10.14 Shareholders' Agreement dated as of May 12, 2000, by and among the
Company, Hafeez Karamath Engineering Services Limited, and
Desalination Company of Trinidad and Tobago Ltd., as amended on
June 16, 2000 (filed as Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 2000). *
10.15 Loan Agreement dated as of October 25, 2000 between the Company
and Hafeez Karamath Engineering Services Limited (filed as Exhibit
10.13 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000). *
10.16 Loan Agreement dated as of July 31, 2003 between Desalination
Company of Trinidad and Tobago Ltd., and Ionics Ventures Ltd.
(filed as Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2003). *
10.17 Shareholders' Agreement dated April 3, 2001 between the Company
and Mohammed Abdulmohsin Al-Kharafi & Sons (filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2001). *
10.18 Employment Agreement dated as of April 1, 2003 between the Company
and Douglas R. Brown (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2003). *
95
10.19 Inducement Non-Qualified Stock Option Agreement dated as of April
1, 2003 between the Company and Douglas R. Brown (filed as Exhibit
4.3 to Registration Statement No. 333-107473 on Form S-8 effective
July 30, 2003). *
10.20 Employment Agreement dated as of August 28, 2003 between the
Company and John F. Curtis (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2003). *
10.21 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. 333-10894 on Form S-8 effective
September 18, 2003). *
10.22 Purchase Agreement for the acquisition of Ecolochem, Inc., and its
related companies between the Company and the individuals and
entities listed on Exhibit A thereto dated as of November 18, 2003
(filed as Exhibit 2.1 to the Company's Current Report on Form 8-K
filed on February 27, 2004). *
10.23 Amendment No. 1 dated as of February 13, 2004 to the Purchase
Agreement between the Company and the individuals and entities
listed on Exhibit A thereto dated as of November 18, 2003 (filed
as Exhibit 2.3 to the Company's Current Report on Form 8-K filed
on February 27, 2004). *
10.24 Stockholders Agreement dated as of February 13, 2004 among the
Company and the individuals and entities listed on Exhibit A
thereto (filed as Exhibit 2.2 to the Company's Current Report on
Form 8-K filed on February 27, 2004). *
10.25 Escrow Agreement among the Company, the entities and persons
listed on Annex A thereto, Lyman B. Dickerson and Douglas G.
Dickerson (as Sellers' Representatives) and Citibank, N.A. (as
escrow agent) dated as of February 13, 2004 (filed as Exhibit 2.4
to the Company's Current Report on Form 8-K filed on February 27,
2004). *
10.26 Section 338 Escrow Agreement among the Company, the entities and
persons listed on Annex A thereto, Lyman B. Dickerson and Douglas
G. Dickerson (as Sellers' Representatives) and Citibank, N.A. (as
escrow agent) dated as of February 13, 2004 (filed as Exhibit 2.5
to the Company's Current Report on Form 8-K filed on February 27,
2004). *
10.27 Employment Agreement between the Company and Lyman B. Dickerson
dated as of February 13, 2004 (filed as Exhibit 2.6 to the
Company's Current Report on Form 8-K filed on February 27, 2004). *
96
10.28 Credit Agreement dated as of February 13, 2004 by and among the
Company as borrower; certain of its domestic subsidiaries as
guarantors, UBS Securities LLC as Lead Arranger, Sole Bookmanager
and Documentation Agent; Fleet Securities, Inc. and Bank of
America, N.A. as Syndication Agents; Wachovia Bank, N.A. and
General Electric Capital Corporation as Co-Documentation Agents;
UBS A.G., Stamford Branch as Administrative Agent and Collateral
Agent; UBS Loan Finance LLC as Swingline Lender; HSBC Bank USA as
Issuing Bank; and the lender parties thereto. +
10.29 Security Agreement between the Company as Borrower; certain of its
domestic subsidiaries as Guarantors; and UBS A.G., Stamford Branch
as Collateral Agent. +
14.0 Code of Ethics +
21.0 List of Subsidiaries. +
23.0 Consent of PricewaterhouseCoopers LLP. +
24.0 Power of Attorney. +
31.0(i) Certification of Principal Executive Officer required by Rule 13a-14(a) or
Rule 15d-14(a) of the Exchange Act. +
31.0(ii) Certification of Principal Financial Officer required by Rule 13a-14(a) or
Rule 15d-14(a) of the Exchange Act. +
32.0(i) Certification of Principal Executive Officer pursuant to 18 U.S.C. Section
1350. +
32.0(ii) Certification of the Principal Financial Officer pursuant to 18 U.S.C. Section
1350. +
-------------------------------
*Incorporated herein by reference.
+Filed herewith.
(b) Reports on Form 8-K
The Company filed five (5) reports with the Securities and Exchange
Commission (Commission) during the three-month period ended December
31, 2003, as follows:
(i) Filed October 7, 2003, reported under Item 7 and Item 9 the
issuance of a press release by the Company reporting
information about its business strategy, a restructuring
program previously announced on September 3, 2003, and its
2004 financial forecast. The press release was filed as an
exhibit.
(ii) Filed November 4, 2003, furnishing (not filing) under Item 7
and Item 12 the issuance of a press release by the Company
reporting its financial results for the third quarter ended
September 30, 2003 and the first nine months of 2003. The
press release was attached as an exhibit.
(iii) Filed November 19, 2003, reporting under Item 5 the issuance
of a press release by the Company announcing the signing of a
definitive agreement to acquire Ecolochem, Inc. and its
affiliated companies. The press release was filed as an
exhibit.
(iv) Filed November 26, 2003 reporting under Item 5 and Item 7 a
description of the Purchase Agreement entered into by the
Company with the shareholders and members of Ecolochem, Inc.
and its affiliated companies
97
("Ecolochem Group") to acquire the Ecolochem Group, and an
amendment to the Company's Renewed Rights Agreement dated as
of August 19, 1997. The Purchase Agreement and Amendment No. 1
to the Company's Renewed Rights Agreement were filed as
exhibits.
(v) Filed December 24, 2003, reporting under Item 5 that the
Company, in connection with the anticipated filing of a proxy
statement in connection with the acquisition of the Ecolochem
Group, was updating certain information that the Company had
previously reported in its Annual Report on Form 10-K for the
year ended December 31, 2002, to reflect the impact of the
classification of the consumer chemical business operations as
discontinued operations pursuant to SFAS 144. The Company
filed selected consolidated financial data for the five years
ended December 31, 2002, audited consolidated financial
statements of the Company and its consolidated subsidiaries as
of December 31, 2002 and 2001 and for each of the three years
in the period ended December 31, 2002, and certain disclosures
regarding the Company's results of operations and financial
condition as of and for the periods reflected in such audited
financial statements as Exhibits 99.1, 99.3 and 99.2,
respectively.
Copies of Exhibits described in Item 15 filed with the Securities and
Exchange Commission (SEC) are available from the website maintained by
the SEC at www.sec.gov. Copies are also available from the Company upon
payment of a copying charge plus postage. Requests should be directed
to Investor Relations, Ionics, Incorporated, 65 Grove Street,
Watertown, MA 02472.
98
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
IONICS, INCORPORATED
(Registrant)
By: /s/Douglas R. Brown
------------------------------
Douglas R. Brown
President and Chief Executive
Officer
Date: March 15, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
Date: March 15, 2004 By: /s/Douglas R. Brown
-------------------
Douglas R. Brown
President and Chief Executive
Officer
(principal executive officer)
Date: March 15, 2004 By: /s/Daniel M. Kuzmak
-------------------
Daniel M. Kuzmak
Vice President and Chief
Financial Officer
(principal financial officer)
Date: March 15, 2004 By: /s/Anthony Di Paola
-------------------
Anthony Di Paola
Vice President and Corporate
Controller
(principal accounting officer)
99
Date: March 15, 2004 By: /s/Douglas R. Brown
--------------------------
Douglas R. Brown, Director
Date: March 15, 2004 By: /s/Stephen L. Brown
--------------------------
Stephen L. Brown, Director
Date: March 15, 2004 By: /s/Lyman B. Dickerson
--------------------------
Lyman B. Dickerson, Director
Date: March 15, 2004 By: /s/Kathleen F. Feldstein
--------------------------
Kathleen F. Feldstein,
Director
Date: March 15, 2004 By: /s/Arthur L. Goldstein
--------------------------
Arthur L. Goldstein,
Director, and Chairman of the
Board
Date: March 15, 2004 By: /s/William K. Reilly
--------------------------
William K. Reilly, Director
Date: March 15, 2004 By: /s/John J. Shields
--------------------------
John J. Shields, Director
Date: March 15, 2004 By: /s/Frederick T. Stant, III
--------------------------
Frederick T. Stant, III,
Director
Date: By:
_____________________________
Robert H. Temkin
Date: March 15, 2004 By: /s/Daniel I. C. Wang
--------------------------
Daniel I. C. Wang, Director
Date: March 15, 2004 By: /s/Mark S. Wrighton
--------------------------
Mark S. Wrighton, Director
Date: March 15, 2004 By: /s/Allen S. Wyett
--------------------------
Allen S. Wyett, Director
100
EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION
----------- -----------
3.0 Articles of Organization and By-Laws
3.1 Restated Articles of Organization filed April 16, 1986 (filed as
Exhibit 3.1 to the Company's Annual Report on Form 10-K for the
year ended December 31, 1997). *
3.1(a) Amendment to Restated Articles of Organization filed June 19, 1987
(filed as Exhibit 3.1(a) to the Company's Annual Report on Form
10-K for the year ended December 31, 1997). *
3.1(b) Amendment to Restated Articles of Organization filed May 13, 1988
(filed as Exhibit 3.1(b) to Registration Statement No. 33-38290 on
Form S-2 effective January 24, 1991). *
3.1(c) Amendment to Restated Articles of Organization filed May 8, 1992
(filed as Exhibit 3.1 to the Company's Quarterly Report on Form
10-Q for the quarterly period ending June 30, 1996). *
3.1(d) Amendment to Restated Articles of Organization filed May 8, 1998
(filed as Exhibit 3.1(a) to the Company's Quarterly Report on Form
10-Q for the quarterly period ending March 31, 1998). *
3.1(e) Amendment to Restated Articles of Organization filed February 13,
2004. +
3.2 By-Laws, as amended through February 13, 2004. +
4.0 Instruments defining the rights of security holders, including indentures
4.1 Renewed Rights Agreement dated as of August 19, 1997 between the
Company and Equiserve Trust Company as successor Rights Agent
(filed as Exhibit 1 to the Company's Current Report on Form 8-K
dated August 27, 1997). *
4.2 Amendment No. 1 dated as of November 17, 2003 to the Renewed
Rights Agreement dated August 19, 1997 between the Company and
Equiserve Trust Company as Rights Agent (filed as Exhibit 4.1 to
the Company's Current Report on Form 8-K filed November 26, 2003). *
4.3 Form of Common Stock Certificate (filed as Exhibit 4.2 to the
Company's Annual Report on Form 10-K for the year ended December
31, 1997). *
10.0 Material Contracts
10.1 1979 Stock Option Plan, as amended through March 27, 2003 (filed
as Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2003). *
101
10.2 1986 Stock Option Plan for Non-Employee Directors, as amended
through February 26, 2002 (filed as Exhibit 10.2 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001). *
10.3 Amended and Restated 1997 Stock Incentive Plan, as amended through
March 11, 2004. +
10.4 Ionics, Incorporated Supplemental Executive Retirement Plan
effective as of January 1, 1996 (filed as Exhibit 10.10 to the
Company's Annual Report on Form 10-K dated December 31, 1997). *
10.5 First Amendment to Ionics, Incorporated Supplemental Executive
Retirement Plan, effective April 1, 2003 (filed as Exhibit 10.3 to
the Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2003). *
10.6 1994 Restricted Stock Plan (filed as Exhibit 10.12 to the
Company's Annual Report on Form 10-K dated March 30, 1995). *
10.7 1998 Non-Employee Directors Fee Plan (filed as Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the quarterly period
ending September 30, 1998). *
10.8 Ionics, Incorporated 2003 Non-Employee Directors Stock Option Plan
(filed as Exhibit 10.5 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2003). *
10.9 Form of Stock Option Agreement issued pursuant to the Ionics,
Incorporated 2003 Non-Employee Directors Stock Option Plan (filed
as Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2003). *
10.10 Form of Employee Retention Agreement dated February 24, 1998
between the Company and certain officers of the Company and its
subsidiaries (filed as Exhibit 10.9 to the Company's Annual Report
on Form 10-K dated December 31, 1997). *
10.11 Master Agreement dated as of November 30, 2001 by and between the
Company and The Perrier Group of America, Inc. (filed as Exhibit
2.1 to the Company's Current Report on Form 8-K dated January 15,
2002). *
10.12 Second Amendment and Waiver to Third Amended and Restated
Revolving Credit Agreement dated as of March 28, 2002 between the
Company and Fleet National Bank (filed as Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the year ended December
31, 2001). *
10.13 Third Amendment and Waiver to Third Amended and Restated Revolving
Credit Agreement between the Company and Fleet National Bank dated
as of April 14, 2003 (filed as Exhibit 10.4 to the Company's
Quarterly Report on Form 10-Q for the quarter ended March 31, *
2003).
102
10.14 Shareholders' Agreement dated as of May 12, 2000, by and among the
Company, Hafeez Karamath Engineering Services Limited, and
Desalination Company of Trinidad and Tobago Ltd., as amended on
June 16, 2000 (filed as Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the quarterly period ended June 30, 2000). *
10.15 Loan Agreement dated as of October 25, 2000 between the Company
and Hafeez Karamath Engineering Services Limited (filed as Exhibit
10.13 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2000). *
10.16 Loan Agreement dated as of July 31, 2003 between Desalination
Company of Trinidad and Tobago Ltd., and Ionics Ventures Ltd.
(filed as Exhibit 10.3 to the Company's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 2003). *
10.17 Shareholders' Agreement dated April 3, 2001 between the Company
and Mohammed Abdulmohsin Al-Kharafi & Sons (filed as Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2001). *
10.18 Employment Agreement dated as of April 1, 2003 between the Company
and Douglas R. Brown (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2003). *
10.19 Inducement Non-Qualified Stock Option Agreement dated as of April
1, 2003 between the Company and Douglas R. Brown (filed as Exhibit
4.3 to Registration Statement No. 333-107473 on Form S-8 effective
July 30, 2003). *
10.20 Employment Agreement dated as of August 28, 2003 between the
Company and John F. Curtis (filed as Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarterly period ended
September 30, 2003). *
10.21 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. 333-10894 on Form S-8 effective
September 18, 2003). *
10.22 Purchase Agreement for the acquisition of Ecolochem, Inc., and its
related companies between the Company and the individuals and
entities listed on Exhibit A thereto dated as of November 18, 2003
(filed as Exhibit 2.1 to the Company's Current Report on Form 8-K
filed on February 27, 2004). *
10.23 Amendment No. 1 dated as of February 13, 2004 to the Purchase
Agreement between the Company and the individuals and entities
listed on Exhibit A thereto dated as of November 18, 2003 (filed
as Exhibit 2.3 to the Company's Current Report on Form 8-K filed
on February 27, 2004). *
103
10.24 Stockholders Agreement dated as of *
February 13, 2004 among the Company
and the individuals and entities listed
on Exhibit A thereto (filed as Exhibit
2.2 to the Company's Current Report on
Form 8-K filed on February 27, 2004).
10.25 Escrow Agreement among the Company, the *
entities and persons listed on Annex A
thereto, Lyman B. Dickerson and Douglas
G. Dickerson (as Sellers'
Representatives) and Citibank, N.A. (as
escrow agent) dated as of February 13,
2004 (filed as Exhibit 2.4 to the
Company's Current Report on Form 8-K
filed on February 27, 2004).
10.26 Section 338 Escrow Agreement among the *
Company, the entities and persons
listed on Annex A thereto, Lyman B.
Dickerson and Douglas G. Dickerson (as
Sellers' Representatives) and Citibank,
N.A. (as escrow agent) dated as of
February 13, 2004 (filed as Exhibit 2.5
to the Company's Current Report on Form
8-K filed on February 27, 2004).
10.27 Employment Agreement between the Company *
and Lyman B. Dickerson dated as of
February 13, 2004 (filed as Exhibit 2.6
to the Company's Current Report on Form
8-K filed on February 27, 2004).
10.28 Credit Agreement dated as of February +
13, 2004 by and among the Company as
borrower; certain of its domestic
subsidiaries as guarantors, UBS
Securities LLC as Lead Arranger, Sole
Bookmanager and Documentation Agent;
Fleet Securities, Inc. and Bank of
America, N.A. as Syndication Agents;
Wachovia Bank, N.A. and General Electric
Capital Corporation as Co-Documentation
Agents; UBS A.G., Stamford Branch as
Administrative Agent and Collateral
Agent; UBS Loan Finance LLC as Swingline
Lender; HSBC Bank USA as Issuing Bank;
and the lender parties thereto.
10.29 Security Agreement between the Company +
as Borrower; certain of its domestic
subsidiaries as Guarantors; and UBS
A.G., Stamford Branch as Collateral
Agent.
14.0 Code of Ethics +
21.0 List of Subsidiaries. +
23.0 Consent of PricewaterhouseCoopers LLP. +
24.0 Power of Attorney. +
31.0(i) Certification of Principal Executive Officer required by +
Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.
31.0(ii) Certification of Principal Financial Officer required by +
Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act.
32.0(i) Certification of Principal Executive Officer pursuant to +
18 U.S.C. Section 1350.
104
32.0(ii) Certification of the Principal Financial Officer pursuant to 18 U.S.C. +
Section 1350.
-------------------------------
* Incorporated herein by reference.
+ Filed herewith.
105