UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 1-7211
IONICS, INCORPORATED
(Exact name of registrant as specified in its charter)
Massachusetts 04-2068530
(State or other jurisdiction of (IRS Employer Identification Number)
incorporation or organization)
65 Grove Street
Watertown, Massachusetts 02472-2882
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 926-2500
Former name, former address and former fiscal year,
if changed since last report: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
At April 30, 2004 the Company had 22,585,184 shares of Common Stock, par value
$1.00 per share, outstanding.
INDEX
Page
PART I - FINANCIAL INFORMATION
ITEM 1. Financial Statements 2
Consolidated Statements of Operations
Quarters Ended March 31, 2004 and 2003 2
Consolidated Balance Sheets
March 31, 2004 and December 31, 2003 3
Consolidated Statements of Cash Flows
Quarters Ended March 31, 2004 and 2003 4
Notes to Consolidated Financial Statements 5
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 19
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 32
ITEM 4. Controls and Procedures 33
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 34
ITEM 4. Submission of Matters to a Vote of Security Holders 34
ITEM 6. Exhibits and Reports on Form 8-K 36
SIGNATURES 39
EXHIBIT INDEX 40
-1-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
IONICS, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands, except per share amounts)
Quarter Ended
March 31,
----------------------
2004 2003
---------- ----------
Revenues:
Equipment Sales $ 33,430 $ 29,552
Operations 52,406 27,682
Consumer Water 5,721 5,200
Instruments 8,751 8,379
Affiliated companies 7,115 11,777
---------- ----------
107,423 82,590
---------- ----------
Costs and expenses:
Cost of sales of Equipment Sales 27,873 22,642
Cost of sales of Operations 34,548 19,133
Cost of sales of Consumer Water 2,405 2,238
Cost of sales of Instruments 4,006 3,589
Cost of sales to affiliated companies 6,110 10,217
Research and development 1,531 1,777
Selling, general and administrative 29,023 21,674
Restructuring charges 564 -
---------- ----------
106,060 81,270
---------- ----------
Income from continuing operations 1,363 1,320
Interest income 514 778
Interest expense (3,836) (222)
Equity income (loss) 490 (101)
---------- ----------
(Loss) income from continuing operations before
income taxes and minority interest expense (1,469) 1,775
Income tax benefit (expense) 470 (624)
---------- ----------
(Loss) income from continuing operations before
minority interest expense (999) 1,151
Minority interest expense 253 198
---------- ----------
(Loss) income from continuing operations (1,252) 953
Loss from discontinued operations, net of income tax (2,699) (377)
---------- ----------
Net (loss) income $ (3,951) $ 576
========== ==========
Basic (loss) earnings per share from continuing operations $ (0.06) $ 0.05
Basic (loss) earnings per share from discontinued operations (0.13) (0.02)
----------------------
Basic (loss) earnings per share $ (0.19) $ 0.03
======================
Diluted (loss) earnings per share from continuing operations $ (0.06) $ 0.05
Diluted (loss) earnings per share from discontinued operations (0.13) (0.02)
----------------------
Diluted (loss) earnings per share $ (0.19) $ 0.03
======================
Shares used in basic (loss) earnings per share calculations 20,322 17,555
========== ==========
Shares used in diluted (loss) earnings per share calculations 20,322 17,562
========== ==========
The accompanying notes are an integral part of these consolidated financial
statements.
-2-
IONICS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands, except share and par value amounts)
March 31, December 31,
2004 2003
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 68,002 $ 133,815
Restricted cash 18,730 -
Short-term investments 679 -
Notes receivable, current 7,810 6,365
Accounts receivable, net 106,071 87,415
Receivables from affiliated companies 13,787 22,140
Inventories:
Raw materials 19,457 15,269
Work in process 6,655 5,621
Finished goods 4,182 3,826
-------------- -------------
30,294 24,716
Deferred income taxes 15,008 13,585
Assets from discontinued operations 2,976 7,466
Other current assets 35,907 20,316
-------------- -------------
Total current assets 299,264 315,818
Receivables from affiliated companies, long-term 10,046 20,915
Notes receivable, long-term 28,700 28,408
Investments in affiliated companies 11,042 14,362
Property, plant and equipment:
Land 11,717 6,297
Buildings 65,283 43,070
Machinery and equipment 491,408 279,997
Other, including furniture, fixtures and vehicles 38,739 35,677
-------------- -------------
607,147 365,041
Less accumulated depreciation 207,736 193,256
-------------- -------------
399,411 171,785
Goodwill 183,435 7,695
Intangible assets, net 79,830 6,378
Deferred income taxes, long-term 24,005 21,305
Other assets 7,005 5,311
-------------- -------------
Total assets $ 1,042,738 $ 591,977
============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term debt $ 9,129 $ 6,276
Accounts payable 36,429 28,279
Billings in advance from affiliated companies - 3,629
Income taxes payable 33,395 32,840
Liabilities from discontinued operations 239 396
Other current liabilities 55,573 46,672
-------------- -------------
Total current liabilities 134,765 118,092
Long-term debt and notes payable 290,108 8,889
Deferred income taxes 34,360 30,979
Minority interest 14,926 1,426
Accumulated losses in investments in affiliated companies 6,079 5,068
Other liabilities 11,413 11,358
Commitments and contingencies
Stockholders' equity:
Common stock, par value $1, authorized
shares: 100,000,000 at March 31,2004 and 55,000,000
at December 31, 2003
issued: 22,578,484 at March 31, 2004 and 17,898,486
at December 31, 2003 22,578 17,898
Additional paid-in capital 334,413 198,285
Retained earnings 198,388 202,339
Accumulated other comprehensive loss (4,292) (2,357)
-------------- -------------
Total stockholders' equity 551,087 416,165
-------------- -------------
Total liabilities and stockholders' equity $ 1,042,738 $ 591,977
============== =============
The accompanying notes are an integral part of these consolidated financial
statements.
-3-
IONICS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Quarter ended
March 31,
-------------------------
2004 2003
----------- -----------
Operating activities:
Net (loss) income $ (3,951) $ 576
Less: loss from discontinued operations (2,699) (377)
----------- -----------
(Loss) income from continuing operations (1,252) 953
Adjustments to reconcile net (loss) income from
continuing operations to net cash used in
operating activities:
Depreciation 8,865 5,994
Amortization of intangibles 1,066 79
Provision for losses on accounts and notes receivable 680 414
Equity in earnings (losses) of affiliates (490) 101
Changes in assets and liabilities,
net of effects of businesses acquired:
Notes receivable (3,988) 1,734
Accounts receivable (1,323) 820
Receivables from affiliated companies (3,434) (2,012)
Inventories (2,213) (1,710)
Other current assets (6,880) 1,651
Investments in affiliated companies (848) (32)
Deferred income taxes 7,926 (294)
Accounts payable and accrued expenses (4,688) (7,577)
Deferred revenue from affiliates (337) (546)
Accrued expenses for affiliated companies (3,598) -
Customer deposits 2,756 (1,717)
Income taxes payable 3,548 2,001
Accumulated losses in investments in affiliated companies 1,013 -
Other 1,113 (81)
--------------------------
Net cash provided by used in operating activities (2,084) (222)
Investing activities:
Additions to property, plant and equipment (8,264) (5,730)
Disposals of property, plant and equipment 180 83
Additional investments in affiliated companies - (75)
Acquisitions, net of cash acquired (223,336) -
Sales (purchases) of short-term investments (828) 202
--------------------------
Net cash used in investing activities (232,248) (5,520)
Financing activities:
Restricted cash (2,642) 4,250
Principal payments on current debt (3,493) (234)
Proceeds from borrowings of current debt - 143
Principal payments on long-term debt (934) (249)
Proceeds from borrowings of long-term debt 175,000 -
Deferred financing costs (6,233) -
Proceeds from issuance of stock under stock option plans 875 -
--------------------------
Net cash provided by financing activities 162,573 3,910
Effect of exchange rate changes on cash 403 660
Net cash used in continuing operations (71,356) (1,172)
Net cash provided by discontinued operations 5,543 653
Cash and cash equivalents at beginning of period 133,815 136,044
--------------------------
Cash and cash equivalents at end of period $ 68,002 $ 135,525
==========================
The accompanying notes are an integral part of these consolidated financial
statements.
-4-
IONICS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying consolidated quarterly financial statements of Ionics,
Incorporated (the "Company") are unaudited; however, in the opinion of the
management of the Company, all adjustments of a normal recurring nature have
been made that are necessary for a fair statement of the Company's consolidated
financial position, results of operations and cash flows for each period
presented. The consolidated results of operations for the interim periods are
not necessarily indicative of the results of operations to be expected for the
full year or any future period.
The accompanying financial statements have been prepared with the assumption
that users of the interim financial information have either read or have access
to the Company's financial statements for the year ended December 31, 2003.
Accordingly, footnote disclosures that would substantially duplicate the
disclosures contained in the Company's audited financial statements as of and
for the year ended December 31, 2003 have been omitted from these financial
statements. These financial statements have been prepared in accordance with the
instructions to Form 10-Q and the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
instructions, rules and regulations. These financial statements should be read
in conjunction with the Company's 2003 Annual Report on Form 10-K as filed with
the Securities and Exchange Commission.
During the first quarter of 2004, the Company realigned its business structure
and began reporting new business segments. This segment realignment combined
most of its existing Equipment Business Group and Ultrapure Water Group, as well
as the operations of Ecolochem, Inc. and its affiliated companies (the
"Ecolochem Group") acquired by the Company on February 13, 2004 (see Note 3) and
the Desalination Company of Trinidad and Tobago Ltd. ("Desalcott") which has
been consolidated effective January 1, 2004 upon the adoption of Interpretation
No. 46, "Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin No. 51" ("FIN 46"), into a new business group
called Water Systems. The newly formed Water Systems Group is comprised of two
reporting segments, Equipment Sales and Operations. The Consumer Water Group
remains a reporting group as previously constituted. The Instruments Group
continues with its existing activities and includes all worldwide instrument
sales. The Corporate Group captures all corporate overhead not specifically
assignable to the other business groups.
Certain prior year amounts have been reclassified to conform to the current year
presentations with no impact on net income.
2. Variable Interest Entities
In January 2003, the Financial Accounting Standards Board ("FASB") issued FIN
46. In December 2003, the FASB issued a revised version of FIN 46, which
incorporated a number of changes to the prior version. Prior to the effective
date of FIN 46, an entity was generally included in the Consolidated Financial
Statements if it was controlled through ownership of a majority voting interest.
In FIN 46, the FASB concluded that the voting interest approach is not always
effective in identifying controlling financial interests. In some arrangements,
equity investors may not bear the residual economic risks, and in others,
control is not exercised through voting shares. Prior to the first quarter of
2004, the Company was required to apply the provisions of FIN 46 to variable
interests in variable interest entities ("VIEs") created after January 31, 2003.
There were no VIEs meeting this criteria. During the first quarter of 2004, the
Company was required to apply the provisions of FIN 46 to variable interests in
VIEs created before February 1, 2003.
FIN 46 provides guidance for determining whether an entity lacks sufficient
equity or its equity holders lack adequate decision-making ability. These VIEs
are evaluated for consolidation. Variable interests are ownership, contractual
or other interests in a VIE that change with changes in the VIE's net assets.
The Company has evaluated its equity investments and non wholly-owned
subsidiaries to determine whether the Company is the primary beneficiary,
defined as the entity that is required to absorb the majority of the expected
gains or losses of the VIE. For any VIE in which the Company has been determined
to be the primary beneficiary, the VIE has been consolidated.
-5-
As a result, effective January 1, 2004, the Company consolidated the operations,
assets, liabilities and minority interests of Desalcott in which the Company
holds a 40% equity interest, because the Company believes it holds a majority of
the related financial risks. As of March 31, 2004, Desalcott had total assets
and total liabilities of approximately $159.5 million and $133.9 million,
respectively. Included in assets is $18.7 million of restricted cash and
property, plant and equipment totaling $128.4 million and included in
liabilities is debt of $112.4 million, which is collateralized by substantially
all of the assets and the outstanding common stock of Desalcott, and is
non-recourse to the Company.
3. Ecolochem Acquisition
On February 13, 2004, the Company acquired all of the outstanding shares of
capital stock and ownership interests of Ecolochem, Inc. and its affiliated
companies ("Ecolochem Group"). The Ecolochem Group, privately held companies
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 expands the Company's outsourced or customer
facility-based water treatment capabilities in North America and Europe and
provides the Company with better access into the energy and utilities markets.
The Company's financial statements include the results of operations of the
Ecolochem Group subsequent to the acquisition date.
The total purchase price was $366.5 million, consisting of $219.0 million in
cash (which includes $9.8 million in escrow to be paid when the Company makes a
Section 338 (h) (10) election with respect to selected acquired intangible
assets) and 4,652,648 shares of the Company's common stock. The issuance of
4,652,648 shares of the Company's common stock was valued at $139.9 million
based on the closing price of the common stock for the two days before, the day
of and the two days after the announcement by the Company of its agreement to
acquire the Ecolochem Group. The purchase price includes capitalizable
acquisition costs of $7.6 million, consisting of investment banking, legal,
consulting and accounting services. The cash portion of the consideration was
financed with the Company's available cash resources and proceeds from $255
million senior credit facilities with a syndication of lenders led by UBS, Fleet
Bank and Bank of America. Proceeds from these credit facilities were used to
fund the acquisition, pay certain transaction-related 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 5-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 of its domestic subsidiaries and by 65% of certain 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 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
credit facility, the Company entered into interest rate swap agreements that fix
the Company's LIBOR rate on $100 million of the term loan at 3.1175% per annum.
The swap agreements expire in 2010.
-6-
The preliminary allocation of the $366.5 million purchase price to the estimated
fair values of the assets acquired and liabilities assumed at the date of
acquisition was as follows:
(Dollars in millions)
Assets
Current assets $ 26.7
Property, plant and equipment 101.6
Intangible assets 72.8
Goodwill 176.6
Other assets 1.9
-------------
Total assets acquired $ 379.6
-------------
Liabilities
Current liabilities $ 11.0
Other liabilities 2.1
-------------
Total liabilities assumed 13.1
-------------
-------------
Total purchase price including acquisition costs $ 366.5
=============
The purchase price is subject to a final determination of working capital
amounts, to be agreed to by the sellers and the Company. Goodwill was recognized
for the excess purchase price over the fair value of the assets and liabilities
acquired. Goodwill apportioned to domestic operations for tax purposes is
deductible over a fifteen year period.
The following table reflects the estimated fair values of the acquired
intangible assets and related estimates of useful lives:
(Dollars in millions)
Contractual relationships $ 57.8 10-year economic consumption life
Technology and know-how 10.8 10-year useful life
Trade names and trademarks 2.4 9-year useful life
Non-compete agreements 0.1 5-year useful life
Discharge permits 1.7 Indefinite life
-------------
$ 72.8
=============
The following pro forma information presents a summary of the historical
consolidated statements of operations of the Company and Ecolochem for the
quarters ended March 31, 2004 and 2003, giving effect to the merger as if it
occurred on January 1, 2004 and 2003, respectively.
(Amounts in thousands, except per share amounts)
Quarter ended March 31,
--------------------------------------------
2004 2003
-------------------- --------------------
Pro forma revenues $ 119,709 $ 110,776
Pro forma net (loss) income (3,132) 4,747
Pro forma (loss) earnings per share:
Basic $ (0.14) $ 0.21
Diluted (0.14) 0.21
The pro forma net (loss) income and (loss) earnings per share for each period
presented primarily includes adjustments for depreciation of fixed assets,
amortization of intangibles and debt financing costs, interest expense, tax rate
changes and the issuance of common stock. Amortization of the acquired
intangibles is included on an economic consumption basis for contractual
relationships and a straight-line basis for all other intangibles. This pro
forma information does not purport to indicate the results that would have
actually been obtained had the merger been completed on the assumed date or for
the periods presented, or which may be realized in the future.
-7-
4. 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, for options with an exercise price less than the fair market value
of the stock at the date of grant, if any, stock-based compensation is measured
as the difference between the option exercise price and fair market value of the
stock at the date of grant and is charged to operations over the expected period
of benefit to the Company. For the quarters ended March 31, 2004 and 2003, no
stock-based compensation expense is reflected in net (loss) 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 is not indicative of future awards, which
are anticipated.
Quarter ended March 31,
--------------------------------
(Amounts in thousands, except per share amounts) 2004 2003
---------------- --------------
Net (loss) income, as reported $ (3,951) $ 576
Less: Stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects (755) (792)
---------------- --------------
Pro forma net loss $ (4,706) $ (216)
================ ==============
---------------- --------------
(Loss) earnings per basic share, as reported $ (0.19) $ 0.03
================ ==============
Loss per basic share, pro forma $ (0.23) $ (0.01)
================ ==============
---------------- --------------
(Loss) earnings per diluted share, as reported $ (0.19) $ 0.03
================ ==============
Loss per diluted share, pro forma $ (0.23) $ (0.01)
================ ==============
The fair value of each option granted during the first quarter of 2003 was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions:
2004 2003
---------------- --------------
Expected term (years) not applicable 6
Volatility not applicable 40.4%
Risk-free interest rate (zero coupon U.S. treasury note) not applicable 3.2%
Dividend yield not applicable None
No options were granted during the first three months of 2004.
5. Discontinued Operations
In the third quarter of 2003, the Company's management and Board of Directors
approved a plan to sell its consumer chemical business, the Elite Consumer
Products division in Ludlow, MA, which was part of the Consumer Water Group. In
the fourth quarter of 2003, the Company's management and Board of Directors
approved a plan to sell its European point-of use (POU) cooler businesses in the
United Kingdom (U.K.) and Ireland, which was also part of the Consumer Water
Group. 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 quarter ended March 31, 2004 was $0.1 million, or $0.2 million
on a pre-tax basis. In the first quarter of 2004, the Company completed the sale
of the Elite Consumer Products division for approximately $5.2 million.
-8-
The net loss from discontinued operations for the European POU cooler business
in the U.K. for the quarter ended March 31, 2004 was $1.0 million, or $1.5
million on a pre-tax basis. The net loss from discontinued operations for the
European POU cooler business in Ireland for quarter ended March 31, 2004 was
$1.6 million. The Company expects to complete the sale of the European POU
cooler business in the U.K. and Ireland during the second quarter of 2004.
The Company's financial statements have been reclassified to reflect these
businesses 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.
(Dollars in thousands)
Quarter ended March 31,
----------------------------------------
2004 2003
-------------------- -----------------
Revenues $ 1,724 $ 5,615
Gross margin (168) 338
==================== =================
Loss from discontinued operations,
before income tax (3,303) (527)
Income tax benefit 604 150
-------------------- ------------------
Loss from discontinued operations,
net of income tax $ (2,699) $ (377)
==================== =================
Assets and liabilities from discontinued operations at March 31, 2004 and
December 31, 2003 consist of the following:
(Dollars in thousands)
March 31, December 31,
2004 2003
-------------- --------------
Current assets $ 1,879 $ 2,709
Non-current assets 1,097 4,757
-------------- --------------
Assets from discontinued operations $ 2,976 $ 7,466
============== ==============
Liabilities from discontinued operations $ 239 $ 396
============== ==============
Current assets include cash and cash equivalents, accounts and notes receivable,
inventory and other current assets. Non-current assets include property, plant
and equipment, intangible assets and other assets. Liabilities consist of
accounts payable and accrued expenses.
6. Restructuring Charges
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 is consolidating the Company's sales, engineering,
manufacturing and accounting functions, which existed in many reporting
entities, into several regional centers in the United States, Europe and Asia.
During the first quarter of 2004, the Company recorded restructuring charges of
approximately $0.6 million relating primarily to vacating leased facilities. At
March 31, 2004, the Company has approximately $0.7 million accrued for
restructuring costs associated with vacated leased facilities and employee
severance arrangements. The Company expects the remaining severance payments to
be made during the second quarter of 2004 and facility lease payments, less
estimates of sub-lease rental income, through the second quarter of 2006.
-9-
7. Goodwill and Intangible Assets
The carrying amounts of goodwill for the quarters ended March 31, 2004 and 2003
are as follows:
Equipment Consumer
(Dollars in thousands) Sales Operations Water Instruments Corporate Total
--------- -------------------- -------------------------------
Balance December 31, 2002 $ 9,233 $ 10,023 $ 862 $ - $ - $ 20,118
Cumulative translation adjustment/other - 179 - - - 179
--------- --------- --------- -------- ------- --------
Balance March 31, 2003 $ 9,233 $ 10,202 $ 862 $ - $ - $ 20,297
========= ========= ========= ======== ======= ========
Balance December 31, 2003 $ 899 $ 5,934 $ 862 $ - $ - $ 7,695
Goodwill acquired during the period - 176,635 - - - 176,635
Cumulative translation adjustment/oher - (895) - - - (895)
--------- --------- --------- -------- ------- --------
Balance March 31, 2004 $ 899 $ 181,674 $ 862 $ - $ - $ 183,435
========= ========= ========= ======== ======= ========
The Company's intangible assets consist principally of contractual relationships
and customer lists, technology and know-how, patents, trade names and
trademarks. At March 31, 2004 and 2003, the gross carrying value of intangible
assets was $82.4 million and $2.9 million, respectively, and the accumulated
amortization was $2.6 million and $0.8 million, respectively. The increase in
intangible assets during the first quarter of 2004 primarily reflects the
acquisition of the Ecolochem Group (see Note 3). Amortization expense for
intangible assets is estimated to be approximately $7.2 million in 2004, $8.2
million in 2005 and 2006, and $8.1 million in 2007 and 2008.
8. Long-Term Debt and Notes Payables
March 31, December 31,
(Dollars in thousands) 2004 2003
------------- ---------------
Borrowings outstanding $ 299,237 $ 15,165
Less: Installments due within one year 9,129 6,276
------------- ---------------
Long-term debt and notes payable $ 290,108 $ 8,889
============= ===============
Acquisition of the Ecolochem Group
----------------------------------
On February 13, 2004, the Company acquired the stock and membership interests of
the Ecolochem Group from the shareholders and owners of the Ecolochem Group. The
total purchase price was $366.5 million, consisting of $219.0 million in cash
(which includes $9.8 million in escrow to be paid when the Company makes a
Section 338 (h) (10) election with respect to selected acquired intangible
assets) and 4,652,648 shares of the Company's common stock. The issuance of
4,652,648 shares of the Company's common stock was valued at $139.9 million
based on the closing price of the common stock for the two days before, the day
of and the two days after the announcement by the Company of its agreement to
acquire the Ecolochem Group. The purchase price includes capitalizable
acquisition costs of $7.6 million, consisting of investment banking, legal,
consulting and accounting services. The cash portion of the consideration was
financed with the Company's available cash resources and proceeds from $255
million senior credit facilities with a syndication of lenders led by UBS, Fleet
Bank and Bank of America. Proceeds from these credit facilities were used to
fund the acquisition, pay certain transaction-related 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 5-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 of its domestic subsidiaries and by 65% of certain 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 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
credit facility, the Company entered into interest rate swap agreements that fix
the Company's LIBOR rate on $100 million of the term loan at 3.1175% per annum.
The swap agreements expire in 2010.
-10-
Consolidation of Desalcott
--------------------------
Pursuant to FIN 46 (see note 2), effective January 1, 2004, the Company
consolidated the operations, assets, liabilities and majority interests of the
Desalination Company of Trinidad and Tobago Ltd. ("Desalcott"), in which the
Company holds a 40% equity interest, because the Company believes it holds a
majority of the related financial risks. Included in liabilities at March 31,
2004 is debt of $112.4 million. The debt outstanding consists of 20-year loans
for $79.3 million and $33.1 million. Each loan bears interest at 8.5%, which is
payable quarterly. As a result of an agreed upon "Moratorium Period" on the
$33.1 million loan, interest payments do not commence until October 2005.
Interest rates are fixed on each loan for the first five years and ten years,
respectively. Interest rates may change at the end of each subsequent five-year
period. The total debt is collateralized by substantially all of the assets and
the outstanding common stock of Desalcott, and is non-recourse to the Company.
Notes Payable
-------------
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% to 8.75%. The controlled affiliate had outstanding borrowings of
$6.3 million and $6.4 million against these loans at March 31, 2004 and December
31, 2003, 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 $5.4 million and $3.8 million against these loans at
March 31, 2004 and December 31, 2003, respectively.
Maturities of all cash borrowings outstanding for the five years ended December
31, 2004 through December 2008 are approximately $9.1 million, $8.1 million,
$9.2 million, $9.1 million, $9.3 million, respectively, and $254.4 million
thereafter. The weighted average interest rate on all borrowings was 6.33% and
6% at March 31 2004 and December 31, 2003, respectively.
9. Commitments and Contingencies
Litigation
----------
On April 28, 2004, the Company was served with a summons and complaint captioned
Caldon, Inc. v. Ionics, Incorporated and Key Technologies, Inc., filed in the
U.S. District Court for the Western District of Pennsylvania, Pittsburgh.
Caldon, Inc. (Caldon) alleges that certain flow measurement systems, which it
provides to the nuclear power industry to measure feedwater flow, and which were
designed by defendant Key Technologies, Inc. and fabricated by the Company's
Bridgeville division, failed after installation. Caldon further alleges that
defendant Key Technologies, Inc. failed to design the systems adequately and
that the Company failed to weld the systems properly. Caldon claims that it has
incurred damages in excess of $2.7 million and has made commitments to customers
that will cause it to incur an additional $4.0 million, as well as other damages
in an unspecified amount. The Company believes that Caldon's allegations as to
the Company are without merit, and intends to defend itself vigorously in this
matter. While the Company believes that this 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.
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.
("Intersuero"). Iberica is seeking the return of certain membrane-based
production equipment, which it had supplied under a lease agreement to
Intersuero (which had previously initiated 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 included in the lawsuit are without merit and
-11-
will defend itself vigorously in this matter, 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 this 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 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 entity 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. The Company generally has no commitment to
fund the joint venture's working capital or other cash needs. The joint venture
entities typically obtain third-party debt financing for a substantial portion
of the project's total capital requirements. In these situations, the Company is
not responsible for the repayment of the indebtedness incurred by the joint
venture entity. In connection with a joint venture's project, the Company may
also enter into contracts for the supply and installation of the Company's
equipment during the construction of the project or 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.
The operations, assets and liabilities of Desalcott are consolidated with the
Company effective January 1, 2004, as a result of the adoption of FIN 46. The
operations, assets and liabilities of the Algerian joint venture company are
consolidated with the Company as a majority-owned subsidiary. The Kuwait and
Israel projects discussed below constitute off-balance sheet arrangements.
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 ("WASA").
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 collateralized 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
-12-
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.
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.
Upon adoption of FIN 46 (see Note 2), as of January 1, 2004, the Company has
consolidated the operations, assets, liabilities and minority interests of
Desalcott and its results of operations for the first quarter of 2004.
In April 2004, following an unsuccessful mediation attempt, Desalcott notified
WASA that it had commenced an arbitration proceeding under the dispute
resolution procedures of the water supply agreement between Desalcott and WASA
dated August 29, 1999 and amended in May 2000 (the "Water Supply Agreement").
Desalcott is seeking, among other things, payments from WASA for certain water
price increases as provided for in the Water Supply Agreement, as well as
damages for delays in plant completion which Desalcott claims resulted from
delays in obtaining a government guaranty of payments by WASA and certain tax
incentives. WASA has contested the amounts of the water price increases claimed
by Desalcott, asserting that Desalcott did not pass along to WASA certain cost
savings realized by Desalcott. In addition, WASA asserts that Desalcott's
ability to make up production shortfalls by selling excess production is more
limited contractually than claimed by Desalcott. In addition, WASA has also
asserted that Desalcott is liable for liquidated damages because of delays in
the completion of the plant, irrespective of the delay in obtaining the
government guaranty, and that such liquidated damages currently total
approximately $4.0 million and are still accumulating. WASA has asserted
additional liquidated damages will be owed by Desalcott for the delay in the
completion of Phase 5 of the project, or that in the alternative it may seek to
reject or terminate Phase 5. Under the currently projected timetable, this
matter should be heard in arbitration by the International Chamber of Commerce
in London late in 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 March
31, 2004, the Company had invested a total of $10.9 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 $6.4
million over the next two years. In addition, a total of $18.6 million in
performance bonds have been issued on behalf of the Company's Italian subsidiary
in connection with the project.
-13-
Israel
------
In 2001, the Company entered into agreements with an Israeli cooperative society
and an Israeli corporation for the establishment of Magan Desalination Ltd.
("MDL") as an Israeli project company in which the Company has a 49% equity
interest. During the second quarter of 2003, the Israeli cooperative society and
the Company acquired the ownership interest of the Israeli corporation in MDL.
In the second quarter of 2003, MDL finalized a concession contract with a
state-sponsored water company for the construction, ownership and operation of a
brackish water desalination facility in Israel. In the second quarter of 2003,
MDL obtained $8 million of debt financing for the project from an Israeli bank,
and the Company has guaranteed repayment of 49% of the loan amount in the form
of a bank letter of guarantee. In the third quarter of 2003, the Company through
its Israeli subsidiary made an equity investment of $1.5 million in MDL for its
49% equity interest. This project is scheduled to be completed in the second
quarter of 2004.
In 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"). 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. As
of March 31, 2004, the Company had made an equity investment of $0.2 million in
CDL and had deferred costs of $0.6 million relating to the engineering design
and development work on the project. 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. CDL was unable to obtain long-term
financing by the required date. CDL asserts that its inability to obtain
financing resulting from certain errors and omissions in WDA's tendering process
which would have prevented CDL from constructing the facility as proposed. On
April 1, 2004 the WDA notified CDL of its intent to terminate the concession
agreement and to take action to collect on a performance bond (of which it is
the beneficiary) issued on behalf of CDL. On May 5, 2004, the WDA issued a
notice of termination to CDL and made a demand upon the issuing bank of the
performance bond. The Company's liability under the performance bond is
approximately $2.5 million (a one-third proportionate share of the approximate
$7.5 million performance bond). During the first quarter of 2004, as a result of
the notification by the WDA of their intent to collect on the performance bond,
the Company recorded a liability of $2.5 million related to its proportionate
share. In addition, the Company expensed its deferred costs relating to the
construction project and its investment in CDL of $0.8 million. The dispute
between CDL and the WDA concerning the errors and omissions in the tendering
process, the termination of the concession agreement and the demand made upon
the bid bond has been submitted to binding arbitration in Israel (with CDL and
WDA both as claimants and respondents), and it is expected that the matter will
be heard and a decision rendered by the arbitrator in the third quarter of 2004.
The Company believes that it has legitimate claims and meritorious defenses in
this matter and, in cooperation with the Company's partners in CDL and CDL's
outside counsel, intends to aggressively pursue recovery of performance bond
payments made to WDA as well as other damages.
In the third quarter of 2003, a 50/50 joint venture between the Company and an
Israeli engineering corporation was selected by Mekorot, the Israeli
state-sponsored water company, to design, supply and construct a 123,000 cubic
meter per day (32.5 million gallons per day) seawater desalination facility in
Ashdod, Israel. The estimated value 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 construct. 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 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 the fourth quarter of 2003, the Company and Algerian Energy Company (AEC)
were selected for a 25-year seawater desalination build-own-operate project.
Sonatrach, the Algerian 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), in which the Company has a 70% ownership interest.
The projected $220 million capital investment will be financed by a combination
of equity and non- recourse debt. Through March 31,2004, the Company made an
equity investment of $0.2 million in HWD and 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.
-14-
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 and other undertakings
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 with the exception of the performance
bond associated with CDL, as previously described. Approximately $113.7 million
of these instruments were outstanding at March 31, 2004. 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 the first three months of 2004 is not material. Accordingly, the
Company has not recorded any liabilities for these instruments as of March 31,
2004.
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. The Company has made a variety of warranties and
indemnifications to sellers and purchasers that are typical for such
transactions through the first quarter of 2004. The Company has not recorded any
liabilities for these obligations as of March 31, 2004, as it believes that it
will incur no liabilities under such provisions.
Warranty Obligations
--------------------
The Company's products generally include warranty obligations and the related
estimated costs are included in cost of sales when revenue is recognized. While
the Company engages in extensive product quality programs and processes, the
Company's estimated costs to satisfy its warranty obligations are based upon
historical product failure rates and the costs incurred in correcting such
product failures. If actual product failure rates or the costs associated with
fixing such product failures differ from historical rates, adjustments to the
warranty obligations may be required in the period in which determined. The
changes in accrued warranty obligations for the quarters ended March 31, 2004
and 2003, are as follows:
Quarter ended March 31,
-------------------------------
(Dollars in Thousands) 2004 2003
-------------- ---------------
Balance at end of prior year $ 1,173 $ 625
Accruals for warranties issued during the period 55 315
Accruals related to pre-existing warranties - 135
Settlements made (in cash or in kind) during the period (209) (256)
-------------- ---------------
Balance at end of period $ 1,019 $ 819
============== ===============
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.
-15-
10. Income Taxes
For the quarter ended March 31, 2004, the Company recorded income tax benefit of
$0.5 million on consolidated pre-tax loss from continuing operations before
minority interest expense of $1.5 million, yielding an annual effective tax rate
of 32.0%. For the quarter ended March 31, 2003, the Company recorded income tax
expense of $0.6 million on consolidated pre-tax income from continuing
operations before minority interest of $1.8 million, yielding an annual
effective tax rate of 35.2%. The change in the effective tax rate for the
quarter ended March 31, 2004 compared to the quarter ended March 31, 2003
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.
11. Earnings Per Share (EPS)
The effect of dilutive stock options excludes those stock options for which the
impact was antidilutive based on the exercise price of the options. The number
of options that were antidilutive for the three months ended March 31, 2004 and
2003 was 1,182,117 and 3,245,167, respectively. All options outstanding for the
three months ended March 31, 2004 were antidilutive, based on the Company's net
loss.
(Amounts in thousands, except per share amounts)
Quarter ended March 31,
---------------------------------------------------------------------------------------
2004 2003
------------------------------------------ ------------------------------------------
Net Net
(Loss) Per Share (Loss) Per Share
Income Shares Amount Income Shares Amount
------------ ------------- ------------- ------------- ------------- ------------
Basic EPS
Income available to
common stockholders $ (3,951) 20,322 $ (0.19) $ 576 17,555 $ 0.03
Effect of dilutive
stock options - - - - 7 -
------------ ------------- ------------- ------------- ------------- ------------
Diluted EPS $ (3,951) 20,322 $ (0.19) $ 576 17,562 $ 0.03
============ ============= ============= ============= ============= ============
12. Profit Sharing and Pension Plan
The Company has contributory profit-sharing plans (defined contribution plans)
which cover employees of the Company who are members of the Fabricated Products
Group of the Bridgeville division ("FPG Plan") and Ecolochem (the "Ecolochem
Plan"). The Company contributions to the FPG 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. The Company made no contributions to the FPG Plan
during either of the quarters ended March 31, 2004 and 2003. The Company will
contribute $0.5 million to the FPG Plan in 2004 in respect of the 2003 plan
year. The Ecolochem Plan covers all eligible employees of the Ecolochem Group
and all contributions are made at the discretion of the Board of Directors of
Ecolochem, Inc.
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. Company contributions to the pension plan
were $0.7 million and $0.3 million for the three months ended March 31, 2004 and
2003, respectively. The Company expects to contribute $3.0 million to this plan
in 2004.
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
-16-
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 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, and the
cessation of future benefit accruals. 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 for both the Retirement Plan and SERP, which were recorded
during the period ending December 31, 2003.
The Company plans to implement changes to its post-retirement plans during the
second half of 2004, including the potential merger of all defined contribution
plans.
Net periodic benefit cost for all defined benefit plans consisted of the
following:
Quarter ended March 31,
---------------------------------
(Dollars in Thousands) 2004 2003
--------------- --------------
Components of Net Periodic Benefit Cost:
Service cost $ 513 $ 443
Interest cost 458 492
Expected return on plan assets (412) (298)
Amortization of transition asset - (11)
Amortization of prior service cost - 137
Recognized net actuarial loss 73 147
--------------- --------------
Net periodic benefit cost $ 632 $ 910
=============== ==============
13. Comprehensive (Loss) Income
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income," which
establishes standards for the reporting and display of comprehensive income and
its components. The table below sets forth comprehensive (loss) income as
defined by SFAS No. 130 for the quarters ended March 31, 2004 and 2003.
(Dollars in thousands)
Quarter ended March 31,
--------------------------
2004 2003
----------- -------------
Net (loss) income $ (3,951) $ 576
Other comprehensive (loss) income, net of tax:
Changes in value of foreign exchange
contracts designated as cash flow hedges (531) 352
Translation adjustments (1,404) 1,042
----------- -------------
Comprehensive (loss) income $ (5,886) $ 1,970
=========== =============
14. Segment Information
During the first quarter of 2004, the Company realigned its business structure
and began reporting new business segments. This realignment combined most of the
Equipment Business Group and Ultrapure Water Group with the operations of the
Ecolochem Group (see Note 3), into the new business group called Water Systems.
The newly formed Water Systems Group is comprised of two operating segments,
Equipment Sales and Operations. The Consumer Water Group remains a reporting
group as previously constituted. The Instruments segment continues with its
existing activities and combines global instrument sales by all business units.
The Corporate Group captures all corporate overhead not specifically assignable
to the other business groups including; certain corporate administrative and
insurance costs, foreign exchange gains and losses on corporate assets, as well
as the elimination of intersegment transfers. Prior year amounts have been
reclassified to conform to the current year presentations with no impact on net
income.
-17-
The following table summarizes the Company's operations by the four major
operating segments. Corporate includes legal and research and development
expenses not allocated to the business groups, certain corporate administrative
and insurance costs, certain foreign exchange gains and losses, as well as the
elimination of inter-segment transfers. The Company measures segment
profitability on earnings before interest, taxes and minority interest.
Quarter ended March 31, 2004
------------------------------------------------------------------------------------
Equipment Consumer
Sales Operations Water Instruments Corporate Total
------------- ------------ ------------ -------------------------- -------------
(Amounts in thousands)
Revenue - unaffiliated $ 33,430 $ 52,406 $ 5,721 $ 8,751 $ - $ 100,308
Revenue - affiliated 7,005 84 - 26 - 7,115
Inter-segment transfers 1,331 406 2 38 (1,777) -
Gross profit - unaffiliated 5,557 17,858 3,316 4,745 - 31,476
Gross profit - affiliated 1,001 (8) - 12 - 1,005
Equity income (loss) - 583 80 - (173) 490
(Loss) earnings before interest,
tax and minority interest (122) 8,395 93 1,431 (7,944) 1,853
Interest income 514
Interest expense (3,836)
Loss before income taxes and
minority interest (1,469)
Identifiable assets 407,610 637,544 98,263 36,778 (148,499) 1,031,696
Goodwill 899 181,674 862 - - 183,435
Other intangible assets 29,227 45,716 4,616 271 - 79,830
Quarter ended March 31, 2003
------------------------------------------------------------------------------------
Equipment Consumer
Sales Operations Water Instruments Corporate Total
------------- ------------ ------------ -------------------------- -------------
(Amounts in thousands)
Revenue - unaffiliated $ 29,552 $ 27,682 $ 5,200 $ 8,379 $ - $ 70,813
Revenue - affiliated 11,653 75 16 33 - 11,777
Inter-segment transfers 1,234 1,139 4 435 (2,812) -
Gross profit - unaffiliated 6,910 8,549 2,962 4,790 - 23,211
Gross profit - affiliated 1,500 35 8 17 - 1,560
Equity income (loss) - (78) 181 - (204) (101)
Earnings (loss) before interest,
tax and minority interest 1,200 4,308 527 1,534 (6,350) 1,219
Interest income 778
Interest expense (222)
Income before income taxes and
minority interest 1,775
Identifiable assets 222,039 204,960 106,172 32,249 18,535 583,955
Goodwill 9,233 10,202 862 - - 20,297
Other intangible assets 849 784 74 319 99 2,125
15. Derivative Financial Instruments and Hedging Activity
In the fourth quarter of 2002, the Company entered into a series of U.S.
dollar/euro forward foreign exchange contracts with the intent of offsetting the
foreign exchange risk associated with the forecasted revenues related to an
ongoing project. At March 31, 2004, the notional amount of outstanding forward
foreign exchange contracts to exchange U.S. dollars for euros, which were
designated as forecasted cash flow hedging instruments, was $4.4 million. The
fair values of the forward contracts, based upon dealer quotations, are recorded
as components of the "Other current assets" or "Other current liabilities",
depending upon the amount of the valuation. At March 31, 2004, the fair value of
these forward contracts of $0.6 million was recorded as a component of "Other
current assets." The net unrealized gain of $0.6 million on the forward
contracts that qualified as cash-flow hedging instruments was included in
"Accumulated other comprehensive loss," in the "Stockholders equity" section of
the Consolidated Balance Sheets The Company expects these instruments to affect
earnings over the next eighteen months. To the extent that any portion of the
hedge is determined to be ineffective, the related gain or loss is required to
be included in income currently. For the quarter ended March 31, 2004, the
Company had no gains or losses related to ineffective cash flow hedges.
-18-
In February 2004, the Company entered into a British pound ("GBP")/U.S. dollar
foreign forward exchange contract to hedge the balance sheet exposure related to
an intercompany loan. At March 31, 2004, the notional amount of the outstanding
forward contract to exchange U.S. dollars for GPBs, which was designated as fair
value hedging instrument, was GBP 1.25 million. The fair value of this forward
contract, based upon dealer quotations, is recorded as a component of "Other
current assets" or "Current liabilities," depending on the amount of the
valuation. At March 31, 2004, the fair value of this hedging instrument, which
was immaterial, was recorded as a component of "Other current liabilities." The
net unrealized loss on the instrument, which was immaterial, was recorded in
"Selling, general and administrative expenses."
In connection with the acquisition of the Ecolochem Group and the execution of
the credit facility, the Company entered into interest rate swap agreements that
fix the Company's LIBOR rate on $100 million of the term loan at 3.1175% per
annum. The swap agreements, which qualify for hedge accounting, expire in 2010.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the consolidated financial
statements and the related notes thereto included elsewhere in this Form 10-Q
and the audited consolidated financial statements and notes thereto and
Management's Discussion and Analysis of Financial Condition and Results of
Operations included in our Annual Report on Form 10-K for the year ended
December 31, 2003, which has been filed with the Securities and Exchange
Commission.
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.
During the first quarter of 2004, the Company realigned its business structure
and began reporting new business segments. The segment realignment combined two
previously reported segments, the Equipment Business Group and Ultrapure Water
Group, with the operations of the Ecolochem Group, which was acquired on
February 13, 2004, to form the Water Systems Group ("WSG"). WSG results also
include the consolidated results of Desalcott.
The following discussion and analysis of financial condition and results of
operations refers to the activities of the Company's four operating units, which
comprise the Company's reportable operating segments. These groups are Equipment
Sales, Operations, Consumer Water and Instruments. The Water Systems Group
consists of equipment sales and operations, and includes the operations of the
Ecolochem Group, which was acquired in February 2004. The Equipment Sales
segment will reflect all sales of the Company's capital equipment and related
spare parts, and the Operations segment will include recurring revenue from
regeneration, operating plants, disinfection chemicals and other related
products. The Consumer Water Group remains unchanged, except to the extent that
operations have been discontinued or shutdown. The Instruments Group operations
includes all sales of instruments, including those previously reported by the
Equipment Business Group and Ultrapure Water Group.
WSG provides products and related activities 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.
-19-
WSG also 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. WSG has historically been heavily reliant
upon the microelectronics industry and the continued softness in that industry
has adversely impacted both revenue and profitability. WSG has been pursuing
applications in other markets, such as power, pharmaceuticals and flat panel
display, to lessen its reliance upon the microelectronics market.
The Consumer Water Group (CWG) 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 Instrument Group (IBG) manufactures and sells instruments and related
products for the measurement of impurities in water. The Group 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. IBG 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 WSG,
the performance of the IBG segment has been impacted by the downturn in the
microelectronics industry, although to a lesser extent than the WSG.
WSG has 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 Water Systems Group, 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 is consolidating the Company's sales, engineering,
manufacturing and accounting functions, which were spread among numerous
reporting entities, into several regional centers in the United States, Europe
and Asia. The Company also announced plans to divest the Elite Consumer Products
division in Ludlow, MA (which was sold in January 2004), 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 these decisions, the Company recorded restructuring charges of
approximately $2.8 million during 2003 relating primarily to employee severance
-20-
costs for the elimination of approximately 160 positions, and an additional $0.6
million during the first quarter of 2004. The Company expects to realize a
reduction of approximately $15.4 million in operating expenses in 2004 as a
result of these restructuring initiatives.
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 CWG, 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. Losses from discontinued operations were $2.7 million for the
first quarter of 2004 and $0.4 million for the first quarter of 2003.
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 Operations unit of the Company's Water Systems
segment, 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 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.
The following discussion and analysis describes material changes in the
Company's financial condition since December 31, 2003. The analysis of results
of operations compares the quarter ended March 31, 2004 with the comparable
period of the prior fiscal year.
-21-
RESULTS OF OPERATIONS
Comparison of the Quarters Ended March 31, 2004 and March 31, 2003
------------------------------------------------------------------
The Company reported consolidated revenues of $107.4 million and a net loss of
$4.0 million for the first quarter of 2004, compared to consolidated revenues of
$82.6 million and net income of $0.6 million for the first quarter of 2003.
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 ("POU") cooler business. Accordingly, results for the Company's Elite
Consumer Products division and European POU cooler 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. 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. In the first quarter of
2004, the Company acquired substantially all of the assets of the Ecolochem
Group, which are a leading provider of emergency, short and long-term mobile
water treatment services to the power, petrochemical and other industries. Also,
the Company has consolidated Desalination Company of Trinidad and Tobago Ltd.
("Desalcott"), a Trinidad project company upon adoption of FIN 46, which the
Company adopted effective January 1, 2004.
Revenues
--------
Total Company's revenues of $107.4 million for the first quarter of 2004
increased $24.8 million or 30.1% from revenues of $82.6 million for the first
quarter of 2003. Revenues in 2004 include $11.9 million from the Ecolochem Group
from the acquisition date of February 13, 2004 through the end of the first
quarter, as well as revenues of $6.9 million from Desalcott for the first
quarter of 2004. The Company expects to include revenues from the Ecolochem
Group and Desalcott in future periods.
The following table reflects the revenues of the Company's four business
segments and sales to affiliated companies for the first quarter of 2004 and
2003:
(Dollars in thousands) Quarter ended March 31,
-------------------------------------
2004 2003 Dollar Change Percentage Change
----------------- ------------------ --------------- -------------
Revenues
Equipment Sales $ 33,430 $ 29,552 $ 3,878 13.1 %
Operations 52,406 27,682 24,724 89.3 %
Consumer Water 5,721 5,200 521 10.0 %
Instruments 8,751 8,379 372 4.4 %
Affiliated companies 7,115 11,777 (4,662) (39.6)%
----------------- ------------------ --------------- -------------
$ 107,423 $ 82,590 $ 24,833 30.1 %
================= ================== =============== =============
Equipment Sales revenues of $33.4 million in the first quarter of 2004 increased
$3.9 million, or 13.1%, compared to revenues of $29.6 million in the first
quarter of 2003. The increase in revenues was primarily attributable to the sale
of capital equipment to the microelectronics industry by the Company's Singapore
subsidiary.
Operations revenue of $52.4 million in the first quarter of 2004 increased $24.7
million, or 89.3%, compared to revenues of $27.7 million in the first quarter of
2003. The increase in revenues was attributable to several sources, including
revenues from the Ecolochem Group of $11.9 million in the first quarter of 2004,
which was acquired on February 13, 2004, and from Desalcott of $6.9 million,
which was consolidated upon adoption of FIN 46 effective January 1, 2004.
Operations revenue also increased in the first quarter of 2004 compared to the
first quarter of 2003, as a result of increased sales of $2.5 million of sodium
hypochlorite in Australia and increased domestic ion-exchange regeneration
revenue of $1.3 million.
CWG revenues totaled $5.7 million in the first quarter of 2004 compared to
revenues of $5.2 million in the first quarter of 2003, representing an increase
of $0.5 million, or 10.0%. Any sales relating to the Company's Elite Consumer
Products division in Ludlow, MA, as well as the Company's European POU cooler
businesses, have been reclassified to discontinued operations for all periods
presented.
Instruments revenues of $8.8 million in the first quarter of 2004 increased $0.4
million, or 4.4%, compared to revenues of $8.4 million in the first quarter of
2003. The increase in revenues primarily resulted from increased sales of
aftermarket products.
-22-
Revenues from sales to affiliated companies of $7.1 million in the first quarter
of 2004 decreased $4.7 million, or 39.6%, compared to revenues from affiliated
companies of $11.8 million in the first quarter of 2003. The decrease in
revenues from sales to affiliated companies primarily resulted from lower
capital equipment revenue associated with the Company's Kuwait joint venture
company, Utilities Development Company, W.L.L. ("UDC"), in connection with the
Kuwait wastewater treatment project.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or "build, own and operate"
(BOO) contracts. The Company believes that the remaining duration on its
existing sale of equipment contracts ranges from less than one year to three
years and the remaining duration on its existing BOO contracts ranges from one
year to 25 years. The time to completion of any of these contracts, however, is
subject to a number of variables, including the nature and provisions of the
contract and the industry being served. Historically, as contracts are
completed, the Company has entered into new contracts with the same or other
customers. In the past, the completion of any one particular contract has not
had a material effect on the Company's business, results of operations or cash
flows.
Cost of Sales
-------------
The following table reflects cost of sales and cost of sales as a percentage of
revenue of the Company's four business segments and to affiliated companies for
the first quarter of 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
-------------------------------------------------------------------------
Percentage of Percentage
2004 Revenue 2003 of Revenue
----------------- ----------------------------------- ---------------
Cost of Sales
Equipment Sales $ 27,873 83.4% $ 22,642 76.6%
Operations 34,548 65.9% 19,133 69.1%
Consumer Water 2,405 42.0% 2,238 43.0%
Instruments 4,006 45.8% 3,589 42.8%
Affiliated companies 6,110 85.9% 10,217 86.8%
----------------- --------------- ----------------- ---------------
$ 74,942 69.8% $ 57,819 70.0%
================= =============== ================= ===============
The Company's total cost of sales as a percentage of revenue was 69.8% in the
first quarter of 2004 and 70.0% in the first quarter of 2003. The resulting
gross margin increased to 30.2% in the first quarter of 2004 from to 30.0% in
the first quarter of 2003. Cost of sales as a percentage of revenue increased in
the Equipment Sales and Instruments segments and decreased for
Operations, Consumer Water and Affiliated companies.
Equipment Sales cost of sales as a percentage of revenue increased to 83.4% in
the first quarter of 2004 from 76.6% in the first quarter of 2003. The increase
in cost of sales as a percentage of revenue for Equipment Sales is primarily
attributable to charges relating the write-off of deferred project costs of $0.6
million associated with the CDL joint venture desalination project in Israel and
$0.4 million for charges for domestic project overruns. Additionally, other
long-term contracts generated less gross profit during the first quarter of 2004
compared to the first quarter of 2003.
Operations cost of sales as a percentage of revenue decreased to 65.9% in the
first quarter of 2004 from 69.1% in the first quarter of 2003. The decrease in
cost of sales as a percentage of revenue is attributable to the consolidation of
Desalcott effective January 1, 2004 and the acquisition of the Ecolochem Group
on February 13, 2004, both of which have lower prevailing cost of sales
percentages. The approximate impact of the Desalcott consolidation was 2.7
percentage points and the impact of Ecolochem was approximately 2.0 percentage
points.
CWG cost of sales as a percentage of revenue decreased to 42.0% in the first
quarter of 2004 from 43.0% in the first quarter of 2003. Results for the
Company's Elite Consumer Products division in Ludlow, MA, as well as the
Company's European POU cooler business, have been reclassified to discontinued
operations for all periods presented.
IBG's cost of sales as a percentage of revenue increased to 45.8% in the first
quarter of 2004 from 42.8% in the first quarter of 2003 primarily due to a less
favorable product mix and lower software sales.
-23-
Cost of sales to affiliated companies as a percentage of revenue decreased to
85.9% in the first quarter of 2004 from 86.8% in the first quarter of 2003 and
primarily represents cost of sales to UDC, for which the Company eliminates
intercompany profit equal to its 25% equity ownership in UDC.
Operating Expenses
------------------
The following table compares the Company's operating expenses for the first
quarter of 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
--------------------------------------------------------
2004 Percentage 2003 Percentage
of Revenue of Revenue
----------- ------------- ------------- ------------
Operating expenses
---------- ------------- ------------- ------------
Research and development expenses $ 1,531 1.4% $ 1,777 2.2%
----------- ------------- ------------- ------------
---------- ------------- ------------- ------------
Selling, general and administrative expenses $ 29,023 27.0% $ 21,674 26.2%
----------- ------------- ------------- ------------
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 Equipment Sales, Operations and Instruments segments. Research
and development expenses decreased $0.2 million during the first quarter of 2004
compared to the first quarter of 2003. The Company currently expects to continue
to invest in new products, processes and technologies at the current spending
level.
Selling, general and administrative expenses increased $7.3 million during the
first quarter of 2004 to $29.0 million from $21.7 million during the first
quarter of 2003. Selling, general and administrative expenses as a percentage of
sales increased to 27.0% in the first quarter of 2004 from 26.2% in the first
quarter of 2003. The increase in selling, general, and administrative costs was
primarily attributable to the consolidation of Desalcott, effective January 1,
2004, upon the adoption of FIN 46 and the acquisition of Ecolochem on February
13, 2004. Also, the Company recorded a $2.5 million loss associated with a
performance bond that has been drawn upon in connection with the CDL joint
venture's desalination project in Israel. The Company also incurred $0.6 million
in costs associated with the implementation of a Company-wide enterprise
resource planning system.
Restructuring Charges
---------------------
The following table compares the Company's expenses relating to restructuring
expenses for the first quarter of 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
------------------------------------------------------------------------
2004 Percentage 2003 Percentage
of Revenue of Revenue
----------------- ----------------------------------- ---------------
---------------- ---------------- ----------------- ---------------
Restructuring charges $ 564 0.5% $ - 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 is consolidating the Company's sales, engineering,
manufacturing and accounting functions, which were located in many reporting
entities, into several regional centers in the United States, Europe and Asia.
The Company also announced plans to consolidate the Equipment Business Group and
Ultrapure Water Group into a single business group, divest the Elite Consumer
Products division in Ludlow, MA, shut down the 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 cooler
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 to employee severance costs for
the elimination of approximately 160 positions primarily in the EBG and UWG
segments and an additional $0.6 million in the first quarter of 2004, relating
primarily to the termination of facility leases. At March 31, 2004,
substantially all of the employees whose employment was terminated as a result
of these restructuring activities left the Company. Additionally, at March 31,
2004, the Company has approximately $0.7 million accrued for restructuring costs
associated with vacated leased facilities and employee severance arrangements.
The Company expects the remaining severance payments to be made during the
second quarter of 2004 and facility lease payments, less estimates of sub-lease
-24-
rental income, through the second quarter of 2006. The Company expects to
realize a reduction of approximately $15.4 million in operating expenses in 2004
as a result of these actions.
Interest Income and Interest Expense
------------------------------------
The following table compares the Company's interest income and interest expense
for the first quarter of 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
--------------------------------------------------------------------------
2004 Percentage 2003 Percentage
of Revenue of Revenue
------------------ ----------------------------------- ---------------
Interest Income $ 514 0.5% $ 778 0.9%
------------------ --------------- ------------------ ---------------
Interest Expense $ (3,836) (3.6)% $ (222) (0.3)%
------------------ --------------- ------------------ ---------------
Interest income totaled $0.5 million in the first quarter of 2004 and $0.8
million in the first quarter of 2003. Interest expense was $3.8 million in the
first quarter of 2004 compared to $0.2 million in the first quarter of 2003. The
increase in interest expense is attributable to increased borrowings as a result
of the Ecolochem acquisition as well as interest expense from the consolidation
Desalcott upon adoption of FIN 46, on January 1, 2004.
Equity Income (Loss)
--------------------
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 first quarter of 2004
and 2003:
(Dollars in thousands) Quarter ended March 31,
--------------------------------------------------------------------------
2004 Percentage 2003 Percentage
of Revenue of Revenue
------------------ ----------------------------------- ---------------
----------------- --------------- ------------------ ---------------
Equity income (loss) $ 490 0.5 % $ (101) (0.1)%
------------------ --------------- ------------------ ---------------
Equity income amounted to $0.5 million in the first quarter of 2004 and an
equity loss of $0.1 million was incurred in the first quarter of 2003. The
Company's equity income (loss) is derived primarily from its 20% equity interest
in a Mexican joint venture company, which owns two water treatment plants in
Mexico, 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. In 2003, equity losses were
also included as a result of the Company's 40% equity interest in Desalcott,
which was consolidated upon the adoption of FIN 46, on January 1, 2004.
Income Tax Benefit (Expense)
----------------------------
The following table compares the Company's income tax benefit (expense) and
effective tax rates for the first quarter of 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
--------------------------------------------------------------------------
2004 Effective Tax Rate 2003 Effective Tax Rate
------------------ ----------------------------------- ---------------
----------------- --------------- ------------------ ---------------
Income tax benefit (expense) $ 470 32.0 % $ (624) (35.2)%
------------------ --------------- ------------------ ---------------
For the quarter ended March 31, 2004, the Company recorded income tax benefit of
$0.5 million on consolidated pre-tax loss from continuing operations before
minority interest expense of $1.5 million, yielding an annual effective tax rate
of 32%. For the quarter ended March 31, 2003, the Company recorded income tax
expense of $0.6 million on consolidated pre-tax income from continuing
operations before minority interest of $1.8 million, yielding an annual
effective tax rate of 35.2%. The change in the effective tax rate for the
-25-
quarter ended March 31, 2004 compared to the quarter ended March 31, 2003
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.
Deferred tax assets 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 had 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.
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 Consumer Water
Group. Additionally, during the fourth quarter of 2003, the Company's management
and Board of Directors approved a plan 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 quarter ended March 31, 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
-------------------------------
2004 2003
--------------- --------------
Discontinued Operations
Loss from operations $ (3,303) $ (527)
Income tax benefit 604 150
--------------- --------------
Loss from discontinued operations, net of tax $ (2,699) $ (377)
=============== ==============
The loss from discontinued operations of $2.7 million, or $3.3 million on a
pre-tax basis, in the first quarter of 2004 includes losses to adjust the net
book value to the expected purchase price of the European POU business. In the
first quarter of 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 during the second quarter of 2004.
Net (Loss) Income
-----------------
The following table compares the Company's net (loss) income and percentage of
revenues for the quarter ended March 31, 2004 and 2003:
(Dollars in thousands) Quarter ended March 31,
------------------------------------------------------------------------------------
2004 Percentage of Revenue 2003 Percentage of Revenue
------------------ ----------------- ----------------- ----------------------
----------------- --------------- ------------------ ---------------
Net (loss) income $ (3,951) (3.7)% $ 576 0.7%
------------------ --------------- ------------------ ---------------
-26-
Net loss amounted to $4.0 million in the first quarter of 2004 compared to net
income of $0.6 million for the first quarter of 2003.
FINANCIAL CONDITION
The following table compares the Company's net working capital and current ratio
at March 31, 2004 and at December 31, 2003:
(Dollars in thousands)
March 31, 2004 December 31, 2003 Change
------------------ -------------------- ----------------
Total current assets $ 299,264 $ 315,818 $ (16,554)
Total current liabilities 134,765 118,092 16,673
----------------- -------------------- ----------------
Net working capital $ 164,499 $ 197,726 $ (33,227)
------------------ -------------------- ----------------
----------------- -------------------- ----------------
Current ratio 2.2 2.7 (0.5)
------------------ -------------------- ----------------
Net working capital decreased $33.2 million during the first quarter of 2004,
while the Company's current ratio, defined as current assets divided by current
liabilities, of 2.2 at March 31, 2004 decreased from 2.7 at December 31, 2003.
The decrease in the current ratio primarily reflects the use of the Company's
cash for the acquisition of the Ecolochem Group.
At March 31, 2004, the Company had total assets of $1,039.6 million, compared to
total assets of $592.0 million at December 31, 2003. The increase in total
assets primarily relates to the acquisition of Ecolochem $366.5 million and the
consolidation of Desalcott $158.5 million, upon adoption of FIN 46, on January
1, 2004. Cash and cash equivalents decreased $47.1 million, primarily reflecting
funds used for the acquisition of the Ecolochem Group in February 2004.
Net cash used in operating activities amounted to $2.1 million during the first
quarter of 2004 included the loss from continuing operations, adjusted to
exclude the effects of non-cash items for depreciation and amortization of $9.9
million and deferred tax assets of $7.9 million. These sources of operating cash
were offset by uses for increased affiliate accounts receivable of $3.4 million,
primarily from continuing work on the Kuwait wastewater project and the
reduction of other current assets of $6.9 million.
Net cash used in investing activities during the first quarter of 2004 amounted
to $232.2 million, primarily reflecting the use of $223.3 million for the
acquisition of the Ecolochem Group, net of cash acquired, and investments of
$8.3 million for property, plant, and equipment.
Net cash provided by financing activities during the first quarter of 2004
amounted to $162.6 million, reflecting the borrowings under the Company's new
credit facility established for the acquisition of the Ecolochem Group of $175.0
million, deferred financing costs of $6.2 million and restricted cash from
Desalcott upon adoption of FIN 46 on January 1, 2004.
Borrowings and Lines of Credit
------------------------------
On February 13, 2004, the Company acquired all of the outstanding shares of
capital stock and ownership interests of the Ecolochem Group from the
shareholders and owners of the Ecolochem Group for an aggregate purchase price
of $366.5 million, consisting of $219.0 million in cash (which includes $9.8
million in escrow to be paid when the Company makes a Section 338 (h) (10)
election with respect to selected acquired intangible assets) and 4,652,648
shares of the Company's common stock. The issuance of 4,652,648 shares of the
Company's common stock was valued at $139.9 million based on the closing price
of the common stock for the two days before, the day of and the two days after
the announcement by the Company of its agreement to acquire the Ecolochem Group.
The purchase price includes capitalizable acquisition costs of $7.6 million,
consisting of investment banking, legal, consulting and accounting services. The
cash portion of the consideration was financed with the Company's available cash
resources and proceeds from $255 million senior credit facilities with a
syndication of lenders led by UBS, Fleet Bank and Bank of America. Proceeds from
these credit facilities were used to fund the acquisition, pay certain
transaction-related 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 5-year revolving credit facility.
-27-
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 of its domestic subsidiaries
and by 65% of certain 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 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 credit facility, the Company entered into interest rate swap
agreements that fix the Company's LIBOR rate on $100 million of the term loan at
3.1175% per annum. The swap agreements expire in 2010.
During the first quarter of 2004, the Company was required to apply the
provisions of FIN 46 to variable interests entities created before February 1,
2003. As a result, effective January 1, 2004, the Company consolidated the
operations, assets, liabilities and minority interests of the Desalination
Company of Trinidad and Tobago Ltd. ("Desalcott"), in which the Company holds a
40% equity interest, because the Company believes it holds a majority of the
related financial risks. As of March 31, 2004, Desalcott had total assets and
total liabilities of approximately $159.5 million and $134.7 million,
respectively. Included in liabilities is debt of $112.4 million, which is
collateralized by substantially all of the assets of Desalcott, and is
non-recourse to the Company.
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 entity 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. The Company generally has no commitment to
fund the joint venture's working capital or other cash needs. The joint venture
entities typically obtain third-party debt financing for a substantial portion
of the project's total capital requirements. In these situations, the Company is
not responsible for the repayment of the indebtedness incurred by the joint
venture entity. In connection with a joint venture's project, the Company may
also enter into contracts for the supply and installation of the Company's
equipment during the construction of the project or 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.
The operations, assets, liabilities and minority interests of Desalcott are
consolidated with the Company effective January 1, 2004, as a result of the
adoption of FIN 46. The operations, assets and liabilities of the Algerian joint
venture company are consolidated with the Company as a majority-owned
subsidiary. The Kuwait and Israel projects discussed below constitute
off-balance sheet arrangements.
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 ("WASA").
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
-28-
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 collateralized 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.
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.
Upon adoption of FIN 46 (see Note 2), as of January 1, 2004, the Company has
consolidated the operations, assets, liabilities and minority interests of
Desalcott and its results of operations for the first quarter of 2004.
In April 2004, following an unsuccessful mediation attempt, Desalcott notified
WASA that it had commenced an arbitration proceeding under the dispute
resolution procedures of the water supply agreement between Desalcott and WASA
dated August 29, 1999 and amended in May 2000 (the "Water Supply Agreement").
Desalcott is seeking, among other things, payments from WASA for certain water
price increases as provided for in the Water Supply Agreement, as well as
damages for delays in plant completion which Desalcott claims resulted from
delays in obtaining a government guaranty of payments by WASA and certain tax
incentives. WASA has contested the amounts of the water price increases claimed
by Desalcott, asserting that Desalcott did not pass along to WASA certain cost
savings realized by Desalcott. In addition, WASA asserts that Desalcott's
ability to make up production shortfalls by selling excess production is more
limited contractually than claimed by Desalcott. In addition, WASA has also
asserted that Desalcott is liable for liquidated damages because of delays in
the completion of the plant, irrespective of the delay in obtaining the
government guaranty, and that such liquidated damages currently total
approximately $4.0 million and are still accumulating. WASA has asserted
additional liquidated damages will be owed by Desalcott for the delay in the
completion of Phase 5 of the project, or that in the alternative it may seek to
reject or terminate Phase 5. Under the currently projected timetable, this
matter should be heard in arbitration by the International Chamber of Commerce
in London late in 2004.
-29-
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 March
31, 2004, the Company had invested a total of $10.9 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 $6.4
million over the next two years. In addition, a total of $18.6 million in
performance bonds have been issued on behalf of the Company's Italian subsidiary
in connection with the project.
Israel
------
In 2001, the Company entered into agreements with an Israeli cooperative society
and an Israeli corporation for the establishment of Magan Desalination Ltd.
("MDL") as an Israeli project company in which the Company has a 49% equity
interest. During the second quarter of 2003, the Israeli cooperative society and
the Company acquired the ownership interest of the Israeli corporation in MDL.
In the second quarter of 2003, MDL finalized a concession contract with a
state-sponsored water company for the construction, ownership and operation of a
brackish water desalination facility in Israel. In the second quarter of 2003,
MDL obtained $8 million of debt financing for the project from an Israeli bank,
and the Company has guaranteed repayment of 49% of the loan amount in the form
of a bank letter of guarantee. In the third quarter of 2003, the Company through
its Israeli subsidiary made an equity investment of $1.5 million in MDL for its
49% equity interest. This project is scheduled to be completed in the second
quarter of 2004.
In 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"). 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. As
of March 31, 2004, the Company had made an equity investment of $0.2 million in
CDL and had deferred costs of $0.6 million relating to the engineering design
and development work on the project. 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. CDL was unable to obtain long-term
financing by the required date. CDL asserts that its inability to obtain
financing resulting from certain errors and omissions in WDAs tendering process
which would have prevented CDL from constructing the facility as provided. On
April 1, 2004 the WDA notified CDL of its intent to terminate the concession
agreement and to take action to collect on a performance bond (of which it is
the beneficiary) issued on behalf of CDL. On May 5, 2004, the WDA issued a
notice of termination to CDL and made a demand upon the issuing bank of the
performance bond. The Company's liability under the performance bond is
approximately $2.5 million (a one-third proportionate share of the approximate
$7.5 million performance bond). During the first quarter of 2004, as a result of
the notification by the WDA of their intent to collect on the performance bond,
the Company recorded a liability of $2.5 million related to its proportionate
share. In addition, the Company expensed its deferred costs relating to the
construction project and its investment in CDL of $0.8 million. The dispute
between CDL and the WDA concerning the errors and omissions in the tendering
process, the termination of the concession agreement and the demand made upon
the bid bond has been submitted to binding arbitration in Israel (with CDL and
WDA both as claimants and respondents), and it is expected that the matter will
be heard and a decision rendered by the arbitrator in the third quarter of 2004.
The Company believes that it has legitimate claims and meritorious defenses in
this matter and, in cooperation with the Company's partners in CDL and CDL's
outside counsel, intends to aggressively pursue recovery of performance bond
payments made to WDA as well as other damages.
In the third quarter of 2003, a 50/50 joint venture between the Company and an
Israeli engineering corporation was selected by Mekorot, the Israeli
state-sponsored water company, to design, supply and construct a 123,000 cubic
meter per day (32.5 million gallons per day) seawater desalination facility in
Ashdod, Israel. The estimated value 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 construct. 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 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.
-30-
Algeria
-------
In the fourth quarter of 2003, the Company and Algerian Energy Company (AEC)
were selected for a 25-year seawater desalination build-own-operate project.
Sonatrach, the Algerian 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), in which the Company has a 70% ownership interest.
The projected $220 million capital investment will be financed by a combination
of equity and non- recourse debt. Through March 31, 2004, the Company made an
equity investment of $0.2 million in HWD and 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.
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 and other undertakings
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 with the exception of the performance
bond associated with CDL, as previously described. Approximately $113.7 million
of these instruments were outstanding at March 31, 2004. 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 the first three months of 2004 is not material. Accordingly, the
Company has not recorded any liabilities for these instruments as of March 31,
2004.
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. The Company has made a variety of warranties and
indemnifications to sellers and purchasers that are typical for such
transactions through the first quarter of 2004. The Company has not recorded any
liabilities for these obligations as of March 31, 2004, as it believes that it
will incur no liabilities under such provisions.
The following table reflects significant changes to the Company's contractual
obligations from December 31, 2003. The cash portion of the Ecolochem
acquisition was primarily financed from the proceeds from the new $255 million
senior credit facilities with the syndication of lenders. The facilities consist
of a $175 million 7-year term loan and an $80 million 5-year revolving credit
facility. Also, pursuant to FIN 46, effective January 31, 2004, the Company
consolidated the assets, liabilities and minority interests of Desalcott. The
Desalcott debt consists of 20-year loans and is secured by substantially all the
assets of Desalcott, and is non-recourse to the Company.
-31-
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 $ 2,425 $ 3,113 $ 3,288 $ 2,969 $ 11,795
Debt for Ecolochem acquisition 1,750 3,500 3,500 166,250 $ 175,000
Desalcott Notes Payable 4,954 10,695 11,618 85,175 $ 112,442
--------------------------------------------------------------------------------
-------------------------------------------------------------------------------
Total Contractual Obligations $ 9,129 $ 17,308 $ 18,406 $ 254,394 $ 299,237
================================================================================
Maturities of all cash borrowings outstanding for the five years ended December
31, 2004 through December 2008 are approximately $9.1 million, $8.1 million,
$9.2 million, $9.1 million, $9.3 million, respectively, and $254.4 million
thereafter. The weighted average interest rate on all borrowings was 6.33% and
6% at March 31 2004 and December 31, 2003, respectively.
The Company believes that its existing and cash equivalents, cash generated from
operations, and senior credit facilities will be sufficient to fund its capital
expenditures, working capital requirements and contractual obligations and
commitments at least through 2005.
FORWARD-LOOKING INFORMATION
Safe Harbor Statement under Private Securities Litigation Reform Act of 1995
----------------------------------------------------------------------------
Certain statements contained in this report, including, without limitation,
statements regarding expectations as to the Company's future results of
operations, statements in the "Notes to the Consolidated Financial Statements"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" constitute forward-looking statements. Such statements are based on
management's current views and assumptions and are neither promises nor
guarantees but involve risks, uncertainties and other factors that could cause
actual results to differ materially from management's current expectations as
described in such forward-looking statements. Among these factors are the
matters described under "Risks and Uncertainties" contained in the "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
section of the Company's Annual Report on Form 10-K for the year ended December
31, 2003, 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 activities of the Ecolochem Group with those of the Company;
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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Derivative Instruments
----------------------
The Company enters into foreign exchange contracts including forwards, options
and swaps. The Company's policy is to enter into such contracts only for the
purpose of managing exposures and not for speculative purposes. The Company
holds a series of U.S. dollar/euro forward contracts that were executed to
offset the foreign exchange risk associated with forecasted revenues related to
an ongoing project. As of March 31, 2004, the notional amount of the contracts
was $4.4 million. The fair value of the forward contracts, which was $0.6
million at March 31, 2004, is recorded in the "Other current assets" section of
the Consolidated Balance Sheets. End of period changes in the market value of
the forward contracts that qualify as cash flow hedging contracts are recorded
as a component of "Accumulated other comprehensive loss" in the "Stockholders'
equity" section of the Consolidated Balance Sheets.
The Company also maintains foreign exchange forward contracts to hedge the
balance sheet exposure related to an intercompany loan. At March 31, 2004, the
-32-
fair value of the forward contracts, which was immaterial, was recorded in the
"Other current assets" section of the Consolidated Balance Sheets. The end of
period change in the fair market value of the contracts, which was immaterial,
was recorded in "Selling, general and administrative" expenses. At March
31,2004, a hypothetical change of 10% in exchange rates would change the fair
value of the Company's portfolio of foreign exchange contracts by approximately
$1.0 million.
Market Risk
-----------
The Company's primary market risk exposures are in the areas of interest rate
risk and foreign currency exchange rate risk. The Company's investment portfolio
of cash equivalents is subject to interest rate risk fluctuations, but the
Company believes the risk is not material due to the short-term nature of these
investments. At March 31, 2004, the Company had $9.1 million of short-term debt
and $299 million of long-term debt outstanding. 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. In connection with the
acquisition of the Ecolochem Group and the execution of the credit facility, the
Company entered into interest rate swap agreements that fix the Company's LIBOR
rate on $100 million of the term loan at 3.1175%. The swap agreements expire in
2010. The Company's net foreign exchange currency gain was $0.6 million and $0.3
million for the three months ended March 31, 2004 and 2003, respectively. The
Company's exposure to foreign currency exchange rate fluctuations is mitigated
by the fact that the operations of its international subsidiaries are primarily
conducted in their respective local currencies. Also, in certain situations, the
Company enters into foreign exchange contracts to mitigate the impact of foreign
exchange fluctuations.
ITEM 4. CONTROLS AND PROCEDURES
The Company carried out an evaluation, under the supervision and with the
participation of the Company's management, including the Company's Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
Company's "disclosure controls and procedures" as of March 31, 2004. 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
March 31, 2004 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 first quarter ended March 31, 2004 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.
-33-
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On April 28, 2004, the Company was served with a summons and complaint captioned
Caldon, Inc. v. Ionics, Incorporated and Key Technologies, Inc., filed in the
U.S. District Court for the Western District of Pennsylvania, Pittsburgh.
Caldon, Inc. ("Caldon") alleges that certain flow measurement systems which it
provides to the nuclear power industry to measure feedwater flow, and which were
designed by defendant Key Technologies, Inc. and fabricated by the Company's
Bridgeville division, failed after installation. Caldon further alleges that
defendant Key Technologies, Inc. failed to design the systems adequately and
that the Company failed to weld the systems properly. Caldon claims that it has
incurred damages in excess of $2.7 million and has made commitments to customers
that will cause it to incur an additional $4.0 million, as well as other damages
in an unspecified amount. The Company believes that Caldon's allegations as to
the Company are without merit, and intends to defend itself vigorously in this
matter. While the Company believes that this 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 made no
assurances as to the ultimate outcome of this matter.
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.
("Intersuero"). 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, interest 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
a) A Special Meeting of Stockholders of the Company was held on February 11,
2004.
c) The following matters were acted upon by the stockholders:
(i) Authorization to issue up to 4,905,660 shares of common stock in
connection with the Company's proposed acquisition of Ecolochem,
Inc. and its affiliated companies.
Votes For: 12,668,595
Votes Against: 131,143
Abstain: 50,749
Broker Non-Votes: 3,450,092
(ii) Approval of an amendment to the Company's Articles of
Organization to increase the number of authorized shares of
common stock from 55 million to 100 million.
Votes For: 13,401,534
Votes Against: 2,851,762
Abstain: 47,283
(iii) Approval of an amendment to the Company's 1997 Stock Incentive
Plan to increase the number of shares available for issuance
thereunder by 1,200,000 shares.
Votes For: 9,143,817
Votes Against: 3,669,061
Abstain: 37,609
Broker Non-Votes: 3,450,092
-34-
(iv) Approval of an amendment to the Company's 1997 Stock Incentive
Plan to authorize grants of restricted stock thereunder.
Votes For: 9,199,953
Votes Against: 3,616,884
Abstain: 33,650
Broker Non-Votes: 3,450,092
-35-
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) 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 (filed as *
Exhibit 3.1(e) to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.0 Material Contracts
10.1 Amended and Restated 1997 Stock Incentive Plan, as amended through March 11, 2004 *
(filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2003).
10.2 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).
10.3 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).
10.4 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).
-36-
10.5 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).
10.6 Section 338 Escrow Agreement among the Company, the entities and persons listed *
on Annex A thereby, 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).
10.7 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).
10.8 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 (filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2003).
10.8(i) Amendment No. 1 to Credit Agreement dated as of March 15, 2004. +
10.9 Security Agreement dated as of February 13, 2004 among the Company as Borrower; *
certain of its domestic subsidiaries as Guarantors; and UBS A.G., Stamford Branch
as Collateral Agent (filed as Exhibit 10.29 to the Company's Annual Report on
Form 10-K for the year ended December 31, 2003).
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.
-37-
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 March 31,
2004, as follows:
(i) Filed February 12, 2004, disclosing under item 5 and filing as
exhibits the unaudited combined financial statements of the
Ecolochem Group as of December 31, 2003 and for the three
months ended December 31, 2003 and 2002. The unaudited
combined financial statements of the Ecolochem Group were
filed as exhibits.
(ii) Filed February 17, 2004, reporting under item 5 the issuance
of a press release announcing the completion of the
acquisition of Ecolochem, Inc. and its related companies. The
press release was filed as an exhibit.
(iii) Filed February 27, 2004, reporting under item 2 the
acquisition of the stock and membership interests of
Ecolochem, Inc., and its affiliated companies. The Purchase
Agreement, certain other agreements entered into in connection
with the acquisition, and certain financial statements of the
acquired business were filed as exhibits.
(iv) Filed March 16, 2004, reporting under item 5 the issuance of a
press release announcing the election of a new director by the
Board of Directors, the appointment of a lead independent
director, and the appointment of a new Chairman of the Board
effective May 6, 2004. The press release was filed as an
exhibit.
(v) Filed March 19, 2004, reporting under item 5 the issuance of a
press release announcing the departure of an officer of the
Company and the appointment of an officer. The press release
was filed as an exhibit.
In addition, the Company filed two additional reports on Form 8-K dated March
16, 2004, furnishing under items 9 and 12 a financial results press release and
a slide presentation used in an investor conference.
-38-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
IONICS, INCORPORATED
Date: May 10, 2004 By: /s/Douglas R. Brown
----------------------------------------
Douglas R. Brown
President and Chief Executive Officer
(duly authorized officer)
Date: May 10, 2004 By: /s/Daniel M. Kuzmak
----------------------------------------
Daniel M. Kuzmak
Vice President and Chief Financial Officer
(principal financial officer)
-39-
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 (filed as *
Exhibit 3.1(e) to the Company's Annual Report on Form 10-K for the year ended
December 31, 2003).
10.0 Material Contracts
10.1 Amended and Restated 1997 Stock Incentive Plan, as amended through March 11, 2004 *
(filed as Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year
ended December 31, 2003).
10.2 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).
10.3 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).
10.4 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).
10.5 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).
-40-
10.6 Section 338 Escrow Agreement among the Company, the entities and persons listed *
on Annex A thereby, 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).
10.7 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).
10.8 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 (filed as Exhibit 10.28 to the Company's Annual Report on Form 10-K for
the year ended December 31, 2003).
10.8(i) Amendment No. 1 to Credit Agreement dated as of March 15, 2004. +
10.9 Security Agreement dated as of February 13, 2004 among the Company as Borrower; *
certain of its domestic subsidiaries as Guarantors; and UBS A.G., Stamford Branch
as Collateral Agent (filed as Exhibit 10.9 to the Company's Annual Report on Form
10-K for the year ended December 31,2003)..
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.
-41-
EXHIBIT 31.0(i)
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, Douglas R. Brown, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ionics,
Incorporated;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s)s and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
most recent fiscal quarter (the registrant's fourth fiscal quarter in
the case of an annual report) that has materially affected, or is
reasonably likely to materially affect, the registrant's internal
control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect the
registrant's ability to record, process, summarize and report
financial information; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
/s/Douglas R. Brown
---------------------------------------------
Douglas R. Brown
President and Chief Executive Officer
Date: May 10, 2004
-42-
EXHIBIT 31.0(ii)
CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Daniel M. Kuzmak, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Ionics,
Incorporated;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which
such statements were made, not misleading with respect to the period
covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal
control over financial reporting (as defined in Exchange Act Rules
13a-15(f) and 15d-15(f)) for the registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the
period in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls and
procedures, as of the end of the period covered by this report
based on such evaluation; and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially affect,
the registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed,
based on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information;
and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
/s/Daniel M. Kuzmak
-------------------
Daniel M. Kuzmak
Vice President and Chief Financial Officer
Date May 10, 2004
-43-
EXHIBIT 32.0(i)
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Ionics, Incorporated (the "Company")
on Form 10-Q for the quarter ended March 31, 2004 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), the undersigned
hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company.
/s/Douglas R. Brown
-----------------------------------------------
Douglas R. Brown
President and Chief Executive Officer
Date: May 10, 2004
-44-
EXHIBIT 32.0(ii)
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Ionics, Incorporated (the "Company")
on Form 10-Q for the quarter ended March 31, 2004 as filed with the Securities
and Exchange Commission on the date hereof (the "Report"), the undersigned
hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934, as amended; and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of
the Company.
/s/Daniel M. Kuzmak
---------------------------------------------------
Daniel M. Kuzmak
Vice President and Chief Financial Officer
Date May 10, 2004