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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 02549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION
13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number: 1-7211
IONICS, INCORPORATED
(Exact name of registrant as specified in its charter)
Massachusetts 04-2068530
(State of incorporation) (IRS Employer Identification Number)
65 Grove Street 02472-2882
Watertown, Massachusetts (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (617)926-2500
Securities registered pursuant to Section 12(b) of the Act: Common Stock,
$1.00 par value
Name of each exchange on which registered: New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ___
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
[X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes X No ___
The aggregate market value of the Common Stock of the registrant held by
non-affiliates as of June 28, 2002 was $415,244,560 (17,123,487 shares at $24.25
per share) (includes shares owned by a trust for the indirect benefit of a
non-employee director, and by a trust for the indirect benefit of a spouse of a
non-employee director).
As of March 21, 2003, 17,555,046 shares of Common Stock, $1.00 par value, were
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant intends to file a definitive proxy statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December 31,
2002. Portions of such proxy statement are incorporated by reference into Item 5
and Part III of this Annual Report on Form 10-K.
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IONICS, INCORPORATED
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2002
TABLE OF CONTENTS
PART I............................................................................................................. 3
ITEM 1. BUSINESS....................................................................................3
ITEM 2. PROPERTIES.................................................................................14
ITEM 3. LEGAL PROCEEDINGS..........................................................................15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS........................................15
PART II............................................................................................................15
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS........................
15
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.......................................................16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS........
16
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK..................................36
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA...................................37
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.........
71
PART III...........................................................................................................71
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.........................................71
ITEM 11. EXECUTIVE COMPENSATION.....................................................................71
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT...............................
72
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.............................................72
ITEM 14. CONTROLS AND PROCEDURES....................................................................72
PART IV............................................................................................................73
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K...........................73
SIGNATURES.........................................................................................................77
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS.........................................................................37
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PART I
Except for historical information, the matters discussed in this Annual Report
on Form 10-K are forward-looking statements that involve risks and
uncertainties. The Company makes such forward-looking statements under the
provision of the "Safe Harbor" section of the Private Securities Litigation
Reform Act of 1995. Actual future results may vary materially from those
projected, anticipated, or indicated in any forward-looking statements as a
result of certain risk factors. Readers should pay particular attention to the
considerations described in the section of this report entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations - Risks
and Uncertainties and Forward Looking Information." Readers should also
carefully review the risk factors described in the other documents that we file
from time to time with the Securities and Exchange Commission. In this Annual
Report on Form 10-K, the words "anticipates," "believes," "expects," "intends,"
"future," "could," and similar words or expressions (as well as other words or
expressions referencing future events, conditions or circumstances) identify
forward-looking statements.
ITEM 1. BUSINESS
General
Ionics, Incorporated ("Ionics," or the "Company") is a 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. Ionics' products and services
are used by the Company or its customers to desalt brackish water and seawater,
recycle and reclaim process water and wastewater, treat water in the home,
manufacture and supply water treatment chemicals and ultrapure water, process
food products, and measure levels of waterborne contaminants and pollutants. The
Company's customers include industrial companies, consumers, municipalities and
other governmental entities, and utilities. Unless the context indicates
otherwise, the terms "Ionics" and "Company" as used herein includes Ionics,
Incorporated and all its subsidiaries.
Over fifty years ago, the Company pioneered the development of the ion-exchange
membrane and the electrodialysis process. Since that time, the Company has
expanded its separations technology base to include a number of membrane and
non-membrane-based separations processes which the Company refers to as The
Ionics Toolbox(R). These separations processes include electrodialysis reversal
(EDR), reverse osmosis (RO), ultrafiltration (UF), microfiltration (MF),
electrodeionization (EDI), electrolysis, ion exchange, ozonation, carbon
adsorption, and thermal processes such as evaporation and crystallization. The
Company believes that it is the world's leading manufacturer of ion-exchange
membranes and of membrane-based systems for the desalination of water.
The Company's business activities are reported in four business group segments,
which the Company put into place in 1998. The business group structure is based
upon defined areas of management responsibility with respect to markets,
applications and products. The Company believes that each business group segment
comprises, and represents, a class of similar products or product lines used in
particular water treatment applications. These business group segments are the
Equipment Business Group, Ultrapure Water Group, Consumer Water Group, and
Instrument Business Group. In 2002, these segments accounted for approximately
49.5%, 30.5%, 11.6% and 8.4%, respectively, of the Company's total revenues. See
Note 17 to the Consolidated Financial Statements for additional information
regarding the Company's four business segments. On December 31, 2001, the
Company sold its Aqua Cool Pure Bottled Water division, constituting the major
portion of the assets of the Consumer Water Group. Approximately 40% of the
Company's 2002 revenues were derived from foreign sales or operations.
Within the existing business group structure, the Company has instituted a
matrix-type organization which became effective at the beginning of 2002. Within
each business group, the Company has begun to focus on "centers of excellence,"
which represent the application of treatment or separation technologies
contained in The Ionics Toolbox(R) to solve certain application problems. The
Company utilizes its water treatment and liquids separation expertise by
employing its own proprietary products and other commodity products in the best
integrated combination to solve customers' application problems. These centers
of excellence include desalination, reuse, surface water, microelectronics,
pharmaceuticals and instruments, among others, and each represents a range of
technology solutions to solve a related applications problem. In 2002, no center
of excellence accounted for 10% or more of the Company's total revenues. The
Company will continue to report its results under the current "business group"
segment structure. Starting in 2002, as part of the matrix organization, the
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lease of trailers for the production of ultrapure water is included in the
results of the Ultrapure Water Group, rather than the Equipment Business Group,
where such results had been included through 2001. In addition, the Company's
non-consumer bleach-based chemical supply business, which through 2001 had been
included in the results of the Equipment Business Group, is included in the
results of the Ultrapure Water Group starting in 2002. The discussion and
financial results contained in this Annual Report on Form 10-K reflect these
changes for all periods presented.
The Company was incorporated in Massachusetts in 1948. The Company's principal
executive offices are located at 65 Grove Street, Watertown, Massachusetts
02472.
Information about Business Segments
Equipment Business Group
- ------------------------
The Equipment Business Group accounted for approximately 49.5% of revenues in
2002. This segment provides technologies, treatment systems and services for
seawater desalination, surface water treatment, brackish water desalination,
wastewater reuse and recycle, potable water and high purity water. In addition,
this segment includes the Company's custom fabrication activities and food
processing activities, neither of which are significant activities on which the
Company's business, results of operations or cash flows have relied.
Desalination and Related Water Treatment Equipment and Processes
- ----------------------------------------------------------------
Opportunities for the sale of desalination and related water treatment equipment
and processes arise from changes in the needs of people and municipalities, from
industrial shifts and growth, and from environmental concerns. With less than 1%
of the total water on the planet fresh and usable, desalination has played an
important role in creating new water sources.
The Company sells a wide spectrum of products and systems to serve this market,
which utilize technologies including EDR, ion exchange, EDI, RO, UF, ozonation
and carbon adsorption. Depending on the customers' needs, the Company provides
standardized versions of systems utilizing one or more of the technologies
mentioned, or can supply complete turnkey plants that may include standardized
models as well as peripheral water treatment equipment, complete engineering
services, process and equipment design, project engineering, commissioning,
operator training and field service.
As examples of the Company's activities in this market, during 2002 the Company
received an order from Mason City, Iowa for the sale of EDR-based equipment to
desalinate ground water used by the municipality for drinking water. In
addition, the Company booked an order from the Foss Reservoir Conservancy
District in Oklahoma for the sale of EDR-based equipment to desalinate surface
water used by the District for drinking water.
The Company has also been participating in a growing market for surface water
treatment equipment as municipalities are being required to meet increasingly
stringent regulations for ensuring safe drinking water quality. For example, in
late 2001 the Company received an order for equipment from the City of
Minneapolis for the sale of UF-based water treatment equipment to treat surface
water used by the city for drinking water, and construction of this facility was
well underway by the end of 2002. The Company believes that this facility will
be the largest ultrafiltration water treatment plant in the United States.
Wastewater Treatment Equipment and Processes
- --------------------------------------------
The market for the treatment, recycle and reuse of wastewater has shown
significant growth as world demand for water of specified quality continues to
increase and as regulations limiting waste discharges to the environment
continue to mount. The wastewater market is increasingly driven by the concept
of what Ionics calls "Ionics Total Water Management(R)," which involves the
recognition that the water streams which enter, leave or become part of a
process can be treated for use, recycle or discharge to achieve overall economic
efficiencies. Ionics services the wastewater market with proprietary brine
concentrators and crystallizers, traditional wastewater treatment equipment, and
special EDR membrane-based concentrators for recycle and reuse.
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The Company designs, engineers and constructs brine concentrators, evaporators
and crystallizers which are used to clean, recover and recycle wastewater,
particularly in "zero liquid discharge" (ZLD) industrial uses. Such systems may
also incorporate EDR membrane systems as preconcentrators, and EDI membrane
systems for further treatment of wastewater. A representative example in 2002
was the selection of the Company by the Orlando Utilities Commission in Florida
to supply a brine concentrator and crystallizer ZLD system for the Stanton
Energy Combined Cycle Unit A Power Plant.
Ionics also designs, engineers and constructs customized systems for industrial
wastewater customers which may include conventional treatment systems as well as
advanced separation technologies such as EDR, RO, UF and MF. Typical industrial
customers are power stations, chemical and petrochemical plants, manufacturers
and a variety of other industrial applications. The Company also provides custom
and packaged sewage treatment systems for municipalities and advanced membrane
systems that treat waste from conventional sewage treatment plants so that the
treated wastewater can be recycled and reused for irrigation and process water
needs.
As an example of the Company's activities in membrane-based wastewater
treatment, during 2002, Utilities Development Company W.L.L. (UDC), a Kuwaiti
project company in which the Company has a 25% ownership interest, commenced
activities under a contract to construct, own and operate the largest
membrane-based water reuse facility in the world. The Company is also serving as
a membrane equipment supplier to UDC under an $85 million supply contract
awarded in 2002. For further discussion regarding UDC, see Item 7 of this Annual
Report on Form 10-K under the caption "Financial Condition" and Note 8 to the
Consolidated Financial Statements contained in Item 8 of this Annual Report on
Form 10-K.
Water Supply for Drinking and Industrial Use
- --------------------------------------------
Ionics' position as a seller of purified or treated water has evolved from its
traditional role as a supplier of water treatment equipment. In certain
situations, opportunities are available for the Company to supply the water
itself through the ownership and operation of the water purification facility.
In these situations, the Company is responsible for the financing, construction,
operation and maintenance of the water treatment facilities. For large-scale
water treatment projects, the Company has been utilizing a business model for
participating in such projects using a project company in which the Company
typically will hold a minority equity interest.
As an example, during 2002, a three-member team, including the Company, was
selected by the Ministry of Finance and the Ministry of Infrastructure in Israel
to supply 30 million cubic meters per year of potable water under a 24 year and
11 month build-own-operate (BOO) contract. The team has formed a project company
which is currently seeking financing for the project. For further discussion
regarding this project see Item 7 of this Annual Report on Form 10-K under the
caption "Financial Condition" and Note 8 to the Consolidated Financial
Statements contained in Item 8 of this Annual Report on Form 10-K.
Ionics, through its wholly-owned subsidiary, Ionics Iberica, S.A., owns and
operates an EDR facility with capacity to treat 5.5 million gallons per day of
brackish water and an RO seawater facility with capacity to treat 3.6 million
gallons per day on Grand Canary Island, Spain. Under long-term contracts, the
Company sells the desalted water from both facilities to the local water utility
for distribution.
The Company's wholly owned subsidiary, Ionics (Bermuda) Ltd., owns and operates
an EDR brackish water plant with capacity to treat 600,000 gallons per day on
the island of Bermuda. This plant supplies fresh water under a long-term
contract with Watlington Waterworks Ltd., a Bermuda corporation partially owned
by Ionics.
In the second quarter of 2002, construction was completed with respect to the
first four out of five phases of what the Company believes will be the largest
membrane-based seawater desalination plant in the Western Hemisphere, which is
located in Trinidad. The seawater reverse osmosis (SWRO) desalination plant
provides the Water and Sewerage Authority of Trinidad and Tobago (WASA) and the
industries of the Point Lisas Industrial Estate with a high quality water supply
for industrial requirements. This $120 million project is owned and operated by
a joint venture between the Company (which has a 40% equity ownership interest
in the venture) and its local partner, Hafeez Karamath Engineering Services Ltd.
The plant began to produce and deliver water during 2002 and has a current
design capacity of 26.4 million gallons per day, which will be expanded to 28.7
million gallons per day. For further discussion regarding the Trinidad project
see Item 7 of this Annual Report on Form 10-K under the caption "Financial
Condition" and Note 8 to the Consolidated Financial Statements contained in Item
8 of this Annual Report on Form 10-K.
-5-
The Company also owns and operates more than 40 desalination plants on a number
of Caribbean islands, which provide drinking water to hotels, resorts and
governmental entities. Drinking water on these islands is usually supplied
pursuant to water supply contracts with terms ranging from five to ten years. On
the island of Barbados, a 7.9 million gallon per day brackish water RO plant
which started up successfully in the first quarter of 2000, is providing fresh
potable drinking water to about one-fifth of the island's population.
Desalinated water is being provided to the Barbados Water Authority on a build,
own, operate (BOO) basis by a joint venture (in which the Company has a
controlling ownership interest) between Ionics and its local partner, Williams
Industries.
The Equipment Business Group also carries out the following business activities:
a) Fabricated Products
At its Bridgeville and Canonsburg, Pennsylvania facilities, the Company
fabricates products for industrial and defense-related applications.
b) Food Processing
Under an agreement with a major U.S. dairy cooperative, the Company
oversees whey-processing activities at two plants owned by the
cooperative, and earns revenue based on the production of demineralized
whey for its services. Included in the equipment being utilized at
these plants are its Electromat(R) electrodialysis systems.
Ultrapure Water Group
- ---------------------
The Ultrapure Water Group accounted for approximately 30.5% of the Company's
2002 revenues. This segment provides equipment and other related products for
specialized industrial users of ultrapure water, such as companies in the life
sciences, chemical, microelectronics and power industries. With the Company's
acquisition of Enchem(R) wastewater treatment technology in July 2002, the
Ultrapure Water Group is now able to provide equipment that treats certain
semiconductor industry wastewater streams. Ultrapure water is purified by a
series of processes to the degree that remaining impurities are measured in
parts per billion or trillion. The microelectronics industry has historically
been a significant source of the revenues of the Ultrapure Water Group, and
softness in the microelectronics industry negatively affected the performance of
the Ultrapure Water Group in 2002 and 2001.
Ultrapure Water Equipment
- -------------------------
The demand for technologically advanced ultrapure water equipment and systems
has increased as the industries which use ultrapure water have become more
knowledgeable about their quality requirements and as such requirements have
become more stringent. Ultrapure water needs are particularly important in the
semiconductor, pharmaceutical, petroleum and power generation industries. The
semiconductor industry in particular has increasingly demanded higher purity
water as the circuits on silicon wafers have become more densely packed.
The Company supplies sophisticated ultrapure water systems, which utilize a
combination of ion-exchange, EDI, RO and UF technologies. These systems are
either trailer-mounted or land-based and vary from standardized modules to large
multimillion dollar systems, depending on the customer's requirements.
The Company has been pursuing customers in the developing microelectronics
market in the Far East. For example, during 2002, Ionics was awarded contracts
with Corning and Chungwa Picture Tube (CPT) for supply of water systems to
manufacturing companies in the flat panel market. In addition, Ionics has
supplied new systems to Taiwan Semiconductor Mfg. Corp. (TSMC) for wastewater
reuse. Ionics has established a subsidiary in China for the manufacture of water
systems to serve the China market and for export.
The Company established the Ionics Life Sciences division at the beginning of
1999 to expand its delivery of ultrapure water equipment and services to the
pharmaceutical and biotechnology markets. In 2002, Ionics has developed and
supplied systems in the U.S., Singapore, and Europe. In addition, Ionics has
introduced standardized systems for these markets.
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Ultrapure Water Supply
- ----------------------
In industries such as power generation, semiconductors, pharmaceuticals and
biotechnology, ultrapure water is critical to product volume, quality and yield.
Depending on the composition and quantity of the impurities to be removed or
treated, any one of several membrane separations methods can be utilized to
provide ultrapure water to the customer. Ionics has pioneered in the application
of three membrane technologies (EDR, RO and UF) combined together in a mobile
system called the "triple membrane" trailer (TMT) for use in the commercial
processing of ultrapure water. Ionics provides ultrapure water services and the
production and sale of ultrapure water from trailer-mounted units at customer
sites (until 2002, this activity had been included in the Equipment Business
Group).
The Company's EDI technology is becoming increasingly utilized in the production
of ultrapure water. EDI is a continuous, electrically driven, membrane-based
water purification process, which produces ultrapure water without the use of
strong chemical regenerants, such as sulfuric acid and caustic soda, which are
commonly required. The Company's TMT-II trailers utilize a combination of EDI,
RO and UF technologies and represent what the Company believes to be the most
advanced technology used in the commercial processing of ultrapure water.
At the end of 2002, Company-owned or operated equipment for the production of
ultrapure water and other purified process water under contracts with companies
in various industries had a total capacity of approximately 29,000 gallons per
minute.
One of the Company's important ultrapure water activities is ion-exchange
regeneration, which is provided at four U.S. locations and two foreign
locations. The Company also provides system sanitization and high-flow
deionization services at customer sites.
The Company has been expanding its ultrapure water activities in the Asian
market. The Company established an ultrapure water sales, service and
regeneration facility in Singapore in 1998, opened an office in Taiwan in 1999,
and commenced operation of the first resin regeneration facility in Taiwan in
2002.
Chemical Supply
- ---------------
The Company uses its Cloromat(R) electrolytic membrane-based technology to
produce sodium hypochlorite and related chlor-alkali chemicals for industrial,
commercial and other non-consumer applications. These activities are carried out
by the Company's wholly owned Australian subsidiary, Elite Chemicals Pty. Ltd.
(Elite), and the Company's wholly-owned Mexican subsidiary, Ionics Acapulco Ltd.
(until 2002, this activity had been included in the Equipment Business Group).
Consumer Water Group
- --------------------
This business group segment accounted for approximately 11.6% of the Company's
2002 revenues. The Company's consumer water products currently serve the home
water purification and consumer bleach-based product market. On December 31,
2001, the Company completed the sale of its Aqua Cool Pure Bottled Water
business conducted in the United States, United Kingdom, and France, to
affiliates of Perrier Vittel S.A., a subsidiary of Nestle S.A. In this
transaction, the Company received total proceeds of approximately $207 million,
following finalization of contractual purchase price adjustments in the first
quarter of 2003. See Note 16 to the Consolidated Financial Statements contained
in Item 8 of this Annual Report on Form 10-K. The Company retains equity
ownership interests in certain joint venture entities in Bahrain, Kuwait and
Saudi Arabia which are engaged in the bottled water business.
Home Water Purification Systems
- -------------------------------
Point-of-Entry Devices
Ionics' point-of-entry water products include ion-exchange water conditioners to
"soften" hard water, and chemicals and media for filtration and treatment. The
Company sells its products, under the General Ionics and other brand names,
through both independent distributorships and wholly owned sales and service
dealerships.
-7-
Point-of-Use Devices
The Company participates in the "point-of-use" market for over- and
under-the-sink water purifiers through the sale of RO and activated carbon-based
filtering devices, and through the manufacture and sale of HYgene(R), a
proprietary, EPA-registered, silver-impregnated activated carbon filtering
medium. The Company incorporates HYgene, which is designed to prevent bacterial
build-up while providing the capability of removing undesirable tastes and odors
from the water supply, into its own bacteriostatic water conditioners and also
sells HYgene to manufacturers of household point-of-use water filters.
Other Products
The Company's Elite Consumer Products division operates a Cloromat(R) facility
in Ludlow, Massachusetts to produce and distribute bleach-based products for the
consumer market, primarily one-gallon bleach products under private label or
under the Company's own "Elite(R)", "Super ValueTM" and "UltraPureTM" brands,
and methanol-based automobile windshield wash solution.
Instrument Business Group
- -------------------------
The Company's Instrument Business Group accounted for approximately 8.4% of the
Company's 2002 revenues. This segment designs and manufactures analytical
instruments that serve the pharmaceutical, microelectronic, chemical, power
generation, environmental, municipal water, food and beverage, and medical
research industries. The Instrument Business Group derives more than 40% of its
revenues from service, consumables, spare parts, and training products from its
installed base of more than 8,000 units. During 2000, the Ionics Instrument
Division, which was located in Watertown, Massachusetts, was moved and
consolidated with Ionics Sievers Instruments, located in Boulder, Colorado. This
business group also includes Ionics Agar Environmental, located in Herzlia,
Israel. The Company is a leading manufacturer of instruments that measure total
organic carbon (TOC) across the water "spectrum" from ultrapure water to
wastewater. The Sievers(R) Model 400ES TOC analyzer, introduced at the end of
2001, is designed specifically to comply with United States Pharmacopoeia (USP)
and European Pharmacopoeia (EP) requirements for determining water quality in
the pharmaceutical industry. Ionics' Instrument Business Group offers TOC
analyzers sensitive to the parts-per-trillion range, designed specifically for
ultrapure water measurement in the semiconductor and power generation
industries. In the fourth quarter of 2001, the Company introduced the first
on-line boron analyzer designed specifically for continuous measurement of trace
boron contamination, a capability particularly important in the semiconductor
and power industries.
In 2002 the Company introduced enhancements to its Model 400ES TOC Analyzer that
facilitates pharmaceutical company compliance with FDA electronic record-keeping
requirements. Additionally, the Company expanded its consumables and service
business capability with a new range of products and services, and an expanded
production facility for the manufacture of calibration standards for its
pharmaceutical customers.
In addition to the Sievers product line, the Company offers a full line of TOC
monitors for process water and wastewater applications, as well as other
instruments.
The Company's Ionics Agar Environmental division, acquired in 1999, offers a
line of instruments for the detection of thin layers of oil on water. The
Company's Leakwise(R) oil-on-water detection systems are used by a range of
industries from oil refining to power generation. In 2002, the Company
introduced its Leakwise ID-227WL wireless system for remote sensing and
satellite/cellular communication of environmental oil spills.
Other Information Concerning the Business of the Company
Foreign Operations
- ------------------
The Company has significant operations outside the United States. The Company's
sales to customers in foreign countries primarily involve desalination systems,
ultrapure water systems, water and wastewater treatment systems, Cloromat
systems, instruments and related products and services. The Company believes
that this geographic diversity provides stability to its operations and revenue
streams to offset geographic economic trends and offers it an opportunity to
expand into new markets for its products. The Company conducts operations
outside the United States directly or through its wholly-owned subsidiaries
located in Australia, China, Bermuda, the Caribbean, England, France, Ireland,
Israel, Italy, Korea, Mexico, Singapore, Spain and Taiwan. In addition, the
Company also conducts operations outside the United States through affiliated
-8-
companies and joint venture relationships in the Caribbean (including Trinidad),
Bahrain, Israel, Japan, Kuwait, Mexico and Saudi Arabia. Of these affiliated
company and joint venture operations, the Company believes that the Kuwait,
Trinidad and Mexico ventures are material to its business on a consolidated
basis.
Revenues from operations outside the United States totaled $122.6 million in
2002, $146.2 million in 2001 and $151.5 million in 2000, accounting for
approximately 36.6%, 31.3% and 31.9% respectively, of the Company's total
revenues. No single country outside the United States contributed more than 10%
in 2002, 2001 or 2000 of the Company's total revenues.
For a discussion of risks attendant to the Company's foreign operations, see
Item 7 of this Annual Report on Form 10-K. In addition, further geographical and
financial information concerning the Company's foreign operations appears in
Notes 1, 5, 8, 9, 10, 14, 15, 16 and 17 of the Company's Consolidated Financial
Statements included in Item 8 of this Annual Report on Form 10-K.
Raw Materials and Sources of Supply
- -----------------------------------
All raw materials and parts and supplies essential to the business of the
Company can normally be obtained from more than one source. The Company produces
the membranes required for its equipment and systems that use the ED, EDR, MF,
UF, RO and EDI processes. Membranes used for the MF, UF and RO processes are at
times also purchased from outside suppliers and are normally available from
multiple sources. During 2000, the Company formed a joint venture with Toray
Industries, Inc. and Mitsui & Co. to manufacture and market RO membrane modules
for the desalination of seawater and brackish water using Toray's proprietary RO
manufacturing technology. Ionics has a 43% interest in the joint venture
company, Toray Membrane America, Inc. (TMA). In 2001, TMA commenced the
manufacture of RO membrane modules in space leased from the Company in
Watertown, MA.
Patents and Trademarks
- ----------------------
The Company believes that its products, know-how, servicing network and
marketing skills are more significant to its business than trademarks or patent
protection of its technology. Nevertheless, the Company has a policy of applying
for patents both in the United States and abroad on inventions made in the
course of its research and development work for which a commercial use is
considered likely. The Company owns numerous United States and foreign patents
and trademarks and has issued licenses thereunder, and currently has additional
pending patent applications. Of the approximately 87 outstanding U.S. patents
held by the Company, a substantial portion involves membranes, membrane
technology and related separations processes such as ED and EDR, RO, UF, EDI and
instrumentation technology. The Company does not believe that any of its
individual patents or groups of related patents, nor any of its trademarks, is
of sufficient importance that its termination or abandonment, or the
cancellation of licenses extending rights thereunder, would have a material
adverse effect on the Company.
Seasonality
- -----------
The activities of the Company's businesses are not of a seasonal nature, other
than sales of bleach products for swimming pool use which tend to increase
during the summer months, and sales of automobile windshield wash solution which
tend to increase in the winter months. Together, these products represent less
than 5.0% of the Company's total revenues.
Customers
- ---------
The nature of the Company's business is such that it frequently has in progress
large contracts with one or more customers for specific projects; however, there
is no one customer whose purchases accounted for 10% or more of the revenues of
any business segment and whose loss would have a material adverse effect on the
Company and its subsidiaries taken as a whole.
-9-
Backlog
- -------
The Company's backlog of firm orders was $377.2 million at December 31, 2002 and
$258.9 million at December 31, 2001. For multi-year contracts, the Company
includes in reported backlog the revenues associated with the first five years
of the contract. For multi-year contracts which are not otherwise included in
backlog, the Company includes in backlog up to one year of revenues. The Company
expects to fill approximately 42% of its December 31, 2002 backlog during 2003.
The Company does not believe that there are any seasonal aspects to its backlog
figures.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or build, own and operate
("BOO") contracts. The Company believes that the remaining duration on its
existing equipment sale contracts ranges from less than one year to three years
and the remaining duration on its existing BOO contracts ranges from one year to
25 years. The time to completion of any of these contracts, however, is subject
to a number of variables, including the nature and provisions of the contract
and the industry being served. Historically, as contracts are completed, the
Company has entered into new contracts with the same or other customers. In the
past, the completion of any one particular contract has not had a material
effect on the Company's business, results of operations or cash flows.
Government Contracts
- --------------------
The Company does not believe that any of its sales under U.S. Government
contracts or subcontracts during 2002 are subject to renegotiation. The Company
has not had adjustments to its negotiated contract prices, nor are any
proceedings pending for such adjustments.
Research and Development
- ------------------------
The Company's research and development activities are directed toward developing
new products for use in water and wastewater purification, processing and
measurement, and separations technology. The Company's research and development
expenses were approximately $6.5 million in 2002, $6.4 million in 2001 and $8.0
million in 2000.
Competition
- -----------
The Company experiences competition from a variety of sources with respect to
virtually all of its products, systems and services, however the Company knows
of no single entity that competes with it across the full range of its products
and services. Competition in the markets served by the Company is based on a
number of factors, which may include price, technology, applications experience,
know-how, availability of financing, reputation, product warranties,
reliability, service and distribution. The Company is unable to state with
certainty its relative market position in all aspects of its business. Many of
its competitors have financial and other resources greater than those of the
Company.
With respect to the Company's Equipment Business Group, there are a number of
companies, including several sizable chemical companies that manufacture and
sell membranes, but not water treatment equipment. There are numerous smaller
companies, primarily fabricators, that sell water treatment and desalination
equipment, but which generally do not have proprietary membrane technology. A
limited number of companies, some of which are larger than the Company,
manufacture both membranes and water treatment equipment. The Company has
numerous competitors in its conventional water treatment, instrument and
fabricated products business lines.
In 2002, the International Desalination Association released a report providing
data regarding the manufacturers of desalination equipment. According to the
report, which covered land-based water desalination plants delivered or under
construction as of December 31, 2001, with a capacity to produce 100 cubic
meters (approximately 25,000 gallons) or more of fresh water daily, the Company
ranked first in terms of the number of such plants sold from 1992 to 2001,
having sold more than the next three manufacturers combined. In addition, the
report indicated that the Company ranked first in the total capacity of such
plants sold.
With respect to the Ultrapure Water Group business segment, the Company competes
with suppliers of ultrapure water services and with other manufacturers of
membrane-related equipment on an international, national and regional basis.
-10-
With respect to the Company's Consumer Water Group business segment, most of the
Company's competitors in point-of-entry and point-of-use products for use in the
home or office are small assemblers, serving local or regional markets. However,
there are also several large companies competing nationally in these markets.
Environmental Matters
- ---------------------
The Company continues to fully comply with federal, state and local government
rules and regulations relating to the discharge of materials into the
environment or otherwise relating to the protection of the environment. The
Company was notified in 1992 that it is a potentially responsible party (PRP) at
a Superfund Site, Solvent Recovery Services of New England in Southington,
Connecticut ("SRS Site"). Ionics' share of assessments to date for site work and
administrative costs totals approximately $77,000. The United States
Environmental Protection Agency ("EPA") has not yet issued a decision regarding
clean-up methods and costs. However, based upon the large number of PRPs
identified, the Company's small volumetric ranking (approximately 0.5%) and the
identities of the larger PRPs, the Company believes that its liability in this
matter will not have a material effect on the Company or its financial position,
results of operations or cash flows.
By letter dated March 29, 2000, the Company and other PRPs for the SRS Site were
notified that they may also have potential liability with respect to the
Angelillo Property Superfund Site, also in Southington, Connecticut ("Angelillo
Site"), because hazardous materials were allegedly shipped from the SRS Site to
the Angelillo Site. In April 2001, the Company and certain other PRPs entered
into a settlement agreement with the EPA with respect to the Angelillo Site,
under which the Company made a final settlement payment of approximately $3,300.
The Company has never had a product liability claim grounded in environmental
liability, and believes that the nature of its products and business makes such
a claim unlikely.
Employees
- ---------
The Company and its consolidated subsidiaries employ approximately 1,900 persons
on a full-time basis. None of the Company's employees are represented by unions
or have entered into workplace agreements with the Company, except for the
employees of the Company's Australian subsidiary and certain employees of the
Company's Spanish subsidiary. The Company considers its relations with its
employees to be good.
-11-
Executive Officers of the Registrant
- ------------------------------------
The names, ages and positions of the Company's Executive Officers are as
follows:
Age as of Positions
Name March 1, 2003 Presently Held
---- ------------- --------------
Arthur L. Goldstein 67 President, Chief Executive Officer
and Director since 1971; Chairman
of the Board since 1990
Edward J. Cichon 48 Vice President, Equipment Business Group since July
1998
Alan M. Crosby 50 Vice President, Consumer Water Group since March
2000; previously Vice President and General Manager,
Elite; and Vice President, Operations
Anthony Di Paola 36 Vice President and Corporate Controller
since May 2000
Stephen Korn 57 Vice President, General Counsel and Clerk since 1989
Daniel M. Kuzmak 50 Vice President, Finance and Chief
Financial Officer since January 2001
William J. McMahon 47 Vice President, Ultrapure Water Group
since November 2000
Theodore G. Papastavros 69 Executive Vice President since May 2002; Treasurer
since August 2002; Vice President since 1975
Michael W. Routh 55 Vice President, Instrument Business Group since April
2000
There are no family relationships between any of the officers or directors.
Executive officers of the Company are appointed each year at the meeting of
directors held on the date of the annual meeting of shareholders. There are no
arrangements or understandings pursuant to which any executive officer was
selected.
Except for Messrs. Cichon, Di Paola, Kuzmak, McMahon and Routh, all of the
current executive officers have been employed by the Company in various
capacities for more than five years.
Prior to joining the Company in July, 1998, Mr. Cichon served as a Senior Vice
President of Metcalf & Eddy, Inc., a water and wastewater engineering and
services firm, where he was employed for 18 years.
Mr. Di Paola served in various finance and accounting positions with
Thyssen-Dover Elevator Company North America from 1997 until he joined the
Company, including as Corporate Controller from 1998 to 2000. Prior to 1997, he
served as Assistant Controller for Vector Health Systems, Incorporated.
Mr. Kuzmak joined the Company after 15 years with ABB and its U.S. subsidiary,
including serving as Chief Financial Officer of ABB Inc. (US) from 1998 to 2000,
and Vice President, Finance of ABB Nuclear Operations and ABB Nuclear Business
from 1995 to 1998.
Mr. McMahon served as President and Chief Executive Officer of Stone &
Webster/Sonat Energy Resources LLC from 1998 until he joined the Company;
President of Stone & Webster Energy Services from 1997 to 1998; and General
Manager/Environmental Systems of DB Riley Consolidated, Inc. from 1995 to 1997.
Mr. Routh served as President of the Baird Division of Thermo Instrument
Systems, Inc. from 1995 to 1997, and General Manager of the Spectroscopy
Division of BioRad Laboratories, Inc., from 1998 to March, 2000.
-12-
Available Information
- ---------------------
The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and amendments to those reports are available,
without charge, on our website at www.ionics.com, as soon as reasonably
practicable after they are filed electronically with the Securities and Exchange
Commission.
-13-
ITEM 2. PROPERTIES
The Company's executive offices are located in a Company-owned facility at 65
Grove Street, Watertown, Massachusetts. Manufacturing, assembly, engineering and
other operations are carried out in a number of domestic and international
locations. The following table provides certain information as to the Company's
principal general offices and manufacturing facilities:
Business Segment Approximate Square Feet
Location Utilizing the Location Property Interest of Floor Space
-------- ---------------------- ----------------- -----------------------
Watertown, MA* Equipment Business Group Owned 134,000
(headquarters) Instrument Business Group
Consumer Water Group
Ultrapure Water Group
Watertown, MA Equipment Business Group Owned 127,000
Bridgeville, PA Equipment Business Group Owned 77,000
Consumer Water Group
Canonsburg, PA Equipment Business Group Leased 88,000
Ludlow, MA Consumer Water Group Owned 129,000
San Jose, CA Ultrapure Water Group Owned 66,000
Boulder, CO Instrument Business Group Leased 74,000
Pico Rivera, CA Ultrapure Water Group Owned 68,000
Phoenix, AZ Ultrapure Water Group Leased 34,000
Bellevue, WA Equipment Business Group Leased 21,000
Brisbane, Australia Equipment Business Group Owned 38,000
Brisbane, Australia Ultrapure Water Group Leased 62,000
Milan, Italy Equipment Business Group Leased 18,000
Dallas, TX Ultrapure Water Group Owned 12,000
Dallas, TX Ultrapure Water Group Leased 9,000
Singapore Ultrapure Water Group Leased 9,000
- --------------------
* Approximately 22,000 square feet of this facility are leased to a joint
venture entity engaged in membrane manufacture.
The Company also owns or leases smaller facilities in which its business
segments conduct business.
The Company considers the business facilities that it utilizes to be adequate
for their intended business purpose.
-14-
ITEM 3. LEGAL PROCEEDINGS
The Company and its Chief Executive Officer and 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.
The Company believes the allegations in the lawsuit are without merit and
intends vigorously to defend the litigation. While the Company believes that the
litigation will have no material adverse impact on its financial condition,
results of operations or cash flows, the litigation process is inherently
uncertain and the Company can make no assurances as to the ultimate outcome of
this matter.
The Company 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.
The Company was notified in 1992 that it is a potentially responsible party
(PRP) at a Superfund Site, Solvent Recovery Services of New England in
Southington, Connecticut. Ionics' share of assessments to date for site work and
administrative costs totals approximately $77,000. The United States
Environmental Protection Agency ("EPA") has not yet issued a decision regarding
clean-up methods and costs. However, based upon the large number of PRPs
identified, the Company's small volumetric ranking (approximately 0.5%) and the
identities of the larger PRPs, the Company believes that its liability in this
matter will not have a material effect on the Company or its financial position,
results of operations or cash flows.
In 2002, Sievers Instruments, Inc. ("Sievers"), a wholly owned subsidiary of the
Company, filed a patent infringement suit in the United States District Court
for the District of Colorado against Anatel Corporation and against Anatel's
acquiring company, Hach Company ("Anatel"). The suit alleges that Anatel's
manufacture and sale of its Model 643 organic carbon analyzer unlawfully copied
and interfered with sales of Sievers' TOC 400 total organic carbon analyzer in
that the Model 643 infringes certain claims of Sievers' U.S. patents No.
5,976,468 and No. 6,271,043. The suit further asserts that the continuing sale
of calibration standards by Anatel constitutes infringement. The defendants have
raised certain defenses, withdrawn the accused product from the market, and
introduced a redesigned analyzer. Defendants have asked the Court to rule that
their redesigned analyzer does not infringe, and the Court has not yet issued
its decision. The case is in early stages of discovery.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the New York Stock Exchange under the
symbol ION. As of March 21, 2003, there were approximately 1,100 shareholders of
record. No cash dividends were paid in either 2002 or 2001 pursuant to the
Company's current policy to retain earnings for use in its business. The Company
currently intends to continue to retain future earnings, if any, for use in its
business and does not expect to pay any cash dividends in the foreseeable
future.
-15-
During the period January 1, 2001 to December 31, 2002, the range of high and
low sales prices of the common stock for each quarterly period was as follows:
2002 2001
----------------------------- ---------------------------
High Low High Low
-------------- -------------- ------------- -------------
First Quarter $33.90 $28.86 $30.94 $23.98
Second Quarter 32.22 24.00 31.57 23.40
Third Quarter 25.21 18.90 31.50 19.27
Fourth Quarter 25.15 17.64 31.85 21.44
The information referenced by this item with respect to the Company's
stockholder approved plans and non-stockholder approved plans is hereby
incorporated by reference from the Company's definitive Proxy Statement for the
2003 Annual Meeting (which will be filed with the Securities and Exchange
Commission within 120 days of the close of the Company's fiscal year) under the
caption "Equity Compensation Plan Information."
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data for each of the five years
ended December 31, 2002, 2001, 2000, 1999 and 1998 are derived from the
Company's Consolidated Financial Statements. This data should be read in
conjunction with the Company's audited financial statements and related notes,
and with Item 7 of this Annual Report on Form 10-K.
Consolidated Statement of Operations Data
For the years ended December 31,
-------------------------------------------------------------------------------------------
Dollars in Thousands
Except Per Share Amounts 2002 % 2001 % 2000 % 1999 % 1998 %
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues $335,371 100.0 $466,732 100.0 $474,551 100.0 $358,217 100.0 $351,326 100.0
Income (loss) before income taxes,
minority interest, and gain on sale 2,509 0.7 (16,631) (3.6) (2,224) (0.5) 29,731 8.3 32,883 9.4
Net income (loss)* 4,792 1.4 44,701 9.6 (1,870) (0.4) 19,361 5.4 21,386 6.1
Earnings (loss) per basic share 0.27 2.61 (0.12) 1.20 1.33
Earnings (loss) per diluted share 0.27 2.59 (0.12) 1.18 1.31
*Includes a pre-tax gain on the sale of the Aqua Cool Pure Bottled Water
business of $8.2 million and $102.8million in 2002 and 2001, respectively.
Consolidated Balance Sheet Data
December 31,
------------------------------------------------------------------------------
Dollars in Thousands 2002 2001 2000 1999 1998
- --------------------------------------------------------------------------------------------------------------------
Current assets $328,740 $378,791 $ 252,862 $ 193,802 $ 187,093
Current liabilities 114,168 156,866 173,363 99,475 85,934
- --------------------------------------------------------------------------------------------------------------------
Working capital 214,572 221,925 79,499 94,327 101,159
Total assets 608,013 633,313 585,813 500,906 452,123
Long-term debt and notes payable 9,670 10,126 10,911 8,351 1,519
Stockholders' equity 438,153 423,353 356,861 361,852 345,598
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
The Company is a leading water purification company engaged worldwide in the
supply of water and related activities and the supply of water treatment
equipment through the use of proprietary separations technologies and systems.
The Company's products and services are used by the Company or its customers to
desalt brackish water and seawater, recycle and reclaim process water and
wastewater, to treat water in the home, to manufacture and supply water
treatment chemicals and ultrapure water, to process food products, and to
measure levels of waterborne contaminants and pollutants. The Company's
-16-
customers include industrial companies, consumers, municipalities and other
governmental entities and utilities. The following discussion and analysis of
financial condition and results of operations refers to the activities of the
Company's four business groups, which comprise the Company's reportable
operating segments. These groups are the Equipment Business Group (EBG),
Ultrapure Water Group (UWG), Consumer Water Group (CWG) and Instrument Business
Group (IBG). See Note 17 to the Consolidated Financial Statements contained in
Item 8 of Part II of this Annual Report on Form 10-K for additional information
regarding its four business segments. Within the existing business group
structure, the Company has instituted a matrix-type organization which became
effective at the beginning of 2002. Within each business group, the Company has
begun to focus on "centers of excellence," which represent the application of
treatment or separation technologies contained in The Ionics Toolbox(R) to solve
certain application problems. The Company utilizes its water treatment and
liquids separation expertise by employing its own proprietary products and other
commodity products in the best integrated combination to solve customers'
application problems. These centers of excellence include desalination, reuse,
surface water, microelectronics, pharmaceuticals and instruments, among others,
and each represents a range of technology solutions to solve a related
applications problem.
The EBG segment provides products and services for seawater and brackish water
desalination, water reuse and recycle, surface water treatment, and zero liquid
discharge. Significant factors influencing the desalination market include
worldwide water shortages, the need for better quality water in many parts of
the world, and the reduced cost of operating of modern desalination facilities.
These factors have driven a trend toward larger plants, and toward the purchase
of water supply and operating and maintenance contracts. Trends impacting the
water reuse and recycle market are similar, with membrane technology becoming
proven in reuse and recycling applications. The surface water market has been
influenced primarily by regulatory pressures to reduce contaminants in water
supplies. The use of membrane technology is also becoming more accepted in
surface water applications. The zero liquid discharge market, which consists of
equipment and services for the minimization of liquid waste through such
techniques as evaporation, concentration and crystallization, has been
influenced by regulatory pressures on utilities to eliminate discharge of
process water. The Company believes that it is positioned to be able to compete
successfully in these applications, although it frequently faces substantially
larger competitors.
The UWG segment provides equipment and services for the microelectronics, power,
and pharmaceutical industries, where high quality ultrapure (i.e. very highly
purified) water is required for use in production processes, and is critical to
ultimate product quality and yield. The UWG segment has historically been
heavily reliant upon the microelectronics industry, and the continued softness
in that industry has adversely impacted both revenue and profitability. The UWG
segment has been pursuing applications in other markets, such as power,
pharmaceuticals and flat panel display, to lessen its reliance upon the
microelectronics market.
The CWG segment provides home water units for the treatment of residential
water. 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 produces
bleach-based cleaning products and automobile windshield wash solution. Trends
in the consumer water market include increased consumer awareness of and the
need for improved water quality, and reduced confidence in the quality of
existing water supplies.
The IBG segment manufactures and sells instruments and related products for the
measurement of impurities in water. The segment serves the pharmaceutical,
microelectronics and power markets where the measurement of water quality,
including levels and types of contaminants in process water, is critical to
production processes. The IBG segment has established a strong position in the
pharmaceutical industry, providing products and services that facilitate
compliance with both domestic and foreign regulatory requirements. Like the UWG
segment, the performance of the IBG segment has been impacted by the downturn in
the microelectronics industry, although to a lesser extent than the UWG segment.
The EBG and UWG segments have historically supplied equipment and related
membranes. Starting in the mid-1980's, these groups also began to own and
operate facilities that sell desalted or otherwise treated water directly to
customers under water supply agreements. The revenues and cost of sales
associated with equipment sales are recorded in the revenue and cost of sales
lines on the Company's Consolidated Statement of Operations in the periods in
which the revenues are realized. Equipment contracts are generally accounted for
under the percentage completion accounting method, and the period of time over
which costs are incurred and revenues are realized may vary between six months
-17-
and two years, depending on the nature and amount of equipment being supplied.
For water supply agreements, with respect to smaller projects, of which the
Company is the sole owner, the initial cost of the equipment becomes part of the
Company's depreciable fixed asset base, and the revenues and cost of sales
recorded by the Company are those that are associated with the supply of water
under the water supply agreement. These contracts typically vary in length
between 5 and 15 years.
In the EBG segment, which more recently has begun to pursue large-scale,
long-term water treatment projects, the Company has been utilizing a business
model for participating in such projects typically through joint venture project
companies in which the Company will hold a minority ownership interest. Such
project companies are formed to own and operate larger scale desalination,
reuse, or other projects in which the Company may participate in several ways,
including: having an ownership interest (typically a minority interest) in the
project company; selling the desalination, reuse, or other treatment system to
the project company; and providing operating and maintenance services to the
project company once the project facility commences operations. These projects
often exceed $100 million in total cost and may involve multiple equity
participants in the project company. The Company's participation in major
projects through a minority interest in a project company structure 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.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's Discussion and Analysis of Financial Condition and Results of
Operations is based on the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of consolidated financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent liabilities. On an ongoing basis, the Company evaluates
its accounting policies and estimates, including those related to revenue
recognition, allowance for doubtful accounts, investments in affiliated
entities, income taxes, goodwill and other long-lived assets, pension plans,
loss contingencies and derivative instruments. The Company bases its estimates
on historical experience and other relevant information and on appropriate
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions. The Company's significant accounting policies are described in Note
1 to the Consolidated Financial Statements included in Item 8 of this Annual
Report on Form 10-K. The Company has identified the policies discussed below as
critical to understanding its business and its results of operations.
Revenue Recognition
For certain contracts involving customized equipment eligible for contract
accounting under American Institute of Certified Public Accountants ("AICPA")
Statement of Position No. 81-1, "Accounting for Performance of Construction-Type
and Certain Construction-Type Contracts" (SOP 81-1), revenue is recognized using
the percentage of completion accounting method based upon an efforts-expended
method. The nature of these contracts and the types of products and services
provided are considered in determining the proper accounting for a given
contract. Long-term, fixed-price and cost plus fixed-fee contracts are recorded
on a percentage of completion basis using the cost-to-cost method of accounting
where revenue is recognized based on the ratio of costs incurred to estimated
total costs at completion. The Company follows this method since reasonably
dependable estimates of the costs of the total contract can be made. As a
general rule, sales and profits are recognized earlier under the cost-to-cost
method of percentage of completion accounting compared to the completed contract
method. Contract accounting requires significant judgment relative to assessing
risks, estimating contract costs and making related assumptions regarding
schedules and technical issues. Due to the size and nature of the Company's
long-term contracts, the estimation of cost at completion is complicated and
subject to numerous variables. Contract costs include material, labor,
subcontracting and other related costs. Assumptions must be made relative to the
length of time to complete the contract. With respect to contract change orders,
claims or similar items, judgment must be used in estimating related amounts and
assessing the potential for realization. Such amounts are only included in the
contract value when they can be reliably estimated and realization is reasonably
assured, generally upon receipt of a customer-approved change order. Given the
significance of the judgments and estimation processes described above, it is
likely that materially different amounts could be recorded if different
-18-
assumptions were used or if underlying circumstances were to change. The Company
closely monitors compliance and consistency of application of its critical
accounting policies related to contract accounting. In addition, reviews of the
status of contracts are performed periodically. In all cases, changes to total
estimated costs and anticipated losses, if any, are recognized in the period in
which determined.
For contracts involving the sale of equipment to a joint venture or other
unconsolidated affiliated entity in which the Company has an ownership interest,
the extent of revenue and profit recognized while the contract is being
performed varies based on the level of equity interest held by the Company.
Generally, when the Company's equity ownership in the affiliated customer is
less than 20%, and accounts for such interest on a cost basis, no revenue or
profit is eliminated as the contract is being performed. When the Company's
equity ownership is between 20% and 50%, provided that the Company does not
exercise effective control over the affiliated entity, the Company recognizes
revenue as the contract is being performed but eliminates a portion of the
profit equal to the Company's equity ownership percentage in the entity. After
construction has been completed and commercial operations have commenced, the
resulting eliminated intercompany profit is amortized over the estimated useful
life of the equipment owned by the affiliated entity. When the Company's equity
ownership exceeds 50%, or in instances where the Company effectively controls
the affiliated entity, no revenue or profit is recognized on the sale of
equipment as the contract is executed, and all of the profit on the contract is
eliminated and amortized over the estimated useful life of the equipment after
construction has been completed and commercial operations have commenced.
With respect to the Company's sale of equipment to Desalcott (the project
company) in connection with the Trinidad project (discussed in this Item under
"Financial Condition"), where the Company is a 40% equity owner of Desalcott,
since the Company is considered to have provided all of the cash equity funding
for the project either directly or through a loan to the Company's local
majority partner, equipment revenue earned has been recognized to the extent of
costs incurred as the contract is executed; however, all of the profit has been
eliminated, and will be amortized over the estimated useful life of the
equipment after construction has been completed and commercial operations have
commenced.
The revenues and cost of sales to affiliated companies included in the Company's
Consolidated Statements of Operations reflect the revenue and costs recorded
from the sales of equipment to joint ventures or other unconsolidated entities.
Revenue is recognized in accordance with SOP 81-1 or with Securities and
Exchange Commission's Staff Accounting Bulletin No. 101, "Revenue Recognition in
Financial Statements" (SAB 101), as appropriate, less the amount of intercompany
profit eliminated equal to the Company's ownership interest in the affiliated
company. Eliminated intercompany profit, as described above, is amortized over
the useful life of the equipment placed in service by the affiliated company
(e.g. 23 years of the Trinidad project, and 27 years for the Kuwait project).
The Company believes that the amortization of the intercompany profits is not
material to the Company's financial statements. The amount of deferred profit at
December 31, 2002 was approximately $4.5 million.
In addition to the construction and sale of customized equipment to its
customers, the Company also enters into water and other concession agreements
under which the Company "owns and operates" desalination or water treatment
facilities to produce and supply water to its customers. Under these contracts,
where the Company remains the owner of the facility or equipment, revenue and
profit is recognized as water quantities are sold to the customer (or,
alternatively, pursuant to a "take or pay" arrangement if minimum quantities are
not purchased). More specifically, the revenue derived from these contracts is
generally recognized based on actual meter readings and agreed-upon rates in
effect during the term of the contract. The constructed equipment is capitalized
by the Company, included in property, plant and equipment, and amortized to cost
of sales over the shorter of the estimated useful life of the equipment or the
contract term.
For sales of standard products and equipment not governed by SOP 81-1, such as
the sale of instruments and consumer water products, the Company follows the
guidance provided by SAB 101. The Company does not recognize revenue unless
there is persuasive evidence of an arrangement, title and risk of loss has
passed to the customer, delivery has occurred or the services have been
rendered, the sales price is fixed or determinable and collection of the related
receivable is reasonably assured. It is the Company's policy to require an
arrangement with its customers, either in the form of a written contract or
purchase order containing all of the terms and conditions governing the
arrangement, prior to the recognition of revenue. Title and risk of loss
generally pass to the customer at the time of delivery of the product to a
common carrier. At the time of the transaction, the Company assesses whether the
sale price is fixed or determinable and whether or not collection is reasonably
-19-
assured. The Company assesses whether the sale price is fixed or determinable
based upon the payment terms of the arrangement. If the sales price is not
deemed to be fixed or determinable, revenue is recognized as the amounts become
due from the customer. The Company does not generally offer a right of return on
its products and the products are generally not subject to customer acceptance
rights. The Company assesses collectibility based on a number of factors,
including past transaction and collection history with a customer and the
credit-worthiness of the customer. The Company performs ongoing credit
evaluations of its customers' financial condition but generally does not require
collateral from its customers. If the Company determines that collectibility of
the sales price is not reasonably assured, revenue is deferred until such time
as collection becomes reasonably assured, which is generally upon receipt of
payment from the customer. The Company includes shipping and handling costs in
revenue and cost of sales.
The Company's products are generally subject to warranty, and related costs are
provided for in cost of sales when revenue is recognized. While the Company
engages in extensive product quality programs and processes, the Company's
warranty obligation is based upon historical product failure rates and costs
incurred in correcting a product failure. If actual product failure rates or the
costs associated with fixing failures differ from historical rates, adjustments
to the warranty liability may be required in the period in which determined.
The Company provides lease financing to consumers for the purchase of certain
home water treatment systems. Prior to entering into the lease agreement, the
Company evaluates the creditworthiness of its customer and generally
collateralizes the lease receivable with a security interest in the customer's
personal residence. At the time the lease transaction is consummated, the
Company recognizes revenue for the full amount of the sales value of the
equipment and records a lease receivable on its balance sheet. Interest income
is recognized by the Company over the term of the lease based on the interest
rate stated in the lease. The Company evaluates the collectibility of its lease
receivables based on its historical loss experience and assessment of
prospective risk, and does so through ongoing reviews of its receivables
portfolio.
The Company provides support services to customers primarily through service
contracts and the Company primarily recognizes support service revenue ratably
over the term of the service contract or as services are rendered.
The Company also rents equipment to customers under short-term rental
agreements. The Company generally invoices customers monthly and recognizes
revenue over the rental period based on amounts billed. The rental equipment is
capitalized and depreciated to cost of sales over its estimated useful life.
Allowance for Doubtful Accounts
The Company evaluates the adequacy of its reserve for doubtful accounts on an
ongoing basis through detailed reviews of its receivables portfolio. Estimates
are used in determining the Company's allowance for bad debts and are based on
historical collection experience, current trends including prevailing economic
conditions and adverse events that may affect a customer's ability to repay,
percentage of accounts receivable by aging category, and other factors such as
the financial condition of large customers. The Company makes adjustments to its
reserve if the evaluation of reserve requirements differs from the actual
aggregate reserve. This evaluation is inherently subjective because estimates
may be revised as more information becomes available. Reserves for doubtful
accounts are established through a charge to operations included in selling,
general and administrative expenses.
Investments in Affiliated Companies
The Company consolidates the balance sheet and results of operations of all
wholly and majority owned subsidiaries and controlled affiliates. The Company
also holds minority investments in certain private companies having
complementary or strategic operations in different geographical locations around
the world. These investments are included in investments in affiliates and
include investments accounted for under the equity method of accounting. Under
the equity method of accounting, which generally applies to investments that
represent a 20% to 50% ownership of the equity securities of the affiliates, the
Company's proportionate share of the earnings or losses of the affiliates is
included in equity income. With respect to the Company's investment in
Desalcott, the Company records 100% of any net loss and 40% of any net income
reported by Desalcott. In periods in which Desalcott has an accumulated loss (as
opposed to retained earnings), the Company records 100% of any net income of
Desalcott up to the amount of Desalcott's accumulated loss, and 40% of any net
income thereafter. Realization of the Company's investments in equity securities
may be affected by the affiliate's ability to obtain adequate funding and
execute its business plans, general market conditions, industry considerations
specific to the affiliate's business, and other factors. The inability of an
-20-
affiliate to obtain future funding or successfully execute its business plan
could adversely affect the Company's earnings in the periods affected by those
events. Future adverse changes in market conditions or poor operating results of
underlying investments could result in losses or in an inability to recover the
carrying value of the investments that may not be reflected in an investment's
current carrying value, thereby possibly requiring an impairment charge in the
future. The Company records an impairment charge when it believes an investment
has experienced a decline in value that is other-than-temporary.
Goodwill and Other Long-Lived Assets
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS 144). In accordance with SFAS 144, the Company assesses the
potential impairment of identifiable intangibles and other long-lived assets
whenever events or changes in circumstances indicate that the carrying value may
not be recoverable. Factors the Company considers important which could indicate
an impairment include significant underperformance relative to historical or
projected future operating results, significant changes in the manner of the
Company's use of the acquired asset or the strategy for its overall business and
significant negative industry or economic trends. When the Company determines
that the carrying value of intangible and other long-lived assets may not be
recoverable, the related estimated future undiscounted cash flows expected to
result from the use of the asset and its eventual disposition are compared to
the carrying amount of the asset. If the sum of the estimated future cash flows
is less than the carrying amount, the Company records an impairment based on the
estimated discounted cash flows using a discount rate determined by Company
management to be commensurate with the associated risks. Any resulting
impairment loss could have a material adverse impact on the Company's results of
operations, depending on the magnitude of the impairment.
In 2001, as summarized in Note 6 to the Company's Consolidated Financial
Statements, the Company recognized impairment losses of approximately $13.1
million, which included approximately $9.2 million to reduce the carrying value
of assets held for sale in Malaysia, $3.1 million of goodwill write-downs, and
$0.7 million associated with the residual value of bleach manufacturing
equipment.
Goodwill represents the excess acquisition cost over the fair value of the net
assets acquired in the purchase of various entities. On January 1, 2002, the
Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS 142)
that requires, among other things, the discontinuance of goodwill amortization.
In accordance with SFAS 142, amortization of goodwill was discontinued as of
January 1, 2002. Prior to the adoption of SFAS 142, goodwill was amortized on a
straight-line basis over its estimated useful life, which generally was a period
ranging from 10 to 40 years. SFAS 142 requires the Company to evaluate goodwill
for impairment on an annual basis. The Company evaluates the recoverability of
goodwill annually in the fourth quarter, or more frequently if events or changes
in circumstances, such as declines in sales, earnings or cash flows or material
adverse changes in the business climate, indicate that the carrying value of an
asset might be impaired. Goodwill is considered to be impaired when the net book
value of a reporting unit exceeds its estimated fair value. Fair values are
primarily determined using a discounted cash flow methodology. The determination
of discounted cash flows is based on the businesses' strategic plans and future
forecasts. The revenue growth rates included in the plans are management's best
estimates based on current and forecasted market conditions and the profit
margin assumptions are projected by each reporting unit based on the current
cost structure, as well as any anticipated cost reductions. The Company
completed its annual impairment test in the fourth quarter of 2002 using its
best estimate of forecasts for future periods. No adjustment was required to the
carrying value of goodwill based on the analysis performed. If different
assumptions were used in these plans, the related undiscounted cash flows used
in measuring impairment could be different potentially resulting in an
impairment charge.
Income Taxes
The Company estimates its income tax liability in each of the jurisdictions in
which it operates and which involves an assessment of permanent and temporary
differences resulting from differing treatment of items for tax and book
accounting purposes. Temporary differences result in deferred tax assets and
liabilities, which are included within the consolidated balance sheets. The
Company must also assess the likelihood that any deferred tax assets will be
recovered, and must establish a valuation allowance to the extent that it
believes that it is more likely than not any deferred tax asset will not be
utilized from future taxable income. To the extent the Company has established a
valuation allowance, income tax expense is recorded in the Company's
-21-
Consolidated Statements of Operations. Taxable income in future periods
significantly different from that projected may cause adjustments to the
valuation allowance that could materially increase or decrease future income tax
expense. At any time, the Company's income tax expense could be impacted by
changes in tax laws, or by administrative actions or court rulings.
The Company has taken tax positions in its worldwide corporate income tax
filings based on careful interpretations of global statutes, rules, regulations
and court decisions that may be applied and interpreted differently by various
taxing jurisdictions. These taxing jurisdictions may or may not challenge the
Company's application and interpretation of a wide body of tax jurisprudence.
However, the Company does not anticipate that any sustained challenge by any
taxing jurisdiction could have a material adverse effect on its financial
position or net income.
The Company has elected not to provide tax on certain undistributed earnings of
its foreign subsidiaries which it considers to be permanently reinvested. The
cumulative amount of such unprovided U.S. taxes was approximately $9.7 million,
$8.2 million and $5.1 million as of December 31, 2002, 2001 and 2000,
respectively.
Pension Plans
The Company has a qualified defined benefit pension plan covering most of its
domestic employees. The Company accounts for its pension plan using Statement of
Financial Accounting Standards No. 87, "Employers' Accounting for Pensions"
(SFAS 87). The Company's calculation of pension expense are sensitive to changes
in several key economic assumptions and in the demographics of its workforce.
The Company's pension income or expense for the plan is computed using actuarial
valuations. The assumptions made by the Company relate to financial market and
other economic conditions. Changes in key economic indicators can result in
changes in the assumptions the Company uses. The assumptions made at year-end
used to estimate pension income or expense for the following year are the
discount rate and the expected long-term rate of return on plan assets. The
discount rate states the expected future cash flows necessary to satisfy the
pension obligations at a present value. The Company uses judgment in selecting
these assumptions giving consideration to current market conditions, future
market trends, changes in interest rates and equity market performance. The
Company also considers factors such as the timing and amounts of expected
contributions to the plans and benefit payments to plan participants. The
Company's selection of a discount rate represents the market rate of return on
high-quality fixed income investments. A lower discount rate would increase the
present value of the pension obligation and increase pension expense.
During 2002, the Company's review of market trends, actual returns on plan
assets, and other factors resulted in reducing the expected long-term rate of
return on plan assets for its year-end 2002 actuarial calculations from 9.0% to
7.0% at December 31, 2002. This rate is applied to a calculated value of plan
assets which results in an amount that is included in pension income or expense
in 2003. The Company also reduced the discount rate assumption from 7.0% to 6.5%
at December 31, 2002. These changes, together with other factors such as the
effects of the actual return on plan assets, results in the Company projecting
an increase in pension expense for 2003 of approximately $1.3 million compared
with 2002.
During 2002 and 2001, the Company recorded an adjustment in the stockholders'
equity section of its Consolidated Balance Sheets to reflect a minimum pension
liability for its pension plan. This adjustment is determined by comparing the
accumulated benefit obligation (ABO) for the plan to the fair value of the
plan's assets. The amount by which the ABO exceeds the fair value of the plan
assets, after adjusting for previously recorded accrued or prepaid pension cost
for the plan, must be recorded as a minimum pension liability, with a
corresponding increase in an intangible asset, if appropriate, and a reduction
to stockholders' equity, consistent with SFAS 87. The after-tax adjustment
related to the Company's recording a minimum pension liability in 2002 did not
impact earnings, but reduced stockholders' equity by $1.8 million. This
adjustment is computed each year at December 31 and could potentially reverse in
the future if financial markets improve and interest rates increase, or could
potentially increase if financial market performance and interest rates continue
to decline.
Loss Contingencies
The Company is subject to certain claims and litigation including proceedings
under government laws and regulations and commercial disputes relating to its
operations, including ordinary routine litigation incidental to its business.
(See "Note 8. Commitments and Contingencies to the Consolidated Financial
Statements"). Management reviews and determines which liabilities, if any,
arising from these claims and litigations could have a material adverse effect
on the Company's consolidated financial position, liquidity or results of
operations. Management assesses the likelihood of any adverse judgments or
-22-
outcomes as well as potential ranges of probable losses. Loss contingency
liabilities are recorded for these contingencies based on careful analysis of
each matter with the assistance of outside counsel when it is probable that a
liability has been incurred and the amount of the loss is reasonably estimable.
These liabilities may change in the future due to new developments relating to
each matter or changes in approach such as a change in settlement strategy.
Derivative Instruments
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended by SFAS 137 and SFAS 138 in the first quarter of
2001. SFAS 133 requires all derivatives to be recognized on the Consolidated
Balance Sheet at fair value. The adoption of SFAS 133 did not have a material
impact on the Company's financial position or results of operations. The Company
conducts business in a number of foreign countries, with certain transactions
denominated in local currencies. The purpose of the Company's foreign currency
management is to minimize the effect of exchange rate fluctuations on certain
foreign denominated monetary assets and anticipated cash flows. The terms of
currency instruments used for hedging purposes are consistent with the timing of
the transactions being hedged. The Company does not use derivative financial
instruments for trading or speculative purposes. For purposes of presentation
within the Consolidated Statement of Cash Flows, derivative gains and losses are
presented within cash provided by operating activities.
The Company enters into foreign currency forward contracts to hedge its
exposures associated with a portion of its forecasted revenue transactions.
These derivative instruments are designated as foreign currency cash flow
hedges. All outstanding derivatives are recognized on the Consolidated Balance
Sheet at fair value and changes in their fair value are recorded in accumulated
other comprehensive income (loss) until the underlying forecasted transaction
occurs. Once the underlying forecasted transaction is realized, the gain or loss
from the derivative designated as a hedge of the transaction is reclassified
from accumulated other comprehensive income (loss) to the statement of
operations in the related revenue caption. In the event the underlying
forecasted transaction does not occur, the amount recorded in accumulated other
comprehensive income (loss) will be reclassified to selling, general and
administrative expense in the statement of operations in the then-current
period. No amounts were reclassified from accumulated other comprehensive income
(loss) to selling, general and administrative expense during 2002, 2001 and
2000. The Company's cash flow hedges generally mature within two years or less.
The Company also enters into foreign exchange forward contracts to hedge its
exposures associated with foreign-currency denominated assets and liabilities.
These derivative instruments are designated as foreign currency fair value
hedges. The derivatives are recognized on the Consolidated Balance Sheet at fair
value and period-end changes in fair value are recorded in selling, general and
administrative expense in the statement of operations.
Since the Company is using foreign exchange derivative contracts to hedge
foreign exchange exposures, the changes in the value of the derivatives are
highly effective in offsetting changes in the cash flows of the hedged item.
Hedge effectiveness is assessed on a quarterly basis. Any ineffective portion of
the derivatives designated as cash flow hedges is recognized in current earnings
in "Selling, general and administrative expense." The ineffective portion of the
derivatives consists of discounts or premiums on forward contracts and gains or
losses associated with differences between actual and forecasted amounts. In any
instance in which the designated hedged item matures, is terminated, or, in the
case of an anticipated transaction, is deemed unlikely to occur, the related
derivative contract is closed and any gain or loss is immediately recognized in
the Consolidated Statement of Operations in "Selling, general and administrative
expense."
RESULTS OF OPERATIONS
Comparison of Years Ended December 31, 2002 and December 31, 2001
- -----------------------------------------------------------------
The Company reported consolidated revenues of $335.4 million and net income of
$4.8 million in 2002, compared to consolidated revenues of $466.7 million and
net income of $44.7 million in 2001. Results for 2001 included the operations of
the Aqua Cool Pure Bottled Water business ("Aqua Cool Business"), which was
divested on December 31, 2001, as well as the results of the Company's
majority-owned Malaysian subsidiary, Ionics Enersave ("Enersave") which was
divested in May 2002.
-23-
Revenues
- --------
Total Company revenues of $335.4 million for 2002 decreased $131.4 million or
28.1% from revenues of $466.7 million for 2001. The 2001 revenues of the Aqua
Cool Business represented $76.2 million, or 58.0% of the decrease, and the
revenues of the Company's majority-owned Malaysian subsidiary represented $14.8
million, or 11.3% of the decrease.
EBG revenues of $154.4 million in 2002 decreased $7.2 million, or 4.4%, compared
to revenues of $161.6 million in 2001. The decrease in revenues is primarily
attributable to reduced revenues from the Zero Liquid Discharge ("ZLD")
business, primarily as a result of the Company's business strategy to not pursue
the civil construction scope on ZLD projects. This decrease was partially offset
by increases in EBG's water supply business in Spain, as well as increases in
the revenues of the Company's Italian subsidiary.
UWG revenues of $102.4 million decreased $31.2 million, or 23.4%, compared to
revenues of $133.6 million for 2001. The revenues associated with the Company's
majority-owned Malaysian subsidiary, which was divested in May 2002, amounted to
$19.0 million in 2001 and $4.2 million in 2002, and accordingly represented
11.1% of the revenue decrease. The additional decrease in revenues relates
primarily to the continued downturn in the microelectronics sector.
CWG revenues totaled $38.7 million in 2002 compared to revenues of $123.7
million in 2001, representing a decrease of $85.1 million or 68.7%. The 2001
revenues of the Aqua Cool Business of $76.2 million represented 89.5% of the
decrease in revenues. CWG revenue levels were also adversely impacted by lower
sales of automobile windshield wash solution and consumer bleach products due to
the loss of several customers. Additionally, CWG experienced lower demand for
home water treatment equipment as a result of the general downturn in the
domestic economy.
IBG revenues of $27.7 million in 2002 increased $1.1 million, or 4.3%, compared
to revenues of $26.6 million in 2001. The increase in revenues primarily
resulted from increased sales volume to the pharmaceutical industry driven by
regulatory requirements in that industry, as well as continued growth in
recurring sales of the Company's after-market products.
Revenues from sales to affiliated companies of $12.2 million in 2002 decreased
$9.1 million or 42.7% compared to revenues from affiliated companies of $21.2
million in 2001. The decrease in revenues from affiliated companies primarily
resulted from lower equipment sales to the Trinidad joint venture company,
Desalination Company of Trinidad and Tobago Ltd. ("Desalcott"), as a result of
the substantial completion of the first four out of the five construction phases
of the desalination facility in early 2002. The decrease was partially offset by
an increase in sales of equipment in the second half of 2002 to the Kuwaiti
joint venture company, Utilities Development Company ("UDC"), for the Kuwait
reuse project.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or "build, own and operate"
(BOO) contracts. The Company believes that the remaining duration on its
existing sale of equipment contracts ranges from less than one year to three
years and the remaining duration on its existing BOO contracts ranges from one
year to 25 years. The time to completion of any of these contracts, however, is
subject to a number of variables, including the nature and provisions of the
contract and the industry being served. Historically, as contracts are
completed, the Company has entered into new contracts with the same or other
customers. In the past, the completion of any one particular contract has not
had a material effect on the Company's business, results of operations or cash
flows.
Cost of Sales
- -------------
The Company's total cost of sales as a percentage of revenue was 71.6% in 2002
and 73.1% in 2001. The resulting gross margin increased to 28.4% in 2002
compared to 26.9% in 2001. Cost of sales as a percentage of revenue decreased in
the EBG, UWG, and IBG segments and increased in the CWG segment.
EBG's cost of sales as a percentage of revenue decreased to 74.0% in 2002 from
78.5% in 2001. The improvement in cost of sales as a percentage of revenue from
2001 to 2002 related to the elimination of losses incurred on the civil
construction portion of ZLD projects that were incurred in 2001. Additionally,
-24-
the improvement in cost of sales as a percentage of revenue is attributable to a
shift in product mix from lower margin capital equipment sales to higher margin
water supply and other products.
UWG's cost of sales as a percentage of revenue decreased to 76.6% in 2002 from
80.2% in 2001. The decrease in cost of goods sold as a percentage of revenue
primarily reflects the elimination of losses associated with projects in
Australia, improved operating results in the group's Asian operations, and the
reduction of losses associated with the Company's majority-owned Malaysian
subsidiary, which was divested in May 2002.
CWG's cost of sales as a percentage of revenue increased to 64.4% in 2002 from
59.8% in 2001. The increase in the 2001 cost of sales as a percentage of revenue
compared to 2002 cost of sales as a percentage of revenue was primarily
attributable to the divestiture of the Company's Aqua Cool Business on December
31, 2001, as well as lower margin levels in both the Home Water and Elite
Consumer product lines. The Elite Consumer products line continued to face
pricing pressure due to increased competition while Home Water product line
margins were negatively impacted by the continued decline in the domestic
economy.
IBG's cost of sales as a percentage of revenue decreased to 42.2% in 2002 from
48.0% in 2001, primarily reflecting absorption of manufacturing overhead as a
result of higher sales volume along with cost reductions in the service
businesses.
Cost of sales to affiliated companies as a percentage of revenue decreased to
90.1% in 2002 from 97.4% in 2001. The decrease in 2002 was primarily due to
lower revenues from sales to Desalcott, where, for accounting purposes, all
profit on sales to Desalcott is being deferred, and the increase in equipment
sales to UDC, where the Company defers profit equal to its 25% equity ownership
in UDC, and will subsequently recognize the deferred profit over the estimated
useful life of the equipment.
Operating Expenses
- ------------------
Research and development expenses as a percentage of revenue increased slightly
during 2002 compared to 2001. The Company currently expects to continue to
invest in new products and technologies at approximately the same level as in
prior years.
Selling, general and administrative expenses decreased $28.0 million to $91.8
million in 2002 from $119.8 million in 2001. The elimination of 2001 selling,
general and administrative expenses relating to the Aqua Cool Business resulting
from the divestiture of the business on December 31, 2001, as well as the
divestiture of the Company's majority-owned Malaysian subsidiary in the second
quarter of 2002, and the cessation of goodwill amortization amounted to
approximately $40.2 million. These decreases in 2002 selling, general and
administrative expenses were partially offset by increased operating expenses
associated with the Company's European operations, primarily France, higher than
normal professional service fees related primarily to the Company's restatement
of its interim financial statements for the first and second quarters of 2002,
increased provisions for doubtful accounts, and other general increases.
Interest Income and Interest Expense
- ------------------------------------
Interest income totaled $3.5 million in 2002 and $1.0 million in 2001. Interest
expense, net of capitalized interest of $0.3 million, was $1.2 million in 2002
and $5.2 million in 2001. The increase in interest income in 2002 compared to
2001 reflects the investment of proceeds resulting from the divestiture of the
Aqua Cool Business on December 31, 2001. Additionally, a portion of the proceeds
from the disposition of the Aqua Cool Business were utilized to reduce domestic
short-term borrowings which resulted in lower interest expense of $0.9 million
in 2002 compared to $5.2 million in 2001.
Equity Income
- -------------
The Company's proportionate share of the earnings and losses of affiliated
companies in which it holds a minority equity interest is included in equity
income.
-25-
Equity income amounted to $3.4 million in 2002 and $1.4 million in 2001. The
Company's equity income is derived primarily from its 20% equity interest in a
Mexican joint venture company which owns two water treatment plants in Mexico,
its 40% equity interest in Desalcott, its equity interests in several joint
ventures in the Middle East which engage in bottled water distribution, and to a
lesser extent from its other equity investments in affiliated companies. The
increase in equity income of $2.0 million in 2002 compared to 2001 reflects the
improved performance of Desalcott (the plant began commercial operation in May
2002) and the improved performance of the Company's investments in several joint
ventures in the Middle East.
Gain on Sale of Aqua Cool
- -------------------------
On December 31, 2001, the Company completed the sale of its Aqua Cool Business
in the United States, United Kingdom and France. Giving effect to reserves
established by the Company for purchase price adjustments and direct and
incremental costs, the Company recorded a pre-tax gain of $102.8 million in
2001. As a result of final purchase price adjustments based on the number of
customers and working capital levels, and the resolution of certain claims made
by Nestle, the Company and Nestle reached final agreement on a purchase price of
$207.0 million in the first quarter of 2003. As a result of such adjustments,
the Company realized an additional pre-tax gain of $8.2 million in 2002, net of
direct and incremental costs of the transaction, including approximately $3.4
million of non-recurring management and employee compensation.
Income Taxes
- ------------
The Company's effective tax rate for 2002 was 46% compared to 49% in 2001. The
Company's 2002 tax rate was primarily affected by losses in certain of its
foreign subsidiaries for which the Company may not be able to realize future tax
benefits. The 2001 tax rate was primarily impacted by the gain on the sale of
the Company's Aqua Cool Business, which included non-deductible goodwill, as
well as significant losses by the Company's majority-owned Malaysian subsidiary
that were not benefited since realization of those benefits was not likely.
Net Income
- ----------
Net income amounted to $4.8 million in 2002 compared to $44.7 million for 2001.
Net income in 2002 and 2001 included pre-tax gains of $8.2 million and $102.8
million, respectively, from the sale of the Company's Aqua Cool Business.
Comparison of Years Ended December 31, 2001 and December 31, 2000
- -----------------------------------------------------------------
The Company reported consolidated revenues of $466.7 million and net income of
$44.7 million in 2001, compared to consolidated revenues of $474.6 million and a
net loss of $1.9 million in 2000. The increase in net income resulted primarily
from a pre-tax gain of $102.8 million on the sale of the Aqua Cool Business in
the U.S., U.K. and France.
Revenues
- --------
Total Company revenues were $466.7 million in 2001, compared to $474.6 million
in 2000. Total revenues for 2001 and 2000 include revenues associated with the
Company's Aqua Cool Business which was divested on December 31, 2001, and the
Company's majority-owned Malaysian subsidiary which was divested in May 2002.
EBG revenues of $161.6 million in 2001 decreased slightly compared to 2000
revenues of $162.1 million. Total equipment revenues decreased slightly, while
supply business revenues increased over 2000.
UWG revenues of $133.6 million in 2001 decreased by $22.8 million or 14.6% from
2000 revenues of $156.4 million in 2000. This decrease is primarily the result
of continued deterioration, both domestically and internationally, in the
Company's microelectronics equipment business, which declined substantially from
2000 levels due to softness in the microelectronics industry generally.
CWG revenues of $123.7 million in 2001 increased by $15.8 million or 14.6% from
revenues of $108.0 million in 2000, reflecting increases in the Company's
bottled water, home water and bleach-based consumer product businesses.
-26-
IBG revenues of $26.6 million in 2001 decreased by 6.4% from 2000 revenues of
$28.4 million, also reflecting the further deterioration of the microelectronics
sector, which is an important customer for IBG products.
Revenues from affiliated companies of $21.2 million in 2001 increased $1.5
million compared to revenues from affiliated companies of $19.7 million in 2000.
The increase in revenues from affiliated companies primarily resulted from
increased equipment sales to Desalcott, which was engaged throughout 2001 in the
construction of the Trinidad desalination facility.
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
- -------------
Cost of sales as a percentage of revenues was 73.1% and 73.8% in 2001 and 2000,
respectively, and overall Company gross margin was 26.9% and 26.2% in 2001 and
2000, respectively. Cost of sales as a percentage of revenue decreased in the
EBG and CWG segments, and increased in the UWG and IBG segments.
Cost of sales as a percentage of revenue for the EBG segment was 78.5% in 2001
compared to 79.7% in 2000, reflecting a continued high level of equipment
revenues, which have lower gross margins than service revenues. The losses
incurred on several ZLD equipment contracts with civil construction scope had an
adverse impact on EBG's cost of sales as a percentage of revenue in 2001.
Cost of sales as a percentage of revenues for UWG increased to 80.2% in 2001
from 79.2% in 2000, reflecting cost increases incurred on projects executed by
the Company's majority-owned Malaysian subsidiary and one of the Company's
Australian subsidiaries. The continued downturn of the microelectronics industry
also had an adverse impact on both sales volume and profitability, as the
utilization of capacity decreased with reduced sales volume while certain
components of costs of sales remained fixed.
Cost of sales as a percentage of revenue for CWG decreased to 59.8% in 2001 from
61.3% in 2000. Numerous factors impacted the CWG cost of sales percentage in
2001, including the gain on the sale of certain bottled water assets realized
earlier in the year offset by costs associated with readying the Aqua Cool
Business for sale in the second half of 2001.
IBG cost of sales as a percentage of revenues increased to 48.0% in 2001 from
44.3% in 2000, primarily as a result of reduced sales volume levels caused by
the further deterioration of the microelectronics sector.
Cost of sales to affiliated companies as a percentage of revenue increased to
97.4% in 2001 from 93.1% in 2000. This increase in 2001 was primarily due to
higher revenues from sales to Desalcott, the joint venture company relating to
the Company's Trinidad project.
Operating Expenses
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Research & development expenses decreased to $6.4 million in 2001 compared to
$8.0 million in 2000. Selling, general and administrative expenses increased
5.8% in 2001 to $119.8 million from $113.2 million in 2000. The increase is
primarily attributable to a significant shift in product mix between UWG, which
has a lower operating expense component, and CWG, which has a significantly
higher expense component.
Impairment of Long-Lived Assets
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During 2001 and 2000, the Company wrote down approximately $13.1 million and
$3.4 million, respectively, of impaired long-lived assets. In 2001, the
write-downs included approximately $9.2 million to reduce the carrying value of
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assets held for sale related to the Company's divestiture of its majority-owned
Malaysian subsidiary and $3.1 million of goodwill associated with previous
acquisitions.
In late 2001, the Company began negotiations to sell its majority-owned
Malaysian subsidiary to the subsidiary's minority shareholders. In early 2002,
the Company had signed a term sheet for the disposition of the Malaysian
subsidiary and the sale was completed in May 2002. Accordingly, at December 31,
2001, the Company recorded an impairment charge of approximately $9.2 million,
representing the difference between the Company's 55% ownership interest in the
net asset value of the Malaysian subsidiary (principally property, plant and
equipment and goodwill) and the anticipated net proceeds from the sale of the
subsidiary of approximately $1.0 million.
The Company recorded asset impairment charges related to its decision to abandon
plans to commence bleach-manufacturing operations in Elkton, Maryland. In 2001
and 2000, these impairment charges amounted to $0.7 million and $2.0 million,
respectively. The Elkton plant and equipment were part of a Company strategy to
expand bleach manufacturing in the mid-Atlantic market. This strategy included
the potential acquisition by the Company of a regional bleach manufacturer, but
negotiations relating to the potential acquisition ceased during the fourth
quarter of 2000. The impairment charge recorded in 2000 was consequently derived
by writing off the net book value of specific equipment for which there was no
salvage value or anticipated use within the Company. Due to overcapacity in the
bleach manufacturing industry (as evidenced by the exit of other bleach
manufacturers in the Northeast), the Company was subsequently unable during 2001
to utilize or otherwise sell the remaining equipment and consequently wrote off
the remaining $0.7 million net book value.
Additionally, $0.8 million of goodwill impairment was recognized in 2000
relating to an acquisition made by the Company in 1996.
Interest Income and Interest Expense
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Interest income was $1.0 million in 2001 compared to $1.3 million in 2000.
Interest expense totaled $5.2 million in 2001 and $4.9 million in 2000. Interest
expense in 2001 reflected higher average borrowings (although at lower
prevailing rates) compared to 2000. Increased borrowing levels in 2001 compared
to 2000 were primarily attributable to continued investment in, and working
capital requirements of, the Company's Trinidad project, as well as other
working capital requirements.
Equity Income
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Equity income amounted to $1.4 million in 2001 and $1.6 million in 2000. The
Company's equity income was derived primarily from its 20% equity interest in a
Mexican joint venture company which owns wastewater treatment plants in Mexico,
its 40% equity ownership in Desalcott, as well as 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.
Gain on Sale of Aqua Cool
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On December 31, 2001, the Company completed the sale of its Aqua Cool Business
in the United States, United Kingdom and France. Giving effect to reserves
established by the Company for purchase price adjustments and direct and