FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______ to ______
Commission File Number: 1-7211
IONICS, INCORPORATED
(Exact name of registrant as specified in its charter)
Massachusetts 04-2068530
(State or other jurisdiction of incorporation or (IRS Employer Identification Number)
organization)
65 Grove Street
Watertown, Massachusetts 02472-2882
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (617) 926-2500
Former name, former address and former fiscal year,
if changed since last report: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No ___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No ___
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
At October 31, 2004 the Company had 22,768,527 shares of Common Stock, par value
$1.00 per share, outstanding.
INDEX
Page
PART I - FINANCIAL INFORMATION 2
ITEM 1. Financial Statements 2
Unaudited Consolidated Statements of Operations
Three and Nine Months Ended September 30, 2004 and 2003 2
Unaudited Consolidated Balance Sheets
September 30, 2004 and December 31, 2003 3
Unaudited Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2004 and 2003 4
Notes to Consolidated Financial Statements 5
ITEM 2. Management's Discussion and Analysis of Financial Condition 22
and Results of Operations
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 46
ITEM 4. Controls and Procedures 46
PART II - OTHER INFORMATION 48
ITEM 1. Legal Proceedings 48
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 49
ITEM 6. Exhibits 49
SIGNATURES 50
EXHIBIT INDEX 51
-1-
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
IONICS, INCORPORATED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Amounts in thousands, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
--------------------- ---------------------
2004 2003 2004 2003
--------- ---------- ---------- ----------
Revenues:
Equipment Sales $ 32,843 $ 36,799 $ 104,264 $ 99,637
Operations 62,865 28,179 177,541 82,450
Consumer Water 4,465 3,708 12,455 9,217
Instruments 9,614 7,880 28,065 24,308
Affiliated companies 8,346 11,119 27,262 35,870
--------- ---------- ---------- ----------
118,133 87,685 349,587 251,482
--------- ---------- ---------- ----------
Costs and expenses:
Cost of sales of Equipment Sales 26,561 36,002 84,867 85,317
Cost of sales of Operations 40,235 19,998 113,588 58,227
Cost of sales of Consumer Water 1,604 2,806 5,081 5,219
Cost of sales of Instruments 4,391 3,558 12,374 11,019
Cost of sales to affiliated companies 7,411 9,575 24,014 30,958
Research and development 1,504 1,784 4,607 5,515
Selling, general and administrative 29,166 22,473 87,911 63,225
Impairment of long-lived assets - 2,499 - 2,499
Restructuring charges, net - 2,470 1,172 2,470
Impairment of goodwill - 12,731 - 12,731
--------- ---------- ---------- ----------
110,872 113,896 333,614 277,180
--------- ---------- ---------- ----------
Income (loss) from continuing operations 7,261 (26,211) 15,973 (25,698)
Interest income 524 660 1,372 2,193
Interest expense (5,698) (254) (14,782) (740)
Equity income (loss) 1,210 43 2,501 (2,800)
--------- ---------- ---------- ----------
Income (loss) from continuing operations before
gain on sale of Aqua Cool, income taxes
and minority interest expense 3,297 (25,762) 5,064 (27,045)
Gain on sale of Aqua Cool - 457 - 457
Income tax (expense) benefit (1,652) 7,981 (5,879) 8,542
--------- ---------- ---------- ----------
Income (loss) from continuing operations before
minority interest expense 1,645 (17,324) (815) (18,046)
Minority interest expense 282 249 766 635
--------- ---------- ---------- ----------
Income (loss) from continuing operations 1,363 (17,573) (1,581) (18,681)
Loss from discontinued operations, net of income tax (473) (4,459) (3,807) (7,699)
--------- ---------- ---------- ----------
Net income (loss) $ 890 $ (22,032) $ (5,388) $ (26,380)
========= ========== ========== ==========
Basic income (loss) per share from continuing
operations $ 0.06 $(0.99) $ (0.07) $ (1.06)
Basic loss per share from discontinued operations (0.02) (0.25) (0.17) (0.44)
--------------------- ---------------------
Basic income (loss) per share $ 0.04 $ (1.24) $ (0.25) $ (1.50)
===================== =====================
Diluted income (loss) per share from continuing
operations $ 0.06 $ (0.99) $ (0.07) $ (1.06)
Diluted loss per share from discontinued
operations (0.02) (0.25) (0.17) (0.44)
--------------------- ---------------------
Diluted income (loss) per share $ 0.04 $ (1.24) $ (0.25) $ (1.50)
===================== =====================
Shares used in basic income (loss) per share
calculations 22,637 17,699 21,849 17,607
====================== ====================
Shares used in diluted income (loss) per share
calculations 22,891 17,699 21,849 17,607
====================== ====================
The accompanying notes are an integral part of these consolidated financial statements.
-2-
IONICS, INCORPORATED
CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Amounts in thousands, except share and par value amounts)
December 31,
2004 2003
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 59,439 $ 133,815
Short-term investments 1,504 -
Notes receivable, current 5,912 6,365
Accounts receivable, net 128,228 87,415
Receivables from affiliated companies 23,342 22,140
Inventories:
Raw materials 19,439 15,269
Work in process 4,482 5,621
Finished goods 5,276 3,705
------------- -------------
29,197 24,595
Deferred income taxes 13,585 13,585
Assets from discontinued operations 796 7,959
Other current assets 26,504 20,196
------------- -------------
Total current assets 288,507 316,070
Restricted cash 12,400 -
Receivables from affiliated companies, long-term 11,919 20,915
Notes receivable, long-term 37,641 28,408
Investments in affiliated companies 10,164 14,362
Property, plant and equipment:
Land 11,680 6,297
Buildings 65,704 43,070
Machinery and equipment 467,074 279,997
Other, including furniture, fixtures and vehicles 38,578 34,338
------------- -------------
583,036 363,702
Less accumulated depreciation 190,387 192,169
------------- -------------
392,649 171,533
Goodwill 185,578 7,695
Intangible assets, net 74,787 6,378
Deferred income taxes, long-term 20,085 21,305
Other assets 11,087 5,311
------------- -------------
Total assets $ 1,044,817 $ 591,977
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current portion of long-term debt $ 8,738 $ 6,276
Accounts payable 37,121 28,279
Billings in advance from affiliated companies - 3,629
Income taxes payable 30,700 32,840
Liabilities from discontinued operations - 396
Other current liabilities 73,576 46,672
------------- -------------
Total current liabilities 150,135 118,092
Long-term debt and notes payable 277,763 8,889
Deferred income taxes 33,677 30,979
Minority interest 15,084 1,426
Accumulated losses in investments in affiliated companies 3,279 5,068
Other liabilities 10,374 11,358
Commitments and contingencies
Stockholders' equity:
Common stock, par value $1, authorized
shares: 100,000,000 at September 30, 2004 and 55,000,000
at December 31, 2003
issued: 22,746,329 at September 30, 2004 and 17,898,486
at December 31, 2003 22,746 17,898
Additional paid-in capital 337,904 198,285
Retained earnings 196,951 202,339
Accumulated other comprehensive loss (3,096) (2,357)
------------- -------------
Total stockholders' equity 554,505 416,165
------------- -------------
Total liabilities and stockholders' equity $ 1,044,817 $ 591,977
============= =============
The accompanying notes are an integral part of these consolidated financial statements.
-3-
IONICS, INCORPORATED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Amounts in thousands)
Nine months ended
September 30,
-----------------------
2004 2003
---------- ----------
Operating activities:
Net loss $ (5,388) $ (26,380)
Less: loss from discontinued operations (3,807) (3,478)
Less: loss on disposal of discontinued operations - (4,221)
---------- ----------
Loss from continuing operations (1,581) (18,681)
Adjustments to reconcile net loss from
continuing operations to net cash used in
operating activities:
Depreciation 29,525 18,251
Amortization of intangibles 6,272 426
Deferred tax valuation allowance 4,375 -
Provision for losses on accounts and notes receivable 1,970 3,199
Impairment of long-lived assets - 2,499
Impairment of goodwill - 12,731
Equity in (earnings) losses of affiliates (2,501) 2,800
Changes in assets and liabilities,
net of effects of businesses acquired:
Notes receivable (10,600) (607)
Accounts receivable (23,232) 11,444
Receivables from affiliated companies (9,017) (14,386)
Inventories (1,279) 5,295
Other current assets (2,348) (947)
Investments in affiliated companies 1,362 1,205
Deferred income taxes 9,927 (9,056)
Accounts payable and accrued expenses (4,679) (7,262)
Deferred revenue from affiliates (335) 2,869
Accrued expenses for affiliated companies (3,524) -
Customer deposits 15,270 1,377
Income taxes payable (5,674) (3,999)
Accumulated losses in investments in affiliated companies 1,789 (89)
Other (107) (3,370)
------------------------
Net cash provided by operating activities 5,613 3,699
Investing activities:
Additions to property, plant and equipment (25,709) (18,109)
Disposals of property, plant and equipment 1,883 161
Additional investments in affiliated companies - (1,575)
Acquisitions, net of cash acquired (223,830) (7,092)
(Purchases) sales of short-term investments (1,371) 12
------------------------
Net cash used in investing activities (249,027) (26,603)
Financing activities:
Restricted cash 3,688 4,250
Principal payments on current debt (3,349) (4,662)
Proceeds from borrowings of current debt 244 5,135
Principal payments on long-term debt (12,945) (864)
Proceeds from borrowings of long-term debt 175,418 -
Deferred financing costs (6,233) -
Change in the fair value of financial instruments 2,203 -
Proceeds from issuance of stock under stock option plans 5,498 3,377
------------------------
Net cash provided by financing activities 164,524 7,236
Effect of exchange rate changes on cash (944) 5,519
-----------------------
Net cash used in continuing operations (79,834) (10,149)
Net cash provided by discontinued operations 5,458 4,313
Cash and cash equivalents at beginning of period 133,815 136,044
------------------------
Cash and cash equivalents at end of period $ 59,439 $ 130,208
========================
The accompanying notes are an integral part of these consolidated financial statements.
-4-
IONICS, INCORPORATED
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation
The accompanying consolidated quarterly financial statements of Ionics,
Incorporated (the "Company") are unaudited; however, in the opinion of the
management of the Company, all adjustments of a normal recurring nature have
been made that are necessary for a fair statement of the Company's consolidated
financial position, results of operations and cash flows for each period
presented. The consolidated results of operations for the interim periods are
not necessarily indicative of the results of operations to be expected for the
full year or any future period.
The accompanying financial statements have been prepared with the assumption
that users of the interim financial information have either read or have access
to the Company's financial statements for the year ended December 31, 2003.
Accordingly, footnote disclosures that would substantially duplicate the
disclosures contained in the Company's audited financial statements as of and
for the year ended December 31, 2003 have been omitted from these financial
statements. These financial statements have been prepared in accordance with the
instructions to Form 10-Q and the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally accepted
accounting principles have been condensed or omitted pursuant to such
instructions, rules and regulations. These financial statements should be read
in conjunction with the Company's 2003 Annual Report on Form 10-K as filed with
the Securities and Exchange Commission.
During the first quarter of 2004, the Company realigned its business structure
and began reporting new business segments. This segment realignment combined
most of its existing Equipment Business Group and Ultrapure Water Group, as well
as the operations of Ecolochem, Inc. and its affiliated companies (the
"Ecolochem Group") acquired by the Company on February 13, 2004 (see Note 3) and
the Desalination Company of Trinidad and Tobago Ltd. ("Desalcott") which has
been consolidated effective January 1, 2004 upon the adoption of Interpretation
No. 46, "Consolidation of Variable Interest Entities, an Interpretation of
Accounting Research Bulletin No. 51" ("FIN 46"), into a new business group
called Water Systems. The newly formed Water Systems Group is comprised of two
reporting segments, Equipment Sales and Operations. The Consumer Water Group
remains a reporting group as previously constituted. The Instruments Group
continues with its existing activities and includes all worldwide instrument
sales. The Corporate Group includes all corporate overhead.
Certain prior year amounts have been reclassified to conform to the current year
presentations with no impact on net income.
2. Variable Interest Entities
In January 2003, the Financial Accounting Standards Board ("FASB") issued FIN
46. In December 2003, the FASB issued a revised version of FIN 46, which
incorporated a number of changes to the prior version. Prior to the effective
date of FIN 46, an entity was generally included in the consolidated financial
statements if it was controlled through ownership of a majority voting interest.
In FIN 46, the FASB concluded that the voting interest approach is not always
effective in identifying controlling financial interests. In some arrangements,
equity investors may not bear the residual economic risks, and in others,
control is not exercised through voting shares. Prior to the first quarter of
2004, the Company was required to apply the provisions of FIN 46 to variable
interests in variable interest entities ("VIEs") created after January 31, 2003.
There were no VIEs meeting this criteria. During the first quarter of 2004, the
Company was required to apply the provisions of FIN 46 to variable interests in
VIEs created before February 1, 2003.
FIN 46 provides guidance for determining whether an entity lacks sufficient
equity or its equity holders lack adequate decision-making ability. These VIEs
are evaluated for consolidation. Variable interests are ownership, contractual
or other interests in a VIE that change with changes in the VIE's net assets.
The Company has evaluated its equity investments and non-wholly-owned
subsidiaries to determine whether the Company is the primary beneficiary,
defined as the entity that is required to absorb the majority of the expected
gains or losses of the VIE. For any VIE in which the Company has been determined
to be the primary beneficiary, the VIE has been consolidated.
-5-
As a result, effective January 1, 2004, the Company consolidated the operations,
assets, liabilities and minority interests of Desalcott in which the Company
holds a 40% equity interest, because the Company believes it holds a majority of
the related financial risks. As of September 30, 2004, Desalcott had total
assets and total liabilities of approximately $153.2 million and $130.2 million,
respectively. Included in assets is $12.4 million of restricted cash and
property, plant and equipment totaling $125.9 million and included in
liabilities is debt of $109.0 million, which is collateralized by substantially
all of the assets and the outstanding common stock of Desalcott, and is
non-recourse to the Company.
3. Ecolochem Acquisition
On February 13, 2004, the Company acquired all of the outstanding shares of
capital stock and ownership interests of Ecolochem, Inc. and its affiliated
companies ("Ecolochem Group"). The Ecolochem Group, privately-held companies
headquartered in Norfolk, Virginia, is a leading provider of emergency, short
and long-term mobile water treatment services to the power, petrochemical and
other industries. The acquisition expands the Company's outsourced or customer
facility-based water treatment capabilities in North America and Europe and
provides the Company with better access into the energy and utilities markets.
The Company's financial statements include the results of operations of the
Ecolochem Group subsequent to the acquisition date.
The total purchase price was $366.9 million, consisting of $219.0 million in
cash (which includes $9.8 million in escrow to be paid in the event the Company
makes an election pursuant to Section 338(h)(10) election of the Internal
Revenue Code with respect to selected acquired intangible assets) and 4,652,648
shares of the Company's common stock. The Company intends to make the Section
338(h)(10) election in the fourth quarter of 2004. The issuance of 4,652,648
shares of the Company's common stock was valued at $139.9 million based on the
average of the closing prices of the common stock for the two days before, the
day of and the two days after the announcement by the Company of its agreement
to acquire the Ecolochem Group. The purchase price includes capitalizable
acquisition costs of $8.0 million, consisting of investment banking, legal,
consulting and accounting services. The cash portion of the consideration was
financed with the Company's available cash resources and proceeds from $255
million senior credit facilities with a syndication of lenders led by UBS, Fleet
Bank and Bank of America. Proceeds from these credit facilities were used to
fund the acquisition, pay certain transaction-related fees and expenses, provide
for ongoing working capital and support the issuance of letters of credit. The
credit facilities consist of a $175 million 7-year term loan, of which $166.6
million was outstanding at September 30, 2004, at an average interest rate of
5.75%, and an $80 million 5-year revolving credit facility. The revolving credit
facility consists of a $60.0 million facility available for issuance of letters
of credit, of which $35.9 million was outstanding at September 30, 2004, and a
$20.0 million facility for general purpose borrowings, of which there were no
outstanding borrowings at September 30, 2004. Borrowings under the credit
facilities bear interest equal to a base rate (generally the Prime Rate) plus a
specified margin or the London Interbank Offered Rate ("LIBOR") plus a specified
margin, at the Company's option; the specified margins are a function of the
Company's leverage ratio. Interest on outstanding borrowings is payable
quarterly. The credit facilities are collateralized by the assets of the Company
and of its domestic subsidiaries and by 65% of certain of the equity of the
Company's international subsidiaries. The terms of the credit facilities include
financial covenants relating to fixed charge coverage, interest coverage,
leverage ratio and capital expenditures, the most restrictive of which are
anticipated to be the leverage ratio and limitations on capital spending. The
terms of the credit facilities contain provisions that limit the Company's
ability to incur additional indebtedness in the future and place other
restrictions on the Company's business. At September 30, 2004, the Company was
in compliance with the facilities' covenants. In connection with the execution
of the credit facilities, the Company entered into interest rate swap agreements
that fix the Company's LIBOR rate on $100 million of the term loan at 3.1175%
per annum. The swap agreements expire in 2010. (See Note 15)
-6-
The preliminary allocation of the $366.9 million purchase price to the estimated
fair values of the assets acquired and liabilities assumed at the date of
acquisition based upon a third-party valuation was as follows:
(Dollars in millions)
Assets
Current assets $ 27.4
Property, plant and equipment 101.6
Intangible assets 72.8
Goodwill 179.4
Other assets 1.8
-------------
Total assets acquired $ 383.0
-------------
Liabilities
Current liabilities $ 14.0
Other liabilities 2.1
------------
Total liabilities assumed 16.1
-------------
-------------
Total purchase price including acquisition costs $ 366.9
=============
The purchase price is subject to a final determination of certain cash-related
and working capital amounts, to be agreed to by the sellers and the Company,
which is expected in the fourth quarter of 2004. Goodwill was recognized for the
excess purchase price over the fair value of the assets and liabilities
acquired. Goodwill is primarily attributable to anticipated growth from new
customers and synergies related to the integration of Ecolochem. Goodwill
apportioned to domestic operations for tax purposes is deductible over a 15-year
period.
The following table reflects the estimated fair values of the acquired
intangible assets and related estimates of useful lives:
(Dollars in millions)
Contractual relationships $ 57.8 10-year economic consumption life
Technology and know-how 10.8 10-year useful life
Trade names and trademarks 2.3 9-year useful life
Non-compete agreements 0.1 5-year useful life
Discharge permits 1.8 Indefinite life
-------------
$ 72.8
=============
The following pro forma information presents a summary of the historical
consolidated statements of operations of the Company and Ecolochem for the three
months ended September 30, 2003 and the nine months ended September 30, 2004 and
2003, giving effect to the merger as if it occurred on January 1, 2004 and 2003,
respectively.
(Amounts in thousands, except per share amounts)
Three months ended September 30, Nine months ended September 30,
-------------------------------------------- -------------------------------------------
Actual Pro Forma Pro Forma Pro Forma
2004 2003 2004 2003
--------------------- -------------------- -------------------- --------------------
Revenues $ 118,133 $ 116,148 $ 361,368 $ 332,640
Income (loss) from continuing operations 1,363 (12,963) (1,529) (8,004)
Income (loss) per share from continuing
operations:
Basic $ 0.06 $ (0.58) $ (0.07) $ (0.36)
Diluted 0.06 (0.58) (0.07) (0.36)
The pro forma income (loss) from continuing operations and income (loss) per
share from continuing operations for each period presented primarily includes
adjustments for depreciation of fixed assets, amortization of intangibles and
debt financing costs, interest expense, tax rate changes and the issuance of
common stock. Amortization of the acquired intangibles is included on an
economic consumption basis for contractual relationships and a straight-line
basis for all other intangibles. This pro forma information does not purport to
-7-
indicate the results that would have actually been obtained had the acquisition
been completed on the assumed date or for the periods presented, or which may be
realized in the future.
4. Accounting for Stock-Based Compensation
The Company applies the recognition and measurement provisions of Accounting
Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and
related interpretations in accounting for its stock-based compensation plans.
Accordingly, for options with an exercise price less than the fair market value
of the stock at the date of grant, if any, stock-based compensation is measured
as the difference between the option exercise price and fair market value of the
stock at the date of grant and is charged to operations over the expected period
of benefit to the Company. For the three and nine months ended September 30,
2004 and 2003, no stock-based compensation expense is reflected in net (loss)
income, as all options granted under those plans had an exercise price equal to
or greater than the market value of the underlying common stock on the date of
grant.
The following table illustrates the pro forma effect on net (loss) income and
(loss) earnings per share if the Company had applied the fair value method of
accounting for stock options and other equity instruments defined by SFAS 123,
"Accounting for Stock-Based Compensation," as amended by SFAS 148 "Accounting
for Stock-Based Compensation-Transition and Disclosure." The effect of applying
SFAS 123 in the pro forma disclosure is not indicative of future awards, which
are anticipated.
(Amounts in thousands, except per share amounts)
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------- ------------ -------------
Net income (loss), as reported $ 890 $ (22,032) $ (5,388) $ (26,380)
Less: Stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects(1,299) (1,277) (3,318) (3,698)
------------ ------------- ------------ -------------
Pro forma net loss $ (409) $ (23,309) $ (8,706) $ (30,078)
============ ============= ============ =============
------------ ------------- ------------ -------------
Income (loss) per basic share, as reported $ 0.04 $ (1.24) $ (0.25) $ (1.50)
============ ============= ============ =============
Loss per basic share, pro forma $ (0.02) $ (1.32) $ (0.40) $ (1.71)
============ ============= ============ =============
------------ ------------- ------------ -------------
Income (loss) per diluted share, as reported $ 0.04 $ (1.24) $ (0.25) $ (1.50)
============ ============= ============ =============
Loss per diluted share, pro forma $ (0.02) $ (1.32) $ (0.40) $ (1.71)
============ ============= ============ =============
The fair value of each option granted during the first nine months of 2003 was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions:
Three months ended Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------- ------------ -------------
Expected term (years) N/A 6.0 6.0 6.0
Volatility N/A 41.4% 43.07% 41.4%
Risk-free interest rate (zero coupon U.S. treasury note) N/A 3.77% 4.19% 3.42%
Dividend yield None None None None
Weighted average fair value of options granted N/A $10.07 $11.42 $8.03
5. Discontinued Operations
During the second quarter of 2004, the Company's management decided to sell its
General Ionics home water operation, which is part of the Consumer Water Group.
In the fourth quarter of 2003, the Company's management and Board of Directors
approved a plan to sell its European point-of-use (POU) cooler businesses in the
United Kingdom (UK) and Ireland, which was part of the Consumer Water Group. In
the third quarter of 2003, the Company's management and Board of Directors
approved a plan to sell its consumer chemical business, the Elite Consumer
Products division in Ludlow, Massachusetts, which was also part of the Consumer
Water Group. Accordingly, the Company's financial statements and notes reflect
these businesses as discontinued operations in accordance with the SFAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets."
-8-
The Company's financial statements have been reclassified to reflect these
businesses as discontinued operations for all periods presented. The operating
results of the discontinued operations are summarized below, which exclude
general corporate overhead previously allocated to each entity.
(Dollars in thousands)
Three months ended Nine months ended
September 30, September 30,
------------------------- -------------------------
2004 2003 2004 2003
------------ ----------- ------------ -----------
Income/(loss) from discontinued operations,
net of income tax
Elite New England $ 107 $ (1,170) $ 4 $ (2,777)
Point of Use UK (306) (597) (753) (1,330)
Point of Use Ireland (212) (173) (1,312) (287)
General Ionics (62) 21 (38) 173
------------ ----------- ------------ -----------
(473) (1,919) (2,099) (4,221)
Loss on disposal of discontinued operations,
net of income tax
Elite New England - (2,540) - (3,478)
Point of Use UK - - (585) -
Point of Use Ireland - - (1,123) -
General Ionics - - - -
------------ ----------- ------------ -----------
- (2,540) (1,708) (3,478)
Total loss from discontinued operations,
net of income tax $ (473) $ (4,459) $ (3,807) $ (7,699)
============ =========== ============ ===========
In the first quarter of 2004, the Company completed the sale of the Elite
Consumer Products division for approximately $5.2 million, resulting in a gain
of $0.2 million. In the second quarter of 2004, the Company completed the sale
of the European POU cooler business in the UK and Ireland during the second
quarter of 2004 for approximately $3.0 million, resulting in a gain of $0.5
million.
(Dollars in thousands)
Three months ended Nine months ended
September 30, September 30,
------------------------------------- -------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
Revenues $ 1,516 $ 7,506 $ 6,991 $ 22,850
Gross margin 791 (473) 3,635 3,015
================= ================= ================= =================
Loss from discontinued operations,
before income tax (618) (3,045) (2,521) (6,678)
Income tax benefit 145 1,126 422 2,457
----------------- ----------------- ----------------- -----------------
Loss from discontinued operations,
net of income tax (473) (1,919) (2,099) (4,221)
Loss on disposal of discontinued operations,
net of income tax - (2,540) (1,708) (3,478)
----------------- ----------------- ----------------- -----------------
Total loss from discontinued operations,
net of income tax $ (473) $ (4,459) $ (3,807) $ (7,699)
================= ================= ================= =================
-9-
Assets and liabilities from discontinued operations at September 30, 2004 and
December 31, 2003 consist of the following:
(Dollars in thousands)
September 30, December 31,
2004 2003
-------------- --------------
Current assets $ 498 $ 2,950
Non-current assets 298 5,009
-------------- --------------
Assets from discontinued operations $ 796 $ 7,959
============== ==============
Liabilities from discontinued operations $ - $ 396
============== ==============
At September 30, 2004, current assets primarily include accounts receivable,
inventory and other current assets. Non-current assets primarily include
property, plant and equipment. At December 31, 2003, current assets primarily
include accounts and notes receivable, inventory and other current assets.
Non-current assets primarily include property, plant and equipment, intangible
assets and other assets. Liabilities consist of accounts payable and accrued
expenses.
6. Restructuring Charges
During the third quarter of 2003, the Company announced a restructuring plan
intended to improve financial performance through a realignment of the Company's
management structure, a reduction in personnel, and the consolidation of certain
operations. The program is consolidating the Company's sales, engineering,
manufacturing and accounting functions, which existed in many reporting
entities, into several regional centers in the United States, Europe and Asia.
During the first nine months of 2004, the Company recorded restructuring charges
of approximately $1.2 million relating primarily to vacating leased facilities.
At September 30, 2004, the Company had approximately $0.5 million and $0.3
million accrued for restructuring costs associated with vacated leased
facilities included in "Other current liabilities" and "Other long-term
liabilities," respectively. The Company accrued for the leases in accordance
with SFAS 146 "Accounting for Costs Associated with Exit or Disposal Activities"
based on the value of the lease obligation in excess of the estimated sub-lease
rental income through 2007.
Reconciliation of the restructuring liability as of September 30, 2004 by
segment is as follows:
(Dollars in thousands)
Equipment Consumer
Sales Operations Water Instruments Corporate Total
------------ ------------ ------------ ------------------------- -----------
Balance December 31, 2003 $ 393 $ 382 $ 28 $ - $ 69 $ 872
Accrual for severance - 30 - - 134 164
Accruals for facilities 915 43 - - 50 1,008
Payments (518) (439) (23) - (236) (1,216)
------------ ------------ ------------ ------------ ---------- -----------
Balance September 30, 2004 $ 790 $ 16 $ 5 $ - $ 17 $ 828
============ ============ ============ ============ ========== ===========
7. Goodwill and Intangible Assets
The carrying amounts of goodwill for the quarters ended September 30, 2004 and
December 31, 2003 by segment are as follows:
(Dollars in thousands)
Equipment Consumer
Sales Operations Water Instruments Corporate Total
------------- ------------ ------------ -------------------------- -----------
Balance December 31, 2002 $ 9,880 $ 9,376 $ 862 $ - $ - $ 20,118
Goodwill impairment write off (8,981) (3,750) - - - (12,731)
Cumulative translation adjustment/other 308 - - - 308
-------------- ------------ ------------ ------------ ----------- -----------
Balance December 31, 2003 $ 899 $ 5,934 $ 862 $ - $ - $ 7,695
Goodwill acquired during the period - 179,425 - - - 179,425
Cumulative translation adjustment/other - (1,542) - - - (1,542)
------------- ------------ ------------ ------------ ----------- -----------
Balance September 30, 2004 $ 899 $ 183,817 $ 862 $ - $ - $ 185,578
============= ============ ============ ============ =========== ===========
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The gross carrying value and accumulated amortization of intangible assets as of
September 30, 2004 and December 31, 2003 are as follows:
(Dollars in thousands)
Intangible Assets at September 30, 2004
Contractual Non-Compete Technology and
Relationships Agreements Know-How Patents Trademarks Other Total
--------------- --------------- ----------------- --------- ------------- -------- ----------
Amortized Intangible Assets:
Gross Carrying Amount $ 62,562 $ 400 $ 10,812 $ 735 $ 2,340 $ 3,890 $ 80,739
Accumulated Amortization (5,209) (161) (684) (395) (164) (1,312) (7,925)
--------------- --------------- ----------------- --------- ------------- -------- ----------
Net Intangible Assets 57,353 239 10,128 340 2,176 2,578 72,814
--------------- --------------- ----------------- --------- ------------- -------- ----------
Indefinite-lived Intangible
Assets: - - - - 262 1,711 1,973
--------------- --------------- ----------------- --------- ------------- -------- ----------
Total Intangible Assets $ 57,353 $ 239 $ 10,128 $ 340 $ 2,438 $ 4,289 $ 74,787
=============== =============== ================= ========= ============= ======== ==========
Intangible Assets at December 31, 2003
Contractual Non-Compete Technology and
Relationships Agreements Know-How Patents Trademarks Other Total
--------------- --------------- ----------------- --------- ------------- -------- ----------
Amortized Intangible Assets:
Gross Carrying Amount $ 4,755 $ 275 $ - $ 707 $ - $ 2,031 $ 7,768
Accumulated Amortization (252) (106) - (322) - (972) (1,652)
--------------- --------------- ----------------- --------- ------------- -------- ----------
Net Intangible Assets 4,503 169 - 385 - 1,059 6,116
--------------- --------------- ----------------- --------- ------------- -------- ----------
Indefinite-lived Intangible
Assets: - - - - 262 - 262
--------------- --------------- ----------------- --------- ------------- -------- ----------
Total Intangible Assets $ 4,503 $ 169 $ - $ 385 $ 262 $ 1,059 $ 6,378
=============== =============== ================= ========= ============= ======== ==========
The increase in intangible assets primarily reflects the acquisition of the
Ecolochem Group (see Note 3) during the first quarter of 2004. Amortization
expense for intangible assets is estimated to be approximately $8.6 million in
2004, $9.5 million in 2005, $9.2 million in 2006, $8.7 million in 2007 and $8.4
million in 2008.
8. Long-Term Debt and Notes Payables
(Dollars in Thousands)
September 30, December 31,
2004 2003
---------------- ---------------
Notes Payable $ 10,875 $ 15,165
Debt for Ecolochem acquisition 166,632 -
Desalcott Notes Payable 108,994 -
---------------- ---------------
Total Contractual Obligations 286,501 15,165
Less Current Portion 8,738 6,276
---------------- ---------------
Total Long-Term Contractual Obligations $ 277,763 $ 8,889
================ ===============
Acquisition of the Ecolochem Group
On February 13, 2004, the Company acquired the stock and membership interests of
the Ecolochem Group from the shareholders and owners of the Ecolochem Group. The
total purchase price was $366.9 million, consisting of $219.0 million in cash
(which includes $9.8 million in escrow to be paid in the event the Company makes
a Section 338 (h)(10) election of the Internal Revenue Code with respect to
selected acquired intangible assets) and 4,652,648 shares of the Company's
common stock. The purchase price includes capitalizable acquisition costs of
$8.0 million, consisting of investment banking, legal, consulting and accounting
services. The cash portion of the consideration was financed with the Company's
available cash resources and proceeds from $255 million senior credit facilities
with a syndication of lenders led by UBS, Fleet Bank and Bank of America.
Proceeds from these credit facilities were used to fund the acquisition, pay
certain transaction-related fees and expenses, provide for ongoing working
capital and support the issuance of letters of credit. The credit facilities
consist of a $175 million 7-year term loan, of which $166.6 million was
outstanding at September 30, 2004 at an average interest rate of 5.75%, and an
$80 million 5-year revolving credit facility. The revolving credit facility
consists of a $60.0 million facility available for issuance of letters of
credit of which $35.9 million was outstanding at September 30, 2004, and a $20.0
million facility for general purpose borrowings, of which there were no
outstanding borrowings at September 30, 2004 at an average interest rate of
2.5%. Borrowings under the credit facilities bear interest equal to a base rate
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(generally the Prime Rate) plus a specified margin or LIBOR plus a specified
margin, at the Company's option; the specified margins are a function of the
Company's leverage ratio. Interest on outstanding borrowings is payable
quarterly. The credit facilities are collateralized by the assets of the Company
and of its domestic subsidiaries and by 65% of the equity of certain of the
Company's international subsidiaries. The terms of the credit facilities include
financial covenants relating to fixed charge coverage, interest coverage,
leverage ratio and capital expenditures, the most restrictive of which are
anticipated to be the leverage ratio and limitations on capital spending. The
terms of the credit facilities contain provisions that limit the Company's
ability to incur additional indebtedness in the future and place other
restrictions on the Company's business. At September 30, 2004, the Company was
in compliance with the facilities covenants. In connection with the execution of
the credit facilities, the Company entered into interest rate swap agreements
that fix the Company's LIBOR rate on $100 million of the term loan at 3.1175%
per annum. The swap agreements expire in 2010.
Consolidation of Desalcott
Pursuant to FIN 46 (see note 2), effective January 1, 2004, the Company
consolidated the operations, assets, liabilities and majority interests of the
Desalination Company of Trinidad and Tobago Ltd. ("Desalcott"), in which the
Company holds a 40% equity interest, because the Company believes it holds a
majority of the related financial risks. Included in liabilities at September
30, 2004 is debt of $109.0 million. The debt outstanding consists of 20-year
loans for $75.8 million and $33.2 million. Each loan bears interest at 8.5%,
which is payable quarterly. As a result of an agreed upon "Moratorium Period" on
the $33.2 million loan, principal payments do not commence until October 2005.
Interest rates are fixed on each loan for the first five years and ten years,
respectively. Interest rates may change at the end of each subsequent five-year
period. The total debt is collateralized by substantially all of the assets and
the outstanding common stock of Desalcott, and is non-recourse to the Company.
Other Debt
The Company has three project finance loans for its controlled affiliate in
Barbados. These loans are payable in equal quarterly installments over a
ten-year period that began in 2000, and bear interest at rates ranging from 2%
over LIBOR up to 8.75%. The controlled affiliate had outstanding borrowings of
$5.2 million and $6.4 million against these loans at September 30, 2004 and
December 31, 2003, respectively. The Company also has project financing loans
for its controlled affiliate in Italy. The loans have a ten-year maturity and
bear interest at EURIBOR plus a specified margin. The controlled affiliate had
outstanding borrowings of $5.6 million and $3.8 million against these loans at
September 30, 2004 and December 31, 2003, respectively.
9. Commitments and Contingencies
Litigation
In August 2004, the Company agreed in principle to settle the
securities class action lawsuit brought in March 2003 against the Company and
its former Chief Executive Officer and current Chief Financial Officer in the
U.S. District Court, District of Massachusetts (Jerome Deckler v. Ionics, Inc.
et al., Civil Action No. 03-CV10393(WGY)). Under the terms of the
settlement-in-principle, a settlement fund will be created in the total amount
of $3 million, to be paid entirely by the Company's insurer. The Company will
not be required to make any contribution to this settlement fund. The
settlement-in-principle is subject to the execution and filing with the U.S.
District Court of a definitive stipulation of settlement and also final approval
of the settlement by the Court.
On April 28, 2004, the Company was served with a summons and complaint captioned
Caldon, Inc. v. Ionics, Incorporated and Key Technologies, Inc., filed in the
U.S. District Court for the Western District of Pennsylvania, Pittsburgh.
Caldon, Inc. ("Caldon") alleges that certain flow measurement systems, which
Caldon provides to the nuclear power industry to measure feedwater flow, and
which were designed by defendant Key Technologies, Inc., failed after
installation. Caldon engaged the Company to fabricate these systems using Key
Technologies, Inc.'s designs. Caldon further alleges that defendant Key
Technologies, Inc. failed to design the systems adequately and that the Company
failed to weld the systems properly. Caldon claims that it has incurred damages
in excess of $2.7 million and has made commitments to customers that will cause
it to incur an additional $4.0 million, as well as other damages in an
unspecified amount. The Company believes that Caldon's allegations as to the
Company are without merit, and intends to defend itself vigorously in this
matter. The lawsuit is currently in the early discovery stages. While the
Company believes that this litigation should have no material adverse impact on
its financial condition, results of operations or cash flows, the litigation
process is inherently uncertain and the Company can make no assurances as to the
ultimate outcome of this matter.
On December 16, 2003, Ionics Iberica, S.A., the Company's wholly-owned Spanish
subsidiary ("Iberica"), brought suit in Palencia, Spain against Intersuero, S.A.
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("Intersuero"). Iberica supplied certain membrane-based production equipment
under a lease agreement to Intersuero, which subsequently declared bankruptcy.
In its lawsuit, Iberica sought the return of the equipment or payment of 2.8
million Euros, or $3.5 million, plus interest, for the equipment. On February
17, 2004, Intersuero filed an answer and counterclaim, alleging that the
equipment did not perform to specifications and seeking 15.8 million Euros, or
$19.6 million, in damages, lost profits, interest and costs, plus additional
damages for continuing lost profits. Intersuero subsequently requested that the
Court pursue a criminal investigation against Iberica and its directors (who
include the Company's Chief Executive Officer and Chief Financial Officer),
alleging that Iberica filed false documents in the civil proceedings. Iberica
has acknowledged that it inadvertently filed several intermediate draft
agreements as exhibits, and the Court subsequently was provided with the final
agreements. The Court is currently conducting an investigation to determine
whether criminal charges should be pursued. Intersuero moved to suspend the
civil proceedings pending the outcome of the criminal investigation in an
attempt to delay the trial on the proceedings. Iberica was successful in
opposing this motion. The Company believes Intersuero's allegations and
complaint to be without merit and intends aggressively to pursue its claim
against Intersuero. While the Company believes that this litigation should have
no material adverse impact on its financial condition, results of operations or
cash flows, the litigation process is inherently uncertain, and the Company can
make no assurances as to the ultimate outcome of this matter. The Company, in
2003, recorded an impairment charge associated with the remaining carrying value
of the equipment.
On September 15, 2003, the Company was served with a summons and complaint
captioned Brazos River Authority v. Ionics, Incorporated, Cajun Constructors,
Inc. f/k/a Cajun Contractors, Inc., and HDR Engineering, Inc., in Texas state
court. The suit was subsequently removed to the U.S. District Court, Western
Division of Texas, Waco Division (Civil Action WA: 03-CV-324). On July 1, 2004,
plaintiff filed a first amended complaint. Plaintiff alleges that an
electrodialysis reversal ("EDR") desalination system originally sold by the
Company to the plaintiff in 1989 and expanded by the Company in 1998 is
defective and accuses the Company and the other defendants of, among other
things, negligence, breach of contract, and misrepresentation. The complaint
seeks both compensatory and punitive damages in an unspecified amount, among
other relief. The plaintiff subsequently made a settlement demand of $25
million. The Company has filed an answer to the complaint which states the
Company's belief that any problems encountered by the plaintiff resulted from
its failure to operate and maintain the equipment properly. The Company intends
to defend itself vigorously in this matter. The parties failed to achieve
settlement at a mediation held on August 25, 2004. Trial on this matter is
currently scheduled to commence in January 2005. While the Company believes that
this litigation should have no material adverse impact on its financial
condition, results of operations or cash flow, 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. The Company believes that none of the other pending matters
will have an outcome material to the Company's financial position, results of
operations or cash flows.
Other Commitments and Contingencies
From time to time, the Company enters into joint ventures with respect to
specific projects, including the projects in Trinidad, Kuwait, Israel and
Algeria described below. Each joint venture arrangement is independently
negotiated based on the specific facts and circumstances of the project, the
purpose of the joint venture entity related to the project, as well as the
rights and obligations of the other joint venture partners. Generally, the
Company has structured its project joint ventures so that the Company's
obligation to provide funding to the underlying project or to the joint venture
entity is limited to its proportional capital contribution, which can take the
form of equity or subordinated debt. The Company generally has no commitment to
fund the joint venture's working capital or other cash needs. The joint venture
entities typically obtain third-party debt financing for a substantial portion
of the project's total capital requirements. In these situations, the Company is
not responsible for the repayment of the indebtedness incurred by the joint
venture entity. In connection with a joint venture's project, the Company may
also enter into contracts for the supply and installation of the Company's
equipment during the construction of the project or for the operation and
maintenance of the facility once it begins operation, or both. These commercial
arrangements do not require the Company to commit to any funding for working
capital or any other requirements of the joint venture company. As a result, the
Company's exposure with respect to its joint ventures is typically limited to
its debt and equity investments in the joint venture entity, the fulfillment of
any contractual obligations it has to the joint venture entity and the accounts
receivable owing to the Company from the joint venture entity.
The operations, assets and liabilities of Desalcott are consolidated with the
Company effective January 1, 2004, as a result of the adoption of FIN 46. The
operations, assets and liabilities of the Algerian joint venture company are
consolidated with the Company as a majority-owned subsidiary. The Kuwait and
Israel projects discussed below constitute off-balance sheet arrangements.
-13-
Trinidad
In 2000, the Company acquired 200 ordinary shares of Desalination Company of
Trinidad and Tobago Ltd. ("Desalcott"), for $10 million and loaned $10 million
to Hafeez Karamath Engineering Services Ltd. ("HKES"), the founder of Desalcott
and promoter of the Trinidad desalination project, to enable HKES to acquire an
additional 200 ordinary shares of Desalcott. Prior to those investments, HKES
owned 100 ordinary shares of Desalcott. As a result, the Company currently owns
a 40% equity interest in Desalcott, and HKES currently owns a 60% equity
interest in Desalcott. In the second quarter of 2002, construction was completed
on the first four (out of five) phases of the Trinidad desalination facility
owned by Desalcott, and the facility commenced water deliveries to its customer,
the Water and Sewerage Authority of Trinidad and Tobago ("WASA").
The Company's $10 million loan to HKES is included in "Notes receivable,
long-term" in the Company's Consolidated Balance Sheets. The loan bears interest
at a rate equal to LIBOR + 2%, with interest payable (subject to availability of
funds) starting October 25, 2002 and every six months thereafter and at
maturity. Prior to maturity, accrued interest (as well as principal payments) is
payable only to the extent dividends or other distributions are paid by
Desalcott on the ordinary shares of Desalcott owned by HKES and pledged to the
Company. Principal repayment is due in 14 equal installments commencing on April
25, 2004 and continuing semiannually thereafter. The loan matures and is payable
in full on April 25, 2011. The loan is collateralized by a security interest in
the shares of Desalcott owned by HKES and purchased with the borrowed funds,
which is subordinate to the security interest in those shares in favor of the
Trinidad bank that provided the financing for Desalcott. In addition, any
dividends or other distributions paid by Desalcott to HKES on the pledged shares
must be applied to loan payments to the Company. No payments have been made by
HKES to the Company on this loan.
In 2000, Desalcott entered into a "bridge loan" agreement with a Trinidad bank
providing $60 million in construction financing. Effective November 8, 2001, the
loan agreement was amended to increase maximum borrowings to $79.9 million. The
bridge loan of $79.9 million and the $20 million equity provided to Desalcott
did not provide sufficient funds to pay all of Desalcott's obligations in
completing construction and commissioning of the project prior to receipt of
long-term financing in the second quarter of 2003. Consequently, included in
Desalcott's obligations at March 31, 2003 was approximately $30.1 million
payable to the Company's Trinidad subsidiary for equipment and services
purchased in connection with the construction of the facility. However,
Desalcott disputed certain amounts payable under the construction contract. In
June 2003, Desalcott and the Company's Trinidad subsidiary resolved their
dispute under the construction contract, and reached agreement as to the final
amount owing to the Company for completion of the first four phases of the
project. This settlement had no impact on the Company's Statements of
Operations.
In June 2003, Desalcott entered into a long-term loan agreement with the
Trinidad bank that had provided the bridge loan. In connection with the funding
of the loan, Desalcott paid the Company's Trinidad subsidiary approximately $12
million of outstanding accounts receivable under the construction contract in
July 2003. In addition, pursuant to a previous commitment made by the Company,
the Company, effective July 31, 2003, converted an additional $10 million of
amounts owing under the construction contract into a loan to Desalcott as an
additional source of long-term project financing, subordinated to the long-term
loan with the Trinidad bank. That loan has a seven-year term, and is payable in
28 quarterly payments of principal and interest. No loan payments can be made by
Desalcott to the Company until Desalcott has established a level of cash
reserves required by the Trinidad bank, and no payments have as yet been made.
The interest rate is fixed at two percent above the interest rate payable by
Desalcott on the U.S. dollar portion of its borrowings under its long-term loan
agreement with the Trinidad bank (the initial annual rate on the U.S. dollar
portion was 8 1/2%). In the event of a default by Desalcott, Desalcott's
obligation to the Company is subordinated to Desalcott's obligations to the
Trinidad bank.
As a result of the settlement of the construction contract dispute described
above and Desalcott's $12 million payment to the Company's Trinidad subsidiary,
together with the conversion of an additional $10 million of accounts receivable
into a long-term loan as described above, the remaining amount due to the
Company's Trinidad subsidiary from Desalcott for construction work on the first
four phases of the project is approximately $3.2 million. This amount will be
partially paid out of Desalcott's future cash flow from operations over a period
of time estimated to be two years, and the balance from funds available from
long-term financing proceeds upon completion by the Company of certain "punch
list" items relating to phases 1 through 4. Desalcott also owes the Company
approximately $1.8 million of value added tax (VAT) associated with Phases 1
through 4, and the Company has notified Desalcott that it is in default of such
payment obligation. In addition, Desalcott and the Company agreed that the
Company's Trinidad subsidiary would complete the last phase (phase 5) of the
project (which will increase water production capacity by approximately 9%) for
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a fixed price of $7.4 million. Work on phase 5 was completed during the second
quarter of 2004. As of September 30, 2004, the Company had been paid a total of
$5.8 million for its work on phase 5, and has notified Desalcott that it is in
default of payment for fees, costs and VAT relating to Phase 5 totalling
approximately $1.3 million.
In April 2004, following an unsuccessful mediation attempt, Desalcott notified
WASA that it had commenced an arbitration proceeding under the dispute
resolution procedures of the water supply agreement between Desalcott and WASA
dated August 29, 1999 and amended in May 2000 (the "Water Supply Agreement").
Desalcott is seeking, among other things, payments from WASA for certain water
price increases as provided for in the Water Supply Agreement, as well as
damages for delays in plant completion which Desalcott claims resulted from
delays in obtaining a government guaranty of payments by WASA and certain tax
incentives. At September 30, 2004, Desalcott claimed that WASA owed it $4.0
million, representing revenues under the Water Supply Agreement corresponding to
contractual price increases. WASA has contested the amounts of the water price
increases claimed by Desalcott, asserting that Desalcott did not pass along to
WASA certain cost savings realized by Desalcott. In addition, WASA asserts that
Desalcott's ability to make up production shortfalls by selling excess
production is more limited contractually than claimed by Desalcott. In addition,
WASA has also asserted that Desalcott is liable for liquidated damages because
of delays in the completion of the plant, irrespective of the delay in obtaining
the government guaranty, and that such liquidated damages total approximately
$4.0 million and are still accumulating. WASA has asserted additional liquidated
damages will be owed by Desalcott for the delay in the completion of Phase 5 of
the project, or that in the alternative it may seek to reject Phase 5. Under the
currently projected timetable, this matter should be heard in arbitration by the
International Chamber of Commerce in London in 2005.
Kuwait
During 2001, the Company acquired a 25% equity interest in a Kuwaiti project
company, Utilities Development Company W.L.L. ("UDC"), which was awarded a
concession agreement by an agency of the Kuwaiti government for the
construction, ownership and operation of a wastewater reuse facility in Kuwait.
During the second quarter of 2002, UDC entered into agreements for the long-term
financing of the project, and construction of the project commenced. At
September 30, 2004, the Company had invested a total of $13.2 million as equity
and subordinated debt in UDC. The Company has commitments to make additional
equity investments or issue additional subordinated debt to UDC of approximately
$4.1 million over the next year. In addition, a total of $18.6 million in
letters of credit have been issued on behalf of the Company's Italian subsidiary
in connection with the project. UDC's wastewater treatment facility is expected
to become operational in early 2005.
Israel
In 2001, the Company entered into agreements with an Israeli cooperative society
and an Israeli corporation for the establishment of Magan Desalination Ltd.
("MDL") as an Israeli project company in which the Company has a 49% equity
interest. During the second quarter of 2003, the Israeli cooperative society and
the Company acquired the ownership interest of the Israeli corporation in MDL.
In the second quarter of 2003, MDL finalized a concession contract with a
state-sponsored water company for the construction, ownership and operation of a
brackish water desalination facility in Israel, and obtained $8 million of debt
financing for the project from an Israeli bank. The Company has guaranteed
repayment of 49% of the loan amount in the form of a bank letter of guarantee.
In the third quarter of 2003, the Company through its Israeli subsidiary made an
equity investment of $1.5 million in MDL for its 49% equity interest. The
facility commenced operations in the second quarter of 2004. The Company is
currently working with MDL to resolve certain outstanding issues required to
achieve final completion.
In 2002, the Company entered into agreements with two Israeli corporations
giving the Company the right to a one-third ownership interest in an Israeli
project company, Carmel Desalination Ltd. ("CDL"). CDL was awarded a concession
agreement by the Israeli Water Desalination Agency ("WDA") (established by the
Ministry of Finance and the Ministry of Infrastructure) for the construction,
ownership and operation of a major seawater desalination facility in Israel. As
of March 31, 2004, the Company had made an equity investment of $0.2 million in
CDL and had deferred costs of $0.6 million relating to the engineering design
and development work on the project. The terms of the concession agreement
originally required that long-term financing be obtained by April 2003. CDL was
initially granted an extension to August 20, 2003 and a further extension to
April 1, 2004 was granted by the WDA. CDL was unable to obtain long-term
financing by the required date. CDL asserts that its inability to obtain
financing resulting from certain errors and omissions in WDA's tendering process
which would have prevented CDL from constructing the facility as proposed. On
April 1, 2004, the WDA notified CDL of its intent to terminate the concession
agreement and to take action to collect on a bid bond (of which it was the
beneficiary) issued on behalf of CDL. On May 5, 2004, the WDA issued a notice of
termination to CDL and made a demand upon the bank that issued the bid bond. The
Company's liability under the bid bond was approximately $2.5 million (a
one-third proportionate share of the approximate $7.5 million bid bond). During
-15-
the first quarter of 2004, as a result of the notification by the WDA of their
intent to collect on the bid bond, the Company recorded a liability of $2.5
million related to its proportionate share. WDA collected on the bid bond in the
second quarter of 2004. In addition, the Company expensed its deferred costs
relating to the construction project and its investment in CDL of $0.8 million.
The dispute between CDL and the WDA concerning the errors and omissions in the
tendering process, the termination of the concession agreement and the demand
made upon the bid bond has been submitted to binding arbitration in Israel (with
CDL and WDA both as claimants and respondents), and it is expected that the
matter will be heard and a decision rendered by the arbitrator in the first
quarter of 2005. The Company believes that CDL has legitimate claims and
meritorious defenses in this matter and, in cooperation with the Company's
partners in CDL and CDL's outside counsel, intends to aggressively pursue
recovery of bid bond payments made to WDA as well as other damages.
In the third quarter of 2003, a 50/50 joint venture between the Company and an
Israeli engineering corporation was selected by Mekorot, the Israeli
state-sponsored water company, to design, supply and construct a 123,000 cubic
meter per day (32.5 million gallons per day) seawater desalination facility in
Ashdod, Israel. The estimated value of the equipment supply and construction
contract to be negotiated and entered into with respect to the project is
approximately $95 million, and it is estimated that the plant will require
approximately two years to construct. The joint venture submitted a $5 million
bid bond with its proposal, and the Company would be responsible for 50% of this
amount if a demand were made on the bid bond. It is currently anticipated that
the parties will sign a final form of contract in the first quarter of 2005, at
which time the joint venture will replace the bid bond with a performance bond
in the principal amount of 10% of the contract value.
Algeria
In the fourth quarter of 2003, the Company and Algerian Energy Company ("AEC")
were selected for a 25-year seawater desalination build-own-operate project.
Sonatrach, the Algerian national energy company, will guarantee the water supply
contract. The Company and AEC have formed a joint project company, Hamma Water
Desalination S.p.A. ("HWD"), in which the Company has a 70% ownership interest.
The projected $235 million capital investment will be financed by a combination
of equity and non-recourse debt. Through September 30, 2004, the Company made an
equity investment of $0.7 million in HWD and deferred costs of approximately
$1.6 million relating to the engineering design and development work on the
project. If HWD obtains long-term project financing, the Company has committed
to make additional net equity investments to HWD of approximately $32.0 million.
The Company expects HWD will obtain long-term project financing in the first
quarter of 2005. If HWD is unable to obtain such financing, the Company would
expense its deferred costs relating to the construction project and its
investment in HWD. Additionally, the Company has provided a $1.0 million bid
bond to the customer.
Guarantees and Indemnifications
Financial Accounting Standards Board ("FASB") Interpretation No. 45 "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an interpretation of FASB Statements 5,
57, and 107 and rescission of FASB Interpretation 34" ("FIN 45") requires that a
guarantor recognize, at the inception of a guarantee, a liability for the fair
value of the obligation undertaken by issuing the guarantee and additional
disclosures to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees it has issued. The
following is a summary of the Company's agreements and other undertakings that
were determined to be within the scope of FIN 45.
In the normal course of business, the Company issues letters of credit to
customers, vendors and lending institutions as guarantees for payment,
performance or both under various commercial contracts into which it enters. Bid
bonds are also sometimes obtained by the Company as security for the Company's
commitment to proceed with a project if it is the successful bidder. Performance
bonds in the form of bank guarantees are sometimes issued for the benefit of the
Company's customers as financial security for the completion or performance by
the Company of its contractual obligations under certain commercial contracts.
In the past, the Company has not incurred significant liabilities or expenses as
a result of the use of any or all of these instruments, with the exception of
the bid bond associated with CDL, as described above. Approximately $112.0
million of these instruments were outstanding at September 30, 2004. Based on
the Company's experience with respect to letters of credit and credit
guarantees, bid bonds and performance bonds, the Company believes the estimated
fair value of the instruments entered into during the first nine months of 2004
is not material. Accordingly, the Company has not recorded any liabilities for
these instruments as of September 30, 2004.
As part of acquisitions and divestitures of businesses or assets, the Company
made a variety of warranties and indemnifications to the sellers and purchasers
-16-
that are typical for such transactions. The Company only provides such
warranties or indemnifications after considering the economics of the
transaction and the liquidity and credit risk of the other party in the
transaction. Typically, certain of the warranties and the indemnifications
expire after a defined period of time following the transaction, but others may
survive indefinitely. The warranty and indemnification obligations entered into
prior to December 31, 2002 were grandfathered under the provisions of FIN 45.
For warranties and indemnifications made to sellers and purchasers subsequent to
December 31, 2002, the Company has not recorded any liabilities for these
obligations as of September 30, 2004, as it believes that it will incur no
liabilities under such provisions.
Warranty Obligations
The Company's products generally include warranty obligations and the related
estimated costs are included in cost of sales when revenue is recognized. While
the Company engages in extensive product quality programs and processes, the
Company's estimated costs to satisfy its warranty obligations are based upon
historical product failure rates and the costs incurred in correcting such
product failures. If actual product failure rates or the costs associated with
fixing such product failures differ from historical rates, adjustments to the
warranty obligations may be required in the period in which determined. The
changes in accrued warranty obligations for the nine months ended September 30,
2004 and 2003 are as follows:
(Dollars in Thousands)
Three months ended Nine months ended
September 30, September 30,
----------------------------------- ------------------------------
2004 2003 2004 2003
----------------- --------------- -------------- --------------
Balance at beginning of period $ 1,207 $ 1,095 $ 1,173 $ 1,067
Accruals for warranties issued during the period 733 751 1,322 1,212
Accruals related to pre-existing warranties 120 - 198
Settlements made (in cash or in kind) during the period (577) (684) (1,132) (1,195)
-------------- ----------- ------------ ---------
Balance at end of period $ 1,363 $ 1,282 $ 1,363 $ 1,282
============== =========== ============ ==========
In addition to warranty obligations, the Company recorded a $4.8 million charge
in the third quarter of 2003 to retrofit certain components of the Company's
demineralization systems.
10. Income Taxes
For the three months ended September 30, 2004, the Company recorded income tax
expense of $1.7 million on consolidated pre-tax income from continuing
operations before minority interest expense of $3.3 million, yielding a tax rate
of 50.1% or an annual effective tax rate of 38.7%, excluding a $.6 million
valuation allowance recorded against certain deferred tax assets, primarily
related to prior year foreign tax credits in the U.S., and net operating losses
of foreign subsidiaries. For the three months ended September 30, 2003, the
Company recorded an income tax benefit of $8.0 million on consolidated pre-tax
loss from continuing operations before minority interest expense of $25.3
million, yielding an effective tax rate benefit of 31.5%.
The change in the effective tax rate for the three months ended September 30,
2004 compared to the three months ended September 30, 2003 resulted primarily
from the Company's having reported an effective tax rate benefit, or negative
effective tax rate, during the quarter ended September 30, 2003 that resulted
from significant restructuring and realignment of expenses. A similar effective
tax rate benefit, or negative effective tax rate, would not be expected during
the comparable quarter ended September 30, 2004 due to the Company's projected
earnings for the current year and the absence of significant restructuring and
realignment of expenses recorded in the comparable prior period ended September
30, 2003.
For the nine months ended September 30, 2004, the Company recorded income tax
expense of $5.9 million on consolidated pre-tax income from continuing
operations before minority interest expense of $5.1 million, yielding a tax rate
of 116.1% or an annual effective tax rate of 38.7%, excluding a $3.9 million
valuation allowance recorded against certain deferred tax assets, primarily
related to prior year foreign tax credits in the U.S., and net operating losses
of foreign subsidiaries. For the nine months ended September 30, 2003, the
Company recorded an income tax benefit of $8.5 million on a consolidated pre-tax
loss from continuing operations before minority interest expense of $26.6
million, yielding an effective tax rate benefit of 32.1%.
The change in the effective tax rate for the nine months ended September 30,
2004 compared to the nine months ended September 30, 2003 resulted primarily
from recording deferred tax asset valuation allowances related to prior year
foreign tax credits in the U.S., and net operating losses of foreign
subsidiaries.
-17-
During the three months ended September 30, 2004, the Company determined, in
conjunction with its global restructuring and operational realignment
initiatives, that there was sufficient certainty that certain deferred tax
assets, principally related to its current year foreign tax credits in the U.S.,
would be realized. Consequently, the Company determined that a deferred tax
asset valuation allowance previously recorded and related to the Company's
current year foreign tax credits is not required.
On quarterly basis, the Company assesses its ability to recognize the benefits
of its deferred tax assets. Deferred tax assets may be reduced by a valuation
allowance, if based on the preponderance of all positive and negative evidence;
it is more likely than not that some portion or all of its deferred tax assets
will not be realized in future periods. The Company considers its operational
results, the resultant impact on taxable income, and a continual review of
global tax planning strategies when evaluating the need for a deferred tax asset
valuation allowance.
Negative evidence that would suggest the need for a valuation allowance consists
of the Company's recent cumulative operating losses that were attributable to
unprofitable operations. However, positive evidence that would suggest that a
valuation allowance is not required is the development of comprehensive global
tax planning strategies that demonstrate an ability to recognize the benefits of
deferred tax assets.
11. Earnings Per Share (EPS)
(Shares in thousands)
Three months ended Nine months ended
September 30, September 30,
-------------------------------------------- --------------------------------------------
2004 2003 2004 2003
--------------------- -------------------- -------------------- --------------------
Basic shares 22,637 17,699 21,849 17,607
Effect of diluted stock options 254 - - -
--------------------- -------------------- -------------------- --------------------
Diluted shares 22,891 17,699 21,849 17,607
===================== ==================== ==================== ====================
The effect of dilutive stock options excludes those stock options for which the
impact was antidilutive based on the exercise price of the options. The number
of options that were antidilutive for the three and nine months ended September
30, 2004 were 1,214,217 and 1,202,714, respectively. The number of options that
were antidilutive for the three and nine months ended September 30, 2003 were
1,792,867 and 2,620,367, respectively.
12. Profit Sharing and Pension Plans
The Company has contributory profit-sharing plans (defined contribution plans)
which covers employees of the Company who are members of the Fabricated Products
group of the Bridgeville division ("FPG Plan") and Ecolochem (the "Ecolochem
Plan"). The Company contributions to the FPG Plan are made from the group's
pre-tax profits, may vary from 8% to 15% of participants' compensation, and are
allocated to participants' accounts in proportion to each participant's
respective compensation. The Company made contributions of $0.5 million to the
FPG Plan during each of the nine month periods ended September 30, 2004 and
2003. The Ecolochem Plan covers all eligible US employees of the Ecolochem Group
and all contributions are made at the discretion of the Board of Directors of
Ecolochem, Inc.
The Company also had a contributory defined benefit pension plan ("Retirement
Plan") for all other domestic employees. On December 30, 2003, the Board of
Directors authorized the closing of the Retirement Plan and the associated SERP
(described in the next paragraph) to new participants, effective January 1,
2004. On February 13, 2004, the Company notified the participants in these plans
that no further benefits would accrue after March 31, 2004. Accrued benefits
under the Retirement Plan are based on years of service and the employee's
average compensation. The Company's funding policy for the Retirement Plan had
been to contribute annually an amount that could be deducted for federal income
tax purposes. In 2002, the Board of Directors approved a "prior period update"
to January 1, 1996, so that the base monthly salary for participants in the
Retirement Plan at each January 1 prior to January 1, 1996 is deemed to be the
same as it was on January 1, 1996. Company contributions to the pension plan
were $2.2 million and $1.6 million for the nine months ended September 30, 2004
and 2003, respectively.
In 1996, the Company's Board of Directors adopted a Supplemental Executive
Retirement Plan for officers and key employees of the Company ("SERP"). As
-18-
described above, no further benefits accrue under the SERP after March 31, 2004.
The purpose of the SERP was to permit officers and other key employees whose
base salary exceeds the maximum pay upon which retirement benefits could be
accrued in any year under the Retirement Plan to accrue retirement benefits on
base salary in excess of that amount, equivalent to the benefits that would have
been accrued under the Retirement Plan if base salary levels over that amount
could be taken into account in calculating benefits under the Retirement Plan.
The SERP is administered by the Compensation Committee of the Board of
Directors.
Closing the Retirement Plan and the SERP to new participants and ceasing future
benefit accruals after March 31, 2004 required the recognition of curtailment
losses for both the Retirement Plan and SERP, which were recorded during the
period ended December 31, 2003.
The Company's Section 401(k) Savings Plan ("Savings Plan"), which covers all
domestic employees except those of Ecolochem, Inc., was amended effective July
1, 2004, to add a profit-sharing feature. Under the Savings Plan, the Company
will make profit-sharing contributions to all participants in the Savings Plan
in the event that the Company achieves or exceeds a stated earnings-per-share
target for the fiscal year. The Company's profit-sharing contribution will range
from 2% to 4% of participants' compensation, depending upon the extent to which
the Company exceeds the year's target (there will be no profit-sharing
contribution in the event earnings per share fall short of the target). The
profit-sharing structure is in addition to the Company's matching contribution
to the Savings Plan of up to 2% of a participant's total compensation. No
accruals have been made for the first nine months of 2004 under this Plan.
The Savings Plan was also amended, effective April 1, 2004, to provide, at the
Company's discretion, a prospective "make-up" contribution based on continued
service to all participants in the Retirement Plan who were age 40 or older and
who had at least 10 years of service with the Company at March 31, 2004, when
benefits under the Retirement Plan ceased to accrue. Depending upon the
combination of age and years of service of a participant, the make-up
contribution ranges from 1.5% to 2.5% of a participant's compensation.
Contributions were not significant through September 30, 2004.
Net periodic benefit cost for all defined benefit plans consisted of the
following:
(Dollars in Thousands)
Three Months Nine Months
ended September 30, ended September 30,
--------------------------------- --------------------------------
2004 2003 2004 2003
--------------- -------------- -------------- --------------
Components of Net Periodic Benefit Cost:
Service cost $ - $ 443 513 $ 1,327
Interest cost 458 492 1,375 1,476
Expected return on plan assets (412) (298) (1,236) (895)
Amortization of transition asset - (11) - (33)
Amortization of prior service cost - 137 - 410
Recognized net actuarial loss 73 147 219 441
--------------- -------------- -------------- --------------
Net periodic benefit cost $ 119 $ 910 $ 871 $ 2,726
=============== ============== ============== ==============
-19-
13. Comprehensive (Loss) Income
The table below sets forth comprehensive (loss) income as defined by SFAS No.
130, "Reporting Comprehensive Income," for the three and nine months ended
September 30, 2004 and 2003.
(Dollars in thousands)
Three months ended Nine months ended
September 30, September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
------------- -------------- -------------- --------------
Net income (loss) $ 890 $ (22,032) $ (5,388) $ (26,380)
Other comprehensive (loss) income, net of tax:
Changes in value of foreign exchange
contracts designated as cash flow hedges (2,411) (6) 1,162 480
Translation adjustments 828 875 (1,901) 7,968
------------- -------------- -------------- --------------
Comprehensive loss $ (693) $ (21,163) $ (6,127) $ (17,932)
============= ============== ============== ==============
14. Segment Information
During the first quarter of 2004, the Company realigned its business structure
and began reporting new business segments. This realignment combined most of the
Equipment Business Group and Ultrapure Water Group with the operations of the
Ecolochem Group (see Note 3), into the new business group called Water Systems.
The newly formed Water Systems Group is comprised of two operating segments,
Equipment Sales and Operations. The Consumer Water Group remains a reporting
group as previously constituted. The Instruments segment continues with its
existing activities and combines global instrument sales by all business units.
The Corporate Group includes all corporate overhead not specifically assignable
to the other business groups including; certain corporate administrative and
insurance costs, foreign exchange gains and losses on corporate assets, as well
as the elimination of inter-segment transfers. Prior year amounts have been
reclassified to conform to the current year presentations with no impact on net
income.
The following table summarizes the Company's operations by the four major
operating segments. The Company measures segment profitability on earnings
before interest, taxes and minority interest.
For the three months ended September 30, 2004
-----------------------------------------------------------------------
Equipment Consumer
Sales Operations Water Instruments Corporate Total
---------- ---------------------- -----------------------------------
(Amounts in thousands)
Revenue - unaffiliated $ 32,843 $ 62,865 $ 4,465 $ 9,614 $ - $ 109,787
Revenue - affiliated 8,468 (152) - 30 - 8,346
Inter-segment transfers 1,873 80 14 581 (2,548) -
Gross profit - unaffiliated 6,282 22,630 2,861 5,223 - 36,996
Gross profit - affiliated 1,045 (132) - 22 - 935
Equity (loss) income - 578 193 - 439 1,210
Income (loss) before interest,
income tax and minority interest925 10,372 842 2,123 (5,791) 8,471
Interest income 524
Interest expense (5,698)
Income before income tax and
minority interest 3,297
-20-
For the three months ended September 30, 2003
-----------------------------------------------------------------------
Equipment Consumer
Sales Operations Water Instruments Corporate Total
---------- ---------------------- ----------------------- -----------
(Amounts in thousands)
Revenue - unaffiliated $ 36,799 $ 28,179 $ 3,708 $ 7,880 $ - $ 76,566
Revenue - affiliated 10,523 474 60 62 - 11,119
Inter-segment transfers 254 582 159 557 (1,552) -
Gross profit - unaffiliated 797 8,181 934 4,322 - 14,234
Gross profit - affiliated 1,385 105 (9) 31 - 1,512
Equity (loss) income - (181) 210 - 14 43
Income (loss) before gain on
sale of Aqua Cool, interest
income tax and minority inte(13,628) (6,355) (1,642) 1,117 (5,660) (26,168)
Interest income 660
Interest expense (254)
Loss before gain on sale of
Aqua Cool, income tax and
minority interest (25,762)
For the nine months ended September 30, 2004
-----------------------------------------------------------------------
Equipment Consumer
Sales Operations Water Instruments Corporate Total
---------- ---------------------- -----------------------------------
(Amounts in thousands)
Revenue - unaffiliated $ 104,264 $ 177,541 $ 12,455 $ 28,065 $ - $ 322,325
Revenue - affiliated 26,911 270 - 81 - 27,262
Inter-segment transfers 4,916 1,229 400 710 (7,255) -
Gross profit - unaffiliated 19,397 63,953 7,374 15,691 - 106,415
Gross profit - affiliated 3,306 (98) - 40 - 3,248
Equity (loss) income (16) 1,725 355 - 437 2,501
Income (loss) before interest,
tax and minority interest 1,678 28,206 1,216 5,675 (18,301) 18,474
Interest income 1,372
Interest expense (14,782)
Income before income taxes and
minority interest 5,064
Identifiable assets 413,689 742,480 74,778 41,619 (237,638) 1,034,928
Goodwill 899 183,817 862 - - 185,578
Other intangible assets 294 69,925 4,319 249 - 74,787
For the nine months ended September 30, 2003
-----------------------------------------------------------------------
Equipment Consumer
Sales Operations Water Instruments Corporate Total
---------- ---------------------- ----------------------- -----------
(Amounts in thousands)
Revenue - unaffiliated $ 99,637 $ 82,450 $ 9,217 $ 24,308 $ - $ 215,612
Revenue - affiliated 34,763 846 120 141 - 35,870
Inter-segment transfers 6,615 1,803 190 1,670 (10,278) -
Gross profit - unaffiliated 14,319 24,223 3,999 13,289 - 55,830
Gross profit - affiliated 4,562 237 43 70 - 4,912
Equity (loss) income - (3,117) 608 - (291) (2,800)
Income (loss) before gain on
sale of Aqua Cool, interest
income tax and minority inte(11,084) (1,699) (939) 3,270 (18,046) (28,498)
Interest income 2,193
Interest expense (740)
Loss before gain on sale of
Aqua Cool, income tax and
minority interest (27,045)
Identifiable assets 299,136 193,512 111,500 33,512 (66,194) 571,466
Goodwill 899 5,723 862 - - 7,484
Other intangible assets 963 890 4,911 324 - 7,088
-21-
15. Derivative Financial Instruments and Hedging Activity
In the fourth quarter of 2002, the Company entered into a series of U.S.
dollar/euro forward foreign exchange contracts with the intent of offsetting the
foreign exchange risk associated with the forecasted revenues related to an
ongoing project. At September 30, 2004, the notional amount of outstanding
forward foreign exchange contracts to exchange U.S. dollars for euros, which
were designated as forecasted cash flow hedging instruments, was $2.3 million.
The fair values of the forward contracts, based upon dealer quotations, are
recorded as components of "Other current assets" or "Other current liabilities,"
depending upon the amount of the valuation. At September 30, 2004, the fair
value of these forward contracts of $0.2 million was recorded as a component of
"Other current assets." The net unrealized gain of $0.2 million on the forward
contracts that qualified as cash-flow hedging instruments was included in
"Accumulated other comprehensive loss," in the "Stockholders' equity" section of
the Consolidated Balance Sheets. The Company expects these instruments to affect
earnings over the next six months. To the extent that any portion of the hedge
is determined to be ineffective, the related gain or loss is required to be
included in income currently. For the three and nine months ended September 30,
2004, the Company had no gains or losses related to ineffective cash flow
hedges.
In connection with the acquisition of the Ecolochem Group and the execution of
the credit facility, the Company entered into interest rate swap agreements that
fix the Company's LIBOR rate on $100 million of the term loan at 3.1175% per
annum. The swap agreements, which qualify for hedge accounting, expire in 2010.
At September 30, 2004, the notional amount of the swap agreements was $100
million. The fair values of the swap agreements are recorded as components of
"Other current assets" or "Other current liabilities," depending upon the amount
of the valuation. At September 30, 2004, the fair value of these swap agreements
of $2.0 million was recorded as a component of "Other current assets." The net
unrealized gain of $2.0 million was included in "Accumulated other comprehensive
loss," in the "Stockholders equity" section of the Consolidated Balance Sheets.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of the financial condition and results of operations of
the Company should be read in conjunction with the consolidated financial
statements and the related notes thereto included elsewhere in this Form 10-Q
and the audited consolidated financial statements and related notes thereto and
Management's Discussion and Analysis of Financial Condition