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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended: DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number: 1-7211
IONICS, INCORPORATED
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2068530
(State of incorporation) (IRS Employer Identification Number)
65 GROVE STREET 02472-2882
WATERTOWN, MASSACHUSETTS (Zip Code)
(Address of principal executive offices)
Registrant's telephone number, including area code: (617)926-2500
Securities registered pursuant to Section 12(b) of the Act:
COMMON STOCK, $1.00 PAR VALUE
Name of each exchange on which registered: NEW YORK STOCK EXCHANGE
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes [X] No [ ]
The aggregate market value of the Common Stock of the registrant held by
non-affiliates as of June 30, 2003 was $386,822,853 (17,292,014 shares at $22.37
per share).
As of March 1, 2004, 22,578,284 shares of Common Stock, $1.00 par value, were
issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant intends to file a definitive proxy statement pursuant to
Regulation 14A within 120 days of the end of the fiscal year ended December 31,
2003. Portions of such proxy statement are incorporated by reference into Item 5
and Part III of this Annual Report on Form 10-K.
IONICS, INCORPORATED
ANNUAL REPORT ON FORM 10-K
FOR YEAR ENDED DECEMBER 31, 2003
TABLE OF CONTENTS
PART I.................................................................................................... 3
ITEM 1. BUSINESS.................................................................................. 3
ITEM 2. PROPERTIES................................................................................ 13
ITEM 3. LEGAL PROCEEDINGS......................................................................... 15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS....................................... 16
PART II................................................................................................... 16
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS..................... 16
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA...................................................... 16
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS..... 17
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK................................. 50
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.................................. 51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE...... 92
ITEM 9A. CONTROLS AND PROCEDURES................................................................... 92
PART III.................................................................................................. 92
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT........................................ 92
ITEM 11. EXECUTIVE COMPENSATION.................................................................... 92
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT............................ 92
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS............................................ 93
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.................................................... 93
PART IV................................................................................................... 93
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.......................... 93
SIGNATURES................................................................................................ 99
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS................................................................ 51
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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 global leader in the
supply of water purification and wastewater treatment equipment and services.
Ionics' products and services are used by the Company or its customers to desalt
brackish water and seawater, treat, recycle and reclaim process water and waste
water, treat water for residential and commercial applications, manufacture and
supply disinfection chemicals and process food products. The Company is also a
leader in supplying zero liquid discharge systems, in providing ultrapure water
systems for the power and microelectronics industries, and in the measurement
and analysis of water impurities. With the acquisition of Ecolochem, Inc., and
its affiliated companies (the Ecolochem Group) on February 13, 2004, the Company
has also become a leader in the provision of mobile water treatment. The Company
has over 50 years of experience in the design, installation, operation and
maintenance of water and waste water treatment systems. The Company's customers
include industrial companies, consumers, resorts, municipalities and other
governmental entities and utilities. Unless the context indicates otherwise, the
terms "Ionics" and "Company" as used herein includes Ionics, Incorporated and
all its subsidiaries.
Over fifty years ago, the Company pioneered the development of the ion-exchange
membrane and the electrodialysis process. Since that time, the Company has
expanded its separations technology base to include a number of membrane and
non-membrane-based separations processes. These separations processes include
electrodialysis reversal (EDR), reverse osmosis (RO), ultrafiltration (UF),
microfiltration (MF), electrodeionization (EDI), electrolysis, ion exchange,
carbon adsorption, and thermal processes such as evaporation and
crystallization.
The Company's business activities are reported in four business group segments,
which the Company put into place in 1998. The business group structure is based
upon defined areas of management responsibility with respect to markets,
applications and products. The Company believes that each business group segment
comprises and represents a class of similar products or product lines used in
particular water treatment applications. These business group segments are the
Equipment Business Group, Ultrapure Water Group, Consumer Water Group, and
Instrument Business Group. In 2003, these segments accounted for approximately
41.5%, 29.5%, 6.1% and 8.6%, respectively, of the Company's total revenues. See
Note 18 to the Consolidated Financial Statements for additional information
regarding the Company's four business segments (sales to affiliated companies
accounted for the remaining 14.3%). On December 31, 2001, the Company sold its
Aqua Cool Pure Bottled Water division, constituting the major portion of the
assets of the Consumer Water Group. Approximately 48.4% of the Company's 2003
revenues were derived from foreign sales or operations.
In the first quarter of 2004, the Company completed the acquisition of
Ecolochem, Inc. and its affiliated companies. Ecolochem, a privately held
company headquartered in Norfolk, Virginia is a leading provider of emergency,
short and long-term mobile water treatment services to the power, petrochemical
and other industries. The acquisition significantly increases the Company's
ability to offer extensive outsourced water services to its customer base and
adds significantly to the Company's recurring revenue base.
The Company is changing its operating structure starting in the first quarter of
2004. The Company plans to restructure its organization into three business
groups - water systems, instruments and consumer. The water systems group will
be further classified into equipment sales and operations. Equipment sales will
reflect all of the Company's capital equipment and related sales, including
spare parts and the operations group will include all of its recurring revenue
activities including regeneration, operating plants, disinfection chemicals and
other related products. The consumer group will continue to include its existing
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activities. The instrument group will also continue its existing activities, and
will be credited with all instrument sales made by the Company (the Equipment
Business Group and Ultrapure Water Group were previously credited with
instrument sales made by their own organizations).
The Company was incorporated in Massachusetts in 1948. The Company's principal
executive officers are located at 65 Grove Street, Watertown, Massachusetts,
02472.
INFORMATION ABOUT BUSINESS SEGMENTS
EQUIPMENT BUSINESS GROUP
The Equipment Business Group accounted for approximately 41.5% of revenues in
2003. This segment provides technologies, treatment systems and services for
seawater desalination, surface water treatment, brackish water desalination, and
wastewater reuse and recycle. In addition, this segment includes the Company's
custom fabrication and food processing activities.
Desalination and Related Water Treatment Equipment and Processes
Opportunities for the sale of desalination equipment for seawater and brackish
water have been driven by population growth, increased industrial demands and
decreasing availability of quality water from existing sources. Less than 1% of
the water on the planet is fresh and usable, while 97% of the world's water is
seawater and over 2% is locked in the polar ice caps.
The Company sells a wide spectrum of products and systems to serve this market
utilizing technologies including EDR, ion exchange, EDI, RO, UF, ozonation and
carbon adsorption. Depending on the customers' needs, the Company provides
standardized versions of systems utilizing one or more of the technologies
mentioned, or can supply complete turnkey plants that may include standardized
models as well as peripheral water treatment equipment, complete engineering
services, process and equipment design, project engineering, commissioning,
operator training and field service.
As an example of the Company's activities in this market during 2003, the
Company completed the fabrication and installation of a 6.2 million gallon per
day (MGD) EDR system at Mason City, Iowa. This $3.9 million system is scheduled
to commence operations and to be commissioned in 2004 for the treatment of a
municipal groundwater supply.
The Company has also been participating in a growing market for surface water
treatment equipment as municipalities are being required to meet increasingly
stringent regulations for ensuring safe drinking water quality. For example, in
late 2001 the Company received an order for equipment from the City of
Minneapolis for the sale of UF based water treatment equipment to treat surface
water used by the city for drinking water. The plant is expected to commence
operations in 2004.
In 2003, the Company had completed 50% of the fabrication and assembly of a 15
MGD UF drinking water system to treat water from the Rio Grande River for Eagle
Pass, Texas. This $4.6 million system will be completed in the first half of
2004, with installation and commissioning scheduled for the second half of 2004.
Wastewater Treatment Equipment and Processes
The market for treatment, recycle and reuse of industrial and municipal
wastewaters has shown significant growth as the world-wide demand for water
increases and regulations limiting waste discharges to the environment continue
to mount.
Industrial Wastewater Treatment
The Company designs, engineers and constructs customized systems for industrial
wastewater customers which may include conventional treatment systems, as well
as advanced membrane separation technologies such as EDR, EDI, RO, UF and MF.
Typical industrial customers are power stations, chemical and petrochemical
plants, manufacturers and a variety of other industrial applications.
For "zero liquid discharge" applications the Company designs, engineers and
constructs brine concentrators, evaporators and crystallizers which are used to
clean, recover and recycle wastewaters. Such systems may also incorporate EDR
membrane systems as preconcentrators and EDI membrane systems for further
treatment of wastewater.
4
As an example of the Company's activities in the zero liquid discharge market,
in 2003 the Company began the design and procurement of a zero-liquid-discharge
(ZLD) system for the joint venture between Saudi Arabian Texaco and Kuwait Oil
Company. This $5.0 million system is scheduled for delivery in late 2004. The
equipment will be used to treat and reclaim produced water generated from crude
oil extraction.
Municipal Wastewater Treatment
The Company also provides custom and packaged sewage treatment systems for
municipalities and advanced membrane systems that treat waste from conventional
sewage treatment plants so that the treated wastewater can be recycled and
revised for irrigation and process water needs.
As an example of the Company's activities in membrane based water treatment,
during 2002, Utilities Development Company W.L.L. (UDC), a Kuwaiti project
company in which the Company has a 25% ownership interest, commenced activities
under a contract to construct, own and operate the largest membrane based water
reuse facility in the world. The Company is also serving as a membrane equipment
supplier to UDC under an $85 million supply contract awarded in 2002.
Construction on the Kuwait facility began in 2003 with completion scheduled for
late 2004 and start-up in 2005. For further discussion regarding UDC, see Item 7
of this Annual Report on Form 10-K under the caption "Financial Condition" and
Note 9 to the Consolidated Financial Statements contained in Item 8 of this
Annual Report on Form 10-K.
Water Supply for Drinking and Industrial Use
Ionics' position as a seller of purified or treated water has evolved from its
traditional role as a supplier of water treatment equipment. In certain
situations, opportunities are available for the Company to supply the water
itself through the ownership and operation of the water purification facility.
In these situations, the Company is responsible for the financing, construction,
operation and maintenance of the water treatment facilities. For large-scale
water treatment projects, the Company's business model has been to participate
in such projects through joint ventures in which the Company typically holds an
equity interest.
As an example, the Company and the Algerian Energy Company (AEC), its local
partner, have formed Hamma Water Desalination Ltd. (HWD) as the special purpose
company for the execution of a 200,000 cubic meter per day seawater RO
build-own-operate (BOO) contract. HWD was selected on October 17, 2003 for this
25 year project. HWD is in the process of arranging non-recourse debt financing
for the project.
Ionics, through a wholly-owned subsidiary, owns and operates an EDR facility
with capacity to treat 5.5 million gallons per day of brackish water and an RO
seawater facility with capacity to treat 3.6 million gallons per day on Grand
Canary Island, Spain. Under long-term supply contracts, the Company sells the
desalted water from both facilities to the local water utility for distribution.
Ionics, through its local subsidiary, Ionics Water Resources, Ltd., owns 49% of
Magan Desalination Ltd., a special purpose company established to finance,
design, build, operate and maintain a 23,000 cubic meters per day brackish water
desalination plant that will produce and sell potable water to the local water
authority in Israel. At the end of 2003, the plant was 85% complete with
start-up and commissioning scheduled for the second quarter of 2004.
In 2003, construction was started on the fifth and final stage of what the
Company believes is the largest membrane-based seawater desalination plant in
the Western Hemisphere, which is located in Trinidad. The seawater reverse
osmosis (SWRO) desalination plant provides the Water and Sewerage Authority of
Trinidad and Tobago (WASA) and the industries of the Point Lisas Industrial
Estate with a high quality water supply for industrial requirements. This
project is owned and operated by a joint venture between the Company (which has
a 40% equity ownership interest in the venture) and its local partner, Hafeez
Karamath Engineering Services Ltd. The plant began to produce and deliver water
during 2002 and has a current design capacity of 26.4 million gallons per day,
which will be expanded to 28.7 million gallons per day when Phase 5 is completed
and commences operations in 2004. For further discussion regarding the Trinidad
project, see Item 7 of this Annual Report on Form 10-K under the caption
"Financial Condition" and Note 9 to the Consolidated Financial Statements
contained in Item 8 of this Annual Report on Form 10-K.
The Company also owns and operates more than 40 desalination plants on a number
of Caribbean islands, which provide drinking water to hotels, resorts and
governmental entities. Drinking water on these islands is usually supplied
pursuant to water supply contracts with terms ranging up to ten years. On the
island of Barbados, a 7.9 million gallon per day brackish water RO plant is
5
providing fresh potable drinking water to about one-fifth of the island's
population. Desalinated water is being provided to the Barbados Water Authority
on a build, own, operate (BOO) basis by a consolidated joint venture (in which
the Company has a controlling ownership interest) between Ionics and its local
partner, Williams Industries.
The Equipment Business Group also carries out the following business activities:
Fabricated Products
At its Bridgeville and Canonsburg, Pennsylvania facilities, the Company
fabricates products for industrial and defense-related applications.
Food Processing
Under an agreement with a major U.S. dairy cooperative, the Company oversees
whey-processing activities at a plant owned by the cooperative and earns revenue
based on the production of demineralized whey for its services. Included in the
equipment being utilized at this plant is its Electromat(R) electrodialysis
system.
ULTRAPURE WATER GROUP
The Ultrapure Water Group accounted for approximately 29.5% of the Company's
2003 revenues. This segment provides equipment and other related products for
specialized industrial users of ultrapure water, such as companies in the
microelectronics, power, chemical and life sciences industries. Ultrapure water
is purified by a series of processes to the degree that remaining impurities are
measured in parts per billion or trillion. The microelectronics industry has
historically been a significant source of the revenues of the Ultrapure Water
Group and the downturn in the microelectronics industry in recent years has
negatively affected the performance of the Ultrapure Water Group.
Ultrapure Water Equipment
The demand for technologically advanced ultrapure water equipment and systems
has increased as the industries which use ultrapure water have become more
knowledgeable about their quality requirements and as such requirements have
become more stringent. Ultrapure water needs are particularly important in the
microelectronics, power, chemical and life sciences industries. The
semiconductor industry in particular has increasingly demanded higher purity
water as the circuits on silicon wafers have become more densely packed.
The Company supplies sophisticated ultrapure water systems, which utilize a
combination of ion-exchange, EDI, RO and UF technologies. These systems are
either trailer-mounted or land-based and vary from standardized modules to large
multi-million dollar systems, depending on the customer's requirements.
The Company continues to pursue customers in the developing microelectronics
market in the Far East. For example, during 2003 the Company received a $6.0
million order in connection with a project for Seagate Technology International
in Singapore and a $4.0 million order from Chungwa Picture Tube (CPT) in Taiwan
for the supply of ultrapure water systems for their manufacturing operations.
Ultrapure Water Supply
In industries such as microelectronics, power, chemical and life sciences,
ultrapure water is critical to product volume, quality and yield. Depending on
the composition and quantity of the impurities to be removed or treated, any one
of several membrane separations methods can be utilized to provide ultrapure
water to the customer. Ionics has pioneered the application of three membrane
technologies (EDR, RO and UF) combined together in a mobile system called the
"triple membrane" trailer (TMT) for use in the commercial processing of
ultrapure water. Ionics provides ultrapure water services and the production and
sale of ultrapure water from trailer-mounted units at customer sites.
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The Company's EDI technology is becoming increasingly utilized in the production
of ultrapure water. EDI is a continuous, electrically driven, membrane-based
water purification process, which produces ultrapure water without the use of
strong chemical regenerants, such as sulfuric acid and caustic soda, which are
commonly required. The Company's TMT-II trailers utilize a combination of EDI,
RO and UF technologies and represent what the Company believes to be the most
advanced technology used in the commercial processing of ultrapure water.
As an example of the Company's activities in this area in 2003, the Company
completed a project to supply 2,700 gallons per minute of ultrapure water to a
large cogeneration utility in the Philadelphia area. The Company has a ten year
"own and operate" contract for this ultrapure water supply that utilizes EDI as
one of the key treatment technologies.
One of the Company's important ultrapure water activities is ion-exchange
regeneration, which is conducted at four U.S. locations and two foreign
locations. The Company also provides system sanitization and high-flow
deionization at customer sites. As a result of the acquisition of the Ecolochem
Group in February 2004, the Company now operates six additional ion-exchange
resin regeneration sites in the U.S. and one in England.
The Company has been expanding its ultrapure water activities in the Asian
market. The Company established an ultrapure water sales, service and
regeneration facility in Singapore in 1998, opened an office in Taiwan in 1999,
commenced operation of the first resin regeneration facility in Taiwan in 2002,
and established a subsidiary in China in 2002 for the manufacture of water
systems to serve the China market and for export.
Chemical Supply
The Company uses its Cloromat(R) electrolytic membrane-based technology to
produce sodium hypochlorite and related chlor-alkali chemicals for industrial,
commercial and other non-consumer applications. These activities are carried out
by the Company's wholly owned Australian subsidiary, Elite Chemicals Pty. Ltd.
(Elite), and the Company's wholly-owned Mexican subsidiary, Ionics Acapulco Ltd.
(until 2002, this activity had been included in the Equipment Business Group).
CONSUMER WATER GROUP
This business group segment accounted for approximately 6.1% of the Company's
2003 revenues and currently serves the home water purification and point-of-use
commercial water cooler markets. During 2003, the Company made a decision to
sell its Elite Consumer Products division, located in Ludlow, Massachusetts, and
accordingly the results for that division are reflected as a discontinued
operation for all periods presented. On January 31, 2004, the Company completed
the sale of its Elite Consumer Products division for approximately $5.2 million.
On December 31, 2001, the Company completed the sale of its Aqua Cool Pure
Bottled Water business conducted in the United States, United Kingdom, and
France to affiliates of Perrier Vittel S.A., a subsidiary of Nestle S.A. In this
transaction, the Company received total proceeds of approximately $207 million,
following finalization of contractual purchase price adjustments in the first
quarter of 2003. See Note 17 to the Consolidated Financial Statements contained
in Item 8 of this Annual Report on Form 10-K. The Company retains equity
ownership interests in certain joint venture entities in Bahrain, Kuwait and
Saudi Arabia which are engaged in the bottled water business.
Home Water Purification Systems
Point-of-Entry Home Water Purifiers
Ionics' point-of-entry water products include ion-exchange water conditioners to
"soften" hard water and chemicals and media for filtration and treatment. The
Company sells its products, under the General Ionics and other brand names,
through both independent distributorships and wholly owned sales and service
dealerships.
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Point-of-Use Home Water Purifiers
The Company participates in the "point-of-use" ("POU") market for over- and
under-the-sink water purifiers through the sale of RO and activated carbon-based
filtering devices and through the manufacture and sale of HYgene(R), a
proprietary, EPA-registered, silver-impregnated activated carbon filtering
medium. The Company incorporates HYgene(R), which is designed to prevent
bacterial build-up while providing the capability of removing undesirable tastes
and odors from the water supply, into its own bacteriostatic water conditioners
and also sells HYgene(R) to manufacturers of household point-of-use water
filters.
Point-of-Use Water Coolers
In 2003, the Company acquired the assets and business of CoolerSmart, LLC, a
U.S. company primarily providing point-of-use water coolers to commercial
customers. A point-of-use (POU) cooler provides water treatment systems within
the cooler and therefore eliminates the need for providing bottles of water from
an external service. The Company believes this offers businesses an economical
alternative option to conventional bottled water coolers.
During the fourth quarter of 2003, the Company's management and Board of
Directors approved a plan of disposition to sell its European POU cooler
business in the United Kingdom and Ireland. Accordingly, the results for the
European POU business have been reflected as a discontinued operation for all
periods presented.
Other Products
The Company's Elite Consumer Products division operated a facility in Ludlow,
Massachusetts to produce and distribute bleach-based products for the consumer
market, and methanol-based automobile windshield wash solution. In January 2004,
the Company completed the sale of the assets of this business group.
INSTRUMENT BUSINESS GROUP
The Company's Instrument Business Group accounted for approximately 8.6% of the
Company's 2003 revenues. This segment designs and manufactures analytical
instruments that serve the pharmaceutical, microelectronic, chemical, power
generation, environmental, municipal water, food and beverage, and medical
research industries. The Instrument Business Group derives more than 40% of its
revenues from service, consumables, spare parts, and training products from its
installed base of more than 8,000 units. During 2000, the Ionics Instrument
Division, which was located in Watertown, Massachusetts, was moved and
consolidated with Ionics Sievers Instruments, located in Boulder, Colorado. This
business group also includes Ionics Agar Environmental, located in Herzlia,
Israel. The Company is a leading manufacturer of instruments that measure total
organic carbon (TOC) across the water "spectrum" from ultrapure water to
wastewater. The Sievers(R) Model 400ES TOC analyzer, introduced at the end of
2001, is designed specifically to comply with United States Pharmacopoeia (USP)
and European Pharmacopoeia (EP) requirements for determining water quality in
the pharmaceutical industry. The Instrument Business Group offers TOC analyzers
sensitive to the parts-per-trillion range, designed specifically for ultrapure
water measurement in the semiconductor and power generation industries. In 2001,
the Company introduced the first on-line boron analyzer designed specifically
for continuous measurement of trace boron contamination, a capability
particularly important in the semiconductor and power industries. In addition to
the Sievers product line, the Instrument Business Group offers a full line of
TOC monitors for process water and wastewater applications, as well as other
instruments.
In 2002, the Company introduced enhancements to its Model 400ES TOC Analyzer
that facilitates pharmaceutical company compliance with FDA electronic
record-keeping requirements. Additionally, the Company expanded its consumables
and service business capability with a new range of products and services, and
an expanded production facility for the manufacture of calibration standards for
its pharmaceutical customers.
The Company's Ionics Agar Environmental division, acquired in 1999, offers a
line of instruments for the detection of thin layers of oil on water. The
Company's Leakwise(R) oil-on-water detection systems are used by a range of
industries from oil refining to power generation. In 2002, the Company
introduced its Leakwise ID-227WL wireless system for remote sensing and
satellite/cellular communication of environmental oil spills.
8
OTHER INFORMATION CONCERNING THE BUSINESS OF THE COMPANY
Foreign Operations
The Company has significant operations outside the United States. The Company's
sales to customers in foreign countries primarily involve desalination systems,
ultrapure water systems, water and wastewater treatment systems, Cloromat
systems, instruments and related products and services. The Company believes
that this geographic diversity provides stability to its operations and revenue
streams to offset geographic economic trends and offers it an opportunity to
expand into new markets for its products. The Company conducts operations
outside the United States directly or through its wholly-owned subsidiaries
located in Australia, China, Bermuda, several countries in the Caribbean,
England, France, Ireland, Israel, Italy, Korea, Mexico, Singapore, Spain and
Taiwan as well as through a majority-owned subsidiary in Algeria. In addition,
the Company also conducts operations outside the United States through
affiliated companies and joint venture relationships in the Caribbean (including
Trinidad), Bahrain, Israel, Japan, Kuwait, Mexico and Saudi Arabia. In addition,
the Company recently became a majority owner of an Algerian project company
which is currently seeking financing for the construction of a large seawater
desalination plant in Algeria. See "Water Supply for Drinking and Industrial
Use" in this Item 1. Of these affiliated company and joint venture operations,
the Company believes that the Kuwait, Trinidad and Mexico ventures are material
to its business on a consolidated basis.
Revenues from operations outside the United States totaled $131.2 million in
2003, $121.2 million in 2002, and $146.1 million in 2001, accounting for
approximately 37.8%, 38.0% and 32.6%, respectively, of the Company's total
revenues. The Company's Italian subsidiary contributed approximately 17.1% of
the Company's total revenues in 2003. No single country outside the United
States contributed more than 10% of the Company's total revenues in 2002 and
2001.
For a discussion of risks attendant to the Company's foreign operations, see
Item 7 of this Annual Report on Form 10-K. In addition, further geographical and
financial information concerning the Company's foreign operations appears in the
Notes of the Company's Consolidated Financial Statements included in Item 8 of
this Annual Report on Form 10-K.
Raw Materials and Sources of Supply
All raw materials and parts and supplies essential to the business of the
Company can normally be obtained from more than one source. The Company produces
the membranes required for its equipment and systems that use the ED, EDR and
EDI processes. Membranes used for the MF, UF and RO processes are at times also
purchased from third-party suppliers and are normally available from multiple
sources. During 2000, the Company formed a joint venture with Toray Industries,
Inc. and Mitsui & Co. to manufacture and market RO membrane modules for the
desalination of seawater and brackish water using Toray's proprietary RO
manufacturing technology. Ionics has a 43% interest in the joint venture
company, Toray Membrane America, Inc. (TMA). In 2001, TMA commenced the
manufacture of RO membrane modules in space leased from the Company in
Watertown, MA.
Patents and Trademarks
The Company believes that its products, know-how, servicing network and
marketing skills are more significant to its business than trademarks or patent
protection of its technology. Nevertheless, the Company has a policy of applying
for patents both in the United States and abroad on inventions made in the
course of its research and development work for which a commercial use is
considered likely. The Company owns numerous United States and foreign patents
and trademarks and has issued licenses thereunder, and currently has additional
pending patent applications. Of the approximately 92 outstanding U.S. patents
held by the Company, a substantial portion involve membranes, membrane
technology and related separations processes such as ED and EDR, RO, UF, EDI and
instrumentation technology. The Company does not believe that any of its
individual patents or groups of related patents, nor any of its trademarks, is
of sufficient importance that its termination or abandonment, or the
cancellation of licenses extending rights thereunder, would have a material
adverse effect on the Company.
Seasonality
The activities of the Company's businesses are generally not seasonal in nature.
The operations of the Ecolochem Group do tend to fluctuate when periods of
severe hot weather or cold weather result in increased demand for mobile water
treatment services for power plants.
9
Customers
The nature of the Company's business is such that it frequently has in progress
large contracts with one or more customers for specific projects. In 2003, the
Company's Italian subsidiary contributed approximately 12% of the Company's
total revenue in connection with sales to the Company's Kuwait joint venture
company. There is no other customer whose purchases accounted for 10% or more of
the revenues of any business segment and whose loss the Company believes would
have a material adverse effect on the Company and its subsidiaries taken as a
whole.
Backlog
The Company's backlog of firm orders was $330.0 million at December 31, 2003 and
$377.2 million at December 31, 2002. The majority of the Company's backlog
related to the Equipment Business Group. For multi-year contracts, the Company
includes in reported backlog the revenues associated with the first five years
of the contract at inception. In years two, three and four, the Company includes
in reported backlog revenues associated with four years, three years and two
years, respectively, for the contract. Thereafter, the Company includes in
backlog up to one year of revenue. The Company expects to fill approximately 38%
of its December 31, 2003 backlog during 2004. The Company does not believe that
there are any seasonal aspects to its backlog figures.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or build, own and operate
("BOO") contracts. The Company believes that the remaining duration on its
existing equipment sale contracts ranges from less than one year to three years
and the remaining duration on its existing BOO contracts ranges from one year to
25 years. The time to completion of any of these contracts, however, is subject
to a number of variables, including the nature and provisions of the contract
and the industry being served. Historically, as contracts are completed, the
Company has entered into new contracts with the same or other customers. In the
past, the completion of any one particular contract has not had a material
effect on the Company's business, results of operations or cash flows.
Government Contracts
The Company does not believe that any of its sales under U.S. Government
contracts or subcontracts during 2003 are subject to renegotiation. The Company
has not had adjustments to its negotiated contract prices, nor are any
proceedings pending for such adjustments.
Competition
The Company experiences competition from a variety of sources with respect to
virtually all of its products, systems and services, however the Company knows
of no single entity that competes with it across the full range of its products
and services. Competition in the markets served by the Company is based on a
number of factors, which may include price, technology, applications experience,
know-how, availability of financing, reputation, product warranties,
reliability, service and distribution. The Company is unable to state with
certainty its relative market position in all aspects of its business. Many of
its competitors have financial and other resources greater than those of the
Company.
With respect to the Company's Equipment Business Group, there are a number of
companies, including several sizable chemical companies that manufacture and
sell membranes, but not water treatment equipment. There are numerous smaller
companies, primarily fabricators, that sell water treatment and desalination
equipment, but which generally do not have proprietary membrane technology. A
limited number of companies, some of which are larger than the Company,
manufacture both membranes and water treatment equipment. The Company has
numerous competitors in its conventional water treatment, instrument and
fabricated products business lines.
In 2002, the International Desalination Association released a report providing
data regarding the manufacturers of desalination equipment. According to the
report, which covered land-based water desalination plants delivered or under
construction as of December 31, 2001, with a capacity to produce 100 cubic
meters (approximately 25,000 gallons) or more of fresh water daily, the Company
ranked first in terms of the number of such plants sold from 1992 to 2001,
having sold more than the next three manufacturers combined. In addition, the
report indicated that the Company ranked first in the total capacity of such
plants sold.
With respect to the Ultrapure Water Group business segment, the Company competes
with suppliers of ultrapure water services and with other manufacturers of
membrane-related equipment on an international, national and regional basis.
10
With respect to the Company's Consumer Water Group business segment, most of the
Company's competitors in point-of-entry and point-of-use products for use in the
home or office are small assemblers, serving local or regional markets. However,
there are also several large companies competing nationally in these markets.
Research and Development
The Company's research and development activities are directed toward developing
new products for use in water and wastewater purification, processing and
measurement, and separations technology. The Company's research and development
expenses were approximately $7.4 million in 2003, $6.5 million in 2002, and $6.4
million in 2001.
Environmental Matters
The Company complies with federal, state and local government rules and
regulations relating to the discharge of materials into the environment or
otherwise relating to the protection of the environment. The Company was
notified in 1992 that it is a potentially responsible party (PRP) at a Superfund
Site, Solvent Recovery Services of New England in Southington, Connecticut ("SRS
Site"). Ionics' share of assessments to date for site work and administrative
costs totals approximately $82,000. The United States Environmental Protection
Agency ("EPA") has not yet issued a decision regarding clean-up methods and
costs. However, based upon the large number of PRPs identified, the Company's
small volumetric ranking (approximately 0.5%) and the identities of the larger
PRPs, the Company believes that its liability in this matter will not have a
material effect on the Company or its financial position, results of operations
or cash flows.
The Company has never had a product liability claim grounded in environmental
liability, and believes that the nature of its products and business makes such
a claim unlikely.
Employees
The Company and its consolidated subsidiaries employ approximately 2,350 persons
on a full-time basis, including the employees of the Ecolochem Group. None of
the Company's employees are represented by unions or have entered into workplace
agreements with the Company, except for the employees of the Company's
Australian subsidiary and certain employees of the Company's Spanish subsidiary.
The Company considers its relations with its employees to be good.
11
Executive Officers of the Company
The names, ages and positions of the Company's Executive Officers are as
follows:
Age as of
Name March 1, 2004 Positions Presently Held
---- ------------- ------------------------
Douglas R. Brown 49 President since April 1, 2003; Chief Executive Officer since July 1,
2003; Director since 1996
Edward J. Cichon 49 Vice President, Equipment Business Group, since July 1998
Alan M. Crosby 51 Vice President, Consumer Water Group since March 2000; previously Vice
President and General Manager, Elite Consumer Products;
and Vice President, Operations
John F. Curtis 53 Vice President, Strategy and Operations since August 28, 2003;
Treasurer since February 9, 2004
Lyman B. Dickerson 59 Vice President, Water Systems Division since February 17, 2004
Anthony Di Paola 37 Vice President and Corporate Controller since May 2000
Stephen Korn 58 Vice President, General Counsel and Clerk since September 1989
Daniel M. Kuzmak 51 Vice President, Finance and Chief Financial Officer since January 2001
William J. McMahon 48 Vice President, Ultrapure Water Group, since November 2000
Michael W. Routh 56 Vice President, Instrument Business Group since April 2000
There are no family relationships between any of the officers or directors.
Executive officers of the Company are appointed each year at the meeting of
directors held on the date of the annual meeting of shareholders. There are no
arrangements or understandings pursuant to which any executive officer was
selected.
Except for Messrs. Brown, Curtis, Dickerson, Di Paola, Kuzmak, McMahon and
Routh, all of the current executive officers have been employed by the Company
in various capacities for more than five years.
Prior to joining the Company on April 1, 2003, Mr. Brown had served as President
and Chief Executive Officer of Advent International Corp., a private investment
firm, from January 1996 through December 2002.
Prior to joining the Company on August 28, 2003, Mr. Curtis was employed for
over 30 years by Ernst & Young LLP, in various capacities, most recently as the
partner-in-charge of that firm's Venture Capital Advisory Group, Europe, and as
senior advisory partner.
Prior to the Company's acquisition of the Ecolochem Group on February 13, 2004,
Mr. Dickerson served as President and Chief Executive Officer of Ecolochem, Inc.
for over 30 years.
Mr. Di Paola served in various finance and accounting positions with
Thyssen-Dover Elevator Company North America from 1997 until he joined the
Company, including as Corporate Controller from 1998 to 2000. Prior to 1997, he
served as Assistant Controller for Vector Health Systems, Incorporated.
Mr. Kuzmak joined the Company after 15 years with ABB and its U.S. subsidiary,
including serving as Chief Financial Officer of ABB Inc. (US) from 1998 to 2000,
and Vice President, Finance of ABB Nuclear Operations and ABB Nuclear Business
from 1995 to 1998.
12
Mr. McMahon served as President and Chief Executive Officer of Stone &
Webster/Sonat Energy Resources LLC from 1998 until he joined the Company;
President of Stone & Webster Energy Services from 1997 to 1998; and General
Manager/Environmental Systems of DB Riley Consolidated, Inc. from 1995 to 1997.
Mr. Routh served as President of the Baird Division of Thermo Instrument
Systems, Inc. from 1995 to 1997, and General Manager of the Spectroscopy
Division of BioRad Laboratories, Inc., from 1998 to March, 2000.
Available Information
The Company's Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, and amendments to those reports are available,
without charge, on our website at www.ionics.com, as soon as reasonably
practicable after they are filed (or furnished) electronically with the
Securities and Exchange Commission.
The Company's Corporate Governance Guidelines and the charters for the Company's
Audit, Compensation, and Nominating and Corporate Governance Committees are
posted on the Company's website (www.ionics.com) under the "About Ionics -
Governance" section and address a number of governance items, such as Board size
and membership criteria; director responsibilities; change in director status;
retirement of directors; director compensation; lead independent director;
committees; executive sessions of independent directors; Board access to
management and others; director orientation and continuing education; management
succession; annual performance evaluation of the Board; and stockholder
communications to the Board. Copies of the these corporate governance documents
may be obtained, at no cost, by writing or telephoning Stephen Korn, Clerk,
Ionics, Incorporated, 65 Grove Street, Watertown, MA 02472-2882, telephone (617)
673-4450.
The public may read and copy any materials the Company files with the SEC at the
SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. The
public may also order information on the operation of the Public Reference Room
by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that
contains reports, proxy and information statements, and other information
regarding registrants that file electronically with the SEC
(http://www.sec.gov).
ITEM 2. PROPERTIES
The Company's executive offices are located in a Company-owned facility at 65
Grove Street, Watertown, Massachusetts. Manufacturing, assembly, engineering and
other operations are carried out in a number of domestic and international
locations. The following table provides certain information as to the Company's
principal general offices and manufacturing facilities:
13
BUSINESS SEGMENT APPROXIMATE SQUARE
LOCATION UTILIZING THE LOCATION PROPERTY INTEREST FEET OF FLOOR SPACE
-------- ---------------------- ----------------- -------------------
Watertown, MA* Equipment Business Group Owned** 134,000
(headquarters) Instrument Business Group
Consumer Water Group
Ultrapure Water Group
Watertown, MA Equipment Business Group Owned** 27,000
Bridgeville, PA Equipment Business Group Owned** 77,000
Consumer Water Group
Canonsburg, PA Equipment Business Group Leased 88,000
Fontenay Sous Bois, France Equipment Business Group Leased 17,000
San Jose, CA Ultrapure Water Group Owned** 66,000
Boulder, CO Instrument Business Group Leased 74,000
Pico Rivera, CA Ultrapure Water Group Owned** 68,000
Phoenix, AZ Ultrapure Water Group Owned** 34,000
Brisbane, Australia Equipment Business Group Owned 38,000
Brisbane, Australia Ultrapure Water Group Leased 62,000
Bellevue, WA Equipment Business Group Leased 28,000
Montgomeryville, PA Ultrapure Water Group Leased 20,000
Milan, Italy Equipment Business Group Leased 18,000
Dallas, TX Ultrapure Water Group Owned** 12,000
Singapore Ultrapure Water Group Leased 9,000
East Hartford, CT+ Owned** 23,400
Fontana, CA+ Owned** 13,500
Baytown, TX+ Owned** 48,000
Miami, FL+ Owned** 22,600
Norfolk, VA+ Owned** 62,000
St. Peters, MO+ Owned** 47,000
Peterborough, England, UK+ Owned 83,000
- --------------------
* Approximately 22,000 square feet of this facility are leased to a joint
venture entity engaged in membrane manufacture.
** Subject to a mortgage held by UBS AG, Stamford Branch, as Collateral
Agent for the Lenders pursuant to the Credit Agreement dated as of
February 13, 2004 by and among the Company as borrower; certain of its
domestic subsidiaries as
14
guarantors; UBS Securities LLC as Lead Arranger, Sole Bookmanager and
Documentation Agent; Fleet Securities, Inc. and Bank of America, N.A.
as Syndication Agents; Wachovia Bank, N.A. and General Electric Capital
Corporation as Co-Documentation Agents; UBS A.G., Stamford Branch as
Administrative Agent and Collateral Agent; UBS Loan Finance LLC as
Swingline Lender; HSBC Bank USA as Issuing Bank; and the lender parties
thereto.
+ Owned by Ecolochem, Inc. or related companies, acquired by the Company
on February 13, 2004. These facilities will be utilized by the
Company's newly constituted Water Systems division.
The Company also owns or leases smaller facilities in which its business
segments conduct business. The Company considers the business facilities that it
utilizes to be adequate for their intended business purpose.
ITEM 3. LEGAL PROCEEDINGS
On December 16, 2003, Ionics Iberica, S.A., the Company's wholly-owned Spanish
subsidiary (Iberica) brought suit in Palencia, Spain against Intersuero, S.A.
Iberica is seeking the return of certain membrane-based production equipment
which Iberica had supplied under a lease agreement to Intersuero (which had
begun insolvency proceedings), or payment of 2.8 million Euros or $3.5 million
plus interest for the equipment. On February 17, 2004 Intersuero filed an answer
and counterclaim, alleging that the equipment did not perform to specifications,
and seeking 15.8 million Euros or $19.9 million in damages, lost profits,
interests and costs. The Company believes Intersuero's allegations to be without
merit and will defend itself vigorously in this matter. While the Company
believes that this litigation should have no material adverse impact on its
financial condition, results of operations or cash flows, the litigation process
is inherently uncertain, and the Company can make no assurances as to the
ultimate outcome of this matter.
The Company, its former Chief Executive Officer, and its Chief Financial Officer
have been named as defendants in a class action lawsuit captioned Jerome Deckler
v. Ionics, Inc., et al., filed in the U.S. District Court, District of
Massachusetts in March 2003. Plaintiff alleges violations of the federal
securities laws relating to the restatement of the Company's financial
statements for the first and second quarters of 2002 announced in November 2002,
and other material misrepresentations and omissions concerning the Company's
financial results. The plaintiffs are seeking an unspecified amount of
compensatory damages and their costs and expenses, including legal fees. The
Company believes the allegations in the lawsuit are without merit and intends
vigorously to defend the litigation, which is in the early discovery stage. The
Company had filed a motion to dismiss the lawsuit, but the Court did not grant
the motion. While the Company believes that the litigation will have no material
adverse impact on its financial condition, results of operations or cash flows,
the litigation process is inherently uncertain and the Company can make no
assurances as to the ultimate outcome of this matter.
The Company was notified in 1992 that it is a potentially responsible party
(PRP) at a Superfund Site, Solvent Recovery Services of New England in
Southington, Connecticut. Ionics' share of assessments to date for site work and
administrative costs totals approximately $82,000. The United States
Environmental Protection Agency ("EPA") has not yet issued a decision regarding
clean-up methods and costs. However, based upon the large number of PRPs
identified, the Company's small volumetric ranking (approximately 0.5%) and the
identities of the larger PRPs, the Company believes that its liability in this
matter will not have a material effect on the Company or its financial position,
results of operations or cash flows.
In 2002, Sievers Instruments, Inc. ("Sievers"), a wholly owned subsidiary of the
Company, filed a patent infringement suit in the United States District Court
for the District of Colorado against Anatel Corporation and against Anatel's
acquiring company, Hach Company ("Anatel"). The suit alleges that Anatel's
manufacture and sale of its Model 643 organic carbon analyzer unlawfully copied
and interfered with sales of Sievers' TOC 400 total organic carbon analyzer in
that the Model 643 infringes certain claims of Sievers' U.S. patents No.
5,976,468 and No. 6,271,043. The suit further asserts that the continuing sale
of calibration standards by Anatel constitutes infringement. The defendants have
raised certain defenses, withdrawn the accused product from the market, and
introduced a redesigned analyzer. Defendants have asked the Court to rule that
their redesigned analyzer does not infringe, and the Court has not yet issued
its decision.
The Company is involved in the normal course of its business in various other
litigation matters, some of which are in the pre-trial discovery stages. The
Company believes that none of the other pending matters will have an outcome
material to the Company's financial position, results of operations or cash
flows.
15
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's common stock is traded on the New York Stock Exchange under the
symbol ION. As of March 11, 2004, there were approximately 1,000 shareholders of
record. No cash dividends were paid in either 2003 or 2002 pursuant to the
Company's current policy to retain earnings for use in its business. The Company
currently intends to continue to retain future earnings, if any, for use in its
business and does not expect to pay any cash dividends in the foreseeable
future.
In addition, the Company's ability to pay dividends is restricted by certain
contractual provisions in the Credit Agreement dated as of February 13, 2004 by
and among the Company as borrower; certain of its domestic subsidiaries as
guarantors; UBS Securities LLC as Lead Arranger, Sole Bookmanager and
Documentation Agent; Fleet Securities, Inc. and Bank of America, N.A. as
Syndication Agents; Wachovia Bank, N.A. and General Electric Capital Corporation
as Co-Documentation Agents; UBS A.G. Stamford Branch as Administrative Agent and
Collateral Agent; UBS Loan Finance LLC as Swingline Lender; HSBC Bank USA as
Issuing Bank; and the lender parties thereto, which is attached hereto as
Exhibit 10.28.
During the period January 1, 2002 to December 31, 2003, the range of high and
low sales prices of the common stock for each quarterly period was as follows:
COMMON STOCK PRICE RANGE
2003 HIGH LOW
---- ---- ---
First Quarter $ 24.60 $ 15.70
Second Quarter 24.82 15.96
Third Quarter 28.37 20.04
Fourth Quarter 33.25 24.23
2002 HIGH LOW
---- ---- ---
First Quarter $ 33.90 $ 28.86
Second Quarter 32.22 24.00
Third Quarter 25.21 18.90
Fourth Quarter 25.15 17.64
The information referenced by this item with respect to the Company's
stockholder-approved plans and non-stockholder-approved plans is hereby
incorporated by reference from the Company's definitive Proxy Statement for the
2004 Annual Meeting under the caption "Equity Compensation Plan Information."
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data for each of the five years
ended December 31, 2003, 2002, 2001, 2000 and 1999 are derived from the
Company's Consolidated Financial Statements. This data should be read in
conjunction with the Company's audited financial statements and related notes,
and with Item 7 of this Annual Report on Form 10-K.
CONSOLIDATED STATEMENT OF OPERATIONS DATA
For the years ended December 31,
Dollars in Thousands -----------------------------------------------------------------------------------
Except Per Share Amounts 2003 % 2002 % 2001 % 2000 % 1999 %
------------------------ -------- ----- --------- ----- --------- ----- --------- ----- -------- -----
Revenues $347,407 100.0 $ 318,884 100.0 $ 448,049 100.0 $ 458,058 100.0 $343,184 100.0
(Loss) income from continuing operations
before income taxes, minority interest,
and gain on sale of Aqua Cool (44,333) (12.8) 3,779 1.2 (16,772) (3.7) (682) (0.1) 27,818 8.1
(Loss) income from continuing operations* (33,268) (9.6) 5,504 1.7 44,613 10.0 (922) (0.2) 18,511 5.4
(Loss) earnings from continuing operations
per basic share (1.88) 0.31 2.61 (0.04) 1.16
(Loss) earnings from continuing operations
per diluted share (1.88) 0.31 2.59 (0.04) 1.14
* Includes a pre-tax gain on the sale of the Aqua Cool Pure Bottled Water
business of $0.5 million, $8.2 million and $102.8 million in 2003, 2002 and
2001, respectively.
16
CONSOLIDATED BALANCE SHEET DATA
December 31,
--------------------------------------------------------------
Dollars in Thousands 2003 2002 2001 2000 1999
-------------------- ---------- ---------- ---------- ---------- ----------
Current assets $ 315,818 $ 341,364 $ 392,144 $ 264,976 $ 207,677
Current liabilities 118,092 114,168 156,866 173,363 99,475
---------- ---------- ---------- ---------- ----------
Working capital 197,726 227,196 235,278 91,613 108,202
Total assets 591,977 603,593 633,313 585,813 500,906
Long-term debt and notes payable 8,889 9,670 10,126 10,911 8,351
Stockholders' equity 416,165 438,153 423,353 356,861 361,852
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
OVERVIEW
The Company is a leading water purification company engaged worldwide in the
supply of water and related activities and the supply of water treatment
equipment through the use of proprietary separations technologies and systems.
The Company's products and services are used by the Company or its customers to
desalt brackish water and seawater, recycle and reclaim process water and
wastewater, to treat water in the home, to manufacture and supply water
treatment chemicals and ultrapure water, to process food products, and to
measure levels of waterborne contaminants and pollutants. The Company's
customers include industrial companies, consumers, municipalities and other
governmental entities and utilities. The following discussion and analysis of
financial condition and results of operations refers to the activities of the
Company's four business groups, which comprise the Company's reportable
operating segments. These groups are the Equipment Business Group (EBG),
Ultrapure Water Group (UWG), Consumer Water Group (CWG) and Instrument Business
Group (IBG). See Note 18 to the Consolidated Financial Statements contained in
Item 8 of Part II of this Annual Report on Form 10-K for additional information
regarding its four business segments. The Company is planning a change in its
operating structure starting in the first quarter of 2004. The Company plans to
restructure its organization into three business groups - water systems,
instruments and consumer. The water systems group will consist of equipment
sales and operations, and include the operations of the Ecolochem Group, which
was acquired in February 2004. Equipment sales will reflect all of the Company's
capital equipment and related sales and spare parts, and the operations group
will include recurring revenue from regeneration, operating plants, disinfection
chemicals and other related products. The consumer and instrument groups will
continue to include their existing activities.
The EBG segment provides products and services for seawater and brackish water
desalination, water reuse and recycling, surface water treatment, and zero
liquid discharge. Significant factors influencing the desalination market
include worldwide water shortages, the need for better quality water in many
parts of the world, and the reduced cost of operating modern desalination
facilities. These factors have driven a trend toward larger plants, and toward
the purchase of water supply and operating and maintenance contracts. Trends
impacting the water reuse and recycling market are similar, with membrane
technology becoming proven in reuse and recycling applications. The surface
water market has been influenced primarily by regulatory pressures to reduce
contaminants in water supplies. The use of membrane technology is also becoming
more accepted in surface water applications. The zero liquid discharge market,
which consists of equipment and services for the minimization of liquid waste
through such techniques as evaporation, concentration and crystallization, has
been influenced by regulatory pressures on utilities to eliminate discharges of
process water. The Company believes that it is positioned to be able to compete
successfully in these applications, although it frequently faces substantially
larger competitors.
The UWG segment provides equipment and services for the microelectronics, power,
and pharmaceutical industries, where high quality ultrapure (i.e. very highly
purified) water is required for use in production processes, and is critical to
ultimate product quality and yield. The UWG segment has historically been
heavily reliant upon the microelectronics industry, and the continued softness
in that industry has adversely impacted both revenue and profitability. The UWG
segment has been pursuing applications in other markets, such as power,
pharmaceuticals and flat panel display, to lessen its reliance upon the
microelectronics market.
17
The CWG segment provides home water units for the treatment of residential water
and point-of-use "bottleless" water coolers. Prior to the divestiture of the
Aqua Cool Pure Bottled Water business in the U.S., U.K. and France on December
31, 2001, it was also engaged in the home and office delivery market for bottled
water. The CWG segment also produced bleach-based cleaning products and
automobile windshield wash solution in its Elite Consumer Products division,
which was reclassified as a discontinued operation in 2003 and sold in January
2004. Trends in the consumer water market include increased consumer awareness
of and the need for improved water quality, and reduced confidence in the
quality of existing water supplies.
The IBG segment manufactures and sells instruments and related products for the
measurement of impurities in water. The segment serves the pharmaceutical,
microelectronics and power markets where the measurement of water quality,
including levels and types of contaminants in process water, is critical to
production processes. The IBG segment has established a strong position in the
pharmaceutical industry, providing products and services that facilitate
compliance with both domestic and foreign regulatory requirements. Like the UWG
segment, the performance of the IBG segment has been impacted by the downturn in
the microelectronics industry, although to a lesser extent than the UWG segment.
The EBG and UWG segments have historically supplied equipment and related
membranes. Starting in the mid-1980s, these groups also began to own and operate
facilities that sell desalted or otherwise treated water directly to customers
under water supply agreements. The revenues and cost of sales associated with
equipment sales are recorded in the revenue and cost of sales lines on the
Company's Consolidated Statements of Operations in the periods in which the
revenues are realized. Equipment contracts are generally accounted for under the
percentage of completion accounting method, and the period of time over which
costs are incurred and revenues are realized may vary between six months and two
years, depending on the nature and amount of equipment being supplied. For water
supply agreements, with respect to smaller projects, of which the Company is the
sole owner, the initial cost of the equipment becomes part of the Company's
depreciable fixed asset base, and the revenues and cost of sales recorded by the
Company are those that are associated with the supply of water under the water
supply agreement. These contracts typically vary in length between 5 and 15
years.
In the EBG segment, which more recently has begun to pursue large-scale,
long-term water treatment projects, the Company's business model typically has
been to participate in such projects through joint venture project companies in
which the Company will hold an ownership interest. Such project companies are
formed to own and operate larger scale desalination, reuse, or other projects in
which the Company may participate in several ways, including: having an
ownership interest (typically a minority interest) in the project company;
selling the desalination, reuse, or other treatment system to the project
company; and providing operating and maintenance services to the project company
once the project facility commences operations. These projects often exceed $100
million in total cost and may involve multiple equity participants in the
project company. The Company's participation in major projects through an
interest in a project company structure mitigates the risks of engaging in such
activities, and also provides the Company with potential long-term equity income
from such investments, because these project companies typically enter into
long-term concession agreements with the customer entity.
On September 3, 2003, the Company announced a restructuring plan intended to
improve financial performance through a realignment of the Company's management
structure, a reduction in personnel, and the consolidation of certain
operations. The program will consolidate the Company's sales, engineering,
manufacturing and accounting functions, which are currently spread among
numerous reporting entities, into several regional centers in the United States,
Europe and Asia. The Company also announced plans to consolidate the EBG and UWG
segments into a single business group, to divest the Elite Consumer Products
division in Ludlow, MA, and shut down operations at the Company's Ionics
Watertec facility in Australia. Additionally, during the fourth quarter of 2003,
the Company decided to divest its European POU cooler business.
As a result of the above decisions, the Company recorded restructuring charges
of approximately $2.8 million during 2003 relating primarily to employee
severance costs for the elimination of approximately 160 positions. The Company
expects to realize a reduction of approximately $15.4 million in operating
expenses in 2004 as a result of the restructuring initiatives undertaken in the
third and fourth quarters of 2003.
18
During 2003, the Company's management and Board of Directors approved a plan of
disposition to sell its consumer chemical business, the Elite Consumer Products
division in Ludlow, MA, which was part of the Company's Consumer Water Group,
and its European POU cooler business, which sells point-of-use "bottleless"
water coolers in Ireland and the U.K. Accordingly, the Company's Consolidated
Financial Statements and Notes have been reclassified to reflect these
businesses as discontinued operations in accordance with Financial Accounting
Standards Board Statement No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets," for all periods presented. (Loss) income from discontinued
operations was ($11.5) million, ($0.7) million and $0.1 million in 2003, 2002
and 2001, respectively.
During 2003, the Company recorded an impairment charge relating to production
equipment within the EBG segment that it had previously expected to lease to a
manufacturer of lactic acid in the food industry. During the second half of 2003
the Company's customer, Intersuero, began the process of filing for insolvency
protection. Accordingly, the Company recorded an impairment charge of
approximately $2.5 million associated with the remaining carrying value of the
equipment, as the Company does not expect to recover the asset or receive any
future payments in respect to the asset. This matter is currently in litigation.
See Item 3, Legal Proceedings. Additionally, as a result of the Company's
restructuring plan, the Company ceased or reduced manufacturing operations at
various locations resulting in the impairment of manufacturing equipment
totaling approximately $1.0 million. The Company also recorded an impairment
charge of $0.6 million associated with its decision to abandon a plan to
increase manufacturing capacity in a plant located in Italy.
During the third quarter of 2003, as a result of significant changes in the
business climate which resulted in the Company's restructuring program, the
Company conducted an interim impairment test of the goodwill related to certain
of its reporting units. Based upon this assessment, the Company concluded that
goodwill associated with several reporting units exceeded their fair value and
accordingly recorded a $12.7 million impairment charge.
In the third quarter of 2003, the Company completed the acquisition of
substantially all of the assets of CoolerSmart LLC ("CoolerSmart"), a limited
liability company in the business of leasing POU "bottleless" water coolers to
commercial customers, primarily in the mid-Atlantic region of the United States
for approximately $7 million in cash. This acquisition allows the Company to
enter the domestic POU "bottleless" water cooler market.
In the first quarter of 2004, the Company completed the acquisition of the
Ecolochem Group. The Ecolochem Group, privately held companies headquartered in
Norfolk, Virginia, are a leading provider of emergency, short and long-term
mobile water treatment services to the power, petrochemical and other
industries. The acquisition significantly increases the Company's ability to
offer extensive outsourced water services to its customer base and adds
significantly to the Company's recurring revenue base. The Ecolochem Group,
which will be included in the Water Systems Division in the Company's proposed
new reporting structure for 2004, offers three broad categories of water
treatment offerings: emergency, supplemental and extended term outsourcing.
Emergency. Mobile emergency water treatment responds to unplanned
requests by customers to fulfill their short-term treated water needs.
Periodically, a customer may require a temporary supply of demineralized water
as a result of unpredictable events, such as breakdowns at its water treatment
facilities, extreme temperature and weather conditions, periods of high
production demand or deterioration in the quality of the raw water supply. In
those situations, the customer is often faced with the decision whether to shut
down its facility, reduce production levels or find an alternative water
treatment service. To address these needs, the Ecolochem Group offers mobile
emergency water treatment services provided by mobile units or trailers with the
equipment needed to produce water treated to the customer's specifications. Once
a customer contacts its centralized dispatch center, the Ecolochem Group's
standard procedure requires the prompt dispatch of a mobile unit to the
customer's site. For these services, customers pay fees for the delivery and use
of the mobile units.
Supplemental. Supplemental product offerings address customers'
interim, but planned, water treatment needs, provided with advance notice, to
customers for a variety of reasons, including planned outages (such as scheduled
overhauls or inspections) of their own water treatment facilities, start-up
procedures for the construction of new plants, temporary production requirements
(such as specialty batch processing) and other anticipated increases in demand
for treated water. The typical term of a supplemental services contract is less
than 12 months. The Ecolochem Group also uses its mobile water treatment fleet
to provide these services. For these services, customers pay fees for the
transportation and use of the mobile units.
Extended Term Outsourcing. Extended term outsourcing, or customer
facility-based services, supply customers with long-term on-site water treatment
solutions. The term of a typical extended term contract is five to ten years,
but may range from as short as 12 months to 15 years or more. The Ecolochem
Group retains ownership of the equipment and often operates and maintains the
water treatment system. The technology used in outsourcing is identical to that
used in the mobile services, and although installed at the customer's site, the
equipment is substantially similar to that used in mobile services. This
equipment
19
similarity allows the Ecolochem Group to back-up, with its mobile fleet, any
outsourced installations that are shut down for upgrading or repair or that
requires additional capacity. For these services, customers pay both a fixed fee
based on the cost of the equipment provided and a variable fee based on the
volume of water treated.
Other Activities. The Ecolochem Group also resells both ion-exchange
resins and reverse osmosis membranes. Often, it will provide temporary mobile
services during the replacement and installation of resins or membranes at the
customer's plant. The Ecolochem Group also provides off-site ion exchange resin
regeneration and reclamation services for customer-owned resins. It also
supplies water softening and filtration treatment equipment to residential and
light industrial customers in Southeast Virginia.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company's Discussion and Analysis of Financial Condition and Results of
Operations is based on the Company's consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of consolidated financial
statements requires the Company to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent liabilities. On an ongoing basis, the Company evaluates
its accounting policies and estimates, including those related to revenue
recognition, allowance for doubtful accounts, investments in affiliated
entities, goodwill and other long-lived assets, income taxes, pension plans,
loss contingencies and derivative instruments. The Company bases its estimates
on historical experience and other relevant information and on appropriate
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions. The Company's significant accounting policies are described in Note
1 to the Consolidated Financial Statements included in Item 8 of this Annual
Report on Form 10-K. The Company has identified the policies discussed below as
critical to understanding its business and its results of operations.
Revenue Recognition
For certain contracts involving customized equipment eligible for contract
accounting under American Institute of Certified Public Accountants ("AICPA")
Statement of Position No. 81-1, "Accounting for Performance of Construction-Type
and Certain Construction-Type Contracts" (SOP 81-1), revenue is recognized using
the percentage of completion accounting method based upon an efforts-expended
method. The nature of these contracts and the types of products and services
provided are considered in determining the proper accounting for a given
contract. Long-term, fixed-price and cost plus fixed-fee contracts are recorded
on a percentage of completion basis using the cost-to-cost method of accounting
where revenue is recognized based on the ratio of costs incurred to estimated
total costs at completion. The Company follows this method since reasonably
dependable estimates of the costs of the total contract can be made. As a
general rule, sales and profits are recognized earlier under the cost-to-cost
method of percentage of completion accounting compared to the completed contract
method. Contract accounting requires significant judgment relative to assessing
risks, estimating contract costs and making related assumptions regarding
schedules and technical issues. Due to the size and nature of the Company's
long-term contracts, the estimation of cost at completion is complicated and
subject to numerous variables. Contract costs include material, labor,
subcontracting and other related costs. Assumptions must be made relative to the
length of time to complete the contract. With respect to contract change orders,
claims or similar items, judgment must be used in estimating related amounts and
assessing the potential for realization. Such amounts are only included in the
contract value when they can be reliably estimated and realization is reasonably
assured, generally upon receipt of a customer-approved change order. Given the
significance of the judgments and estimation processes described above, it is
likely that materially different amounts could be recorded if different
assumptions were used or if underlying circumstances were to change. The Company
closely monitors compliance and consistency of application of its critical
accounting policies related to contract accounting. In addition, reviews of the
status of contracts are performed through periodic contract status and
performance reviews. In all cases, changes to total estimated costs and
anticipated losses, if any, are recognized in the period in which determined.
For contracts involving the sale of equipment to a joint venture or other
unconsolidated affiliated entity in which the Company has an ownership interest,
the extent of revenue and profit recognized while the contract is being
performed varies based on the level of equity interest held by the Company.
Generally, when the Company's equity ownership in the affiliated customer is
less than 20% and accounts for such interest on a cost basis, no revenue or
profit is eliminated as the contract is being performed. When the Company's
equity ownership is between 20% and 50%, provided that the Company does not
exercise effective control over the affiliated entity, the Company recognizes
revenue as the contract is being performed but eliminates a portion of the
profit equal to the Company's equity ownership percentage in the entity. The
portion of the profit eliminated is accounted for as a reduction in
20
the Company's carrying amount of the investment in the affiliated company. After
construction has been completed and commercial operations have commenced, the
resulting eliminated intercompany profit is amortized as a basis difference into
equity income over the estimated useful life of the equipment owned by the
affiliated entity. When the Company's equity ownership exceeds 50%, or in
instances where the Company effectively controls the affiliated entity, no
revenue or profit is recognized on the sale of equipment as the contract is
executed, and all of the profit on the contract is eliminated.
With respect to the Company's sale of equipment to Desalcott (the project
company) in connection with the Trinidad project where the Company is a 40%
equity owner of Desalcott, since the Company is considered to have provided all
of the cash equity funding for the project either directly or through a loan to
the Company's local majority partner, equipment revenue earned has been
recognized to the extent of costs incurred as the contract is executed; however,
all of the profit has been eliminated.
The "Revenues: Affiliated companies" and "Cost of sales to affiliated companies"
included in the Statements of Operations reflect the revenue and costs recorded
from the sales of equipment to joint ventures or other unconsolidated entities.
Revenue is recognized in accordance with SOP 81-1 or with Securities and
Exchange Commission's Staff Accounting Bulletin No. 104, "Revenue Recognition"
(SAB 104), as appropriate, less the amount of intercompany profit eliminated
equal to the Company's ownership interest in the affiliated companies.
Eliminated intercompany profit, as described above, is amortized as a basis
difference into equity income over the useful life of the equipment placed in
service by the affiliated company (e.g. 23 years for the Trinidad project, and
27 years for the Kuwait project).
In addition to the construction and sale of customized equipment to its
customers, the Company also enters into water and other concession agreements
under which the Company "owns and operates" desalination or water treatment
facilities to produce and supply water to its customers. Under these contracts,
where the Company remains the owner of the facility or equipment, revenue and
profit is recognized as water quantities are sold to the customer (or,
alternatively, pursuant to a "take or pay" arrangement if minimum quantities are
not purchased). More specifically, the revenue derived from these contracts is
generally recognized based on actual meter readings and agreed-upon rates in
effect during the term of the contract. The constructed equipment is capitalized
by the Company, included in property, plant and equipment, and amortized to cost
of sales over the shorter of the estimated useful life of the equipment or the
contract term.
For sales of standard products and equipment not governed by SOP 81-1, such as
the sale of instruments and consumer water products, the Company follows the
guidance provided by SAB 104. The Company does not recognize revenue unless
there is persuasive evidence of an arrangement, title and risk of loss has
passed to the customer, delivery has occurred or the services have been
rendered, the sales price is fixed or determinable and collection of the related
receivable is reasonably assured. It is the Company's policy to require an
arrangement with its customers, either in the form of a written contract or
purchase order containing all of the terms and conditions governing the
arrangement, prior to the recognition of revenue. Title and risk of loss
generally pass to the customer at the time of delivery of the product to a
common carrier. At the time of the transaction, the Company assesses whether the
sale price is fixed or determinable and whether or not collection is reasonably
assured. If the sales price is not deemed to be fixed or determinable, revenue
is recognized as the amounts become due from the customer. The Company does not
generally offer a right of return on its products and the products are generally
not subject to customer acceptance rights. The Company assesses collectibility
based on a number of factors, including past transaction and collection history
with a customer and the credit-worthiness of the customer. The Company performs
ongoing credit evaluations of its customers' financial condition but generally
does not require collateral from its customers. If the Company determines that
collectibility of the sales price is not reasonably assured, revenue is deferred
until such time as collection becomes reasonably assured, which is generally
upon receipt of payment from the customer. The Company includes shipping and
handling costs in revenue and cost of sales.
The Company provides lease financing to consumers for the purchase of certain
home water treatment systems. Prior to entering into the lease agreement, the
Company evaluates the creditworthiness of its customer and generally
collateralizes the lease receivable with a security interest in the customer's
personal residence. At the time the lease transaction is consummated, the
Company recognizes revenue for the full amount of the sales value of the
equipment and records a lease receivable on its balance sheet. Finance income is
recognized as revenue by the Company over the term of the lease based on the
interest rate stated in the lease. The Company evaluates the collectibility at
point of sale of its lease receivables based on its historical loss experience
and assessment of prospective risk, and does so through ongoing reviews of its
receivables portfolio.
The Company provides support services to customers primarily through service
contracts, and the Company typically recognizes support service revenue ratably
over the term of the service contract or as services are rendered.
21
The Company also rents equipment to customers under short-term rental
agreements. The Company generally invoices customers monthly and recognizes
revenue over the rental period based on amounts billed. The rental equipment is
capitalized and depreciated to cost of sales over its estimated useful life.
The Company's products are generally subject to warranty, and related costs are
provided for in cost of sales when revenue is recognized. While the Company
engages in extensive product quality programs and processes, the Company's
warranty obligation is based upon historical product failure rates and costs
incurred in correcting a product failure. If actual product failure rates or the
costs associated with fixing failures differ from historical rates, adjustments
to the warranty liability may be required in the period in which determined.
Allowance for Doubtful Accounts
The Company evaluates the adequacy of its allowance for doubtful accounts on an
ongoing basis through detailed reviews of its accounts and notes receivables.
Estimates are used in determining the Company's allowance for doubtful accounts
and are based on historical collection experience, current trends including
prevailing economic conditions and adverse events that may affect a customer's
ability to repay, aging of accounts and notes receivable by category, and other
factors such as the financial condition of large customers. This evaluation is
inherently subjective because estimates may be revised in the future as more
information becomes available about outstanding accounts. Allowance for doubtful
accounts are established through a charge to operations included in selling,
general and administrative expenses.
Investments in Affiliated Companies
The Company consolidates the balance sheet and results of operations of all
wholly and majority owned subsidiaries and controlled affiliates. The Company
also holds minority investments in certain private companies having
complementary or strategic operations in different geographical locations around
the world. These investments are included in investments in affiliates and
include investments accounted for under the equity method of accounting. Under
the equity method of accounting, which generally applies to investments that
represent a 20% to 50% ownership of the equity securities of the affiliates, the
Company's proportionate share of the earnings or losses based on its ownership
interest of the affiliates is included in equity income. The Company records
equity losses in excess of the carrying amount of the investment when it
guarantees obligations or is otherwise committed to provide further financial
support to the affiliate. With respect to the Company's investment in Desalcott,
in recognition of the fact that the Company has provided all of the cash equity
funding for Desalcott, the Company has concluded that it would not be
appropriate to recognize equity method losses based solely on its ownership
interest in Desalcott. The Company holds 200 ordinary shares of Desalcott,
representing a 40% ownership interest. The Company also loaned $10 million to
Hafeez Karamath Engineering Services, Ltd. ("HKES"), the founder of Desalcott
and promoter of the Trinidad desalination project, to enable HKES to acquire 200
ordinary shares of Desalcott and thereby raise its existing equity interest in
Desalcott from 100 to 300 ordinary shares. As a result, the Company currently
owns a 40% equity interest in Desalcott, and HKES currently owns a 60% equity
interest in Desalcott. In addition, the Company made a $10 million loan to
Desalcott in the third quarter of 2003 as an additional source of long-term
financing. Accordingly, based on its aggregate economic interests in Desalcott,
the Company records 100% of any net loss reported by Desalcott and 40% of any
net income reported by Desalcott. In periods in which Desalcott has an
accumulated loss (as opposed to retained earnings), the Company records 100% of
any net income of Desalcott up to the amount of Desalcott's accumulated loss,
and 40% of any net income reported thereafter by Desalcott. Realization of the
Company's investments in equity securities may be affected by the affiliate's
ability to obtain adequate funding and execute its business plans, general
market conditions, industry considerations specific to the affiliate's business,
and other factors. The inability of an affiliate to obtain future funding or
successfully execute its business plan could adversely affect the Company's
earnings in the periods affected by those events. Future adverse changes in
market conditions or poor operating results of underlying investments could
result in a write-down or in an inability to recover the carrying value of an
equity investment that may not be reflected in an investment's current carrying
value, thereby possibly requiring an impairment charge in the future. The
Company records an impairment charge when it believes an investment has
experienced a decline in fair value that is other-than-temporary.
Goodwill and Other Long-Lived Assets
The Company assesses the potential impairment of identifiable intangibles and
other long-lived assets whenever events or changes in circumstances indicate
that the carrying value may not be recoverable. Factors that could indicate an
impairment include significant underperformance of the asset as compared to
historical or projected future operating results, significant changes in the
actual or intended future use of the asset, or the strategy for its overall
business and significant negative industry or economic trends. When the Company
determines that the carrying value of intangible and other long-lived assets may
not be recoverable, the related estimated future undiscounted cash flows
expected to result from the use of the asset and its eventual disposition are
compared to the carrying amount of the asset. If the sum of the estimated future
cash flows is less than the carrying amount, the
22
Company records an impairment charge based on the estimated discounted future
cash flows using a discount rate determined by Company management to be
commensurate with the associated risks.
On January 1, 2002, the Company adopted SFAS 142, "Goodwill and Other Intangible
Assets" (SFAS 142). In accordance with SFAS 142, amortization of goodwill was
discontinued as of January 1, 2002. Goodwill represents the excess acquisition
cost over the fair value of the net assets acquired in the purchase of various
entities. Prior to the adoption of SFAS 142, goodwill was amortized on a
straight-line basis over its estimated useful life, which generally was a period
ranging from 10 to 40 years. The Company evaluates the recoverability of
goodwill annually as of December 31, or more frequently if events or changes in
circumstances warrant, such as material adverse changes in the business climate
indicate that the carrying value of an asset might be impaired. Goodwill is
considered to be impaired when the net book value of a reporting unit exceeds
its estimated fair value. Fair values are estimated using a discounted cash flow
methodology. Discounted cash flows are based on the businesses' strategic plans
and management's best estimate of revenue growth and profit margin by each
reporting unit. During the third quarter of 2003, as a result of significant
changes in the business climate, which resulted in the Company's restructuring
program, the Company conducted an interim impairment test of the goodwill
related to certain of its reporting units. Based upon this assessment, the
Company concluded that goodwill associated with several reporting units exceeded
their fair value and accordingly recorded a $12.7 million impairment charge. The
impairment charge represented the entire goodwill balance for these reporting
units.
Income Taxes
The Company estimates its income tax liability in each jurisdiction in which it
operates based on an assessment of permanent and temporary differences resulting
from differing treatment of items for tax and financial reporting purposes.
Temporary differences result in deferred tax assets and liabilities, which are
included within the Consolidated Balance Sheets. The Company assesses the
likelihood that deferred tax assets will be recovered, and establishes a
valuation allowance to the extent that it believes that it is more likely than
not any deferred tax asset will not be realized. All available evidence, both
positive and negative, is considered in the determination of recording a
valuation allowance. The Company considers future taxable income and ongoing tax
planning strategies when assessing the need for a valuation allowance. Negative
evidence that would suggest the need for a valuation allowance consists of the
Company's recent cumulative operating losses that were attributable to
unprofitable businesses.
The positive evidence consists of the Company's current initiative to realign
its businesses to operate more efficiently. In addition, the Company recently
acquired the Ecolochem Group, which has strong historical earnings. The Company
believes that future taxable income will be sufficient to realize the deferred
tax benefit of the net deferred tax assets. In the event that it is determined
that the Company's financial projections of pre tax profits change and it
becomes more likely than not that the net deferred tax assets will not be
realized, an adjustment to the net deferred tax assets will be made and will
result in a charge to income in the period such determination is made. The net
deferred tax asset amount as of December 31, 2003 is $6.3 million.
Taxable income in future periods significantly different from that projected may
cause adjustments to the valuation allowance that could materially increase or
decrease future income tax expense. At any time, the Company's income tax
expense can also be impacted by changes in tax laws, or by administrative
actions or court rulings. The amount of the deferred tax asset considered
realizable is subject to change based on future events, including generating
taxable income in future periods. The Company will continue to assess the need
for the valuation allowance at each balance sheet date based on all available
evidence. The amount of the deferred tax asset considered realizable, however,
could be reduced in the near term, and the amount could be material, if the
Company does not generate sufficient taxable income in future periods.
The Company has taken positions in its worldwide corporate income tax filings
based on careful interpretations of global statutes, rules, regulations and
court decisions that may be applied and interpreted differently by a taxing
authority. These taxing authorities may or may not challenge the Company's
application and interpretation of a wide body of tax jurisprudence. During 2004
and the beginning of 2005, the Company expects that several matters relating to
interpretations made regarding tax positions taken by the Company could be
resolved either through the completion of the examination by taxing authorities
or by the passage of the statute of limitations for review. Although the final
determination of these matters cannot presently be determined, the Company
believes that an unfavorable settlement of any particular matter would likely
require the use of cash while a favorable resolution would likely result in a
reduction in the Company's effective tax rate in the period of resolution. While
the Company believes its accrued income tax liabilities are adequate, the
resolution of certain of these matters could have a material impact on the
Company's results of operations, financial condition or cash flows.
23
The Company has elected not to provide tax on certain undistributed earnings of
its foreign subsidiaries which it considers to be permanently reinvested. The
cumulative amount of such unprovided U.S. taxes was approximately $10.5 million,
$9.7 million and $8.2 million as of December 31, 2003, 2002 and 2001,
respectively.
Pension Plans
The Company has a qualified defined benefit pension plan covering most of its
domestic employees. The Company's calculation of pension expense is sensitive to
changes in several key economic assumptions and in the demographics of its
workforce. The Company's pension income or expense for the plan is computed
using actuarial valuations. The assumptions made by the Company relate to
financial market and other economic conditions. Changes in key economic
indicators can result in changes in the assumptions the Company uses. The
assumptions made at year-end used to estimate pension income or expense for the
following year are the discount rate and the expected long-term rate of return
on plan assets. The discount rate states the expected future cash flows
necessary to satisfy the pension obligations at a present value. The Company
uses judgment in selecting these assumptions giving consideration to current
market conditions, future market trends, changes in interest rates and equity
market performance. The Company also considers factors such as the timing and
amounts of expected contributions to the plans and benefit payments to plan
participants. The Company's selection of a discount rate represents the market
rate of return on high-quality fixed income investments. A lower discount rate
would increase the present value of the pension obligation and increase pension
expense.
During 2003, the Company's review of market trends, actual returns on plan
assets, and other factors resulted in maintaining the expected long-term rate of
return on plan assets at 7.0% for its December 31, 2003 actuarial calculations.
This rate is applied to a calculated value of plan assets which results in an
amount that is included in pension income or expense in 2004. The Company
reduced the discount rate assumption from 6.5% to 6.0% at December 31, 2003.
During the fourth quarter of 2003, the Company's Board of Directors approved
amendments to the defined benefit pension plan and to the Supplemental Executive
Retirement Plan ("SERP") to cease accepting new participants after December 31,
2003 and to freeze benefit accruals as of March 31, 2004. The amendments to
these plans resulted in the recognition of a curtailment loss of approximately
$5.5 million in the fourth quarter of 2003.
During 2003 and 2002, the Company recorded an adjustment in the stockholders'
equity section of its Consolidated Balance Sheets to reflect a minimum pension
liability for its pension plan. This adjustment is determined by comparing the
accumulated benefit obligation (ABO) for the plan to the fair value of the
plan's assets. The amount by which the ABO exceeds the fair value of the plan
assets, after adjusting for previously recorded accrued or prepaid pension cost
for the plan, must be recorded as a minimum pension liability, with a
corresponding increase in an intangible asset, if appropriate, and a reduction
to stockholders' equity, consistent with SFAS 87. The after-tax adjustment
related to the Company's recording a minimum pension liability in 2003 did not
impact earnings, but reduced stockholders' equity by $0.5 million. This
adjustment is computed each year at December 31 and could potentially reverse in
the future if financial markets improve and interest rates increase, or could
potentially increase if financial market performance and interest rates continue
to decline.
Loss Contingencies
The Company is subject to certain claims and litigation including proceedings
under government laws and regulations and commercial disputes relating to its
operations, including ordinary routine litigation incidental to its business.
(See "Note 9. Commitments and Contingencies to the Consolidated Financial
Statements"). Management reviews and determines which liabilities, if any;
arising from these claims and litigations could have a material adverse effect
on the Company's consolidated financial position, liquidity or results of
operations. Management assesses the likelihood of any adverse judgments or
outcomes as well as potential ranges of probable losses. Loss contingency
liabilities are recorded for these contingencies based on careful analysis of
each matter with the assistance of outside counsel when it is probable that a
liability has been incurred and the amount of the loss is reasonably estimable.
These liabilities may change in the future due to new developments relating to
each matter or changes in approach such as a change in settlement strategy.
Derivative Instruments
All derivative instruments are stated at fair value on the Consolidated Balance
Sheets. The Company conducts business in a number of foreign countries, with
certain transactions denominated in local currencies. The Company hedges certain
foreign currency exposures to minimize the effect of exchange rate fluctuations
on certain monetary assets and anticipated cash flows denominated in foreign
currencies. The terms of the currency instruments used for hedging purposes are
consistent with the timing of the transactions being hedged. The Company does
not use derivative financial instruments for trading or speculative purposes.
24
The Company enters into foreign currency forward contracts to hedge its
exposures associated with certain forecasted revenue transactions. These
derivative instruments, which are designated as foreign currency cash flow
hedges and generally mature within two years or less. All outstanding
derivatives are recognized on the Consolidated Balance Sheets at fair value and
changes in their fair value are recorded in accumulated other comprehensive
income (loss) until the underlying forecasted transaction occurs. Once the
underlying forecasted transaction is realized, the gain or loss from the
derivative designated as a hedge of the transaction is reclassified from
accumulated other comprehensive income (loss) to the statement of operations in
the related revenue caption. In the event the underlying forecasted transaction
does not occur, the amount recorded in accumulated other comprehensive income
(loss) will be reclassified to selling, general and administrative expense in
the Consolidated Statements of Operations in the then-current period. No amounts
were reclassified from accumulated other comprehensive income (loss) to selling,
general and administrative expense during 2003, 2002 or 2001.
The Company also enters into foreign exchange forward contracts to hedge its
exposures associated with foreign-currency denominated assets and liabilities.
These derivative instruments are designated as foreign currency fair value
hedges. The derivatives are recognized on the Consolidated Balance Sheets at
fair value and period-end changes in fair value are recorded in selling, general
and administrative expense in the Consolidated Statements of Operations.
Since the Company is using foreign exchange derivative contracts to hedge
foreign exchange exposures, the changes in the value of the derivatives are
highly effective in offsetting changes in the cash flows of the hedged item.
Hedge effectiveness is assessed on a quarterly basis. Any ineffective portion of
the derivatives designated as cash flow hedges is recognized in current earnings
in selling, general and administrative expense. The ineffective portion of the
derivatives consists of discounts or premiums on forward contracts and gains or
losses associated with differences between actual and forecasted amounts. In any
instance in which the designated hedged item matures, is terminated, or, in the
case of an anticipated transaction, is deemed unlikely to occur, the related
derivative contract is closed and any gain or loss is immediately recognized in
the Consolidated Statements of Operations in selling, general and administrative
expense. For the year ended December 31, 2003, the Company recognized a gain of
approximately $0.1 million related to the ineffective portion of its forecasted
cash flow hedge.
RESULTS OF OPERATIONS
COMPARISON OF YEARS ENDED DECEMBER 31, 2003 AND DECEMBER 31, 2002
The Company reported consolidated revenues of $347.4 million and a net loss of
$44.8 million in 2003, compared to consolidated revenues of $318.9 million and
net income of $4.8 million in 2002. During 2003, as part of the Company's
restructuring plan, the Company approved plans to divest its Elite Consumer
Products division and its European Point of Use cooler ("POU") business.
Accordingly, results for the Company's Elite Consumer Products division and
European POU business, which are part of the Consumer Water Group, have been
reclassified to discontinued operations in the Consolidated Statements of
Operations for all periods presented. Results for 2002 included the partial year
operations of the Company's majority-owned Malaysian subsidiary, Ionics Enersave
("Enersave") which was divested in May 2002. In addition, in the third quarter
of 2003, the Company completed the acquisition of substantially all of the
assets of CoolerSmart LLC, a limited liability company in the business of
leasing POU "bottleless" water coolers.
Revenues
Total Company revenues of $347.4 million for 2003 increased $28.5 million or
8.9% from revenues of $318.9 million for 2002. The decreased revenue in EBG and
CWG were primarily offset by increased revenue from affiliated companies.
Included in 2002 are $4.2 million of revenues from partial year results of
Enersave, which was divested in May 2002.
25
The following table reflects the revenues of the Company's four business
segments and sales to affiliated companies for the years ended December 31, 2003
and 2002:
For the years ended December 31,
-------------------------------- Percentage
(Dollars in thousands) 2003 2002 Dollar Change Change
---------- ---------- ------------- ----------
Revenues
Equipment Business Group $ 144,043 $ 154,378 $ (10,335) (6.7)%
Ultrapure Water Group 102,600 102,407 193 0.2%
Consumer Water Group 21,216 22,190 (974) (4.4)%
Instrument Business Group 29,807 27,741 2,066 7.4%
Affiliated companies 49,741 12,168 37,573 308.8%
---------- ---------- ---------- -----
$ 347,407 $ 318,884 $ 28,523 8.9%
========== ========== ========== =====
EBG revenues of $144.0 million in 2003 decreased $10.3 million, or 6.7%,
compared to revenues of $154.4 million in 2002. The decrease in revenues is
primarily attributable to reduced revenues from the Zero Liquid Discharge
("ZLD") business of $13.5 million, primarily as a result of the Company's
business strategy to not pursue the civil construction scope on ZLD projects.
This decrease was partially offset by increases in EBG's water supply business
in the Caribbean ($3.6 million), as well as new sales of capital equipment to
several municipalities for surface water applications.
UWG revenues of $102.6 million in 2003 increased $0.2 million, or 0.2%, compared
to revenues of $102.4 million for 2002. Revenues for 2002 included $4.2 million
from Enersave, which was divested in May 2002. Excluding Enersave revenue from
2002, UWG revenue increased $4.4 million or 4.5% in 2003 compared to 2002. The
increase in revenues is primarily attributable to increased revenues in
Australia ($4.5 million) and Asia ($4.6 million), offset by lower revenues from
domestic operations ($5.3 million).
CWG revenues totaled $21.2 million in 2003 compared to revenues of $22.2 million
in 2002, representing a decrease of $1.0 million or 4.4%. Results for the
Company's Elite Consumer Products division in Ludlow, MA, as well as the
Company's European POU divisions, have been reclassified to discontinued
operations for all periods presented.
IBG revenues of $29.8 million in 2003 increased $2.1 million, or 7.4%, compared
to revenues of $27.7 million in 2002. The increase in revenues primarily
resulted from increased sales to the pharmaceutical industry as a result of
legislative regulations as well as continued growth in sales of consumable
products and instrument services.
Revenues from sales to affiliated companies of $49.7 million in 2003 increased
$37.6 million or 308.8% compared to revenues from affiliated companies of $12.2
million in 2002. The increase in revenues from sales to affiliated companies
primarily resulted from the sale of capital equipment to the Company's Kuwait
joint venture company, Utilities Development Company, W.L.L. ("UDC"), for the
Kuwait wastewater treatment project.
The Company has entered into a number of large contracts, which are generally
categorized as either "equipment sale" contracts or "build, own and operate"
(BOO) contracts. The Company believes that the remaining duration on its
existing sale of equipment contracts ranges from less than one year to three
years and the remaining duration on its existing BOO contracts ranges from one
year to 25 years. The time to completion of any of these contracts, however, is
subject to a number of variables, including the nature and provisions of the
contract and the industry being served. Historically, as contracts are
completed, the Company has entered into new contracts with the same or other
customers. In the past, the completion of any one particular contract has not
had a material effect on the Company's business, results of operations or cash
flows.
26
Cost of Sales
The following table reflects cost of sales of the Company's four business
segments and cost of sales to affiliated companies for the years ended December
31, 2003 and 2002:
For the years ended December 31,
------------------------------------------------------------------
Percentage of Percentage of
(Dollars in thousands) 2003 Sales 2002 Sales
---------- ------------- ---------- -------------
Cost of Sales
Equipment Business Group $ 113,779 79.0% $ 114,251 74.0%
Ultrapure Water Group 80,159 78.1% 78,423 76.6%
Consumer Water Group 9,878 46.6% 9,889 44.6%
Instrument Business Group 1