奇異 (GE) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the third quarter financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. The instructions will be given at that time. If you should require assistance during the call, please depress zero, then star. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Executive Vice President and Treasurer, Mr. Ted Papastavros. Please go ahead.

Good afternoon, all, and welcome to our third quarter conference call. With me this afternoon is Art Goldstein, our Chairman and CEO, and Dan Kuzmak, our Chief Financial Officer. Before starting, let me say that the matters we will discuss today, other than historical information, consist of forward-looking statements relating to future financial and business performance, operating plans and goals and objectives of management made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements may include statements relating to management's expectations for financial and business performance during the remainder of 2002 and 2003 and 2004, and overall economic and business conditions and trends. Words such expects, intends, believes, projects, plans, assumes and similar expressions identify forward-looking statements. Listeners are cautioned that forward-looking statements are not promises or guarantees of future performance, and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements.

These risks and uncertainties include, but are not limited to, those relating to overall economic and business conditions, demand for the company's products, pricing pressures and competition from companies larger than the company, risks of non-payment of accounts receivable, risks associated with foreign operations, technological and product development risks, and fluctuations in our quarterly results.

Any forward-looking statements we make should be considered in light of these factors, as well as those set forth in our press release, and under the heading, "Risks and Uncertainties," in our annual report on form 10-K for the year ended December 31, 2001, which has been filed with the Securities and Exchange Commission. We incorporate here the discussion of those factors. Existing and prospective investors are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. We undertake no obligation to update or revise the information provided on this call, whether as the result of new information, future events, or circumstances or otherwise.

Having dispensed with that, let me now turn the call over to our Chairman and CEO, Art Goldstein, who will make some opening comments. Art?

Thank you, Ted. Good afternoon, ladies and gentlemen. This is an unusual conference call for Ionics to be on because we have some things to report of a nature that we have not reported or addressed before, and I think before people draw conclusions on what some of the things meant or mean, that it's important to listen to what we will try to describe in this conference call. And we appreciate the opportunity you're giving us to do so.

First of all, let me say that our earnings for this quarter were a disappointment. They were 11 cents a share, profit, compared to a Street estimate roughly of 18 cents a share, and that was

reflecting about nine cents a share in the quarter, and about 15 cents a share on a year to date basis. As we will describe, we pushed some of this back to Q1 and Q2, for a total impact on a year to date basis of 15 cents per share relative to issues at our French subsidiary.

We'll be talking more about those issues in a moment. The remaining shortfall relative to Street estimate of 18 cents a share, as we'll be describing, is due primarily to some pressure on gross margins in the period, some of it relating to mix, some capacity underutilization, and continued weakness in some industrial markets, particularly microelectronics. There were also in the quarter some startup costs relative to a new venture we've begun in the consumer PLU business in the United Kingdom, which is replacing -- at least we hope it will be replacing the bottled water business that we sold to Nestle.

Ladies and gentlemen, the issues in France that we're talking about were discovered less than two weeks ago, as we were in the process of closing our third quarter. In the past few days, last week, really, we took action to downsize the French operation. We also took action, as you've seen in the release today, to restate earnings by approximately one cent for Q1, and about 3.5 cents for Q2, and that's on a normalized tax basis. Dan will be talking a little more about that later.

We believe the issue we uncovered in France was an anomaly as far as operations at Ionics are concerned. What we discovered ourselves and what we communicated to our outside auditors -- they didn't discover this, we did -- were two improper, inaccurate recordings of what essentially was a single inter-company transactions which was done by the Controller at our French subsidiary. In looking at the problems in France, the second issue we addressed was certain overstaffing in France relative to current and expected future revenues.

I should point out that to a significant degree, the problem we had in France before we recognized the inter-company transactions issue masked the operating problem that we had there and pushed the resolution of staffing and overhead reduction issues from the end of Q3 -- from the end of Q2, when we should have discovered it, to the end of Q3. In conjunction with our actions in informing our auditors of the improper recording of the inter-company transactions I just mentioned, which were caused by the failure of our subsidiary Controller to follow corporate instructions, and his incorrect recording of inter-company transactions, we took the following immediate actions in France. We fired the French Controller. We took action to eliminate 25 to 30 positions, which will take place, some immediately, and some over the next two months, as well as portions of the facilities they occupy.

Incidentally, these charges will result in a charge to earnings of somewhere between five and six cents per share, total, in between either Q4 of this year, probably somewhat more of it in Q4, and some in Q1 of next year. We also took actions to redistribute certain of the business activities we have in France to our other business groups. We assigned our instrument activities there to our instrument business group, and our ultra-pure water activities there to our ultra-pure water group, all this with the idea of downsizing in France.

We also assigned the project and contract operations in France to Ionics

, which is our very strong Italian subsidiary. I should point out our strong belief that the recognition of these issues at the end of the third quarter, when we were doing our normal audit, was in significant part attributable to the work of Ionics people, people we added to our control staff over the last two to three quarters.

We have also implemented the installation of new consolidation software during the quarter, and we believe this will significantly help us eliminate similar inter-company transaction issues in the future. I would like to point out that despite the embarrassment and surprise relating to Q3, particularly with the issues in France, we continue to believe that we have formed a very significant and very solid foundation for growth in 2003 and continuing into 2004, and hopefully, beyond.

That solid foundation is based on our backlog, which grew by $17 million in the quarter, and reached a record level of $388 million at the end of the quarter. And that was based on bookings during the quarter of 104.7 million. That was up 76.6 percent from the same -- and that resulted in a backlog which was up 76.6 percent from the backlog we had one year ago. Included in this $388 million backlog -- I should point out, we call this backlog our reportable, or reported short-term backlog. That includes equipment bookings representing about 20 percent of the backlog plus the first five years of our own and operate projects, which represent the remainder. As many of you know, our own and operate contracts often run substantially more than five years. If we were to factor in this longer term backlog, our total backlog, the total backlog currently on the books of Ionics, would be easily double the short-term backlog of 388 million.

So we would have a backlog which I can say conservatively is over $800 million. I should also point out that a growing fraction of our backlog, approximately 15 percent -- 50, five, zero percent of it now represents municipal type own and operate type business, and equipment business. It's been a very solid type of business for Ionics. I'd like to point out that during the quarter, we booked a significant municipal order, including in that $104 million for the quarter for brackish water desalination system in Oklahoma, a water disinfection systems for Abu Dabi, a major zero liquid discharge job in Kazahkstan, a major zero liquid discharge job in Mississippi, three microelectronics orders in Taiwan, two major waste water orders in Pennsylvania, including one which is a sizable build own and operate contract, and also, after the end of the quarter -- since the end of the quarter, we were awarded a municipal brackish water desal job, a significant one, in Iowa, and our second very important order for desal systems in Iowa. These are all brackish water desal systems, and we were selected for a major drinking water order in Texas.

I'd like to point out that in Israel, a joint venture team of which we are a partner was recently selected, and we recently signed a contract to build a 30 million cubic meter per year desalination plant. This is a build, own and operate project which will require $100 million of capital. It will be financed primarily with debt. Ionics is a 20 percent equity partner in this project. We expect financial close in this project in approximately six months.

I'd like to report also that in Trinidad we are on a good track to achieve permanent financing in the next two months. I'm very pleased to report that the plant is running very well at a contractual capacity of 100,000 cubic meters per day. That is the largest plant in our part of the world, and it's performing just as we hoped it would.

So, ladies and gentleman, let me say in conclusion that despite what's happened in this quarter, despite what we consider to be an anomaly, and with some product mix issues which we'll be discussing, we very strongly continue to believe that with record short-term and long-term backlogs totaling over 800 million, with substantial capital at our balance sheet for expansion, that Ionics remains in excellent shape for the future. And we continue to see a very strong foundation for growth in 2003 and 2004.

Ted, let me turn it back to you.

Thank you, Art. I'd like to turn now to a review of the financial numbers for the quarter, and Dan Kuzmak, our CFO, will address those numbers. Dan?

Thank you, Ted. As Art has already indicated, and I'll just say again, the results for the quarter of two cents would have been approximately nine cents higher if not for the losses in France. Indeed, those losses were unexpected, and upon our review of what we found there, that led to the need to restate Qs two and Q1. So clearly our Q3 result would have been substantially better if not for that, and I won't repeat actions, steps, as Art has already described that the company is taking in response to that.

We also had gross margin levels that were less than expected in a few, or a couple, areas of the company, and that impacted us in the quarter as well. And I'll comment on those in a moment, but first, let me just talk about volume. If I adjust, or we adjust for the Aquacool bottled water sales of approximately 21.5 million in the third quarter of 2001, revenues of 86.8 million would compare to 96.8 million last year.

This reduction or difference of $10 million was principally due to the ultra-pure water segment, and is a reflection of the softness in the microelectronics arena, again, affecting us this quarter. Compared to Q2 of this year, revenues were up by approximately seven million, most of that was in our equipment business group and related to various equipment and contract revenues in that segment.

Regarding gross margins, and again if I adjust for Aquacool, total company gross margin in the quarter increased over Q3 of last year by approximately two points, up from 24 percent to 26. So our margins, on a comparable basis year to year, actually showed an improved performance versus Q3 of last year.

By segment, those numbers were -- gross margin was up in the equipment and the instrument business groups, flat in the ultra-pure group, and down somewhat in the consumer group. So that's how the margins would compare to a year ago. As far as the current quarter and where we expected the results to come out, gross margin rates for the quarter were less than expected, primarily in the equipment and the ultra-pure water business groups.

Now, in the equipment business group, certainly there was the impact of France over what we had expected for the quarter, and that was a good portion of the difference from where we expected to be. There were some other variances, but I would say those relate primarily to mix and timing and it's not indicative of any change in expectations in that segment. There were, however, some reductions in margin over what we expected in the ultra-pure water group, and those were due to two factors, primarily. One being the continued overcapacity in the microelectronics sector and the unabsorbed overhead that we had incurred as a result.

In addition, we had contract overruns on two ultra-pure projects that also impacted us during the quarter. So those brought our ultra-pure water group margins down from where we expected them to be in the quarter. And in conjunction with the equipment business group, particularly France, caused the margin to be less than we expected it to be for the quarter.

SG&A for the quarter was flat compared to Q2, at about $21.3 million, compared to 25.7 last year, and most of that difference is reflective of the bottled water business, which was divested, as you know, on December 31st of 2001. Other key performance indicators for the quarter were depreciation charges of approximately $6 million, net working capital of $222.3 million, an overall tax rate, which I'll comment on in a moment of 42 percent, versus the rate that we had in effect prior of 34, and capital expenditures of $10.4 million.

The change in the overall tax rate is, simply put, primarily a reflection of the French losses, which, because we cannot benefit, has an impact in terms of increasing the rate for the year. So, essentially, we went from 34 to 41 predominately because of the issues in France and how they impacted us. The company remains in a very strong cash position, with a cash balance of $143 million, 143.9 at the end of September, which is up about 4.8 million from June.

The September balance includes several changes in working capital, including reductions in net accounts receivable, some improvement in our DSO over last quarter, and also offset by some reductions in short-term borrowings and capital spending during the quarter. So that's the summary of the financials, and again, not to repeat what we've already covered in terms of what we discovered in France and how we're dealing with that, instead I'll turn it back to you.

OK, thanks, Dan. We're now ready to go to questions and answers.

Ladies and gentlemen, if you wish to ask a question, please depress the one on your touchtone phone. You'll hear a tone indicating you've been placed in queue, and may remove yourself from the queue at any time by depressing the pound key. If you are using a speakerphone, please pick up your handset before pressing the one.

Our first question is from the line of

with

Capital. Please go ahead. And

, your line is open, does anyone there have a question or comment?

Hello?

Yes, hello, did you have a question?

Actually, no, I haven't -- no.

Oh, thank you. We'll move on to our next question, from the line of

with

. Please go ahead.

Hi guys. I'm a bit confused. You're blaming this restatement on the Controller of the French subsidiary and saying that you fired the French Controller. What did you do after your auditors recognized the misclassification of receivables from affiliates from accounts receivables after the second quarter was reported? Excuse me. Was anybody fired then?

Sir, I would have to say you're not making it very clear what you're talking about ...

OK, after the -- in the second quarter 10-Q, you said that -- let's see ...

Well, let us get a hold of it, sir.

OK, $22 million -- $22.288 million, from the press release that had been accounts receivable moved to receivables from affiliates. OK, and then you also changed your December numbers in the 10-Q from the prior statements. I was just wondering if anybody got fired over that misstatement.

That wasn't a ...

No, that wasn't a misstatement. They moved to the -- well, we ...

Well, you had -- you had receivables in accounts receivable that really were product that you sold to yourselves, right?

Well, the item to which you refer related to, substantially, our Trinidad receivable, which we talked about at length both in the Q and also in the conference call. And that was the reason for the change in the A/R with affiliates that you saw in the second quarter. That had nothing at all to do, nothing whatsoever -- wasn't even related and didn't affect the same accounts as the French issue. The French issue was different ...

No, I understand that. That's why I'm saying -- who got fired over this?

Well, you don't understand ...

No, that amount was ...

... what the answer that you're being given. The two things had nothing to do with each other. There was no firing, there was no loss. The money was transferred ...

When are you going to get that money -- you have this -- you have this -- you say that you're expecting to obtain the long-term financing for the Trinidad product in what, two months?

No, as we've said, the amount of receivable with Trinidad, with the

, the entity in which we have a 40 percent interest, first of all, we have and we've mentioned this throughout, a $10 million commitment to that project, so we have a commitment to put $10 million in. And we will essentially reclass from the A/R with affiliates $10 million to sub-debt to that project. That's been clear and evident for the whole time we've been involved in the project.

The balance of the receivable, we expect if not before to be paid out with the dispersement of the long-term financing. We are progressing on the long-term financing, making excellent progress with the expectation that we'll close in the next couple of months, and in fact, they're probably at the point of reviewing the second draft of documents, and so that process is proceeding extremely well.

So the brackish water problem at the plant, if there should be a period of heavy rain, that's not affecting the financing at all?

No.

Sir, I don't think you are coming from a factual basis with any of your questions ...

So what you're telling me on this conference call, which is being recorded, is that you are not having a problem with heavy rain at the plant in Trinidad, that it needs to be shut down due to brackish water?

No sir, we are not.

OK, thank you.

The plant is running at 100,000 cubic meters a day, right?

Right, when it's not raining, correct. OK.

It has nothing to do with whether it's raining or not. The plant has an intake filtration system -- I mean, obviously, if there was a hurricane down there, we probably would shut the plant down. But there's been nothing like that that's affected operations at the plant.

Because there has not been a period of heavy rain.

You're starting off on a foot which makes assumptions about things which are totally incorrect. And the $10 million thing where you're talking about firing somebody was a transaction under which we were able to extract $10 million of cash because we made some transactions which related to the conversation of a receivable to a different kind of financing, as ...

So you're saying that the reclassification, or the conversion, or the extraction of $10 million of accounts receivable, which gets changed to receivables from affiliates, that goes into notes receivable, is actually an extraction? That's a good thing?

We've had -- I don't want to confuse the other callers, sir. The fact that we've made a $10 million commitment to the project has been long standing. I mean, that's absolutely clear.

And that's all this is.

And as we've said, that will be reclassed as part of the conditions precedent to the closing of long-term financing. We're in the process of getting that finalized as well. And then, when the project financing is closed again, which we expect to occur within the next couple of months, we would expect to be paid down for the balance of the receivable. So I just want to divorce what you're asking about from the issue in France for everyone's clarity's sake. They're not at all similar and one has nothing to do with the other.

That's correct. I agree with you 100 percent, all I know is that stuff gets moved around on your balance sheet and it gets me incredibly nervous.

For valid reasons, sir, for valid reasons.

One question, page 18 ...

I think we're going to limit you -- right now, we're going to ask you to come back in line, sir.

OK, thank you.

We'll go after the next questioner, please.

Our next question is from the line of

with Schwab Capital Markets. Please go ahead.

Yes, good morning.

Good afternoon, Deborah.

Afternoon. Couple questions, one specific question on France and then a bigger picture question. How large were the operations in France in terms of revenues?

Revenues were in the $7 to $9 million range in the past and were lower -- had been lower this year, particularly this quarter.

That's one of the reasons,

, that we were a little slow to react, because we did not completely understand because of the masking of the inter-company transactions, what the impact of the lower revenues and the higher expenses really were. And that's why we're about 90 days late in taking action on this.

Yes, I understand. And then just to walk me down through how it works. Even though the revenue restatements are quite small that all basically goes straight to the bottom line in terms of the larger expense issues?

Correct.

OK, and how confident are you in this five to six cent write-off in Q4 toward Q1 timeframe? In other words, do you feel like you've gotten to the bottom of this?

I think so. I mean, these are mainly severance payments,

.

OK, so it's basically just the cost of -- the accounting issues are straightened out, and it's just the cost of eliminating the positions and so on.

That's correct.

... exactly, yes.

OK. My bigger picture question, Art, really is, it does feel like there have been a number of surprise issues from the various overseas operations, and I'm sure you'll tell me that I'm being unfair, but it does feel that not only us as shareholders/analysts get blindsided, but you as well by some of these things, whether it's Kuwait -- but whether it's Malaysia, or some of the other issues in recent quarters, you know, Trinidad not going to plan. I guess my very large picture question is, how well, now that you have -- you know, you've established some new reporting systems, you've established a stronger financial team. You know, how good of a handle do you really feel that you have on your entire operations, globally, at this point?

And obviously, the reason for the question is, you know, how much at risk are we from these sorts of things of various types happening again?

Well, first of all,

, it's a good question, and let me say that we take that question extremely seriously. One of the reasons we beefed up our internal audit team, our controller team -- we hired a new manager of corporate accounting. We hired new controllers in our equipment business group and our ultra-pure water group was because Ionics, even though it's a relatively small company, is dealing with some very interesting, challenging and wonderful opportunities in our business where we've been the pioneer. And, unfortunately, what comes with that is a fair amount of complexity and we've been working very hard to get that complexity under control. When we discovered these problems, which, incidentally, I would say would fall in the category where several years ago a problem that you had in one quarter would simply be fixed in the subsequent quarter, without re-statement. In these days of

and sensitivity to reporting issues, our sensitivity immediately took us to the point where we informed our auditors that we had uncovered these transactions which had been improperly recorded in one quarter and erroneously put in a second quarter.

It was our own fastidiousness with respect to dealing with this problem that really resulted in this report. In a way, it's a confirmation of the fact that the new glasses we purchased to see things better, to see things more clearly, are actually working. And so while I can't tell you that there will never be another problem--and I don't think any CEO in any company could say that--I feel pretty good about the systems we've put in place, I feel pretty good about the new software package and consolidation package we've put in place, which worked for the first time this quarter, and I think--I'll knock wood as I say this,

--I think we're OK going forward. I don't expect to see this kind of problem again.

Alright. Well, last question, then, just to put it into perspective. I mean, 15 cents year-to-date certainly is very significant, especially for such a small revenue piece, and I also noticed that you have not given guidance for 4Q, even, as per your usual practice. So I guess my last question is what's your comfort level on visibility on a general trend and profitability level going forward?

, I think, as

said in his introductory comments and given our backlong, given the nature of the business, the number of projects that are out there that are coming up for bid and general business conditions, especially in the Deep South, a zero liquid discharge area, we're feeling pretty good about 2003 and beyond. Given the immediacy of the French effect and the fact that it was only ten days ago that this surfaced, we're still reassessing the short-term, so we're not in a position today to make any confirmation towards existing forecasts or make any independent forecasts.

OK. And you can't say whether, then, you would have even, you know, a target of taking your operating margin--leaving France aside, once that's cleaned up--a target on an operating margin? In terms of where you'd like to be?

, this is

, I--you know, we are going to be constantly working at deriving numbers that we feel fully reflect what we've done in the last ten days. We're doing that right now. But I think it's reasonably premature to try and say anything. By that I don't mean that we see a big negative. It's just that I think we're unprepared to give guidance at this moment.

Sure. Understood. Fair enough. I would only just comment that there is always been a good revenue trends generally, in the business, and a lot of potential operating margin leverage, and anything you can help us on, and when we will begin to realize, that will be great.

Well, I think Ted's guidance, we feel good, you know, with the backlog that we have. That backlog has got to come into revenue, and it's good backlog. A big chunk of it is build on and operate backlog, which is our most profitable backlog. So, that is at least some indication for you.

OK. Thank you.

Our next question will be from the line of

with Merrill Lynch. Please go ahead.

Thank you. Could you give us an update on the progress in Kuwait. Was there any revenue in the quarter booked from that job?

Yes. Hi Loraine, this is Art. The Kuwait project is underway. Construction is -- engineering is being done. Preliminary civil construction is taking place. We are somewhere between 5% and 10% along on the project. From our point of the project, it is - it is on schedule, and things are progressing very well so far.

OK. And then looking to your consumer margins,

Incidentally, for those people who don't know that, our booking on this project was 130 million, which consisted of an $80 million capital equipment fees and the first five years of our owned and operate fees. And that went into our short-term backlog. And into our long-term backlog, went $10 million a year for 22 years, which is the remaining owned and operate portion of the contract. I am sorry Loraine, please go ahead.

Thanks. Consumer products, Morgan. Gross margins went from 35% in Q1 to 44% in Q2 back down to 35% in Q3. Could you talk a little bit about what caused that variability?

Right. Some of that - I'm sorry, this is Dan - some of that variation came with our consumer chemical business, the Elite business, and that is part of the swing from quarter to quarter, and that's part of the reduction that we saw in Q3. I would say that our home water business is down slightly, not greatly, but there is a slight reduction they're reflecting, I think, just conditions in the economy more than anything else. So that's basically the things that have moved around in that particular segment.

I would like to add a couple of other things. I think some of the first quarter of this year, we had effects that were tied in with some restructuring we were doing after we sold bottled water group, and most recently we're launching a new product as Art had mentioned earlier, in the U.K. as a test market for what we call a

water drinking system. Basically this system provides the same quality water as bottled water, except instead of providing bottled water that is shipped in from remote locations, it will actually do the purification and clarification within the cooler, so it - you might say it's like a bottle in the cooler, or a coolerless bottle, and we are launching that product in test marketing in the U.K., and we took some losses for that activity in the quarter.

Right.

OK. One final question. UltraPure margins, you said were lowered than you expected. Were you anticipating some pricing gains there that didn't happen?

I think the items that effected us is, as the charge indicate, we're - in one particular case, a loss as a result of some cost overruns on a project that was a terribly large, but that nonetheless effected the margin rate for the quarter. And then the remainder was - hit several of the units, and I would best characterize as unabsorbed expense. Just reflecting the impact of the volume levels that we are at.

I think one important thing to interject, Loraine, is that we've been keeping the staff at most of our microelectronics' locations in tact. We have some outstanding people at those locations. Some of the best in the world at designing UltraPure water systems, and we have to sort of walk in place for a while, as far as the overhead absorption was concerned, because the number of new jobs coming in was not that great. But as I just mentioned, we've booked three orders in microelectronics' arena in Taiwan recently. So that will help us absorb overhead and get back to work and improve our profitability in our microelectronics' center of excellence.

OK, thank you.

Our next question is from the line of

with

. Please go ahead.

Yeah. I just - a couple questions. I found - I just want a just big picture of these adjustments that we saw in the first and second quarter as you reported them, and then as you adjusted them on the financial release. It appears as though there is a lot of shifting going on, and also, you know, again it looks at one point like gross margin's impacted, at another point SG&A is impacted, and then it - it also impacts the whole P&L, including minority interest. I am just a little curious as to why there is not more consistency with the adjustments?

Rick, I would say, you know, because we are in the unfortunate situation of restating Q2 and Q1, there were a few other lesser items that we restated in the process. But the reason predominately was France, and that's why it effected a few different lines in - you know, we corrected what we found, and that's the result of the pushback.

Huh. Is there - as we go into the fourth quarter, we have severance costs there. Are there any projects that have a long tail that are - that you will have to - you know, that you have a commitment to?

No.

OK, so it is strictly service and short-term

Right. Most of the projects - there was one

that was just completed in fact.

There are a couple of small projects that have tails, but not long tails, that are being transferred to our Italian subsidiary, and any new orders - in fact we just received an order for a power plant in eastern Europe into our French office. That is being transferred immediately to our Italian subsidiary. So we are not taking any new projects into the French office.

But is there a backlog - a tail on the backlog of anything that came out of there that we should be worried about?

Well, I don't think so. One of the things that we did in this exercise is we carefully reviewed the projects that were still in process, and adjusted any that we thought were in any kind of trouble, so that whatever we did as well as looking at the expense side, we also looked at the project side in this evaluation, and feel comfortable that they are under control now.

OK. Alright. And obviously, you consulted with the outside auditors - they are aware of the numbers and they are - have they scrubbed them themselves?

Absolutely. We have gone through them and -

Totally intense

with the outside auditors, Rick.

OK, and then, let me ask you. In terms of the core business, the trends are a little bit disappointing here in the third quarter, and I think Dan, you addressed them in - those issues, there were some crossed over runs, some mix issues. How does - how do we look for the fourth quarter? When you look

the business in the backlog, do we - can we use - you know, Q3's margins in UltraPure and equipment as a stepping-stone, or are we likely to stay down at those levels for another quarter or two?

No, I think to answer that, Rick, one of the problems in this business is that mix and activity changes from quarter to quarter. When one quarter - you may have some heavy stair parts in our I-Margin job moving through that disproportionately shifts the margin for that business group for that quarter higher than what might be the average for a series of quarters, and I think we suffered some of that in Q2, and you know, I would look for a more average margin for the UltraPure water group going forward, that was more like the first quarter which was like 22%-23%.

OK.

I think, just to pick up on what Ted said, Rick.

, when we have a lot of

,

margins, gross margins, highly predictable, and they are excellent. Product margin are excellent, particularly in our EDI product, and EDR product. And incidentally, the projects that we just received in Ireland were EDR projects using our brackish water technology, which is very fundamental to Ionics. It represents our highest margin kind of business. But when a project comes through, that is more than one product, but is the sum of a variety of different projects. That is when variability can creep into the gross margin, and it is the timing of the recognition of income and the overall profitability with which that project was bid and executed. That has become somewhat variable from quarter to quarter, because there is still a significant fraction of Ionics' business which is - you know, ad hoc project by project. Booking a project, not booking a project. And what I was describing in my introduction were some recent new projects that we had built. Most of those projects will be moving through the P&L statement in 2003.

OK. OK, so at least we should look at - whether it changes appreciably in the fourth quarter, we should look at this as somewhat of a base, or

, or for margins? Is that fair in the equipment and UltraPure side?

I think that - I do think that is fair.

OK. Let me - one other thought here, and I will get back in queue. For the fourth quarter, if we exclude the French situation and the four or five pennies, whatever materializes in the fourth quarter, seasonally your fourth quarter is better, you backlog is up, we have some cost over runs, but hopefully they flush through. Why wouldn't your fourth quarter be better than $0.11?

Well, you know. It possibly could be, but we are not a - in a position today, having spent two weeks of very, very intense effort in France - in uncovering France we need to have some time to regroup and to take another look at where we are before we go out and confirm any estimates,

.

OK. OK. Thanks.

there's nothing in the woodwork that one should interpret from that statement.

OK.

Thank you. Our next question will be from the line of

with Credit Suisse First Boston.

Please go ahead.

Hi. This is actually

on behalf of

.

A couple of quick questions to follow-up on France. You said 7 to 9 million in revenues. I understand that some of it will be picked up by other operations, including Italy. How much of that 7 to 9 million do you expect to lose going forward?

That 7 to 9 million was a number that I used. I believe I said that's where their historical volume has been . .

OK.

And it slipped even in this year. So, you know, the amount of revenue level that they've been at currently, in particular in the quarter, is down quite a bit. So, you know, I think we'll be successful in transferring much of the business that they would have done to our Italian subsidiary as we've described and I don't think the net impact on revenue will be great.

OK. So then I know you said that part of the reason that the restatement was mass was due to the operations. How much were the operations down in France and was that included in this quarter's 9 cents or was that part of the additional adjustment from 11 cents to the consensus of 18?

No, the -- let me explain it this way, the results of 2 cents that we reported for the quarter were burdened by or included approximately 9 cents that came as a result of the losses sitting in Q3 for France.

Of which that was only a part because the other losses for France, which totaled 6 cents, were pushed into quarters one and two.

Correct and the only point I'll add again, just for clarity, is when I quote 9 cents or we quote 9 cents in that fashion, we have included the tax rate impact which went from 34 to 41 because it was caused by the French losses that we found and had -- and we found ourselves with and the impact that those had on our annual tax provision and tax planning and a result in tax rate.

I think it should be pointed out that because we did not have enough income in France, we could not benefit as a

in the tax

.

Right.

All of the losses that we had in France in this quarter we could not benefit from the losses because there was no equivalent in country income. As a result, our tax rate has gone up from a normalized 34 percent to 41 percent in this quarter.

What will be the normalized rate going forward?

Well 41 is actually our rate for the year at this point and our year-to-date results reflect the 41. So that's where we're at for -- as a result of the change

.

For 2003, do you think that's an appropriate barometer as well?

Excuse me?

Do you think that that will be an appropriate barometer for 2003 as well?

Oh, I hope not. No. No, that's just an effect of what we found this year and the effect, again, of not being able to benefit the France losses, no.

The French effect.

OK. And then last question on France and then I'll let it go. When looking at the prior quarters, first quarter and second quarter, we can see how all the other lines, and I know there were other items in there as well, if I want to get to the 11 cents, can you tell me like specifically where those items or where that 9 cents adjustment from 2 cents to 11 cents is located?

I don't know if we can do that quickly. Can we?

I can get it later. That -- I mean . . .

Yeah, that would be helpful if you could.

OK. That's fine but you do have that -- you will provide that information?

We have that information and we'll give it to you subsequently.

OK. I'll get back in the queue. Thank you.

Thank you, sir.

And our next question is from the line of

with Lord Abbott.

Please go ahead.

Good afternoon, gentlemen.

Hi, Fred.

You have about 40 percent, not quite, about 35 percent book value still

cash proceeds from your asset sale last year earning, you know, 2 percent pre-tax or some other similar money market fund rate. Have you articulated your year long, long term plan for those funds and, if so, could you update us on . . .

Sure.

.

Sure, Fred. Let me say, we're happy to have some cash right now even though it's not earning a lot and the reasons are, the Kuwait job is going to take an equity infusion of about $16 million, the Israel job is going to take an equity infusion of about $7 million. We have another Israeli job that we got earlier which could take an equity infusion up to $10 million. Plus, we are working on several other jobs that will require a

which we've been building steadily over quite a few years which will contribute greatly to profits in the future. So we see these as excellent investments. They have excellent IRR's, after tax IRR's and we see that as the best place to put our money.

OK.

Having said that, I will say we're keeping our eyes open for acquisition opportunities and this is an interesting market to be in that position and if we see anything that compliments our strategy or helps us move more quickly in areas of our core

, we are certainly considering those opportunities.

I guess the reason I ask is, you know, your return on equity is extremely low and has been each of the last three years and, you know, obviously, having a large amount of cash on the balance sheet in a low interest rate environment unduly penalizes you on that score but, nonetheless, you know, returns on capital haven't been good in your business since 1997. That's an awfully long dry spell. I see this building backlog but I'm not hearing anything today on this call that leads me to conclude that there's going to be any rapid or significant improvement in earnings over the near to intermediate term and so I'm, you know, I'm faced with the prospect of single digit returns on capital as I look forward at least over the next year or there about. Longer term, you think returns are ever going to get back into your double -- the double digit range that you demonstrated, you know, earlier in the last decade?

Well I think so. You're right, it has been a while but we've gone though a difficult

in the company and if you recall that in the mid '90s we were seeing the benefits of an extraordinarily, highly accelerated rate of business growth in the semiconductor business . . .

Right.

And the profits were excellent, the revenues were excellent, the returns were excellent. That business fell off the cliff in '97 and we had nothing to replace it.

Right.

We've spent the last four or five years filling in that hole. We haven't, in every case, had the choice of situations where we could pick and chose something that was growing as quickly as

was in the late '80's and through the mid '90's. What we latched on to was the

strategy. The problem with that strategy is that it takes a long time to put the activities in place. For example, the Kuwait job that I mentioned before, Fred. We've been working on that job for five years. It is just starting to produce its first flows of income and then it will start up and two years from now and only then will we see the fruits of all that work.

I understand.

But -- so it's that kind of a situation but we think we've made pretty darn good investments for the future and as Ted and I were indicating, we think that will start to come to

in 2003 and 2004 and beyond.

Thanks very much for addressing that. I appreciate it.

You're welcome, sir.

Our next question is from the line of

with

.

Please go ahead.

Good afternoon guys.

,

.

First a non-France question. Just to get your perspective on the overall dynamics. I'm sure you're aware of GE's purchase this last week. How do you view that and how do you see that impacting you at all or the market at all?

Well it's hard to say. First of all, GE is a

company, well managed. We have a lot of respect for what they're doing and we see another consolidation taking place within GE in terms of their attention to the water business. The previous company in this business that was a consolidator and I don't think GE is going to behave anywhere near close to the way this other company did

and

, whatever you might think of their acquisition strategy and what they accomplished, was not a competitor that, even though they tried, was able to knock Ionics off the block. We've been an excellent competitor to

. We think we can compete. Obviously GE is much more

than

but they're not, as far as I can see with any of the acquisitions they've done, in any of the businesses that compete with Ionics, except for ultra-pure water in power systems and pharmaceuticals.

Very good. And final question back to France. Just to confirm my understanding of what you're communicating. In the third quarter effectively the impact on you was 9 cents for the French operations. The prior two quarters you've restated then downward but that's not, as I understand it, that might not be necessarily the total impact of the French operations, it's just a restatement.

Yeah, let me try and . . .

the total impact?

Let me try and explain it. We essentially had an impact. Just give or take a few cents on this explanation because some of it is tax related. We had an impact from France of 15 cents a share. It was determined that approximately 6 cents of that impact should have been reflected in our earnings for Q1 and Q2. And as I said earlier in the phone call, we discovered that, not our auditors. We discovered that those quarters had not reflected certain costs that belong in the French subsidiary. So of that 15 cents, six cents was pushed back to Q1 and Q2, and that's left nine cents impacting Q3 as you see it.

But the French operation could have had, on your absolute bottom line, a bigger negative impact than just that restated effect. Am I correct? As you booked it, or showed it in the P&L, it could have been a drag -- on the original earnings.

You mean back in Q2 or Q1? I'm not sure I understand your question. One more time.

Right. OK. If I take a look at the impact of France in the first quarter or the second quarter, I'm asking, is there a difference between what you're communicating as a restatement of those quarters versus what was the absolute total P&L impact of France in the first quarter and second quarter, because it had some impact before you restated it.

Yes, I think France is the -- the French operations ere not doing great, even in Q1 and Q2.

Right.

So there were some losses associated with those operations prior to the restatement.

And that's why I was wondering -- do you have a ballpark what that was so that now you're restructuring we have an idea of maybe the total

?

Yes, it's going to be greater than 15 cents, if that's your question.

That's part of the question. I was wondering how much greater.

Well, I don't think we have it right in front of us.

Do we know the answer to that?

I think, approximately ...

If you give us your phone number, we'll get back to you. I'm not sure we have the exact number.

That would be fine.

OK,

, we'll do that.

Yes, that's the best.

Thank you guys very much.

All right.

Our next question is from the line of

with NEMO Capital. Please go ahead.

Hi, gentlemen, thanks for taking my call. Just some housekeeping items. I know you said it in the beginning of the call -- just so I can do apples to apples in the consumer water business from the prior quarter, what was the comparable revenue number to the 86.8?

21.5 million was included in the Q3 of 2001 figures.

So if I'm going take that down by 21.5, what do I take the gross margin down by?

I think the gross margin for consumer was probably in the mid to low 40s for the third quarter last year?

OK, OK. And let me just -- because I'm kind of new to this story, if you would -- let me just understand, the receivable from affiliated companies, the 26.9, is that all from the desal

projects?

There are a few other small pieces. It's predominately related to our Trinidad project and the receivable that we have with

which is the company we have an equity interest in.

Right, so just so I understand the -- and I don't need this to be an education session for me or anybody else, but ...

It's all right.

But it's indicated in the revenue recognition category of the publicly available filings, and I took the time to read this, that if you have effective control, you're not booking any gross margins on the equipment sales during the project completion stage, so is there anything on the liabilities side associated with that 26.9? Is there any gross margin anywhere on your balance sheet?

Well, we defer the gross margin. When we sell, in effect, as the earlier gentleman used the phrase, to ourselves or a portion to ourselves, we defer the margin in relationship to the percentage we hold. So in Trinidad, you can read in our filings, is a little different because of the constructive ownership situation, so we defer the margin on equipment sales in those instances.

OK, understood. So what I can anticipate happening, given what you said on the call so far is, you anticipate getting permanent financing on the $79 million bridge loan in Trinidad in the next two months, you said?

It'll be more than the 79.

It'll more than that, and it'll -- you know, it's going extremely well, and again, we're in the second draft stage of the documents ...

Right, and that's obviously off balance sheet. You know, I don't' see that loan come on anywhere except on the joint venture. But does that 26.9 go away, i.e., do you get that paid back when that permanent financing comes into place?

Yes, except bear in mind that that's not all related to Trinidad. But bear in mind the other portion, which is 10 million of that, will remain as a note or a debt through the project.

Right, debt gets moved down. So the cash flow impact will be approximately 16 million to you in receivables as soon as that financing this. And if the financing doesn't hit, then that category continues to build until you receive it.

Well, it won't build much more because construction is complete, but you are essentially making a very good estimate.

OK, I'm just trying to get a sense of where things are going to shake out. And obviously, if and when that financing occurs, that is press release material? Could we anticipate that?

Yes.

OK, well thank you for your time. I appreciate that.

All right.

You're welcome.

All right, take are.

Our next question is a follow up question from the line of

with

. Please go ahead.

Regarding the revenue recognition on page 18 of the 10-K, I just want to better understand it. It says when the company's equity ownership exceeds 50 percent, or in instances where the company effectively controls the affiliated entity, no revenue or profit or profit is recognized as the contract is executed. And then later, it says, regarding the company's sale of equipment to

in connection with the Trinidad project, where the company is a 40 percent equity of

, since the company is considered to have provided all of the equity funding for the project, either directly or through a loan to the company's local majority partner, the full amount of the equipment revenue earned has been recognized as the contract is executed. Isn't that incongruous with the prior sentence?

I don't have the wording in front of me, but believe me, the revenue is deferred and it's not incongruous. What you need to bear in mind in the first instance ...

Wait, the revenue is deferred?

No, the profit is deferred.

The portion of the revenue equal to the profit. OK, we're getting caught up in semantics, but that's ...

I'm just trying to read from the 10-K, so I'm sorry.

It's easier just to assume that it's profit, but I was just explaining the mechanics by which it happens. But no, it's not inconsistent. And in the first instance that we talk about there in the Q or the K, it refers to an instance where you consolidate -- obviously there's no sale in that case. This is different. We did not consolidate our interest in

. We do sell to it, but we have deferred the margin related to the sale.

So the effect, sir, was the same as if we owned 100 percent as far as our profit is concerned.

As far as the profit. I just ...

As far as profit, right, not ...

I just found the wording on revenue recognition to be a bit hard to understand, if you will.

Yes, I think we've been trying to explain Trinidad for some time, and the problem in that job arose because we lent the money to our partner in Trinidad who was on the verge of financial difficulty ...

That's a good partner to have, huh?

Well, it turned out that way. He was an excellent partner. And is an excellent partner. But when -- and he's a contractor, and when he ran into some financial difficulty on some other projects, we lent him the money, which he's repaying us, to put in his equity. Because we did that, we were deemed to be 100 percent owner. Even though in reality we're only the 40 percent owner of the equity.

So it's a little bit of a, an unusual situation as far as your reading of the revenue recognition paragraph that you're quoting.

I see. Well, all right.

We've worked this issue very hard, sir, and I can tell it's been audited, re-audited, not only by ourselves, by outside auditors. We believe we're handling it absolutely correctly.

And we've tried to make it very clear. Off line, if you want me to go through any of those accounting policies, I'd be happy to.

I just don't want to hear the word Enron brought up with Ionics. Thank you very much.

OK. And our next question from the line of

with Credit Suisse First Boston, please go ahead.

Two really quick follow-ups, first one, on the severance payments that will be coming. How much of that - of those payments will be cash? Are they 100 percent cash?

Yes. They're virtually all cash.

OK.

They're essentially salaries paid for severance under French law.

OK. So virtually all of the five cent charge will be paid out in cash as it is accrued over fourth and first quarters?

Yes, I mean, I think as Art said earlier, that'll occur over the fourth and the first quarter.

OK.

You know, the timing of the charge versus the cash, I mean that certainly could vary within weeks or months.

Yes, that's fine.

It's a short issue.

Right. Right. Right. And then the last question would be I know you said earlier in the call that on the adjustments to first and second quarter that there were other things that were adjusted for in addition to France. As I look through and I see some of the other line items that were adjusted, some of them look like they could be of, you know, fairly decent amounts. I was just wondering if you could tell me what some of the material other changes were besides France to first and second quarter.

I think, you know, the easiest way to respond is the predominant portion of the changes as we said were France related. There were some others. You know, at this point in time that's all we're prepared to really cover.

And France did - it did impact the SG&A line, is that correct?

Yes.

OK. Thank you.

And our next question we'll back to the line of

with

. Please go ahead.

Yes, just to clarify that. When I look at the adjustments as you've made them in the press release, the EPS basis for Q1, Q2, they do sum to like eight cents. And you're talking about six cents of those is France, is that - is the balance that other two pennies kind of the other stuff?

That's in the ballpark, yes.

OK. So that's the discrepancy there.

I'd say that, you know, that's the reasonable ...

OK.

... assessment.

As we - as we go forward into the fourth quarter, we have the severance costs. Are you going to run that through the P&L or will that be a charge?

Well it will go through the P&L in any event.

Yes, I understand. But it'll be a line item? You'll ...

You mean will be separately take out ...

Here's my question. If I take those into account in the fourth quarter, if I just take half of that into account, it's half a million bucks, we've got a business that's operating, you know, at an 11 cent quarterly rate plus hopefully a little better. If I remember there's still some outstanding adjustments, potentially positive adjustments on the bottled water sale. Do we end up in the fourth quarter in a loss position assuming all charges and operations? Do you expect that?

If I understand your question,

, are you questioning whether based on these charges we could wind up in a loss position?

Yes that would be a negative to the book value.

Yes, let me - let me just say if I understood your question correctly. On bottled water, you know, it's our - it's our belief that when that contract - when that finalization of that decision takes place, we will be in a position to potentially reap a significant improvement to our P&L. Although we have not - we have not taken that into account anywhere and I don't want anyone to be assuming that that is anything that is going to happen quickly. And, or, you know, to be fair, at all. But, in other words we've made a substantial provision for that. So that's number one.

Number two, there is no knowledge that we have right now that would indicate in any way manner, shape, or form that we'd be in a loss position ...

Right.

...for the fourth quarter.

OK. OK. That's fine. I appreciate that. Thank you.

And Mr. Papastavros, we have no further questions at this time. Please continue.

Well thank you all for the questions and thank you for attending the conference call. If any of you have further follow-up questions, we'll be available this afternoon and tomorrow. Thank you again.

Thank you, ladies and gentlemen.

Ladies and gentlemen that does conclude our conference call for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.