奇異 (GE) 2002 Q4 法說會逐字稿

Ladies and gentlemen. Thank you for standing by. And welcome to the fourth quarter and year-end 2002 financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If you should require assistance during the call please depress zero, and then star. As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Ted Papastavros, and he is the Executive Vice President. Please go ahead, sir.

Thank you. And good afternoon, everybody. And welcome to our afternoon conference call.

With me this afternoon is Art Goldstein, our Chairman and CEO, as well as Dan Kuzmak, our CFO. And we’ll follow our usual format on some opening remarks from Art, followed by Dan running through the numbers.

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 related to management’s expectations for financial and business performance for 2003 and beyond, and overall economic, and business conditions, and trends. Words such as ‘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 as they may be adversely affected by current world events, demand for the company’s products, pricing pressures, and competition from company’s 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 dated today, 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 & Exchange Commission. We incorporate herein the discussion of those factors.

Existing and prospective investors are cautioned not to place undue reliance on those 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 a result of new information, future events, our circumstances, or otherwise.

Having dispensed with that, let me go on with our business, and turn it over to Art Goldstein for his opening comments. Art.

Thank you very much, Ted. And good afternoon, ladies and gentlemen.

Before getting into our presentation today and our analysis of the results for the quarter which I think you will find quite interesting, which Dan will be presenting, and then followed by your questions on the quarter, I wanted to begin today’s conference by commenting on the short position that’s out there on Ionics. And then commenting on the rumors on Wall Street that we’ve been hearing about and have been asked about.

First, let me talk about the short position. As many of you know, the short position in Ionics currently totals about 22 percent of our shares outstanding. This is certainly the largest short we’ve ever had. The last time we had such a large short was actually in the early 90’s. At that time, there was a rumor out there that our Santa Barbara desalination plant was going to be a financial disaster. Santa Barbara was the first build-own-and-operate plant in the United States, and the largest membrane based desalination plant in the United States, and probably the world at that time.

The rumor was that the plant wouldn’t work, that the drought in California would end, and that situation would result in substantial losses for Ionics. Needless to say, the improvement in our earnings in 1992, 1993, 1994, 1995, 1996 proved that those rumors were wrong. Under our well-thought out [take or pay] pay contract the Santa Barbara Plant made a very significant impact on our profits even after the California drought ended and our desalination plant was put on standby. Needless to say, the shorts began to run for the exits. And our stock rallied from a low of $12 per share at the end of 1990 to a high of $50 per share at the end of 1996.

It is interesting to point out that perhaps a similar starting point for rumors seems to exist today, with regard to the operation of the Trinidad desalination plant. One story that’s been floating out there is that the plant was or is not operating properly. You may recall that we had questions about this at our last conference call. Even though our responses to questions on Trinidad thus far apparently have done very little to stop the rumors I’d like to take a moment to bring you up-to-date on the facts.

The desal plant in Trinidad, which still is the largest desal plant in the Western Hemisphere, started up successfully about 11 months ago. And is operated virtually on a 24 x 7 basis since then. So the plant has met all applicable production and water quality requirements. And it’s generating substantial cash flow.

The second rumor regarding Trinidad is that long-term financing will not be taking place because the plant was believed to be not operating properly. And that this situation, as in the Santa Barbara situation, would be a major detriment to Ionics. The facts are (a) that the plant is operating very well, (b) that the Trinidad Water Authority is very pleased with the facility and said it wants to increase capacity, and (c) that negotiations on the long-term financing are actively underway and are expected to be completed shortly.

A second set of rumors now making the rounds relates to our Middle East business in general, and to our Kuwait Project in particular. The apparent basic issue is that with the prospect of war now on the horizon that there are three issues out there. And let me just say any one of these can apply to any one of the rumor situations. First, that the Kuwait Project is in trouble. (b) that if Iraq destroys its oil wells and dumps oil into the Gulf the oil pollution will damage our desal plants in the area, and (c) that war with Iraq will have a great negative impact on our Middle East business.

So let me give you the facts on these stories. First, the Kuwait Project which will be the largest membrane based water reuse plant in the world is currently on schedule and within budget. Second, long-term financing for the project is already in place. Should there be an act of war which affects our work on that facility our contracts force majeure provisions provide Ionics with protection.

On another aspect of this regarding oil spilling in the Gulf the facts are that we have no Ionics owned desal plants operating on Gulf seawater. Virtually all of our desal plants in the Middle East operate on inland [brackage] [ph] waters, and so the pollution issue even if it was a threat would not apply to Ionics.

Third, regarding the impact of war on our Middle East business, obviously, I cannot make a prediction of what could happen. The facts in this case are that in the war that existed long ago between Iran and Iraq, during that period our business in the Middle East actually increased. And I’ll put it this way, delicately, as the bombed-out Ionics built desal plants in both countries were refurbished. In the last war that we had with Iraq our business in that region increased again, as we supplied drinking and process water to troop installations in the region. Today we still have Aqua Cool affiliates that were not part of the sale to Nestle that exist in Kuwait, Saudi Arabia, and [Bahrain] [ph] that are producing bottled water for drinking. So ladies and gentlemen, I just wanted to summarize that for you as our response on the rumors that are out there. And we’re getting them literally every day.

And finally, beyond the rumors I’d like to comment on the current business situation as we see it generally. 2002 was obviously a tough year for us. Certain segments of our business including the water supply piece, new build-own-and-operate projects that we booked which are going to generate revenues in future years, our instrument business did perform quite well. But other segments, particularly those involving industrial capital equipment had an extremely difficult year. This impact of a difficult industrial capital spending environment, plus much higher than normal legal and accounting expenses and overhead expenses, which Dan will be talking about in a moment, significantly offset profits that we made elsewhere.

In saying this it is important to recognize that Ionics is still dependent on industrial capital spending cycles despite our efforts to reinvent ourselves by shifting to more service and supply business to reduce this dependence. I believe we’re making good progress on the reinvention. New build-own-and-operate water supply projects are expected to be coming online in [Kerasal] [ph], in Philadelphia, and several facilities in the Caribbean this year. In addition to coming online in Kuwait in early 2005. This – the affect of these projects obviously will further help to reduce Ionics exposure to these capital equipment cycles.

I should also mention that this latest reinvention of Ionics of itself is the third in the last three decades. I believe after each reinvention we’ve come out a stronger company. We’ve not only survived, but we’ve prospered. In the early 1970’s, for example, in a very difficult economic period similar to what we’re seeing today we reinvented ourselves to change from an R&D company focused on making new membranes to a manufacturing company focused on separations technology relating to water. This was followed by six years of sustained growth.

Then in the early 80’s we hit another cycle. Once more we went into difficult economic times, and we again changed the company. This time we did it by pioneering the build-own-and-operate concept in the Canary Islands, getting into the Ultrapure water business for microelectronics, and starting the Aqua Cool bottled water business which we sold to Nestle for $220m at the end of 2001. These reinvention’s fueled 11 plus years of growth, which ran from 1986 to ’97.

And in the last few years with the continued weakening of the microelectronics capital spending segment, and our investment in build-own-and-operate which effectively moved water supply income from the current period to future periods, and with the sale of the bottled water business we’ve once again been dealing with the need to reinvent Ionics. This time to focus on the application of our water expertise to water services and supply. As of today, having built a very substantial backlog which is now on our books we believe we are most of the way through this change.

The perspective I would like to close on is that Ionics has always been a long cycle business. But once we start a cycle we’re likely to remain in it for awhile. Hopefully the seeds we’ve planted with new municipal capital sales, and our investment in [BU] [ph] projects over the past few months, and over the last year, will bear fruit in terms of starting the next up cycle. That is what our strategy and our plan has been.

I will end by saying that despite our recent performance we remain very enthusiastic about the future of the water business, and Ionics’ continuing role as a leader in this business. Thank you very much. And I’ll turn it back to you, Ted.

Thank you, Art.

Let’s move on and take a review of the numbers with Dan Kuzmak, our CFO. Dan.

Ted, thank you. And good afternoon to everyone on the call.

As you know, from our press release and our discussion thus far we reported earnings in the quarter of 10 cents a share. And as you’ve already also determined, that would have been without the gain on the Aqua Cool sale something closer to an 11 cent loss. And I’d like to speak from the perspective of that number, if I could, for the next few minutes to give you some perspective on the quarter.

And let me just point out, as Art has already in some cases indicated, that there were some charges that impacted us in the quarter which if not for those we would have been profitable. And I will describe those for you.

The most significant of those was an increase in our allowance for doubtful accounts. And that had an approximate six cent a share impact. Now, in that particular case I would tell you that that increase revolved around a couple of customers where in our judgment those customers’ ability to pay was significantly impacted by circumstances specific to each customer in the quarter. And as a result of that we increased our provision for bad debt accordingly.

Having said that, let me assure you it’s certainly our intent to continue to pursue those. And we believe that the probability of collection is reasonably good. But for financial statement purposes we recorded it the way we did. And so that was an impact that hit us for about six cents in the quarter, which from an 11 cent loss would have brought us up to about a five cent loss if not for that item.

In addition to that Art also mentioned substantial additional legal and accounting expenses in the quarter. Now these amounted to approximately four cents per share. And they came as a result of a combination of things. Certainly, part of that was some of the new requirements we face under Sarbanes-Oxley. And it also related to legal costs that we incurred in settlements of projects where we had civil construction work. And the combination of those two items, as I say, legal and accounting impacted us by about four cents a share in the quarter.

And so between the increase in the reserve for doubtful accounts and the legal and accounting expense that was an approximate 10 cent a share impact. In addition to that we had some smaller items including the settlement of one of the projects where we had civil construction for a couple cents. We had restructuring costs in France of approximately a penny, and some other accounts receivable write-offs of about a penny, all of which would have brought us up to a three, four cent per share profit if not for those items.

At that point I would say had we maintained our normal or something closer to our normal SG&A rate as a percent of revenue we probably would have had an additional two to four cents in earnings which would have put us up in the five to seven range. Our SG&A goes up and down according to a number of things, like projects that we’re working on, and support for certain projects. And had it been closer to the year-to-date average, as I say, we would have been up in certainly the five to seven cent range for the quarter. But those are some of the big impact items that hit us. And why we had a result that we did in the quarter.

Regarding revenue, let me just say that excluding the Aqua Cool bottled water sales of 18.5m in the fourth quarter of 2001 revenues in the quarter, fourth quarter of 2002 were 89.1m. And that compared to 93.3m last year.

Year-on-year I would say they were relatively flat. There was a decrease in our Ultrapure segment of approximately 4m, but that was due in large part to the divestiture of our Malaysian business earlier last year. And that was offset partially by increased revenues elsewhere in Asia and Australia.

On the gross margin line, again, excluding Aqua Cool bottled water business our total gross margin increased over Q4 of last year by about 11 points, going from approximately 17 to 28 percent. I would say by segment gross margin was up in the equipment, the instrument, and Ultrapure groups, and down slightly in the consumer group, reflecting softness in the economy affecting us a bit in that segment. But margins overall held up extremely well in the quarter and for the year.

Other key performance indicators for the quarter included depreciation charges of $6.5m, net working capital of $211.7m, capital expenditures of approximately $9.5m.

A quick comment on our tax rate, our annual effective tax rate of 46 percent continues to reflect the impact of foreign losses for which a current benefit is not available, combined with a slightly lower overall pre-tax income than we anticipated for the year.

The company remains, let me just say in conclusion, in a very strong cash position with a cash balance of $140.3m at the end of last year. This declined slightly, $3.6m in the quarter, and that was primarily a result of a continued higher level of capital spending predominantly for build-to-own-operate projects. And also for our continued equity investment in the Kuwait Project.

And that is a summary of the financials. And Ted, I will turn it back to you.

Thank you, Dan.

Before we go to questions and answers, just a few quick notes on guidance for 2003. For the first quarter of 2003 we’re giving guidance to a range of eight to 10 cents per share for Q1. We anticipate that earnings will gradually improve during the year. And for the year 2003 we’re setting a range of 50 to 60 cents.

I guess we’ll now go to questions and answers.

Thank you, sir. (Caller Instructions.)

The first question is from the line of Cliff [Josephie] [ph] with [HD Rowell] [ph]. And your line is open.

Hi. You mentioned that you’ll be getting the financing for [Desellcott] [ph] shortly. In the September 10-Q that you filed in 2001 you said that ‘Desellcott has accepted an offer to provide long-term financing from the same bank subject to certain conditions. The proceeds from the long-term financing is currently proposed, should be sufficient to repay the bridge loan and the $10m loan to be made by the company to Desellcott.’

Why – what has transpired between the time you filed the 10-Q in 2001 and now that you have not been able to get the long-term financing in place? And why should we believe that you will have it in place soon, as you said on the call?

Well, that’s a very fair question, sir. And I can’t blame you for asking it. Obviously, we did not accomplish the goal of getting the financing by year-end as we had originally thought. But let me point out something that needs to be said. This is not financing for Ionics per se. This is …

Well, considering that they owe you so much money …

Excuse me.

I am sorry, go ahead. I apologize.

May I finish my question, sir? Some people might get the wrong opinion about this if I don’t finish my question – finish my answer to your question. The financing is not financing to Ionics. It is financing to a project company that will in turn be reimbursing Ionics for certain monies that Ionics has advanced to the project company.

Can you quantify the amount?

The terms and conditions for the establishment of the long-term financing are actually controlled by the shareholder who owns the majority interest in Desellcott. And Ionics is a minority holder in that company. And so, we do not control that Board. We do not control those decisions per se, particularly as they relate to [Trinidadian] [ph] Bank.

And so we’ve had to work within the guidelines of the local community. We’ve had to work with our local partner. And there have been some questions that have come up with respect to are we getting the best interest rate that we possibly can. And those things have put some delays into the closing.

But the indication we have is that everybody wants to go through with the closing. They want to do it quickly. There’s no indication whatsoever that we have that this won’t succeed in due course and in the not too distant future.

You know, you guys were confident in the September conference call that you’d have it by year-end. And then you also mentioned it in the 10-K.

That’s right.

And this thing keeps getting pushed down. Now, I mean this is significant, because you guys are receiving revenues from Desellcott. You guys are the only ones who put money into Desellcott because you leant the money to your local majority partner to put up in the first place because they were under-capitalized, if I remember what you said correctly.

You remember accurately.

Okay, you have receivables due from Desellcott, you have notes receivable due from Desellcott.

Yes.

I mean you guys are into this thing for a lot of money.

That – well, we’ve disclosed exactly what we’re – we’ve disclosed exactly where we were in our – all of our filings. First of all, I’d like to make it clear that we’ve never said that the financing would repay our loan to Desellcott. We will get paid out of the proceeds but the financing itself will not pay it. We will be paid out of the water fees that come from that.

Well, because in the 10-Q – is this different? In the 10-Q from 2001 it says ‘the proceeds from the long-term financing is currently proposed. It should be sufficient to repay the bridge loan. And the $10m loan to be paid by the company to Desellcott.’ So you are talking about the loan to the partner, is that what you’re saying?

Yes. Yes, exactly.

All right. But let’s get off this subject for a second.

That would be nice.

Okay, on the – can you give a cash flow from operations for the quarter, as it will read in the 10-K which should be filed soon?

Yes, we don’t have a cash flow number to give you right here today, but if you look at an equivalent of an EBITDA we were slightly positive, and then we had capital spending in the quarter that – and I also mentioned the continuing investments in our Kuwait Project that resulted in the change of cash over the end of the quarter in Q3.

How much was capex?

$9.5m in the quarter.

And what was depreciation and amortization?

Depreciation was about 6.5.

That doesn’t – all right. I will try to figure that out. And why were the payables up so much sequentially, ballpark 11m, if I remember correctly?

Hold on one second. Yeah, primarily that relates to activity on our Kuwait project.

Activity on your Kuwait project.

Right. Sales of equipment to our – to Kuwait, to the project that we have there.

Sales of equipment – why would that be in your payables?

Just in terms of contract activity, the purchasing, the procurement of …

Oh, I see.

Of equipment, and so forth.

Oh, as associates of Kuwait. I see.

Yes.

And then the allowance for doubtful accounts, I mean was there one item in specific? Or a particular customer? Or was it just you’re getting more conservative in your accounting?

No, no. It related, as I said, to a couple specific accounts. And we increased the allowance up to approximately $6m. And it was for specific customers and specific events that caused us to do that.

Okay, and how much revenue did these customers account for in the fiscal year ending ’02?

Not a – you know, an amount commensurate with the receivable. Yeah, I am not sure exactly what their number was.

Okay. You know what, why don’t I let somebody else ask, and I’ll get back into queue with whatever else I have. Thank you.

That’s fine, sir. Thank you.

And our next question comes from the line of [Lorraine Micus] [ph] with Merrill Lynch. And your line is open.

Thank you. In terms of Trinidad could you just give us an update on the equity income that you’re earning at this point on the water flow?

I don’t think we’ve released separately, Lorraine, any numbers on that. And we have not made any decision at this point whether to start releasing income by contract. So rather than jump into something like that over the telephone let me take that under consideration, and if we do we will do that as a general disclosure.

Okay. And then in terms of France, you had discussed some costs that would be in the numbers this quarter from severance from closing down that office. Is that all completed, or will we see more of that in the first quarter?

I think we have substantially completed what we have to do there. There’ll be some follow-on but not a great deal. And we were probably, as I indicated earlier, a penny or two in those type of costs that we were, that we incurred in the quarter.

There were some severance costs, Lorraine, if that’s what you were talking about.

Okay, so only about a penny or two?

Yes. And there’ll be some to go in the future, but I don’t think it’s going to be a large number.

Okay, and have you augmented any type of internal control policy or oversight over your international operations so, you know, so something like this doesn’t occur again?

Yes, we’ve done a number of things to enhance our internal control. And we’ve spelled some of those out in our disclosures in the Q. And we feel quite confident that we’ve gotten our arms around things. We’ve got additional people and additional procedures that are aimed at improving our internal control environment, and so we’ve made some great strides.

And just one further question. Kind of forward-looking, I am looking at one of the new FASB interpretations about consolidating variable entities. Have you started looking at this in terms of some of your joint ventures? And …

[Vin 46] [ph].

Right. Seeing the affect on – if you’ll be required to consolidate any of these?

We’re looking at that, of course, and we’ll go through that as we do all new accounting requirements, and evaluate it. But I don’t – there’s no particular comment I would make on that at this point.

Okay, thank you.

And the next question comes from Mike [Marionati] [ph] with [Massus Capital] [ph]. And your line is open.

Yeah, hi Art. Thanks very much for the history lesson. It’s very pertinent to what’s going on today. I just had a couple of questions for Dan regarding capex for ’03 and also depreciation for ’03. What are those numbers expected to be?

We’re looking at capital spending probably comparable, a little higher than it was this year. And I would say it’d be in the $35m to $40m range. And depreciation is approximately, it’s fairly steady at $6.5, $7m a quarter. That won’t change a great deal.

Okay.

But that gives you some idea of the number for next year.

All right. And the laundry list of items that you had brought up that, you know, affected the quarter. It sounds like some of these things might be ongoing to shore-up some of the lax financing, or some of the policies in the international divisions. Or should we think of it more as sort of one-time things, or more ongoing kind of things?

Yeah, I mean as far as an ongoing impact, I mean I can’t tell you there wouldn’t be any as a result of Sarbanes-Oxley and additional requirements. So there would be some cost level, but nothing like we experienced in the quarter because of the events that I described. And certainly those would not be something we would imagine to continue.

All right. And the Sarbanes-Oxley, what exactly is the additional – it’s a couple of extra pages you’ve got to file in the Q, or what is it exactly?

Well, it’s additional, it’s some additional accounting support. It’s some additional audit testing, and things of that nature. It’s a combination.

Okay. All right, thanks so much.

You’re welcome, sir.

And the next question comes from John Gruber with [Gruber and McVane Capital] [ph]. And your line is open, sir.

Thank you. You were a little thin on the guidance here, eight to 10 cents? On what revenue are we talking about? And the year revenue, what kind of revenue are we talking about, give us a little help here? So you’re throwing some -- one number in the air?

No, we just – we’re not going to give any more guidance than basically the earnings per share ranges. Historically we’ve never gone to revenues, or CGS, or any of those details.

What also is – I look back, and every year you report this quarter one week later than you do the previous year. And we’re getting – we’re pretty much going to run out of time here as you’re getting up to the legal limit. Why are you guys so much slower than everybody in the world reporting your numbers?

Well, we hope to make – we understand that. And, of course, we want to release earlier. And we have made a number of improvements to our processes to facilitate that, including putting in the new financial consolidation system. But, you know, certainly dealing with last year we had the Aqua Cool sale and some other extenuating circumstances.

That was on the last day of the year that that happened. And wrapping all of that up did take us a lot of time. And then we had another Aqua Cool gain, actually let me just make it clear. The Aqua Cool gain that we had this year took, gave us a gain of the $8m net that is reported there. But actually took the price down from roughly $220m down to roughly $217m – I mean $207m.

So, but even that this time, Mr. Gruber, did cause some special calculations to be made which did add a little time to our reporting. And so we apologize for that. As Dan says, it’s not our objective to be a few days late in reporting. And we’re going to make every effort not to let that happen again.

Okay, thank you.

Thank you. We have a question from the line of [Jim Rommel] [ph] with [Rommel Asset Management[ [ph]. Please go ahead.

Thank you. Hi, Ted.

Hi.

Two questions regarding the own-and-operates approach. A, who are you competing against for anyone on these own-and-operates? When we talk to other people in the industry there seems to be a consensus to kind of not be in the own-and-operate business, but to just supply the membrane or to supply equipment. So (a) kind of who else is taking this same approach of own-and-operate?

And two, is there anything different about how you’re approaching the own-and-operate business now in terms of the requirement of your equity investment, as opposed to earlier deals like the Santa Barbara deal? Were you always, did it always involve an equity investment up front on your part?

And I guess maybe lastly, attached to that, what is the kind of rough number of commitments you have, equity commitments you have to these projects that should really be subtracted out of the cash because it’s required to be paid out over the next couple of years?

Okay. Well, those are all great questions. Let me see if I can hit them, and if I don’t please ask it again. First, I guess your first part of your question, Mr. Rommel, was who are we competing against?

Yes.

Well, you know, who we’re competing against in this business, there are very few American companies that are competing across-the-board with us on build-to-own-operate. The big players in build-to-own-operate now who do the whole thing as we do are the two large French companies, [Suez Lianas] [ph] and [Vivendi] [ph].

Right.

We do have from time to time other large companies coming in to build-own-and-operate in situations where they are partners with companies like Ionics. Now, that gets to the second question I think you’re asking, why are other companies just doing the membranes only?

Well, there are a few companies just doing smaller pieces of equipment or membranes. One of the parts of our strategy years ago was the realization that the membrane part of the business, the pump part of the business, the components part of the business was getting commoditized. And that having done a lot of initial pioneering work in the technology we were realizing that the technological benefit, the value added from these technology increments was getting smaller and smaller. And so we pushed into this new arena. We were the pioneers in this new arena.

And to get to your third question, that really took place in two different ways. On the smaller plants Ionics like Santa Barbara was, Ionics is essentially investing 100 percent of the capital into that project, and owning the project outright. And that project is on Ionics books. And so all of it is an investment on Ionics books.

On the larger projects, like Kuwait, which was a $400m project of which we’re doing say 20 percent of the project, that project is on the books for the project company. And I am pretty sure just to maybe foreshadow a little bit the answer to Lorraine’s question. Even under the new Vin 46 rules it’s unlikely that any consolidation of those kinds of things will every be required because we don’t control those project companies in any way, manner, shape, or form.

Now what we try and do on those projects, and someone asked about the payables that the Kuwait project owed to Ionics. We try, and this is just something we try to do. We try to make enough money cash wise on the sale of the project to the project company, and this doesn’t work in every case, every time. We try and make enough money on the sale to the project company to essentially cover most if not all of our equity investment. And so we try to come out as near to cash neutral as we can.

And then you had a last question. I am sorry, I …

Just in terms of the outstanding equity commitments?

On – you mean in general or on specific projects?

Well, no, in terms of the own-and-operate projects that you’re kind of involved in or getting involved in – how much capital is committed for, you know, various equity positions?

I see. Yeah, at this point in time in terms of signed deals, it’s probably somewhere between $10m and $15m.

Okay, okay. And just lastly …

And that cash should start following the formula I just explained, that we put cash in yet we get money out.

And just lastly, can you remind everyone what percentage of stock is owned by you guys, roughly?

You mean the inside management?

Yeah. Because one thing I’ve always been impressed with is in a day and age when management changes as often as some of us change our underwear you guys have been there an awfully long time.

Well, that’s right. And we’ve held on to our stock, too. As crazy as that sounds. Let me look in the proxy, and I can tell you. Hold on one second. In the proxy for last year it was reported 8.4 percent.

Okay. Good, thanks very much.

You’re welcome, sir.

The next question is from the line of Alan Pavese with CSFB. And your line is open, sir.

Thank you. I was wondering if I could just follow-up on a couple of the issues that have been touched upon? First, on the bad debt expense, I guess kind of for six cents in the quarter, or the allowance, what were the overall amounts in 2002? And how will that compare in 2003? Are we going to see a sustained amount? Or is that actually going to decrease going into 2003?

Yeah, no, we wouldn’t expect that to be sustained. As I indicated, I mean these were specific circumstances, and unique. So, no.

So they’re just going to drop off right in the first quarter? We’ll see that improvement?

Right.

Okay. It sounds like you were saying from the Sarbanes-Oxley that’s kind of part of a new process of doing business. And so that’s kind of into the permanent overhead, I would imagine?

Yeah, I mean, you know, I did not spike out a number separately for that.

Right.

That was part of what I aggregated in legal and accounting, but there’ll be some amount that will impact us.

Okay, so some of that is going to be ongoing? I am just trying to figure-out how much is ongoing and how much is one-time in nature?

No, I mean my intent in going through that was to try to spike out the things that, you know, we would view as unusual.

Right.

There were other things that Dan analyzed in going through that, that were extra costs in Q4. But which he did not use as part of his explanation, Alan.

Right.

Because those would not be regarded as non-repetitive.

Okay, that’s what I thought, but then when you started to talk about some of the Sarbanes-Oxley things it sounded like some of the things were going to be happening every quarter, like the auditing process, and some of the overview of the numbers, and filings, and things like that.

All right, just one other issue. On the French facility you were saying last quarter that you were still reviewing whether or not there was going to be an impact from prior quarters, or additional impact from the last quarter. What was the conclusion of that review? Was there no prior period adjustments that needed to be made?

No, we – there’s nothing more in that arena. What I thought we said, or I think we said, Alan, was that there’d be some severance costs that would affect us in the future quarters. And that’s what I talked about earlier with a penny or two that impacted us in Q4.

Right, but I thought there was some other accounting reviews taking place that you were looking at historically, as well?

No.

No? Okay. On the tax rate, are you saying that it’s going to be 43 percent in 2003?

No, we’ll be lower than that in 2003.

Can you get more specific? It’s kind of all over the place here this year. Can you be more specific?

Yeah, we’re going to be in the 30’s, probably in the 36, 38 range, somewhere in there.

Does that presume a certain level of profitability in the French business? And is that level an improvement from where you’re currently at?

Some level of – yeah, it’s not highly dependent on that.

No, okay. Because it looked like, if I am doing this correctly, in the fourth quarter you were somewhere in the 50’s, low to mid 50’s?

Well, yeah, that’s a result of changing the annual effective tax rate. Of course, it flushes through in the quarter.

Right, okay. And so you feel very confident, though, that you’re going to be back down into the – what would you say, mid to high 30’s? Or?

Yeah, we’ve got – yes, I do.

Okay. And then factoring all of that in, it seems like, I know you don’t want to get specific on revenues, but it seems like to get to the 50 to 60 percent range it certainly seems like it implies a level of improvement in operating conditions from fourth quarter’s level other than just the seasonality which, you know, has a little bit of an affect. Is that a fair statement? Or are you assuming that things stay kind of at the level that they’re at now for the next 12 months? Just the operating environment in general?

Let me say, Alan, you know, the thing that’s changed in the last 12 months is that we’ve built a substantial backlog. And we are probably six months, in some cases maybe as much as nine months late in getting releases to work that backlog off. We are now starting, we’ve started to do that. And so I think there will be some benefit along the lines that you just assumed would be the case in moving forward in 2003.

Okay, and so basically it’s not necessarily macro economic improvement, but just an improvement in the release of funds and the greenlighting of projects?

Yes, which are now greenlighted. And we’re not, you know, we’re not going far afield in presuming too much about new projects coming on and being in that same category.

Okay. And then, Art, I guess just lastly, I mean you talked certainly about, you know, a number of the projects that have had people concerned. And I think one of the issues is that in the past when the company has been delivering better, more consistent operating performance I guess it was easier to, you know, swallow a couple of these, you know, troublesome projects.

But as I look back here you haven’t been free cash flow positive from operations since 1998, and kind of missed earnings guidance, short-term earnings guidance in something like seven out of the last 10 quarters. And so, you know, it doesn’t seem like there’s a lot out there for investors to hang their hat on, and say ‘yeah, we’re going to weather through this.’

Is there, you know, an effort to just improve the execution levels in terms of earnings and meeting market expectations? And you know, getting back to where Ionics had been a positive operating cash flow company, as was the case up until the mid to late 90’s?

Well, first of all, that’s a very fair question, Alan. The reason I gave that little history lesson that was referred to is that we’ve sort of been in this position before. We were in this position in the early 70’s – I hate to go back that far – in the early 80’s, and now we’re in it in the last four-and-a-half years. Where we’ve had, you know, difficulty sustaining the kind of momentum that we need in this business.

What’s happened in the last four years that has created some of this unpredictability has been the decline of the semiconductor business, which we kept thinking, erroneously as it turned out, that that business was going to recover. And in our forecast that we have subsequently missed we had assumed that certain projects would not get cancelled. We had assumed that certain jobs that we were told were going to go ahead would go ahead.

And I think you and people on the call know that we’ve been one of the major leaders in building the water plants, the Ultrapure water plants for new fabs, for new microelectronics facilities. And the number of those new fab starts has gone down to almost zero in the United States and only a few overseas in the last four-and-a-half years. That has had a dramatic affect not only on our business but on our ability to predict well. And I just, I can’t explain it any better than that. We kept being told, and we kept thinking that the business was going to get better, and the truth is we were wrong.

And a lot of the free cash flow problems, like I said, are four years – you know, go four years back, well before the semiconductor started to fall apart.

Well, it really doesn’t have anything to do with the semiconductor. The free – it would have to do with it only in terms of the profits that would have been generated from that business.

Right.

But the free cash flow that we’re left with in terms of issues was during a period where we were continuing to make substantial investments in the build-own-and-operate business. And that was what was – that capex from those investments substantially reduced our available cash flow. And that was a deliberate plan that we went into in order to get away from the cyclicality of the capital equipment business, which I think correctly we foresaw.

And hopefully, what’s happened by building this large backlog of build-own-and-operate projects, which did impact our free cash flow in order to get there, we’ll start paying dividends as these plants start to roll on-stream, and additional in the future. And make more water.

One of the interesting statistics, Alan, that many people do not know, but I will reveal it, is there’s approximately 37b gallons a year of water being sold every year by Ionics under build-own-and-operate contracts, as of right now. And that number, and it’s an approximate number, so don’t hold me to it exactly. But, and that number will double in the next let’s say by the time the Kuwait project comes on. And so I don’t think anybody in the world can match that. And that does mean some substantial future income.

It does, but the fact that you’re not generating free cash flow despite that very impressive statistic is unnerving to, you know, people …

Well, because we’re putting money into new projects a little faster than the cash flow for the old projects.

Right, so you would you venture to say Ionics …

At this moment in time.

Right, would you venture to say that Ionics will be operationally free cash flow positive finally this year? Or is it going to be still a couple of years out?

I don’t know that we’ve actually made that calculation. But I think we know this from other businesses. There is an investment period, and after you go through the investment period you get to a point where the cash that’s generated from your prior investments covers the cash that you need for your new investments. Clearly, we’re not at that point yet.

Right.

But as these new projects come on the likelihood of getting there in the next year or two certainly improves. Now, having said that, if we get some opportunities for new build-own-and operates that are significant and we decide to go after we may continue our investment policy in the future. And I wouldn’t want to sit here and say that those opportunities won’t be coming along.

For example, in California they’re supposed to be building five major desalination plants sometime in the next five, six, seven years. We will, we would most certainly want to be a player in those projects.

All right. I would just caution you that for investors to, you know, be more supportive and to have less of an issue with the short prospects I would say that you’d probably want to get back to a position of generating free cash flow and not using some things, like the Aqua Cool proceeds to kind of fund these, although, and operate projects without them demonstrating that they are getting returns.

I mean it might be better if you’d just focus on the ones that you have and getting them to profitability, and you know, showing the market that there are attractive returns here being pursued now that it’s been four years, rather than looking at a decade of non free cash flow generation, and asking investors to, you know, hold on and wait till 2008 or something to …

Well, I don’t think it’ll be that long. But I understand your point. I understand your point very much.

Great.

That’s why I mentioned it was a long cycle business. And it is unique. And we just have to try and explain it, Alan. Thank you very much. Your comments are taken to heart.

Great, thank you.

The next question is from Debra Coy with Schwab Capital Markets. And your line is open.

Yes, thanks. Hi, guys.

Hi.

A couple of specific questions, and then I have a couple of big picture questions as well. One, can you say or, Ted, how much we have in, how much is invested in Kuwait thus far? I know you’re, I think you’re a 25 percent equity partner?

Correct.

Yeah, I think – I’ll – I’m going to give you a generic answer, and then if people have a specific, they can give it. Our total expected investment in the Kuwait project, I think we’ve disclosed is something like $16m.

Right.

We’re probably about a quarter of the way there right now.

Okay.

Does that sound about right?

That’s fair, yes.

So are we at this point, I mean you talked about trying to keep your equity investment cash neutral with your revenue income. Are we behind at this point?

No, I think it’s happening commensurate with the project, and with the equipment activity.

There may be a couple of months’ delay, Debra, as the ins and outs get balanced.

But you’re basically, you think you’re even?

Yes.

And then just on the – just on the war stuff, there have been, I am sure it has concerned people, all the stories of foreign workers being pulled out of Kuwait and so on. So you’re saying that everything at the project is exactly as planned, everybody is there working, and everything is going, nothing has changed given war preparations?

Well, let me give you, you know, an accurate portrayal. First of all, we are in the early stages of building that project.

And so there aren’t many workers?

If you were ever to come and visit us in Watertown you would see some enormous membrane skids on the floor, here at our facility. Those skids will be in the process of being shipped eventually to Kuwait over the next year or so. And then started up in the current schedule, I think, in early 2005.

Now, so, there are no Ionics people per se out there in Kuwait right now.

Okay.

And we are a – I would make it clear so that you understand, we’re not the major constructor of this plant.

Yes, I know.

We are a contractor into the plant. We’re supplying the membrane system. There are local people who are Kuwaitis who are building the rest of the plant.

Okay, so they can continue – and so you’re basically saying unless things change dramatically thus far your projection for your revenues that you hope to collect on this this year are still on-track?

Oh, yes.

Okay. On the SG&A, Dan, you mentioned that there’s some you said ‘normal ebb and flow.’ This seems rather abnormal, though, this jump of $8m almost sequentially. Can you give us a little more color on where that’s coming from? And that must be – and also, what it’s looking like going forward? Because I assume that’s one of the reasons why your earnings guidance is fairly low for ’03?

Yeah, I think on a normalized basis, Debra, the rate, 27, 28 percent of – hopefully closer to 27 – of revenues would be a more indicative number. And there were, as I mentioned, increases in several different places other than the specific things that I called out, so.

Right.

So, you know, I guess would say the 27, 28 percent range is probably more in the realm of a normalized figure.

A normalized on a go-forward basis. And then, the overall big picture, and Art, you kind of talked about this in a number of different ways, but I guess what I come away with here is, you know, number one we’re talking about 50 to 60 cents in earnings next year. And even today. You know, the stock is even at that, still trading at a pretty hefty multiple for a company that has, you know, been showing well below what we would think would be the earnings power.

I think that number probably implies still operating margins that are in the low single digits, I assume. And you’ve also said that as you move toward this build-own-operate model your primary competition is Vivendi and Suez, who are, you know, huge global companies with a lot of financial resources, fairly low margins, and also pretty horrible stock prices right now.

I guess what I am trying to figure out is, you know, with the consolidation that’s taken place in the sector, you know, Ionics is still a small company. You know, how do you really bring value from the financial and project management expertise side, in addition to the technology side to, you know, to gain some edge, some value, some, you know, some reason for investors to regain some confidence here? It certainly has been frustrating.

Yeah, it has for us, too, Debra. As you can imagine. And if we hadn’t been through this before, at least the people here, as someone said, ‘you’ve been around for awhile.’ I think, you know, we might be, you know, saying things a little differently. But, you know, we have been through it before. And I have to say to you there is no magic answer to all this, except hard work.

And you’re right, you know, Suez and Vivendi are huge companies with – and there’s a lot of interest in water now around the world. We get inquiries every week from companies that want to partner with us on these projects. But having said that, I want to point out to you, Debra, that most of the business of Ionics so far and even the business that we’re projecting for next year is not in these large projects. It’s in much smaller projects. And in these smaller projects it goes to the people that can bring the best technology to the customer faster.

And there has been a lull in capital spending. In my initial remarks I pointed out that industrial capital spending has been terrible for the last year. And you know, when you get into a cycle like that it’s very difficult for us to break it, because it’s not a question of our costs. It’s not a question of our deliverability. It’s a question of whether the customer has got enough confidence in their business and their industry, and the economy to make a major capital expenditure.

So we are caught – we’ve been caught on that for awhile. And our strategy has been to try and [ameliorate] [ph] some of that by getting into these longer cycled projects that would essentially generate annuities for Ionics over a fairly long period of time. And the ones we’re involved in now, as I mentioned also in my earlier remarks on water supply, have been very profitable. The problem is that that’s not a large enough percentage of our total business just yet to have made the kind of difference that we’re looking to make. And I can only say we believe we’re on-track to accomplish that.

Debra, while Art was talking I was just sharpening up my figures there, and I probably overstated SG&A a little bit.

I hope so, because actually I was looking at my model as well, and going ‘gee, that’s going to be tough.’

Yeah, I think that in the probably 26, 27 range would be more appropriate.

Even – okay – even so it’s still higher than I think we had been hoping. And that’s still then – well, you know, my last question then, and I’ll get off – is it’s hard to see our way out of this tunnel on operating margins.

I mean I guess my last question would be whether you guys can give us any hope for the future, if you will, in terms of what you think the margins can get back to, and what the earnings power of this company is? Even given the current, you know, even not assuming a lot of new projects, but even given the current projects, and backlog, and revenue outlook over the next couple of years?

I think the – Debra, this is Ted. I think the real goal, and hope in terms of swinging the operating profit line is to do two things. Continue to improve our gross margin line which will happen as we swing more to the service based and own-and-operate revenue streams. We see that and the streams we have today, they’re in the 30’s if, as we get more and more of that business and increase the percentage of recurring revenue business that makes up our total business, the margin on the gross margin line will improve.

And secondly, we have to keep working on the SG&A line. It’s still too high. It was high in 2002, and we’re going to work hard to get that down.

Yeah, perhaps to the 25 percent range.

So that we could get back to a at least seven or eight percent operating margin?

Right.

Okay. Thanks.

Thanks, Debra.

And we have a question from [Nick Spar] [ph] with [Trafele & Company] [ph]. And your line is open.

Good afternoon.

I am sorry, sir. I didn’t get your name?

It’s Nick Spar from Trafele & Company.

Thank you, sir.

Just a quick question on the balance sheet. We saw receivables from affiliates tick down quite a bit this quarter, or sequentially. And then we saw a bit of a rise in other current items. Can you just help me reconcile what’s going on there? Are you reclassifying some of those receivables?

Yeah, we talked about that last quarter, and the $10m sub-debt commitment that we have through the [Desaca] [ph] Project is classified down below, out of the receivables from affiliates line. And so that’s the predominant reason for the change there.

Okay, great. And the increase in allowance for doubtful accounts, I mean which business segment is that related to? Is that in equipment? Is it Ultrapure?

It’s predominantly in our equipment business segment.

Equipment business, okay. And in your equipment business, is – in the United States, the domestic business, is that – are your customers mostly, you know, State and local governments?

Most of them are not.

Yeah, I would say not.

Most of them are not. And I mean they are – there’s a lot of industrial customers in there. And while that’s been a weak area of our business, as I said, but they are companies in a wide range of process technology businesses, the power business, the pharmaceutical business, some portions of businesses such as flat panel display, things like that, and chemical business, petroleum business. That’s the area that we’re referring to.

Okay, what percentage of your overall revenues then would come from, I guess, State and local governments?

My goodness, State, local, and you mean – let me think. Would you – the Kuwait job would be …

I am now talking domestically.

Oh, domestically.

Okay, just domestic.

Well, I don’t think it’s a large number.

I would say for sure under 25 percent.

Yes.

Okay.

I think maybe even under 10.

Yes, I am just thinking out loud about the recent jobs we just got, Ted, in Texas and Oklahoma. Okay, anyway, it’s – let’s say it’s for sure under 25, and Ted says it may be under 10.

Okay. Well, that’s a big range, but …

We could get back to you with an exact number.

Okay, I’d appreciate that. All right, that’s it. Thank you very much.

You’re welcome.

And we have a question from Richard Eastman with Robert W. Baird. And your line is open.

Thank you. Guys, you’re not instilling much confidence on this SG&A number. I mean if our gross margin is running 27, 28 percent, and it has been. In fact, we’ve struggled to get 27 percent. You know, trying to work our SG&A down from the current 30 percent level, to 25, it seems to me it should be part of the business plan.

And Art, you talk about redoing, you know, redoing the business model here. And I am struggling. If you’re redoing the business model as more build-own-and-operate is there not too much overhead left in this business? To go to that business model? I mean if you do 60 cents next year you’re basically suggesting that your OP margin is going to be in the two to three percent range.

Well, I realize that that was implicit in the answer that Dan gave to the question. And I think he was working off the historical numbers, not the forecast numbers for the future. We are working very hard, as Ted said, to bring the SG&A, to right size the SG&A in terms of what our current business model requires. And Dan certainly wasn’t quoting …

No, it’s certainly our objective to bring the SG&A spending down, and we’ve got a number of things that we’re trying to do to do just that.

Well, let me ask you this.

And the numbers he was quoting, you know, include all overhead, including R&D, and things like that. So I think we need to be, you know, apples-to-apples on this.

Yeah, I think we do, too. Let me ask you another question. Currently with the mix of business and the capital equipment side of the business being so depressed it’s been my impression that, you know, the consumables, the sale of water, the ongoing revenue stream is 50 percent, or maybe north of that. And when I look at a three percent operating margin, and I assume that the service business is nicely profitable there is a lot of this business that’s clearly not making money. And is the intent to just wait out this business cycle?

Well, again, a very good question. Let me just say we are one of the few companies that’s got the capacity to deal with the business cycle even though we’re a smaller company. The question you’re raising is whether we should? And we ask ourselves that same question. But we truly believe that in order to be successful in the long-term build-own-and-operate business we can’t abandon the capital equipment business.

And we have, you know, it’s obvious if we were trying to maximize short-term profits, you know, by abandoning the capital equipment business we could improve our profitability dramatically. And some people might say ‘well, go ahead and do that.’ But if we do we won’t stay in the long-term build-own-and-operate business very long.

And so we think we need to be a player in both. And I think what your question is raising, Rick, and it’s a question we’re asking ourselves, is ‘what should the balance be, what should the balance be between the build-own-and-operate forays that we make, and the bids that we put in in those areas, and the commitment that we’re making to the capital equipment side of the business?’ And we continuously reevaluate that. We are reevaluating it now. We will be reevaluating it this year.

And, you know, the past history, and you’ve followed us for a long time is these cycles eventually do let-up, and these cycles eventually do turn-around. And so, you know, then we would be criticized for not being there when the cycle turned around.

I don’t think you’d be criticized for making money.

No, no.

If the business model shifted towards the build-own-and-operate side, it seems to me you can stay in the equipment manufacturing business with a smaller footprint. I guess that’s, maybe that’s the point.

Well, and I think that’s a fair point.

The other thing I would just say to Ted’s earlier answer, if these large projects are being booked, we’re a minority partner in these projects. And so when we book the gross margin on the equipment sale we’re only able to book the one minus minority interest component of the gross margin, correct?

Correct.

That’s correct.

And so isn’t it going to be rather difficult to gravitate our gross margin up when you can only book, you know, a 15 to 17 percent gross margin on some of this stuff?

Well, that, again is a timing issue, Rick, because we can only book one minus the minority interest at the time we start-up the plant. But as the plant rolls forward we rebook, we recapture …

The minority piece.

The minority piece. And so that starts adding back in. As well as a higher margin on the actual operating and maintenance contract, as well as the equity income.

But that falls below the OP line.

That is correct.

Well, to the extent that we have 100 percent owned facilities, though, Rick, it does have an elevating affect on our margin as those margins go up.

All right, thank you.

So it’s a combination.

And we have a question from Edward Hatch with Mediavision Capital. And your line is open.

I’d like to ask a few questions. Could you talk a little more about your backlog and the visibility of it? In terms of both the size and how many years it goes out? If you could touch upon perhaps any sort of visibility you have, on new orders? And then one last question, talk a little bit about what competitive advantages you feel you have over the Vivendi’s and GE’s of the world?

Okay! Okay, let me try that. First of all, Mr. Hatch, let me explain a little about our backlog, which I think people who follow the company know, for awhile know this is the way we do it. We report our backlog as what some people would call a short-term backlog. That is whatever that number was – was it 377m? The backlog shown at the end of the year of roughly 377m was what people would normally refer to as ‘short-term backlog.’ That is backlog that we have on our books of orders received from a customer that will be shipped and the revenue taken within five years.

However, in addition to that, Ionics has backlog that goes beyond five years which is in contractual form and obligated. And that, I would say, just to be on the conservative side would roughly double that number. And so …

And so there’s another 700m behind that?

No, no, wait. No, the sum of the two.

The sum of the two.

Right. Okay, I guess that was the first part of your question. The second, I guess, was on competitive advantage?

And also you touched a little bit on it, just saying how industrial conditions are tough. But, you know, how do you feel about your visibility, and customer confidence?

I think we’re trying to give you as good a picture as we can. And certainly, you know, we are basing most of the guidance that Ted gave you on what’s in our backlog currently.

Okay.

We are trying very hard not to be over-optimistic, or anything other than realistic about business conditions. And certainly, as people well recognize, business conditions in the areas we’ve been discussing are certainly difficult right now, to say the least. And so we are trying to reflect that in the way we’ve expressed ourselves. If these things should turn, obviously, we will inform the Street accordingly. But that’s the picture as we see it right now.

Now in the competitive advantage, or that area against the Suez’s and the Vevendi’s, and the GE’s, as you said, you know, each one of those companies including Ionics have their own particular strengths. And there are certain businesses that each of those competitors are in, and there’s some that they’re not in. If you compare them to Ionics we make our own membranes. We build our own modules. We’re sea water and brackage water. We service our own plants.

And we are, we do a lot of research in engineering on developing new technology, including things like we just did recently, licensing technology that’s being developed in certain locations where that technology has been put forward by others. For example, we just licensed some new technology from MIT, which we hope will enhance membrane performance of the type that we can manufacture.

So, you know, this competitive advantage thing I would have to say at this point not Suez, and not Vivendi has in certainly the areas I’ve mentioned I know Suez is not a membrane manufacturer. And yet they have other strengths that we don’t have. They obviously probably cover a lot more of the world than we do. And they have relationships that we don’t have. The same can be said for Vivendi and GE. I think it’s fair to say GE is not in the desal business. They’re not in some of the other businesses.

And so they bring their particular strengths in a lot of the companies they’ve recently announced and acquired, and to the best of my knowledge there is not a whole range of competition with some of their activities. Moreso with Vevendi and Suez, and it’s not to say that every time we compete against them that any one of us wins. In the Kuwait job we did beat out Vivendi and Suez, but on other jobs they’ve beaten us out. So all I can say is we’re holding our own out there.

Okay, thank you very much.

You’re welcome.

And the next question comes from Robert J. Smith with Center for Performance. And your line is open.

That’s the Center for Performance Investing. Good afternoon. Is there another way to look at the backlog, the complexion of the backlog? As to how you would look at it to divide the backlog into various segments?

Okay. What have you got in mind, sir?

Well, I mean as to what part of the backlog addresses various segments? In other words, the industrial, the municipal, whatever you may be interested in?

I am not sure we’ve ever, you know, in the interest of FD I would say I don’t think – Ted, do you know, have we ever given backlog?

We’ve not categorized backlog by …

Is there anything to be gained by doing that, or? From our perspective?

If you think so, tell us what it might be, sir?

Well, I am asking you. I mean you’re running the business.

Well, I think, let me say that one aspect of it probably would surprise people is the amount of backlog that's associated with our recurring revenue own-and-operate, and service based businesses.

And why would that surprise us?

Well, I think because it’s – there are really two elements to that. And I think Art alluded to it earlier in the Q&A period. And that for these long-term contracts that we have with an entity like Kuwait, we only book for published backlog the first five years of that 27-year contract. And the 22 years that run out from year six to 27 are not in your backlog. But we look at that as a very significant portion of a building recurring revenue and profit stream going off for 27 years. And as we add to that total year-in and year-out that begins to add up to a fairly significant number, which in future years will provide a stream of revenue and profit.

Yeah, I would daresay you’re right. Yes. Okay. And just a second question, are you in any way part of the – what’s called the ‘homeland security equation?’ I mean have you ever had any discussions with Government officials as far as water supply, and anything associated with that?

Well, I am not sure – Ted will answer.

Let me say that there has been some interest in some discussions that we can’t talk about.

How long would it take you to put up a facility from scratch, so to speak?

It depends on what it’s got to do, sir. For example, in the City of Minneapolis right now we’re putting up a facility to treat Mississippi River Water. That’s, you know, that’s going to take about a year.

In emergency situations we can certainly move quickly, you know, maybe again depending on what the facility has got to do, and what it’s got to deal with. You know, in a shorter time than that. We did the Santa Barbara Project which was an emergency project under emergency drought conditions, under Governor [Magian] [ph] of California’s emergency proclamation. We put that one up in nine months. And so, God knows, in answer to your question. But certainly, we’re well aware of what you’re talking about.

Okay. And where would be the competition in that area? How many players would be visible?

Again, it would depend on what the particular problem that was being …

Well, I mean the problem would be contamination of drinking water, and let’s be up front about this.

All right, well then the question is are you trying to protect the reservoir? Or are you trying to protect at the sink tap?

I am trying to answer, compromise on the reservoirs.

Say it again, sir.

A compromise on the reservoirs.

A compromise on the reservoirs. That is, there would only be a few companies that could deal with that.

Of which you are one?

Yes, I would say, you know, maybe a dozen in this country.

All right.

The sink tap issue there would be many more.

Okay, thanks so much.

You’re welcome, sir.

And we have question from [Nathaniel Pulsifer] [ph] with [Pulsifer and Associates] [ph]. And your line is open.

Thank you. Good afternoon, gentlemen. I’d like to pick-up a bit on this backlog question. Art and Ted, I hadn’t realized that half the backlog was beyond this five-year period. Is that a normal relationship, or is it unique to this particular period of time?

Well, let me explain something, Nat, just so there isn’t any confusion. When you say half the backlog is beyond.

I misspoke Arthur, you’re right. Twice, total backlog is twice what you report.

That is correct.

And is the – is it normal for the unreported backlog to roughly equal the reported, or because of the difficulties of today it’s that relationship SKU’d one way or the other?

Well, that’s a good question. I can’t speak for, you know, what other companies are doing in this regard. It – we felt it would be unreasonable, you know, to report the large backlog number when so much of it goes beyond the fifth year. And incidentally, we don’t carry the five years all the time, as some people in the audience know. After we book the first five years but after each year it goes down by the year, and so we only carry one year going forward of all these multi-year contracts. And so we do that to not distort the backlog. And people might be comparing it to some close-in delivery schedule.

Oh, okay. Moving to the balance sheet question, neither the press release or the fax that you sent contained any balance sheet information. And I’ve been to the web site. Where can I get the balance sheet that others on this call have referred to?

You should have gotten that. That is all …

The press release.

It’s part of the press release.

Nope, it didn’t come through, and I printed it out twice. So.

We’ll check it. I mean …

Robert has got it, Art. So I’ll follow through on that.

Now, in the Q3 10-Q describing the Kuwait project, the project appears to be one for a waste water reuse facility.

That’s correct.

And could you discuss that kind of a project relative to the total backlog that you have there? Some $700m of backlog? Or is water reuse a significant part of the backlog? Are we seeing a rise in these kinds of orders? I'm interested in water reuse because of our general interest in water and shortages, and so on.

Nat, this is Ted. Let me see if I can answer that. First off, water reuse of this type in Kuwait is a relatively new way of providing additional sources of water. And in addition to desal and just general conservation it is our expectation that this reuse will play a major role in the world’s future water needs.

Now, what they’re doing in Kuwait, which is quite different from desal, let’s take desal where you’re basically taking seawater and purifying it to provide drinking water and other water requirements, in Kuwait they’re taking the discharge from the sewage plant and putting it through, or we’re putting it through very special membrane processes, and then recycling the sewage to Kuwait for use for processed water and for irrigation water. And technically it’s purified to a point where you could actually drink it, but they’re not planning on drinking it in Kuwait.

So this is a massive project, and will provide us a substantial part of Kuwait’s ongoing water needs. And at the present time this is really the first major project of this type that we’re doing so, therefore, it’s new to our backlog.

Okay. What distinguishes the technology here, Ted, from a for instance a desalinization plant? Or is it the same technology with the knobs set differently?

Well, in both desal and reuse you have two steps, a pre-treatment step and then a final membrane process. In this case we’re using some of the pre-treatment step, it’s a rather new membrane technology, and then that will be followed by more conventional reverse osmosis membrane technology. And so some of the, the membrane technology steps, Nat, are very similar.

Okay.

To desal.

Okay. Have domestic entities, municipalities, government expressed interest in this Kuwait type of project for areas here in the country that experience water shortages?

There’s world wide interest. In this country most of the interest is centered in Southern California, and we’re doing some work with the San Diego Municipal Department.

Any of that interest translated yet into contracts?

Oh, yes. We have an order from what’s called the North City.

North City.

San Diego.

San Diego Water Treatment Facility, which is running just fine. Already running.

So it’s an order that’s been completed?

Correct.

And the system is in place. Is that a build-and-operate, Art?

No, no it’s not. That is a straight sale.

Okay. And then, a final question please. On this margin issue, sometime back I recall a real frontal attack on this issue, and you dubbed the coming year ‘this is the year of the gross margin.’ Well, that was a frontal attack that got diverted by something. And you’ve certainly reminded us of the history of the capital cycles. What is an achievable operating margin for a company engaged in the kinds of businesses that you are?

Well, I think – Ted will correct me – but when the semiconductor business was in bloom in the mid 90’s our gross margins were over 30 percent. I believe at one point they actually hit 34 percent.

You’re correct.

And when that, when the bloom came off that rose and the -- that sophisticated portion of the water business went into decline our gross margins started to suffer. And what business was out there in microelectronics was very strongly competed for. And the margins were sharply reduced.

I think this will ebb and flow again. I think the margins we’ve shown recently have stabilized to some degree from what they had been, as Ted reported earlier. And I think there’s some hope that we can get the margins back toward our 30 percent. And we certainly are striving for that. There’s many things we have underway to try and prove our internal efficiency with respect to margin improvement. So that’s a goal.

30 percent?

Yes, sir.

Okay, well good luck, and thank you very much.

You’re welcome.

We have a follow-up question from Cliff Josephie with HD Rowell. And your line is open.

I got the beep, but I didn’t press it. But I guess I could ask one question. Did you cosign the loan to Desellcott? The bridge loan? Do you have any responsibility in that regard?

When you say ‘cosign the loan?’

I mean the money that the joint venture owes to the Trinidad Bank?

Yes.

Do you have any responsibility directly to the Trinidad Bank if for some reason Desellcott is unable to pay it back?

Yes, zero.

Okay, thank you.

You’re welcome.

And we have a follow-up question from Edward Hatch with Mediavision Capital. And your line is open.

Thank you. Earlier on you made a comment, saying ‘every week several people call you to partner.’ Would you be able to identify who some of those companies are so we have a sense?

Okay, sir. Well, look, I will give you a generic answer. Without patting ourselves on the back, they are some of the top companies in the engineering and construction field worldwide.

So these are very big companies that want to use your technology, products, and services to enhance their business?

To – for them to enter new markets and provide the skill sets that they undoubtedly add, they sometimes have a missing piece, and that missing piece more and more frequently is relating to membrane technology of the type that we do. And that’s why they are approaching us.

And then one last question, other companies in membrane technology, is it the [Millipore] ph] one, or [Poll] [ph]?

Well, yes. They have a different type – they are in a different segment of the membrane technology business. Not in desal, not in reuse, not in surface water treatment, to the best of my knowledge. That’s not to say they couldn’t change their strategy at least at some point and move in that direction. But to my knowledge Millipore is focusing primarily on biotech, healthcare, biotech applications. And Poll is strongly in end use industrial filtration. Those are, those also use a form of membrane technology, but it is in many ways different from ours.

Okay, that’s great. Thank you very much, again.

You’re welcome, sir.

And gentlemen, there are no further questions in queue.

Okay, ladies and gentlemen, thank you very much. And we’ll see you again for the first quarter conference call.