奇異 (GE) 2003 Q1 法說會逐字稿

Ladies and gentlemen good morning and thank you for standing by. Welcome to Ionics Review of First Quarter Financial Conference Call. During this conference, all lines are in a listen-only mode. Later there will be a question-and-answer session. Instructions will be given at that time. If you do require assistance during the call, please press "0" and then "*" and as a reminder, this conference call is being recorded. I will now turn the conference call over to your host, Executive Vice President, Mr. Ted Papastavros. Please go ahead sir.

Thank you. Good morning everyone. With me this morning is Art Goldstein, our Chairman and CEO; also Dug Brown, our new President and CEO Elect; and Dan Kuzmak, our Chief Financial Officer. As usual, Art will start with his comments and he will introduce Dug Brown. A recorded replay of this conference call will be accessible on the company's website at www.ionics.com for a two-week period commencing at 5 p.m. today. 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 for 2003 and beyond and overall economic and business conditions and trends. Words such as "expects," "intends," "beliefs," "project," "plans," "assumes" and similar expressions identifies forward-looking statements. This one is the caution 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 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 company's products, pricing pressures, and competition for companies larger than the company, risks of non payment of accounts receivables, 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 and Form 10-K for the year ended December 31, 2002, which has been filed with 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 with the result of new information, future events, or circumstances, or otherwise. Okay, let me now turn the call over to our Chairman and CEO, Art Goldstein.

Ted, thank you very much. Good morning ladies and gentlemen. As you all have just seen our first quarter was a disappointing quarter in terms of earnings, but there were some specially mitigating circumstances and certain other aspects of the quarter which we want to shed some light on during this conference call. Dan Kuzmak will be providing more detail on our results but I wanted to note that at business group level for the quarter when compared to 2002, our revenues were up and our gross margin dollars were up in each of our business groups.

The increase in gross margin compared to the first quarter of 2002 totaled $2.3m, which is the equivalent of 8 cents per share improvement; however, again we will explain this improvement was offset by higher G&A cost and lower equity income during the quarter. After Dug Brown gives you his comments, Ted will be discussing our guidance for the remainder of 2003. In this regard I should point out with the generally weak United States economy, as eminent by the announcement regarding the nation's 6% unemployment last week; it is somewhat difficult for us to predict when strong domestic industrial activity will resume, particularly, in the power and semiconductor segments of our business. In this regard we are examining options and taking actions at several locations to reduce costs until this economic black cloud passes.

In the meantime it must be said that prospects of major short term improvements in the US industrial markets are not very bright. At the same time, we feel very fortunate to have a solid back-off. We believe new business in the United States and the overseas markets will be coming primarily from municipal and public used applications involving the building of new water resources and the upgrading of existing water resources. Now with respect to our two large projects in Kuwait and Trinidad, I want to mention that in Kuwait we are on schedule and we are on budget. Approximately 50% of Ionics' portion of the Kuwait project is complete. We expect the entire project including the local construction portion, which by the way is not Ionics' responsibility, to be completed by the end of 2004 and we expect the plant to begin operation under the supply contract in early 2005. With respect to Trinidad, all water supply operations are running smoothly and Doug will soon give us an update on his recent visit to Trinidad.

As the hostilities in Iraq are coming to an end, we were recently asked about what this could mean for Ionics. As many of you know; Ionics for many years had a thriving business in the Middle-East. We have built several hundred, primarily smaller brackish water desalination plants there. In Iraq and Iran, there are over 60 of our plants in those two countries combined; 48 of them are in Iraq. We know some of these plants were destroyed in the Iran-Iraq war and some were refurbished or rebuilt. We have also built other types of water and waste-water treatment plants in the region.

USAID and [Bechtel] are well aware of our work in that region. While it is too early to predict, what there maybe in terms of new activity in Iraq and the Middle-East; in general it would appear that the stage is set for a pick-up of activity, particularly if the peace process advances. I would like to spend a moment on internal controls. In the past year, we rebuilt most of the remote porting and controller ship system in this company. We have increased the scope of the internal audit function, added or upgraded four internal controllers and filled several executive positions in tax and accounting. This area remains a top priority, not only in response to requirements of Sarbanes Oxley but to improve our global ability to manage and control costs as well as bid and proposal activity.

I would like now to turn the next portion of our presentation over to Doug Brown, our new President and CEO elect, but before I do, I would like to tell you little about Doug and how we came to be on this conference call with us today. Three years ago when I reached the age of 65, I initiated a succession planning process with Ionics' Board of Directors, which resulted in the establishment of the succession planning committee to set the stage and prepare the way for my eventual step down as CEO. As a board member and as the Chairman of our audit Committee, Doug Brown was one of the board members originally asked to serve on the succession planning committee. We have known Doug Brown and Doug Brown has known Ionics for many years. After he graduated from MIT as a chemical engineer, he was hired to work at Ionics by our Executive Vice President Ted Papastavros. He worked for Ted, for another Executive Vice president Bill Katz, and for me from 1976 to 1984 in several management engineering and marketing positions. Doug Brown did so much initial market studies that led to our very successful entry into the bottled water business. In 1984, Doug left Ionics to go to Harvard Business School with the intention of returning after he finished his studies, but an opportunity in the private equity business came along and Doug took a position at Advent International. Over the next 10 years, Doug had several management positions at Advent and was chosen as President and CEO of Advent in 1995. While he was there, the firm grew to a level of $6b under management, making it one of the largest private equity firms in United States. When Advent decided to reorganize into more of a partnership format, Doug decided to move onto other things. At that time, he resigned from the succession planning committee and decided himself to become a candidate for the President and CEO elect position. All of us at Ionics feel very unfortunate -- very fortunate indeed that he did. It is a very special pleasure, therefore, to introduce Douglas Brown for his remarks and then we will go on to Ted, Dan and your questions. Now I like to turn it over to Doug Brown. Doug.

Thank you Arth. First, I would like to say what a pleasure it is to be here. Today Ionics has been facing significant challenges and I feel excited about the opportunity and my ability to help the company improve its operations.

As, I think, you all know I started as President on the 1st of April and will take over from Arth as CEO on the 1st of July. This three month interim period allows me to develop a more detailed understanding of the company and to refine my strategic and operating plans, which I intend to implement when I take over as CEO.

During this interim period, I have basically set three priorities for myself. The first is Trinidad to get involved, then to try and understand the outstanding issues and help resolve it. The second is the strategy the company is following; I am refining the strategy that I believe the company should pursue. And the third is development of an operating plan; I intend to finalize this plan which then I would hope to implement when I take over as CEO in the third quarter.

Regarding Trinidad, as Arth mentioned, I have been down to visit the plant site; I had met a couple of times with our operating partner, with the local banks. I am happy to report that from an operating perspective the company is operating very strongly, basically above [nameplate] capacity and producing better product [souvernity]. There have been no material disturbances that were created by failures of the plant. It is true that in Q1 the production output for the plant overall for the quarter was a couple of percent below plan. This was due to unexpected power outages, which is experienced at the plant site. Down in Trinidad they harvest a lot of sugarcane during the harvesting process they burn the cane fields and this year for the first time the farmers did not notify the power authorities that they were planning to burn the fields, which meant that the power authority did not have the opportunity to redirect power grid and it resulted in power failures at the plant site on three specific occasions.

Under most circumstances we would be able to make up for that shortfall by overproducing, but unfortunately in the first quarter of the year you have a seasonal high in the sea water salinity it's about 38,000 ppm and a seasonal low in terms of raw water temperature and the combined effect of those made it difficult to overproduce enough to make up for this shortfall caused by the power outages. But overall I'd say that the -- despite those particular interruptions which we do not expect to see recurring in the balance of the year. The company as the plan is producing above capacity; the customer is very happy and has stated that they are prepared to buy everything we can produce. Clearly, one of the issues that is there on lot of peoples mind is the long-term financing this still needs to be resolved. One needs to remember that is that -- the operating company in Trinidad is a local company which is owned 60% by an Trinidadian partner and 40% by Ionics and it has been the responsibility of Trinidadian partner to deal with the financing of this facility. A bridge loan was used to build the plant. The plant was basically finished last year and the bridge loan should have been replaced by the end of last year.

Unfortunately, our partner was slow to develop alternative bids or multiple bids for replacing the bridge loan with the term facility and that meant it was slow in getting offers on the table and what we would consider competitive or reasonable terms. I am happy to report though that now we do have two bona fide offers on the table from lending institutions at much better terms, much more competitive terms and we appear to be getting close to being able to complete this financing on reasonably attractive terms. Completing this financing is important for two reasons, because we are late in repaying the bridge loan; the project has been subject to penalty interests imposed by the bank which has the bridge loan outstanding. Completing the term facility will significantly lower the interest expense being incurred by the project, and the second issue completing this term loan will allow Ionics to collect a sizeable receivable that will be due from the operating company. So we're pushing as hard as we can to help resolve the banking facility situation. We think that the delay has resulted in a significant improvement in the terms that we can achieve, and I'm cautiously optimistic that we appear close to resolving this issue once and for all.

The second thing I pointed out was the strategic plan. The company, in my view, has core competencies in analyzing the contaminance in water, designing processes for removing these contaminance, and operating plans in a wide variety of operating conditions. Ionics is one of the most experienced companies in designing and operating water and waste water treatment plans in the world. I intend to leverage this expertise in businesses with high degree of recurring revenues and operating margins in excess of 10%. Currently, I am reviewing each operating unit the company has to see how it fits within this strategy. It's too early to tell and I wouldn't want to give any guidance in this area, but it is reasonable to expect that the result of this review and analysis will probably be the divestiture of a one or two or few non-core businesses and possible acquisitions to support and further develop our core businesses.

The third thing I talked about was in operations and the development of an operating plan. This is an operating plan, which I would intend to implement when I take over as CEO on July 1st. I think there is no question that the company needs to reduce its SG&A from its current 26-27% range including R&D expenses. Overall, it's too early to give you specific guidance on this issue, but my overall strategy is focused on simplifying the organization structure which will allow for reduced overheads and at the same time improve controls. I hope to be able to give you more details about this in the future when I'm further along in preparing this plan. At this point, I'd like to turn it over to Ted.

Thank you, thank you Wang and thank you Doug for those introductory comments. I can now go to Dan Kuzmak, our CFO, to go over the first quarter numbers.

Thank you Ted. Revenues for the first quarter of 2003 totaled $88.2m which represented an increase of $8.2m or approximately 10% from the year earlier period. Revenues including the sales to affiliated companies increased in all four of the business segments during the quarter, again compared to last year. Overall gross margins of 28.5% remained essentially flat in Q1 of '03 compared to the year earlier and as has already been mentioned SG&A expense for the quarter was up about $2.7m over the comparable period last year. This was primarily attributable to post-retirement charges and increased pension related accruals, the total of which was 1.3m. And I should say approximately a million of which was unusual, I won't repeat, and it was also attributable to increased professional service fees of approximately 6.6m, $600,000.

On a normalized basis, if you take out some of the items I would say that our SG&A expense currently is in the $21-22m in quarter range and that would be excluding R&D. As has also been mentioned equity earnings for the quarter was a loss of 0.1m compared to equity income of 0.9m for the year earlier period. There were several items that impacted equity earnings in the current period including, as Doug has already mentioned, the higher interest charges and lower production volumes at our Trinidad affiliated company in the [inaudible]. We also had lower profits from our Mexican affiliated company compared to what was unusually high level of earnings in Q1 of '02 and also lower earnings from our TMA affiliated company related to lower membrane production. So, those items affected equity earnings again in the quarter and were the result or as a result we had a 0.1m loss in equity earnings as compared to the 0.9m in profit the year earlier.

The effective tax rate for the quarter was 38%, capital spending for the quarter was approximately 5.7m, and depreciation expense was 6.1m in the quarter. Working capital was 215.9m at the end of the first quarter compared to 214.6 at the end of 2002 and bookings in the quarter of approximately 60m included a backlog adjustment in one of our shops of approximately 16m. So, actual bookings for the quarter were closer to 76m.

Now by segment, I would offer a few comments as follows. Revenues for the equipment business group decreased 2.4m without the affiliated company sales but they were up including them compared to the prior year. Gross margin increased to 28.2% compared to 27 for the same quarter last year and that was primarily a result of favorable manufacturing absorption in our Watertown manufacturing facilities. Revenues for the Ultrapure water group increased slightly by 0.5m in the quarter and gross margin increased by 2.4 point to 25.6 compared to the same quarter last year. This improvement is primarily a reflection of the fact that last years result included costs associated with our majority owned Malaysian subsidiary, which we divested in May of 2002. And then revenues for the consumer water group increased and gross margin decreased compared to the last year. The decrease from 35.3 to 30.5 was primarily attributable to increased revenue and lower margins derived from the group's consumer chemical business.

And then in the instrument business, revenue increased by 1.1m compared to last year and gross margin increased 1.6 points in the quarter to 59.5%. And then lastly on the affiliated revenue line, the increase to 11.8 during the quarter from 3.1 last year, it's primarily a reflection of the volume on the Kuwait contract that is flowing through at this point in time. So again a big change there is the increase in revenues associated with the Kuwaiti contract. And Ken (ph.) I will turn it back to you, but that's a highlighted summary of the numbers for the quarter.

Good, thank you Dan. A comment on guidance. With regard to guidance for 2003, we have reviewed the year with consideration of first quarter results, taken a look at the general economic conditions, our backlog situation, and we are concluding at this time that the current first call consensus for the year is still reasonable. With that let me now go to questions from our people that are on the line.

Are you ready for questions at this time?

We are ready for questions.

Very good. Ladies and gentlemen, if you wish to ask a question, please depress the "1" on your touchtone phone. You will hear a tone indicating you have been placed in queue. You may remove yourself from queue by pressing the "#" key. If you are on a speaker phone, please pick up the handset before pressing the number and if you have pressed "1" prior to this announcement, we ask you please do so again at this time. First question in queue is form the line of Debra Cloy (ph.) from Schroder (ph.) Capital Management. Please go ahead.

Yes, good morning. Can you talk a little bit more about the trend line on bookings and backlog? Even and actually maybe explain then the backlog adjustment of 16m but even including that 76m is low. It's the second quarter in a row that we have seen bookings and backlog decline. Can you give a sense of -- you have certainly talked about your concerns about the industrial side of the business. Can you give a sense of what your pipeline looks like out there?

Yes I think Debra, as we commented in the past, I mean the bookings from quarter-to-quarter obviously will vary and I think at one point I would make it as this past quarter, as there weren't any unusually large bookings in the quarter. So it was mostly our normal flow of business and no predominant single bookings that were large in size. I think we continue to face a very good pipeline of bid activity and would expect our bookings activity to pickup over the level that we had for this quarter, but again it's blotchy at times, depending on the exact timing of some of the awards and when they come in.

Sure, I understood.

And I don't think that we rate into it as significant concern. It's again where we look at a pretty good healthy flow of bid activity and feel optimistic about the future. The backlog adjustment was simply that was one of our side business have an adjustment into their backlog number and so in effect we take that out of the current quarter bookings and it just had the effect of making bookings look lower than they actually were and that's why I commented on it.

It wasn't an actual change in the project size or something like that?

No, it wasn't that.

Okay. And then on the margin, now that you are breaking out the affiliated, we can clearly see the much lower gross margin of that revenues coming in at. Can you give us a sense of how that's likely to look going forward on these larger projects? I mean I assume if you are half way through Kuwait that the margin we are seeing on that line now is probably going to stay fairly stable. Is that one of the areas were there are some potential improvement?

Well, one thing, I know you know this Debra as the others, but let me just point it out, I mean one thing to bear in mind on the affiliated revenue and cost-to-sales lines, we do defer a portion of the profit equal to our ownership percent.

Right.

We have to bear that in mind when looking at the numbers here. And again our ownership percentage in Kuwait is 25%. So, in effect we defer that amount from the equipment sales to the joint venture company. So, that is, you know, if you don't know that you might think that the margins are lower than they really are. But that's a significant factor to bear in mind.

And that would then in the case of Kuwait start coming in 2005, when you start the operating contract?

Right. Correct.

Okay. All right thanks.

Thank you. Our next question is from Alan Pavese from CSFB. Please go ahead.

Good morning. Actually this is Keith Signasky (ph.) on behalf of Alan. Last quarter we saw a dramatic miss versus estimates and then we saw everyone bring down 2003 estimates. Now this quarter it just seems that we have an additional miss versus a pretty uniform and [inaudible] series of expectations and I know we went through some of the reasons. But I was just wondering if you could talk about some of the changes -- actually this question will probably for Doug (ph.), in the way that the company might be approaching it's ability to deliver better and more reliable performance and in setting expectations with the market going forward and how that might impact your decisions in setting the strategic and operating plans?

Well, in terms of being able to meet plan, I think that, you know, that's an issue that we definitely have to wrestle with -- probably start with being fairly conservative on our forecasting. In some cases I think the company has been hit with some issues -- a lot of the issues this quarter are related to SG&A issues, which I plan on attacking directly. When you look at the operating line and the operating units, I think as Dan said, the operating units have actually performed very well. So, you know, my first approach is improving profitability with a more efficient organization structure, which would be best subject to, you know, surprises or changes in overhead expenses as we go through the year.

Well, I guess does the increased focus on the long-term contract for Kuwait and Trinidad, you know, would we continue or could we expect to continue to see as much of a focus because it seems like especially with this quarters equity income line they continue to cause some variability as well that has made it somewhat difficult for everyone to accurately anticipate quarterly estimates.

I think it's fair to say that in case of Trinidad the expectation was that they would have been producing a higher equity income number by this time and there have been delays in getting that project to the point were it's producing the kind of equity income it should be. I am confident that the Trinidad project will end up being an attractive contract for the company that will make significant contribution to the operating profits of the business. And once it's in that mode, the contribution will be quite reliable, because the bottom line is that the customers in Trinidad are needing the water and are using the water and the water authority in Trinidad once they all the water we can produce.

Right.

The challenge is being reasonably conservative in our estimates for when it takes the plant to get online and producing profit to the equity income line.

I guess then -- in terms of specific issue of Trinidad and then in terms of additional future contracts of similar type, if the focus remains that way, how do we approach setting reliable expectations, in case similar things would happen on future contracts?

Well, this is Alan Crosby. Let me try and give an answer to that. We do have over hundred plants that are out build-own-operate plants out there now, that are producing reliable and predictable streams of income and had been doing it for years. The problem on these big plants, as Douglas was just mentioning, is there some times are some hiccups before they get into the most stable mode, and relative to the size of our business, those hiccups are quite visible. Once this stabilizes and we get rolling and stabilized at that new level, those would be [common] part of the ordinary earnings of the company and will become less visible. Things at Trinidad should settle down, things at Kuwait should roll in, and we will then have a -- what we think is a higher level of income coming from these sources, which frankly were put in place strategically so that we can get away from the kinds of ups and downs that you are talking about and make the business more predictable. That's really the whole strategy in back of getting into the [inaudible] and outbreak business in the first place and getting away from alliance on the straight capital equipment business but we are not there yet and we are still fighting our way through some of the underbrush. But we seem to clearing up ahead and as Douglas said, I think we just have to put into proper contacts and perspective of how fast we are going to get there and not overestimate the speed that will take to do that.

That's fine. Thank you.

You are welcome.

Next question is from the line of Lorraine Maikis from Merrill Lynch. Please go ahead.

Thank you. When you gave the 8 to 10 cents guidance on the last quarter's conference call, we were about two weeks from the close of the quarter; could you just talk about which of those items really surprised you to bring that down to the 3 cents?

Lorraine this is Ted. I think the major surprise was in the SG&A line. We had to take some unexpected cost down relative to retirement benefits and pension costs, and there were some unexpected rate charges relative to professional services and both of those were major impacts to our earnings. And in addition to that was the equity income line situation which was unexpected and was a result of some rather late information that we received relative to our joint venture company in Trinidad's resolution of their financials for the quarter. And -- that is -- both of those items were unavailable at the time we gave guidance in the fourth quarter of year-end conference call.

What's the frequency of reporting from the Trinidad joint venture; is that more of a quarterly level?

It is quarterly. It is not as timely or as accurate as we would like it to be and, you know, that's one of the things we are working on improving. And one of the good things that I think it's going to reinforce that, Lorraine, is that, as Doug was talking about in terms of relationships with the banks; we are a little bit at the mercy of Trinidad time down there, but the banks are insisting in terms of any new financing our instruments that these financial documents be prepared timely and quarterly. So, I think you will see all of this sort of roll together into a much more professional kind of reporting package.

And then just touching on the pension expense for a minute; you had said in the 10-K that you would have about $1.3m in addition costs in '03; were those all taken in the first quarter or should we expect further charges throughout the year?

No, that well might would be spread throughout the year. So, we are fortunate that impacted the quarter and then as I mentioned, in addition there were some, essentially one-time charges of approximately $1m in the quarter we have now recurred. So, my comment earlier on SG&A was, you know, business of normalizing SG&A taking $1m out of the number, approximately 3 to 4 cents a share.

And then finally, could you just walk us through the consumer business? Have you divested all of the non-core or businesses that you were planning to discontinue and then profitability going forward?

This is Ted. I would say that that is work-in-process. We are still looking at our consumer business. I would say that they continue to be possible candidates for divestiture and we are also looking at some new strategic directions for our consumer group, and I think we will have more news on that as the year progresses but as Doug had mentioned earlier that this is certainly an area that we are reviewing relative to core competencies and strategic fit going forward.

Thank you.

Your next question is from Tracy Marshbanks (ph.) from First Analysis. Please go ahead.

Good morning guys.

Good morning.

Hitting on a couple of different line items here. You discussed a swing in equity income and I think Doug did a good job of addressing at least the operational issues at the [Sievers cost]; you mentioned a couple of other specific items in there that had hurt you year-over-year; what's your outlook and dynamic on those other items and where you see equity income sort of trending?

We basically see equity income trending back upward from where it was in Q1. The items that affected us, the two other things I mentioned were membrane production, the TMA and then the lower earnings than last year for our Mexican affiliate and we would expect to see a rebounding in equity income. So, it's more or less impacts that hit us in the quarter that the damage thus in this [inaudible] of past quarter but we would see a trending upwards in future.

Are the items you mentioned are of similar magnitude or was the [Sievers cost] served the majority of dominant affect there?

No they al contributed to the variance. They are differing amounts but they are all significant that's why I mentioned those three items.

Okay. And in the consumer segment a couple of questions; I just missed exactly what you said about the impact of the margins in your chemicals business, was that the mix change and the lower margins on those -- brought margins down or that there was actually an impact on the margins in the chemicals and what was the dynamic?

No, you capture this properly. Earlier there was mix change with higher revenues coming from our consumer chemical business where the margins were less and that diluted the margins for the month. That was the predominant effect.

Margin percent.

Margin percent, right.

Okay. And we talked before; you actually had business development initiatives ongoing in consumer I believe; did you have, if you will, additional spending out in front of revenue that impacted you in the quarter?

Yes, we are still -- we are running a number of pilot programs in the consumer business as we look at new directions and new opportunities, and, yeah, you are correct we are absorbing some expenses as we run those pilot systems and build those businesses.

And turning to the [Sievers cost] financing; just my perception is, given the conversations that are going on that they are looking for a better deal; last quarter you mentioned looking for a little bit better on interest rate -- it almost seems like you guys are too nicer guys in dealing with the company owing 40% [inaudible]. They were happier with your money then looking for somebody else's. What do you do to sort of shake up the situation, because that sort of - if your whole attitude carries over into a lot of different aspects of running a business?

It's -- you are absolutely right. There is an attitude -- first there is a Caribbean issue here; the things don't move quickly and there is not a sense of urgency in a lot of things that happen down there.

That's why it's a great place for a vacation.

Great place for vacation. It's hard to build a water plant there, but the other side of it is, we've had some direct communications with the bank. I think the banks are anxious to see the financing completed as well because for them having a bridge facility out longer than it should be creates concern. So, I think it's a combination of working with our partners there to increase this sense of urgency. We are working with the banks to let them know that we want to solve the problem too and, you know, I think it's having a desired affect but it's not an easy profit.

Alright. Finally now my wishful thinking question may be -- there have been some of the semiconductor manufactures talking about not dramatic upturns, but an increase in capacity utilization and increase in way for a starts; do you see any signs of life there either on the equipment side or just the throughput in consumption?

Not in the U.S. market in particular -- in terms of the way our business and the semiconductor business flows, most of our business -- the dramatic portion of our business comes from new plants sales, new Fab starts, and we are only seeing those now and very infrequently in Asia, in China, and Taiwan. To a lesser degree our business comes from the run rate on existing facilities that is the service that is required in terms of [region] services or in terms of supplying new parts and filtering equipment services that may occur when plant production is increased to use a greater portion of their capacity. We were starting to see some of that, just some of that, but it's not really enough to make a huge bet, but in terms of the capital equipment side in the U.S. market, really that has been off the radar screen now for the better part of the last two years.

Is it fair to say that your run rate in that group then, you know, what type of proportion is the ongoing business and do you have, you know, approximate number of what equipment was contributing?

Well the service portion of the business is continuing not on a decline basis, right now it is holding its own. The capital equipment portion, both on the power side and the pharmaceutical side, as well as, the semiconductor side seems to be influenced by general economic conditions, and we have talked to other people in our industry and they are all seeing the same picture right now and that is that the pace of investment and new commitments has slowed dramatically and really is only taking place on what you might call an exception basis. So, we are seeing a few orders in that area but as I was saying in my opening remarks, we don't see a major pick up at least in the short-term.

And do you have a ballpark of how at the bottom let see -- what it is at 25m a quarter run rate. Your business, sort of, breaks out between the recurring service and the small amount of the equipment at the bottom of the cycle?

Are you talking in our Ultrapure Water Group or in the corporation as a whole?

Ultrapure.

I think, we will have to look before we get answer that question. I think generally we have not really broken out the capital equipment and service segments of that business, but I can say that given the economic conditions in microelectronics sector in recent years, we have not based a significant part of that budget on our capital equipment sales.

That's as I would expect. Thanks a lot guys.

All right.

Next question is from Chris Josephy (ph.) from [inaudible]. Please go ahead.

Hi, guys. You said that some of the Kuwait profits get deferred, and I was wondering how much that was and where it is in the balance sheet since the deferred revenues from affiliates actually dropped 24% in the quarter that is my first question?

Okay, well the profit that's deferred, first of all, [since] down in deferred revenue from affiliated companies long-term, so if you look at that you will see the number actually went up in the quarter.

So that was 500,000, the other number came down one point [something]?

The other line more relates to advanced payments on that particular contract, so that's short-term that will go up and down, but the long -- the long fees of the deferral is in the line I just mentioned. Now the 25% is what we defer and that's on the equipment sales to the joint venture companies, so to the extent that we are selling equipment to a company that we have an equity interest in we differ a portion equal to our equity interest and in the case to Kuwait that's 25%.

Okay that's it is in both the deferred lines short-term and long-term?

Yes.

Okay.

That goes into the long-term line when that shows up.

Okay. Can you -- I may have missed this in the prepared comments but the sale [count], can you just talk about that individual company's capitalization? You know what their balance sheet looks like right now?

Sure, I mean the value in the plant operates of $100m in terms of construction costs and there is other costs that are part of that that would go into the capitalization, so you know, as you know, we have bridge financing and they have bridge financing of $79.6m, the long-term financing will be higher than that. So it gives you a rough idea of the capitalization of the plant, certainly north of the 100m in the 120 and 130 range.

Okay, and then just house keeping question that I didn't understand from the 10-K. You initially had reached a final agreement, I guess you put this in your press release and talked about it in the last quarter. They got 10m out of Aspro, and also you guys gave them $2.9m in cash, and you guys booked a gain on that of $8.2m, it seems like they got some money back, so I was wondering, have you over accrued there or you know how do you explain that?

We didn't over accrue I mean bear in mind the Aspro piece doesn't or didn't show in our financials, I meant that money was in Aspro so, that piece wasn't on the balance sheet and we had accruals based on a number of items that would come out of the sale that large as you would expect. And we also had -- you know made up our estimates in terms of what we thought would come out in the form of price adjustments and it turned out, we did better than we had thought.

Okay, great, thank you very much.

You are welcome.

The next question is from Richard Eastman from Robert W. Baird, please go ahead.

Yes a couple of questions; first of all on this SG&A line, Dan, you mentioned there is a 1.3m in pension and medical, and another 1m of unknown surprise cost. In the 1.3m is an annual number, so there is year-over-year, there is another 300,000 in that number?

Let me just clarify there Rick, there was a 1.3m in post-retirement and pension related accruals, and what I was trying to say out of that there was a 1m of that would not recurred basically with a special charge.

Yes, so, total of the 1.3m?

Right, but if you are looking for the year, the change in pension cost of a 1.3m will still apply. We had a rate of [a portion] hit us in Q1.

I understand, I just felt -- I have a question on $1m annualized as 4m, who is responsible? Is that a corporate number? I mean, we were surprised by the same number in the fourth quarter.

Rick its -- maybe I missed -- let me try to -- yes the $1m was a charge in Q1 and will not repeat and so, its not 4m for the year.

I know, but it's a 4m run rate for the year and the question is, it's not an insignificant number and I don't know how we can get surprised by a $1m number when we came out of the fourth quarter with a similar surprise, I mean is it just professional fees? Is it -- [so it's] actually what -- where do they go? Why is it a one-time charge? It wasn't--?

A lot of it related to post-retirement charges which related in part to my exit from the company and those are one-time charges. We took all those charges upfront, some of them will be spent in future periods, but the accrual was made all upfront so, that's a non repeat item.

Okay.

That's essentially is Rick, and that's why [inaudible] in the quarter.

Okay let me ask a question; do you allocate this SG&A number to the 4 operating groups internally?

Yes, internally yes.

Can you share with us, the EBIT contribution of the 4 groups in the quarter?

No, we don't have that to that level but I mean as you -- I think--.

We do have it but we have really not disclosed it.

internally yes but--.

You reported in the K that's why I asked, I mean that would be a more helpful number as we sit here trying to analyze the gross margin line, all the profit is leaking away at the SG&A line, so when you are talking about the business groups and the possibility of the business groups, I am not sure that the gross margin disclosure helps us a tremendous amount. Second thing, on the Trinidad project--?

Well let me answer that one with just to say you understand it. What we do every year, at the beginning of the year is that we estimate our SG&A and that's based on sort of normal SG&A charges and we try and estimate what our legal fees going to be, we try and estimate what our accounting fees are going to be, we try and estimate what our pension fees are going to be, and then we allocate to each division, a fixed amount of coverage for the SG&A, so, we ask each business group to cover 'x' dollars out of that and its divided in proportion to things like revenues, number of employees, etc., and each business group is responsible in their pricing, in the jobs they take and so on to cover that amount of SG&A and make a profit. The portion of the SG&A that is an overwrite, and what Dan was describing is in effect some charges that were not contemplated when the original budget was put together. Our fallout what we call the corporate side of things, and those do not get allocated add to the deletions or the business groups. We keep that at the corporate level because if there is an unusual charge it's unreasonable in terms of how you measure performance of an individual business group leader to say well there was an unusual charge that came down and you have to cover it. And we have done a -- use that as a measure of your performance. So we keep that at the corporate level. What Doug was, what Dan was describing were couple of items that sell in that category as he said we don't expect those to repeat to the tune of about a $1m or about 4 cents of share that impacted this quarter, which we don't see impacting the business going forward.

Okay. And just two other things, in Trinidad the profit on Trinidad after this sell comp level was impacted by two things, the higher interest expense and also the unscheduled outages due to the power outages. So essentially you got -- you received no other income from your 40% ownership in this quarter. Is that -- you don't account for those expenses other than they fall the [inaudible] doesn't' show a profit in which case you don't' book another income item?

Yes that's correct. There is a technical advisory agreement that we have with the [inaudible] there is an expense for the [inaudible] that is an offsetting income line of products, but other than that that's correct.

Okay and then just the last question is I just want to circle back for a second on this $16m booking adjustment. The sizeable amount -- I mean did that project gets cancelled or where did that go any explanation for that?

Wasn't a cancellation it was just an error in there back log they needed to be corrected. Without reductions for this goal of a project or a particular project it's a back log error that was adjusted and has the effect of taking bookings down in the quarter by $16m.

Okay thank you.

Next question is from the line of Nathaniel Postofer (ph.) Postofer & Associates (ph.). Please go ahead.

Good morning the $16m adjustment is a significant adjustment and I am not satisfied with the explanations that have been given to-date would you please give us more color?

Okay let me Nath this is Arthur let me ask how are you.

Feeling very good sir.

Let me just say what we normally do when we book back log is on multiyear contracts we only book the first five years of a contract.

Right.

On this particular contract there was a misreporting of that amount and the five year amount was booked twice. And it should have only been booked once and we got that this period so that this doesn't affect anything in the short-term it affects things that in terms of how the backlog looks over the long-term. So what this was a cumulative -- was a correction to cumulative backlog. The real bookings in this quarter as Dan said was $76m, not $60m.

Right.

The real bookings, but in order to adjust the cumulative backlog the only way to do that is to take it out of the bookings now we could have shown it by showing a fifth term, showing $76m worth of bookings which is the true bookings and then showing an adjustment to cumulative backlog which was this double recording in a prior period of a booking, because someone had improperly interpreted the five year rule. But there was no change in actual business, there was no change in the actual contract amount.

Right and that makes to key point in so far as all of that was long-term back log and the correction of that really has no bearing on our outlook for this short-term.

Understood and thank you very much. I had another question for you would you put some color please to municipal orders. How does that order book look?

Well what I -- what we were talking about earlier is you know as desalination costs have come down and membrane technology costs have come down, there are many communities around the world that are water short and have been thinking for years about how they are going to fund their requirements particularly in times when budgets are very tight and they don't know where they are going the get the money and so the timing of our introducing concepts like [build loan] operating have turned especially in the direction of municipal kinds of business because they now realized that water cost are down and this is one of the few ways to get access to new water resources. So, our pipeline of increase of four water reuse surface water treatment and desalination is pretty full right now. That doesn't mean we are going to get the orders; it just means that we are seeing a reasonable amount of activity and we are sort of heartened by that because....

Would you put that inflow request for proposals in comparison with say the quarters of last year? Are you down or above or?

Well, in the industrial area I would say it's anything is down. In the municipal area, I would say it's up compared to a year ago. Now, I just -- I am doing a general think on that and just trying to compare where we were a year ago at this time, but I would say in terms of projects that we are seeing that look attractive both in the United States and as you know there are a bevy of big desalination plants that are going to be build in California, that have come into the area of getting ready for bid this year. There are plants for the Middle East being discussed, so I would say in general in municipal area it's stronger now than it was a year ago and the trend seems to be continuing in that direction based on the fact that people are now realizing that the fact that desalination costs and water reuse cost and membrane technology costs have come down and this represents probably the only reasonable long-term solution to their problem, but as you now that for having followed the company for year these things -- for years is that these things are cyclical. The decisions often take a long time and as many people on the call know that the great job which is going to come [inaudible] and put the first supply income on the table in 2005 was really in the process for a long time, over 6 years and so be able to particularly exact point and time when these things will happen is very difficult, but in answer to your question I would say we are seeing a good trend line in terms of activities in the municipal business.

That's the very message that I wanted. A question for Dan. An earlier caller commented that much of the profit seems to leak away in the SG&A area, but I am interested in attention paid at the gross margin level and perhaps you and Dough could give some color, some expansion on plans to improve that area of profitability.

Sure. I think to comment as earlier the overall margins stayed at 28.5 level and they were up in the number of segments, so I think we were heartened or continue to be in the [inaudible] for holding margins and have moved up very substantially over the last year or so and it's our intent to continue to do that's through the various mechanisms that we have in place, starting with you know, very rigorous bid control, going thorough bids --just really go out to make sure that they are priced in the way that it is satisfying solution, ultimately we will deliver good margins. So, I mean that continues to be a point of emphasis for the business as we go forward.

There are -- and looking at the different business units. There are clearly some business units the company has now, that produced a very low gross margins. Businesses that arguably are not strategic to the company and it's likely that these will make up some of the divestitures you know, come out of this strategy study. Again, margin improvement is an objective looking at businesses with recurring revenue and operating margins in excess. That percent is where we are trying to focus our efforts for businesses that don't hold up to those objectives. Our view is we shouldn't be in them.

Do you have a target that you might look for say 2004, something that we might take away from this call with, Doug?

I am afraid, it's too early for me to make a reasonable estimate for you at this point, but certainly my objective going forward is being able to be clearer with you about our expectations, business, and how we are going to get there.

Excellent. Well, thank you very much. Thanks Arth, you have assembled a great team.

Thanks very much.

We have a follow up a question from Debra Cloy (ph.) from Schroder (ph.) Capital. Please go ahead.

Yes. Thanks very much, and actually a quick comment and then follow up big picture question. Certainly the higher level of disclosure is helpful, understanding the million dollar retirement payment is very helpful and understanding SG&A, I wish we had not to try to get out of you. So, my big picture question is Doug, you have been looking at this company for a longtime. Clearly its encouraging to hear you talk about 10% operating margins and that's something we haven't seen for many years and in fact a quarter ago you were still talking about 7% or 8% operating margin target. What I would -- well I'd like to hear your comment on is as the business has changed we are looking at more of these larger projects that are definitely back-end loaded in terms of there returns, sort of the J curve thing that we have been seeing already with the big global water companies. How do you get there in terms of profitability when you look at your gross margins even though you have stabilized here at 28.5% range or certainly below where they used to be, obviously you can take costs out of the SG&A line, but can you give us any preliminary color on sort of how you get from here to there? It certainly not apparent in the backlog that has com in thus far and what we have been seeing quarter after quarter after quarter?

Let me try the beginning of that, maybe Doug will pickup. As our business shifts more and more to the service side and the supply side of our business; that's certainly a business where the gross margins are higher, more predictable, and more continuous. The place where the gross margins are low are primarily in capital equipment portions of the business. Now, I mean as we have said in various venues on various occasions, if we would have stopped today, selling capital equipment and just working the revenue stream from our service business this will be an extraordinarily profitable company. The problem is, you know, what would you do two years from now? And what would you do for the long term? So there is a -- it's like saying to Gillette stop selling razors and just sell the blades. And that would -- they make much more money on the blades because they basically give away the razors, after a while someone would take over there business. We have the same issue. We feel we have to stay involved in capital equipment in order to make the whole thing work long term. What we are trying to do and I know Doug's going to focus on this, is emphasize the service business, the build-own-operate portion with a recurring stream of revenues and the higher gross margins. So, I think the long term answer to your question is that as the business mix continues to shift more in this direction and capital equipment becomes a smaller fraction of the total mix between -- total revenues between service and capital equipment becomes a lower fraction that the gross margins and the bottom line profit, that I think you were alluding to, can move in the direction that you are asking about.

I would say that there are two things that happen in the short-term, one is, we cull out our low margin businesses which will improve our margins overall. And we focus on controlling our bidding process more tightly so that we're only taking on projects with adequate margins. I think in the longer term though the issue is that, is that the company is going through a period where it's taken on two huge own-and-operate businesses in Trinidad and Kuwait without having -- with an operating base that actually is relatively modest compared to the size of these two projects. So, as we go through the startup phase of these projects they don't -- we don't have the supporting, you know, portfolio of operating plans, producing equity income to support the startup phase. I don't, in the long run, believe that mega projects are really necessarily going to makeup the bull of our portfolio. In fact, I'm more of an advocate for developing a portfolio that has, you know, selected large projects and that's where we think the economics are particularly compelling, but focusing on more of the middle market, which is where the core of our expertise is and where history says we're able to get better operating margins. We're planning to focus resources on the development effort in this area. We think that we can be proactive in developing these business opportunities not being strictly reactive to bids that come in the door, but by going out and trying to be proactive in identifying the areas of the world that we think have a water need that has not been addressed and that we can work with local authorities to develop a solution for their long term problem. And with that strategy should allow us to focus on building a portfolio of own-and-operate plants that has better margin in it than what often happens in these large mega projects which often can be quite competitive.

Well, you're right and that's actually very helpful because certainly though it feels looking at it now is that, you know, we're three or four years away from getting to those margin targets you talked about if we continue to bring in this low margin business.

Right. I -- it's not my intention to take three or four years to get to this target.

Good. Glad to hear it. And last final question, this Trinidad financing being sewn -- has been sewn for many, many months now, are you willing to go, are you willing to go to the point of giving us any sort of a target closure, date?

Well, I think our intent have been [borne] by this before. So being the new kid on the block, I guess, I can take a shot at it. I do believe that this is something that can be completed this quarter. Again it's not a process that we're in control of, but I do believe that we all have the same objective, the banks, Ionics, our local Trinidadian partner, we all do have the same objective of getting this completed and based on what I've seen over the last 30 days I've been here, I think we've made a lot of progress in getting here. So, I would be cautiously optimistic that I can get -- that we can get there.

Okay, that's fair enough. And then assumingly you get there; that we don't have these extra interest costs, that we don't have the unusual power related operating issues, what is the normalized equity income run rate on a quarterly basis out of Trinidad?

I'm afraid I don't think we can disclose that.

Okay.

I think we'd rather wait until we get the permanent financing in place and everything organized, and then I think we'll be more forthcoming on Trinidad going forward.

Are you willing to [inaudible] to even give any sort of a range, I mean between a 0.5-1m or more or less or not at all?

I'd just like to say something about Trinidad. We certainly have taken a lot of heat on the project.

Yes.

But you know Doug and I went down to Trinidad. We actually -- Doug went down on his first day. He was on the plane the first day of his work here and I -- and that was my first assignment for Doug. So Doug and I went down to Trinidad. I will tell you that the long term opportunities and prospects on Trinidad are very bright. This is an island in the Caribbean that is moving ahead vigorously on economic expansion and has a large share of merchant chemical business that supports the economy of the island. We're selling a large percentage of the water to this industrial estate. There are opportunities for expansion not only on Trinidad but on neighboring islands. So long term, we really think Trinidad is going to be a winner and I know we're going to have to demonstrate that by earnings, but we really feel confident about where this project and where efforts on this are undergoing.

Short term, this was a tough decision but I think, as we have been saying long term, it is going to turn out to be an excellent decision and it will give us an opportunity to choose between large projects and medium-sized projects as Doug was suggesting, but we can be in the game and we can be in the game for a whole variety of projects selectively.

In that region you mean?

In that -- not only in that region geographically, but we are wide because the Trinidad project is certainly -- the visitors that are coming to see Trinidad in operation are coming from all around the world.

Right, okay. And well certainly whenever you can give us any guidance on equity income contribution potential there that will be helpful. Thanks very much.

You are welcome. Thanks.

We have a question from the line of Neil Miller from Fidelity Investments. Please go ahead.

Yes, I am still perplexed over the reversal of the backlog item discussed and I am wondering about the accountability for that and I am wondering the implication that that you have got a paper-based system and I am just kind of thinking in the aftermath of the French situation, why through investigation on every rock that could have been turned over and why it wasn't done?

Sure, I mean, you never want to have a backlog adjustment that's it and by the same token, I mean, they do happen and it was something recorded related to the difference between short and long-term backlog in essence and it was a mistake so it was corrected. My point and comment to get on the quarter is to not do some otherwise it would appear that bookings were lower than they actually were, but I mean going forward it's not something we have really seen much of at all in terms of any of our numbers, Our backlog adjustment -- our backlog figures are very reliable but this was something unfortunately that happened and so we fixed it. And I don't see any - I don't see it recurring or being coming or anything to that extent. So, I don't think there is a whole lot to say beyond what we have about it.

Well, I appreciate those comments but I guess they -- there has been a less than satisfactory path that's let up to this -- your adjustment -- whatever it was called last quarter when somebody in $8m write-off for whatever it was on a bad debt and so there has been a whole series of kind of things like this. And so, I guess, the question is though what led to that is the person who oversaw that still employed; in other words this is a material information, historically I think that the company has been sensitive in terms of the opportunities that going ahead based on the bookings?

Right, let me, maybe just make a general comment, I think the record in terms of the number of changes we have made in the financial organization over the last year or two has been pretty substantial and obviously we react when there is a need to react, we do, and that's been our history over the last few years and I feel very good about the changes we made in the organization, we have in place. So, that's not a specific comment relative to this particular item but again this item was something that was part of our review of the numbers, it was discovered with mistake, we fixed it, and...

Just as a comment, this is Doug, clearly improving internal controls of systems is a key priority that I have. We have made significant improvements over the last couple of years but I believe that more action is required to eliminate the potential for these kind of mistakes and to make for more accurate reporting on an ongoing basis. We believe that what we have reported is accurate to the best of our knowledge but I know that we can improve the level of controls, simplify the organization that will allow for more efficient reporting, and more effective control at the same time.

Thanks Dough, I really appreciate that answer and look forward to good path going forward.

Thanks Neil.

This is a follow up question from Chris Josephy (ph.) from [inaudible]. Please go ahead.

Hi I have just one question for Doug. Doug, are you related to Steven Brown?

No I am not.

Okay great, that's good stuff.

Just a confusion; we also used to have Bill Brown on our Board. Bill Brown was the -- was then the Chairman of Bank of Boston. So at one point of time, we had actually three Browns on our Board, all unrelated.

Oh that great, that is second history lesson you have given us. Thank you much; I appreciate two quarters in a row. Thank you guys.

Okay.

Thank you. There are no further questions in queue at this time.

Well, thank you all for joining us on this conference call. As usual if you have follow up questions, please call either myself or Dan Kuzmak.

Ladies and gentlemen, this concludes your conference for today. Thank you for your participation in using AT&T Executive teleconference. You may now disconnect.