奇異 (GE) 2004 Q2 法說會逐字稿

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  • Operator

  • Welcome to the Ionics Inc. second-quarter 2004 earnings results conference call. This call is being recorded. At this time for opening comments and introductions, I would like to turn the call over to the Chief Executive Officer, Mr. Douglas Brown. Please go ahead, sir.

  • Douglas Brown - CEO

  • Thank you very much and welcome, everyone, to our Q2 earnings review.

  • Just as a beginning, I know that I have to remind you about the Safe Harbor provisions; that certain matters I will discuss today and information that I will present will contain forward-looking statements and that you're cautioned that these statements are not promises or guarantees of future performance and are subject to risks and uncertainties.

  • You should review our most recent 10-K and 10-Q and other SEC filings for a discussion of those risks and uncertainties. And you are reminded that we're not obligated to update any of these forward-looking statements in the event there are any change in facts or circumstances or expectations.

  • For those of you who are relatively new to Ionics, I just wanted to just briefly review our business focus. We are in the water purification, equipment and services business; providing ultrapure water for industrial customers; taking seawater and converting it into drinking water or for water for industrial use; treating surface waters to remove microbiological contaminants; and we're able to recycle and reclaim wastewater from waste streams.

  • In short, our mission is to use our advanced water treatment technologies -- these are membrane, ion exchange and thermal technologies, which we have significant experience in. We leverage our extensive plant operating experience because we own and operate over 250 water treatment plants. And we combine that with our comprehensive service solutions to provide purified water to people and industry.

  • The end of the second quarter actually marks my first anniversary as Chief Executive of Ionics, and I thought I would take just a moment to look back at what we've accomplished over the last year.

  • The first and I think most important of course is that we have revised our strategy to focus more on water services and plant operations as opposed to capital equipment sales, which is the Company's historical background. The reason we're focused on this is, first of all, we think it has a more compelling economic model for the Company and for our investors. The revenue streams which we generate tend to be recurring in nature, and the margins tend to be higher. For those that have had an opportunity to review our 10-Q which is filed for the second quarter, you'll see that in that in the second quarter 75 percent of our EBIT before corporate overheads in the quarter came from plant operations, which is effectively water services.

  • The second thing we did was we initiated a reorganization of the Company to streamline our operating structure. We started that process in September of last year, and to date we've implemented about $15 million of cost savings. We see additional opportunities for cost savings in the future, most notably coming from a centralized purchasing activity which we now have in-place (technical difficulty) save us as much or more as we've already saved in the past.

  • The third thing we accomplished was to complete the acquisition of Ecolochem. This was important because it added over $100 million a year in revenue related to water services. And Ecolochem is an organization which offers significant synergies between Ionics and Ecolochem that have the opportunity to be realized.

  • And finally, in the process of reorganizing the Company from a company which was effectively a holding company with a lot of smaller operating entities into one large and integrated company, we have undertaken a process to put everybody on the same reporting platform. And as such we initiated an Oracle implementation that started -- the process started soon after I took over CEO. And I'm happy to report that the Company has actually gone online with Oracle in Watertown in the last few weeks.

  • So a lot has been accomplished over the last year. There's no doubt that we still have a lot to do. But the second quarter I think is showing signs of some of the improvements that are coming through as a result of these activities.

  • The four points that I think will come out of today's review is, first of all, on the revenue side, if you strip out Ecolochem and Desalcott so you can compare our results in Q2 of this year to Q2 of last year, you'll see that revenue increased 12 percent. You'll see a significant improvement in profitability of the Company. EBIT from continuing operations was over $8 million in Q2, and pre-tax profit from continuing operations was over 3 million. Water services, or plant operations as it is defined in our filings, has increased and now represents about 50 percent of our total revenue. And the consolidation with Ecolochem is underway. And again, there are substantial opportunities for revenue growth and cost savings out of the synergies of combining Ecolochem and Ionics.

  • The first slide on the numbers -- this is just looking at the Q2 revenue numbers comparing it to Q2 of 2004 of this year versus Q2 of 2003. And first of all, sales to third parties increased 16 percent. Sales to affiliates -- these are sales primarily to the project in Kuwait and there is also sales -- well, this is primarily sales to Kuwait -- actually decreased in the quarter from the same quarter last year. But overall revenue increased 12 percent. And as we complete the Kuwait project we will expect to see sales from affiliates decline. And we expect to replace those mostly with sales to third parties.

  • The next slide actually shows a quick summary of our P&L for the quarter -- revenues of about 126 million; gross margin of $40 million represents a 32 percent gross margin percentage; SG&A at 32 million is 26 percent of revenue. You will remember when I took over as CEO SG&A was in the mid 30s.

  • Finally, EBIT at $8 million is 6.5 percent of revenue. We in the past have talked about our objectives of getting to 12 percent EBIT margin. We believe we're halfway there. We said we would get halfway there by the end of this year. We think there is still further improvement that we can make throughout this year. So we're confident of our ability to hit 12 percent by the end of next year.

  • And then finally, profit before tax from containing operations is 3 million. You'll notice the income tax number of 4.7. That includes a normalized tax of 1.4 and a onetime write-off of deferred tax assets of 3.3 million. I will get into that a little bit later.

  • Net earnings per share from continuing operations showed a loss of 7 cents a share.

  • This next slide just compares Q2 of 2004 versus Q2 the same quarter of last year. Obviously a significant increase in revenue coming both from the 12 percent increase I referred to earlier and also adding in Desalcott and Ecolochem which are now consolidated in our 2004 results.

  • I think the one thing I'd like to draw your attention to is at the EBIT line where we went from a loss of 3.4 million in the Q2 of last year to a profit of 8.2 million in the quarter for this year. So there's a $12 million profit improvement in the EBIT line for the quarter. We think that that's a significant accomplishment.

  • This next slide takes a look specifically at Trinidad, which is Desalcott, and how that has impacted our financial statements in the second quarter. You notice that revenue generated by Desalcott was about 7.5 million; gross margin 3.5 at 3.6 million; and the EBIT contribution was 2.8. So of the 12 million of EBIT improvement that I referred to in the previous slide, 3 million has come from Desalcott -- the consolidation of Desalcott.

  • The second point, and I think the most important, is you will see that after interest expense Desalcott actually contributed a pre-tax profit of about $0.5 million to Ionics in the quarter. We think that that's a significant accomplishment and a milestone for this project.

  • What are some of the things that are in those numbers -- in the 7 cents loss number that we would view as noteworthy items, nonrecurring items or unusual items? The first is this deferred tax asset reserve. We can get into this a little bit later in the Q&A, but effectively we took a decision to write off foreign tax credits for the US of $3.3 million, which represents a 15 cents a share charge. It's a non-cash charge. We had restructuring charges that net after-tax cost about $400,000. This is most notably the cost of getting out of a facility in Seattle as a result of a consolidation of two facilities into one. We then had third party costs related to the Oracle implementation and the 404 readiness activity. We're paying Ernst & Young as an outside consultant to help us on 404. We're paying Oracle and another consultant to help us with Oracle implementation. Net of taxes this is about $0.5 million for the quarter or 2 cents a share. And then finally, the intangible asset amortization related to the Ecolochem acquisition which is in the numbers that I previously stated is net after-tax about $1.5 million or 7 cents a share. So in total, there's about 5.5 to $6 million in charges here, representing about 25 cents a share. And all of those values are after-tax.

  • During the quarter we did have some significant events. In Israel we actually started up the Magone (ph) plant and we started the process of selling water on a commercial basis. And I think it's important because this represents the first operating privately financed and privately built desal plant in Israel.

  • The second milestone is, as I noted that we've realized a profit from our investment in Trinidad. We still think that there's a lot to do on that project to improve the situation and the profit performance of that facility, but we think it's an important milestone.

  • The third point I mentioned is we started up Oracle in Watertown. That seems to be operating well. And we have a plan in place to roll out Oracle to our other facilities over the next three quarters.

  • Finally, I think another point to note is in our Instrument Business in the second quarter we released a new product line which has been receiving very significant and positive results from the customers. And in fact, Q2 revenue was up about 11 percent over Q1 and the profit margin for that business is now in excess of 20 percent. The EBIT margin is in excess of 20 percent. So we're encouraged by that activity in the (technical difficulty) business.

  • So in summary for the quarter, we think it's been a good quarter for the Company. It's healthy revenue growth, both with Ecolochem and Desalcott and as a stand-alone basis; significant in profit improvement for the Company, both being able to produce significant EBIT and significant pre-tax profit. Our water service revenues have increased and now represent 50 percent to total revenue. And the consolidation with Ecolochem is well underway and we see significant opportunities going forward.

  • We're very encouraged about the rest of the year. So far on a pre-onetime charge and pre-amortization basis we've reported about 30 cents a share of earnings for the first two quarters. And we think that we will be about 70 cents a share for the year. So we're cautiously optimistic about the future for the Company.

  • At this point I'd like to open the call to questions and answers.

  • Operator

  • (OPERATOR INSTRUCTIONS) Tracy Marshbanks, First Analysis.

  • Tracy Marshbanks - Analyst

  • A couple of questions. It looks like the two big swing factors (technical difficulty) quarter to the second quarter are Ecolochem and Desalcott. So maybe if I can just sort of focus on those for my part of the questions.

  • On Ecolochem in the first quarter (technical difficulty) a little bit light. You talked about revenue recognition. And in the second quarter it looks like it's about at the same run rate, and there had also been a seasonality. It looks like the second quarter as far as revenue maybe came in a bit light. Could you discuss the dynamics there?

  • Unidentified Company Representative

  • Well, in Q1 it's true, we only had half the quarter consolidation; Q2 we have had the full quarter. There has been some improvement in Q2, but there's no question that there's been a -- the market in the US in the power industry is notably soft. There's excess production -- electrical production capacity in the US. And that is affecting Ecolochem's domestic business. Their international -- and their domestic business is operating below budget. Their international business is operating well above budget, and we're seeing strong growth opportunities, particularly in Europe. And in fact, this is one of the things that has led overall to Ionics being in a situation where our domestic profitability is off what it was historically and our international profitability is higher, which is effectively what led to the decision on the deferred tax asset.

  • Tracy Marshbanks - Analyst

  • Were there revenues that were moved from first quarter to second quarter, as you discussed in the first quarter? And so kind of what was the underlying run rate? Or were they not significant?

  • Unidentified Company Representative

  • They weren't significant.

  • Tracy Marshbanks - Analyst

  • If I go down the P&L, at least to the gross profit line on Ecolochem, it looks like the gross margin did improve versus the first quarter back to maybe it's more historic levels. It seemed like the first quarter was a bit low, even though the revenue run rate was similar. Anything moving on the gross margin line?

  • Unidentified Company Representative

  • There were some cost reductions as a result of the consolidation with Ionics that helped help that. I think there's also -- they have just gotten some improved efficiencies.

  • Tracy Marshbanks - Analyst

  • So the calculation is correct; they did a (technical difficulty) their own margin. And sort of the same drill on Desalcott. Revenues looked nice. Was that part of the expansion kicking in; just an exceptional operating quarter? And how should we view it going forward?

  • Unidentified Company Representative

  • The expansion came in toward the end of the quarter, so it helped a little bit. We expect to see further improvement in Q3. And I think that mostly it was -- there was better online percentage for the plant in the quarter so they were able to make the 100,000 cubic meters a day on a more reliable basis.

  • Tracy Marshbanks - Analyst

  • Then just a little reconciliation between what I saw in the presentation and what I tried to pull out of the Q on Desalcott. The Q, I think it mentioned something about 1.3 million coming in on operating expenses. And in the overhead -- they weren't moving correctly, but I think it was 800,000. And the gross margin, if I calculated it based upon information on the Q, was a little bit higher than you had (technical difficulty). Is there a (technical difficulty) of those?

  • Unidentified Company Representative

  • I'm going to have to take a look at that.

  • Tracy Marshbanks - Analyst

  • Page 27 of the Q.

  • Unidentified Company Representative

  • Let us take a look at it and we will come back to that question.

  • I think in Desalcott the thing you have to understand is that there are some income items to Ionics that have to be netted against the Desalcott numbers because we have a technical services agreement that Ionics is paid by Desalcott for.

  • When we consolidate our numbers for the purposes of the slide we eliminate that expense to Desalcott and eliminate the income to Ionics on a consolidating basis. There's also -- on interest line you'll see the interest expense is lower than Desalcott's actual interest expense because part of the interest (multiple speakers) Desalcott is interest paid to Ionics, which we then eliminate from interest income to Ionics and we eliminate it as interest expense to Desalcott.

  • So I think that the material on the slides is accurate when you look at it consolidating and netting Ionics' expenses versus Desalcott's reported numbers. (multiple speakers) the difference. We will take a look (multiple speakers)

  • Unidentified Company Representative

  • We will take a look it again, but that is exactly the right explanation.

  • Tracy Marshbanks - Analyst

  • Thanks a lot. Appreciate it.

  • Operator

  • Lorraine Maikis, Merrill Lynch.

  • Gina Gordon - Analyst

  • This is Gina Gordon (ph) calling in for Lorraine.

  • Just wanted to talk a little bit about the restructuring. What should we expect for the balance of the year? I know last call you said that you expect expenses to take place through the first quarter 2005.

  • Unidentified Company Representative

  • This is for restructuring expenses?

  • Gina Gordon - Analyst

  • That's correct.

  • Unidentified Company Representative

  • Yes, probably on the order of 0.5 million a quarter. I'd say that's probably a reasonable estimate. I think we have -- I'm optimistic that we have found all the big items. But there is still some restructuring related to mostly the facilities as we get out of facilities. The accounting rules say we can't take the charges on getting out of facilities until everybody's out and we lock the door. So that's what causes the delay in that. But yes, I think that 0.5 million a quarter through Q1 next year is probably a reasonable estimate.

  • Gina Gordon - Analyst

  • Sounds good. The gross margins that we soft in the operations segment, the 38 percent, what is a more normalized level that we should expect going forward?

  • Unidentified Company Representative

  • For the plant operations (multiple speakers) or just in total for the Company?

  • Gina Gordon - Analyst

  • The operations business segment.

  • Unidentified Company Representative

  • We have not given a good -- we haven't given a breakdown of that historically. I think that as we go forward we will try and be more precise about our forecasts. But I'd rather deferred that question for the moment.

  • Gina Gordon - Analyst

  • Also, backlog and bookings. Can you provide some numbers?

  • Unidentified Company Representative

  • We've reported the backlog in the Q.

  • Gina Gordon - Analyst

  • Maybe I just overlooked that.

  • Unidentified Company Representative

  • (multiple speakers) 424.

  • Gina Gordon - Analyst

  • How were bookings through the quarter? How was activity through the quarter?

  • Unidentified Company Representative

  • Bookings are reported -- this is an issue that I think we have to try and address. The way we report bookings is peculiar, because the Company books capital equipment sales as backlog on the date that it enters the contract and it takes the full value of the sale.

  • When we have a plant operating contract what we historically have done is book five years of plant operating revenue. And so if you look at Desalcott, which is consolidated, and therefore consolidated in our backlog number, we take five years of revenue into the backlog, and then as we use that revenue we don't replace it until we get down to one year of backlog. So we keep -- for older contracts we keep one year of plant operating revenue in the backlog. For a brand-new contract we start with five years. And so what you see is in the case of Desalcott, we're using about 7 or 8 -- $7 million a quarter of revenue out of backlog and we're not replacing it in backlog. And that's true for all of our plant operating activities.

  • Our bookings then for the quarter ended up at about 86 million. And the difference between the bookings and the revenue are largely associated with the plant operating side of our business, which is using that five years of backlog that we previously recorded that we're not replacing.

  • I think it's a policy that we need to review. It's a little hard to understand from my perspective why you'd want to keep five years of operating revenue in the backlog number.

  • Gina Gordon - Analyst

  • Thank you for the clarification.

  • Operator

  • John Quealy, Adams, Harkness, Hill.

  • John Quealy - Analyst

  • Congratulations on a solid quarter. First off on the revenue line item, last quarter you mentioned you got six microelectronic orders, roughly $19 million. Can you talk about how that business looks moving forward? We noted some softness in some of the semi-cap equipment stocks earlier this month or last month. Can you talk a little bit about your visibility and expectations for that segment moving forward?

  • Unidentified Company Representative

  • I don't think we had any -- we had a couple of microelectronics orders in the quarter, but nothing significant. But there's a lot of quotation activity there, so it still seems to be fairly active. But the bookings in the capital equipment business is lumpy. So Q1 was very strong; Q2 has not been so strong. But from the sales pipeline it still looks like it's a fairly active market.

  • John Quealy - Analyst

  • Moving on to Trinidad, right around a 7 percent pre-tax margin, Doug, can you go into a little bit more detail on how exactly that operation did get to the positive number down in the bottom line here; the steps you took and the steps you're taking moving forward to hopefully keep that line nice and firm and growing in the future?

  • Unidentified Company Representative

  • Obviously we're working closely with our local partner there because they have responsibility for operating the plant. I think they have done a good job of controlling expenses. We've seen increased output from the plant in the quarter. We've successfully implemented the phase five expansion which increases the capacity from 100,000 to 109,000 cubic meters a day. And that's going to add basically 9 percent our revenue number.

  • So I think what we've been doing is working effectively with our local partner to get production up and get the online the reliability higher. There is still more that I think we can do, but I would say that that's the main reason for the improvement in the Desalcott results.

  • John Quealy - Analyst

  • In terms of the language you used in the 10-Q on the spin-out of the Consumer Water business, can you clarify a bit that for us in terms of the size of the operation you're looking to spin out there and any additional comments you can give us on that particular transaction?

  • Unidentified Company Representative

  • That particular spin-out was a small subset of the Consumer Water business. It's really in a couple million dollar revenue range per year. So it's essentially a fairly small piece of that business and it's the retail end of our Consumer Water business.

  • Unidentified Company Representative

  • In the water softener business Ionics had historically owned a number of the dealers as a wholly-owned dealers. When you look at our Consumer Water business, almost all -- most of the businesses conducted through independent dealers. We made a decision to convert those wholly-owned dealers to independent dealers so that we would not own any dealers going forward.

  • John Quealy - Analyst

  • My final two questions. First off, Doug, you mentioned the new products in instrumentation. Can you touch on a little bit what end markets they are geared for; and secondly, if you've done any cross selling as it were with Ecolochem at this stage on Instrumentation Group?

  • Douglas Brown - CEO

  • The markets that they serve are the same markets that we serve -- microelectronics; they're very big in pharmaceutical and also in municipal applications. Their real forte is TOC analyzers. And we have been working hard to get cross-selling synergies out of the instrument business for both Ecolochem and the rest of Ionics.

  • There has been some good idea sharing in terms of new product development. They recently came out with a new boron analyzer that came out internal discussions between microelectronics group and the instrument group. So we're looking for ways to get ideas that lead to new products as well as cross-selling opportunities as well.

  • John Quealy - Analyst

  • My last question -- with regard to the year guidance for calendar year '04, you mentioned a 70 cent number, again excluding someone times, etc. That's a little bit ahead of where the Street is right now for '04. Doug, can you talk a little bit about what gives you the added confidence into the visibility of that number this quarter moving forward?

  • Douglas Brown - CEO

  • That's also pre-amortization. We feel that the costs reduction efforts have been solid. We've got fairly good visibility on our plant operating side, which if you look back again at the -- in the Q you see that the plant operation side of our business is generating 75 percent of our EBIT pre-corporate overhead. And that's mostly a recurring revenue forecastable business. So in fact, when you run that number of 70 cents, you see that it is actually a pretty conservative estimate going forward, and so that's why (technical difficulty) with it.

  • John Quealy - Analyst

  • Thanks very much.

  • Operator

  • Adam Tomoro (ph), Intrust Capital (ph).

  • Adam Tomoro - Analyst

  • I just had a couple of quick questions. The first is I just want to clarify the second half guidance. I guess pro forma it sounded like you say you earned 35 cents in the first half of the year.

  • Unidentified Company Representative

  • 30.

  • Adam Tomoro - Analyst

  • 30, okay. So in the back half we're expecting 40 cents?

  • Unidentified Company Representative

  • Right.

  • Adam Tomoro - Analyst

  • So when I look at the estimates out there of 43 cents, sort of in line with I guess where people are.

  • Unidentified Company Representative

  • Right.

  • Adam Tomoro - Analyst

  • I had a couple of quick questions. Why was the backlog down 40 million from the first quarter to the second quarter? What was happening there?

  • Douglas Brown - CEO

  • I started to get into that I think with Gina. You want to take this?

  • Unidentified Company Representative

  • I think as Doug was trying to explain earlier, a part of that decrease relates to just the manner in which we book the backlog. And specifically, if you look at Desalcott where we have recorded five years worth of revenue in backlog, there will be a play out of that every quarter. That had an approximate $7.5 million detrimental effect on backlog this quarter. So we're going to take a look at this, as Doug indicated, in terms of how we report backlog. But that's certainly one of the significant reasons.

  • We also have the play out of the UDC contract, which is Kuwait -- our equipment contract with Kuwait, which over a two-year period is approximately $80 million in revenue. And that's playing out. And that had an effect of approximately $11 million in the quarter. Between those two items, they explain approximately half of the backlog reduction that you just alluded to.

  • Adam Tomoro - Analyst

  • Can you just give me a since which business line the other half of the decline was in?

  • Unidentified Company Representative

  • I think the balance of the decline relates primarily to the Equipment Business, which is somewhat lumpy in terms of quarters. You can't exactly trend it. But two-thirds or so of that decrease is essentially in the Equipment Business and just reflects the activity of the quarter.

  • Adam Tomoro - Analyst

  • It also looks like 1.3 million options were granted in the quarter at around $11. Can you just tell me what they were for and sort of the circumstances for that?

  • Unidentified Company Representative

  • I wish they were $11. They were at the market values at the days that they were implemented. There were two groups of options that were implemented. One was for the senior management team of the Company, and then a more broad section of options that was issued to a larger number of employees across the Company. They were all priced at the stock price on the date of issuance -- the market price of the date of issuance. So they were not issued at $11. I think a lot of people would be happy if they were.

  • Adam Tomoro - Analyst

  • I would have to check in the Q. I thought that's what it said.

  • Also, what were the foreign exit it exchanged effects on revenue in the quarter? You said that Ecolochem had strong international revenues. Was FX a benefit in the quarter?

  • Unidentified Company Representative

  • FX was not a big player in the quarter (technical difficulty) 4 or 500,000 at most.

  • Adam Tomoro - Analyst

  • My last question is free cash flow targets for the year. I think it looked like you burned 7 million in the quarter, 17 million year-to-date. I thought previously we thought we were going to generate 30 to 40. Is that still an accurate target? Are we still shooting for that?

  • Unidentified Company Representative

  • I think that is still accurate. We had a considerable usage of cash for working capital, specifically receivables in the quarter which we will see play out over the next two. And essentially, as I'm sure you noted from the cash flow, we paid down debt of approximately 7.5 million as well in the quarter.

  • Unidentified Company Representative

  • Net of debt repayments the quarter was basically cash break even.

  • Adam Tomoro - Analyst

  • I'm sorry. One last quick one. I see the first quarter it looks like you restated revenues down a couple million from where it was reported in the first Q. I'm just curious what sort of happened; why the shift down in revenues?

  • Unidentified Company Representative

  • What happens when we make a decision to put something into discontinued operations as we did with the general Ionics business that we just talked about a few minutes ago, we go back and extract the impact from all the prior periods. So that's the only changed to Q1.

  • Adam Tomoro - Analyst

  • Thanks a lot.

  • Operator

  • Debra Coy, Schwab Capital Markets.

  • Debra Coy - Analyst

  • First, let me just try again to clarify your 70 cent outlook for the year. I thought what you said was that it was 70 cents pre-amortization.

  • Douglas Brown - CEO

  • Correct.

  • Debra Coy - Analyst

  • The intangibles amortization this quarterly about 7 cents?

  • Douglas Brown - CEO

  • Right.

  • Debra Coy - Analyst

  • So would we subtract 14 cents from the 40 cents for second half (multiple speakers) outlook (multiple speakers) for second half?

  • Douglas Brown - CEO

  • After amortization, it would be about -- yes. That's about right. And then there would also be some other -- some small non-recurring charges.

  • Debra Coy - Analyst

  • That would not be included?

  • Douglas Brown - CEO

  • Right.

  • Debra Coy - Analyst

  • Similar to what we had in this quarter?

  • Douglas Brown - CEO

  • Right.

  • Debra Coy - Analyst

  • Because the way you talk about intangibles perhaps is I think a little different from how other people tend to include it in the overall earnings number. So your earnings for this quarter would have been 17 cents on an operating basis if we took out the intangibles?

  • Douglas Brown - CEO

  • 18, yes.

  • Debra Coy - Analyst

  • I just wanted to clarify. So I think what you're really saying is that your guidance for the second half of the year is considerably below where the Street is at about 13 cents a quarter.

  • Unidentified Company Representative

  • That depends on --

  • Debra Coy - Analyst

  • On how people are measuring --

  • Douglas Brown - CEO

  • Yes, I think some of the Street guidance is coming before asset intangible amortization.

  • Debra Coy - Analyst

  • Then I guess we will each of us sort that out for ourselves. I just wanted to clarify how you were looking at it.

  • On a further clarification on the power market, you said that the reason that you had taken that tax asset write-off was because of weaker profitability in the US relative to your foreign earnings. Can you give a little bit more color about what you're seeing in the power market in terms of why it made you change your tax asset assessment and also how you expect that market to play out in the second half of the year?

  • Douglas Brown - CEO

  • Yes. The power market is a contributing factor to the softness in the US, but it's not the only factor. When we look at our overall profitability we had a substantial increase in international profitability and a decline in domestic profitability, which caused us to take a look at the foreign tax credits on our books. And the prudent thing to do from an accounting perspective was to take a reserve against it.

  • The power industry, the softness in the power industry, contributed to that. But it wasn't solely responsible for it. The power industry in the US is softer. It has clearly had a negative effect on not only Ecolochem's business, but Ionics' business in the power sector. We are actively and aggressively looking to generate business in other markets such as refining and petrochemicals to (technical difficulty) for that because we don't expect the power sector to recover in the second half of this year.

  • It will recover as the economy improves. And this is a natural part of the cycle of post-recession where there was significant buildup of capacity in the industry in the US, and as the economy improves that excess capacity will get consumed and the power industry will again start to see utilization rates go up. But it's going to take some quarters to see the effect on our business.

  • Debra Coy - Analyst

  • So you're redeploying those assets where you can?

  • Douglas Brown - CEO

  • Right.

  • Debra Coy - Analyst

  • And then just related to that, on the margin line you mentioned in the Q that if you consolidate in Desalcott and Ecolochem it added a little over 10 percentage points of margin to your operations line. And so if you back that out it actually looks like the gross margin on the operations business is actually a little bit below where it was last year. I know we've restated and things have changed around, but I'm just trying to get a sense of how you see the margin trend going in the underlying business.

  • Unidentified Company Representative

  • It's true that the consolidation at Desalcott and Ecolochem both had an upward lift in terms of the overall gross margin and operations. And in the case of Ecolochem, we have the benefit for of course a full quarter as opposed to a partial quarter in Q1. But I don't think that the margins dropped appreciably on the beforehand side. Let me take a quick look at that.

  • Debra Coy - Analyst

  • I'm just looking at the 28 percent that you had last year. And I guess the more relevant question is whether the normalized margin and operations is about 38 percent going forward.

  • Unidentified Company Representative

  • I think that's indicative of the margin rates in that segment of the business, absolutely.

  • Debra Coy - Analyst

  • Fair enough. My final question -- Doug, clearly we've seen a nice and rather dramatic improvement in Trinidad in the quarter. And you have said you think you see some additional opportunities there. It sounds like perhaps you're working a little better with the local partner. What's your thought on the outlook for resolution of ownership issues down there over the next, call it 12 months?

  • Douglas Brown - CEO

  • I'd love to be able to answer that question, but if you can understand I'd rather not at the moment.

  • Debra Coy - Analyst

  • I do understand. And I guess is it sort of business as usual for the foreseeable future?

  • Douglas Brown - CEO

  • Well, it's not going to be business as usual, but I'd rather not talk about the outcomes at this point.

  • Debra Coy - Analyst

  • All right. Fair enough. Thanks very much.

  • Operator

  • David Kurtzman (ph), Needham & Company.

  • David Kurtzman - Analyst

  • Most of my questions have been asked, but one housekeeping. If you had reported a profitable GAAP number what would your diluted shares have been?

  • Unidentified Company Representative

  • I'll have to take a look at that. Can we get back to you on that?

  • David Kurtzman - Analyst

  • The reason why I'm asking is because when I sort of calculate the restructuring, the system development and the charge for deferred tax assets, the deferred tax assets I do get the 15 cents that you guys show, but on the restructuring where you guys show a penny a share and the systems development 2 pennies, I'm getting sort of 1.6 pennies on restructuring and I am getting the 2 pennies on the system development. So maybe it's rounding error, but I just want to see if maybe it was shares.

  • Unidentified Company Representative

  • I think it's probably (multiple speakers) probably some of the movement in the tax rate in the quarter, that's all.

  • David Kurtzman - Analyst

  • One of the earlier questions before was dealing with now that you're sort of -- you've gotten rid of some businesses and so forth, what do you seeing as your sustainable in or sustainable, or shall we say we'll go look out two or three years, your target gross margin and EBIT margins that you're sort of targeting to reach once this business is fully where you want it to be?

  • Unidentified Company Representative

  • Gross margin, we've been a little less well-defined on. Clearly on the EBIT margin we have a target of 12 percent and to get to 12 percent by the end of next year. Beyond that, we think there's additional upside in that. The operating -- the gross margin should be in the upper-30s to even 40 percent. On the operations side we should be able to get into the low-40s. The equipment business gross margins is typically going to be in the low-20s. And then as we increase the percentage of our business that is plant ops that runs in 40 plus percent range, we should see our EBIT margins improve to well north of 12 percent.

  • David Kurtzman - Analyst

  • I'll hop back in the queue. Thank you.

  • Operator

  • Richard Eastman, Robert W. Baird Investments.

  • Richard Eastman - Analyst

  • Just a couple of questions. One is Doug or Dan, could you give us -- actually give us the backlog number that you're carrying on Ecolochem and Desalcott at the end of the quarter?

  • Unidentified Company Representative

  • Sure.

  • Richard Eastman - Analyst

  • (indiscernible) bookings number or so.

  • Unidentified Company Representative

  • The Desalcott number at the end of the quarter is approximately 93; and for Ecolochem, about 56.

  • Richard Eastman - Analyst

  • So in effect the bookings number on the operations at Desalcott in the quarter is kind of 0?

  • Unidentified Company Representative

  • On bookings it is 0 from Desalcott. Yes, that's the phenomenon we described. And backlog will reduce but there's no bookings.

  • Richard Eastman - Analyst

  • So the bookings number on the core Equipment Business was in the 86 million range?

  • Unidentified Company Representative

  • Yes, exactly (multiple speakers)

  • Unidentified Company Representative

  • Not on core equipment. The bookings -- the overall bookings level for the business was in the $86 million range.

  • Richard Eastman - Analyst

  • Lastly, I'm curious on the equipment side of the business, I know we're supposed to be kind of in the low-20s eventually, but we're stuck at 19 to 20 percent from a gross margin standpoint. Is any of the -- what are we seeing there? Is that lower margin backlog flushing through. Is that caused efforts? Is that too much overhead? Why is that number -- how does that number increase 3 to 500 basis points?

  • Unidentified Company Representative

  • When we started last year we were not reporting to the external environment this way, but (technical difficulty) margin on capital equipment business was 15 percent range. And now it's up to 19 percent through a combination of cost reductions. And I think we're more disciplined about our proposal activity now. We're probably going to see less bookings on capital equipment, but the margin will be higher because we're being more selective on the jobs (inaudible). But that does take -- these jobs take a year to work through the shop so there is a lag effect.

  • Richard Eastman - Analyst

  • As we get into next year we should be modeling that more in the solid 20s, low-20s?

  • Unidentified Company Representative

  • Right.

  • Richard Eastman - Analyst

  • Okay, very good. Thank you.

  • Operator

  • Lee Atzil, Elm Ridge Capital Management.

  • Lee Atzil - Analyst

  • Just a few clarifications. Looking back to last year's quarter, I have six or seven different revenue numbers I'm looking at between different analysts, your old Qs and the current report. If you exclude affects of acquisitions and FIN 46, what was revenue last year?

  • Unidentified Company Representative

  • On a like -- the same quarter?

  • Unidentified Company Representative

  • That's the 83.6 right off the Q -- right off the income statement.

  • Lee Atzil - Analyst

  • That is not restated for the impact of FIN 46?

  • Unidentified Company Representative

  • No. FIN 46 impact to us was Desalcott, which if you look at this year's revenues there's about $7 million included as a result of that. But those would not have been last year. So the 83.6 does not include any FIN 46 effect.

  • Lee Atzil - Analyst

  • And discontinued operations, what impact did they have? The numbers are materially different.

  • Unidentified Company Representative

  • (multiple speakers) last year we still had Elite that was $20 million run rate (multiple speakers)

  • Unidentified Company Representative

  • Elite, the POU in Europe and General Ionics have all gone into discontinued operations since that point in time. So there's an adjustment to revenue for those in the aggregate, which is -- hold on I will get it for you. Right, but (multiple speakers) wanting to put it back in. I will have to get that (multiple speakers) the 83.6 has all the discontinued operations revenue extracted, and it does not include any thing for FIN 46. I can tell you that in Q2 of this year Desalcott is about 7.5 million, but I'd have to go back to get the cumulative effect of the discontinued operations revenue.

  • Lee Atzil - Analyst

  • What I'm trying to get that is it would be helpful if you were to provide us with historic like-for-like financials because looking at Street models and your various financials -- historic financials for various periods you get different numbers, and it's difficult to get at what the organic revenue growth rate is. So if you can provide that, that would be helpful in the future.

  • Unidentified Company Representative

  • That's why I did that slide. I think it was the fourth or fifth slide of revenue excluding Ecolochem and Desalcott from Q2 of '04 versus Q2 of '03, and that was on a like-for-like basis.

  • Lee Atzil - Analyst

  • But then last quarter changed and you can look at basically trends, so that would be helpful.

  • But I guess another question -- previously you were asked about the options. I guess the caller mentioned it was issued at $11.40. On your Q it does say $11.41.

  • Unidentified Company Representative

  • That's a typo.

  • Lee Atzil - Analyst

  • That's a typo?

  • Unidentified Company Representative

  • Let me just take a look at that. I believe that's due to an analysis that effectively represents the weighted average fair value. Let me come back to you on that.

  • Unidentified Company Representative

  • That's exactly what that represents.

  • Lee Atzil - Analyst

  • Weighted average fair value would still -- that's a relevant number, so what the caller was getting at is that they were granted below the market, or is that wrong?

  • Unidentified Company Representative

  • (multiple speakers) they were not granted below market, no.

  • Unidentified Company Representative

  • They were standard ten-year options granted at the closing market price on the date of issue.

  • Lee Atzil - Analyst

  • I'm sorry. So what was the weighted average share value? Was it a typo or --?

  • Unidentified Company Representative

  • The exercise prices on these stocks were between 23 and $25 a share. Depending on the date of issue, the exercise price was the closing price on the date of issue. And in some cases it was $23 a share and in some cases it was $24.90.

  • Lee Atzil - Analyst

  • So this is the value of an option, is what you're saying, is $11.40?

  • Unidentified Company Representative

  • (multiple speakers) the option might be $11.40 (multiple speakers)

  • Unidentified Company Representative

  • That's a future Black Scholes analysis (multiple speakers) the value has nothing to do with the price of issuance.

  • Lee Atzil - Analyst

  • How many options are now outstanding at what weighted average exercise price?

  • Unidentified Company Representative

  • I don't have that number of the top of my head (multiple speakers)

  • Lee Atzil - Analyst

  • Because you just granted almost 6 percent it seems. So is it 10 percent higher, 15 percent higher than the basic share count?

  • Unidentified Company Representative

  • About 11 percent.

  • Lee Atzil - Analyst

  • 11 percent higher than the 22?

  • Unidentified Company Representative

  • No, it is 11 percent of the outstanding share (multiple speakers) number of options. (multiple speakers)

  • Unidentified Company Representative

  • Let me check that.

  • Unidentified Company Representative

  • Yes, I believe it's about 3 million shares on 23 million outstanding. Something like that.

  • Unidentified Company Representative

  • Which is 13 percent.

  • Unidentified Company Representative

  • It may be high. The 3 million may be --

  • Lee Atzil - Analyst

  • And what weighted average price strike?

  • Unidentified Company Representative

  • The range from a low of 22 to a high of 45. (multiple speakers) I believe if you look in our most recent 10-K you'll see a schedule of the outstanding options and the exercise price of the options.

  • Lee Atzil - Analyst

  • It just seems like there have been significant grants since the K, so I'm trying to get a snapshot of where we stand now.

  • Unidentified Company Representative

  • This is the only grant that's occurred since the K.

  • Lee Atzil - Analyst

  • I guess the last question is (multiple speakers)

  • Unidentified Company Representative

  • These grants, by the way, happen once every two years or so. The last grant that happened was over two years ago. Except of course my options, which were granted when I joined the Company.

  • Lee Atzil - Analyst

  • How do think of a normalized annual grant; what percent of shares or how do think about that going forward?

  • Unidentified Company Representative

  • We put together a plan -- when the Ecolochem acquisition was being considered, we put together a stock option plan that represented about 10 percent of the shares outstanding. And we said that that was going to last us for three years, three to four years. So that is on the order of 2 to 3 percent issued per year. Now this grant occurred two years since the last date of grant. The next date of grant will probably be -- a significant grant will be two years from or so. But on the order of 2 to 3 percent per year.

  • Lee Atzil - Analyst

  • Perfect. Thanks for taking the time.

  • Operator

  • Tracy Marshbanks.

  • Tracy Marshbanks - Analyst

  • A couple questions that have not been touched done. Generally, on the underlying tax rate the first half in sort of equal to your expectation in the back half. What is sort of the go-forward tax rate? And when might it change back to something a bit lower to occur?

  • Unidentified Company Representative

  • I would say that the tax rate for the year reflects in part some of the valuation allowance charge that we discussed earlier. That resulted in the impact in the quarter in terms of a charge. But also it's reflected in the rate for the balance of the year. So the rate for the year is higher than we would expect on a go forward basis. And I would expect that in the future years to come back down into the ranges where it has been and its influence, as I say, this year in part because of this eval allowance issue around the foreign tax credits.

  • Unidentified Company Representative

  • To the extent that we're able to recover our earnings in United States or approve our earnings in United States so that we -- those reserves we have taken against those tax assets, those foreign tax credits, we have the opportunity to recover them, which would effectively lower the tax rate.

  • Tracy Marshbanks - Analyst

  • For the back half pro forma where you're looking at 40 cents, that's based on what tax rate?

  • Unidentified Company Representative

  • That's based on a tax rate just about 52 percent.

  • Tracy Marshbanks - Analyst

  • That explains some things too. Second question. On Algeria, it looks like the expected date of the long-term financing got moved back. Generally when that's occurring there are specific reasons. Anything additional or insight you could provide on that? Is there a gap and what's causing the gap?

  • Unidentified Company Representative

  • (indiscernible) nothing out of the ordinary we're still targeting for this year. At the beginning of these programs it's a lengthy process, but everything from both ends here and in Algeria are moving forward to close this year.

  • Tracy Marshbanks - Analyst

  • So it's not one of these situations where things changed and you're having to sort of juggle what the project looks like. It's sort of been stable and you're still in negotiations?

  • Unidentified Company Representative

  • Nothing -- the characteristics of the project have not changed at all.

  • Tracy Marshbanks - Analyst

  • Finally, on the membrane business, which comes in through the JV, is that starting to ramp up shipments to Kuwait this quarter? Do we still see a slug of that to come in the back half?

  • Unidentified Company Representative

  • Shipping membranes.

  • Unidentified Company Representative

  • Some have arrived in Kuwait and others are in transit. Most are (multiple speakers) shipped.

  • Unidentified Company Representative

  • So we'll see that impact in the future.

  • Unidentified Company Representative

  • That impact on TMA has not really been significant through the end of Q2, and is something that will be coming through over the next two or three quarters.

  • Tracy Marshbanks - Analyst

  • So we still have the bulk of that to come through and not much in the quarter?

  • Unidentified Company Representative

  • Right.

  • Tracy Marshbanks - Analyst

  • Okay, thanks.

  • Operator

  • Adam Tomoro.

  • Adam Tomoro - Analyst

  • Just two quick clarifications. The first one -- what was the bookings number last year in the first quarter that corresponds to this year's 86 million?

  • Unidentified Company Representative

  • We will get that. Why don't we go on to the next question and we'll get that. I don't have that in front of me.

  • Adam Tomoro - Analyst

  • The second question is a clarification on free cash flow. I sort of use operating cash flow minus CapEx for free cash flow, and that was -7 million in the quarter. What are you guys referring to when you say positive 30 to 40 of free cash flow in the year? Is it not operating cash flow minus CapEx?

  • Unidentified Company Representative

  • No, we're looking at it on the same basis. But again we had a significant buildup in working capital in the quarter. So (multiple speakers)

  • Adam Tomoro - Analyst

  • Sort of follow-up to the bookings. I'm curious what are you guys using for revenue assumptions to get to your earnings targets in the back half?

  • Unidentified Company Representative

  • Flat revenue.

  • Unidentified Company Representative

  • Yes, flat revenue.

  • Adam Tomoro - Analyst

  • From last year.

  • Unidentified Company Representative

  • No, from this quarter.

  • Unidentified Company Representative

  • From the quarter, right.

  • Adam Tomoro - Analyst

  • So the third and the fourth quarter basically look like the second quarter?

  • Unidentified Company Representative

  • Yes, the same ballpark.

  • Adam Tomoro - Analyst

  • Thanks.

  • Operator

  • Nathaniel Pulsifer (ph), Pulsifer & Associates.

  • Nathaniel Pulsifer - Analyst

  • I am unable to go backwards through the slide presentation and I wanted to look at something. Could you ask your tech people how one goes about doing that so we can pull some of the slides back up?

  • You mentioned that there was a new (multiple speakers) product, and I'm wondering if you can talk about that.

  • Unidentified Company Representative

  • We will post the slides on our website, which then you'll be able to --

  • Nathaniel Pulsifer - Analyst

  • They're on the website now and I tried to go back one or two, and unable to do it and I couldn't go back to the beginning.

  • Unidentified Company Representative

  • Right now, the slight presentation is controlled by the webcasting service. After the webcast has finished we will post (multiple speakers) presentation to the webcast, and you will be able to go back and forth through the slides as you would like.

  • The new instrument release is really a replacement for old TOC analyzers and the new line has much more functionality at a lower cost to produce. And so the customers are looking at the performance capability of (inaudible)

  • Nathaniel Pulsifer - Analyst

  • Are these instruments -- the demand for these instruments driven by government regulations or are there industry requirements that make them attractive?

  • Unidentified Company Representative

  • In a lot of cases it's driven by government regulations that say you have to test for TOC. But there are a lot of industrial applications as well where they look for TOC because it affects the performance of their systems and their plants. So semiconductor manufacturers are going to look at TOC because they want to make sure they don't have organics in the waters that they using to process water, whereas pharmaceutical companies have test for TOC because the government says you're not allowed to have organics in WFI.

  • Nathaniel Pulsifer - Analyst

  • Okay, that's good. It was mentioned that there had been some debt repayment during the quarter, but I don't see it in the reports for either Q1 or for Q2. Can you talk to me a bit about that because the balance sheet is certainly skewed during the past three months.

  • Unidentified Company Representative

  • There clearly was debt repayment in the quarter. And that was about $7.5 million.

  • Nathaniel Pulsifer - Analyst

  • That's hardly an amount to stop and take a deep breath about. What's going to --

  • Unidentified Company Representative

  • Well, that's on a debt structure that we just recently took out to fund the acquisition so (multiple speakers) we would characterize it slightly different than (multiple speakers)

  • Nathaniel Pulsifer - Analyst

  • Coming from a company that discouraged the use of debt to where we are know, it's been quite a change. I understand the reason for it. 7.5 million?

  • Unidentified Company Representative

  • Yes, approximately.

  • Nathaniel Pulsifer - Analyst

  • Thank you, gentleman. Good quarter.

  • Operator

  • Matt Hagerty (ph), Penning Capital Management (ph).

  • Matt Hagerty - Analyst

  • Most of my questions have been answered. I just -- you guys used to disclose unbilled recounts up accounts receivable in the Q, and I was unable to find it this time. Do you still do that or is there something different about your business that you don't have significant unbilled AR anymore?

  • Unidentified Company Representative

  • We do. That's a significant piece of the balance, and I will tell you what it is in a minute. It is -- we will get that. By the way, the answer to the earlier question on bookings in Q2 of last year's, approximately $89 million in Q2 of last year. Yes did you take out dis ops out of that?

  • Unidentified Company Representative

  • That's a gross number.

  • Unidentified Company Representative

  • That would actually be less when one takes out dis ops from the operations that we mentioned, probably several million minimally anyways -- 5.

  • Matt Hagerty - Analyst

  • The unbilled AR, if you had that for this quarter and Q1 that would be great.

  • Unidentified Company Representative

  • That's in the low 30s, about $32 million.

  • Matt Hagerty - Analyst

  • For both quarters?

  • Unidentified Company Representative

  • It's Q2. I will give you Q1. A little lower. 28 million.

  • Matt Hagerty - Analyst

  • Can you remind me -- I don't have it in front of me -- what the intangible asset is that you guys are amortizing and how you sort of figure out the economic life? Is it pretty cut and dry or --? I think that came along with Ecolochem, but I am not --

  • Unidentified Company Representative

  • (multiple speakers) across with Ecolochem.

  • Unidentified Company Representative

  • Came across with Ecolochem. It's evaluated on a cash flow basis. And it in the low-70s in terms of intangible value.

  • Unidentified Company Representative

  • And it's a combination of customer contracts, technology, etc.

  • Unidentified Company Representative

  • Which there's a schedule in the Q and it shows the different lives that they are depreciated over. Most significant is the contractual relationships which is depreciated over ten years (multiple speakers) not on a straight line, no on an accelerated basis reflecting the economic assumption.

  • Matt Hagerty - Analyst

  • Is this something you update on a quarterly basis in terms of the cash flow valuation you talk about?

  • Unidentified Company Representative

  • Yes.

  • Matt Hagerty - Analyst

  • Thanks guys.

  • Operator

  • (OPERATOR INSTRUCTIONS) John Quealy, Adams Harkness.

  • John Quealy - Analyst

  • Just a clarification again on the back half of the year guidance. 40 cents in EPS, that's excluding roughly 14 cents in intangible amortization. Do I understand that right?

  • Douglas Brown - CEO

  • Yes.

  • John Quealy - Analyst

  • Secondly, on the cost savings supply program and purchasing consolidation program you're putting in place, you mentioned that it could equal or exceed the savings that you took out over the last year on the SG&A side. Can you talk a little bit about it? Are you one-third complete with that, fully complete? And when can we start to see potential benefits from that?

  • Unidentified Company Representative

  • We've really just started that in Q2 with no real impact on Q2. And I would say to get the full benefit it's going to take us several quarters, perhaps even a year, because the job that they have to do is, first of all, consolidate the purchasing requirements of the Company of all these different operating units of the Company into a central database; understand what are the largest purchase components that we buy. We have to then go after vendors on that.

  • We have done some things already in the consolidation effort in the purchasing area. For instance, we've consolidated all of our domestic travel activity into one travel provider, one service provider, and negotiated better terms and costs associated with that. But again, that's kind of a second half event.

  • We've also had the opportunity to consolidate all of our domestic employees onto one common benefits program where it's actually a couple of programs but it's all provided by one vendor; negotiated very attractive costs there that allows us to deliver for the average employee better benefits and for the Company at a reduced cost, saving us on the order of $0.5 million a year. And that doesn't come through until the second half.

  • So there's a lot of initiatives, but the purchasing area as a whole, it's large task to try and consolidate the purchasing activities of the Company that have been so distributed over the years throughout the organization to consolidate the information, distilled it, and then to go and start negotiating with vendors on a one-by-one basis. That's why it takes a while to implement.

  • John Quealy - Analyst

  • Thanks.

  • Operator

  • Mr. Brown, there appears to be no further questions. At this time I would like to turn the call back over to you, sir.

  • Douglas Brown - CEO

  • I appreciate all of the interest from everybody and the questions. Hopefully you share our sentiment that the quarter was a significant improvement for the Company. We think that this puts us on a track of trend of continuing to improve performance on a quarter-by-quarter basis. As I said in the beginning, there's a lot we've accomplished over the last year, but there's still an awful lot to do to realize our full potential. I appreciate the sport of our investors and our employees, and we will be looking forward to talking to you again in three months to review the next quarter. Thank you very much.

  • Operator

  • This does conclude today's conference call. At this time you may disconnect.