奇異 (GE) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the ZENON fourth-quarter and year-end 2005 results conference call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS). I would like to remind everyone that this conference call is being recorded on Wednesday, March 8, 2006 at 10 AM Eastern Time.

I will now turn the conference over to Andrew Benedek, Chairman and Chief Executive Officer. Please go ahead, Mr. Benedek.

Good morning, ladies and gentlemen. We're now reporting for our watershed [honors honorable] this year. We are finally reporting it, and we are over it. We are starting the new year now. We started new year with an increased backlog that bodes well for our revenue, and we now have the capability of producing the product unlike in the year past.

The most important issue as you'll know has been our ZeeWeed 1000 manufacturing line. This line is now very close to what it was originally intended to. It's running at the targeted rate -- within 10% of targeted rate. We are very comfortable with the process, so we are beginning now to go to the next stage of production, which we intended to do as soon as we're comfortable with the first phase. The good news is that because of our backlog, pretty much all of what we're going to produce even with the expansion that's happening is directed to the backlog.

We are going to continue to improve on all fronts and Rafael will outline that after John Barker, our Chief Financial Officer, who speak to the financial numbers. John?

Thank you, Andrew. To start with, our revenue in the quarter was up 2.3% from last year and 1.9% year to date. As Andrew said, the major impact of that revenue -- low revenue increase was the impact of the V3 throughout the year and into the fourth quarter.

Gross profit -- gross profit was disappointing at 23.2%. But we looked at gross profit on the year at 32%. Typically, we have a lower gross margin in the fourth quarter. We had some project issues and V3 issues which continued through, especially in the beginning of the quarter; that accounted for about 9% of our margin. So if we looked at it, our margin in the quarter without those issues would have been above 30, which typically we've seen in the past in the fourth quarter.

Selling, general and administration were at 32% of revenue again. As we've mentioned in another quarters, we have made investments this year in various offices, new sales offices for the growth that we see in the future. That has impacted the cost, and we look at it as partly an investment for the future. Rafael will be talking more about our position in the future on SG&A.

In general, we do as management believe will still be -- our target is below 25%.

Just a quick note on amortization on the quarter that reflects the commercialization of our V3 product and just some other increases in amortization and depreciation in the quarter. Our operating loss is $11.3 million for the quarter, 13.9 million year-to-date. Again, that reflects the issues that we have had all year. A point of notice, our provision for tax came in at 44%. We did have a favorable tax ruling, which allowed us to write back some tax in the amount of $1.7 million. The tax rate without that write-back was an actual effective tax rate of 30% and just under 30% for the year. That was up from our 20%, but it's generally just because of the loss in the geographical allocation of that loss to higher tax areas, especially Canada.

A quick comment on that -- on the cash flow. Overall, our usage of cash in the quarter was $20.8 million, partly coming from the loss. But I think the majority we can look at is looking towards the future. We did have almost $14 million of capital assets purchased in the quarter, which was a split between our both membrane plants -- manufacturing plants, both in Hungary and Canada. And we had the payment for the acquisition of our Alpha Plan business in Germany of 6 million. So that amounted to almost the $20 million that was used.

(multiple speakers) Thank you, John. Rafael?

As you mentioned, the manufacturing ramp-up of the ZeeWeed 1000 is going well; our production is strong now. We will be delivering all of our orders in 2006 that we need to deliver. We continue to have strong bookings for the ZeeWeed 1000 project for the ZeeWeed 1000 product, so we see a strong future for this product now. In addition, in our Hungarian plants with our ZeeWeed 500 line, we are running at full capacity right now and we are working on our expansion there to be able to support future orders as well.

We are continuing our process of restructuring our operating model and reducing our expenses. It's now several months into this program. We are confident that we will see a decrease in our overhead in 2006 over 2005 levels, an absolute decrease in dollar amount despite continued revenue growth in 2006 to record levels. We're doing this through efficiency, improvements in all aspects of our overhead and both in selling and in G&A areas.

On the positive side going forward, we're very proud of the technology improvements that we have made and that we are continuing to make and that are now being reflected in our current bidding activities both in the water and wastewater categories. We're seeing significant improvements both in our manufacturing and in our system design and our process design. We see a very strong future going forward for continued technology improvements.

Thank you very much, Rafael. We now stand ready for questions.

(OPERATOR INSTRUCTIONS). Bert Powell, BMO Nesbitt Burns.

Thanks. Andrew, the $7 million order you lost in the quarter, was that for the ZeeWeed 1000 or ZeeWeed 500?

John, do you--? I believe it was an order in Hungary, and I think it was an order for the 500 if I recall correctly.

Can you maybe give us a bit of color as to why that was canceled? Also, I know you guys typically realize some cancellation fees associated with these type of events.

I believe that the order was basically canceled because of the financing required by the government. It was a relatively small order for capital equipment, but it was a longer-term support component as well. I think there is a cancellation fee here because the structure of this particular small capital order.

So, there's no cancellation fee with it?

I don't think so.

Andrew, in your press release, you talked about seeing competitive pressures, which could have a negative impact on profitability, and that -- you expect that kind of to be somewhat short-term. I am wondering if you could just give us a bit of color in terms of where you're seeing the most competitive pressures. Is it on the industrial side, municipal? Is it membrane bioreactors? Is it across the board? Can you just help us see a little bit what you're -- when you look out on your landscape, what you're seeing?

Sure. I will give you a -- if you don't mind -- a little bit of a background around this whole issue. When we first started, we had no competition but there was no market. As the market gets created, eventually competition arrives. As the market grows so that it becomes the critical technology in the whole field, clearly anybody in the water business has to react to that. Otherwise, they will not be in the business. So then, it becomes an issue of market share and technological innovation. This happens in every technology area.

In terms of the specific areas where the competition has always been and still is the toughest, it is in the drinking water side. Because all original patterns and technology base was critical for wastewater but was not as critical for drinking water. So that pretty much continues.

What's happened over the years is that as the market opened as competition increased, our technology costs came down and we sustained relatively flat margins. During the last 2 years, we have been really trying to move the latter, the quality of our products to a level far beyond anything we've ever had. Because we think in the long term, that's what will give us the brand value. I believe we've done this now. I'm very proud of our two major products. They are superb products in the industry, and we are positioned well because we have the largest volume.

In terms of competition, the competition is trying to reach the market. Some of the competitors have prepared to do it at a loss simply to get market share. But in the end, we have four times larger volume I believe than our next competitor. I believe that this is a very strong base, and our manufacturing lines are large and automated -- relatively automated compared to anyone else. We believe we have the highest quality. Ultimately, this is an advantage that is very hard to overcome. If you look at the situation in any market, the front guy who's got that kind of market share, market leadership given the nature of technology is very hard to beat -- as an example, Intel in the computer business -- which is pretty much the position we think we occupy in the water business. Does that cover your question?

Yes, I just -- a follow-up to that. So if I look at the trend and if I look at it kind of relative to the backlog, the backlog today as it stands would have weaker margins than last year because of pricing pressure. Now you expect new orders to have better margins, so the backlog that you are booking or the new orders you book this year should have better margin? Or are you expecting that you will have continued pricing pressure this year as well?

I got it. I got it. That's a very important question. Thank you for clarifying your question. Rafael talked about this, but I will repeat. We are very proud of our technological improvement rate and currently having gone through this bad year, we have made dramatic improvements in our technology that makes it very hard for our competitors to push us further down in price unless they really want to lose an enormous amount of money. So we feel that our margins will improve and are improving as we sit here.

Last question, CapEx, you spent 34 million this year. What is the plan for '06?

John, could you answer the question?

I would say we are looking at a major expansion in our Hungarian plant, and our CapEx will be burning at the same levels.

So kind of 35 million, excluding whatever you would have to pay out for any additional payments on Alpha Plan? It's just pure CapEx, John?

Yes, on top of pure CapEx.

Lawrence Casse, M Partners, Inc.

One of the things you mentioned in the release was that the payment cycle -- you were seeing because of competitive pressures some further delays in the payment cycle. It's already a pretty long payment cycle. Could you talk about that a bit? Could you please comment on it?

I think what we've seen with our bidding that the orders are back ended. We are seeing more payments towards the back end. What's happening with the larger orders that we have on this, the order size is growing and the dollars are growing. We're seeing this impacting our balance sheet.

This is merely an issue in the municipal market. Do you expect this, John? That's the question -- to stabilize at this point or--?

I believe it will stabilize. I believe again this relates back to the situation in the marketplace and what's been going on in the last year. So, I do believe it's going to stabilize, and I think saner minds will --

Would you look at an alternative way of financing some of these long-term contracts?

We have done that. We do look at project financing outside of the Company. We have the capability of doing that around the world at this point. So we are talking to our customers in that regard.

I noticed that the long-term debt is now less than 1 million and there's a current portion I guess coming due this year. Are you going to renegotiate your debt line or bank line to deal with financing some of these contracts?

As far as the long-term debt, we expect that to be paid off. But renegotiating the bank lines, we're looking at this -- doing it outside of our own borrowing capabilities through third-party project financing, through more utilization of government funding.

Just finally, you have gone through all of this pain in 2005. You're going to presumably have the manufacturing going back to more normalized gross margins. Could you give us an estimate of what you see the gross margins as looking like over the next year?

We're not into giving you gross margins by department or by product. It's bad enough we have to -- we're the only public Company that reports our numbers the way we are. As you're asking the question, there is I'm sure a minimum of five competitors listening on my answer. So if you want us to give that information directly, this is a good way -- I prefer not to do it unless we have to.

Okay.

I just had a comment. Really, our policy is not to give out future projections.

Finally, in terms of the 1000 serious, if you had to summarize quickly what are some of the main advantages of this product that's going to put you ahead of the competition and also the new improvements you're making on the 500 series, how would you summarize it?

Improved margins. Again, I don't want to go blow by blow.

No.

But let me put it this way. As a policy -- and we've announced this before -- we never enter into any product development unless we think it's better than 20% improvement on product costs.

I meant also from a technology point of view.

Customer point of view -- I'm sorry, what is your question?

My question is the main competitive advantages the new 1000 series product is giving you against the competition from a--?

Products have the same -- every time you do this, we do 20% target. Usually, we reach that or better. We -- on the cost of our space, higher quality; water treated easier to operate; more reliable -- all those things happen every single time. It's exactly like computer chips -- Pentium I, Pentium II, Pentium III. You've been through that. So it's no different.

Finally, I noticed in the last quarter, there was a bit of an increase in the membrane-only revenues. Do you expect to start seeing some of that replacement membrane cycle picking up in 2006?

You should be careful to not go by quarter this kind of things. But the membrane replacement cycle is still relatively low, but (technical difficulty) and probably where it's beginning to show numbers.

Andrew, that also relates to our sales to our licensees, where we are selling membranes directly.

You are right. That's usually what you see right now more than membrane replacements.

When do you expect some significant ramp-up in membrane replacements to start showing?

You know what the problem is that as that's going to happen and it's going to keep happening, our revenue is increasing so much every year relatively speaking. Although, it will be profitable and contribute, it will still be a small percentage of our revenue.

Roland Keiper, Clearwater.

Could you comment on your anticipated 2006 tax rate?

John?

Or at least a range?

Historically, we've always believed we were going to be in the 20% tax range area and don't see that greatly fluctuating.

Could you comment on what type of working capital changes you might anticipate in '06 due to growth and the change in payment terms cited in today's press release that you foresee on a go-forward basis?

I don't think on a percentage basis I can give you an indication. I think we're going to see hopefully not the same growth pattern as we've seen in this year. I would say it would come down a bit. Typically, when we look at account on working capital and the impact of financing, we look at Accounts Receivable, unbilled revenue net of customer advances. If you just overall relate that to revenue, 2003, 2004, we had some very good percentages. We saw that drop in 2005, but the 2005 level was about -- at the same level as 2002.

Let me give you some background on where I am coming from. Last year, your cash, cash equivalent, marketable securities were 115 million at year-end. This year, they are at 41 million I believe for a change of roughly $75 million. Obviously, the drivers there are operating profit, CapEx, and working capital -- are significant elements, and you've made reference to that in your release. You've made earlier comments that the CapEx is going to be similar to last year -- working capital changes. Obviously, you still have some payments due on Alpha -- on acquisitions in '06. But, I would anticipate some reduction in the cash and marketable security combined line item of $41 million. Subject to that, you may even be into the bank line as a way of improving your liquidity position. Do you foresee that you'll be drawing your bank line at some point in time in '06?

It's not our view at this point (multiple speakers). Our return to profitability will generate significant funds. But we will see working capital increases. I don't believe it will stay flat.

The lessons of last year is that we will never start another line by stopping the previous one again. The other one is that we have to really control our growth. It's better to have a little less growth but more profit. It's better to conserve cash. So we are really going to focus as we did 5 years ago with the major miracles on how he handled our cash flow. We're going to be doing similar things. We're not anticipating on the line, nor are we anticipating needing to raise money.

Are there restrictive covenants on that bank line in terms of performance covenants, either fixed charge coverages or EBITDA performance, to have that line available to you?

There are always restrictive covenants. But if you are not borrowing any, who the hell cares?

Fair enough. Just a couple of questions on FX since it's impacting your results in terms of margins, could you comment on your end what is the face value of FX forwards and their average FX rate at the end of '05?

If you give me a moment, I can.

I'm also going to ask what the benefits of FX hedging were in the fourth quarter of '05 as well as for the entire year in '05.

You know what, why don't we come back with that when Johnny is ready? It should be -- it is not in the financial statement.

It will be -- some of which will be in your Annual Report. But it's not yet disclosed in today's release.

Reports right now.

Andrew, I can -- right now, we're sitting on CAD$122.8 million. This was as of year end at a weighted average exchange rate of 1.208.

208? 122 Canadian at 1.208.

Recognized gain on these hedges at the year end was $6.3 million.

Unrealized gain, right?

The (multiple speakers) --

What would you have realized in '05 from your FX forwards that benefits your operating profit from having those in place?

Oh, I can't give you that number; it definitely improves it. But what happens is we buy forwards at the time we book the contract. The intent there is always to cover our -- and protect our margins.

Well, this has had a benefit in '03 and '04 -- sorry, '04 and '05 and given what may have a continued benefit in '06 given where the dollar is. But ultimately if the dollar stops strengthening against US dollars, it no longer has this impact on operating profit.

Well, I think if you looked at our margin over the last 3 to 4 years, we've been able to maintain our margins with a significant decrease in the dollar. That comes back to what Andrew was saying, where the product improvements that we put into improve margins, we have been able to offset our US exchange erosion. We are fortunate to do that.

When we bid an order and we get the order and we can lock in to maintain the margin that we bid on, we're comfortable at those margin rates.

But bottom line, the exchange rate has not been helping the Company. Certainly, the locking in has not been helping. It's just a downside protection from further erosion once you book a contract. If the exchange rate went the other way, that would be good for us.

In terms of how you present your backlog, the majority of your sales are outside of Canada and are likely US dollar-denominated sales. Your backlog as you express it is in C dollars when it is reported. To the extent that you have unfavorable translation -- currency translation in your backlog, is that buried in the backlog number so that you are always fighting the head -- in the past couple of years -- the past year, you fought the headwind if strengthening C dollar. So your backlog in -- had it not been for the impact of foreign exchange would be even larger or--?

I think we're getting into stuff that has no -- sorry, Roland, my apologies -- that has no real difference. We fundamentally have the same policy. We hedge. When we get a contract, we hedge. We lock in whenever we think we sold the job at. We continue to have that policy.

So your foreign exchange, there's no -- it's really when you get a contract, you find a hedge out forward that's appropriate from a timeline for the delivery -- anticipated delivery of that contract or realization of cash from that contract (multiple speakers)?

The only issue hedge has on us is that we have fixed assets in a foreign country, and those are the adjustments of the income -- of the bottom of the income --

No, bottom of the balance sheet.

Bottom of the balance sheet. So (multiple speakers) not on income statement; that's all I have to say.

Could I ask some questions on --

Do you mind, Roland, to finish up because we have limited time, and there is many other people wanting to ask questions.

Okay, thank you very much.

Jacob Bout, CIBC World Markets.

Just where are things at right now with Homespring?

Roland, Jacob, my apologies to both of you. Sorry, Jacob, go ahead.

My question is -- my first question anyway is where do things stand right now with Homespring?

Homespring continues to be an issue for us, and management is looking at making some changes to what we do in that product. It's a great product. We're very proud of it. We have not done as well as we would have liked with Maytag. Maytag is going through a transition, and that's never good for a partnership. We are not a core product to them. So we have been in discussions with them right now.

What type of contribution has this been? Has it been increasing, declining?

It's been a loss that's been significant, not improving. So given the current climate, the commitment that Rafael has made to all of you a few minutes ago, we have to look at this issue.

Then just looking at your revenue, how much has been pushed from the fourth quarter into the first quarter '06? Then, if you can help me out on the macro side of things. I know previously, I think you've made the statement that you expected I think 1 billion in revenue by 2010. What are your thoughts on that as well?

I don't have the exact number of how much has been pushed into which quarter. Fundamentally, a fair amount of our growth this year will come from orders that have been delayed from last year. So I think we can look into that.

We don't have (multiple speakers) --

We don't have a precise number on that.

(multiple speakers) don't have a precise number.

I am sorry, your second question was?

Was just about your projected revenue forecast. I know you've made the statement that you expect to have $1 billion in revenue by 2010 if I remember correctly.

If I can give you -- we're still on that track. This year, we expect we don't give forecast in general, but we can say a little bit different or the normal. Our normal growth rate has been -- average revenue growth has been 24% up until prior to this past year -- have been consistently up or down from that range. We should have no problem beating that this year.

Okay.

We still expect given what we see in the marketplace to continue on a solid footing to get to those -- the $1 billion number as well.

Then just continue on with the revenue here -- when I take a look at the breakdown geographically -- US, Europe, Canada and the rest of the world -- it looks like revenues declined both in the US and Europe, increased in Canada. Is Canada -- is that basically just a reflection of the Lakeview projects? Or what is going on in the US and European market? Is that just issues that you're having with production, or is this increased competition? In the US, would that be primarily from let's say like a US Filter in Europe, Hydranautics? How would that work out, or can you talk to that?

I think the overall situation vary geographically from year to year. I think we have had -- and this is a personal disappointment for me because I was pushing very much European sales -- we've had a slowdown in Europe I think not just for us. I think for other water companies. But some of that also is in the traditional markets. We really wanted to change the operating structure of the European company, and some of that may have also impacted. In terms of the North American situation, there is no fundamental change from the sort of operations we have had in the past.

As far as your market share goes in the US, clearly at one point, you were the clear leaders. Are you essentially neck and neck with US Filter at this point or what is your feeling there?

We're still the clear leader. We believe we are approximately four times larger in revenue than that particular division that is in this business sector. We do have more competition. So overall, we don't have exact numbers on this. But if I add up all the competitors, all the people trying to get in, we are probably losing a little bit of market share. But we're still far and away the leader in the market.

Is there only two competitors that have the submersive ultrafiltration?

There's one main one in the US, and that's US Filter. There are -- because we are the market leader, anybody wants into the market obviously -- especially they don't think our patents are valid, we will want to jump on this horse. As long as our competitor thinks that they're not, other people are encouraged by it. So we are pursuing a lawsuit patiently, and we think we will prevail.

What is the status of the patent dispute?

Rafael, would you like to address that?

When do you expect that to go to trial, that type of thing?

Well, we've already had -- it's a multiphase process. We've already had the first major phase that was done in April/May of last year, and we had a resounding victory in that. We are currently waiting for an appeal process on that phase to go through. Then once that gets through with this appeal, then we would go on to the final phase. This could --

The appeal, what patent was that again?

The appeal is on the victory that we had back in April and May. It's on a patent relating to the module design, a core module design.

Okay.

Which if they are continuing to succeed on that particular loss, we will put out an injunction that US Filter or anyone else breaking that will not be able to produce that product.

We are simplifying a bit (multiple speakers) --

Of selling that product and producing it.

For the purposes of this call, there are several very similar patents involved. It would take a very long time to go into exactly the detail, so -- but we're giving you the general summary.

Thank you very much, Rafael.

I guess I'll talk to you more about this off-line. Thank you, guys.

Sara Elford, Canaccord Adams.

I have a bunch of questions, and I'm hoping perhaps we can start with Rafael, maybe some more detail on your efforts to reduce expenses. Could we -- could you kind of flush that out a little bit and maybe talk about some of the initiatives that you're talking about? Is there -- will we be seeing offices closing, headcount reductions, lower commission rates? I'm just trying to understand how you will do that.

Yes, all of the above there. The background behind this is when you are a growth company growing at 20 to 30% per year for a very long time, revenue growth keeping up with demand and leading the market is the primary focus. We've had a humbling experience in 2005, and it's caused us to reevaluate from a clean sheet perspective all of our operations, all of our sales, all of our project delivery, the way that we are structured geographically, where we are basing our offices, where we are basing our manufacturing facilities, how we're dealing with our expenses, where are we centralized, where are we decentralized?

So as we've looked into all of these issues, we've already made some significant shifts in terms of manufacturing, in terms of consolidating our manufacturing all of our 500 now in Hungary, all of our non-supported fibre in Canada. We are looking at all -- we have cut the profitability of all of our different operations under many different dimensions, ranging from geographic to product focus to different types of delivery models.

As we have made these different cuts and looked at the different variances and obviously when you do segmentation like this, you're going to see profitability -- it's real popular in some areas and less profitability in others for all the different areas, whether they be geographic, product based, delivery based models, we have -- the ones which are not profitable, we have looked at -- is this an area that we can turn around or is this an area that we want to cut?

So we're continuously reevaluating and making adjustments to our business model. As I mentioned upfront, this is now in hindsight a long overdue process, so we've seen a number of improvements. On top of all that, we are enforcing some very strict controls on our expenses and a whole -- on virtually every area that you would segment selling, general, administrative costs in in putting cost controls across the Company.

So given the less focus on this than there should have been in the past, we are able to see some pretty substantial changes. As I mentioned, this is going to result in a significant decline in SG&A in the absolute dollars compared to a -- along with the growing revenue, which on a percentage base will give us a very -- much improved performance even as well.

Can you just elaborate a little bit further in terms of where you are in that process? I'm just trying to understand how -- closing offices and reducing headcounts and doing all those things basically costs money upfront in order to affect the benefits of it. Will we see some -- in the 2005 results, are there some provisions for those things in your SG&A? Additionally, will we continue to see some provisions for those things in 2006?

We have made a lot of changes in 2005, and we're continuing to make them in 2006. We don't take these as restructuring charges. They are factored right into our financials, so obviously there's a lot of the things that you mentioned in there. There were significant changes in 2005 already. We factor -- when we look at cuts up, we factor these in and are focused on the next cuts. Because to have what I just said -- to have an absolute reduction in our SG&A in 2006, obviously you have overcome all of the negatives as well.

My next question is probably for John. I'm kind of curious just with some of the issues that were faced in 2005 if you are able to tell me what your warranty liability was at the end of the year. By that, I mean what amount is included in the Accounts Payable and accrued liabilities line at the end of the year?

We have accrued warranty at $15.5 million, which is up from $14.7 million at the previous year end.

So no material increase given the new product going out there at this point, and you're comfortable with that situation?

We think it's the new products that have less warranty -- that being previously.

Final -- one of my final questions -- just, I don't want to belabor the point, but I do want to understand with respect to your credit facility, obviously you have never really drawn too much off of that credit facility. Although, I do understand that it is important with respect to your bonding and other performance requirements that you have. All I really want to understand is -- obviously, there always restricted covenants as you say, Andrew.

I'm just curious if at this point in time, there is any limitation to your ability to access that should you so choose. Regardless of whether you do or not, I just want to know if there's any restrictions with respect to your access -- or any change with respect to your access to that credit facility?

No change at all for the access to the credit facility.

Finally, just last question -- delivery timeline of the backlog you're sitting on today, do you have any sense or can give us any idea of how that looks?

We will deliver a normal growth in revenue or better. But that's about the only thing we're prepared to say. Thank you very much for speaking as fast as usual and getting right to the points.

Thank you.

We do want to try to wrap up by 11. So we've got about 10 minutes, maybe a bit more. Next question?

Avi Dalfen, Blackmont Capital.

First off, I will say just briefly I am disappointed that you are not willing to give more financial guidance. As you have demonstrated in the results you released yesterday that even 2 weeks before year end, you could predict very accurately what the results would be. So I would encourage you to be a bit braver and try to give even if with a wider range, some sort of expectation for future results.

Mr. Dalfen, we have heard you. We will give it some thought as usual. Anytime you make a comment, we will listen.

My questions -- can you talk a bit about the market for which you are expanding your production in Hungary? I guess well number one, what assurance with regards to the Hungarian expansion -- what assurance can you give us that it won't be as noteworthy as the changes in production in Oakville? Number two, what is the growth of this market, and can you contrast the growth in the sewage market with the growth in the drinking water market?

2 questions -- first one, I think we may have already stated prior to this is we'll never expand by shutting down existing lines. So any expansion anywhere, whether it's Hungary or Canada, is going to be alongside, ramped up and switched to when it's ready to go. We will continue to maintain the old line. So that's the first question.

As far as the sewage market, we think right now, we see the growth of that market probably a little bit faster than the water market.

What would the drivers for the faster growth in sewage be?

2 things -- water shortage globally. So for example, we see lots of things happening in Middle East, where water is in very short supply, and the Southwest of United States, in China. So those things -- a lot of demand is pushing water use.

The second thing is that the adoption of the technology has taken longer than the water to go large scale. But as we have seen with the Seattle job, even big cities are now looking at and buying bioreactors. Whereas 2 years ago, only small towns could even think about it. So it's -- we are amazed that the -- rather the very rapid adoption that's happening right now.

I know you don't like to comment too much on margins. But would it be fair to generalize and say that because the sewage market is less competitive than the drinking water market that you would probably be able to obtain better margins on that side of the business?

We think we probably have a more discernible advantage in the sewage market. We have dominated that part of the market for a longer period or at least being the most important supplier. I have to watch my words.

But when you've been talking about competitiveness in the marketplace, you've been talking -- have you been talking predominately about the drinking water market or--?

Oh, no, because as again -- again, particular market segment, what happened is that the market was not there. So we've been pushing, pushing, pushing. As the market opens -- and it's opening up dramatically right now -- inevitably there will be competitors. So they are coming -- many of them are coming out of the woodwork right now all over the world. But we think we have a very significant lead there, and we will continue to advance that lead.

Thank you.

John Chu, Research Capital.

I have just got a few quick questions. For some of the issues that were impacting on the margins that you cited for the quarter, such as production, subcontracting, some cost overruns, is any of that going to spillover into Q1 or Q2 or is that behind you now?

I believe it's kind of going into the second quarter, there was -- there is a small effect of it in this quarter.

Can you be more specific? Is that regarding the production issues or subcontracting or--?

Sorry. I think we have talked about rejection rate. The rejection rate just now at the targeted or near-targeted values. They were a little bit higher in the quarter than we -- than the target. So as a result of that -- affects our profitability.

So there are still some minor --

Comparison to previous orders, it's much smaller effect, much smaller effect.

But there still are some minor quality control problems right now still?

Even now, but it's getting slowly more and more perfect. That's how these things go.

So by Q2 then, everything should be pretty well-resolved by that time is your best guess?

Well, we think -- what I am trying to say, we know what we're doing. It's working. It needs to continue to improve, and it will continue to improve every quarter.

The new orders I thought were a little soft for the quarter. Is that related possibly to some of the production issues you've had, where customers are delaying placing new orders until they can feel comfortable that the quality issues, production issues are behind you?

We're not aware of -- you would expect that. But we really are not aware of that being an issue in any single order. We have had cases where competitors try to use that against us, but we still got the order as far as we know. There may be some orders where they used it and we don't know about it and then we may have lost some orders that way.

Earlier, you mentioned competitive pressures. Is it across the board globally or are there any specific regions that seem to be a little bit more competitive than others?

I think it's across the global market. It's the best market, the fastest-growing market. So, we've got people who want to take us on everywhere.

Then finally just on the cost control initiatives that Rafael was highlighting. I'm just wondering, where are you with that? Are you -- do you expect to be halfway through that process by mid year, or is it an early ramp-up in netted? I guess I am trying to figure out when do we start to see the real impact of these initiatives, probably by the second half of the year?

Well, we're about I guess you could say more or less halfway through it. So the initial phase we took some of the quick rations, we put a complete freeze on, we adjusted the budgets, implemented new cost controls. Some of the issues, which involve some of the more complicated consolidations (technical difficulty) planning to do. So those are still -- some of them have been done; some of them haven't been done. So it's a full year long process.

Just finally, just the integration of the new sales offices, is that pretty well complete or can we still see some impact to margins on that?

Like integration of new sales offices?

Yes.

It will be in the (multiple speakers) opening of new sales offices in Europe.

So that was an issue that you cited before?

Yes, that's -- I mean we're looking at all of the office. This is all of our new offices and all of our existing offices and trying to find ways to run them better. We definitely -- in some of the cases, we've scaled back. In all of the cases, we've scaled back our growth. So to answer your question, there's been several, several adjustments in a lot of the offices, probably some more still to go. (technical difficulty) we're also not -- we've skipped any future growth of new offices, we put off until future years.

But it could still be a bit of a drag on margins going forward, while you're sorting this out?

I wouldn't say that because some of the new offices and some of the people that we brought in have had very, very positive affects on our margins. So it's -- nothing is -- can you make an across the board statement like that. We've tried to get all of our cases focused on making cuts that will if anything not have an affect on our sales. In some cases, you can make a cut and actually have a positive impact on a sale by getting people more focused. We've been looking at that for offices, which are very strong and profitable and growing. We're not going to be making those kind of cuts because (technical difficulty) to our growth.

That's great. Thank you very much.

Gentlemen, please go ahead.

I guess we are wrapping up the calls. Thank you for all those questions. We tried our best to answer it. Sometimes, it's a little more difficult because it requires forecasting or competitive information. We look forward to having a good call with you next time. Thank you very much.

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. You may now disconnect your lines.