SECURITIES AND EXCHANGE COMMISSION 	WASHINGTON, D.C. 20549 	 	FORM 10-Q 	x Quarterly Report Pursuant to Section 13 or 15 (d) 	of the Securities Exchange Act of 1934 	For Quarter Ended June 30, 1997 	OR 	o Transition Report Pursuant to Section 13 or 15 (d) 	of the Securities Exchange Act of 1934 	For the transition period from to 	Commission File No. 1-12714 OSMONICS, INC (Exact name of registrant as specified in its charter) Minnesota 41-0955759 (State or other jurisdiction of (I.R.S. Employer Incorporation or organization) Identification Number) 5951 Clearwater Drive, Minnetonka, MN 55343 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (612) 933-2277 N/A Former name, former address and former fiscal year, if changed since last report Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for at least the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. At July 31, 1997, 13,915,394 shares of the issuer's Common Stock, $0.01 par value, were outstanding. OSMONICS, INC. INDEX PART I. FINANCIAL INFORMATION 		 PAGE ITEM I. FINANCIAL STATEMENTS Consolidated Statements of Income -	 2 For the Three and Six Months Ended 	 June 30, 1997 and 1996 Consolidated Balance Sheets -	 3 June 30, 1997 and December 31, 1996 Consolidated Statements of Cash Flows	 4 For the Six Months Ended June 30, 1997 and 1996 Notes to Consolidated Financial Statements 5 ITEM II. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 	 6-8 PART II. OTHER INFORMATION 	ITEM 4. SUBMISSION OF MATTERS TO A 	 VOTE OF SECURITY HOLDERS	 10 	 	ITEM 5. EXHIBITS AND REPORTS ON FORM 8-K	 11 SIGNATURES	 12 ITEM I - FINANCIAL STATEMENTS 	OSMONICS, INC. 	CONSOLIDATED STATEMENTS OF INCOME 	(In Thousands Except Per Share Data) Three Months Ended Six Months Ended 	 June 30, 	 June 30, 	 1997	 1996	 1997	 1996 Sales 	$41,789 	$36,727 	$84,102 	$75,778 Cost of sales	 24,931 	 21,502 	 50,895 	 44,529 Gross profit 	16,858 	15,225 	33,207 	31,249 Less:				 Selling, general and administrative 	 10,205 	8,560 	19,922 	16,893 Research, development and engineering	 2,773	 2,676	 5,559	 5,180 Income from operations 	3,880 	3,989 	7,726 	9,176 Other income 	 23	 459	 (78) 	 615 Income from continuing operations before income taxes 3,903 	4,448 	7,648 	9,791 Income taxes 	 1,310	 1,387	 2,621	 3,095 Income from contin operations 	2,593 	3,061 	5,027 	6,696 Recovery on discontin operations 	- 	- 	325 	- Net income 	$ 2,593 	$ 3,061 	$ 5,352 	$ 6,696 Income from continuing operations per common and common equivalent share 	0.18 	0.21 	0.35 	0.46 Recovery on discontinued operations per common and common equivalent share 	- 	- 	0.02 	- Net income per common and common equivalent share 	0.18 	0.21 	 0.37	 0.46 Average common shares and common equivalent shares outstanding 	14,358 	14,483 	14,450 	14,464 	OSMONICS, INC. 	CONSOLIDATED BALANCE SHEETS 	(In Thousands Except Share Data) June 30, December 31, 		 1997 1996 ASSETS Current assets Cash and cash equivalents 	$ 4,415 	$ 5,392 Marketable securities 	17,654 	19,098 Trade accounts receivable, net of allowance for doubtful accounts of $1,019 in 1997, and $907 in 1996 	30,794 	28,200 Inventories 	33,269 	32,322 Deferred tax assets 	 1,767 	1,559 Other current assets	 1,562 	 2,026 Total current assets	 89,461 	 88,527 Property and equipment, at cost Land and land improvements 	5,383 	5,485 Building 	 29,434 	27,158 Machinery and equipment	 55,980 	50,045 Construction in progress	 4,482	 3,438 	 95,279 	86,126 Less accumulated depreciation and amortization	 (39,557)	 (34,332) 	 55,722 	 51,794 Other assets	 18,877	 11,855 	$164,060 	$152,176 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable 	$ 9,483 	$ 12,511 Notes payable and current portion of long-term debt 	19,777 	7,493 Reserve for discontinued operations 	1,448 	1,957 Other accrued liabilities	 15,653 	 12,560 Total current liabilities	 46,361 	 34,521	 Long-term debt 	15,797 	15,900 Other liabilities 	192 	196 Deferred income taxes 	3,962 	3,616 Shareholders' equity Common stock, $0.01 par value Authorized -- 50,000,000 Issued -- 1997: 14,231,494 and 1996: 14,193,239 shares 	142 	142 Capital in excess of par value 	23,673 	23,128 Retained earnings 	77,134 	71,781 Treasury Stock 	(5,249) 	- Unrealized gain on marketable securities	 2,292 	2,864 Foreign currency translation adjustments	 (244) 	 28 Total shareholders' equity	 97,748 	 97,943 	$164,060 	$152,176 OSMONICS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) 		Six Months Ended 		 June 30, Cash flows from: 	 1997 	1996 Operations: Net income 	$ 5,352 	6,696 Non-cash items included in net income: Depreciation and amortization 	2,632 	2,421 Deferred income taxes 	111 	 214 Gain on sale of investments	 (560) 	(715) Gain on sale of Property, Plant & Equipment 	(7) 	 - Gain on sale of land 	- 	(640)	 Accounts receivable 	(1,057) 	(1,364) Inventories and other current assets 	3,450 	(1,351) Accounts payable and accrued liabilities	 (5,884)	 (4,001) Net cash provided by operations	 4,037 	 1,260 Investing activities: Business acquisition (net of cash acquired) 	(10,203) 	- Purchase of investments 	(461) 	(454) Sale of investments	 1,251 	4,823 Purchase of property and equipment 	(3,491) 	(9,489) Disposal of property and equipment 	57 	- Sale of land 	- 	731 Other	 86 	 (311) Cash provided by (used in) investing activities 	(12,761)	 (4,700) Financing activities: Increases in debt 	12,284 	1,913 Reduction of debt	 (103) 	(1,288) Issuance of Common Stock 	545 	640 Purchase of Treasury Stock	 (5,249)	 - Net cash provided by (used in) financing activities	 7,477 	 1,265 Effect of exchange rate changes on cash 	270 	30 Decrease in cash and cash equivalents 	(977) 	(2,145) Cash and cash equivalents - beginning of year	 5,392 	 4,729 Cash and cash equivalents - end of quarter 	$ 4,415 	$ 2,584 	OSMONICS, INC. 	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10-Q and do not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the six months ended June 30, 1997, are not necessarily indicative of the results that may be expected for the year 1997. These statements should be read in conjunction with the financial statements and related notes included in the Company's Annual Report to shareholders and Form 10-K for the year ended December 31, 1996. ITEM II.	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 		(Dollars in thousands, except per share data) As an aid to understanding the Company's operating results, the following table shows the percentage of sales that each income statement item represents for the three-month and six-month periods ended June 30, 1997 and 1996. 				 Percent of Sales Percent of Sales 				Three Months Ended Six Months Ended 					 June 30 	 June 30, 					 	1997 	1996 	1997 	1996 Sales	 100.0% 100.0%	 100.0% 100.0% Cost of sales 	 59.7 	58.5 	 60.5 	 58.8 Gross profit 	40.3 	41.5 	39.5 	41.2 				 Selling, general and administrative 	24.4 	23.3 	23.7 	22.3 Research, development and engineering	 6.6 	 7.3 	 6.6 	 6.8 Operating expenses	 31.0 	30.6 	30.3 	 29.1 				 Income from operations 	9.3 	10.9 	 9.2 	12.1 Other income (expense) 	- 	1.2 	(0.1) 	.8 Income from continuing operations before income taxes 	9.3 	12.1 	9.1 	12.9 Income taxes	 3.1 	 3.8 	 3.1 	 4.1 Income from continuing operations 	6.2 	8.3 	6.0 	8.8 Recovery on discontinued operations 	- 	- 	.4 	- Net income 	 6.2% 8.3% 	 6.4% 	 8.8% 	 Sales Sales for the second quarter ended June 30, 1997 of $41,789 increased 13.8% over sales for the second quarter of 1996. Year-to-date 1997 sales through June increased 11% over the corresponding 1996 level. Sales of equipment represent 47% of year-to-date sales. Sales generated internally increased slightly under 6% on a year-to-year comparison with the remaining growth resulting from the February 1997 acquisition of AquaMatic. Gross Margin Gross margin for the second quarter of 1997 was 40.3% versus 41.5% for the corresponding period in 1996. The gross margin for the six months ended June 30 was 39.5% in 1997 and 41.2% in 1996. The second quarter 1997 result is an improvement from the 38.6% gross margin in first quarter 1997. Operating Expenses Operating expenses increased to 31.0% in the second quarter of 1997 from 30.6% in the second quarter of 1996. On a year-to-date basis, operating expenses were 30.3% for six months ending June 30, 1997 versus 29.1% for the same period last year. Operating expenses have increased on a short term basis partly due to the implementation of a new management information system. Other Income Other income decreased by $693 in the first six months of 1997 versus the same period for 1996. Prior year results included a $640 gain on the sale of land. Income Taxes The effective tax rate for the six months ended June 30, 1997 was 34.3% based on the forecast for the full year. This compares to 31.6% for the six months ending June 30, 1996. The increase is due to the completed utilization of tax loss carryforwards and credits from the Autotrol acquisition. Recovery on Discontinued Operations The company recognized $325 ($0.02 per share) of after tax income in the first quarter of 1997 from a reduction in the reserve for discontinued operations from the Autotrol merger, after a lawsuit was successfully defended. Net Income Net income for the quarter ended June 30, 1997 was $2,593 versus $3,061 for the quarter ended June 30, 1996. Net income per common share for the quarter was $0.18 versus $0.21 for the same period last year. Year-to-date net income was $5,352 for 1997 versus $6,696 for the same period last year. Net income per common share year-to-date was $0.37 in 1997 versus $0.46 in 1996. Liquidity and Capital Resources As of June 30, 1997, the company had cash, cash equivalents and marketable securities of $22,069 versus $24,420 at December 31, 1996. The current ratio was 1.9 at June 30, 1997 as compared to 2.6 at year-end 1996. The company's current debt increased from $7,493 at December 31, 1996 to $19,777 at June 30, 1997. The increase was due to short term borrowings for the AquaMatic acquisition. The Company announced on March 17, 1997 that its Board of Directors authorized purchase of up to 1,500,000 shares of the Company's common stock. The Company purchased 68,600 shares in March 1997, 220,000 shares in April 1997, 20,000 shares in May 1997 and 7,500 shares in June 1997. The company believes that its current cash and investments position, its cash flow from operations, and amounts available from bank credit will be adequate to meet its anticipated cash needs for working capital, capital expenditures, and potential acquisitions during the foreseeable future. Private Securities Litigation Reform Act The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information included in this Form 10-Q and other materials filed or to be filed with the Securities and Exchange Commission (as well as information included in oral or other written statements made or to be made by the Company) contains statements that are forward-looking. Such statements may relate to plans for future expansion, business development activities, other capital spending, financing, or the effects of regulation and comptetition. Such information involves important risks and uncertainties that could significantly affect anticipated results in the future and, accordingly, such results may differ from those expressed in any forward- looking statements made by or on behalf of the Company. These risks and uncertainties include, but are not limited to, those relating to product development activities, dependence on existing management, global economic and market conditions, and changes in federal or state laws. OSMONICS, INC. PART II OTHER INFORMATION Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 	The Company's Annual Meeting of Stockholders was held on May 14, 1997. The following members were elected to the Company's Board of Directors to hold office for the ensuing three years: 		 Nominee	 In Favor 	Withheld 	 		D. Dean Spatz 	11,867,773 	44,785 		Verity C. Smith 	11,867,015 	45,544 	 Item 5. EXHIBITS AND REPORTS ON FORM 8-K 	(a) None 	(b)	During the quarter ended June 30, 1996, the Registrant did not file a Form 8-K report. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Dated: _____________________ 	 OSMONICS, INC. 	 (Registrant) 	/s/ L. Lee Runzheimer 		L. Lee Runzheimer 		Chief Financial Officer 	/s/ Howard W. Dicke 		Howard W. Dicke 		Treasurer and Vice President 		Corporate Development 	/s/ D. Dean Spatz 		D. Dean Spatz 		Chief Executive Officer