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 September 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 October 31, 1997, 13,934,720 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 Nine Months Ended September 30, 1997 and 1996 Consolidated Balance Sheets 3 September 30, 1997 and December 31, 1996 Consolidated Statements of Cash Flows 4 For the Nine Months Ended September 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 5. A. NEW BOARD OF DIRECTOR NAMED 9 B. ACQUISITION OF TWO PRODUCT LINES 9 C. SUBSEQUENT EVENT 10 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 10 SIGNATURES 11 ITEM I - FINANCIAL STATEMENTS OSMONICS, INC. CONSOLIDATED STATEMENTS OF INCOME (In Thousands Except Per Share Data) Three Months Ended Nine Months Ended September 30, September 30, 1997 1996 1997 1996 Sales $42,420 $39,493 $126,522 $115,271 Cost of sales 25,466 23,247 76,361 67,776 ------ ------ ------ ------ Gross profit 16,954 16,246 50,161 47,495 Less: Selling, general and administrative 10,461 8,771 30,383 25,664 Research, development and engineering 2,676 2,750 8,235 7,930 ------ ------ ------ ------ Income from operations 3,817 4,725 11,543 13,901 Other income (expense) (616) 297 (694) 912 ------ ------ ------ ------ Income from continuing operations before income taxes 3,201 5,022 10,849 14,813 Income taxes 906 1,708 3,526 4,803 ------ ------ ------ ------ Income from continuing operations 2,295 3,314 7,323 10,010 Recovery on discontinued operations - - 325 - Net income $ 2,295 $ 3,314 $ 7,648 $10,010 ======= ======= ====== ======= Income from continuing operations per common and common equivalent share 0.16 0.23 0.51 0.69 Recovery on discontinued operations per common and common equivalent share - - 0.02 - Net income per common and common equivalent share 0.16 0.23 0.53 0.69 Average common shares and common equivalent shares outstanding 14,285 14,470 14,360 14,442 OSMONICS, INC. CONSOLIDATED BALANCE SHEETS (In Thousands Except Share Data) September 30, December 31, 1997 1996 ASSETS Current assets Cash and cash equivalents $ 3,977 $ 5,392 Marketable securities 19,122 19,098 Trade accounts receivable, net of allowance for doubtful accounts of $872 in 1997, and $907 in 1996 32,742 28,130 Inventories 33,788 32,322 Deferred tax assets 1,445 1,559 Other current assets 1,708 2,026 ------ ------ Total current assets 92,782 88,527 ------ ------ Property and equipment, at cost Land and land improvements 5,383 5,485 Building 29,683 27,158 Machinery and equipment 61,265 50,045 Construction in progress 7 3,438 ------- ------- 96,338 86,126 Less accumulated depreciation and amortization (40,878) (34,332) ------- ------- 55,460 51,794 Other assets 18,916 11,855 ------- ------- $167,158 $152,176 LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Accounts payable $ 12,652 $ 12,511 Notes payable and current portion of long-term debt 19,697 7,493 Reserve for discontinued operations 1,448 1,957 Other accrued liabilities 14,404 12,560 ------ ------ Total current liabilities 48,201 34,521 ------ ------ Long-term debt 13,731 15,900 Other liabilities 26 196 Deferred income taxes 4,286 3,616 Shareholders' equity Common stock, $0.01 par value Authorized -- 50,000,000 Issued -- 1997: 14,246,034 and 1996: 14,193,239 shares 142 142 Capital in excess of par value 23,928 23,128 Retained earnings 79,429 71,781 Treasury Stock (5,249) - Unrealized gain on marketable securities 2,896 2,864 Foreign currency translation adjustments (232) 28 ------- ------- Total shareholders' equity 100,914 97,943 OSMONICS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands) Nine Months Ended September 30, Cash flows from: 1997 1996 Operations: Net income $ 7,648 $ 10,010 Non-cash items included in net income: Depreciation and amortization 4,118 3,672 Deferred income taxes 434 366 Gain on sale of investments (628) (1,328) Gain on sale of land - (640) Accounts receivable (3,005) (1,237) Inventories and other current assets 2,785 (5,123) Accounts payable and accrued liabilities (2,634) (4,340) ------ ------ Net cash provided by operations 8,718 1,380 Investing activities: Business acquisition (net of cash acquired) (11,970) - Purchase of investments (1,658) (608) Sale of investments 2,271 6,311 Purchase of property and equipment (5,167) (12,167) Disposal of property and equipment 374 1,667 Sale of land - 731 Other 270 (841) ------ ------ Cash provided by (used in) investing activities (15,880) (4,907) ------ ------ Financing activities: Addition (reduction) in debt 10,035 (2,071) Issuance of Common Stock 800 1,162 Purchase of Treasury Stock (5,249) - Cash restricted for purchase and construction of equipment (150) 2,034 ------ ------ Net cash provided by (used in) financing activities 5,436 1,125 ------ ------ Effect of exchange rate changes on cash 311 17 Decrease in cash and cash equivalents (1,415) (2,385) Cash and cash equivalents - beginning of year 5,392 4,729 ------ ------ Cash and cash equivalents - end of quarter $3,977 $2,344 ====== ====== 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 nine months ended September 30, 1997, are not necessarily indicative of the results that may be expected for the full 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 nine-month periods ended September 30, 1997 and 1996. Percent of Sales Percent of Sales ---------------- ---------------- Three Months Ended Nine Months Ended September 30 September 30, -------------- -------------- 1997 1996 1997 1996 ---- ---- ---- ---- Sales 100.0% 100.0% 100.0% 100.0% Cost of sales 60.0 58.9 60.4 58.8 ---- ---- ---- ---- Gross profit 40.0 41.1 39.6 41.2 Selling, general and administrative 24.7 22.2 24.0 22.3 Research, development and engineering 6.3 7.0 6.5 6.9 ---- ---- ---- ---- Operating expenses 31.0 29.2 30.5 29.2 ---- ---- ---- ---- Income from operations 9.0 11.9 9.1 12.0 Other income (expense) (1.5) 0.8 (0.5) .8 Income from continuing operations before income taxes 7.5 12.7 8.6 12.8 Income taxes 2.1 4.3 2.8 4.2 --- ---- --- ---- Income from continuing operations 5.4 8.4 5.8 8.6 Recovery on discontinued operations - - .2 - Net income 5.4% 8.4% 6.0% 8.6% === === === === Sales - ----- Sales for the third quarter ended September 30, 1997 of $42,420 increased 7.4% over sales for the third quarter of 1996. Year-to-date 1997 sales through September increased 9.8% over the corresponding 1996 level. Sales of equipment represent 46% and replaceable products 54% of year-to-date sales. Domestic capital equipment business was slower than anticipated. Gross Margin - ------------ Gross margin for the third quarter of 1997 was 40.0% versus 41.1% for the corresponding period in 1996. The gross margin for the nine months ended September 30 was 39.6% in 1997 and 41.2% in 1996. The third quarter 1997 result is an improvement from the 39.5% gross margin in the first half of 1997. Gross margins have been affected by product mix and price competition. Operating Expenses - ------------------ Operating expenses increased to 31.0% in the third quarter of 1997 from 29.2% in the third quarter of 1996. On a year-to-date basis, operating expenses were 30.5% for nine months ending September 30, 1997 versus 29.2% for the same period last year. Operating expenses as a percent of sales have increased on a near term basis due to the decline in sales below expected levels, and to the implementation of a new management information system. Other Income - ------------ Other income decreased by $1,606 in the first nine months of 1997 versus the same period for 1996. Prior year results included a $640 gain on the sale of land, not repeated in the current year. Net interest expense increased by $595 during the first nine months of 1997 primarily as a result of funding for the acquisition of AquaMatic during first quarter 1997. Income Taxes - ------------ The effective tax rate for the nine months ended September 30, 1997 was 32.5% based on the forecast for the full year. This compares to 32.4% for the nine months ending September 30, 1996. 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 September 30, 1997 was $2,295 versus $3,314 for the quarter ended September 30, 1996. Net income per common share for the quarter was $0.16 versus $0.23 for the same period last year. Year-to-date net income was $7,648 for 1997 versus $10,010 for the same period last year. Net income per common share year-to-date was $0.53 in 1997 versus $0.69 in 1996. Liquidity and Capital Resources - ------------------------------- As of September 30, 1997, the company had cash, cash equivalents and marketable securities of $23,099 versus $24,490 at December 31, 1996. The current ratio was 1.9 at September 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 $19,697 at September 30, 1997. The increase was primarily 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 first quarter 1997 and 247,500 shares in second quarter 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 competition. 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, computer systems conversion, dependence on existing management, global economic and market conditions, and changes in federal or state laws. OSMONICS, INC. PART II OTHER INFORMATION Item 5. OTHER INFORMATION ----------------- A. New Board of Director Named --------------------------- The Company announced on October 20, 1997 that William Eykamp has been named to its Board of Directors. Eykamp is a management consultant and an adjunct professor of Chemical Engineering at Tufts University in Medford, Massachusetts. Eykamp was president and director of Koch Membrane Systems, Inc., Wilmington, Massachusetts, formerly Abcor, Inc. He has won several professional honors and awards for his scientific achievements, lectured on ultrafiltration and membrane technology and is widely published in technical journals. His 40-year career includes a professorship at the University of California, Berkeley, where he taught courses in membrane separation and management of innovation. B. Acquisition of Two Product Lines -------------------------------- The Company announced during the third quarter the acquisition for cash of two product lines from ORS Environmental Systems, a division of Sippican, Inc. The product lines, AccuSensor and ChemSensor, are field-portable, hand-held screening instruments for on-site testing for certain contaminants in water. AccuSensor enables quick, on-site measurement of trichloroethylene (TCE) and other trihalomethanes (THM's). The product requires no special training, sample preparation or calibration procedures. It features a rugged, lightweight design for easy portability, and is an ideal screening tool for bottled water and soft drink production, as well as municipal water treatment applications. ChemSensor uses a fiber optic chemical sensor to make accurate, real-time measurements of semi-volatile and volatile organic compounds (VOC's), the hazardous by-products from the power, petrochemical, and materials industries. ChemSensor can be used in monitoring wells, process streams or surface waters as a fast, inexpensive alternative to laboratory analysis of groundwater samples. Both the AccuSensor and ChemSensor products will be manufactured at the Company's Phoenix facility, along with its current line of water quality instrumentation products. C. Subsequent Event ---------------- The Company in October announced a partnership with Fuji Electric (Fuji Electric Co., Ltd., Japan and Fuji Electric Corp. of America) to manufacture high concentration ozone generators using proprietary Fuji Electric technology and components. The Company receives the rights to manufacture and sell equipment throughout North America. The parties will cooperatively pursue large ozonation projects worldwide. The innovative Microgap technology with enhanced cooling produces 15% weight concentrations of ozone-effectively doubling the 6% to 8% weight that standard ozone generators typically achieve. Fuji has world-leading ozonation technology and the Company has a reputation for developing and cost-effectively manufacturing complete ozonation solutions for specific applications. This combination gives the Company a strong entry to the municipal water treatment market, as well as pulp and paper and other large-scale oxidation applications. Item 6. EXHIBITS AND REPORTS ON FORM 8-K -------------------------------- (a) Exhibit 27 - Financial Data Schedule (b) During the quarter ended September 30, 1997, 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: 14 NOV 97 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