OSMONICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share data)
Year ended December 31,
1998 1997 1996
-------- -------- --------
Sales $177,819 $164,905 $155,946
Cost of sales 114,718 99,860 92,523
Gross profit 63,101 65,045 63,423
Operating expenses:
Selling, general and
administrative 43,487 39,603 35,079
Research, development and
engineering 9,913 10,635 10,937
Special charges 7,988 1,448 -
61,388 51,686 46,016
Income from operations 1,713 13,359 17,407
Other income (expense), net:
Interest income 668 913 1,023
Interest expense (4,288) (2,226) (1,594)
Other 829 344 3,072
(2,791) (969) 2,501
Income (loss) from
continuing operations
before income taxes (1,078) 12,390 19,908
Income taxes (benefit)
(Note 11) (25) 3,927 6,441
Income (loss) from
continuing operations (1,053) 8,463 13,467
Recovery on discontinued
operations
(less income tax of $617) - 1,330 -
Net income (loss) $(1,053) $ 9,793 $ 13,467
Earnings (loss) per share -
basic (Note 16)
Income (loss) from
continuing operations $(0.08) $0.60 $0.95
Net income (loss) $(0.08) $0.70 $0.95
Earnings (loss) per share -
assuming dilution (Note 16)
Income (loss) from
continuing operations $(0.08) $0.59 $0.93
Net income (loss) $(0.08) $0.68 $0.93
The accompanying notes are an integral part of the
consolidated financial statements.
OSMONICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
1998 1997
------- -------
ASSETS
Current assets:
Cash and cash equivalents $ 576 $4,872
Marketable securities (Note 3) 14,271 17,004
Trade accounts receivable, net of
allowance for doubtful accounts of
$1,057 in 1998 and $888 in 1997 34,767 28,969
Inventories (Note 4) 28,123 35,228
Deferred tax assets (Note 12) 6,610 1,413
Other current assets 5,034 1,639
Total current assets 89,381 89,125
Property and equipment, at cost:
Land and land improvements 5,606 5,535
Buildings 30,568 29,278
Machinery and equipment 69,510 62,770
105,684 97,583
Accumulated depreciation (48,871) (42,550)
56,813 55,033
Cash restricted for purchase and
construction of equipment (Note 5) 560 1,130
Goodwill, net of accumulated
amortization of $2,214 in 1998 and
$960 in 1997 43,927 15,257
Long-term investments 1,016 1,016
Other assets, net of accumulated
amortization of intangible assets of
$709 in 1998 and $412 in 1997 2,352 2,922
Total assets $194,049 $164,483
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 9,156 $ 9,728
Line of credit advances (Note 6) 26,000 14,012
Notes payable and current portion of
long-term debt (Note 9) 2,177 2,162
Accrued compensation and employee
benefits 4,475 6,125
Other accrued liabilities (Note 8) 13,597 11,825
Total current liabilities 55,405 43,852
Long-term debt (Note 9) 31,665 13,792
Deferred income taxes (Note 12) 4,806 4,439
Other liabilities 18 25
Commitments and contingencies (Note 14)
Shareholders' equity (Note 10):
Common stock, $0.01 par value
Authorized -- 50,000,000 shares
Issued -- 1998: 13,991,291 and 1997:
13,943,544 shares 140 140
Capital in excess of par value 20,733 20,261
Retained earnings 79,075 80,128
Other comprehensive income 2,207 1,846
Total shareholders' equity 102,155 102,375
Total liabilities and shareholders'
equity $194,049 $164,483
The accompanying notes are an integral part of the
consolidated financial statements.
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year ended December 31,
1998 1997 1996
------- ------- -------
Cash flows from operations:
Net income (loss) $(1,053) $ 9,793 $13,467
Non-cash items included in net
income:
Depreciation and amortization 7,964 5,791 4,874
Deferred income taxes (2,059) 1,176 1,849
Gain on sale of land and (1,285) (573) (3,396)
investments
Special charges 9,988 1,448 -
Recovery on discontinued
operations - (1,947) -
Changes in assets and liabilities
(net of business acquisitions):
Accounts receivable (3,774) 1,370 (4,648)
Inventories 7,367 1,806 (3,349)
Other current assets (3,052) 457 155
Accounts payable and accrued
liabilities (5,994) (2,553) (3,216)
Net cash provided by operations 8,102 16,768 5,736
Cash flows from investing
activities:
Business acquisitions (net of cash
acquired) (39,880) (13,992) -
Purchase of investments (808) (902) (1,418)
Maturities and sales of
investments 4,480 2,478 9,570
Purchase of property and equipment (7,808) (6,609) (15,658)
Sales of property and equipment 110 456 2,535
Pending acquisition costs - (1,200) -
Other 424 (245) (169)
Net cash used in investing
activities (43,482) (20,014) (5,140)
Cash flows from financing
activities:
Proceeds from notes payable and
current debt 32,000 16,967 882
Reduction of long-term debt (2,264) (10,394) (2,219)
Cash restricted for purchase and
construction of Equipment 570 830 74
Issuance of common stock 472 934 1,324
Purchase of common stock - (5,249) -
Net cash provided by financing
activities 30,778 3,088 61
Effect of exchange rate changes on
cash 306 (362) 6
Increase (decrease) in cash and cash
equivalents (4,296) (520) 663
Cash and cash equivalents -
beginning of year 4,872 5,392 4,729
Cash and cash equivalents - end of
year $ 576 $4,872 $ 5,392
The accompanying notes are an integral part of the
consolidated financial statements.
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands, except share data)
Capital Accum-
in ulated
Excess Ret- Other Total
of ained Compre- Share-
Common Stock Par Earn- hensive holders
Shares Amount Value ings Income(2) Equity
Balance -
January 1,
1996 14,086,007 $141 $21,805 $58,314 $4,013 $84,273
Comprehensive
income
Net income - - - 13,467 - 13,467
Other
compre-
hensive
income(1)
Trans-
lation
adjustment - - - - (291) (291)
Marketable
securities
adjustment
(3) - - - - (830) (830)
Other
comprehensive
income - - - - (1,121) (1,121)
Total
comprehensive
income - - - - - 12,346
Employee
stock
purchase
plans 107,232 1 1,323 - - 1,324
Balance -
December 31,
1996 14,193,239 142 23,128 71,781 2,892 97,943
Comprehensive
income
Net income - - - 9,793 - 9,793
Other
compre-
hensive
income(1)
Trans-lation
adjustment - - - - (362) (362)
Marketable
securities
adjustment (3) - - - - (684) (684)
Other
comprehensive
income - - - - (1,046) (1,046)
Total
comprehensive
income - - - - - 8,747
Purchase of
common stock (316,100) (3) (3,800) (1,446) - (5,249)
Employee stock
purchase plans 66,405 1 933 - - 934
Balance -
December 31,
1997 13,943,544 140 20,261 80,128 1,846 102,375
Comprehensive
income (loss)
Net loss - - - (1,053) - (1,053)
Other
compre-
hensive
income(1)
Translation
adjustment - - - - 306 306
Marketable
securities
adjustment (3) - - - - 55 55
Other
comprehensive
income - - - - 361 361
Total
comprehensive
income (loss) - - - - - (692)
Employee stock
purchase plans 64,819 - 664 - - 664
401(k) stock
match 23,468 - 234 - - 234
Recovery of
common stock (40,540) - (426) - - (426)
Balance -
December 31,
1998 $13,991,291 $140 $20,733 $79,075 $2,207 $102,155
(1) All items included in other comprehensive income are shown net
of taxes. The tax effect for the marketable securities
adjustment was $22, $(265), and $(315) for 1998, 1997 and 1996,
respectively.
(2) Accumulated other comprehensive income is comprised of
accumulated currency translation of $(28), $(334) and $28; and
marketable securities adjustment of $2,235, $2,180 and $2,864 at
December 31, 1998, 1997 and 1996, respectively.
(3) Marketable securities reclassification adjustment for gains
realized in net income (net of tax) was $859, $573 and $2,766
for 1998, 1997 and 1996, respectively.
FIVE-YEAR RESULTS
(In thousands, except per share amounts)
INCOME DATA: (Restated for poolings-of-interests)
Year ended December 31,
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
Sales $177,819 $164,905 $155,946 $130,783 $112,908
Income (loss)
rom continuing
operations (1,053) 8,643 13,467 11,879 10,454
Net income
(loss) (1,053) 9,793 13,467 11,879 10,454
Earnings (loss)
per share -
basic (Note 16)
Income (loss)
from continuing
operations $(0.08) $0.60 $0.95 $0.84 $0.75
Net income
(loss) $(0.08) $0.70 $0.95 $0.84 $0.75
Earnings (loss)
per share -
assuming
dilution
(Note 16)
Income (loss)
from continuing
operations $(0.08) $0.59 $0.93 $0.83 $0.74
Net income
(loss) $(0.08) $0.68 $0.93 $0.83 $0.74
Average shares
outstanding
Basic 13,976 14,031 14,145 14,058 13,941
Assuming
dilution 13,976 14,313 14,458 14,365 14,206
BALANCE SHEET DATA: (Restated for poolings-of-interests)
Total assets $194,049 $164,483 $152,176 $142,419 $110,715
Long-term debt 31,665 13,792 15,900 20,919 14,475
QUARTERLY FINANCIAL DATA
(In thousands, except per share amounts)
Quarterly Financial Data - 1998
Quarter Ended
March 31 June 30(b) September 30 December 31
-------- ---------- ------------ -----------
Sales $42,150 $47,353 $44,606 $43,710
Gross profit 16,107 15,445 16,506 15,043
Net income (loss) 2,164 (5,283) 977 1,089
Net income (loss)
per share - $0.16 $(0.38) $0.07 $0.08
basic (a)
Net income (loss)
per share -
assuming $0.15 $(0.38) $0.07 $0.08
dilution(a)
Quarterly Financial Data - 1997
Quarter Ended
March 31(b) June 30 September 30 December 31
----------- ------- ------------ -----------
Sales $42,313 $41,789 $42,420 $38,383
Gross profit 16,349 16,858 16,954 14,884
Net income 2,759 2,593 2,296 2,145
Net income per
share - $0.19 $0.18 $0.16 $0.15
basic (a)
Net income per
share - assuming $0.19 $0.18 $0.16 $0.15
dilution(a)
(a) Income per share has been restated to reflect the
adoption of the Statement of Financial Accounting
Standards No. 128, "Earnings per Share" (SFAS No. 128).
See Note 16 of the consolidated financial statements.
(b) Special charges of $9,988 ($0.54 per share after taxes
assuming dilution) were recorded during the second
quarter of 1998. Special charges of $1,448 ($0.07 per
share after taxes) were recorded during the fourth
quarter of 1997. Recovery from discontinued operations
of $325 ($0.02 per share) and $1,005 ($0.07 per share)
were recorded in first and fourth quarters of 1997,
respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
1. Summary of Significant Accounting Policies
Osmonics, Inc. is a manufacturer and marketer of high
technology water purification, fluid filtration, fluid
separation, and fluid transfer equipment and
instruments, as well as the replaceable components used
in purification, filtration, and separation equipment.
These products are used by a broad range of industrial,
commercial, consumer and institutional customers.
The consolidated financial statements include the
accounts of Osmonics, Inc. and its wholly and majority
owned subsidiaries (the Company). Significant
intercompany accounts and transactions have been
eliminated.
Sales are recorded when the product is shipped or the
service is provided.
The estimated fair value for notes payable and long-term
debt approximates carrying value due to the relatively
short-term nature of the instruments and/or due to the
short-term floating interest rates on the borrowing.
The estimated fair value of notes receivable
approximates the net carrying value, as management
believes the respective interest rates are commensurate
with the credit, interest rate, and repayment risks
involved.
The Company considers highly liquid debt instruments
purchased with a maturity of three months or less to be
cash equivalents.
Inventories are stated at lower of cost (first-in, first-
out method) or market for all operations except for two
plants which have historically valued inventory on the
last-in, first-out method.
Depreciation and amortization of property and equipment
are provided on the straight-line method over estimated
lives of 3 to 40 years.
Deferred income taxes have been provided for income and
expenses which are recognized in different accounting
periods for financial reporting purposes than for income
tax purposes.
The Company accrues for the estimated cost of warranty
obligations at the time revenue is recognized.
The excess of cost over the fair market value of assets
acquired in acquisitions is amortized over not more than
40 years, with the majority at 30 years. In accordance
with Statement of Financial Accounting Standards (SFAS)
No. 121 on impairment of long-lived assets, the carrying
values of these intangibles are reviewed quarterly for
impairment using discounted cash flows when events or
circumstances warrant such a review. Other intangibles
are carried at cost and amortized using the
straight-line method over their estimated lives of 5 to
20 years.
In 1998, the Company adopted SFAS No. 130, Reporting
Comprehensive Income; SFAS No. 131, Disclosure about
Segments of an Enterprise and Related Information
(Note 13); and SFAS No. 132, Pension and Other Post-
Retirement Disclosures which did not have a material
impact on operating results or financial position.
The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates that affect the reported
amounts of assets and liabilities, the disclosure of
contingent assets and liabilities, and the reported
amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Certain reclassifications have been made to prior year
amounts to conform with current year presentations.
2. Business Acquisitions
On February 17, 1998, the Company acquired all of the
equity interest of Micron Separations, Inc. (MSI) of
Westborough, Massachusetts. The purchase price was
approximately $25,000 which included $1,902 of in-
process research and development (R&D) and $13,600 of
goodwill, which is being amortized on the straight-line
method over 30 years. MSI products are being sold
through existing Osmonics distribution channels,
complementing the Company's existing cartridge filter
products and providing a broader portfolio of diagnostic
and laboratory membrane products to the laboratory and
analytical testing markets. Revenues of MSI were less
than $15,000 in 1997 and 1996. The acquisition was
recorded under the purchase method of accounting.
The results of operations of MSI are included in the
consolidated statements of operation from the date of
acquisition.
On April 29, 1998, the Company acquired all of the equity
interest of Membrex Corp. ("Membrex") of Fairfield, New
Jersey. The purchase price was approximately $16,000
plus assumed net liabilities of approximately $3,000.
The price included $4,320 of in-process R&D and $15,700
of goodwill, which is being amortized on the straight-
line method over 30 years. Membrex products are
primarily related to membrane products and oil/water
separating systems for commercial and industrial
customers. Revenues of Membrex were less than $10,000
in 1997 and 1996. The acquisition was recorded under
the purchase method of accounting.
The results of operations of Membrex are included in the
consolidated statements of operations from the date of
acquisition.
Pro forma 1997 combined financial results of Osmonics,
Inc., MSI and Membrex would be as follows:
1997: Osmonics MSI Membrex Combined
----- -------- ------- ------- --------
Sales $164,905 $10,038 $6,333 $181,276
Income from
operations 13,359 244 (1,920) 11,683
Net income (loss) 9,793 (1,233) (3,237) 5,323
Net income per
share - assuming
dilution $0.68 $0.37
1997 financial results of MSI include $3,200 of non-
recurring charges associated with the settlement of a
patent infringement lawsuit.
The pro forma combined impact on financial results for
1998 was not material.
On February 25, 1997, the Company acquired all of the
equity interest of AquaMatic, Inc. of Rockford,
Illinois. The purchase price was approximately $15,000
and included $7,600 of goodwill which is being amortized
on the straight-line method over 40 years. AquaMatic
products are being sold through existing Osmonics
distribution channels, offering a more complete line of
specialty valves and controllers. Revenues of AquaMatic
were less than $15,000 in 1996 and 1995. The
acquisition was recorded under the purchase method of
accounting.
The results of operations of AquaMatic are included in
the consolidated statements of operations from the date
of acquisition.
On July 24, 1996, Desalination Systems, Inc. (DSI) merged
with the Company through an exchange of 1,312,827 shares
of the Company's common stock for the Class A common
stock and Class B common stock of DSI. The transaction
was accounted for as a pooling-of-interests. DSI's
principal business is the manufacture of membranes used
for reverse osmosis, nanofiltration, ultrafiltration and
microfiltration. The historical financial statements of
the Company have been restated to give effect to the
acquisition as though the companies had operated
together from the beginning of the earliest period
presented. Separate results of operations of the
combined entities for the six months ended June 30, 1996
were as follows:
Six Months
Ended June 30, 1996
-------------------
Sales:
Osmonics $ 64,405
DSI 11,642
Eliminations (269)
Combined $ 75,778
Net income:
Osmonics $ 5,975
DSI 721
Combined $ 6,696
The eliminations represent sales between the combined
entities prior to the combination. The sales
elimination had no significant effect on net income in
the years presented.
3. Marketable Securities
The Company considers all of its marketable securities
available-for-sale. Marketable securities at December
31, 1998 consisted of the following:
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------- ---------- ---------- -----
U.S. government
securities
0-5 year
maturity $1,640 $ 36 $ (1) $1,675
Municipal bonds
0-5 year
maturity 3,847 222 - 4,069
6 year or
greater maturity 1,009 47 - 1,056
Corporate debt
securities
and other
0-5 year
maturity 478 2 (3) 477
Equity securities 3,602 3,723 (331) 6,994
Total before-tax
effect $10,576 4,030 (335) $14,271
Deferred tax
effect of
unrealized
(gains) losses (1,592) 132
Net unrealized
gains (losses)
on marketable
securities $2,438 $(203)
Marketable securities at December 31, 1997 consisted of the
following:
Amortized Unrealized Unrealized Fair
Cost Gains (Losses) Value
--------- ---------- ---------- -----
U.S. government
securities
0-5 year
maturity $3,835 $ 28 $ (15) $3,848
6 year or
greater maturity 400 - (1) 399
Municipal bonds
0-5 year
maturity 3,517 175 - 3,692
6 year or
greater maturity 998 91 - 1,089
Corporate debt
securities
and other
0-5 year
maturity 707 2 (7) 702
6 year or
greater maturity 100 4 - 104
Equity securities 3,887 3,432 (149) 7,170
Total before-tax
effect $13,444 $3,732 $ (172) $17,004
Deferred tax
effect of
unrealized
(gains) losses (1,447) 67
Net unrealized
gains (losses)
on marketable
securities $2,285 $ (105)
In 1998, proceeds from sales of available-for-sale
securities were $2,253. The gains and losses on these
sales were $949 and $90, respectively, determined on the
specific identification method.
Market values are based on quoted market prices.
In 1997, proceeds from sales of available-for-sale
securities were $1,678. The gains and losses on these
sales were $614 and $41, respectively, determined on the
specific identification method.
4. Inventories
Inventories consist of the following:
December 31,
1998 1997
-------- --------
Finished goods $ 9,455 $ 9,757
Work in process 5,156 7,544
Raw materials 15,479 19,832
30,090 37,133
Adjustment to reduce
inventories of $10,700 and
$12,446 to the last-in,
first-out method
(See Note 1) (1,967) (1,905)
$28,123 $35,228
5. Restricted Cash
Cash restricted for purchase and construction of
equipment at December 31, 1998 and 1997 represents
proceeds received from the issuer of Industrial
Development Revenue Bonds (see Note 9) restricted to the
purchase and construction of property and equipment used
in one of the Company's operations.
6. Line of Credit
The Company, at December 31, 1998, had an unsecured
revolving line of credit of $35,000 for working capital
needs. The revolving line of credit matures on March
31, 2003 and borrowings bear a variable interest rate
related to LIBOR. The terms of the credit agreement
contain certain restrictions related to financial
ratios, indebtedness, tangible net worth and capital
expenditures. As of December 31, 1998, the Company was
not in compliance with all debt covenants; however, a
debt compliance waiver was obtained (Note 9). As of
December 31, 1997, the Company was in compliance with
all debt covenants. At December 31, 1998, the Company
had borrowings outstanding under the line of $26,000,
and the interest rate was 7.08%. At December 31, 1997,
the Company had borrowings outstanding under the line of
$14,012, and the interest rate was 6.27%.
7. Discontinued Operations
In September 1982, Autotrol Corporation (Autotrol), which
has since been merged with the Company, discontinued its
wastewater business. In subsequent years Autotrol
incurred certain expenses related to the wastewater
products and accrued for contingent liabilities. The
Company determined in 1997 that the reserve was no
longer required and recognized $1,330 ($0.09 per
share.assuming dilution) of after-tax income as a
recovery on discontinued operations.
8. Other Accrued Liabilities
Other accrued liabilities consist of the following:
December 31,
1998 1997
------- -------
Warranty and start-up $ 2,098 $ 1,900
Professional fees and other
accruals 4,390 2,123
Deferred acquisition-related
payments 2,827 3,000
Customer deposits 4,282 4,802
$13,597 $11,825
9. Debt
Long-term debt is as follows:
December 31,
1998 1997
------- -------
Promissory notes; interest
payable quarterly at the
three-month LIBOR plus 80
b.p.; due through 2001. The $ 5,725 $ 7,150
interest rate on December
31, 1998 was 6.24%.
Industrial development revenue
bonds (IDRB's), principal
due in varying annual
payments over 30 years;
interest payable monthly at
a variable rate determined 7,450 7,950
periodically by the bond
remarketing agent (5.35% at
December 31, 1998).
Promissory notes; interest
payable quarterly at fixed 5,000 -
rate of 6.72%; due through
2008.
Promissory notes; interest
payable quarterly at the
three-month LIBOR plus
75 b.p.; due through 2008. 15,000 -
The interest rate on
Decembber 31, 1998 was 6.19%.
Mortgage notes payable to two
French banks; interest
payable monthly at PIBOR
plus 40 b.p. The interest 402 502
rate on December 31, 1998
was 3.25%.
Other notes 265 352
33,842 15,954
Current portion (2,177) (2,162)
$31,665 $13,792
The IDRB debt and mortgage notes payable to French banks
are collateralized by real and personal property of the
Company.
Aggregate maturities of long-term debt outstanding at
December 31, 1998 are:
1999 - $2,177; 2000 - $2,253; 2001 - $2,253; 2002 -
$5,146; 2003 - $3,679; beyond 2003 - $18,334.
The promissory notes contain a covenant which limits the
payment of dividends to shareholders. At December 31,
1998, approximately $5,000 of retained earnings were
restricted under this covenant. In addition, the
Company's various debt agreements contain certain
restrictions related to financial ratios, indebtedness,
tangible net worth and capital expenditures.
As a result of financial results in 1998, the Company was
out of compliance with the Leverage Ratio requirement
related to its revolving line of credit at various
measurement dates throughout the year and the Fixed
Charge Coverage ratio related to its long-term debt at
December 31, 1998. The Company has received a waiver
from the lenders in regard to these covenants. In
addition, the Company entered into a loan amendment with
the revolving line of credit lender in February 1999
which reduces the Leverage Ratio requirement. As of
December 31, 1998 and 1997, the Company was in
compliance with all other debt covenants.
The Company also has an unsecured standby letter of
credit of $5 million with a large financial institution.
As of December 31, 1998, no amount was outstanding.
Cash payments for interest related to all debts of the
Company were $4,037, $2,033, and $1,551, for the years
ended December 31, 1998, 1997, and 1996, respectively.
10. Stock Options
In 1998, the Board of Directors approved an amendment to
the 1993 Stock Option Plan which expanded reserved
common shares to 800,000 from 298,863. The expansion of
this plan is intended to facilitate ownership and
increase the interest of key employees in the growth and
performance of the Company, thus enhancing the value of
the Company for the benefit of the shareholders.
Options are granted at a price not less than market
value on the date of the grant and become exercisable
over a period of up to ten years, after which they
expire. The 1993 Stock Option Plan terminates on
September 1, 2003.
The Company's 1995 Director Stock Option Plan provides
that each director of the Company shall automatically
receive, as of the date of each Annual Meeting of
Shareholders, a non-qualified option to purchase 3,000
shares of the Company's common stock. The options have
a ten-year term and are exercisable one year after the
grant date at an exercise price equal to the fair market
value of the shares on the grant date. The 1995
Director Stock Option Plan terminates on May 17, 2005.
Shares reserved for future issuance under all of the
Company's plans totaled approximately 1.855 million at
December 31, 1998.
The Company applies Accounting Principals Board (APB)
Opinion No. 25 "Accounting for Stock Issued to
Employees" and related interpretations in accounting for
its plans. No compensation cost has been recognized for
its stock-based compensation plans as the exercise price
of the stock option grants was equal to the fair market
value of the shares on the grant date. Had compensation
costs been determined based on the fair value of the
1998, 1997, and 1996 stock option grants consistent with
the requirements of SFAS No. 123 "Accounting for Stock-
Based Compensation" (SFAS 123), net income and earnings
per share would have been reported as the following pro
forma amounts:
1998 1997 1996
-------- ------ -------
Net income (loss)
As reported $(1,053) $9,793 $13,467
Pro forma $(1,468) $9,613 $13,422
Earnings (loss)
per share _
assuming dilution
As reported $ (0.08) $ 0.68 $ 0.93
Pro forma $ (0.11) $ 0.67 $ 0.93
The fair value of the stock options used to calculate the
pro forma net income and earnings per share amounts
above is estimated using the Black-Scholes options
pricing model with the following weighted average
assumptions:
1998 1997 1996
----- ----- -----
Dividend yield 0% 0% 0%
Expected
volatility 42.5% 24.2% 22.5%
Risk-free
interest rate 6.0% 6.0% 6.1%
Expected life 5.0 5.0 5.0
Information related to stock options at December 31 under
the aforementioned stock option plans is as follows:
1998 1997 1996
Weighted Weighted Weighted
Average Average Average
Shares Exercise Shares Exercise Shares Exercise
Stock Options (000) Price (000) Price (000) Price
------------- ------ -------- ------ -------- ------ --------
Outstanding at
beginning of
year 653 $ 9.9 505 $ 7.8 470 $ 6.9
Granted 379 11.9 154 17.2 35 19.7
Exercised - - - - - -
Forfeited 85 15.5 6 17.5 - -
Outstanding at
end of year 947 10.2 653 9.9 505 7.8
Options
exercisable
at year-end 486 7.4 410 6.7 329 6.0
Weighted
average
fair value of
options
granted
during the
year $5.48 $5.81 $6.59
The following table summarizes information about stock
options outstanding at December 31, 1998:
Options
Options Outstanding Exercisable
------------------------------ -----------------
Shares Shares
Outstandi Remaining Weighted Exercis- Weighted
Range of ng at Con- Average able at Average
Exercise 12/31/98 tractual Exercise 12/31/98 Exercise
Prices (000) Life Price (000) Price
------------- --------- -------- -------- -------- --------
2.23 - 6.72 373 3.7 yrs $ 4.95 373 $ 4.95
8.95 - 13.42 286 9.0 yrs 10.41 45 12.33
13.43 - 17.90 253 8.5 yrs 16.42 50 16.68
17.91 - 22.38 35 7.5 yrs 19.57 18 19.57
In 1998, the Company adopted a Stock Match Plan under
which the Company matches, in the form of Company common
stock, certain eligible U.S. employee savings plan
contributions. Employees are vested in the shares
immediately. Shares issued under the Stock Match Plan
approximated 23,468 shares in 1998 at a cost of
approximately $234,000. At December 31, 1998, there
were approximately 176,500 shares reserved for future
issuance.
The Company has an Employee Stock Purchase Plan which
allows eligible employees to purchase common shares of
the Company at 85% of market price. During 1998,
approximately 64,819 shares were issued at prices
ranging from $7.18 to $14.08 per share. During 1997,
approximately 59,000 shares were issued at prices
ranging from $12.40 to $17.58 per share. During 1996,
approximately 41,000 shares were issued at prices
ranging from $16.10 to $20.03 per share. At December
31, 1998, there were approximately 213,000 shares
reserved for future issuance.
The Company had 500,000 authorized and unissued shares of
preferred stock at December 31, 1998 and 1997.
11. Income Taxes
Income tax expense consists of:
Year ended December 31,
1998 1997 1996
------- ------- -------
Current:
Federal $ 213 $2,741 $3,556
State 261 (39) 395
Foreign 395 666 640
Deferred:
Depreciation 298 351 370
Amortization of
intangibles (1,387) 261 47
Net operating loss usage 508 - -
Allowance for doubtful
accounts, start-up,
warranty, inventory and
other accruals (347) 100 462
Other 34 (153) 971
Total continuing
operations $ (25) $3,927 $6,441
Discontinued operations,
deferred - 617 -
Total provision $ (25) $4,544 $6,441
Cash payments for income taxes were $3,624, $3,728, and
$5,204, for the years ended December 31, 1998, 1997, and
1996, respectively.
At the point when the Company acquired MSI on February
17, 1998, MSI had incurred $11,827 of tax losses, which
had not yet been offset against previous or subsequent
years' taxable income of MSI. Subsequent to the period
reported herein, MSI filed a refund request that offset
$8,684 of these losses against income of MSI for the
years from 1988 to 1995, under the "Claim of Right"
rule. $1,329 of the remaining losses were offset
against MSI income in 1998. The balance of the losses,
amounting to $1,814, will be offset against future
years' income. These loss carryforwards expire after
the year 2017.
A reconciliation of the income taxes computed at the
Federal statutory rate to the Company's income tax
expense is as follows:
Year ended December 31,
1998 1997 1996
------- ------ ------
Taxes at Federal rate (35%) $ (377) $4,337 $6,950
Increase (decrease)
resulting from:
State taxes, net of Federal
tax benefit 216 132 397
Foreign Sales Corp. benefit (503) (546) (361)
Tax credits (307) (249) (197)
Tax-exempt
interest/dividend
deduction (123) (123) (128)
Effect of foreign
affiliates with different
tax rates or net losses 91 167 30
Nondeductibility of
intangible write-offs and
amortization 851 35 (15)
Uncollectible account
write-off - - (442)
Other 127 174 206
Total continuing operations $ (25) $3,927 $6,440
Discontinued operations - 617 -
Total provision $ (25) $4,544 $6,440
12. Deferred Tax Assets and Liabilities
Temporary differences which give rise to deferred tax
assets and liabilities are as follows as of December 31:
1998 1997
------ ------
Current assets:
Allowance for doubtful
accounts, start-up,
warranty, inventory and $3,966 $2,955
other accruals
Unrealized gain on
marketable securities (1,410) (1,380)
Inventory costs 122 81
capitalized for tax
Net operating losses
available for carryback 4,051 -
or carryforward
Other (119) (243)
Total current deferred
Assets $6,610 $1,413
Noncurrent liabilities:
Depreciation $4,098 $3,718
Other 708 721
Total non-current
deferred tax liabilities $4,806 $4,439
13. Sales and Segment Information
The Company designs, manufactures and markets equipment,
systems and components used in the processing and
handling of fluids. The Company markets through five
marketing units made up of related product lines.
Certain marketing units have similar economic
characteristics and have been aggregated under Statement
of Financial Accounting Standards No. 131, "Disclosures
about Segments of an Enterprise and Related
Information,"(SFAS No. 131). As a result of aggregation,
the Company has two reportable business segments,
Consumables and Equipment.
The Consumables segment, comprised of two marketing
units, includes products such as filter cartridges,
membrane elements, membrane, instruments, and laboratory
products. The Equipment segment, comprised of three
marketing units, includes products such as pumps,
housings, valves, controls, reverse
osmosis/ultrafiltration (RO/UF) machines, ozonators,
stills, and water treatment systems. Each segment is
currently supported by several manufacturing facilities,
a similar sales force and various corporate functions.
The segments do not have separate accounting, customer
service, administration, or purchasing functions.
The marketing unit structure was established to provide
strategic leadership for related products. It was
implemented on July 1, 1998. As a result, six months of
financial results are available to report under SFAS No.
131. Restatement of prior period results under this
method of reporting has been deemed impracticable due to
the anticipated costs and unavailability of such
financial information.
Sales include external sales only. Inter-segment sales
primarily occur with Consumables products being included
in Equipment products which could be significant. The
reportable segment information for the six-month period
ended December 31, 1998 is as follows:
Consumables Equipment Consolidated
Total
----------- --------- ------------
Sales $36,631 $51,685 $ 88,316
Cost of sales 22,342 34,425 56,767
Gross profit 14,289 17,260 31,549
Gross margin % 39.0% 33.4% 35.7%
Selling, general &
administrative 9,527 13,579 23,106
Research, development
& engineering 1,904 3,162 5,066
Operating expenses 11,431 16,741 28,172
Operating income $ 2,858 $ 519 $ 3,377
Other income (expense) (1,234)
Income before taxes 2,143
Income taxes 77
Net income $ 2,066
Currently, management does not report or analyze the
balance sheet or any cash-generating measurements by such
segments.
All continuing operations for which geographic data is
presented below are in one principal industry (design,
manufacture and marketing of machines, systems,
instruments and components used in the processing of
fluids).
1998 1997 1996
-------- -------- --------
Sales to unaffiliated
customers from:
United States $163,908 $150,753 $141,124
Foreign operations 13,911 14,152 14,822
Transfers from (to)
geographic areas:
United States 8,780 7,818 7,890
Foreign operations (8,780) (7,818) (7,890)
$177,819 $164,905 $155,946
Income (loss) from
continuing operations
before income taxes:
United States $( 1,926) $10,847 $18,225
Foreign operations 848 1,543 1,683
$ (1,078) $12,390 $19,908
Identifiable assets:
United States $185,814 $155,592 $144,609
Foreign operations 8,235 8,891 7,567
$194,049 $164,483 $152,176
NOTE: Transfers are made at fair market value.
Sales by United States operations to unaffiliated
customers in foreign geographic areas are as follows:
Year ended December 31,
1998 1997 1996
------- ------- -------
Asia/Pacific $15,967 $20,030 $14,661
Euro/Africa 17,710 14,536 9,181
Americas 11,227 11,678 9,222
$44,904 $46,244 $33,064
Total international sales for the Company were as follows:
1998 - $58,815; 1997 - $60,396; and 1996 - $47,886.
14. Commitments and Contingencies
The Company leases facilities for sales, service or
manufacturing purposes in Wisconsin, Massachusetts,
California, New Jersey, Florida, Iowa, Switzerland,
Germany, Hong Kong, Japan, China, Singapore, and
Thailand.
Future minimum lease payments on all operating leases of
$5,195 are payable as follows: 1999 - $1,423; 2000 -
$1,015; 2001 - $862; 2002 - $605; 2003 - $390; and
beyond 2003 - $180. Rent expense for the three years
ended December 31 was: 1998 - $1,794; 1997 - $1,633;
and 1996 - $1,100.
The Company is involved in certain legal actions arising
in the ordinary course of business. In the opinion of
management, based on the advice of legal counsel, such
litigation and claims will be resolved without a
material effect on the Company's financial position or
results of operations.
15. Employee Benefit Plans
The Company has a noncontributory discretionary profit
sharing plan covering certain employees meeting age and
length of service requirements. The Company contributes
annually to the plan an amount established at the
discretion of the Board of Directors.
Total expense recognized by the Company under these plans
amounted to $687, $1,300, and $1,435 in 1998, 1997, and
1996, respectively.
16. Earnings Per Share
Effective December 31, 1997, the Company adopted
Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS No. 128). The following
table reflects the calculation of basic and diluted
earnings per share from continuing operations.
1998 1997 1996
-------- ------ -------
Earnings (loss) per share -
basic
Income (loss) from continuing
operations available to
common stockholders $(1,053) $8,463 $13,467
Weighted average shares
outstanding 13,976 14,031 14,145
Income (loss) from continuing
operations per share - basic $(0.08) $ 0.60 $ 0.95
Earnings (loss) per share -
assuming dilution
Income (loss) from continuing
operations available to
common stockholders $(1,053) $8,463 $13,467
Weighted average shares
outstanding 13,976 14,031 14,145
Dilutive impact of stock
options outstanding - 282 313
Weighted average shares and
potential dilutive shares
outstanding 13,976 14,313 14,458
Income (loss) from continuing
operations per
share - assuming dilution $ (0.08) $ 0.59 $ 0.93
Options to purchase approximately 285,000 shares of
common stock were outstanding during 1998, but were not
included in the computation of diluted earnings per
share because they would have been antidilutive.
Additionally, options to purchase 334,000 shares of
common stock at a range of $13.67 to $22.38 were
outstanding during 1998 but were not included in the
computation of diluted earnings per share because the
options' exercise price was greater than the average
market price of the common share.
17. Special Charges
In 1998, the Company recorded special charges of $9,988
($7,569 net-of-tax or $0.54 per share assuming
dilution). Charges include a $6,222 charge to operating
expense for in-process research and development (Note 2)
related to the acquisitions of Micron Separations, Inc.
($1,902) and Membrex Corp. ($4,320) and a $2,000 charge
to cost of sales for slow moving inventory. The special
charges also included operating expense charges of $875
for corporate restructuring and consolidation of
operations, and $891 for re-engineering costs and write-
downs of assets in connection with the Company's
implementation of a global information system.
Corporate restructuring and consolidation of operations
costs of $875 primarily includes work force reduction
severance and facility closing/consolidation costs.
June 30, 1998 employment of 1,559 was reduced to 1,360
at December 31, 1998. Facility-related costs relate to
closing three manufacturing facilities and relocating
manufacturing-related activities to other existing
locations. Two additional facilities are expected to be
closed in 1999. Expenditures will be funded with cash
generated from operations and were $200 for work force
reductions and $140 for facilities in 1998.
18. Subsequent Event
In February 1999, the Company entered into a Letter of
Intent agreement to acquire all assets of another
company. Revenues of such company were less than $15
million in 1998 and 1997. Upon finalization, the
acquisition will be recorded under the purchase method
of accounting.
INDEPENDENT AUDITORS' REPORT
Osmonics, Inc. Board of Directors and Shareholders
Minnetonka, Minnesota
We have audited the accompanying consolidated balance sheets
of Osmonicis, Inc. and Subsidiaries (the Company) as of
December 31, 1998 and 1997 and the related consolidated
statements of operations, changes in shareholders' equity,
and cash flows for each of the three years in the period
ended December 31, 1998. These financial statements are the
responsibility of the Company's management. Our
responsibility is to express an opinion on the financial
statements based on our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require that
we plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by
management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide
a reasonable basis for our opinion.
In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects,
the financial position of Osmonics, Inc. and Subsidiaries at
December 31, 1998 and 1997 and the results of their
operations and their cash flows for each of the three years
in the period ending December 31, 1998, in conformity with
generally accepted accounting principles.
Deloitte and Touche LLP
Minneapolis, Minnesota
March 3, 1999