**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

----

**FORM 10–Q**

** **

**                                                                                               **
| **ý** | **Quarterly Report  Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934**   |   |
|------------|-------------------------------------------------------------------------------------------------|--------|
|       |                                                                                            |
|       | **For Quarter Ended  September 30, 2001**                                                       |   |
|       |                                                                                            |   |
|       | **OR**                                                                                          |   |
|       |                                                                                            |   |
| **o**      | **Transition  Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of  1934** |   |
|       |                                                                                            |
|       | **For  the transition period from___to___**                                                     |   |

** **

** **

**CommissionFile No.  1-12714**

 

 

**OSMONICS, INC**

(Exact name of registrant as specified inits 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 telephonenumber, including area code  **(952) 933–2277**

 

**N/A**Former name, former address and former

fiscal year, if changed since last report

 

     Indicate by check mark whether theregistrant (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 (orfor 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 90days.

 

Yes  ý    No   o

 

     Indicate the number of shares outstandingof each of the issuer's classes of common stock, as of the latest practicabledate.  At October 31, 2001, 14,509,939shares of the issuer's Common Stock, $0.01 par value, were outstanding.

 

 

OSMONICS, INC.

 

INDEX

 

 
| PART  I.  FINANCIAL INFORMATION                                                                           |   |
|----------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                           |   |
| ITEM  I.  FINANCIAL STATEMENTS                                                                            |   |
|                                                                                                           |   |
| Consolidated Statements  of Operations – For the Three and Nine Months Ended September 30, 2001  and 2000 |   |
|                                                                                                           |   |
| Consolidated Balance Sheets  – September 30, 2001 and December 31, 2000                                   |   |
|                                                                                                           |   |
| Consolidated  Statements of Cash Flows - For the Nine Months Ended September 30, 2001 and  2000                |   |
|                                                                                                           |   |
| Notes to  Consolidated Financial Statements -                                                                  |   |
|                                                                                                           |   |
| ITEM  II. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATIONS               |   |
|                                                                                                           |   |
| PART  II. OTHER INFORMATION                                                                                    |   |
|                                                                                                           |   |
| ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                                 |   |
|                                                                                                           |   |
| SIGNATURES                                                                                                     |   |

 

ITEM I – FINANCIAL STATEMENTS

 

OSMONICS, INC.

 

CONSOLIDATED STATEMENTSOF OPERATIONS

(In Thousands Except PerShare Data)

 

(UNAUDITED)
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
|--------------------------------------------|--------|------------------------|-----------------------|-----------------------|-----------------------|----------|-----------------------|----------|-----------------------|
|                                       |   | **Three Months Ended** |                  | **Nine Months Ended** |                  |
|                                       |   | **September 30,**      |                  | **September 30,**     |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
|                                       |   | **2001**               |                  | **2000**              |                  | **2001** |                  | **2000** |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Sales                                      |   | $                      | 48,372                |                  | $                     | 48,463   |                  | $        | 153,395               |   | $ | 149,668 |   |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Cost of sales                              |   | 34,461                 |                  | 34,363                |                  | 105,542  |                  | 103,396  |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Gross profit                               |   | 13,911                 |                  | 14,100                |                  | 47,853   |                  | 46,272   |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Less:                                      |   |                   |                  |                  |                  |     |                  |     |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Selling,  general and administrative       |   | 10,311                 |             | 10,316                |             | 33,236   |             | 33,162   |             |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Research,  development and engineering     |   | 1,786                  |        | 1,877                 |        | 5,789    |        | 5,950    |        |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Special charges                            |   | -                      |                  | -                     |                  | -        |                  | 250      |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Income from operations                     |   | 1,814                  |                  | 1,907                 |                  | 8,828    |                  | 6,910    |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Other expense                              |   | (178                   | )                     | (463                  | )                     | (1,205   | )                     | (254     | )                     |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Income from operations before income taxes |   | 1,636                  |             | 1,444                 |             | 7,623    |             | 6,656    |             |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Income tax expense                         |   | 497                    |                  | 425                   |                  | 2,592    |                  | 2,197    |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Net income                                 |   | $                      | 1,139                 |                  | $                     | 1,019    |                  | $        | 5,031                 |   | $ | 4,459 |   |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Earnings  per share                        |   |                   |                  |                  |                  |     |                  |     |                  |
| Net income - basic                         |   | $                      | 0.08                  |                  | $                     | 0.07     |                  | $        | 0.35                  |   | $ | 0.31 |   |
| Net income – assuming dilution        |   | $                      | 0.08                  |                  | $                     | 0.07     |                  | $        | 0.34                  |   | $ | 0.31 |   |
|                                       |   |                   |                  |                  |                  |     |                  |     |                  |
| Average shares outstanding                 |   |                   |                  |                  |                  |     |                  |     |                  |
| Basic                                      |   | 14,474                 |                  | 14,347                |                  | 14,448   |                  | 14,310   |                  |
| Assuming dilution                          |   | 14,806                 |                  | 14,420                |                  | 14,627   |                  | 14,380   |                  |

 

OSMONICS, INC.

CONSOLIDATEDBALANCE SHEETS

(In Thousands ExceptShare Data)

 

 
|                                                                                                                                                                     |   | **(UNAUDITED)**          |                  |              |                  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|-----------------------|-------------------|-----------------------|
|                                                                                                                                                                     |   | **  September 30,** |                  | **December  31,** |                  |
|                                                                                                                                                                     |   | **2001**                 |                  | **2000**          |                  |
| ASSETS                                                                                                                                                                   |   |                     |                  |              |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Current assets                                                                                                                                                           |   |                     |                  |              |                  |
| Cash and cash equivalents                                                                                                                                                |   | $                        | 2,990                 |              | $                     | 21 |   |
| Marketable securities                                                                                                                                                    |   | 64                       |                  | 1,889             |                  |
| Trade accounts receivable, net of allowance  for doubtful accounts of $694 in 2001, and $1,008 in 2000                                                                   |   | 34,991                   |        | 37,092            |        |
| Inventories                                                                                                                                                              |   | 33,575                   |                  | 32,758            |                  |
| Deferred tax assets                                                                                                                                                      |   | 4,080                    |                  | 4,314             |                  |
| Other current assets                                                                                                                                                     |   | 3,958                    |                  | 2,487             |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Total current assets                                                                                                                                                     |   | 79,658                   |                  | 78,561            |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Property and equipment, at cost                                                                                                                                          |   |                     |                  |              |                  |
| Land and land improvements                                                                                                                                               |   | 5,085                    |                  | 5,056             |                  |
| Building                                                                                                                                                                 |   | 31,202                   |                  | 30,283            |                  |
| Machinery and equipment                                                                                                                                                  |   | 81,143                   |                  | 76,943            |                  |
|                                                                                                                                                                     |   | 117,430                  |                  | 112,282           |                  |
| Less accumulated depreciation                                                                                                                                            |   | (60,103                  | )                     | (55,381           | )                     |
|                                                                                                                                                                     |   | 57,327                   |                  | 56,901            |                  |
| Other assets                                                                                                                                                             |   | 51,260                   |                  | 53,230            |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Total assets                                                                                                                                                             |   | $                        | 188,245               |              | $                     | 188,692 |   |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| LIABILITIES AND SHAREHOLDERS' EQUITY                                                                                                                                     |   |                     |                  |              |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Current liabilities                                                                                                                                                      |   |                     |                  |              |                  |
| Accounts payable                                                                                                                                                         |   | $                        | 12,870                |              | $                     | 15,262 |   |
| Notes payable and current portion of long–term  debt                                                                                                                |   | 21,734                   |             | 19,759            |             |
| Other accrued liabilities                                                                                                                                                |   | 13,424                   |                  | 13,784            |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Total current liabilities                                                                                                                                                |   | 48,028                   |                  | 48,805            |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Long–term debt                                                                                                                                                      |   | 19,984                   |                  | 24,603            |                  |
| Other liabilities                                                                                                                                                        |   | -                        |                  | 4                 |                  |
| Deferred income taxes                                                                                                                                                    |   | 6,128                    |                  | 6,335             |                  |
| Shareholders’ equity                                                                                                                                                |   |                     |                  |              |                  |
| Common  stock, $0.01 par value Authorized –– 50,000,000 shares Issued ––      2001: 14,502,478 and 2000: 14,408,634  shares |   | 145                      |                  | 144               |                  |
| Capital in excess of par value                                                                                                                                           |   | 24,464                   |                  | 23,818            |                  |
| Retained earnings                                                                                                                                                        |   | 90,489                   |                  | 85,458            |                  |
| Other comprehensive income                                                                                                                                               |   | (993                     | )                     | (475              | )                     |
| Total shareholders’ equity                                                                                                                                          |   | 114,105                  |                  | 108,945           |                  |
|                                                                                                                                                                     |   |                     |                  |              |                  |
| Total liabilities and shareholders' equity                                                                                                                               |   | $                        | 188,245               |              | $                     | 188,692 |   |

 

OSMONICS,INC.

 

CONSOLIDATED STATEMENTSOF CASH FLOWS

(In Thousands)

 

(UNAUDITED)
|                                                              |   |                  |           |           |           |
|-------------------------------------------------------------------|--------|-----------------------|----------------|----------------|----------------|
|                                                              |   | **Nine Months Ended** |           |
|                                                              |   | **September 30,**     |           |
|                                                              |   |                  |           |           |           |
|                                                              |   | **2001**              |           | **2000**       |           |
|                                                              |   |                  |           |           |           |
| Cash flows from operations:                                       |   |                  |           |           |           |
| Net income                                                        |   | $                     | 5,031          |           | $              | 4,459 |   |
| Non–cash items included in net income:                       |   |                  |           |           |           |
| Depreciation and amortization                                     |   | 7,686                 |           | 7,345          |           |
| Deferred  income taxes                                            |   | 240                   |           | 319            |           |
| Gain on sale of investments                                       |   | (972                  | )              | (2,723         | )              |
| Loss on sale of property and equipment                            |   | (8                    | )              | (21            | )              |
| Changes in assets and liabilities (net of  business acquisitions) |   |                  |      |           |      |
| Accounts receivable                                               |   | 2,267                 |           | (2,384         | )              |
| Inventories                                                       |   | (817                  | )              | (7,219         | )              |
| Other current assets                                              |   | (1,896                | )              | (506           | )              |
| Accounts payable and accrued liabilities                          |   | (2,756                | )              | (176           | )              |
|                                                              |   |                  |           |           |           |
| Net cash provided by (used in) operations                         |   | 8,775                 |           | (906           | )              |
|                                                              |   |                  | ** **     |           | ** **     |
| **Cash  flows from investing activities:**                        |   |                  | ** **     |           | ** **     |
| Purchase of investments                                           |   | -                     |           | (1,178         | )              |
| Sale of investments                                               |   | 2,189                 |           | 11,631         |           |
| Purchase of property and equipment                                |   | (6,645                | )              | (4,826         | )              |
| Sales of property and equipment                                   |   | 241                   |           | 568            |           |
| Other                                                             |   | 691                   |           | (1,054         | )              |
|                                                              |   |                  |           |           |           |
| Cash provided by (used in) investing  activities                  |   | (3,524                | )              | 5,141          |           |
|                                                              |   |                  | ** **     |           | ** **     |
| **Cash flows from financing activities:**                         |   |                  | ** **     |           | ** **     |
| Proceeds from notes payable and current debt                      |   | 1,975                 |           | 2,054          |           |
| Reduction of long-term debt                                       |   | (4,619                | )              | (7,969         | )              |
| Cash restricted for purchase and construction  of equipment       |   | (162                  | )              | (162           | )              |
| Issuance of common stock                                          |   | 647                   |           | 946            |           |
|                                                              |   |                  |           |           |           |
| Net cash provided by (used in) financing  activities              |   | (2,159                | )              | (5,131         | )              |
|                                                              |   |                  |           |           |           |
| Effect of exchange rate changes on cash                           |   | (123                  | )              | (386           | )              |
| Increase (decrease) in cash and cash  equivalents                 |   | 2,969                 |           | (1,282         | )              |
| Cash and cash equivalents – beginning of  year               |   | 21                    |      | 1,807          |      |
| Cash and cash equivalents – end of  quarter                  |   | $                     | 2,990          |      | $              | 525 |      |

 

**OSMONICS, INC.**

 

#### **NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

(Dollars in Thousands)

 

 

**Note 1 – Consolidated FinancialStatements**

 

The accompanying unaudited condensedfinancial statements have been prepared in accordance with the instructions toForm 10-Q and do not include all the information and footnotes required bygenerally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments considered necessary for a fair presentation havebeen included.

 

Operatingresults for the three months or nine months ended September 30, 2001, are notnecessarily indicative of the results that may be expected for the full year2001.

 

Thesestatements should be read in conjunction with the financial statements andrelated notes included in the Company’s Annual Report to shareholders and Form10-K for the year ended December 31, 2000.

 

The Company has the following componentsof comprehensive income:

 
|                                                        |   | **Nine  Months Ended September 30,** |   |
|-------------------------------------------------------------|--------|--------------------------------------|--------|
|                                                        |   | **2001**                             |   | **2000** |   |
|                                                        |   |                                 |   |   |   |
| Net income                                                  |   | $                                    | 5,031  |   | $ | 4,459 |   |
| **Other comprehensive income  (loss), net of tax:**         |   |                                 |   |   |   |
| Foreign  currency translation adjustments                   |   | (123                                 | )      | (386 | ) |
| Unrealized  gains/(losses) on available for sale securities |   | (395                                 | )      | (1,014 | ) |
| Other  comprehensive income (loss)                          |   | (518                                 | )      | (1,400 | ) |
| Comprehensive  income                                       |   | $                                    | 4,513  |   | $ | 3,059 |   |

 

OnJune 29, 2001, the Financial Accounting Standards Board approved its proposedStatements of Financial Accounting Standards No. 141 (FAS 141), “BusinessCombinations,” and No. 142 (FAS 142), “Goodwill and Other IntangibleAssets.”  FAS 141 requires that allbusiness combinations subsequent to June 30, 2001 be accounted for under thepurchase method of accounting.  FAS 142requires cessation of goodwill amortization and periodic evaluation of thegoodwill carrying value.  The provisionsof FAS 142 will be effective for fiscal years beginning after December 15,2001.  The Company is evaluating theimpact of the adoption of these standards and has not yet determined the effectof adoption on its financial position and results of operations.

**Note 2 – Business Acquisitions**

 

TheCompany has $13,800 of goodwill recorded as of September 30, 2001 associatedwith the 1998 acquisition of Membrex Corp. (Membrex).  Safety Kleen (SK), the principal customer for the Membrexproducts, filed for Chapter 11 bankruptcy in June of 2000.  As a result, nine months sales endedSeptember 30, 2001 to SK of $1,571 were substantially below same period 2000sales of $3,409.  SK has continued toorder product and parts at reduced levels to support its installed base.  Future sales levels are uncertain and couldbe minimal.

 

TheCompany has a contract with SK that provided some exclusivity to SK for certainMembrex products provided that SK satisfied certain purchase requirements.  Based on the amount of purchases to date,the Company believes that any such exclusivity provisions are no longer ineffect.  The Company had anticipatedrenegotiating the contract with SK during the third quarter 2001; however, anew contract has not yet been completed. The Company continues discussions with SK and expects a contract resolutionduring the fourth quarter 2001.

 

TheCompany has determined that two-thirds ($9,200) of the Membrex goodwill isassociated with the SK purchases of Membrex products.  Business activity in the first six months of 2001 approximatedthe financial forecasts used to support the goodwill balance at December 31,2000; however, business activity in the third quarter ended September 30, 2001was below such financial forecasts. Nevertheless, the Company has concludedthere was no impairment of goodwill at September 30, 2001, based on forecastedbusiness activity levels.

 

Inventoryrelated to the Membrex products for SK was $1,700 while net receivables from SKwere current at September 30, 2001.  TheCompany is monitoring the Chapter 11 bankruptcy proceedings to determine anyfurther financial impact to the Company.

 

 

**Note 3 - Inventories**

 
|                                                                                       |   | **September  30 2001** |   | **December  312000** |   |
|--------------------------------------------------------------------------------------------|--------|------------------------|--------|----------------------|--------|
| Inventories consist of the following:                                                      |   |                   |   |
|                                                                                       |   |                   |   |                 |   |
| Finished goods                                                                             |   | $                      | 9,605  |                 | $      | 8,013 |   |
| Work in process                                                                            |   | 9,821                  |   | 8,775                |   |
| Raw materials                                                                              |   | 15,946                 |   | 17,695               |   |
|                                                                                       |   | 35,372                 |   | 34,483               |   |
| Adjustments to reduce  inventories of $10,384 and $11,643 to the last-in, first-out method |   | (1,797                 | )      | (1,725               | )      |
|                                                                                       |   | $                      | 33,575 |                 | $      | 32,758 |   |

 

 

 

**Note 4 – Segment Information**

 

The Company designs, manufactures andmarkets equipment, systems and components used in the processing and handlingof fluids.  In 2000, the Company changedthe focus of its reporting structure from a two segment, product focusedstructure to a three segment, market focused structure.

 

The three-market-segment structure wasestablished to provide strategic leadership within the three major marketsegments in which the Company conducts business.  The new structure was implemented on January 1, 2000.

 

The Filtration and Separations segmentincludes products such as filter cartridges, membrane elements, membranes,instruments and laboratory products. The Process Water segment includesproducts such as pumps, housings, valves, controls, reverseosmosis/ultrafiltration (RO/UF) machines, ozonators and water treatment systemsused for industrial, commercial and municipal applications. The Household Watersegment includes products such as valves, controls and home reverse osmosismembranes and filters used for the residential water purification and water softeningmarket segments. Each segment is currently supported by several manufacturingfacilities, a sales force and various corporate functions. The segments do nothave separate accounting, administration or research and development functions.

 

Thereportable segment information for the three months and nine months endedSeptember 30, 2001 and 2000 are as follows:
|                        |   | **Third Quarter Ended** |   | **Nine Months Ended** |   |
|-----------------------------|--------|-------------------------|--------|-----------------------|--------|
|                        |   | **September  30,**      |   | **September  30,**    |   |
|                        |   | **2001**                |   | **2000**              |   | **2001** |   | **2000** |   |
| Sales:                      |   |                    |   |                  |   |   |   |   |   |
| Filtration and Separations  |   | $                       | 20,478 |                  | $      | 19,003 |   | $ | 63,091 |   | $ | 60,410 |   |
| Process Water               |   | 18,896                  |   | 19,483                |   | 63,153 |   | 58,927 |   |
| Household  Water            |   | 8,998                   |   | 9,977                 |   | 27,151 |   | 30,331 |   |
| Net Sales                   |   | 48,372                  |   | 48,463                |   | 153,395 |   | 149,668 |   |
| Gross  Profit:              |   |                    |   |                  |   |   |   |   |   |
| Filtration and Separations  |   | 6,903                   |   | 6,177                 |   | 23,042 |   | 21,436 |   |
| Process  Water              |   | 4,527                   |   | 4,345                 |   | 16,987 |   | 14,603 |   |
| Household  Water            |   | 2,481                   |   | 3,578                 |   | 7,824 |   | 9,983 |   |
| Gross  Profit               |   | 13,911                  |   | 14,100                |   | 47,853 |   | 46,022 |   |
| Operating  Income (Loss):   |   |                    |   |                  |   |   |   |   |   |
| Filtration  and Separations |   | 1,540                   |   | 886                   |   | 6,251 |   | 4,364 |   |
| Process  Water              |   | 2                       |   | (379                  | )      | 1,946 |   | (564 | ) |
| Household  Water            |   | 272                     |   | 1,400                 |   | 631 |   | 3,110 |   |
| Operating  Income           |   | $                       | 1,814  |                  | $      | 1,907 |   | $ | 8,828 |   | $ | 6,910 |   |

 

 

Management does notreport the balance sheet or any cash-generating measurements by such segments.

 

## **ITEM II.         MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL**

## **                        CONDITIONAND RESULTS OF OPERATIONS**

 

                        (Dollars in thousands,except share data)

 

 

Asan aid to understanding the Company’s operating results, the following tableshows the percentage of sales that each income statement item represents forthe three months and nine months ended September 30, 2001 and 2000.

 
|                                  |   | **Percent  of Sales**   |       | **Percent  of Sales**  |       |
|---------------------------------------|--------|-------------------------|------------|------------------------|------------|
|                                  |   | **Three  Months Ended** |       | **Nine  Months Ended** |       |
|                                  |   | **September  30,**      |       | **September  30,**     |       |
|                                  |   |                    |       |                   |       |   |   |   |   |
|                                  |   | **2001**                | ** ** | **2000**               | ** ** | **2001** |   | **2000** |   |
|                                  |   |                    |       |                   |       |   |   |   |   |
| Sales                                 |   | 100.0                   | %          | 100.0                  | %          | 100.0 | % | 100.0 | % |
| Cost of sales                         |   | 71.2                    |       | 70.9                   |       | 68.8 |   | 69.1 |   |
| Gross  profit                         |   | 28.8                    |       | 29.1                   |       | 31.2 |   | 30.9 |   |
|                                  |   |                    |       |                   |       |   |   |   |   |
| Selling,  general and administrative  |   | 21.3                    |       | 21.3                   |       | 21.7 |   | 22.1 |   |
| Research, development and engineering |   | 3.7                     |       | 3.9                    |       | 3.8 |   | 4.0 |   |
| Special charges                       |   | -                       |       | -                      |       | - |   | 0.2 |   |
| Operating  expenses                   |   | 25.0                    |       | 25.2                   |       | 25.5 |   | 26.3 |   |
|                                  |   |                    |       |                   |       |   |   |   |   |
| Income  from operations               |   | 3.8                     |       | 3.9                    |       | 5.7 |   | 4.6 |   |
| Other  expense                        |   | (0.4                    | )          | (0.9                   | )          | (0.7 | ) | (0.2 | ) |
| Income  from operations               |   |                    |       |                   |       |   |   |   |   |
| before  income taxes                  |   | 3.4                     |       | 3.0                    |       | 5.0 |   | 4.4 |   |
| Income  taxes                         |   | 1.0                     |       | 0.9                    |       | 1.7 |   | 1.4 |   |
|                                  |   |                    |       |                   |       |   |   |   |   |
| Net  income                           |   | 2.4                     | %          | 2.1                    | %          | 3.3 | % | 3.0 | % |

 

 

## **SALES**

 

Salesfor the third quarter ended September 30, 2001 of $48,372 were flat with salesfor the third quarter of 2000. Year-to-date 2001 sales through September increased 2.5% over thecorresponding 2000 level.  The thirdquarter 2001 Filtration & Separations, Process Water and Household Watersegment sales were 42%, 39% and 19% of total sales, respectively.  The year-to-date 2001 sales increase isattributed to internal growth of existing product offerings.  Globally, international sales have remainedrelatively flat at 35% of total Osmonics sales through the first nine months of2001 compared to full year 2000.  TheEuro/Africa market grew slightly as a percentage of total Osmonics sales in thefirst nine months of 2001, while the Asia/Pacific market dropped slightly.

 

**GROSSMARGIN**

 

Grossmargin for the third quarter of 2001 was 28.8% versus 29.1% for thecorresponding period in 2000.  Grossmargin for the nine months ended September 30 was 31.2% in 2001 compared to30.9% for the same period in 2000.  Thethird quarter 2001 decrease in gross margins is primarily due to lowerutilization of manufacturing capacity in the Household segment resulting from athird quarter 2001 sales decrease of 9.8% from third quarter 2000.  This impact was offset by gross marginimprovements in both the Filtration and Separations and Process Water segmentsfor the same period.

 

Theincrease in gross margins for the nine months ended September 30, 2001 is theresult of improvements in the Filtration and Separation segment and ProcessWater segment.  Filtration andSeparation segment gross margins improved due to a favorable sales mix ofcartridge filter and membrane element products.  Process Water segment gross margins improved due to increasedsales volume, improved utilization of manufacturing capacity, and costreductions resulting from the year 2000 restructurings and plant closures.  These improvements were partially offset bygross margin decreases in the Household segment due to lower utilization ofmanufacturing resulting from a nine months ended September 30, 2001 salesdecrease of 10.5%.

 

Energycosts in California during the third quarter of 2001 approximated the levelsexperienced during the same period in 2000. Raw material costs in the first nine months of 2001 remained comparableto costs incurred during Year 2000.

 

##### **OPERATING EXPENSES**

 

Operating expenses decreased to 25.0% ofsales in the third quarter of 2001 compared to 25.2% in the third quarter of2000.  Operating expenses decreased to25.5% of sales for the nine months ended September 30, 2001 compared to 26.3%for the same period in 2000.  The threemonths and nine months ended September 30, 2001 decrease is primarilyattributed to the Year 2000 restructurings and continued consolidation ofadministrative services.  Year 2000 alsocontained special charges of 0.2% of sales (see Special Charges discussion).

 

**SPECIAL CHARGES**

 

In the first nine months of 2001, theCompany recorded no special charges.  Infirst quarter 2000, the Company recorded special charges and recoveries thatnetted to zero.  Specialcharges in thefirst quarter 2000 included a $250 recovery of inventory accruals primarily dueto gains recognized on the sale of inventory at the Company’s Rockland,Massachusetts manufacturing facility. The special charges also included $250 of workforce reduction severancecosts related to the first quarter 2000 restructuring of several corporatefunctions.  These special charges(recovery) are summarized below:

 
| Corporate restructuring                               |   | $    | 250 |   |
|-------------------------------------------------------|--------|------|-----|--------|
| Special  inventory recovery related to plant closings |   | (250 | )   |
| Gross  special charges (recovery)                     |   | $    | -   |   |
| Less special inventory recovery – in  COS        |   | (250 | )   |
| Special charge in operating expense                   |   | $    | 250 |   |

 

##### **OTHER INCOME(EXPENSE)**

 

Otherexpense decreased by $285 in the third quarter of 2001 versus the same periodfor 2000. The decrease is the result of a $635 pretax gain ($0.03 per dilutedshare after tax) recognized on the sale of marketable securities in the thirdquarter of 2000.  There were no sales orgains on the sale of marketable securities in the third quarter of 2001.  Foreign currency transaction activity,primarily from converting net assets of a foreign subsidiary to US dollars,increased $780 to a gain of $492 in the third quarter 2001 from a $288 loss inthe third quarter 2000.  Net interestexpense decreased $400 to $560 in the third quarter 2001 from $960 in the thirdquarter of 2000 as a result of lower overall debt levels and lower interestrates.

 

Year-to-date other expense increased $951in 2001 compared to 2000.  This increaseis primarily due to $2,723 pretax gains ($0.13 per diluted share after tax)recognized on the sale of securities during the first nine months of 2000compared to $972 pretax gains ($0.04 per diluted share after tax) in the firstnine months of 2001.  Foreign currencytransaction loss, primarily from converting net assets of a foreign subsidiaryto US dollars, decreased $238 to $115 in the first nine months of 2001 from$353 in the first nine months of 2000. Net interest expense decreased $834 to $1,994 in the first nine monthsof 2001 from $2,828 in the first nine months of 2000 as a result of loweroverall debt levels and lower interest rates.

 

##### **INCOME TAXES**

 

Theeffective tax rate for the third quarter of 2001 was 30.4%, reducing theyear-to-date 2001 effective tax rate to 34.0% based on the forecast for thefull year.  This rate is comparable tothe 29.4% and 33.0% in the same periods of 2000, respectively.

 

##### **NET INCOME**

 

Net income for the quarter endedSeptember 30, 2001 was $1,139 compared to $1,019 for the quarter endedSeptember 30, 2000.  Net income perdiluted share for the quarter was $0.08 compared to $0.07 for the same periodlast year.

 

Year-to-date 2001 net income was $5,031compared to $4,459 for the same period last year.  Net income per diluted share year-to-date was $0.34 in 2001compared to $0.31 in 2000.

 

**REVIEW OF INDUSTRY SEGMENTS**

 

As discussed in Note 4 to theconsolidated financial statements, in 2000 the Company changed the focus of itsreporting structure from a two-segment, product-focused structure to athree-segment, market-focused structure. Certain financial results for the three months and nine months endedSeptember 30, 2001 and 2000 are presented below as a percentage of net sales bysegment (all segment information excludes the impact of special charges):

 
|                         |   | **Third Quarter Ended** |   | **Nine Months Ended** |   |
|------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                         |   | **September  30,**      |   | **September  30,**    |   |
|                         |   | **2001**                |   | **2000**              |   | **2001** |   | **2000** |   |
| Filtration  and Separations: |   |                    |   |                  |   |   |   |   |   |
| Sales                        |   | 100.0                   | %      | 100.0                 | %      | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 33.7                    |   | 32.5                  |   | 36.5 |   | 35.5 |   |
| Operating Income             |   | 11.1                    |   | 6.3                   |   | 13.1 |   | 9.5 |   |
|                         |   |                    |   |                  |   |   |   |   |   |
| Process  Water:              |   |                    |   |                  |   |   |   |   |   |
| Sales                        |   | 100.0                   | %      | 100.0                 | %      | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 24.0                    |   | 22.3                  |   | 26.9 |   | 24.8 |   |
| Operating  Income            |   | -                       |   | (2.7                  | )      | 4.1 |   | (1.2 | ) |
|                         |   |                    |   |                  |   |   |   |   |   |
| Household  Water:            |   |                    |   |                  |   |   |   |   |   |
| Sales                        |   | 100.0                   | %      | 100.0                 | %      | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 27.6                    |   | 35.9                  |   | 28.8 |   | 32.9 |   |
| Operating Income             |   | 2.0                     |   | 9.9                   |   | 1.3 |   | 6.8 |   |

 

Filtrationand Separations

Net sales in the Filtration andSeparations segment increased 7.8% in the third quarter and 4.4% in the firstnine months ended September 30, 2001 compared to the same periods in 2000.  Gross margin for the third quarter of 2001was 33.7% versus 32.5% for the corresponding period in 2000.  This increase is primarily the result of afavorable sales mix of membrane element products.  Gross margin for the nine months ended September 30 was 36.5% in2001 compared to 35.5% for the same period in 2000. This increase is primarilythe result of a favorable sales mix in cartridge filter and membrane elementproducts.  Operating income margins forthe third quarter of 2001 was 11.1% versus 6.3% for the corresponding period in2000.  Operating income margins for thenine months ended September 30 was 13.1% in 2001 compared to 9.5% for the sameperiod in 2000.  The operating incomemargin improvement is related to increased sales, gross margin improvements andholding operating expenses constant.

 

ProcessWater

Net sales in the Process Water segmentdecreased 3.0% in the third quarter ended September 30, 2001 compared to thesame period in 2000.  Net sales increased7.2% for the nine months ended September 30, 2001 compared to the same periodin 2000.  Gross margin for the thirdquarter of 2001 was 24.0% versus 22.3% for the corresponding period in 2000.  This increase is primarily the result of

 

cost reductions resulting from the year2000 restructurings and plant closures and standardization of productlines.  Gross margin for the nine monthsended September 30 was 26.9% in 2001 compared to 24.8% for the same period in2000.  This increase is the result of increasedsales volume, improved utilization of manufacturing capacity, cost reductionsresulting from the year 2000 restructurings and plant closures, andstandardization of product lines. Operating income margins for the third quarter of 2001 improved to 0.0%versus a loss of 2.7% for the corresponding period in 2000.  Operating income margins for the nine monthsended September 30 improved to 4.1% in 2001 compared to a loss of 1.2% for thesame period in 2000.  The operatingincome margin improvement is related to increased sales and gross marginimprovements.

 

HouseholdWater

Net sales in the Household Water segmentdecreased 9.8% in the third quarter and 10.5% in the first nine months endedSeptember 30, 2001 compared to the same periods in 2000.  Gross margin for the third quarter of 2001was 27.6% versus 35.9% for the corresponding period in 2000.  Gross margin for the nine months endedSeptember 30 was 28.8% in 2001 compared to 32.9% for the same period in 2000.  These gross margin decreases are primarilythe result of lower utilization of fixed manufacturing capacity driven byreduced sales.  Operating income marginsfor the third quarter of 2001 was 2.0% versus 9.9% for the corresponding periodin 2000.  Operating income margins forthe nine months ended September 30 was 1.3% in 2001 compared to 6.8% for thesame period in 2000.  The operatingincome margin decrease is related to reduced sales and gross margins.  The Segment incurred one-time separationcharges of $250K in the second quarter of 2001 resulting from efforts to reducestaff and management levels to match the current and near-term anticipatedbusiness needs.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

 

As of September 30, 2001, the Company hadcash, cash equivalents and marketable securities of $3,054 versus $1,910 atDecember 31, 2000.  The current ratio atSeptember 30, 2001 was 1.7 versus 1.6 at year-end 2000.

 

The Company’s notes payable, long-termand current debt decreased $2,644 from $44,362 at December 31, 2000 to $41,718at September 30, 2001.  The Company’sborrowing outstanding against its $24,000 revolving line of credit increased to$17,000 as of September 30, 2001 compared to $15,000 as of December 31, 2000.

 

The Company believes that its currentcash and investments position, its cash flow from operations, and amountsavailable from bank credit will be adequate to meet its anticipated cash needsfor working capital and capital expenditures.

 

**PRIVATE SECURITIES LITIGATIONREFORM ACT**

 

The Private Securities Litigation ReformAct provides a “safe harbor” for forward-looking statements. Certaininformation included in this Form 10-Q and other materials filed or to be filedwith the Securities and Exchange Commission (as well as information included instatements made or to be made by the Company) contains statements that areforward looking.  Such statements mayrelate to plans for future expansion and acquisitions, financial status ofmajor customers, the relocation of certain manufacturing processes, businessdevelopment activities, capital spending, financing, or the effects ofregulation and competition.  Suchinformation involves important risks and uncertainties that could significantlyaffect results in the future.  Suchresults may differ from those expressed in any forward-looking statements madeby the Company.  These risks anduncertainties include, but are not limited to, those relating to productdevelopment activities, the inability to accurately estimate the costs ofrelocation of certain manufacturing processes, dependence on existingmanagement, financial viability of major customers, global economic and marketconditions, and changes in federal or state laws.  Investors are referred to the discussion of certain risks anduncertainties associated with forward looking statements contained in theCompany’s report on Form 10-K filed with the Securities and Exchange Commissionfor the year ended December 31, 2000.

 

 

OSMONICS,INC.

 

###### PARTII

 

###### OTHERINFORMATION

 

 

 

Item 6.          EXHIBITS AND REPORTS ON FORM 8-K

 

(a)     During the quarter ended September 30, 2001the Registrant did not file a Form 8-K report.

 

SIGNATURES

 

 

     Pursuant to the requirements of theSecurities Exchange Act of 1934, the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

#      Dated: November 9, 2001

 

 

 

 

 

 

 
|   |   | OSMONICS,  INC.          |
|--------|--------|--------------------------|
|   |   | (Registrant)             |
|   |   |                     |
|   |   |                     |
|   |   |                     |
|   |   |                     |
|   | /s/    | Keith  B. Robinson       |
|   |   | Keith  B. Robinson       |
|   |   | Chief  Financial Officer |
|   |   |                     |
|   |   |                     |
|   |   |                     |
|   |   |                     |
|   | /s/    | D.  Dean Spatz           |
|   |   | D.  Dean Spatz           |
|   |   | Chief  Executive Officer |