**UNITEDSTATES**

**SECURITIESAND 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 June 30, 2002**

 

**OR**

 

**o****  Transition Report Pursuant to Section 13 or 15 (d)of the Securities Exchange Act of 1934**

**For the transition periodfrom       to       **

** **

**Commission File No.  1-12714**

 

| **OSMONICS, INC**                                                                  |
|------------------------------------------------------------------------------------|
| (Exact name of  registrant as specified in its charter)                            |
|                                                                               |   |   |
| **Minnesota**                                                                      |   | **41-0955759** |
| (State or other  jurisdiction of Incorporation or organization)                    |   | (I.R.S. Employer  Identification Number) |
|                                                                               |   |   |
| **5951  Clearwater Drive, Minnetonka, MN**                                         |   | **55343** |
| (Address of  principal executive offices)                                          |   | (Zip Code) |
|                                                                               |   |   |
| Registrant’s telephone  number, including area code  **(952) 933-2277**  |
|                                                                               |   |   |
| **N/A**                                                                            |
| Former name,  former address and former  fiscal year, if changed since last report |

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15 (d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for at least the past 90 days.

 

Yes  ý   No  o

 

Indicate thenumber of shares outstanding of each of the issuer’s classes of common stock,as of the latest practicable date.  AtJuly 31, 2002, 14,577,440 shares 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 Six Months Ended  June 30, 2002 and 2001       |
|                                                                                                        |
| Consolidated Balance  Sheets -   June 30, 2002 and December 31, 2001                                        |
|                                                                                                        |
| Consolidated  Statements of Cash Flows -   For the Six Months Ended  June 30, 2002 and 2001                 |
|                                                                                                        |
| Notes to  Consolidated Financial Statements -                                                               |
|                                                                                                        |
| ITEM  II.  MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
|                                                                                                        |
| ITEM  III.  QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK                                |
|                                                                                                        |
| PART II.   OTHER  INFORMATION                                                                          |
|                                                                                                        |
| ITEM  4.  SUBMISSION OF MATTERS TO A VOTE OF  SECURITY HOLDERS                                         |
|                                                                                                        |
| ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                              |
|                                                                                                        |
| SIGNATURES                                                                                                  |

 

1

----

 

ITEM I - FINANCIAL STATEMENTS

 

OSMONICS, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Data)

 

(UNAUDITED)

 
|                                                   |   | **Three  Months Ended  June 30,** |       | **Six Months  Ended  June 30,** |       |
|--------------------------------------------------------|--------|-----------------------------------|------------|---------------------------------|------------|
|                                                   |   | **2002**                          | ** ** | **2001**                        | ** ** | **2002** | ** ** | **2001** |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Sales                                                  |   | $                                 | 52,557     |                            | $          | 51,721 |   | $ | 105,736 |   | $ | 105,023 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Cost  of sales                                         |   | 37,125                            |       | 35,477                          |       | 73,816 |   | 71,081 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Gross  profit                                          |   | 15,432                            |       | 16,244                          |       | 31,920 |   | 33,942 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Less:                                                  |   |                              |       |                            |       |   |   |   |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Selling,  general and administrative                   |   | 10,195                            |       | 11,516                          |       | 20,837 |   | 22,925 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Research,  development and engineering                 |   | 1,979                             |       | 2,174                           |       | 3,719 |   | 4,003 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Special  charges (recovery)                            |   | (360                              | )          | —                          |       | (360 | ) | — |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Income  from operations                                |   | 3,618                             |       | 2,554                           |       | 7,724 |   | 7,014 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Other  income (expense)                                |   | 138                               |       | (768                            | )          | (15 | ) | (1,027 | ) |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Income  from continuing operations before income taxes |   | 3,756                             |       | 1,786                           |       | 7,709 |   | 5,987 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Income  taxes                                          |   | 1,240                             |       | 625                             |       | 2,544 |   | 2,095 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Net  income                                            |   | $                                 | 2,516      |                            | $          | 1,161 |   | $ | 5,165 |   | $ | 3,892 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Earnings per  share                                    |   |                              |       |                            |       |   |   |   |   |
| Net  income – basic                               |   | $                                 | 0.17       |                            | $          | 0.08 |   | $ | 0.36 |   | $ | 0.27 |   |
| Net  income – assuming dilution                   |   | $                                 | 0.17       |                            | $          | 0.08 |   | $ | 0.35 |   | $ | 0.27 |   |
|                                                   |   |                              |       |                            |       |   |   |   |   |
| Average  shares outstanding                            |   |                              |       |                            |       |   |   |   |   |
| Basic                                                  |   | 14,552                            |       | 14,451                          |       | 14,542 |   | 14,435 |   |
| Assuming  dilution                                     |   | 14,960                            |       | 14,617                          |       | 14,903 |   | 14,534 |   |

 

2

----

 

OSMONICS, INC.

CONSOLIDATEDBALANCE SHEETS

(In Thousands Except Share Data)

 
|                                                                                                    |   | **June 30,2002** |    | **December  31,2001** |   |
|---------------------------------------------------------------------------------------------------------|--------|------------------|---------|-----------------------|--------|
|                                                                                                    |   | **(UNAUDITED)**  |    |                  |   |
| ASSETS                                                                                                  |   |             |    |                  |   |
|                                                                                                    |   |             |    |                  |   |
| Current  assets                                                                                         |   |             |    |                  |   |
| Cash  and cash equivalents                                                                              |   | $                | 1,698   |                  | $      | — |   |
| Marketable  securities                                                                                  |   | 62               |    | 52                    |   |
| Trade  accounts receivable, net of allowance for doubtful accounts of $1,139 in  2002, and $963 in 2001 |   | 36,549           |    | 34,890                |   |
| Inventories                                                                                             |   | 29,520           |    | 32,094                |   |
| Deferred  tax assets                                                                                    |   | 4,726            |    | 4,867                 |   |
| Other  current assets                                                                                   |   | 4,037            |    | 2,041                 |   |
| Total  current assets                                                                                   |   | 76,592           |    | 73,944                |   |
|                                                                                                    |   |             |    |                  |   |
| Property  and equipment, at cost                                                                        |   |             |    |                  |   |
| Land  and land improvements                                                                             |   | 5,350            |    | 5,366                 |   |
| Building                                                                                                |   | 29,124           |    | 30,830                |   |
| Machinery  and equipment                                                                                |   | 76,269           |    | 76,282                |   |
|                                                                                                    |   | 110,743          |    | 112,478               |   |
| Less  accumulated depreciation                                                                          |   | (54,493          | )       | (53,314               | )      |
|                                                                                                    |   | 56,250           |    | 59,164                |   |
|                                                                                                    |   |             |    |                  |   |
| Goodwill                                                                                                |   | 42,829           |    | 42,829                |   |
| Intangible  assets                                                                                      |   | 3,508            |    | 3,575                 |   |
| Other  assets                                                                                           |   | 4,078            |    | 5,286                 |   |
| Total  assets                                                                                           |   | $                | 183,257 |                  | $      | 184,798 |   |
|                                                                                                    |   |             |    |                  |   |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                              |   |             |    |                  |   |
|                                                                                                    |   |             |    |                  |   |
| Current  liabilities                                                                                    |   |             |    |                  |   |
| Accounts  payable                                                                                       |   | $                | 10,978  |                  | $      | 11,860 |   |
| Notes  payable and current portion of long-term debt                                                    |   | 12,575           |    | 13,619                |   |
| Other  accrued liabilities                                                                              |   | 13,421           |    | 16,710                |   |
| Total  current liabilities                                                                              |   | 36,974           |    | 42,189                |   |
|                                                                                                    |   |             |    |                  |   |
| Long-term  debt                                                                                         |   | 17,448           |    | 20,449                |   |
| Other  liabilities                                                                                      |   | —           |    | —                |   |
| Deferred  income taxes                                                                                  |   | 7,148            |    | 6,763                 |   |
| Shareholders’  equity                                                                              |   |             |    |                  |   |
| Common  stock, $0.01 par value                                                                          |   |             |    |                  |   |
| Authorized  — 50,000,000 shares                                                                    |   |             |    |                  |   |
| Issued — 2002:  14,568,649 and 2001: 14,523,579 shares                                             |   | 146              |    | 145                   |   |
| Capital  in excess of par value                                                                         |   | 25,391           |    | 24,701                |   |
| Retained  earnings                                                                                      |   | 96,802           |    | 91,637                |   |
| Other  comprehensive income                                                                             |   | (652             | )       | (1,086                | )      |
| Total  shareholders’ equity                                                                        |   | 121,687          |    | 115,397               |   |
| Total  liabilities and shareholders’ equity                                                        |   | $                | 183,257 |                  | $      | 184,798 |   |

 

3

----

 

OSMONICS, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 

(UNAUDITED)

 
|                                                 |   | **Six Months  Ended  June 30,** |   |
|------------------------------------------------------|--------|---------------------------------|--------|
|                                                 |   |
|                                                 |   | **2002**                        |   | **2001** |   |
|                                                 |   |                            |   |   |   |
| Cash  flows from operations:                         |   |                            |   |   |   |
| Net  income                                          |   | $                               | 5,165  |   | $ | 3,892 |   |
| Non-cash  items included in net income:              |   |                            |   |   |   |
| Depreciation  and amortization                       |   | 4,185                           |   | 5,168 |   |
| Deferred income  taxes                               |   | 522                             |   | (77 | ) |
| Gain  on sale of investments                         |   | (67                             | )      | (972 | ) |
| Special  charges                                     |   | (360                            | )      | — |   |
| Changes  in assets and liabilities                   |   |                            |   |   |   |
| Accounts  receivable                                 |   | (1,607                          | )      | (712 | ) |
| Inventories                                          |   | 2,574                           |   | (376 | ) |
| Other  current assets                                |   | (51                             | )      | (2,080 | ) |
| Accounts  payable and accrued liabilities            |   | (3,811                          | )      | (1,770 | ) |
|                                                 |   |                            |   |   |   |
| Net  cash provided by operations                     |   | 6,550                           |   | 3,073 |   |
|                                                 |   |                            |   |   |   |
| Cash flows from investing activities**:**            |   |                            |   |   |   |
| Maturities  and sales of investments                 |   | —                          |   | 2,088 |   |
| Purchase  of property and equipment                  |   | (2,998                          | )      | (4,338 | ) |
| Proceeds  form the sale of closed facility           |   | 1,698                           |   | — |   |
| Other                                                |   | (247                            | )      | (67 | ) |
|                                                 |   |                            |   |   |   |
| Cash  (used in) investing activities                 |   | (1,547                          | )      | (2,317 | ) |
|                                                 |   |                            |   |   |   |
| Cash flows from financing activities**:**            |   |                            |   |   |   |
| (Payments  of) proceeds from line of credit          |   | (1,500                          | )      | 1,500 |   |
| Payments  of long-term debt and notes payable        |   | (2,545                          | )      | (681 | ) |
| Other                                                |   | 312                             |   | 666 |   |
|                                                 |   |                            |   |   |   |
| Net  cash (used in) provided by financing activities |   | (3,733                          | )      | 1,485 |   |
|                                                 |   |                            |   |   |   |
| Effect  of exchange rate changes on cash             |   | 428                             |   | (311 | ) |
| Increase  in cash and cash equivalents               |   | 1,698                           |   | 1,930 |   |
| Cash  and cash equivalents -                         |   |                            |   |   |   |
| beginning  of period                                 |   | —                          |   | 21 |   |
| Cash  and cash equivalents -                         |   |                            |   |   |   |
| end  of period                                       |   | $                               | 1,698  |   | $ | 1,951 |   |

 

4

----

 

**OSMONICS, INC.**

 

#### **NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

(Dollars inThousands)

 

 

**Note 1 –Consolidated Financial Statements**

 

The accompanying unaudited condensed financial statements have beenprepared in accordance with the instructions to Form 10-Q and do not includeall the information and footnotes required by generally accepted accountingprinciples for complete financial statements. In the opinion of management, all adjustments (consisting of normalrecurring accruals) considered necessary for a fair presentation have beenincluded.

 

Operating results for the three months ended or six months ended June30, 2002, are not necessarily indicative of the results that may be expectedfor the full year 2002.

 

These statements should be read in conjunction with the financialstatements and related notes included in the Company’s Annual Report toshareholders and Form 10-K for the year ended December 31, 2001.

 

The Company has the following components of comprehensive income:

 
|                                      |   | **Six Months  Ended June 30,** |   |
|-------------------------------------------|--------|--------------------------------|--------|
|                                      |   | **2002**                       |   | **2001** |   |
|                                      |   |                           |   |   |   |
| Net income                                |   | $                              | 5,165  |   | $ | 3,892 |   |
| Other comprehensive income (loss):        |   |                           |   |   |   |
| Foreign currency  translation adjustments |   | 428                            |   | (311 | ) |
| Unrealized  gains/(losses) on securities  |   | 6                              |   | (398 | ) |
| Other  comprehensive income (loss)        |   | 434                            |   | (709 | ) |
| Comprehensive  income                     |   | $                              | 5,599  |   | $ | 3,183 |   |

 

In the fourth quarter 2001, the Company recorded special charges of$1,100 related to the closure of the Company’s Syracuse, New York manufacturingfacility and $600 in corporate restructuring. For the six months ended June 30, 2002, the Company expended $340 forworkforce reductions, $530 for asset write-downs, and $16 for facilityclosing/consolidation costs.  In thesecond quarter 2002, the Company recorded a special recovery of $360 inconnection with the closing of the Syracuse facility.  The remaining $143 for workforce reductions is anticipated to beexpended by December 31, 2002.

 

5

----

 

**Note 2 –Goodwill and Other Intangible Assets – Adoption of Statement 142**

 

In the first quarter of fiscal 2002, the Company adopted SFAS No. 142,“Goodwill and Other Intangible Assets,” which eliminated the amortization ofpurchased goodwill and other intangibles with indefinite useful lives.  Upon adoption of SFAS No. 142, the Companyperformed an impairment test of its goodwill and determined that no impairmentof the recorded goodwill existed.  UnderSFAS No. 142, goodwill will be tested for impairment at least annually and morefrequently if an event occurs which indicates the goodwill may be impaired.

 

Included in intangible assets on the Company’s Consolidated BalanceSheet is the following:

 
|                           |   | **June 30  2002** |   | **December  31  2001** |   |
|--------------------------------|--------|-------------------|--------|------------------------|--------|
| Amortizable intangible assets: |   |              |   |                   |   |
| Patents                        |   | $                 | 2,847  |                   | $      | 2,695 |   |
| Accumulated  amortization      |   | (757              | )      | (653                   | )      |
|                           |   | 2,090             |   | 2,042                  |   |
|                           |   |              |   |                   |   |
| Supply agreement               |   | 1,449             |   | 1,449                  |   |
| Accumulated  amortization      |   | (217              | )      | (72                    | )      |
|                           |   | 1,232             |   | 1,377                  |   |
|                           |   |              |   |                   |   |
| Other                          |   | 1,499             |   | 1,413                  |   |
| Accumulated  amortization      |   | (1,313            | )      | (1,257                 | )      |
|                           |   | 186               |   | 156                    |   |
| Total                          |   | $                 | 3,508  |                   | $      | 3,575 |   |

 

Intangible amortization expense for the six months ended June 30, 2002was $305 and is estimated to be $550 for the year 2002.  Intangible amortization expense for each ofthe subsequent four calendar years is estimated at $400 to $500.

 

6

----

 

A reconciliation of previously reported net income and earnings pershare to the amounts adjusted for the exclusion of goodwill amortization net ofthe related income tax effect follows:

 
|                              |   | **Three  Months Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|-----------------------------------|--------|-----------------------------------|--------|---------------------------------|--------|
|                              |   |                              |
|                              |   | **2002**                          |   | **2001**                        |   | **2002** |   | **2001** |   |
|                              |   |                              |   |                            |   |   |   |   |   |
| Reported  net income              |   | $                                 | 2,516  |                            | $      | 1,161 |   | $ | 5,165 |   | $ | 3,892 |   |
| Add  back:                        |   |                              |   |                            |   |   |   |   |   |
| Goodwill  amortization net of tax |   | —                            |   | 343                             |   | — |   | 687 |   |
| Adjusted  net income              |   | $                                 | 2,516  |                            | $      | 1,504 |   | $ | 5,165 |   | $ | 4,579 |   |
|                              |   |                              |   |                            |   |   |   |   |   |
| Basic  earnings per share:        |   |                              |   |                            |   |   |   |   |   |
| Reported  net income              |   | $                                 | 0.17   |                            | $      | 0.08 |   | $ | 0.36 |   | $ | 0.27 |   |
| Goodwill  amortization net of tax |   | —                            |   | 0.02                            |   | — |   | 0.04 |   |
| Adjusted  net income              |   | $                                 | 0.17   |                            | $      | 0.10 |   | $ | 0.36 |   | $ | 0.31 |   |
|                              |   |                              |   |                            |   |   |   |   |   |
| Diluted  earrings per share:      |   |                              |   |                            |   |   |   |   |   |
| Reported  net income              |   | $                                 | 0.17   |                            | $      | 0.08 |   | $ | 0.35 |   | $ | 0.27 |   |
| Goodwill  amortization net of tax |   | —                            |   | 0.02                            |   | — |   | 0.04 |   |
| Adjusted  net income              |   | $                                 | 0.17   |                            | $      | 0.10 |   | $ | 0.35 |   | $ | 0.31 |   |

 

**Note 3 -Inventories**

 
| Inventories consist of the following:                                                    |   | **June 30  2002** |   | **December  31  2001** |   |
|------------------------------------------------------------------------------------------|--------|-------------------|--------|------------------------|--------|
|                                                                                     |   |              |   |                   |   |
| Finished goods                                                                           |   | $                 | 9,841  |                   | $      | 9,353 |   |
| Work in process                                                                          |   | 11,032            |   | 9,415                  |   |
| Raw materials                                                                            |   | 10,296            |   | 14,958                 |   |
|                                                                                     |   | 31,169            |   | 33,726                 |   |
| Adjustments to  reduce inventories of $5,670 and $5,755 to the last-in, first-out method |   | (1,649            | )      | (1,632                 | )      |
|                                                                                     |   | $                 | 29,520 |                   | $      | 32,094 |   |

 

7

----

 

**Note 4 –Segment Information**

 

The Company designs, manufactures and markets equipment, systems andcomponents used in the processing and handling of fluids.  The Company reports financial results forthree operating segments that are based on the three major market segments inwhich the Company conducts business.

 

Effective January 1, 2002, the Company transferred certain products andproduct lines between the Process Water and Household Water operating segmentsto more closely align customers, markets and sales efforts.  All amounts included have been adjusted forthe transfers.

 

The Filtration and Separations segment includes products such as filtercartridges, membrane elements, membranes, and filter media used in commercial,municipal, and laboratory markets. The Process Water segment includes productssuch as pumps, housings, controls, reverse osmosis/ultrafiltration (RO/UF)machines, ozonators and water treatment systems used for industrial, commercialand municipal applications. The Household Water segment includes products suchas valves, controls and home reverse osmosis membranes and filters used for theresidential and commercial water purification and water softening marketsegments. Each segment is currently supported by several manufacturingfacilities, separate sales forces and various corporate functions. The segmentsdo not have separate accounting, administration or research and developmentfunctions.

 

The reportable segment information for the three months and six monthsended June 30, 2002 and 2001 are as follows (all segment information excludesthe impact of special charges):

 
|                        |   | **Second  Quarter Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|-----------------------------|--------|-------------------------------------|--------|---------------------------------|--------|
|                        |   |
|                        |   | **2002**                            |   | **2001**                        |   | **2002** |   | **2001** |   |
| Sales:                      |   |                                |   |                            |   |   |   |   |   |
| Filtration and Separations  |   | $                                   | 19,576 |                            | $      | 20,514 |   | $ | 40,770 |   | $ | 42,613 |   |
| Process Water               |   | 18,521                              |   | 18,770                          |   | 35,846 |   | 37,026 |   |
| Household Water             |   | 14,460                              |   | 12,437                          |   | 29,120 |   | 25,384 |   |
| Net Sales                   |   | 52,557                              |   | 51,721                          |   | 105,736 |   | 105,023 |   |
| Gross Profit:               |   |                                |   |                            |   |   |   |   |   |
| Filtration and Separations  |   | 5,932                               |   | 7,243                           |   | 13,289 |   | 16,139 |   |
| Process Water               |   | 5,350                               |   | 5,670                           |   | 10,304 |   | 10,655 |   |
| Household Water             |   | 4,150                               |   | 3,331                           |   | 8,327 |   | 7,148 |   |
| Gross Profit                |   | 15,432                              |   | 16,244                          |   | 31,920 |   | 33,942 |   |
| Operating Income  (Loss):   |   |                                |   |                            |   |   |   |   |   |
| Filtration and  Separations |   | 329                                 |   | 1,289                           |   | 1,883 |   | 4,711 |   |
| Process Water               |   | 1,411                               |   | 1,228                           |   | 2,511 |   | 1,853 |   |
| Household Water             |   | 1,518                               |   | 37                              |   | 2,970 |   | 450 |   |
| Operating Income            |   | $                                   | 3,258  |                            | $      | 2,554 |   | $ | 7,364 |   | $ | 7,014 |   |

 

Management does not report the balance sheet or any cash-generatingmeasurements by such segments.

 

8

----

** **

**ITEM II.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ANDRESULTS OF OPERATIONS**

 

(Dollars in thousands, except share data)

 

As an aid to understanding the Company’s operating results, thefollowing table shows the percentage of sales that each income statement itemrepresents for the three months and six months ended June 30, 2002 and 2001.

 
|                                        |   | **Percent of  Sales**           |   | **Percent of  Sales**         |   |
|---------------------------------------------|--------|---------------------------------|--------|-------------------------------|--------|
|                                        |   | **Three  Months EndedJune 30,** |   | **Six Months  EndedJune 30,** |   |
|                                        |   |
|                                        |   | **2002**                        |   | **2001**                      |   | **2002** |   | **2001** |   |
|                                        |   |                            |   |                          |   |   |   |   |   |
| Sales                                       |   | 100.0                           | %      | 100.0                         | %      | 100.0 | % | 100.0 | % |
| Cost of sales                               |   | 70.6                            |   | 68.6                          |   | 69.8 |   | 67.7 |   |
| Gross profit                                |   | 29.4                            |   | 31.4                          |   | 30.2 |   | 32.3 |   |
|                                        |   |                            |   |                          |   |   |   |   |   |
| Selling, general  and administrative        |   | 19.4                            |   | 22.3                          |   | 19.7 |   | 21.8 |   |
| Research, development and engineering       |   | 3.8                             |   | 4.2                           |   | 3.5 |   | 3.8 |   |
| Special charges                             |   | (0.7                            | )      | —                        |   | (0.3 | ) | — |   |
| Operating  expenses                         |   | 22.5                            |   | 26.5                          |   | 22.9 |   | 25.6 |   |
|                                        |   |                            |   |                          |   |   |   |   |   |
| Income from  operations                     |   | 6.9                             |   | 4.9                           |   | 7.3 |   | 6.7 |   |
| Other income /  (expense)                   |   | 0.2                             |   | (1.4                          | )      | 0.0 |   | (1.0 | ) |
| Income from  operations before income taxes |   | 7.1                             |   | 3.5                           |   | 7.3 |   | 5.7 |   |
| Income taxes                                |   | 2.3                             |   | 1.3                           |   | 2.4 |   | 2.0 |   |
|                                        |   |                            |   |                          |   |   |   |   |   |
| Net income                                  |   | 4.8                             | %      | 2.2                           | %      | 4.9 | % | 3.7 | % |

 

## **SALES**

 

Sales for the second quarter ended June 30, 2002 of $52,557 increased1.6% over sales for the second quarter of 2001.  Year-to-date 2002 sales through June increased 0.7% over thecorresponding 2001 level.  The secondquarter 2002 Filtration & Separations, Process Water and Household Watersegment sales were 37%, 35% and 28% of total sales, respectively.  Globally, international sales increased to36% of total Osmonics sales in the first six months of 2002 compared to 34% forthe full year 2001.  The internationalsales growth was primarily attributed to the Euro/Africa market while theAsia/Pacific and Americas markets remained consistent with year 2001levels.  International sales areprimarily within the Household Water and Filtration and Separation groups.

 

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**GROSSMARGIN**

 

Gross margin for the second quarter of 2002 was 29.4% versus 31.4% forthe corresponding period in 2001.  Grossmargin for the six months ended June 30 was 30.2% in 2002 compared to 32.3% forthe same period in 2001.  The secondquarter 2002 decrease in gross margins was primarily due to an unfavorablesales mix of replaceable products and pricing pressures in the Filtration andSeparations segment.  In addition, coststotaling $664 (1.3% of net sales) related to the relocation of product linesfrom the closed Syracuse, New York facility unfavorably impacted margins in thesecond quarter of 2002.  Gross marginimprovements in the Household Water segment were primarily due to increasedsales and improved utilization of production capacity.

 

The decrease in gross margins for the six months ended June 30, 2002was primarily the result of an unfavorable sales mix of replaceable productsand pricing pressures in the Filtration and Separations segment. In addition,costs totaling $800 (0.8% of net sales) related to the relocation of productlines from the closed Syracuse, New York facility unfavorably impacted marginsin the first half of 2002.

 

Energy costs in California during the second quarter of 2002approximated the levels experienced during the same period in 2001.  Raw material costs in the first six monthsof 2002 remained comparable to costs incurred during Year 2001.

 

**OPERATINGEXPENSES**

 

Operating expenses decreased to 22.5% of sales in the second quarter of2002 compared to 26.5% in the second quarter of 2001.  Operating expenses decreased to 22.9% of sales for the six monthsended June 30, 2002 compared to 25.6% for the same period in 2001.  The reductions for the three month and sixmonth periods ended June 30, 2002 were partially due to the adoption of SFAS142 and the associated cessation of goodwill amortization in 2002 (see Note2).  First and second quarter 2001operating expenses included $529 (1% of net sales) and $528 (1% of net sales)of goodwill amortization, respectively.

 

A special recovery of $360 (0.7% of net sales) was recorded in thesecond quarter 2002 in connection with the closure of the Syracuse facility(see Special Charges discussion).  Inaddition, the Year 2001 restructurings and continued consolidation ofadministrative services contributed to the decrease in 2002 operating expenses.

 

**SPECIALRECOVERY**

 

In the second quarter ended June 30, 2002, the Company recorded aspecial recovery of $360 related to the fourth quarter 2001 special charge of$1,700.  This recovery was the result ofthe early completion of the closure and sale of the Syracuse, New Yorkmanufacturing facility and gains realized on the sale of certain assets thatexceeded original estimates.

 

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**OTHERINCOME (EXPENSE)**

 

Other income (expense) includes interest income, interest expense, andother miscellaneous items.  Otherexpense decreased by $906 in the second quarter of 2002 versus the same periodfor 2001.  The decrease was the resultof a $352 reduction in net interest expense to $321 in the second quarter 2002from $673 in the second quarter of 2001. The net interest expense reduction was due to reduced total debt andlower interest rates.  Foreign currencyexchange, primarily related to business transactions of the Company’s Frenchsubsidiary, was a gain of $525 in the second quarter 2002 compared to a loss of$176 in the second quarter 2001.

 

Year-to-date other expense decreased $1,012 in 2002 compared to2001.  The decrease was the result of a$907 reduction in net interest expense to $527 in 2002 from $1,434 in2001.  The net interest expensereduction was due to reduced total debt and lower interest rates.  Foreign currency exchange, primarily relatedto business transactions of the Company’s French subsidiary, was a gain of $551in 2002 compared to a loss of $607 in 2001. A $972 pretax gain ($0.04 per diluted share) was recognized on the saleof marketable securities in the first quarter of 2001.  There were no sales of marketable securitiesin the six months ended June 30, 2002.

 

**INCOMETAXES**

 

The effective tax rate for the second quarter and year-to-date 2002 was33.0% based on the forecast for the full year. This rate compares to the 35.0% in the same periods of 2001 and the 34%rate for the full year 2001.  The 2002tax rate reduction is primarily related to the adoption of SFAS 142 and thecessation of goodwill amortization (see Note 2).  This resulted in the elimination of a permanent tax difference.

 

**NETINCOME**

 

Net income for the quarter ended June 30, 2002 was $2,516 compared to$1,161 for the quarter ended June 30, 2001. Net income per diluted share for the quarter was $0.17 compared to $0.08for the same period last year.

 

Year-to-date 2002 net income was $5,165 compared to $3,892 for the sameperiod last year.  Net income perdiluted share year-to-date was $0.35 in 2002 compared to $0.27 in 2001.

 

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**REVIEWOF INDUSTRY SEGMENTS**

 

As discussed in Note 4 to the consolidated financial statements, theCompany reports financial results for three operating segments that are basedon the three major market segments in which the Company conducts business.  Certain financial results for the three andsix months ended June 30, 2002 and 2001 are presented below as a percentage ofnet sales by segment (all segment information excludes the impact of specialcharges):

 
|                         |   | **Second  Quarter Ended  June 30,** |   | **Six Months  Ended  June 30,** |   |
|------------------------------|--------|-------------------------------------|--------|---------------------------------|--------|
|                         |   |                                |
|                         |   | **2002**                            |   | **2001**                        |   | **2002** |   | **2001** |   |
| Filtration and  Separations: |   |                                |   |                            |   |   |   |   |   |
| Sales                        |   | 100.0                               | %      | 100.0                           | %      | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 30.3                                |   | 35.3                            |   | 32.6 |   | 37.9 |   |
| Operating Income             |   | 1.7                                 |   | 6.3                             |   | 4.6 |   | 11.1 |   |
|                         |   |                                |   |                            |   |   |   |   |   |
| Process Water:               |   |                                |   |                            |   |   |   |   |   |
| Sales                        |   | 100.0                               | %      | 100.0                           | %      | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 28.9                                |   | 30.2                            |   | 28.7 |   | 28.8 |   |
| Operating Income             |   | 7.6                                 |   | 6.5                             |   | 7.0 |   | 5.0 |   |
|                         |   |                                |   |                            |   |   |   |   |   |
| Household Water:             |   |                                |   |                            |   |   |   |   |   |
| Sales                        |   | 100.0                               | %      | 100.0                           | %      | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 28.7                                |   | 26.8                            |   | 28.6 |   | 28.2 |   |
| Operating Income             |   | 10.5                                |   | 0.3                             |   | 10.2 |   | 1.8 |   |

 

Filtration and Separations

Net sales in the Filtration and Separations segment decreased 4.6% inthe second quarter and 4.3% in the first six months ended June 30, 2002compared to the same periods in 2001. This decrease was attributed to recessionary pressures in industrialfiltration and slower than planned start-up of new alternative sales channelsfor the Company’s WasteWizard products. Gross margin for the second quarter of 2002 was 30.3% versus 35.3% forthe corresponding period in 2001.  Grossmargin for the six months ended June 30 was 32.6% in 2002 compared to 37.9% forthe same period in 2001. The 2002 decrease in gross margins was primarily theresult of an unfavorable sales mix of replaceable products and pricingpressures.  Operating income margins forthe second quarter of 2002 was 1.7% versus 6.3% for the corresponding period in2001.  Operating income margins for thesix months ended June 30 was 4.6% in 2002 compared to 11.1% for the same periodin 2001.  The 2002 operating incomemargin decrease was primarily related to reduced gross margins.  Operating expenses for the six months endedJune 30, 2002 are flat with the corresponding period in 2001.

 

Process Water

Net sales in the Process Water segment decreased 1.3% in the secondquarter ended June 30, 2002 compared to the same period in 2001.  Net sales decreased 3.2% for the six monthsended June 30, 2002 compared to the same period in 2001.  These decreases were primarily the result oflower capital equipment shipments to the power industry.  Gross margin for the second quarter of 2002was 28.9% versus 30.2% for the corresponding period in 2001.  This decrease was primarily related to anunfavorable sales mix of equipment shipments in the second quarter of2002.  Gross margin for the

 

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six months ended June 30 was 28.7% in 2002 compared to 28.8% for thesame period in 2001.  Prior period costreductions and standardization of product lines have continued to offsetsoftness in the capital equipment market. Operating income margins for the second quarter of 2002 improved to 7.6%versus 6.5% for the corresponding period in 2001.  Operating income margins for the six months ended June 30improved to 7.0% in 2002 compared to 5.0% for the same period in 2002.  The operating income margin improvement wasprimarily related to a $503 (11.3%) and $1,009 (11.5%) reduction in operatingexpenses in the second quarter and six months ended June 30, 2002 resultingfrom cost containment efforts.

 

Household Water

Net sales in the Household Water segment increased 16.3% in the secondquarter and 14.7% in the first six months ended June 30, 2002 compared to thesame periods in 2001.  Gross margin forthe second quarter of 2002 was 28.7% versus 26.8% for the corresponding periodin 2001.  Gross margin for the sixmonths ended June 30 was 28.6% in 2002 compared to 28.2% for the same period in2001. The gross margin improvements in 2002 were primarily the result ofincreased sales and improved utilization of production capacity.  In addition, costs totaling $740 related tothe relocation of product lines from the closed Syracuse, New York facilityunfavorably impacted margins in the first six months of 2002.  Operating income margins for the second quarterof 2002 was 10.5% versus 0.3% for the corresponding period in 2001.  Operating income margins for the six monthsended June 30 was 10.2% in 2002 compared to 1.8% for the same period in 2001.  The operating income margin improvement wasprimarily related to increased net sales and a $662 (20.1%) and $1,341 (20.0%)reduction in operating expenses in the second quarter and six months ended June30, 2002.

 

### **LIQUIDITYAND CAPITAL RESOURCES**

 

As of June 30, 2002, the Company had cash, cash equivalents and marketablesecurities of $1,760 versus $52 at December 31, 2001.  The current ratio at June 30, 2002 was 2.07 versus 1.75 atyear-end 2001.

 

Cash provided by operations was $6,550 and $3,073 for the six monthsended June 30, 2002 and 2001, respectively. The increase in cash provided by operating activities during 2002 wasdue to reductions in inventory and improved earnings.  Cash used in investing activities was $1,547 and $2,317 for thesix months ended June 30, 2002 and 2001, respectively.  The decrease in cash used in investingactivities is primarily related to a reduction in purchases of property andequipment in 2002. Cash used in financing activities was $3,733 for the sixmonths ended June 30, 2002 in comparison to cash provided by financing activitiesof $1,485 during the same period of 2001. The increase in cash used infinancing activities is primarily related to scheduled principal payments oflong term debt and payments on the Company’s line of credit in 2002.

 

The Company’s notes payable, long-term and current debt decreased$4,045 from $34,068 at December 31, 2001 to $30,023 at June 30, 2002.  The Company’s borrowing outstanding againstits $24,000 revolving line of credit decreased to $8,000 as of June 30, 2002compared to $9,500 as of December 31, 2001.

 

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The Company believes that its current cash and investments position,its cash flow from operations, and amounts available from bank credit will beadequate to meet its anticipated cash needs for working capital, capitalexpenditures, and potential acquisitions during the foreseeable future.

 

**ITEMIII.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

Information about market risks for the three months and six monthsended June 30, 2002 does not differ materially from that discussed in ourAnnual Report on Form 10-K for 2001.

 

**PRIVATE SECURITIES LITIGATION REFORM ACT**

 

The Private Securities Litigation Reform Act provides a “safe harbor”for forward-looking statements. Certain information included in this Form 10-Qand other materials filed or to be filed with the Securities and ExchangeCommission (as well as information included in statements made or to be made bythe Company) contains statements that are forward looking.  Such statements may relate to plans forfuture expansion and acquisitions, financial status of major customers, therelocation of certain manufacturing processes, business development activities,capital spending, financing, or the effects of regulation and competition.  Such information involves important risksand uncertainties that could significantly affect results in the future.  Such results may differ from those expressedin any forward-looking statements made by the Company.  These risks and uncertainties include, butare not limited to, those relating to product development activities, theinability to accurately estimate the costs of products and the cost 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.

 

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OSMONICS, INC.

 

###### PART II

 

###### OTHER INFORMATION

 

Item4.             SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

 

The Company’s AnnualMeeting of Stockholders was held on May 8, 2002.  The following members were elected to the Company’s Board ofDirectors to hold office for the ensuing three years:

 
| **Nominee**       |   | **In Favor** |   | **Withheld** |   |
|-------------------|--------|--------------|--------|--------------|--------|
|              |   |         |   |         |   |
| Charles W. Palmer |   | 12,547,432   |   | 77,129       |   |

 

An amendment ofthe Company’s 1993 Employee Stock Option and Compensation Plan to increase by250,000 the number of shares reserved under such Plan was approved with thevote of 10,426,659 in favor, 1,619,964 against, and 577,938 abstained.

 

An amendment ofthe Company’s 1995 Employee Stock Purchase Plan to allow for the issuance ofrestricted Common Stock of the Company to independent Directors in lieu of theannual cash retainer was approved with the vote of 10,628,889 in favor,1,316,045 against, and 679,627 abstained.

 

Item 6.             EXHIBITSAND REPORTS ON FORM 8-K

 

(10)  Change of Control Agreement dated June 5, 2002with D. Dean Spatz (schedule attached listing executives / officers withsubstantially identical change in control agreements).

 

(a)    During the quarter ended June 30, 2002 theRegistrant did not file a Form 8-K report.

 

(b)            1993 Employee StockOption and Compensation Plan (Incorporated herein by reference to theRegistrant’s Proxy Statement dated April 8, 2002).

 

(c)             1995 Director Stock OptionPlan (Incorporated herein by reference to the Registrant’s Proxy Statementdated April 8, 2002).

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| Dated:  August 14, 2002 |                       |
|------------------------------|----------------------------|
|                         |                       |
|                         | OSMONICS, INC.             |   |
|                         | (Registrant)               |   |
|                         |                       |
|                         |                       |
|                         | /s/  James A. Davison |   |
|                         |                       | James A. Davison |
|                         |                       | Chief Accounting  Officer |
|                              |                            |  |  |  |

 

 

Each of theundersigned hereby certifies in his capacity as an officer of Osmonics, Inc.(the “Company”) that the Quarterly Report of the Company on Form 10-Q for theperiod ended June 30, 2002 fully complies with the requirements of Section13(a) of the Securities Exchange Act of 1934 and that the information containedin such report fairly presents, in all material respects, the financialcondition of the Company at the end of such period and the results ofoperations for the Company for such period.

 

 
| Dated:  August 14, 2002 |   |                    |
|------------------------------|--------|-------------------------|
|                         |   |                    |
|                         | /s/    | Keith B. Robinson       |   |
|                         |   | Keith B. Robinson       |
|                         |   | Chief Financial Officer |
|                         |   |                    |
|                         | /s/    |  D. Dean Spatz     |   |
|                         |   | D. Dean Spatz           |
|                         |   | Chief Executive Officer |

 

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