**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**ý****  Quarterly Report Pursuant toSection 13 or 15(d) of the Securities Exchange Act of 1934**

 

**For Quarter Ended September 30, 2002**

 

**OR**

 

**o****  Transition Report Pursuant toSection 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                                                   |   | (I.R.S. Employer        |
| Incorporation or  organization)                                                    |   | Identification  Number) |
|                                                                               |   |                    |
| **5951  Clearwater Drive, Minnetonka, MN**                                         |   | **55343**               |
| (Address of  principal executive offices)                                          |   | (Zip Code)              |
|                                                                               |   |                    |
| Registrant’s  telephone number, including area code   **(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 the preceding12 months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for at leastthe 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.  AtOctober 31, 2002, 14,657,668 shares of the issuer’s Common Stock, $0.01 parvalue, 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, 2002 and 2001 |
|                                 |   |   |
|                                 |   | Consolidated  Balance Sheets -  September 30, 2002 and December 31, 2001 |
|                                 |   |   |
|                                 |   | Consolidated  Statements of Cash Flows -  For the Nine Months Ended September 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 |
|                                 |   |   |
|                                 | ITEM IV. CONTROL AND  PROCEDURES |
|                                 |   |   |
| PART II. OTHER  INFORMATION          |
|                                 |   |   |
|                                 |   | ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K |
|                                 |   |   |
| SIGNATURES                           |
|                                      |  |  |  |  |

 

1

----

 

ITEM I – FINANCIALSTATEMENTS

 

OSMONICS, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Data)

 

(UNAUDITED)

 
|                                        |   | **Three  Months Ended  September 30,** |   | **Nine Months  Ended  September 30,** |       |
|---------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                                        |   | **2002**                               |   | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Sales                                       |   | $                                      | 51,253 |                                  | $          | 48,372 |   | $ | 156,989 |   | $ | 153,395 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Cost  of sales                              |   | 35,524                                 |   | 34,461                                |       | 109,340 |   | 105,542 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Gross  profit                               |   | 15,729                                 |   | 13,911                                |       | 47,649 |   | 47,853 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Less:                                       |   |                                   |   |                                  |       |   |   |   |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Selling,  general and administrative        |   | 10,423                                 |   | 10,311                                |       | 31,260 |   | 33,236 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Research,  development and engineering      |   | 1,932                                  |   | 1,786                                 |       | 5,651 |   | 5,789 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Special  recovery                           |   | —                                 |   | —                                |       | (360 | ) | — |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Income  from operations                     |   | 3,374                                  |   | 1,814                                 |       | 11,098 |   | 8,828 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Other  income (expense)                     |   | (384                                   | )      | (178                                  | )          | (399 | ) | (1,205 | ) |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Income  from operations before income taxes |   | 2,990                                  |   | 1,636                                 |       | 10,699 |   | 7,623 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Income  taxes                               |   | 773                                    |   | 497                                   |       | 3,317 |   | 2,592 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Net  income                                 |   | $                                      | 2,217  |                                  | $          | 1,139 |   | $ | 7,382 |   | $ | 5,031 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Earnings per  share                         |   |                                   |   |                                  |       |   |   |   |   |
| Net  income - basic                         |   | $                                      | 0.15   |                                  | $          | 0.08 |   | $ | 0.51 |   | $ | 0.35 |   |
| Net  income - assuming dilution             |   | $                                      | 0.15   |                                  | $          | 0.08 |   | $ | 0.50 |   | $ | 0.34 |   |
|                                        |   |                                   |   |                                  |       |   |   |   |   |
| Average  shares outstanding                 |   |                                   |   |                                  |       |   |   |   |   |
| Basic                                       |   | 14,578                                 |   | 14,474                                |       | 14,554 |   | 14,448 |   |
| Assuming  dilution                          |   | 14,897                                 |   | 14,806                                |       | 14,904 |   | 14,627 |   |

 

2

----

 

OSMONICS, INC.

CONSOLIDATEDBALANCE SHEETS

(In Thousands Except Share Data)

 
|                                                                                                    |                                       | **(UNAUDITED)**          |    |                    |   |
|---------------------------------------------------------------------------------------------------------|--------------------------------------------|--------------------------|---------|-------------------------|--------|
|                                                                                                    |                                       | **September  30,  2002** |    | **December  31,  2001** |   |
| ASSETS                                                                                                  |                                       |                     |    |                    |   |
|                                                                                                    |                                       |                     |    |                    |   |
| Current  assets                                                                                         |                                       |                     |    |                    |   |
| Cash  and cash equivalents                                                                              |                                       | $                        | 2,967   |                    | $      | — |   |
| Marketable  securities                                                                                  |                                       | 62                       |    | 52                      |   |
| Trade  accounts receivable, net of allowance for doubtful accounts of $1,120 in  2002, and $963 in 2001 |                                       | 35,442                   |    | 34,890                  |   |
| Inventories                                                                                             |                                       | 27,282                   |    | 32,094                  |   |
| Deferred  tax assets                                                                                    |                                       | 4,374                    |    | 4,867                   |   |
| Other  current assets                                                                                   |                                       | 1,915                    |    | 2,041                   |   |
| Total  current assets                                                                                   |                                       | 72,042                   |    | 73,944                  |   |
|                                                                                                    |                                       |                     |    |                    |   |
| Property  and equipment, at cost                                                                        |                                       |                     |    |                    |   |
| Land  and land improvements                                                                             |                                       | 5,443                    |    | 5,366                   |   |
| Building                                                                                                |                                       | 31,004                   |    | 30,830                  |   |
| Machinery  and equipment                                                                                |                                       | 77,100                   |    | 76,282                  |   |
|                                                                                                    |                                       | 113,547                  |    | 112,478                 |   |
| Less  accumulated depreciation                                                                          |                                       | (55,998                  | )       | (53,314                 | )      |
|                                                                                                    |                                       | 57,549                   |    | 59,164                  |   |
|                                                                                                    |                                       |                     |    |                    |   |
| Goodwill                                                                                                |                                       | 42,829                   |    | 42,829                  |   |
| Intangible  assets                                                                                      |                                       | 3,402                    |    | 3,575                   |   |
| Other  assets                                                                                           |                                       | 3,695                    |    | 5,286                   |   |
| Total  assets                                                                                           |                                       | $                        | 179,517 |                    | $      | 184,798 |   |
|                                                                                                    |                                       |                     |    |                    |   |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                                                              |                                       |                     |    |                    |   |
|                                                                                                    |                                       |                     |    |                    |   |
| Current  liabilities                                                                                    |                                       |                     |    |                    |   |
| Accounts  payable                                                                                       |                                       | $                        | 9,154   |                    | $      | 11,860 |   |
| Notes  payable and current portion of long-term debt                                                    |                                       | 6,714                    |    | 13,619                  |   |
| Other  accrued liabilities                                                                              |                                       | 15,320                   |    | 16,710                  |   |
| Total  current liabilities                                                                              |                                       | 31,188                   |    | 42,189                  |   |
|                                                                                                    |                                       |                     |    |                    |   |
| Long-term  debt                                                                                         |                                       | 16,416                   |    | 20,449                  |   |
| Other  liabilities                                                                                      |                                       | —                   |    | —                  |   |
| Deferred  income taxes                                                                                  |                                       | 7,286                    |    | 6,763                   |   |
| Shareholders’  equity                                                                              |                                       |                     |    |                    |   |
| Common  stock, $0.01 par value                                                                          |                                       |                     |    |                    |   |
|                                                                                                    | Authorized ––  50,000,000 shares |                     |    |                    |   |   |
|                                                                                                    | Issued ––                        | 2002: 14,648,744 shares  |    |                    |   |   |   |
|                                                                                                    | 2001: 14,523,579 shares                    |                     | 146     |                    | 145    |   |
| Capital  in excess of par value                                                                         |                                       | 26,149                   |    | 24,701                  |   |
| Retained  earnings                                                                                      |                                       | 99,019                   |    | 91,637                  |   |
| Other  comprehensive income                                                                             |                                       | (687                     | )       | (1,086                  | )      |
| Total  shareholders’ equity                                                                        |                                       | 124,627                  |    | 115,397                 |   |
| Total  liabilities and shareholders’ equity                                                        |                                       | $                        | 179,517 |                    | $      | 184,798 |   |

 

3

----

 

OSMONICS, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

 

(UNAUDITED)

 
|                                             |   | **Nine  Months Ended  September 30,** |   |
|--------------------------------------------------|--------|---------------------------------------|--------|
|                                             |   | **2002**                              |   | **2001** | ** ** |
|                                             |   |                                  |   |   |   |
| Cash  flows from operations:                     |   |                                  |   |   |   |
| Net  income                                      |   | $                                     | 7,382  |   | $ | 5,031 |   |
| Non-cash  items included in net income:          |   |                                  |   |   |   |
| Depreciation  and amortization                   |   | 6,001                                 |   | 7,686 |   |
| Deferred income  taxes                           |   | 1,012                                 |   | 240 |   |
| Gain  on sale of investments                     |   | —                                |   | (972 | ) |
| Gain  on sale of property and equipment          |   | (137                                  | )      | (8 | ) |
| Special  recovery                                |   | (360                                  | )      | — |   |
| Changes  in assets and liabilities               |   |                                  |   |   |   |
| Accounts  receivable                             |   | (496                                  | )      | 2,267 |   |
| Inventories                                      |   | 4,812                                 |   | (817 | ) |
| Other  current assets                            |   | 126                                   |   | (1,896 | ) |
| Accounts  payable and accrued liabilities        |   | (3,736                                | )      | (2,756 | ) |
|                                             |   |                                  |   |   |   |
| Net  cash provided by operations                 |   | 14,604                                |   | 8,775 |   |
|                                             |   |                                  |   |   |   |
| Cash flows from investing activities:            |   |                                  |   |   |   |
| Maturities  and sales of investments             |   | —                                |   | 2,189 |   |
| Purchase  of property and equipment              |   | (6,054                                | )      | (6,645 | ) |
| Proceeds  form the sale of closed facility       |   | 3,643                                 |   | — |   |
| Other                                            |   | (280                                  | )      | 932 |   |
|                                             |   |                                  |   |   |   |
| Net  cash (used in) investing activities         |   | (2,691                                | )      | (3,524 | ) |
|                                             |   |                                  |   |   |   |
| Cash flows from financing activities:            |   |                                  |   |   |   |
| (Payments  of) proceeds from line of credit      |   | (6,500                                | )      | 500 |   |
| Payments  of long-term debt and notes payable    |   | (4,438                                | )      | (3,144 | ) |
| Other                                            |   | 1,599                                 |   | 485 |   |
|                                             |   |                                  |   |   |   |
| Net  cash (used in) financing activities         |   | (9,339                                | )      | (2,159 | ) |
|                                             |   |                                  |   |   |   |
| Effect  of exchange rate changes on cash         |   | 393                                   |   | (123 | ) |
| Increase  in cash and cash equivalents           |   | 2,967                                 |   | 2,969 |   |
| Cash  and cash equivalents - beginning of period |   | —                                |   | 21 |   |
| Cash  and cash equivalents - end of period       |   | $                                     | 2,967  |   | $ | 2,990 |   |

 

4

----

 

**OSMONICS, INC.**

 

#### **NOTES TO CONSOLIDATED 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 nine months endedSeptember 30, 2002, are not necessarily indicative of the results that may beexpected for 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:

 
|                                      |   | **Nine  Months Ended September 30,** |   |
|-------------------------------------------|--------|--------------------------------------|--------|
|                                      |   | **2002**                             |   | **2001** |   |
|                                      |   |                                 |   |   |   |
| Net income                                |   | $                                    | 7,382  |   | $ | 5,031 |   |
| Other comprehensive income (loss):        |   |                                 |   |   |   |
| Foreign currency  translation adjustments |   | 393                                  |   | (123 | ) |
| Unrealized  gains/(losses) on securities  |   | 6                                    |   | (395 | ) |
| Other  comprehensive income (loss)        |   | 399                                  |   | (518 | ) |
| Comprehensive  income                     |   | $                                    | 7,781  |   | $ | 4,513 |   |

 

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 nine months ended September 30, 2002, the Company expended $446for workforce reductions, $530 for asset write-downs, and $16 for facilityclosing costs.  In the second quarter2002, the Company recorded a special recovery of $360 in connection with theclosing of the Syracuse facility.  Theremaining $37 for workforce reductions is anticipated to be expended byDecember 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:

 
|                            |   | **September 30  2002** | ** ** | **December 31  2001** | ** ** |
|---------------------------------|--------|------------------------|------------|-----------------------|------------|
| Amortizable  intangible assets: |   |                   |       |                  |       |
| Patents                         |   | $                      | 2,909      |                  | $          | 2,695 |   |
| Accumulated  amortization       |   | (810                   | )          | (653                  | )          |
|                            |   | 2,099                  |       | 2,042                 |       |
|                            |   |                   |       |                  |       |
| Supply agreement                |   | 1,449                  |       | 1,449                 |       |
| Accumulated  amortization       |   | (290                   | )          | (72                   | )          |
|                            |   | 1,159                  |       | 1,377                 |       |
|                            |   |                   |       |                  |       |
| Other                           |   | 1,499                  |       | 1,413                 |       |
| Accumulated  amortization       |   | (1,355                 | )          | (1,257                | )          |
|                            |   | 144                    |       | 156                   |       |
| Total                           |   | $                      | 3,402      |                  | $          | 3,575 |   |

 

Intangible amortization expense for the nine months ended September 30,2002 was $473 and is estimated to be $640 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  September 30,** |   | **Nine  Months Ended  September 30,** |       |
|-----------------------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                              |   | **2002**                               |   | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
|                              |   |                                   |   |                                  |       |   |   |   |   |
| Reported  net income              |   | $                                      | 2,217  |                                  | $          | 1,139 |   | $ | 7,382 |   | $ | 5,031 |   |
| Add  back:                        |   |                                   |   |                                  |       |   |   |   |   |
| Goodwill  amortization net of tax |   | —                                 |   | 368                                   |       | — |   | 1,047 |   |
| Adjusted  net income              |   | $                                      | 2,217  |                                  | $          | 1,507 |   | $ | 7,382 |   | $ | 6,078 |   |
|                              |   |                                   |   |                                  |       |   |   |   |   |
| Basic  earnings per share:        |   |                                   |   |                                  |       |   |   |   |   |
| Reported  net income              |   | $                                      | 0.15   |                                  | $          | 0.08 |   | $ | 0.51 |   | $ | 0.35 |   |
| Goodwill  amortization net of tax |   | —                                 |   | 0.02                                  |       | — |   | 0.07 |   |
| Adjusted  net income              |   | $                                      | 0.15   |                                  | $          | 0.10 |   | $ | 0.51 |   | $ | 0.42 |   |
|                              |   |                                   |   |                                  |       |   |   |   |   |
| Diluted  earnings per share:      |   |                                   |   |                                  |       |   |   |   |   |
| Reported  net income              |   | $                                      | 0.15   |                                  | $          | 0.08 |   | $ | 0.50 |   | $ | 0.34 |   |
| Goodwill  amortization net of tax |   | —                                 |   | 0.02                                  |       | — |   | 0.07 |   |
| Adjusted  net income              |   | $                                      | 0.15   |                                  | $          | 0.10 |   | $ | 0.50 |   | $ | 0.41 |   |

 

**Note 3 -Inventories**

 
|                                                                                     |   | **September  30  2002** | ** ** | **December  31  2001** | ** ** |
|------------------------------------------------------------------------------------------|--------|-------------------------|------------|------------------------|------------|
|                                                                                     |   |                    |       |                   |       |
| Inventories  consist of the following:                                                   |   |                    |       |                   |       |
|                                                                                     |   |                    |       |                   |       |   |   |
| Finished goods                                                                           |   | $                       | 7,930      |                   | $          | 9,353 |   |
| Work in process                                                                          |   | 11,605                  |       | 9,415                  |       |
| Raw materials                                                                            |   | 9,396                   |       | 14,958                 |       |
|                                                                                     |   | 28,931                  |       | 33,726                 |       |
| Adjustments to  reduce inventories of $5,896 and $5,755 to the last-in, first-out method |   | (1,649                  | )          | (1,632                 | )          |
|                                                                                     |   | $                       | 27,282     |                   | $          | 32,094 |   |

 

7

----

 

**Note 4 –Susequent Event**

 

On November 4, 2002, the Company announced anagreement to merge into a wholly owned subsidiary of General Electric Company(GE) in a stock and cash transaction. In the merger, Osmonics shareholders will receive the equivalent of$17.00 of GE common stock for each share of Osmonics.  Shareholders may elect to receive $17.00 in cash per shareinstead of GE shares, subject to proration so that the total cash paid does notexceed 55 percent of the total merger consideration.

 

The merger, which is subject to the approvalof the holders of a majority of Osmonics’ outstanding common shares, governmentapprovals and other customary conditions, is expected to close in the firstquarter of 2003.  Following thecompletion of the acquisition, Osmonics will be integrated with GE Water, aunit of GE Power Systems.

 

**Note 5 –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.

 

8

----

 

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

 
|                        |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |       |
|-----------------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                        |   | **2002**                               |   | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
| Sales:                      |   |                                   |   |                                  |       |   |   |   |   |
| Filtration and Separations  |   | $                                      | 19,837 |                                  | $          | 20,478 |   | $ | 60,607 |   | $ | 63,091 |   |
| Process Water               |   | 17,046                                 |   | 15,462                                |       | 52,892 |   | 52,488 |   |
| Household Water             |   | 14,370                                 |   | 12,432                                |       | 43,490 |   | 37,816 |   |
| Net Sales                   |   | 51,253                                 |   | 48,372                                |       | 156,989 |   | 153,395 |   |
| Gross Profit:               |   |                                   |   |                                  |       |   |   |   |   |
| Filtration and Separations  |   | 6,355                                  |   | 6,903                                 |       | 19,644 |   | 23,402 |   |
| Process Water               |   | 4,991                                  |   | 3,738                                 |       | 15,295 |   | 14,393 |   |
| Household Water             |   | 4,383                                  |   | 3,270                                 |       | 12,710 |   | 10,418 |   |
| Gross Profit                |   | 15,729                                 |   | 13,911                                |       | 47,649 |   | 47,853 |   |
| Operating Income:           |   |                                   |   |                                  |       |   |   |   |   |
| Filtration and  Separations |   | 693                                    |   | 1,540                                 |       | 2,576 |   | 6,251 |   |
| Process Water               |   | 1,186                                  |   | 70                                    |       | 3,697 |   | 1,923 |   |
| Household Water             |   | 1,495                                  |   | 204                                   |       | 4,465 |   | 654 |   |
| Operating Income            |   | $                                      | 3,374  |                                  | $          | 1,814 |   | $ | 10,738 |   | $ | 8,828 |   |

 

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

 

9

----

 
| **ITEM II.** | **MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS 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 nine months ended September 30, 2002 and2001.

 
|                                        |   | **Percent of  Sales**                  |       | **Percent of  Sales**                 |       |
|---------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                        |   | **Three  Months Ended  September 30,** | ** ** | **Nine  Months Ended  September 30,** | ** ** |
|                                        |   | **2002**                               |       | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                        |   |                                   |       |                                  |       |   |   |   |   |
| Sales                                       |   | 100.0                                  | %          | 100.0                                 | %          | 100.0 | % | 100.0 | % |
| Cost of sales                               |   | 69.3                                   |       | 71.2                                  |       | 69.6 |   | 68.8 |   |
| Gross profit                                |   | 30.7                                   |       | 28.8                                  |       | 30.4 |   | 31.2 |   |
|                                        |   |                                   |       |                                  |       |   |   |   |   |
| Selling, general  and administrative        |   | 20.3                                   |       | 21.3                                  |       | 19.9 |   | 21.6 |   |
| Research, development and engineering       |   | 3.8                                    |       | 3.7                                   |       | 3.6 |   | 3.8 |   |
| Special charges                             |   | —                                 |       | —                                |       | (0.2 | ) | — |   |
| Operating  expenses                         |   | 24.1                                   |       | 25.0                                  |       | 23.3 |   | 25.4 |   |
|                                        |   |                                   |       |                                  |       |   |   |   |   |
| Income from  operations                     |   | 6.6                                    |       | 3.8                                   |       | 7.1 |   | 5.8 |   |
| Other income  (expense)                     |   | (0.8                                   | )          | (0.4                                  | )          | (0.3 | ) | (0.8 | ) |
| Income from  operations before income taxes |   | 5.8                                    |       | 3.4                                   |       | 6.8 |   | 5.0 |   |
| Income taxes                                |   | 1.5                                    |       | 1.0                                   |       | 2.1 |   | 1.7 |   |
|                                        |   |                                   |       |                                  |       |   |   |   |   |
| Net income                                  |   | 4.3                                    | %          | 2.4                                   | %          | 4.7 | % | 3.3 | % |

 

## **SALES**

 

Sales for the third quarter ended September 30, 2002 of $51,253increased 6.0% over sales for the third quarter of 2001.  Year-to-date 2002 sales through Septemberincreased 2.3% over the corresponding 2001 level.  The third quarter 2002 Filtration & Separations, ProcessWater and Household Water segment sales were 39%, 33% and 28% of total sales,respectively.  Globally, internationalsales increased to 37% of total Osmonics sales in the first nine months of 2002compared to 34% for the full year 2001. The international sales growth was attributed to the Euro/Africa andAmericas markets while the Asia/Pacific market remained consistent with year2001 levels.  International sales areprimarily within the Household Water and Filtration and Separation groups.

 

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**GROSSMARGIN**

 

Gross margin for the third quarter of 2002 was 30.7% versus 28.8% forthe corresponding period in 2001.  Grossmargin for the nine months ended September 30 was 30.4% in 2002 compared to31.2% for the same period in 2001.  Thethird quarter 2002 increase in gross margins was primarily due to increasedsales and improved utilization of production capacity in the Process Water andHousehold Water segments.  Gross marginreduction in the Filtration and Separations segment was primarily due to anunfavorable sales mix of replaceable products.

 

The decrease in gross margins for the nine months ended September 30,2002 was primarily the result of an unfavorable sales mix of replaceableproducts and reduced sales in the Filtration and Separations segment. Inaddition, costs totaling $800 (0.5% of net sales) related to the relocation ofproduct lines from the closed Syracuse, New York facility unfavorably impactedmargins in the first half of 2002.

 

Energy costs in California during the third quarter of 2002approximated the levels experienced during the same period in 2001.  Raw material costs in the first nine monthsof 2002 remained comparable to costs incurred during the same period in Year2001.

 

**OPERATING EXPENSES**

 

Operating expenses decreased to 24.1% of sales in the third quarter of2002 compared to 25.0% in the third quarter of 2001.  Operating expenses decreased to 23.3% of sales for the ninemonths ended September 30, 2002 compared to 25.4% for the same period in2001.  The reductions for the threemonth and nine month periods ended September 30, 2002 were partially due to theadoption of SFAS 142 and the associated cessation of goodwill amortization in2002 (see Note 2).  Goodwill expenserecognized in 2001 was $529 ($0.02 per diluted share) in each quarter or $1,587($0.07 per diluted share) for the nine-month period ended September 30, 2001.

 

A special recovery of $360 (0.2% of net sales) was recorded in thesecond quarter 2002 in connection with the closure of the Syracuse facility(see Special Recovery discussion).  Inaddition, the Year 2001 restructurings and continued consolidation of administrativeservices contributed to the decrease in 2002 operating expenses.

 

**SPECIAL RECOVERY**

 

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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**OTHER INCOME (EXPENSE)**

 

Other income (expense) includes interest income, interest expense, andother miscellaneous items.  Other income(expense) increased by $206 in the third quarter of 2002 versus the same periodfor 2001.  The increase was the resultof foreign currency exchange, primarily related to business transactions of theCompany’s French subsidiary, which was a loss of $7 in the third quarter 2002compared to a gain of $492 in the third quarter 2001.  Net interest expense was reduced $291 to $269 in the thirdquarter 2002 from $560 in the third quarter of 2001.  The net interest expense reduction was due to reduced total debtand lower interest rates.

 

Year-to-date other income (expense) decreased $806 in 2002 compared to2001.  The decrease was the result of a$1,198 reduction in net interest expense to $796 in 2002 from $1,994 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 $544in 2002 compared to a loss of $124 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 nine months ended September 30, 2002.

 

**INCOME TAXES**

 

The effective tax rate for the third quarter was 25.9%, reducing theyear-to-date 2002 effective tax rate to 31.0% based on the forecast for thefull year.  This rate is compared to 30.4%and 34.0% in the same periods of 2001, respectively.  The 2002 tax rate reduction is related to the elimination of apermanent tax difference from the adoption of SFAS 142 (see Note 2) and theimpacts of settling a recently completed IRS audit for calendar years 1997through 2000.

 

**NET INCOME**

 

Net income for the quarter ended September 30, 2002 was $2,217 comparedto $1,139 for the quarter ended September 30, 2001.  Net income per diluted share for the quarter was $0.15 comparedto $0.08 for the same period last year.

 

Year-to-date 2002 net income was $7,382 compared to $5,031 for the sameperiod last year.  Net income perdiluted share year-to-date was $0.50 in 2002 compared to $0.34 in 2001.

 

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**SUBSEQUENTEVENT**

 

On November 4, 2002, the Company announced anagreement to merge into a wholly owned subsidiary of General Electric Company(GE) in a stock and cash transaction. In the merger, Osmonics shareholders will receive the equivalent of$17.00 of GE common stock for each share of Osmonics.  Shareholders may elect to receive $17.00 in cash per shareinstead of GE shares, subject to proration so that the total cash paid does notexceed 55 percent of the total merger consideration.

 

The merger, which is subject to the approvalof the holders of a majority of Osmonics’ outstanding common shares, governmentapprovals and other customary conditions, is expected to close in the firstquarter of 2003.  Following the completionof the acquisition, Osmonics will be integrated with GE Water, a unit of GEPower Systems.

 

**REVIEWOF INDUSTRY SEGMENTS**

 

As discussed in Note 5 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 andnine months ended September 30, 2002 and 2001 are presented below as apercentage of net sales by segment (all segment information excludes the impactof special charges):

 
|                         |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |       |
|------------------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                         |   | **2002**                               |   | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
| Filtration and  Separations: |   |                                   |   |                                  |       |   |   |   |   |
| Sales                        |   | 100.0                                  | %      | 100.0                                 | %          | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 32.0                                   |   | 33.7                                  |       | 32.4 |   | 36.5 |   |
| Operating Income             |   | 3.5                                    |   | 7.5                                   |       | 4.3 |   | 9.9 |   |
|                         |   |                                   |   |                                  |       |   |   |   |   |
| Process Water:               |   |                                   |   |                                  |       |   |   |   |   |
| Sales                        |   | 100.0                                  | %      | 100.0                                 | %          | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 29.3                                   |   | 24.2                                  |       | 28.9 |   | 27.4 |   |
| Operating Income             |   | 7.0                                    |   | 0.5                                   |       | 7.0 |   | 3.7 |   |
|                         |   |                                   |   |                                  |       |   |   |   |   |
| Household Water:             |   |                                   |   |                                  |       |   |   |   |   |
| Sales                        |   | 100.0                                  | %      | 100.0                                 | %          | 100.0 | % | 100.0 | % |
| Gross Profit                 |   | 30.5                                   |   | 26.3                                  |       | 29.2 |   | 27.5 |   |
| Operating Income             |   | 10.4                                   |   | 1.6                                   |       | 10.3 |   | 1.7 |   |

 

13

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Filtration and Separations

 

Net sales in the Filtration and Separations segment decreased 3.1% inthe third quarter and 3.9% in the first nine months ended September 30, 2002compared to the same periods in 2001. This decrease was attributed to recessionary pressures in industrialfiltration.  Gross margin for the thirdquarter of 2002 was 32.0% versus 33.7% for the corresponding period in2001.  Gross margin for the nine monthsended September 30 was 32.4% in 2002 compared to 36.5% for the same period in2001. The 2002 decrease in gross margins was primarily the result of anunfavorable sales mix of replaceable products and reduced sales.  Operating income margin for the thirdquarter of 2002 was 3.5% versus 7.5% for the corresponding period in 2001.  Operating income margin for the nine monthsended September 30 was 4.3% in 2002 compared to 9.9% for the same period in2001.  The 2002 operating income margindecrease was primarily related to reduced gross margins.  Operating expenses for the nine months endedSeptember 30, 2002 were comparable with the corresponding period in 2001.

 

Process Water

 

Net sales in the Process Water segment increased 10.2% in the thirdquarter ended September 30, 2002 compared to the same period in 2001.  Net sales increased 0.8% for the nine monthsended September 30, 2002 compared to the same period in 2001.  These increases were primarily the result ofincreased capital equipment shipments to the municipal and beverage markets,offsetting lower capital equipment shipments to the power industry.  Gross margin for the third quarter of 2002was 29.3% versus 24.2% for the corresponding period in 2001.  Gross margin for the nine months endedSeptember 30 was 28.9% in 2002 compared to 27.4% for the same period in2001.  The gross margin improvements arerelated to prior period cost reductions, continuing productivity improvements,and cost control.  Operating incomemargin for the third quarter of 2002 improved to 7.0% versus 0.5% for thecorresponding period in 2001.  Operatingincome margin for the nine months ended September 30 improved to 7.0% in 2002compared to 3.7% for the same period in 2001. The operating income margin improvement was related to improved grossmargin and $872 (7.0%) reduction in operating expenses for the nine monthsended September 30, 2002 resulting from cost containment efforts.

 

Household Water

 

Net sales in the Household Water segment increased 15.6% in the thirdquarter and 15.0% in the first nine months ended September 30, 2002 compared tothe same periods in 2001.  Gross marginfor the third quarter of 2002 was 30.5% versus 26.3% for the correspondingperiod in 2001.  Gross margin for thenine months ended September 30 was 29.2% in 2002 compared to 27.5% for the sameperiod in 2001. The gross margin improvements in 2002 were primarily the resultof increased sales and improved utilization of production capacity.  In addition, third quarter gross marginbenefited from the closure of the Syracuse, New York facility and theelimination of the associated overhead expenses.  Operating income margin for the third quarter of 2002 was 10.4%versus 1.6% for the corresponding period in 2001.  Operating income margin for the nine months ended September 30was 10.3% in 2002 compared to 1.7% for the same period in 2001.  The operating income margin improvement wasprimarily related to increased sales and $1,519 (15.6%) reduction in operatingexpenses for the nine months ended September 30, 2002 resulting from costcontainment efforts.

 

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### **LIQUIDITY ANDCAPITAL RESOURCES**

 

As of September 30, 2002, the Company had cash, cash equivalents andmarketable securities of $3,029 versus $52 at December 31, 2001.  The current ratio at June 30, 2002 was 2.31versus 1.75 at year-end 2001.

 

Cash provided by operations was $14,604 and $8,775 for the nine monthsended September 30, 2002 and 2001, respectively.  The increase in cash provided by operating activities during 2002was due to reductions in inventory and improved earnings.  Cash used in investing activities was $2,691and $3,524 for the nine months ended September 30, 2002 and 2001,respectively.  The decrease in cash usedin investing activities is primarily related to proceeds from the sale ofclosed facilities in 2002 that exceeded proceeds from the maturity and sale ofinvestments in 2001.  Cash used in financingactivities was $9,339 and $2,159 for the nine months ended September 30, 2002and 2001, respectively.  The increase incash used in financing activities is primarily related to scheduled principalpayments of long term debt and payments on the Company’s line of credit in2002.

 

The Company’s notes payable, long-term and current debt decreased$10,938 from $34,068 at December 31, 2001 to $23,130 at September 30,2002.  The Company’s borrowingoutstanding against its $24,000 revolving line of credit decreased to $3,000 asof September 30, 2002 compared to $9,500 as of December 31, 2001.

 

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 nine monthsended September 30, 2002 does not differ materially from that discussed in ourAnnual Report on Form 10-K for 2001.

 

**ITEM IV.  CONTROL AND PROCEDURES**

 

Under the supervision and with the participation of our management,including our principal executive officer and principal financial officer, wehave evaluated the effectiveness of the design and operation of our disclosurecontrols and procedures within 90 days of the filing date of this quarterlyreport, and, based on their evaluation, our principal executive officer andprincipal financial officer have concluded that these controls and proceduresare effective.  There were nosignificant changes in our internal controls or in other factors that couldsignificantly affect these controls subsequent to the date of their evaluation.

 

Disclosure controls and procedures are actions and activities that aredesigned to ensure that information required to be disclosed in the reportsfiled or submitted under the Exchange Act is recorded, processed, summarized, andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

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**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, 2001.

 

OSMONICS, INC.

 

###### PART II

 

###### OTHER INFORMATION

 
| Item 6. | EXHIBITS AND REPORTS ON FORM 8-K |
|---------|----------------------------------|
|    |                             |   |   |
|    |                             | (a) | During the quarter ended September 30, 2002 the  Registrant did not file a Form 8-K report. |
|    |                             |   |   |
|    |                             | (b) | 1993 Employee Stock Option and Compensation Plan as  amended (Incorporated herein by reference to the Registrant’s Proxy Statement  dated April 8, 2002). |
|    |                             |   |   |
|    |                             | (c) | 1995 Director Stock Option Plan as amended  (Incorporated herein by reference to the Registrant’s Proxy Statement dated  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:  November 13, 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 September 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:   November 13, 2002 |   |
|--------|---------------------------------|--------|
|   |                            |   |
|   |                            | /s/    | Keith B. Robinson |   |
|   |                            |   | Keith B. Robinson |
|   |                            |   | Chief Financial Officer |
|   |                            |   |   |
|   |                            |   |   |
|   |                            | /s/    | D. Dean Spatz |   |
|   |                            |   | D. Dean Spatz |
|   |                            |   | Chief Executive Officer |

 

17

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CERTIFICATIONS

 

Chief Executive Officer Certification pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002

 

I, D. Dean Spatz, Chairman and Chief Executive Officer certify that:

 

1.     I havereviewed this quarterly report on Form 10-Q of  Osmonics, Inc. ;

 

2.     Based onmy knowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.     Based onmy knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.     Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.     Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud, whether ornot material, that involves management or other employees who have asignificant role in the registrant’s internal controls; and

 

6.     Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses. 

 
|   | Date:   November 13, 2002 | /s/ D. Dean Spatz                                     |   |
|--------|--------------------------------|-------------------------------------------------------|--------|
|   |                           | D. Dean Spatz,  Chairman and Chief  Executive Officer |

 

Chief Financial Officer Certification pursuant to Section 302 ofthe Sarbanes-Oxley Act of 2002

 

18

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I, Keith B. Robinson, certify that:

 

1.     I havereviewed this quarterly report on Form 10-Q of Osmonics, Inc.;

 

2.     Based onmy knowledge, this quarterly report does not contain any untrue statement of amaterial fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.     Based onmy knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.     Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a) designed suchdisclosure controls and procedures to ensure that material information relatingto the registrant, including its consolidated subsidiaries, is made known to usby others within those entities, particularly during the period in which thisquarterly report is being prepared;

 

b) evaluated theeffectiveness of the registrant’s disclosure controls and procedures as of adate within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c) presented in thisquarterly report our conclusions about the effectiveness of the disclosurecontrols and procedures based on our evaluation as of the Evaluation Date;

 

5.     Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee of theregistrant’s board of directors (or persons performing the equivalentfunction):

 

a) all significantdeficiencies in the design or operation of internal controls which couldadversely affect the registrant’s ability to record, process, summarize andreport financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b) any fraud, whether ornot material, that involves management or other employees who have a significantrole in the registrant’s internal controls; and

 

6.     Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 
|   | Date:   November 13, 2002 | /s/ Keith B. Robinson                                                 |   |
|--------|--------------------------------|-----------------------------------------------------------------------|--------|
|   |                           | Keith B. Robinson  Senior Vice President and  Chief Financial Officer |

 

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