**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****WASHINGTON, D.C.  20549**

 

**FORM 10–Q**

|                                                                                                                                                            |   |   |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| **ý    Quarterly Report Pursuant to Section 13 or 15 (d)**                                                                                       |
| **of the Securities Exchange Act of 1934**                                                                                                                      |
| **For  Quarter Ended March 31, 2002**                                                                                                                           |
|                                                                                                                                                            |   |   |   |   |
| **OR**                                                                                                                                                          |
|                                                                                                                                                            |   |   |   |   |
| **o    Transition Report Pursuant to Section 13 or 15 (d)**                                                                                           |
| **of the Securities Exchange Act of 1934**                                                                                                                      |
| **For  the transition period from            to          ** |
|                                                                                                                                                            |   |   |   |   |
|                                                                                                                                                                 |        |        |        |        |  |

**Commission File No.  1-12714**

 

 

**OSMONICS, INC**(Exact name ofregistrant 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 formerfiscal 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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date. At April 30, 2002, 14,551,309 shares of the issuer’s Common Stock, $0.01par value, were outstanding.

 

 

1

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OSMONICS, INC.

 

INDEX

 

 
| PART I.  FINANCIAL INFORMATION |
|-------------------------------------|
|                                |   |   |
|                                | ITEM I.  | FINANCIAL STATEMENTS |
|                                |   |   |
|                                |   | Consolidated  Statements of Operations –  For the Three Months Ended March 31, 2002 and 2001 |
|                                |   |
|                                |   |   |
|                                |   |   |
|                                |   | Consolidated Balance Sheets –  March 31, 2002 and December 31, 2001 |
|                                |   |
|                                |   |   |
|                                |   | Consolidated  Statements of Cash Flows -  For the Three Months Ended March 31, 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 6.  | EXHIBITS AND REPORTS  ON FORM 8-K |
|                                |   |   |
| SIGNATURES                          |   |
|                                     |  |  |  |

 

 

 

1

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ITEM I – FINANCIAL STATEMENTS

 

OSMONICS, INC.

 

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Data)

 

(UNAUDITED)

 
|                                                    |   | **Three Months Ended** |   |
|---------------------------------------------------------|--------|------------------------|--------|
|                                                    |   | **March 31,**          |   |
|                                                    |   | **2002**               |   | **2001** |   |
| Sales                                                   |   | $                      | 53,179 |   | $ | 53,302 |   |
|                                                    |   |                   |   |   |   |
| Cost  of sales                                          |   | 36,691                 |   | 35,604 |   |
|                                                    |   |                   |   |   |   |
| Gross  profit                                           |   | 16,488                 |   | 17,698 |   |
|                                                    |   |                   |   |   |   |
| Less:                                                   |   |                   |   |   |   |
|                                                    |   |                   |   |   |   |
| Selling, general  and administrative                    |   | 10,642                 |   | 11,409 |   |
|                                                    |   |                   |   |   |   |
| Research,  development  and engineering                 |   | 1,740                  |   | 1,829 |   |
|                                                    |   |                   |   |   |   |
| Income  from operations                                 |   | 4,106                  |   | 4,460 |   |
|                                                    |   |                   |   |   |   |
| Other  income (expense)                                 |   | (153                   | )      | (259 | ) |
|                                                    |   |                   |   |   |   |
| Income  from continuing  operations before income taxes |   | 3,953                  |   | 4,201 |   |
|                                                    |   |                   |   |   |   |
| Income  taxes                                           |   | 1,304                  |   | 1,470 |   |
|                                                    |   |                   |   |   |   |
| Net  income                                             |   | $                      | 2,649  |   | $ | 2,731 |   |
|                                                    |   |                   |   |   |   |
| Earnings  per share                                     |   |                   |   |   |   |
| Net  income — basic                                |   | $                      | 0.18   |   | $ | 0.19 |   |
| Net  income — assuming dilution                    |   | $                      | 0.18   |   | $ | 0.19 |   |
|                                                    |   |                   |   |   |   |
| Average  shares outstanding                             |   |                   |   |   |   |
| Basic                                                   |   | 14,531                 |   | 14,419 |   |
| Assuming  dilution                                      |   | 14,837                 |   | 14,465 |   |

 

 

2

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OSMONICS, INC.

CONSOLIDATEDBALANCE SHEETS

(In Thousands Except Share Data)

 

 

 
|                                                                     |   | (UNAUDITED)   |    |              |   |
|--------------------------------------------------------------------------|--------|---------------|---------|-------------------|--------|
|                                                                     |   | **March 31,** |    | **December  31,** |   |
|                                                                     |   | **2002**      |    | **2001**          |   |
| ASSETS                                                                   |   |          |    |              |   |
|                                                                     |   |          |    |              |   |
| Current  assets                                                          |   |          |    |              |   |
| Cash  and cash equivalents                                               |   | $             | 1,296   |              | $      | — |   |
| Marketable  securities                                                   |   | 56            |    | 52                |   |
| Trade  accounts receivable, net of                                       |   |          |    |              |   |
| allowance  for doubtful accounts of                                      |   |          |    |              |   |
| $1,203  in 2002, and $963 in 2001                                        |   | 35,758        |    | 34,890            |   |
| Inventories                                                              |   | 31,590        |    | 32,094            |   |
| Deferred  tax assets                                                     |   | 4,799         |    | 4,867             |   |
| Other  current assets                                                    |   | 1,524         |    | 2,041             |   |
| Total  current assets                                                    |   | 75,023        |    | 73,944            |   |
|                                                                     |   |          |    |              |   |
| Property  and equipment, at cost                                         |   |          |    |              |   |
| Land  and land improvements                                              |   | 5,539         |    | 5,366             |   |
| Building                                                                 |   | 30,706        |    | 30,830            |   |
| Machinery  and equipment                                                 |   | 77,618        |    | 76,282            |   |
|                                                                     |   | 113,863       |    | 112,478           |   |
| Less  accumulated depreciation                                           |   | (55,117       | )       | (53,314           | )      |
|                                                                     |   | 58,746        |    | 59,164            |   |
|                                                                     |   |          |    |              |   |
| Goodwill                                                                 |   | 42,829        |    | 42,829            |   |
| Intangible  assets                                                       |   | 3,478         |    | 3,575             |   |
| Other  assets                                                            |   | 3,933         |    | 5,286             |   |
| Total  assets                                                            |   | $             | 184,009 |              | $      | 184,798 |   |
|                                                                     |   |          |    |              |   |
| LIABILITIES  AND SHAREHOLDERS’ EQUITY                               |   |          |    |              |   |
|                                                                     |   |          |    |              |   |
| Current  liabilities                                                     |   |          |    |              |   |
| Accounts  payable                                                        |   | $             | 12,694  |              | $      | 11,860 |   |
| Notes  payable and current portion   of long–term debt              |   | 12,297        |    | 13,619            |   |
| Other  accrued liabilities                                               |   | 16,223        |    | 16,710            |   |
| Total  current liabilities                                               |   | 41,214        |    | 42,189            |   |
|                                                                     |   |          |    |              |   |
| Long–term  debt                                                     |   | 17,749        |    | 20,449            |   |
| Deferred  income taxes                                                   |   | 6,807         |    | 6,763             |   |
| Shareholders’  equity                                               |   |          |    |              |   |
| Common  stock, $0.01 par value                                           |   |          |    |              |   |
| Authorized  –– 50,000,000 shares                               |   |          |    |              |   |
| Issued  ––  2002: 14,543,578 and  2001: 14,523,579 shares |   | 145           |    | 145               |   |
| Capital  in excess of par value                                          |   | 24,943        |    | 24,701            |   |
| Retained  earnings                                                       |   | 94,286        |    | 91,637            |   |
| Other  comprehensive income                                              |   | (1,135        | )       | (1,086            | )      |
| Total  shareholders’ equity                                         |   | 118,239       |    | 115,397           |   |
| Total  liabilities and shareholders’ equity                         |   | $             | 184,009 |              | $      | 184,798 |   |
|                                                                          |        |               |         |                   |        |  |  |  |  |  |  |  |  |

 

 

3

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OSMONICS, INC.

 

CONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)

 

(UNAUDITED)

 
|                                                 |   | **Three Months Ended** |       |
|------------------------------------------------------|--------|------------------------|------------|
|                                                 |   | **March  31,**    |       |
|                                                 |   | **2002**               |       | **2001** |   |
| Cash  flows from operations:                         |   |                   |       |   |   |
| Net  income                                          |   | $                      | 2,649      |   | $ | 2,731 |   |
| Non–cash  items included in net income:         |   |                   |       |   |   |
| Depreciation  and amortization                       |   | 2,069                  |       | 2,533 |   |
| Deferred  income taxes                               |   | 110                    |       | (29 | ) |
| Gain  on sale of investments                         |   | —                 |       | (972 | ) |
| Gain  on sale of property and equipment              |   | (17                    | )          | — |   |
| Changes  in assets and liabilities                   |   |                   |       |   |   |
| (net  of business acquisitions)                      |   |                   |       |   |   |
| Accounts  receivable                                 |   | (838                   | )          | (136 | ) |
| Inventories                                          |   | 504                    |       | (121 | ) |
| Other  current assets                                |   | 517                    |       | (1,718 | ) |
| Accounts  payable and accrued liabilities            |   | 347                    |       | (1,440 | ) |
|                                                 |   |                   |       |   |   |
| Net  cash provided by (used in) operations           |   | 5,341                  |       | 848 |   |
|                                                 |   |                   | ** ** |   | ** ** |
| **Cash flows from investing  activities:**           |   |                   | ** ** |   | ** ** |
| Maturities  and sales of investments                 |   | —                 |       | 2,088 |   |
| Purchase  of property and equipment                  |   | (1,619                 | )          | (1,721 | ) |
| Proceeds  from sale of property and equipment        |   | 99                     |       | 6 |   |
| Proceeds  from sale of closed facility               |   | 1,698                  |       | — |   |
| Other                                                |   | (392                   | )          | 615 |   |
|                                                 |   |                   |       |   |   |
| Net  cash (used in) provided by investing activities |   | (214                   | )          | 988 |   |
|                                                 |   |                   | ** ** |   | ** ** |
| **Cash flows from financing activities:**            |   |                   | ** ** |   | ** ** |
| Payments  of notes payable and current debt          |   | (1,322                 | )          | (557 | ) |
| Payments  of long-term debt                          |   | (2,700                 | )          | (750 | ) |
| Issuance  of common stock                            |   | 242                    |       | 228 |   |
|                                                 |   |                   |       |   |   |
| Net  cash (used in) provided by financing activities |   | (3,780                 | )          | (1,079 | ) |
|                                                 |   |                   |       |   |   |
| Effect  of exchange rate changes on cash             |   | (51                    | )          | (222 | ) |
| Increase  in cash and cash equivalents               |   | 1,296                  |       | 535 |   |
| Cash  and cash equivalents –  beginning of year |   | —                 |       | 21 |   |
| Cash  and cash equivalents –  end of quarter    |   | $                      | 1,296      |   | $ | 556 |   |

 

 

4

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**OSMONICS, INC.**

 

#### **NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

(Dollars in Thousands)

 

**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 March 31, 2002, are notnecessarily indicative of the results that may be expected for the full year2002.

 

These statements shouldbe read in conjunction with the financial statements and related notes includedin the Company’s Annual Report to shareholders and Form 10-K for the year endedDecember 31, 2001.

 

The Company has thefollowing components of comprehensive income:

 
|                                      |   | **Three  Months Ended March 31,** |       |
|-------------------------------------------|--------|-----------------------------------|------------|
|                                      |   | **2002**                          |       | **2001** |   |
| Net income                                |   | $                                 | 2,649      |   | $ | 2,731 |   |
| **Other comprehensive income  (loss):**   |   |                              | ** ** |   | ** ** |
| Foreign currency  translation adjustments |   | (51                               | )          | (222 | ) |
| Unrealized  gains/(losses) on securities  |   | 2                                 |       | (390 | ) |
| Other comprehensive  income (loss)        |   | (49                               | )          | (612 | ) |
| Comprehensive  income                     |   | $                                 | 2,600      |   | $ | 2,119 |   |

 

 

In the fourth quarter2001, the Company recorded special charges of $1,100 related to the closure ofthe Company’s Syracuse, New York manufacturing facility and $600 in corporaterestructuring.  For the three monthsended March 31, 2002, the Company expended $209 for workforce reductions and $6for facility closing/consolidation costs. The remaining $1,175 is anticipated to be expended by December 31, 2002.

 

5

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**Note 2 — Goodwill and Other Intangible Assets — Adoption ofStatement 142**

 

In the first quarter offiscal 2002, the Company adopted SFAS No. 142, “Goodwill and Other IntangibleAssets,” which eliminated the amortization of purchased goodwill and otherintangibles with indefinite useful lives. Upon adoption of SFAS No. 142, the Company is required to perform aninitial impairment test of its goodwill within the first six months of 2002.  The Company expects to complete the analysisin the second quarter of 2002.  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 intangibleassets on the Company’s Consolidated Balance Sheet is the following:

 
|                            |   | **March 31** |   | **December 31** |   |
|---------------------------------|--------|--------------|--------|-----------------|--------|
|                            |   | **2002**     |   | **2001**        |   |
| Amortizable intangible  assets: |   |         |   |            |   |
|                            |   |         |   |            |   |
| Patents                         |   | $            | 2,801  |            | $      | 2,695 |   |
| Accumulated amortization        |   | (705         | )      | (653            | )      |
|                            |   | 2,096        |   | 2,042           |   |
|                            |   |         |   |            |   |
| Supply agreement                |   | 1,449        |   | 1,449           |   |
| Accumulated amortization        |   | (145         | )      | (72             | )      |
|                            |   | 1,304        |   | 1,377           |   |
|                            |   |         |   |            |   |
| Other                           |   | 1,339        |   | 1,413           |   |
| Accumulated amortization        |   | (1,261       | )      | (1,257          | )      |
|                            |   | 78           |   | 156             |   |
| Total                           |   | $            | 3,478  |            | $      | 3,575 |   |

 

 

Intangible amortizationexpense for the first quarter ended March 31, 2002 was $114 and is estimated tobe $550 for the year 2002.  Intangibleamortization expense for each of the subsequent four calendar years isestimated at $400 to $500.

 

6

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A reconciliation ofpreviously reported net income and earnings per share to the amounts adjustedfor the exclusion of goodwill amortization net of the related income tax effectfollows:

 
|                                        |   | **Three months ended March 31,** |   |
|---------------------------------------------|--------|----------------------------------|--------|
|                                        |   | **2002**                         |   | **2001** |   |
| Reported net income                         |   | $                                | 2,649  |   | $ | 2,731 |   |
| Add back: Goodwill amortization net of  tax |   | —                           |   | 344 |   |
| Adjusted net income                         |   | $                                | 2,649  |   | $ | 3,075 |   |
|                                        |   |                             |   |   |   |
| Basic earnings per  share:                  |   |                             |   |   |   |
| Reported net income                         |   | $                                | 0.18   |   | $ | 0.19 |   |
| Goodwill amortization net of tax            |   | —                           |   | 0.02 |   |
| Adjusted net income                         |   | $                                | 0.18   |   | $ | 0.21 |   |
|                                        |   |                             |   |   |   |
| Diluted earnings per  share:                |   |                             |   |   |   |
| Reported net income                         |   | $                                | 0.18   |   | $ | 0.19 |   |
| Goodwill amortization net of tax            |   | —                           |   | 0.02 |   |
| Adjusted net income                         |   | $                                | 0.18   |   | $ | 0.21 |   |

 

 

 

**Note 3**—**Inventories**

 
|                                  |   | **March 31** |   | **December 31** |   |
|---------------------------------------|--------|--------------|--------|-----------------|--------|
|                                  |   | **2002**     |   | **2001**        |   |
| Inventories consist of the following: |   |         |   |            |   |
|                                  |   |         |   |            |   |
| Finished goods                        |   | $            | 9,585  |            | $      | 9,353 |   |
| Work in process                       |   | 11,646       |   | 9,415           |   |
| Raw materials                         |   | 12,008       |   | 14,958          |   |
|                                  |   | 33,239       |   | 33,726          |   |
| Adjustments to reduce inventories     |   |         |   |            |   |
| of $11,438 and $9,487 to the last-    |   |         |   |            |   |
| in, first-out method                  |   | (1,649       | )      | (1,632          | )      |
|                                  |   | $            | 31,590 |            | $      | 32,094 |   |

 

 

7

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**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, instruments and laboratory products.The Process Water segment includes products such as pumps, housings, controls,reverse osmosis/ultrafiltration (RO/UF) machines, ozonators and water treatmentsystems used for industrial, commercial and municipal applications. TheHousehold Water segment includes products such as valves, controls and homereverse osmosis membranes and filters used for the residential waterpurification and water softening market segments. Each segment is currentlysupported by several manufacturing facilities, a sales force and variouscorporate functions. The segments do not have separate accounting,administration or research and development functions.

 

The reportable segmentinformation for the three months ended March 31, 2002 and 2001 are as follows:

 
|                        |   | **Third Quarter Ended** |   |
|-----------------------------|--------|-------------------------|--------|
|                        |   | **March 31,**           |   |
|                        |   | **2002**                |   | **2001** |   |
| Sales:                      |   |                    |   |   |   |
| Filtration and Separations  |   | $                       | 21,194 |   | $ | 22,099 |   |
| Process Water               |   | 17,325                  |   | 18,256 |   |
| Household Water             |   | 14,660                  |   | 12,947 |   |
| Net Sales                   |   | 53,179                  |   | 53,302 |   |
| Gross Profit:               |   |                    |   |   |   |
| Filtration and Separations  |   | 7,357                   |   | 8,896 |   |
| Process Water               |   | 4,954                   |   | 4,985 |   |
| Household Water             |   | 4,177                   |   | 3,817 |   |
| Gross Profit                |   | 16,488                  |   | 17,698 |   |
| Operating  Income:          |   |                    |   |   |   |
| Filtration and  Separations |   | 1,554                   |   | 3,422 |   |
| Process Water               |   | 1,100                   |   | 625 |   |
| Household Water             |   | 1,452                   |   | 413 |   |
| Operating Income            |   | $                       | 4,106  |   | $ | 4,460 |   |

 

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

 

8

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

## **                        CONDITIONAND RESULTS OF OPERATIONS**

 

                        (Dollars in thousands,except share data)

 

 

As an aid tounderstanding the Company’s operating results, the following table shows thepercentage of sales that each income statement item represents for the threemonths ended March 31, 2002 and 2001.

 
|                                  |   | **Percent of  Sales**   |   |
|---------------------------------------|--------|-------------------------|--------|
|                                  |   | **Three  Months Ended** |   |
|                                  |   | **March 31,**           |   |
|                                  |   | **2002**                |   | **2001** |   |
| Sales                                 |   | 100.0                   | %      | 100.0 | % |
| Cost of sales                         |   | 69.0                    |   | 66.8 |   |
| Gross profit                          |   | 31.0                    |   | 33.2 |   |
|                                  |   |                    |   |   |   |
| Selling, general  and administrative  |   | 20.0                    |   | 21.4 |   |
| Research, development and engineering |   | 3.3                     |   | 3.4 |   |
| Special charges                       |   | —                  |   | — |   |
| Operating  expenses                   |   | 23.3                    |   | 24.8 |   |
|                                  |   |                    |   |   |   |
| Income from  operations               |   | 7.7                     |   | 8.4 |   |
| Other income  (expense)               |   | (0.3                    | )      | (0.5 | ) |
| Income from  continuing               |   |                    |   |   |   |
| operations  before income taxes       |   | 7.4                     |   | 7.9 |   |
| Income taxes                          |   | (2.4                    | )      | (2.8 | ) |
|                                  |   |                    |   |   |   |
| Net income                            |   | 5.0                     | %      | 5.1 | % |

 

 

## **SALES**

 

Salesfor the first quarter ended March 31, 2002 of $53,179 were flat with sales forthe first quarter of 2001.  The firstquarter 2002 Filtration & Separations, Process Water and Household Watersegment sales were 40%, 33% and 27% of total sales, respectively.  Globally, international sales increased to37% of total Osmonics sales in the first three months of 2002 compared to 34%for the full year 2001.  Theinternational sales growth was primarily attributed to the Euro/Africa marketwhile the Asia/Pacific and Americas markets remained consistent with year 2001levels.

 

9

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**GROSSMARGIN**

 

Gross margin for the first quarter of 2002 was 31.0% versus 33.2% forthe corresponding period in 2001.  Thefirst quarter 2002 decrease in gross margins was primarily due to anunfavorable sales mix of replaceable products and pricing pressures in theFiltrations and Separations segment.  Inaddition, the Household Water segment gross margins decreased primarily due toan unfavorable mix of valve product shipments. Gross margin improvements in the Process Water segment were primarilydue to continued benefits from prior period cost reductions and standardizationof product lines.

 

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

** **

**OPERATING EXPENSES**

** **

Operating expenses decreased to 23.3% of sales in the first quarter of2002 compared to 24.8% in the first quarter of 2001.  This reduction was primarily due to the adoption of SFAS 142 andthe associated cessation of goodwill amortization in 2002 (see Note 2).  First quarter 2001 operating expensesincluded $529 (1.0% of net sales) of goodwill amortization.  In addition, the Year 2001 restructuringsand continued consolidation of administrative services contributed to thedecrease.

** **

**OTHER INCOME (EXPENSE)**

** **

Otherincome (expense) includes interest income, interest expense, gains on assetsales and other miscellaneous items. This expense decreased by $106 in the first quarter of 2002 versus thesame period for 2001. The decrease is the result of a $555 reduction in netinterest expense to $206 in the first quarter 2002 from $761 in the firstquarter of 2001.  Foreign currencyexchange, primarily related to business transactions of the Company’s Frenchsubsidiary, was a gain of $26 in the first quarter 2002 compared to a loss of$431 in the first quarter 2001.  A $972pretax gain ($0.04 per diluted share) was recognized on the sale of marketablesecurities in the first quarter of 2001. There were no sales of marketable securities in the first quarter of2002.

** **

**INCOME TAXES**

** **

Theeffective tax rate for the first quarter of 2002 was 33.0% based on theforecast for the full year.  This ratecompares to the 35.0% in the same period of 2001 and the 34% rate for the fullyear 2001.  The first quarter of 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.

 

 

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** **

**NET INCOME**

** **

Net income for the quarter ended March 31, 2002 was $2,649 compared to$2,731 for the quarter ended March 31, 2001. Net income per diluted share for the quarter was $0.18 compared to $0.19for the same period last year.

 

**REVIEW OF 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 threemonths ended March 31, 2002 and 2001 are presented below as a percentage of netsales by segment:

 
|                         |   | **First Quarter Ended** |   |
|------------------------------|--------|-------------------------|--------|
|                         |   | **March 31,**           |   |
|                         |   | **2002**                |   | **2001** |   |
| Filtration and  Separations: |   |                    |   |   |   |
| Sales                        |   | 100.0                   | %      | 100.0 | % |
| Gross Profit                 |   | 34.7                    |   | 40.3 |   |
| Operating Income             |   | 7.3                     |   | 15.5 |   |
|                         |   |                    |   |   |   |
| Process Water:               |   |                    |   |   |   |
| Sales                        |   | 100.0                   | %      | 100.0 | % |
| Gross Profit                 |   | 28.6                    |   | 27.3 |   |
| Operating  Income            |   | 6.3                     |   | 3.4 |   |
|                         |   |                    |   |   |   |
| Household Water:             |   |                    |   |   |   |
| Sales                        |   | 100.0                   | %      | 100.0 | % |
| Gross Profit                 |   | 28.5                    |   | 29.5 |   |
| Operating Income             |   | 9.9                     |   | 3.2 |   |

 

 

Filtration andSeparations

Net sales in the Filtration and Separations segment decreased 4.1% inthe first quarter ended March 31, 2002 compared to the same period in2001.  This decrease was attributed torecessionary pressures in industrial filtration and slower than plannedstart-up of new WasteWizard alternative sales channels.  Gross margin for the first quarter of 2002was 34.7% versus 40.3% for the corresponding period in 2001.  This decrease was primarily the result of anunfavorable sales mix of replaceable products and pricing pressures.  Operating income margins for the firstquarter of 2002 was 7.3% versus 15.5% for the corresponding period in 2001.  The operating income margin decrease wasprimarily related to reduced gross margins and a $329 (6.0%) increase inoperating expenses.

 

 

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Process Water

Net sales in the Process Water segment decreased 5.1% in the firstquarter ended March 31, 2002 compared to the same period in 2001.  This decrease was primarily the result oflower capital equipment shipments to the power industry.  Gross margin for the first quarter of 2002was 28.6% versus 27.3% for the corresponding period in 2001.  This increase was primarily due to continuedbenefits from prior period cost reductions and standardization of productlines.  Operating income margins for thefirst quarter of 2002 improved to 6.3% versus 3.4% for the corresponding periodin 2001.  The operating income marginimprovement was primarily related to a $506 (11.6%) reduction in operatingexpenses and improved gross margins.

 

Household Water

Net sales in the Household Water segment increased 13.2% in the first quarterended March 31, 2002 compared to the same period in 2001.  This increase was attributed to increasedsales to nearly all of the Company’s OEM customers.  Gross margin for the first quarter of 2002 was 28.5% versus 29.5%for the corresponding period in 2001. This decrease was primarily due to an unfavorable mix of valve productshipments and pricing pressures in the International markets.  Operating income margins for the firstquarter of 2002 was 9.9% versus 3.2% for the corresponding period in 2001.  The operating income margin improvement wasprimarily related to increased net sales and a $679 (19.9%) reduction inoperating expenses.

 

This Segment incurred approximately $100 in one-time costs included incost of sales associated with the movement of manufacturing activities from itsSyracuse, New York facility that is scheduled to be closed in July 2002.  Additional and increased costs areanticipated to be incurred in the second quarter as the production moves arecompleted.

 

### **LIQUIDITY AND CAPITAL RESOURCES**

 

As of March 31, 2002, the Company had cash, cash equivalents andmarketable securities of $1,352 versus $52 at December 31, 2001.  The current ratio at March 31, 2002 was 1.82versus 1.75 at year-end 2001.

 

The Company’s long-term and current debt decreased $4,022 from $34,068at December 31, 2001 to $30,046 at March 31, 2002.  The Company’s borrowing outstanding against its $24,000 revolvingline of credit decreased to $8,000 as of March 31, 2002 compared to $9,500 asof 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.

 

 

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

 

Information about market risks for the three months ended March 31,2002 does not differ materially from that discussed in our Annual Report onForm 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, the anticipated costs for relocation ofcertain manufacturing processes, business development activities, capitalspending, 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, the ability to realize backlog sales orders, those relatingto product development activities, the inability to accurately estimate thecosts of relocation of certain manufacturing processes, dependence on existingmanagement, global economic and market conditions, and changes in federal orstate laws.  Investors are referred tothe discussion of certain risks and uncertainties associated with forwardlooking statements contained in the Company’s report on Form 10-K filed with theSecurities and Exchange Commission for 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 March 31, 2002 the Registrantdid not file a Form 8-K report.

 

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SIGNATURES

 

 

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

 

 

 

#      Dated: May 13, 2002

 

 

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

 

 

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