----

----

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****WASHINGTON,D.C.  20549**

----

**FORM 10–Q**
| x | **Quarterly Report  Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934** |
|---|----------------------------------------------------------------------------------------------|

**ForQuarter Ended June 30, 2001**

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

**For thetransition period from              to             **

**CommissionFile No.  1-12714**

| **OSMONICS, INC**                                       |
|---------------------------------------------------------|
|                                                         |
| (Exact  name of registrant as specified in its charter) |

 

| **Minnesota**                                                    |   | **41–0955759**                       |
|------------------------------------------------------------------|--------|-------------------------------------------|
|                                                                  |   |                                           |
| (State  or other jurisdiction of  Incorporation or organization) |   | (I.R.S.  Employer  Identification Number) |
|                                                             |   |                                      |
| **5951 Clearwater Drive, Minnetonka, MN**                        |   | **55343**                                 |
|                                                                  |   |                                           |
| (Address  of principal executive offices)                        |   | (Zip  Code)                               |

 
| Registrant's  telephone number, including area code   | ** (952) 933–2277** |
|------------------------------------------------------------|-------------------------------|
|                                                       | ****                          |

 

| N/A                                                                               |
|-----------------------------------------------------------------------------------|
|                                                                                   |
| Former  name, former address and former fiscal year, if changed since last report |

 

             Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15 (d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports) and (2) has been subjectto such filing requirements 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 July 31, 2001, 14,473,436 shares of the issuer's Common Stock, $0.01par value, were outstanding.

 OSMONICS, INC.
INDEX
PART I.FINANCIAL INFORMATION             ITEM I.FINANCIAL  STATEMENTS         Consolidated  Statements of Operations – For the Three and Six Months Ended June 30,  2001 and 2000         Consolidated Balance Sheets  – June 30, 2001 and December 31, 2000         Consolidated  Statements of Cash Flows - For the Six Months Ended June 30, 2001 and 2000         Notes to  Consolidated Financial Statements        ITEM  II.MANAGEMENT'S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS        PART  II.OTHER  INFORMATION        ITEM  4.SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS        ITEM  6EXHIBITS  AND REPORTS ON FORM 8-K        SIGNATURES   
** **
ITEM IFINANCIAL  STATEMENTS
OSMONICS, INC.

CONSOLIDATED STATEMENTSOF OPERATIONS(In Thousands Except Per Share Data)

(UNAUDITED)
 Three  Months Ended  June 30, Six  Months Ended  June 30,       2001 2000 2001 2000        Sales$51,721 $50,110 $105,023 $101,205   Cost of sales35,477 34,222 71,081 69,033        Gross profit16,244 15,888 33,942 32,172   Less:           Selling, general and administrative11,516 11,273 22,925 22,846    Research, development and engineering2,174 1,977 4,003 4,073    Special charges- - - 250        Income from operations2,554 2,638 7,014 5,003   Other income (expense)(768)162 (1,027)209        Income from continuing operations before income taxes1,786 2,800 5,987 5,212   Income taxes625 952 2,095 1,772        Net income$1,161 $1,848 $3,892 $3,440        Earnings per share         Net income - basic$0.08 $0.13 $0.27 $0.24  Net income – assuming  dilution$0.08 $0.13 $0.27 $0.24   Average shares outstanding         Basic14,451 14,309 14,435 14,291  Assuming dilution14,617 14,391 14,534 14,361 
OSMONICS, INC.

CONSOLIDATEDBALANCE SHEETS(In Thousands Except Share Data)

 
 (UNAUDITED)  June 30,  2001 December  31,  2000    ASSETS    Current assets     Cash and cash  equivalents$1,951 $21  Marketable securities160 1,889     Trade accounts  receivable, net of allowance for doubtful accounts of $633 in 2001, and  $1,008 in 200037,913 37,092  Inventories33,134 32,758  Deferred tax assets4,606 4,314  Other current assets4,042 2,487     Total current assets81,806 78,561         Property and  equipment, at cost5,056 5,056  Land and land  improvements30,831 30,283  Building79,603 76,943     Machinery and  equipment115,490 112,282  Less accumulated  depreciation(58,428)(55,381)    57,062 56,901 Other assets52,397 53,230    Total assets$191,265 $188,692         LIABILITIES  AND SHAREHOLDERS' EQUITY    Current liabilities$13,475 $15,262  Accounts payable     Notes payable and  current portion of long – term debt21,288 19,759  Other accrued  liabilities13,805 13,784     Total current liabilities48,568 48,805    Long – term debt23,893 24,603 Other liabilities- 4 Deferred income taxes6,335 6,335 Shareholders’ equity     Common stock, $0.01  par value     Authorized ––  50,000,000 shares     Issued ––2001: 14,467,919 and  2000: 14,408,634 shares145 144  Capital in excess of  par value24,158 23,818  Retained earnings89,350 85,458  Other comprehensive  income(1,184)(475)    Total shareholders’  equity112,469 108,945     Total liabilities and  shareholders' equity$191,265 $188,692    
 

OSMONICS,INC.

CONSOLIDATED STATEMENTSOF CASH FLOWS(In Thousands)

(UNAUDITED)
 Six  Months Ended  June 30,    2001 2000    Cash  flows from operations:     Net income$3,892 $3,440  Non – cash items  included in net income:     Depreciation and  amortization5,168 4,837  Deferred income taxes(77)50  Gain on sale of  investments(972)(2,088) Loss on sale of  property and equipment- 49 Changes  in assets and liabilities   (net of business acquisitions)           Accounts receivable(712)(3,940) Inventories(376)(4,900) Other current assets(2,080)(399) Accounts payable and  accrued liabilities(1,770)(642)      Net cash provided by (used in) operations3,073 (3,593)   **Cash flows from investing activities:**     Purchase of  investments- (1,004) Sale of investments2,088 9,947  Purchase of property  and equipment(4,338)(3,517) Sales of property and  equipment24 311  Other(91)(1,116)      Cash provided by (used in) investing activities(2,317)4,621    ****Cash flows from  financing activities:     Proceeds from notes  payable and debt1,529 1,006  Reduction of debt(710)(4,173) Cash restricted for  purchase and construction of equipment325 325  Issuance of common  stock341 651     Net cash provided by  (used in) financing activities1,485 (2,191)   Effect of exchange  rate changes on cash(311)(190)Increase (decrease) in  cash and cash equivalents1,930 (1,353)Cash and cash  equivalents –  beginning of year21   1,807      Cash and cash  equivalents –   end of quarter$1,951   $454      
 

**OSMONICS, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS******(Dollars in Thousands)

The accompanyingunaudited condensed financial statements have been prepared in accordance withthe instructions to Form 10-Q and do not include all the information andfootnotes required by generally accepted accounting principles for completefinancial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.

On June 29, 2001, theFinancial Accounting Standards Board approved its proposed Statements ofFinancial Accounting Standards No. 141 (FAS 141), “Business Combinations,” andNo. 142 (FAS 142), “Goodwill and Other Intangible Assets.”  FAS 141 requires that all businesscombinations subsequent to June 30, 2001 be accounted for under the purchasemethod of accounting.  FAS 142 requirescessation of goodwill amortization and periodic evaluation of the goodwillcarrying value.  The provisions of FAS142 will be effective for fiscal years beginning after December 15, 2001.  The Company is evaluating the impact of theadoption of these standards and has not yet determined the effect of adoptionon its financial position and results of operations.

The Company has thefollowing components of comprehensive income:
 Six  Months Ended June 30,    2001 2000    Net  income$3,892 $3,440 Other  comprehensive income (loss), net of tax:     Foreign  currency translation adjustments(311)(190) Unrealized  gains/(losses) on securities(398)(423)     Other  comprehensive income (loss), before tax(709)(613)   Comprehensive  income$3,183 $2,827    
The Company has $13,900 of goodwillrecorded as of June 30, 2001 associated with the 1998 acquisition of MembrexCorp. (Membrex).  Safety Kleen (SK), theprincipal customer for the Membrex products, filed for Chapter 11 bankruptcy inJune of 2000.  As a result, six monthssales ended June 30, 2001 to SK of $1,097 were substantially below same period2000 sales of $2,781.  SK has continuedto order product and parts at reduced levels to support its installedbase.  Future sales levels are uncertainand could be minimal.

The Company has a contract with SK thatprovides some exclusivity to SK for certain Membrex products.  The Company anticipates that the exclusivityprovisions of the contract will expire in the third quarter of 2001 due toanticipated failure of SK to buy the required minimum amount of products andcontinues discussions with SK to renegotiate the contract based on the currentsituation.

The Company has determined thattwo-thirds ($9,300) of the Membrex goodwill is associated with the SKproducts.  Business activity in thefirst six months of 2001 approximated the financial forecasts used to supportthe goodwill balance at December 31, 2000; therefore, the Company has concludedthere was no impairment of goodwill at June 30, 2001.

Inventory related to the Membrex productsfor SK was $1,700 while net receivables from SK were current at June 30,2001.  The Company is monitoring theChapter 11 bankruptcy proceedings to determine any further financial impact tothe Company.

Operating results for the three months orsix months ended June 30, 2001, are not necessarily indicative of the resultsthat may be expected for the full year 2001.

These statements should be read inconjunction with the financial statements and related notes included in theCompany’s Annual Report to shareholders and Form 10-K for the year endedDecember 31, 2000.

** **
**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’soperating results, the following table shows the percentage of sales that eachincome statement item represents for the three months and six months ended June30, 2001 and 2000.
 Percent  of Sales Percent  of Sales     Three  Months Ended  June 30, Six  Months Ended  June 30,     2001 2000 2001 2000      Sales100.0%100.0%100.0%100.0%Cost  of sales68.6 68.3 67.7 68.2      Gross  profit31.4 31.7 32.3 31.8   Selling, general and administrative22.3 22.5 21.8 22.7 Research,  development and engineering4.2 3.9 3.8 4.0 Special  charges- - - 0.2      Operating  expenses26.5 26.4 25.6 26.9   Income from operations4.9 5.3 6.7 4.9 Other  income (expense)(1.5)0.3 (1.0)0.2      Income  from continuing operations before income taxes3.4 5.6 5.7 5.1 Income  taxes1.2 1.9 2.0 1.7        Net income2.2%3.7%3.7%3.4%     
**SALES**

Sales for the second quarter ended June30, 2001 of $51,721 increased 3.2% from sales for the second quarter of2000.  Year-to-date 2001 sales throughJune increased 3.8% over the corresponding 2000 level.  The second quarter 2001 Filtration &Separations, Process Water and Household Water segment sales were 40%, 43% and17% of total sales, respectively.  Thesecond quarter and year-to-date 2001 sales increase is attributed to internalgrowth of existing product offerings. Globally, international sales have remained relatively flat as apercentage of total Osmonics sales through the first six months of 2001compared to full year 2000.  The Americasmarket grew as a percentage of total Osmonics sales in the first six months of2001, while the Asia/Pacific market dropped slightly.

**GROSS MARGIN**

Gross margin for the second quarter of2001 was 31.4% versus 31.7% for the corresponding period in 2000.  Gross margin for the six months ended June30 was 32.3% in 2001 compared to 31.8% for the same period in 2000.  The second quarter 2001 decrease in grossmargins is primarily due to an unfavorable sales mix within the Filtration andSeparations segment and larger weighting of Process Water segment shipmentsthat carry gross margins below the Company average.  Also, lower utilization of manufacturing capacity in theHousehold segment contributed to the decrease.

The increase in gross margins for the sixmonths ended June 30, 2001 is primarily due to reduced overhead costs resultingfrom the Company-wide Year 2000 restructuring, plant closures and costreduction efforts.

Energy costs in California during thefirst half of 2001 were approximately 33% above the levels experienced duringthe second half of 2000.  Managementbelieves that due to product demand the Company has been able to pass theadditional costs onto its customers in the first half of 2001; however, thereis no assurance that this will continue.

Raw material costs in the first half of2001 remained comparable to costs incurred during Year 2000.

**OPERATING EXPENSES**

Operating expenses increased to 26.5% ofsales in the second quarter of 2001 compared to 26.4% in the second quarter of2000.  Operating expenses decreased to25.6% of sales for the six months ended June 30, 2001 compared to 26.9% for thesame period in 2000.  The six monthsended June 30, 2000 decrease is primarily attributed to the Year 2000 restructuringsand continued consolidation of administrative services.  Year 2000 also contained special charges of0.2% of sales (see Special Charges discussion).

**SPECIAL CHARGES**

In the first six months of 2001, theCompany recorded no special charges.  Infirst quarter 2000, the Company recorded special charges and recoveries thatnetted to zero.

Special charges in the first quarter 2000included a $250 recovery of inventory accruals primarily due to gainsrecognized on the sale of inventory at the Company’s Rockland, Massachusettsmanufacturing facility.  The specialcharges also included $250 of workforce reduction severance costs related tothe first quarter 2000 restructuring of several corporate functions.  These special charges (recovery) aresummarized below:
Corporate  restructuring$250 Special  inventory recovery related to plant closings(250)   Gross  special charges (recovery)$-  Less  special inventory recovery – in COS(250)    Special  charge in operating expense$250    
**OTHER INCOME (EXPENSE)**

Other expense increased by $930 in thesecond quarter of 2001 versus the same period for 2000.  The increase is primarily the result of a$1,142 pretax gain ($0.05 per diluted share after tax) recognized on the saleof marketable securities in the second quarter of 2000.  There were no sales of marketable securitiesin the second quarter of 2001. Translation loss, primarily from converting net assets of a foreignsubsidiary to US dollars, increased $138 to $176 in the second quarter 2001from $38 in the second quarter 2000. Net interest expense decreased $275 to $673 in the second quarter 2001from $948 in the second quarter of 2000.

Year-to-date other expense increased$1,236 in 2001 compared to 2000.  Thisincrease is primarily due to $2,088 pretax gains ($0.10 per diluted share aftertax) recognized on the sale of securities during the first six months of 2000compared to $972 pretax gains ($0.04 per diluted share after tax) in the firstsix months of 2001.  Translation loss,primarily from converting net assets of a foreign subsidiary to US dollars,increased $598 to $639 in the first six months of 2001 from $41 in the firstsix months of 2000.  Net interestexpense decreased $434 to $1,434 in the first six months of 2001 from $1,868 inthe first six months of 2000.

**INCOME TAXES**

The effective tax rate for the secondquarter and year-to-date 2001 was 35.0% based on the forecast for the fullyear.  This rate is comparable to 34.0%in the same periods of 2000.

**NET INCOME**

Net income for the quarter ended June 30,2001 was $1,161 compared to $1,848 for the quarter ended June 30, 2000.  Net income per diluted share for the quarterwas $0.08 compared to $0.13 for the same period last year.

Year-to-date 2001 net income was $3,892compared to $3,440 for the same period last year.  Net income per diluted share year-to-date was $0.27 in 2001compared to $0.24 in 2000.

**LIQUIDITY AND CAPITAL RESOURCES**

As of June 30, 2001, theCompany had cash, cash equivalents and marketable securities of $2,111 versus$1,910 at December 31, 2000.  Thecurrent ratio at June 30, 2001 was 1.7 versus 1.6 at year end 2000.

The Company’s long-termand current debt increased $819 from $44,362 at December 31, 2000 to $45,181 atJune 30, 2001.  The Company’s borrowingoutstanding against its $24,000 revolving line of credit increased to $16,500as of June 30, 2001 compared to $15,000 as of December 31, 2000.

The Company believesthat its current cash and investments position, its cash flow from operations,and amounts available from bank credit will be adequate to meet its anticipatedcash needs for working capital, capital expenditures, and potentialacquisitions during the foreseeable future.

**REVIEW OF INDUSTRY SEGMENTS**

The Company designs,manufactures and markets equipment, systems and components used in theprocessing and handling of fluids.  In2000, the Company changed the focus of its reporting structure from a twosegment, product focused structure to a three segment, market focusedstructure.

The three-market-segmentstructure was established to provide strategic leadership within the threemajor market segments in which the Company conducts business.  The new structure was implemented on January1, 2000.

The Filtration andSeparations segment includes products such as filter cartridges, membraneelements, membranes, instruments and laboratory products. The Process Watersegment includes products such as pumps, housings, valves, controls, reverseosmosis/ultrafiltration (RO/UF) machines, ozonators and water treatment systemsused for industrial, commercial and municipal applications. The Household Watersegment includes products such as valves, controls and home reverse osmosismembranes and filters used for the residential water purification and watersoftening market segments. Each segment is currently supported by severalmanufacturing facilities, a sales force and various corporate functions. Thesegments do not have separate accounting, administration or research anddevelopment functions.

The reportable segmentinformation for the three months and six months ended June 30, 2001 and 2000are as follows:
 Second  Quarter Ended  June 30, Six  Months Ended  June 30,     2001 2000 2001 2000      Sales:        Filtration  and Separations$20,514 $20,081 $42,613 $41,407 Process  Water22,251 19,865 44,257 39,444 Household  Water8,956 10,164 18,153 20,354       Net  Sales51,721 50,110 105,023 101,205 Gross  Profit:        Filtration  and Separations7,243 7,694 16,139 15,259 Process  Water6,516 5,104 12,460 10,258 Household  Water2,485 3,090 5,343 6,405       Gross  Profit16,244 15,888 33,942 31,922 Operating  Income:        Filtration  and Separations1,289 1,987 4,711 3,478 Process  Water1,217 (117)1,944 (185)Household  Water48 768 359 1,710       Operating  Income$2,554 $2,638 $7,014 $5,003 
Net sales in theFitration and Separations and Process Water segments increased in both thesecond quarter ended and first six months ended June 30, 2001 compared to thesame periods in 2000.  Filtration andSeparations and Process Water segments sales growth was organic.  Net sales in the Household Water segmentdecreased in both the second quarter ended and first six months ended June 30,2001 compared to the same periods in 2000. Management believes this decrease was the result of the continuedeconomic slowdown and customer inventory level adjustments.

Gross profit margins andoperating income margins in the Filtration and Separations segment were lowerin the second quarter and higher in the first six months ended June 30, 2001compared to the same periods in 2000. The second quarter 2001 decrease was primarily related to a reduction insales of its higher margin filtration products and a unfavorable sales mixshift within its membrane element products. The six months 2001 increase is primarily related to a favorable salesmix within the Segment’s membrane element product shipments.

Gross profit margins andoperating income margins in the Process Water segment were higher in the secondquarter and six months ended June 30, 2001 compared to the same periods in2000.  This was primarily related toincreased sales volume (six month 2001 organic growth rate over 12%), improvedutilization of manufacturing capacity, and cost reductions resulting from theYear 2000 restructuring and plant closures.

Gross profit margins andoperating income margins in the Household Water segment were lower in thesecond quarter and six months ended June 30, 2001 compared to the same periodsin 2000.  This was primarily related toreduced sales volume (three and six month 2001 sales declined approximately11%) that resulted in lower utilization of manufacturing capacity.  The Segment incurred one-time separationcharges of $250K in the second quarter of 2001 resulting from efforts to reducestaff and management levels to match the current and anticipated businessneeds.

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

**PRIVATE SECURITIES LITIGATION REFORM ACT**

The Private SecuritiesLitigation Reform Act provides a “safe harbor” for forward-looking statements.Certain information included in this Form 10-Q and other materials filed or tobe filed with the Securities and Exchange Commission (as well as informationincluded in statements made or to be made by the Company) contains statementsthat are forward looking.  Suchstatements may relate to plans for future expansion and acquisitions, financialstatus of major customers, the relocation of certain manufacturing processes,business development activities, capital spending, financing, or the effects ofregulation and competition.  Such informationinvolves important risks and uncertainties that could significantly affectresults in the future.  Such results maydiffer from those expressed in any forward-looking statements made by theCompany.  These risks and uncertaintiesinclude, but are not limited to, those relating to product developmentactivities, the inability to accurately estimate the costs of relocation ofcertain manufacturing processes, dependence on existing management, financialviability of major customers, global economic and market conditions, andchanges in federal or state laws. Investors are referred to the discussion of certain risks anduncertainties associated with forward looking statements contained in theCompany’s report on Form 10-K filed with the Securities and Exchange Commissionfor the year ended December 31, 2000.

OSMONICS,INC.

PART II

OTHERINFORMATION
Item  4.SUBMISSION OF MATTERS  TO A VOTE OF SECURITY HOLDERS
 

The Company’s AnnualMeeting of Stockholders was held on May 9, 2001.  The following members were elected to the Company’s Board of Directorsto hold office for the ensuing three years:
Nominee In  Favor Withheld    William  Eykamp 12,270,296 110,052 Michael  L. Snow 12,176,866 230,482 Ruth  Carol Spatz 11,577,640 802,708 
Anamendment of the Company’s 1993 Employee Stock Option and Compensation Plan toincrease by 150,000 the number of shares reserved under such Plan was approvedwith the vote of 9,785,628 in favor, 2,108,011 against, and 486,709 abstained.

Anamendment of the Company’s 1995 Employee Stock Purchase Plan to increase by400,000 the number of shares reserved under such Plan was approved with thevote of 11,065,992 in favor, 815,534 against, and 498,822 abstained.

Anamendment to Osmonics’ By-Laws to provide that no person over the age of 72 maybe elected or appointed to the Board was approved with the vote of 11,377,200in favor, 875,913 against, and 103,245 abstained.
Item 6.EXHIBITS AND REPORTS  ON FORM 8-K
 

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

SIGNATURES

             Pursuant to the requirements of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned thereunto duly authorized.
Dated:August  10, 2001     OSMONICS,  INC.      (Registrant)           /s/Keith  B. Robinson       Keith  B. Robinson    Chief  Financial Officer             /s/D.  Dean Spatz       D.  Dean Spatz    Chief  Executive Officer