SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1997
OR
[ ] 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 of registrant as specified in its charter)
Minnesota 41-0955959
(State or other jurisdiction (I.R.S. Employer
of incorporation or Identification No.)
organization)
5951 Clearwater Drive, Minnetonka, Minnesota 55343
(Address of principal executive offices) (Zip Code)
(612) 933-2277
(Registrant's telephone
number)
Securities registered pursuant to Section 12(b) of the Act:
Common Shares, par value
$0.01 per share New York Stock Exchange
(Title of each class) (Name of each exchange on which
registered)
Securities registered pursuant to Section 12(g) of the Act:
None.
Indicate by check mark whether the registrant (1) has
filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has
been subject to such filing requirements for the past 90
days.
Yes X No <PAGE>
Indicate by check mark if disclosure of delinquent
filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of
Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this
Form 10-K or any amendment to this form 10-K. [X].
As of March 4, 1998, 13,953,584 Common Shares were
outstanding. The aggregate market value of the Common
Shares held by non-affiliates of the Registrant on such date
(based upon the closing price of such shares on the New York
Stock Exchange on March 4, 1998) was $228,489,938.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Shareholders for the
fiscal year ended December 31, 1997 (the "Annual Report to
Shareholders"), are incorporated by reference into Parts II
and IV. Portions of the definitive Proxy Statement for the
Annual Meeting of Shareholders to be held on May 13, 1998
(the "Proxy Statement"), and to be filed within 120 days
after the Registrant's fiscal year ended December 31, 1997,
are incorporated by reference into Part III.
PART I
ITEM 1. BUSINESS
The following discussion contains certain information
and other forward-looking statements that involve a number
of risks and uncertainties. The actual results of Osmonics
could differ materially from the Company's historical
results of operations and those discussed in the forward-
looking statements.
Osmonics, Inc. and its wholly-owned subsidiaries (the
"Company") design, manufacture and market machines, systems
and components used in the processing and handling of
fluids. The Company was founded in 1969 and manufactures
replaceable, semi-permeable membranes and other filter media
for use in fluid separation and filtration. The Company's
processing equipment employs crossflow filtration (including
reverse osmosis, nanofiltration, ultrafiltration and
microfiltration), normal filtration (including
microfiltration and particle filtration), coalescing
filtration, ion exchange, clarification, chromatography,
ozonation and distillation. The Company's fluid handling
equipment includes centrifugal, diaphragm and bellows pumps;
electronic controllers to operate precision valves for water
conditioning; flow control and measuring devices and
instrumentation; and specialty holders and devices for
retaining its membranes and filter media.
Crossflow, normal and coalescing filtration are
precision processes in which a semi-permeable membrane or
other filter material separates a fluid's components.
Separation is accomplished by applying pressure to a fluid
in order to cause selective passage of some components of
the fluid through the membrane or filter media. Ion
exchange and chromatography are quasi-filtration processes
in which specialized plastic beads are used to selectively
remove ionized or charged particles from a fluid. The fluid
is pressurized and passes through a bed of the plastic beads
in a normal filtration mode. Distillation is the
condensation of steam from boiling water to produce
ultrapure water. Ozone generation equipment uses
electricity to develop a corona discharge which produces
ozone, a strong oxidant used in the purification of water
and other fluids.
The Company's processing products are used in
fractionation, preferential separation, conditioning and
purification in connection with such processes as
purification of water and industrial solutions, dewatering
and recycling of commercial and industrial fluids, pollution
control and seawater desalting. The Company's principal
domestic and international markets, from which it derives
more than 50% of its sales, include the electronics, potable
water, health care, biotechnology, food and beverage,
chemical processing and power generation industries.
Filtration processes cover a broad spectrum ranging
from those which separate discrete molecules and ions to
those which separate particles visible to the naked eye.
Historically, the Company specialized in products utilizing
crossflow filtration processes designed to separate
particles in the molecular range. Through acquisitions and
internal product developments, the Company now has a full
line of filtration products including depth cartridge
filters for particle filtration and pleated membrane
cartridge filters for microfiltration. The filtration media
and membrane is produced primarily from polymers; however,
inorganic membranes and filters of metal and ceramic are
also manufactured. In addition, the Company manufactures
housings to contain the filters. The crossflow filter
membrane elements, and the microfilter and depth filter
cartridges are replaceable while the housings are a
permanent fixture in the fluid processing system.
To provide a complete line of products for the
production of pure water, the Company manufactures
distillation equipment, both single-effect and more energy
efficient multi-effect. In addition, deionization and
softening equipment in both laboratory size and large scale
is manufactured in multiple locations.
In June 1989, the Company acquired Ozone Research &
Equipment Corporation of Phoenix, Arizona. Ozone Research
was founded in 1957 and is a pioneer in the manufacture of
ozone generation equipment for the purification of water and
the testing of elastomeric materials.
In November 1989, the Company acquired certain assets
for the manufacture and sale of MACE flow control and
pumping products to increase its fluid handling offerings.
MACE products are made from Teflon PTFE, the most chemically
stable polymer available, and are used to handle ultrapure
and aggressive chemicals.
In December 1990, the Company acquired certain assets
of the FASTEK Division of Eastman Kodak for the production
of reverse osmosis membrane, home reverse osmosis membrane
elements, a rolled filter product, and a blown microfiber
filter cartridge product. This Syracuse, New York facility
and manufacturing equipment provides the Company with added
capacity and capability and gives the Company three sites
for manufacturing membrane and membrane elements.
In October 1993, the Company acquired Autotrol
Corporation through a pooling-of-interests, stock-for-stock
transaction. Autotrol was founded in 1962 and is a leader
in the manufacture of controllers for water softening and
filtration equipment. In addition, Autotrol manufactures
other fluid control and measuring devices such as a
totalizing flow meter and dosing system to assure proper
treatment of cooling tower water. Most of Autotrol's
products are sold to OEM's who then use them as a component
in a water conditioning device which is then sold to
consumers.
In November 1994, the Company acquired substantially
all of the assets of Lakewood Instruments of Phoenix,
Arizona. This acquisition adds a line of instruments,
sensors and analyzers used in the measurement of fluid
characteristics in the chemical water treatment and pure
water industries.
In October 1995, the Company acquired the assets and
operations of Western Filter Company, Denver, Colorado, an
important supplier to the beverage and bottled water
industry for over 50 years. Western Filter has extensive
experience in providing the beverage market with
conventional water treatment technologies and membrane water
treatment. Western Filter also has experience in
coagulation clarification pretreatment technologies. These
technologies will be utilized with Osmonics' existing
distribution channels, allowing the Company to expand
capability in the international markets where conventional
water treatment is required, as well as complement municipal
sales in the United States where ozone disinfection is
becoming accepted.
In July 1996, the Company acquired Desalination
Systems, Inc. ("Desal") through a pooling-of-interests,
stock-for-stock transaction. Desal manufactures crossflow
filtration membrane and membrane elements. Desal has
manufacturing facilities in Vista, California, and markets
its products world-wide. Desal's products extend the range
of membranes and membrane elements previously offered by the
Company. The acquisition also extends the Company's
distribution network for such products.
In February 1997, the Company acquired AquaMatic, Inc.
of Rockford, Illinois. AquaMatic, started in 1930, offers a
line of specialty valves and controllers for the water
conditioning market, which will be sold through existing
Osmonics distribution channels.
In December 1997, the Company acquired Purifications
Products Company ("PPC") of San Marcos, California. PPC
manufactures a line of reverse osmosis membrane elements and
related products for purifying home drinking water and
producing high-quality water for other applications. In
addition, PPC has a line of Silt Density Index instruments
and a line of UV sterilization products. These products
will be sold through existing Osmonics distribution
channels.
In February 1998, the Company acquired Micron
Separations, Inc. ("MSI") of Westborough, Massachusetts.
MSI, in business for 16 years, develops, manufactures and
markets microfilter membrane and membrane products for
diagnostic, laboratory and industrial use. These products
will expand the Company's range of nylon and cellulosic
membrane applications. The products will be sold through
existing Osmonics distribution channels.
In March 1998, the Company signed a definitive
agreement, to acquire Membrex Corp. of Fairfield, New
Jersey. The acquisition is subject to Membrex shareholder
approval. The acquisition of Membrex would give the Company
the most hydrophilic UF membrane in the market, which is
used to separate oil from water in a variety of
applications, including biotechnology, laboratory and
chemical processes. Membrex also has a patented machine
using its UF membrane which will separate oil from water for
use in parts cleaning and other industrial and commercial
applications. Some products will be sold through our
exclusive agreement with Safety-Kleen Corp. and the
remainder through existing Osmonics distribution channels.
The Company focuses the marketing of its products
through three domestic and international sales groups:
1. Large equipment and systems.
2. Components and product sales.
3. Catalog and telephone sales.
These sales groups are supported by application engineers
and market support personnel.
Products
Membranes: The Company markets polymer membranes for
crossflow applications sold in replaceable elements. Most
membranes are produced in a spiral-wound configuration
ranging in diameter from two to twelve inches and in length
from twelve to sixty inches.
Membrane elements are typically replaced every 6 to 60
months, depending upon the severity of the application. The
Company manufactures the membrane material and membrane
elements used in its own systems, and also manufactures
membrane elements for other original equipment manufacturers
(OEM's) who include them as component parts in their
products.
The Company's membranes are used in many bioengineering
processes such as the production of high fructose corn
sugar, enzyme purification, and purification of
pharmaceuticals produced by biological processes. Other
uses include water purification applications in
hemodialysis, semiconductor manufacturing, production of
pure water for beverages, production of ultrapure
pharmaceutical and boiler feed water, industrial water
purification and waste removal for pollution control
compliance. In addition, the Company sells its home reverse
osmosis (HRO) membrane elements to OEM's who package them
into systems for use in homes, offices and retail vending
establishments to produce purified drinking water. The
Company is registered with the United States Food and Drug
Administration for the manufacture and sale of certain
membrane elements used in biological preparations. The
Company is registered with the U.S. FDA for the manufacture
of Class II medical devices used to purify water for
hemodialysis.
The Company markets microfiltration normal flow membrane and
the hardware for use in a variety of laboratory and medical
diagnostic applications. The Company manufactures nylon,
cellulosic polysulfone, polycarbonate, and numerous other
polymer-based microfiltration membrane as well as silver
microfiltration membranes and ceramic microfilters.
Numerous applications exist for the Company's microfilters
because of unique features, including use in air monitoring
and in laboratory procedures for cancer and other research.
Filters: The Company markets replaceable depth
cartridge filters, pleated cartridge filters, and rolled
cartridge filters. The depth cartridge filters consist of a
matrix of thermally-bonded polypropylene blown microfibers.
The structure of these fibers allows particles to be
trapped throughout the depth of the cartridge filter rather
than simply on its surface, enhancing the efficiency of the
filtration process. The pleated cartridge filters use
either a specially processed sheet of blown polypropylene
microfibers or microporous membranes and use surface
filtration to act as a very selective filter. Rolled
cartridge filters use media similar to pleated filters in a
semicrossflow configuration, for enhanced filtration in
specialized applications. Cartridge filters are
manufactured in a range of pore sizes and particulate
retention ratings. As a result of retention of particles in
the filters, cartridge filters are typically replaced at
intervals of eight hours to four weeks.
The Company markets ceramic cartridge filters for
microfiltration and particulate filtration. The ceramic
cartridge filters operate similar to the pleated cartridge
filters in that particles are trapped on the surface.
Ceramic cartridge filters are used to sterilize
pharmaceutical solutions and are used in laboratory
applications, where many analytic and diagnostic procedures
require purification or sterilization.
The Company also markets separation elements and
equipment used in coalescing filtration, a process distinct
from crossflow and normal filtration, which separates
different liquids based on their density and adsorption
differences. This process can reduce concentrations of
contaminants of several percent to only a few parts per
million. Applications of coalescing filtration include
removal of contaminants from compressed air and gas lines,
dewatering of solvents and jet fuel, and removal of trace
oil from waste water prior to disposal.
Ion Exchange and Chromatography Equipment: The Company
markets equipment using ion exchange technology. Ion
exchange plastic beads and selected polymer gels are
utilized to preferentially adsorb ionized and charged
material from a fluid stream. After the ion exchange beads
have adsorbed a certain amount of material, they must be
regenerated, typically with acid or caustic, or in the case
of chromatography with a selected fluid to strip off the
adsorbed material. The most used ion exchange process is
for water softening where the ions of calcium and magnesium
are replaced with sodium to reduce soap usage, improve
boiler operation and improve cleaning. The Company is a
leader in the manufacture of the controllers and valves used
to effect ion exchange. Another ion exchange application is
to polish ultrapure water for electronics manufacture and
high pressure boiler feed. Chromatography is primarily used
to purify biotech fluids and food proteins.
Distillation Equipment: The Company markets
distillation and related water purification equipment used
primarily in the laboratory and pharmaceutical industries.
Distillation, which involves the condensation of steam from
boiling water, was one of the first technologies used to
purify water. The Company's distillation product lines
range from laboratory stills to elaborate 5000-gallon-per-
hour multi-stage purifiers.
Ozonation Equipment: The Company markets equipment to
generate ozone from electricity using corona discharge.
Ozone is becoming increasingly important as a bactericide
and water purifier because it kills bacteria, virus and
giardia cysts 10 to 300 times faster than chlorine.
Ozone is also effective in oxidizing trace organic
materials in water which are precursors of the carcinogenic
trihalomethanes. Ozone can also be used to purify solvent-
contaminated groundwater and is often used to de-color water
and waste water.
In 1997, the Company announced a partnership with Fuji
Electric Co., Ltd., Japan and Fuji Electric Corp. of America
(Fuji) to manufacture high concentration ozone generators
using proprietary Fuji technology and components. This
partnership will provide the Company a strong entry into the
municipal water treatment market, as well as pulp and paper
and other large-scale oxidation applications. As part of
the agreement, the Company has the rights to manufacture and
sell such equipment world-wide except for Japan and Korea.
Pumps, Valves and Flow Control Devices: The Company
markets a line of multi-stage centrifugal pumps. These
pumps were developed by the Company to meet the need for
dependable high pressure pumps and are available in 60
standard sizes with flows ranging from 3 gallons per minute
to 500 gallons per minute and pressure capabilities from 25
pounds per square inch (psi) to 500 psi. The pumps are
capable of operating in series to obtain 1000 psi for
seawater desalting and other high pressure applications.
The Company markets two types of chemical-resistant,
air-operated pumps used in both the chemical and electronics
industries. These unique pumps are constructed of Teflon
PTFE or polypropylene materials making them resistant to
acids, caustics, solvents and numerous other aggressive
chemicals.
The Company markets a dry chemical feeder system to
sanitize well water and reduce iron and sulfur odors, and
also markets the pellets used in the feeder.
The Company markets totalizing flow meters and
electronic controllers made of corrosion resistant Noryl
plastic, as well as a line of Teflon PTFE fluid control
products including valves, fittings and flow meters used in
the electronics, pharmaceutical and chemical industries.
The PTFE is molded and machined into unique shapes to
provide extremely chemical resistant high temperature parts.
The Company markets both analog and digital instruments
for chemical water treatment and monitoring.The instruments
are used to measure and control conductivity, pH, ORP,
chlorine, specific ions, trihalomethanes (THM's) and
solvents in water, such as trichloroethyleneThe instruments
are capable of being used in local operating network (LON)
communications and data acquisition.
Machines and Systems: The crossflow and normal
filtration machines manufactured by the Company are
comprised of one or more membrane elements, cartridge
filters, pumps, valves, controls, transformers, heat
exchangers, pipes and a steel frame on which the components
are mounted. The size and number of membrane elements and
filters can vary greatly. Pumps, pipes and frames of
various sizes can be combined and configured to accommodate
the membrane elements or filters required for various fluid
handling or separation tasks.
The systems sold by the Company are comprised of one or
more machines or pieces of equipment designed and
manufactured by the Company as well as ancillary equipment,
such as additional pumps, heat exchangers and holding tanks.
The type, size and number of machines and the ancillary
equipment included in a system will vary with the nature and
size of the fluid separation task.
The following table shows the percentage of net sales
during the past five years attributable to the Company's
fluid processing and handling equipment compared to its
replaceable components:
Year Ended Replaceable
December 31 Equipment(1) Components(2)
1997 46% 54%
1996 49% 51%
1995 48% 52%
1994 51% 49%
1993 49% 51%
(1) Equipment includes: (i) pumps, control valves,
instruments and machines sold separately, (ii) pumps,
controls, instruments, valves, fittings, chemicals, and
other ancillary equipment sold with systems and (iii)
membrane elements, filter elements, ion exchange resin
and filter cartridges sold with machines.
(2) Replaceable components include only those membrane,
coalescer and dielectric elements, cartridges,
membranes, filters and other components sold by the
Company as replacements for its machines, systems and
products, or as replaceable components for products
manufactured by others. They do not include those
components originally sold as parts of new machines or
systems manufactured by the Company. Sales of
components and replacement parts provide the Company
with a relatively stable and continuing source of
revenue.
Sales and Marketing
The Company markets its custom machines and systems
through its direct sales force. The Company's standard
products are marketed to a network of independent
distributors with the help of Company district managers.
These distributors provide world-wide installation service
and stocking of a wide range of the Company's standard
products. Some sales are made directly to certain of the
Company's largest customers and to other manufacturers of
filtration equipment and systems.
The Company's marketing activities include appearances
at trade shows, direct mail campaigns, advertisements in
professional and trade journals and appearances before
professional organizations. The Company participates with
its customers in planning the systems in which its products
are to be used, particularly if new applications are
involved. In some cases, the sale of a system designed for
a particular customer may result from an engineering and
service relationship which has extended over several years.
Research and Development
Research and development activities emphasize product
development and applied research, with the goal of
developing proprietary products. Such expenditures totaled
$10,635,000 in 1997, $10,937,000 in 1996 and $9,399,000 in
1995. The Company anticipates that research and development
expenditures in 1998 will be reduced fromthe 1997 level as a
percent of sales.
Patents and Trademarks
The Company has been granted domestic and certain
foreign trademarks on numerous product names, and on its
logo-types. The Company holds domestic and foreign patents
on certain of its filter media, filters, controlling valves,
machine designs and other products. Although the Company
believes that its patents have value, the Company's business
is not dependent on any patent or group of related patents.
The Company considers its technological position to be
based primarily on its proprietary manufacturing methods,
innovative engineering and marketing expertise.
Employees
As of December 31, 1997, the Company employed 1,433
persons, including 257 holding engineering or technical
degrees.
Competition
The Company experiences competition from a variety of
sources with respect to virtually all of its products,
although the Company knows of no single entity that competes
with it across the full range of its products and systems.
Competition in the markets served by the Company is based on
a number of factors, which may include price, technology,
applications experience, know-how, availability of
financing, reputation, product warranties, reliability,
service and distribution.
With respect to the Company's membrane and related
water treatment equipment business activity, there are a
number of companies, including several sizable chemical
companies, that manufacture membranes, but not equipment.
There are numerous smaller companies, primarily fabricators,
that build water treatment and desalination equipment, but
which generally do not have their own proprietary membrane
technology. A limited number of companies manufacture both
membranes and equipment. In ozone and distillation
equipment, there are both large and small competitors with
no single dominant competitor. In water softener controls
and valves, the Company has three primary and numerous
secondary competitors. Some competitors sell only
controller valves and some sell complete softeners. The
Company has numerous competitors in its conventional water
treatment and filtration products business activities.
With respect to the Company's disposable filter and lab
products, two companies, Pall and Millipore, dominate the
industry with several smaller companies competing in
selected product lines.
With respect to the Company's pump and fluid handling
products, there are numerous competitors of larger size and
with greater resources than the Company. Some competitors
have significantly broader product lines than the Company.
The Company is unable to state with certainty its
relative market position in all aspects of its business.
Many of its competitors have financial and other resources
greater than those of the Company.
Raw Materials
The principal raw materials used by the Company are
various plastic materials including polyvinyl chloride,
polypropylene, Noryl PPO, Nylon cellulose acetate,
polycarbonate, polyester, polysulfone, and PTFE; ceramic and
glass materials, stainless steel, steel, brass, copper,
titanium, silver and various other synthetic materials, all
of which are normally available from sources within the
continental United States. Most raw materials used by the
Company are available from multiple sources of supply. A
limited number of materials are proprietary products of
major chemical companies which, if not available, would have
a material effect on the Company's sales and profits. The
Company believes it could find substitutes for these
materials if they should become unavailable, but has no
assurance that the substitute would perform as well or be
priced as favorably.
To date, the Company has experienced no difficulty in
securing any of its needed raw materials and components.
Customers
No one customer accounted for 10 percent or more of the
Company's consolidated revenue in 1997, 1996 or 1995.
Backlog
The dollar amount of the Company's backlog of orders
considered to be firm at December 31, 1997, was $28.2
million. The comparable backlog at December 31, 1996, was
$27.9 million. The Company expects that nearly all orders
included in the backlog at December 31, 1997, will be filled
during the 1998 fiscal year. The Company does not believe
that its backlog at any time is necessarily indicative of
annual sales. The business of the Company is not subject to
significant seasonal variations.
Governmental Regulation
Certain applications of the Company's reverse osmosis
and ultrafiltration products and distillation equipment are
subject to governmental regulation. Products used for
fractionation of cheese whey for human consumption are
subject to regulation by the United States Department of
Agriculture. Reverse osmosis, ultrafiltration and
distillation systems used in medical applications,
particularly the systems used in artificial kidney dialysis
equipment and pharmaceutical water for injection, are
subject to regulation by the United States Food and Drug
Administration. Ultrafiltration and microfiltration
products used for biological separations are subject to
regulation by the United States Food and Drug
Administration.
To date, compliance with federal, state and local
provisions relating to the protection of the environment has
had no material effect upon the capital expenditures,
earnings or competitive position of the Company.
Foreign Operations
Substantially all of the Company's operations and
assets are located in the United States. The Company has
sales offices and distribution facilities in France,
Thailand, Switzerland, Hong Kong, Japan, Singapore and
China. Limited assembly is conducted in Europe and Asia.
The profitability of domestic and foreign sales is
substantially equal. Sales to Canada are made on the same
trade terms as are available to U.S. customers.
Large export sales are primarily made on the basis of
confirmed irrevocable letters of credit or time drafts to
selected customers in U.S. dollars. Therefore, the Company
believes that problems of currency fluctuation or political
and economic stability do not constitute substantial risks.
See Note 13 of Notes to Consolidated Financial Statements
for a breakdown of the Company's foreign operations and
export sales by geographic area.
ITEM 2. PROPERTIES
The executive offices and principal manufacturing
facilities of the Company are located in Minnetonka,
Minnesota, a suburb of Minneapolis.
A summary of the Company's main operating facilities is
as follows:
Location Status Size Function
Minnetonka, MN Owned 309,600 sq Sales, Manufacturing,
ft Warehouse
Vista, CA Owned 108,000 sq Sales, Manufacturing,
ft Warehouse
Milwaukee, WI Owned 103,700 sq Sales, Manufacturing,
ft Warehouse
Rockford, IL Owned 58,400 sq Sales, Manufacturing,
ft Warehouse
Phoenix, AZ Owned 57,600 sq Sales, Manufacturing,
ft Warehouse
Syracuse, NY Owned 48,500 sq Sales, Manufacturing,
ft Warehouse
Westborough, M Leased 47,500 sq Sales, Manufacturing,
ft Warehouse
Rockland, MA Leased 38,200 sq Sales, Manufacturing,
ft Warehouse
Escondido, CA Leased 30,000 sq Manufacturing
ft
Upland, CA Leased 22,000 sq Sales, Manufacturing,
ft Warehouse
Denver, CO Owned 20,700 sq Sales, Manufacturing,
ft Warehouse
Ft. Lauderdale Leased 20,000 sq Sales, Warehouse
FL ft
Le Mee, France Owned 18,300 sq Sales, Manufacturing,
ft Warehouse
Emmetsburg, IA Leased 8,800 sq Manufacturing,
ft Warehouse
Livermore, CA Leased 6,000 sq Sales, Manufacturing,
ft Warehouse
Bryan, TX Owned 2,500 sq Manufacturing,
ft Warehouse
Total Owned 727,300 sq
ft
Total Leased 172,500 sq
ft
Total Owned
and Leased 899,800 sq
ft
Certain industrial revenue bonds of the Company are
collateralized by real property of the Company.
The current manufacturing facilities are adequate for
intermediate-term operations. In addition, the Company
leases space in Thailand, China, Japan, Hong Kong,
Switzerland and Singapore that is used primarily for sales
activities.
ITEM 3. LEGAL PROCEEDINGS
The Company is currently involved in several lawsuits
incidental to its business. Management does not believe
that any of the lawsuits will have a material adverse effect
on the Company's financial position or results of
operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of the Company's
security holders during the fourth quarter of the fiscal
year that ended December 31, 1997.
Executive Officers of the Registrant
Officer
Name and Age Position with Company Since
D. Dean Spatz (53) Chief Executive Officer 1969
and Chairman of the Board
Ruth Carol Spatz (53) Secretary 1969
Howard W. Dicke (60) Vice President Human 1978
Resources and Corporate
Development, and Treasurer
L. Lee Runzheimer (55) Chief Financial Officer 1988
James J. Carbonari (56) Vice President Sales &
Marketing 1989
Kenneth E. Jondahl (41) Vice President
International 1991
Andrew T. Rensink (41) Vice President Technology 1991
Kenton C. Toomey (50) Vice President Operations 1997
All of the executive officers except Mr. Toomey have
been officers of the Company for more than five years. Mr.
Toomey joined Osmonics in April of 1997 as Vice President
Operations. Prior to that he had been the Vice President of
Operations for DeZurik, a unit of General Signal.
Previously, throughout his 26 years with 3M Company, Mr.
Toomey held numerous director and management positions in
several 3M business units including plant manager of the
Dental Products Division. All executive officers are
elected annually by, and serve at the direction of, the
Board of Directors. D. Dean Spatz and Ruth Carol Spatz are
husband and wife.
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND
RELATED SHAREHOLDER MATTERS
"Common Stock Data," and "Notes to Consolidated
Financial Statements," pages 19-23 of the Annual Report to
Shareholders, are incorporated herein by reference. As of
March 4, 1998 there were 2,499 shareholders of record.
The Company has not paid cash dividends on its common
shares. The Board of Directors currently intends to retain
its earnings for the expansion of the Company's business.
The Company has issued promissory notes which contain a
covenant limiting the payment of dividends to shareholders.
At December 31, 1997, approximately $38,901,000 of retained
earnings was restricted under this covenant.
ITEM 6. SELECTED FINANCIAL DATA
"Selected Financial Data," page 29 of the Annual Report
to Shareholders, is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
"Management's Discussion and Analysis of Financial
Condition and Results of Operations," pages 24 and 25 of the
Annual Report to Shareholders, is incorporated herein by
reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following consolidated financial information of the
Registrant and its subsidiaries, included in the Annual
Report to Shareholders, is incorporated herein by reference:
Page(s)
Consolidated Statements of Income . . . . . 16
Consolidated Balance Sheets . . . . . . . . 17
Consolidated Statements of Cash Flows . . . 18
Consolidated Statements of Changes in
Shareholders' Equity . . . . . . . . . . . 19
Notes to Consolidated Financial Statements . 19-23
Independent Auditors' Report . . . . . . . 24
Quarterly Income Data . . . . . . . . . . . 26
PART III
ITEM 10. DIRECTORS
The information required by this Item is incorporated
herein by reference to the definitive Proxy Statement, to be
filed with the Securities and Exchange Commission within 120 days
after the close of the Company's fiscal year ended December 31,
1997 and forwarded to stockholders prior to the Company's 1998
Annual Meeting of Stockholders (the 1998 Proxy Statement).
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated
herein by reference to the 1998 Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT
The information required by this Item is incorporated
herein by reference to the 1998 Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated
herein by reference to the 1998 Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND
REPORTS ON FORM 8-K
(a) (1) Financial Statement
The consolidated financial statements of the
Registrant and its subsidiaries, included in
the Annual Report to Shareholders, are
incorporated by reference in Item 8, and are
also incorporated herein by reference.
(a) (2) Financial Statement Schedules
Reports of Independent Public Accountants on
Supplemental Schedules to the Consolidated
Financial Statements.
Valuation and qualifying accounts.
Schedules not listed above have been omitted
because they are either not applicable, not
material or the required information has
been given in the financial statements or in
the notes to the financial statements.
(2) Agreement and Plan of Merger among
Desalination Systems, Inc., Osmonics, Inc.
and DSI Acquisition Corp. dated
May 17, 1996. (Incorporated herein by
reference to Exhibit 2 to Registration
Statement on Form S-3, File No. 33-05029.)
(3)A. Certificate of Incorporation of the
Registrant, as amended. (Incorporated
herein by reference to Exhibit 3.1 to
Registration Statement on Form S-2,
File No. 33-336.) Certificate of
Amendment. (Incorporated herein by
reference to Exhibit (3)A on Form 10-K
for fiscal year ended December 31,
1987, File No. 0-8282.)
B. By-Laws of the Registrant.
(Incorporated herein by reference to
Exhibit 3.2 to Registration Statement
on Form S-2, File No. 33-336.)
(4)A. Note Purchase Agreement dated July 12,
1991. (Incorporated herein by
reference to Annual Report on Form 10-
K for fiscal year ended December 31,
1991.)
(10)A.* 1993 Stock Option Plan and related
form of stock option agreement.
(Incorporated herein by reference to
Annex C of the Registrant's Joint
Proxy Statement/Prospectus dated
September 10, 1993.)
B. Stock Option Agreement with Michael L.
Snow, Director. (Incorporated herein
by reference to Annual Report on Form
10-K for fiscal year ended December
31, 1993.)
C.* 1983 Stock Option Plan and related
form of stock option agreement.
(Incorporated herein by reference to
Exhibit 10.2 to Registration Statement
on Form S-2, File No. 33-336.)
D. 1995 Employee Stock Purchase Plan.
(Incorporated herein by reference to
the Registrant's Proxy Statement dated
March 27, 1995.)
E.* 1995 Director Stock Option Plan.
(Incorporated herein by reference to
the Registrant's Proxy Statement dated
March 27, 1995.)
* Denotes Executive Compensation Plan.
(13) 1997 Annual Report to Shareholders.
(Only those portions incorporated
herein by reference shall be deemed
filed with the Commission.)
(21) Subsidiaries of the Registrant.
(23) Consent of Deloitte & Touche LLP.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the
quarter ended December 31, 1997.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of
the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
OSMONICS, INC.
By /s/ D. Dean Spatz
D. Dean Spatz, President
Dated: March 30, 1998
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated:
Signatures Title Date
/s/ L.Lee Runzheimer Chief Financial March 30,
L.Lee Runzheimer Officer 1998
(Principal Finance
and Accounting
Officer)
/s/ Howard W. Dicke Vice President March 30,
Howard W. Dicke Human Resources 1998
and Corporate
Development, and
Treasurer
/s/ Ruth Carol Spatz Director March 30,
Ruth Carol Spatz 1998
/s/ Michael L. Snow Director March 30,
Michael L. Snow 1998
/s/ Ralph E. Crump Director March 30,
Ralph E. Crump 1998
/s/ Verity C. Smith Director March 30,
Verity C. Smith 1998
/s/ Charles W. Palmer Director March 30,
Charles W. Palmer 1998
/s/ William Eykamp Director March 30,
William Eykamp 1998
/s/ D. Dean Spatz President, March 30,
D. Dean Spatz Chairman of the 1998
Board and Director
(Principal
Executive Officer)<PAGE>
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except share data)
Year ended December 31,
1997 1996 1995
Sales $164,905 155,946 $130,783
Cost of sales 99,860 92,523 74,670
Gross profit 65,045 63,423 56,113
Operating expenses:
Selling, general and
administrative 39,603 35,079 31,377
Research, development and
engineering 10,635 10,937 9,399
Special charges 1,448 - -
51,686 46,016 40,776
Income from operations 13,359 17,407 15,337
Other income (expense), net:
Interest income 913 1,023 1,649
Interest expense (2,226) (1,594) (1,565)
Other 344 3,072 1,412
(969) 2,501 1,496
Income from continuing
operations before income 12,390 19,908 16,833
taxes
Income taxes (Note 11) 3,927 6,441 4,954
Income from continuing
operations 8,463 13,467 11,879
Recovery on discontinued
operations
(less income taxes of $617) 1,330 - -
Net income $ 9,793 $13,467 $ 11,879
Earnings per share _ basic
(Note 16)
Income from continuing
operations $0.60 $0.95 $0.84
Net income $0.70 $0.95 $0.84
Earnings per share _
assuming dilution
(Note 16)
Income from continuing
operations $0.59 $0.93 $0.83
Net income $0.68 $0.93 $0.83
OSMONICS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
December 31,
1997 1996
ASSETS
Current assets:
Cash and cash equivalents $4,872 $5,392
Marketable securities (Note 3) 17,004 19,028
Trade accounts receivable, net of
allowance for doubtful 28,969 28,200
accounts of $888 in 1997 and
$907 in 1996
Inventories (Note 4) 35,228 32,322
Deferred tax assets (Note 12) 1,413 1,559
Other current assets 1,639 2,026
Total current assets 89,125 88,527
Property and equipment, at cost:
Land and land improvements 5,535 5,485
Buildings 29,278 27,158
Machinery and equipment 62,555 50,045
Construction in progress 215 3,438
97,583 86,126
Accumulated depreciation (42,550) (34,332)
55,033 51,794
Cash restricted for purchase and
construction of equipment (Note 5) 1,130 1,960
Goodwill, net of accumulated
amortization of $960 in 1997 and 15,257 7,395
$553 in 1996
Long-term investments 1,016 726
Other assets, net of accumulated
amortization of tangible assets of 2,922 1,774
$412 in 1997 and $342 in 1996
Total assets $164,483 152,176
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $9,728 $12,511
Line of credit advances (Note 6) 14,012 2,511
Notes payable and current portion of 2,162 4,982
long-term debt (Note 9)
Accrued compensation and employee 6,125 5,254
benefits
Reserve for discontinued operations - 1,957
(Note 7)
Other accrued liabilities (Note 8) 11,825 7,306
Total current liabilities 43,852 34,521
Long-term debt (Note 9) 13,792 15,900
Deferred income taxes (Note 12) 4,439 3,616
Other liabilities 25 196
Commitments and contingencies (Note 14)
Shareholders' equity (Note 9 and 10):
Common stock, $0.01 par value
Authorized -- 50,000,000 shares
Issued -- 1997: 13,943,544 and 1996:
14,193,239 shares 140 142
Capital in excess of par value 20,261 23,128
Retained earnings 80,128 71,781
Unrealized gain on marketable
securities (Note 3) 2,180 2,864
Cumulative effect of foreign currency
translation adjustments (334) 28
Total shareholders' equity 102,375 97,943
Total liabilities and shareholders'
equity $164,483 $152,176
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year ended December 31,
1997 1996 1995
Cash flows from operations:
Net income $9,793 $13,467 $11,879
Non-cash items included in net
income:
Depreciation and amortization 5,791 4,874 3,795
Deferred income taxes 1,176 1,849 (71)
Gain on sale of land and (573) (3,396) (810)
investments
Special charges 1,448 - -
Recovery on discontinued (1,947) - -
operations
Changes in assets and liabilities
(net of business acquisitions):
Accounts receivable 1,370 (4,648) (4,494)
Inventories 1,806 (3,349) (6,517)
Other current assets 457 155 (727)
Accounts payable and accrued
liabilities (2,553) (3,216) 5,798
Reserve for deferred
compensation - - (432)
Net cash provided (used) by
operations 16,768 5,736 8,421
Cash flows from investing
activities:
Business acquisitions (net of (13,992) - (5,380)
cash acquired)
Purchase of investments (902) (1,418) (6,633)
Maturities and sales of 2,478 9,570 13,228
investments
Purchase of property and (6,609) (15,658) (20,818)
equipment
Sales of property and equipment 456 2,535 -
Pending acquisition costs (1,200) - -
Other (245) (169) (367)
Net cash provided (used) for
investing activities (20,014) (5,140) (19,970)
Cash flows from financing
activities:
Proceeds from notes payable and
current debt 16,967 882 13,928
Reduction of long-term debt (10,394) (2,219) (5,898)
Cash restricted for purchase and
construction of equipment 830 74 (2,034)
Issuance of common stock 934 1,324 761
Purchase of common stock (5,249) - -
Dividends paid by a pooled
company - - (90)
Net cash provided (used) in
financing activities 3,088 61 6,667
Effect of exchange rate changes (362) 6 (94)
on cash
Increase (decrease) in cash and (520) 663 (4,976)
cash equivalents
Cash and cash equivalents - 5,392 4,729 9,705
beginning of year
Cash and cash equivalents - end of $4,872 $5,392 $4,729
year
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(In thousands)
Unreal
ized
Capital Gain Cumul-
in on ative
Common Stock Excess Ret- Market Transl-
of ained able ation
Common Par Earn- Securi Adjust-
Shares Amt. Value ings ties ments
Balance -
January 1, 1995 13,999 $140 $21,045 $46,525 $1,038 $178
Net income - - - 11,879 - -
Translation
adjustment - - - - - 141
Change in
unrealized gain - - - - 2,656 -
on marketable
securities
Dividends of
pooled company - - - (90) - -
Employee stock
purchase 87 1 760 - - -
plans
Balance - 14,086 141 21,805 58,314 3,694 319
December 31,
1995
Net income - - - 13,467 - -
Translation
adjustment - - - - - (291)
Change in
unrealized gain - - - - (830) -
on marketable
securities
Employee stock
purchase 107 1 1,323 - - -
plans
Balance -
December 31, 14,193 142 23,128 71,781 2,864 28
1996
Net income 9,793
Translation
adjustment (362)
Change in
unrealized gain (684)
on marketable
securities
Employee stock
purchase 66 1 933
plans
Purchase of
common stock (316) (3) (3,800) (1,446)
Balance _
December 31, 13,943 $140 $20,261 $80,128 $2,180 $(334)
1997
FIVE-YEAR RESULTS
(In thousands, except per share amounts)
INCOME DATA: (Restated for poolings-of-interests)
Year ended December 31,
1997 1996 1995 1994 1993
Sales $164,905 $155,946 $130,783 $112,908 $108,212
Income from
continuing 8,643 13,467 11,879 10,454 9,294
operations
Net income 9,793 13,467 11,879 10,454 9,294
Earnings per
share _ basic
(Note 16)
Income from
continuing
operations $0.60 $0.95 $0.84 $0.75 $0.67
Net income $0.70 $0.95 $0.84 $0.75 $0.67
Earnings per
share -
assuming
dilution
(Note 16)
Income from
continuing
operations $0.59 $0.93 $0.83 $0.74 $0.66
Net income $0.68 $0.93 $0.83 $0.74 $0.66
Average shares
outstanding
Basic 14,031 14,145 14,058 13,941 13,897
Assuming-
dilution 14,313 14,458 14,365 14,206 14,075
BALANCE SHEET DATA: (Restated for poolings-of-interests)
Total assets $164,483 $152,176 $142,419 $110,715 $96,812
Long-term debt 13,792 15,900 20,919 14,475 14,532
ELEVEN-YEAR RESULTS
(In thousands, except per share amounts)
SUPPLEMENTARY DATA:
These schedules present the prior eleven-year results of the
Company as originally reported, before restatement of prior
period data for those acquisitions accounted for as
poolings-of-interests, to show the effect of the Company's
strategic acquisition activity.
INCOME DATA: (As Originally Reported)
<TABLE>
Year ended December 31,
<C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
Sales $164,905 $155,946 $111,610 $96,180 $89,043 $50,541 $46,738 $43,553 $36,223 $31,058 $20,464
Net
income 9,793 13,467 11,212 9,955 7,895 4,528 3,902 3,714 4,047 2,990 1,151
BALANCE SHEET DATA: (As Originally Reported)
Total
asets $164,483 $152,176 $125,058 $102,035 $88,826 $60,300 $54,931 $54,370 $45,884 $43,430 $37,715
Working
capital 45,273 54,006 54,224 55,995 45,281 29,471 25,955 21,692 21,117 15,707 13,836
Long-
term
debt 13,792 15,900 12,441 14,050 13,913 13,221 13,697 13,761 3,788 3,664 3,753
Share-
holders'
equity 102,375 97,943 78,471 63,751 52,070 33,793 28,891 24,720 33,067 28,909 25,598
(a) 1992 Net income includes an increase in earnings of $420
($0.05 per share) as a result of adopting the Financial
Accounting Standards Board Statement No. 109, "Accounting
for Income Taxes."
</TABLE>
QUARTERLY FINANCIAL DATA
(In thousands, except per share amounts)
Quarterly Financial Data - 1997
Quarter Ended
March 31(b) June 30 Sept. 30 Dec. 31(b)
Sales $42,313 $41,789 $42,420 $38,383
Gross profit 16,349 16,858 16,954 14,884
Net income 2,759 2,593 2,296 2,145
Net income per
share _ $0.19 $0.18 $0.16 $0.15
basic (a)
Net income per
share _ assuming $0.19 $0.18 $0.16 $0.15
dilution(a)
Quarterly Financial Data - 1996
Quarter Ended
March 31 June 30 Sept. 30 Dec. 31
Sales $39,051 $36,727 $39,493 $40,675
Gross profit 16,024 15,225 16,246 15,928
Net income 3,635 3,061 3,314 3,457
Net income per
share _ $0.26 $0.22 $0.23 $0.24
basic(a)
Net income per
share _ assuming $0.25 $0.21 $0.23 $0.24
dilution(a)
(a)Income per share has been restated to reflect the
adoption of the Statements of Financial Accounting
Standards No. 128, "Earnings per Share" (SFAS No. 128).
See Note 16 of the consolidated financial statements.
(b)Special charges of $1,448 ($0.07 per share after taxes)
were recorded during the fourth quarter of 1997.
Recovery from discontinued operations of $325 ($0.02 per
share) and $1,005 ($0.07 per share) were recorded in
first and fourth quarter of 1997, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except share data)
1. Summary of Significant Accounting Policies
The Company is a manufacturer and marketer of high
technology water purification, fluid filtration, fluid
separation, and fluid transfer equipment and
instruments, as well as the replaceable components used
in purification, filtration, and separation equipment.
These products are used by a broad range of industrial,
commercial, consumer and institutional customers.
The consolidated financial statements include the
accounts of Osmonics, Inc. and its wholly and majority
owned subsidiaries (the Company). Significant
intercompany accounts and transactions have been
eliminated.
Sales are recorded when the product is shipped.
The estimated fair value for notes payable and long-term
debt approximates carrying value due to the relatively
short-term nature of the instruments and/or due to the
short-term floating interest rates on the borrowing.
The estimated fair value of notes receivable
approximates the net carrying value, as management
believes the respective interest rates are commensurate
with the credit, interest rate, and repayment risks
involved.
The Company considers highly liquid debt instruments
purchased with a maturity of three months or less to be
cash equivalents.
Inventories are stated at lower of cost (FIFO method) or
market for all operations except for two business units
which have historically valued inventory on the LIFO
method.
Depreciation and amortization of property and equipment
are provided on the straight-line method over estimated
lives of 3 to 40 years.
Deferred income taxes have been provided for income and
expenses which are recognized in different accounting
periods for financial reporting purposes than for income
tax purposes.
The Company accrues for the estimated cost of warranty
and start-up obligations at the time revenue is
recognized.
The Company recorded special charges of $1,448 during
the fourth quarter of 1997. These non-recurring charges
of $0.07 per share after taxes assuming dilution were
for the write-offs of certain impaired assets and
expenses related to recent acquisitions.
The excess of cost over the fair market value of assets
acquired in acquisitions is amortized over not more than
40 years. In accordance with SFAS 121 on impairment of
long-lived assets, the carrying values of these
intangibles are reviewed quarterly for impairment using
discounted cash flows when events or circumstances
warrant such a review. Other intangibles are carried at
cost and amortized using the straight-line method over
their estimated lives of 5 to 20 years.
The preparation of financial statements in conformity
with generally accepted accounting principles requires
management to make estimates that affect the reported
amounts of assets and liabilities, the disclosure of
contingent assets and liabilities, and the reported
amounts of revenues and expenses during the reporting
period. Actual results could differ from those
estimates.
Certain reclassifications have been made to prior year
amounts to conform with current year presentations.
2. Business Acquisitions
On February 25, 1997, the Company acquired all of the
equity interest of AquaMatic, Inc. of Rockford,
Illinois. The purchase price was approximately $15,000
and included $7,600 of goodwill which is being amortized
on the straight-line method over 40 years. AquaMatic
products are being sold through existing Osmonics
distribution channels, offering a more complete line of
specialty valves and controllers for the water treatment
market. Revenues of AquaMatic were less than $15,000 in
1996 and 1995. The acquisition was recorded under the
purchase method of accounting.
The results of operations of AquaMatic are included in
the consolidated statements of income from the date of
acquisition.
On July 24, 1996, Desalination Systems, Inc. (DSI)
merged with the Company through an exchange of 1,312,827
shares of the Company's common stock for the Class A
common stock and Class B common stock of DSI. The
transaction was accounted for as a pooling-of-interests.
DSI's principal business is the manufacture of membranes
used for reverse osmosis, nanofiltration,
ultrafiltration and microfiltration. The historical
financial statements of the Company have been restated
to give effect to the acquisition as though the
companies had operated together from the beginning of
the earliest period presented. Separate results of
operations of the combined entities for the six months
ended June 30, 1996 and the year ended December 31, 1995
were as follows:
Six Months Year ended
ended June 30, December 31,
1996 1995
Sales:
Osmonics $ 64,405 $111,610
DSI 11,642 20,348
Eliminations (269) (1,175)
Combined $ 75,778 $130,783
Net income:
Osmonics $ 5,975 $11,212
DSI 721 667
Combined $ 6,696 $11,879
The eliminations represent sales between the combined
entities prior to the combination. The sales
elimination had no significant effect on net income in
the years presented.
On October 4, 1995, the Company acquired the assets and
operations of Western Filter Co., Denver, Colorado. The
purchase price was approximately $7,000 and included
$5,780 of goodwill which is being amortized on the
straight line method over 30 years. Western Filter
products are being sold through the existing Osmonics
distribution channels, offering a more complete line of
water and waste water treatment options. Sales of
Western Filter were less than $10,000 in 1995. The
purchase method of accounting was used. The Company may
be required to make additional payments of up to $2,000
over the period ending December 1998, contingent upon
the sales and gross margins of Western Filter Co. Such
additional payments would increase recorded goodwill.
The results of operations of Western Filter are included
in the consolidated statements of income from the date
of acquisition.
3. Marketable Securities
The Company considers all of its marketable securities
available-for-sale. Marketable securities at December
31, 1997 consisted of the following:
Amorti Unreal Unreal
-ized -ized -ized Fair
Cost Gains (Losses) Value
U.S. government
securities
0-5 year
maturity $3,835 $28 $ (15) $3,848
6 year or
greater maturity 400 - (1) 399
Municipal bonds
0-5 year
maturity 3,517 175 - 3,692
6 year or
greater maturity 998 91 - 1,089
Corporate debt
securities and
other
0-5 year
maturity 707 2 (7) 702
6 year or
greater maturity 100 4 - 104
Equity securities 3,887 3,432 (149) 7,170
Total before tax
effect $13,444 3,732 (172) $17,004
Deferred tax
effect of
unrealized
(gains) losses (1,447) 67
Net unrealized
gains (losses)
on marketable
securities $2,285 $(105)
Marketable securities at December 31, 1996 consisted of the
following:
Amorti Unreal Unreal
-zed -ized -ized Fair
Cost Gains Losses Value
U.S. government
securities
0-5 year
maturity $3,781 $ 29 $(49) $3,761
6 year or
greater maturity 447 0 (10) 437
Municipal bonds
0-5 year
maturity 2,836 118 - 2,954
6 year or
greater maturity 2,281 134 - 2,415
Corporate debt
securities and
other
0-5 year
maturity 866 - (67) 799
6 year or
greater maturity 299 - (3) 296
Equity securities 3,897 4,612 (143) 8,366
Total before tax $14,407 4,893 (272) $19,028
effect
Deferred tax
effect of
unrealized
(gains) losses (1,860) 103
Net unrealized
gains (losses)
on
marketable
securities $3,033 $(169)
Market values are based on quoted market prices.
In 1997, proceeds from sales of available-for-sale
securities were $1,678. The gains and losses on these
sales were $614 and $41, respectively, determined on the
specific identification method.
In 1996, proceeds from sales of available-for-sale
securities were $8,068. The gains and losses on these
sales were $2,832 and $44, respectively, determined on
the specific identification method.
4. Inventories
Inventories consist of the following:
December 31,
1997 1996
Finished goods $ 9,757 $ 5,276
Work in process 7,544 9,319
Raw materials 19,832 18,416
37,133 33,011
Adjustment to reduce
inventories of $12,446 and
$6,016 to the last-in, (1,905) (689)
first-out method (See Note
1)
------- -------
$35,228 $32,322
5. Restricted Cash
Cash restricted for purchase and construction of
equipment at December 31, 1997 and 1996 represents
proceeds received from the issuer of Industrial
Development Revenue Bonds (see Note 9) restricted to the
purchase and construction of property and equipment used
in the Company's operations.
6. Line of Credit
The Company, at December 31, 1997, had an unsecured
revolving line of credit of $22,000 for working capital
needs. The revolving line of credit matures on October
8, 1998 and borrowings bear a variable interest rate
related to LIBOR. The terms of the credit agreement
contain certain restrictions related to financial
ratios, indebtedness, tangible net worth and capital
expenditures. As of December 31, 1997 and 1996, the
Company was in compliance with all debt covenants. At
December 31, 1997, the Company had borrowings
outstanding under the line of $14,000, and the interest
rate was 6.27%. At December 31, 1996, the Company had
borrowings outstanding under the line of $2,511, and the
interest rate was 6.19%.
7. Discontinued Operations
In September 1982, Autotrol Corporation (Autotrol),
which has since been merged with the Company,
discontinued its wastewater business. In subsequent
years Autotrol incurred certain expenses related to the
wastewater products and accrued for contingent
liabilities. The Company determined in 1997 that the
reserve was no longer required and recognized $1,330
($0.09 per share.assuming dilution) of after-tax income
as a recovery on discontinued operations.
8. Other Accrued Liabilities
Other accrued liabilities consist of the following:
December 31,
1997 1996
Warranty and start-up $1,900 $1,802
Professional fees and other 2,123 2,480
accruals
Deferred acquisition 3,000 -
payments
Customer deposits 4,802 3,024
------- ------
$11,825 $7,306
9. Debt
Long-term debt is as follows:
December 31,
1997 1996
Promissory notes; interest
payable quarterly at the
three month LIBOR rate plus
80 b.p.; due through 2001. $7,150 $ 8,575
The interest rate on
December 31, 1997 was 6.52%.
Industrial development revenue
bonds (IDRB's), principal
due in varying annual
payments over 30 years;
interest payable monthly at
a variable rate determined 7,950 8,270
periodically by the bond
remarketing agent (6.61% at
December 31, 1997).
Industrial revenue bonds
(IRB's); paid in 1997. - 2,800
Mortgage notes payable to two
French banks; interest
payable monthly at PIBOR
plus 40 b.p. The interest 502 727
rate on December 31, 1997
was 3.57%.
Other notes 352 510
------ ------
15,954 20,882
Current portion (2,162) (4,982)
------- -------
$13,792 $15,900
The IDRB debt and mortgage notes payable to French banks
are collateralized by real and personal property of the
Company.
Aggregate maturities of long-term debt outstanding at
December 31, 1997 are:
1998 - $2,162; 1999 - $2,159; 2000 - $2,250; 2001 -
$3,700; 2002 - $834; beyond 2002 - $4,849.
The interest rate on the IRB's was determined in part by
the amount of collateral held by the lender. At
December 31, 1996, $2,000 of collateral was held by the
lender, resulting in an interest rate of LIBOR plus 45
b.p. The $2,000 of collateral is included in marketable
securities.
The promissory notes contain a covenant which limits the
payment of dividends to shareholders. At December 31,
1997, approximately $38,901 of retained earnings were
restricted under this covenant. In addition, the
Company's various debt agreements contain certain
restrictions related to financial ratios, indebtedness,
tangible net worth and capital expenditures. As of
December 31, 1997 and 1996, the Company was in
compliance with all debt covenants.
Cash payments for interest related to all debts of the
Company were $2,033, $1,551, and $1,409, for the years
ended December 31, 1997, 1996, and 1995, respectively.
10.Stock Options
At December 31, 1997, the Company had reserved no common
shares for issuance to key employees under a 1983 stock
option plan. Options were issued at a price not less
than market value on the date of grant and became
exercisable over a five-year period, after which they
expired. The following is a summary of activity under
the 1983 stock option plan. No additional options can
be granted under the 1983 plan.
1997 1996 1995
Options held by
employees
at December 31 - 7,500 86,206
Exercise price range on - $10.50 $ 6.45
to to
options held at - $10.50 $13.50
December 31
Number of options
exercised
during the year 7,500 65,805 34,920
Price range of options $10.50 $ 6.45 $ 3.63
Exercised during the to to to
year $10.50 $13.50 $10.16
Exercisable options held
at December 31 - 7,500 84,330
Exercise price range of - $10.50 $ 6.45
Exercisable options to to
- $10.50 $13.50
The Company also has reserved 298,863 common shares at
December 31, 1997 for issuance to key employees under a
1993 Stock Option Plan. Options are granted at a price
not less than market value on the date of the grant and
become exercisable over a period of up to ten years,
after which they expire. The following is a summary of
activity under the 1993 Stock Option Plan.
1997 1996 1995
Options held by employees
at December 31 177,588 50,200 34,163
Exercise price range on $13.67 $13.67 $13.67
Options held at to to to
December 31 $22.38 $22.38 $18.25
Number of options
exercised
during the year 187 263 500
Price range of options $13.67 $13.67 $14.38
Exercised during the to to to
year $17.50 $14.38 $14.38
Exercisable options held
at December 31 20,513 10,687 2,463
Exercise price range of $13.67 $13.67 $13.67
Exercisable options to to to
$22.38 $18.25 $14.50
Desalination Systems, Inc. (DSI), a pooled company (Note
2), has a stock option plan for which 371,841 shares of
the Company's common stock are reserved. Options issued
under the plan vest in varying periods of up to 5 years
and expire on various dates through March 2003. The
following is a summary of activity under the plan. No
additional options can be granted under the DSI plan.
1997 1996 1995
Options held by
employees
at December 31 371,841 371,841 371,841
Exercise price range on $3.18 $3.18 $3.18
Options held at to to to
December 31 $6.94 $6.94 $6.94
Number of options
exercised
during the year - - 14,407
Price range of options
exercised during the - - $3.47
year
Exercisable options held
at December 31 368,958 360,315 351,672
Exercise price range of $3.18 $3.18 $3.18
exercisable options to to to
$6.94 $6.94 $6.94
The Company also had a 1985 Employee Stock Purchase
Plan. In 1995, 14,548 shares were issued under the 1985
Plan at an average price of $13.58. No additional
shares may be issued under the 1985 Plan.
The 1985 Plan was superseded by the 1995 Employee Stock
Purchase Plan, approved by the shareholders at the 1995
Annual Meeting and effective June 1, 1995. Employees
may purchase common shares of the Company at 85% of
market price. In 1997 and 1996, 58,720 and 41,154
shares were issued, respectively, under the 1995 Plan at
an average price per share of $14.48 and $17.41,
respectively. At December 31, 1997, 277,946 shares
remain unissued in the 1995 Plan.
In 1993, the Company granted a director an option to
purchase 45,000 shares of common stock at an exercise
price of $12.33 per share. This option vests over a
five-year period.
In 1995, the Board of Directors adopted a 1995 Director
Stock Option Plan. The plan provides that each director
of the Company shall automatically receive, as of the
date of each Annual Meeting of Shareholders, a non-
qualified option to purchase 3,000 shares of the
Company's common stock. The options have a ten-year
term and are exercisable one year after the grant date
at an exercise price equal to the fair market value of
the shares on the grant date. In 1997, options to
purchase 21,000 shares at a price ranging from $15.38 to
$16.81 were issued under this plan. In 1996, options to
purchase 18,000 shares at a price of $19.88 were issued
under this plan. In 1995, options to purchase 18,000
shares at a price of $17.13 were issued under this plan.
At December 31, 1997, 18,000 options were exercisable
under this plan at a price of $19.88 and 18,000 options
were exercisable at a price of $17.13.
The Company applies APB Opinion No. 25 "Accounting for
Stock Issued to Employees" and related interpretations
in accounting for its plans. No compensation cost has
been recognized for its stock-based compensation plans
as the exercise price of the stock option grants was
equal to the fair market value of the shares on the
grant date. Had compensation costs been determined
based on the fair value of the 1997, 1996 and 1995 stock
option grants consistent with the requirements of SFAS
No. 123 "Accounting for Stock-Based Compensation" (FAS
123), there would have been less than a $0.01 per share
effect on the Company's pro forma net income per share
for 1997, 1996 or 1995. The fair value of options
granted under the Company's stock option plans during
1997, 1996 and 1995 was estimated using the Black-
Scholes option-pricing model with the following
weighted-average assumptions used: no dividend yield,
expected volatility between 22.6% and 25.0%, risk-free
interest rates between 6.0% and 6.1% and expected lives
of 5 years.
The Company had 500,000 authorized and unissued shares
of preferred stock at December 31, 1997 and 1996.
11.Income Taxes
Income tax expense consists of:
Year ended December 31,
1997 1996 1995
Current:
Federal $2,741 $3,556 $3,975
State (39) 395 423
Foreign 666 640 372
Deferred:
Depreciation 351 370 130
Valuation allowance
adjustment - - (197)
Allowance for doubtful
accounts, start-up,
warranty, inventory and
other accruals 100 462 310
Other 108 1,018 (462)
------ ------ ------
Total continuing
operations $3,927 $6,441 $4,954
Discontinued operations,
deferred 617 - (228)
------ ------ ------
Total provision $4,544 $6,441 $4,679
Cash payments for income taxes were $3,728, $5,204, and
$5,079, for the years ended December 31, 1997, 1996, and
1995, respectively.
A reconciliation of the income taxes computed at the
Federal statutory rate to the Company's income tax
expense is as follows:
Year ended December 31,
1997 1996 1995
Taxes at Federal rate (35%) $4,337 $6,950 $5,563
Increase (decrease)
resulting from:
Valuation allowance
adjustment - - (197)
State taxes, net of Federal
tax benefit 132 397 203
Foreign Sales Corp. benefit (546) (361) (190)
Tax credits (249) (197) (271)
Tax exempt
interest/dividend
deduction (123) (128) (200)
Effect of foreign
affiliates with different
tax rates or net losses 167 30 245
NOL and credit
carryforwards used - - (274)
Uncollectible account
write-off - (442) -
Other 209 192 (200)
------ ------ ------
Total continuing operations $3,927 $6,441 $4,679
Discontinued operations 617 - -
------ ------ ------
Total provision $4,544 $6,441 $4,679
12.Deferred Tax Assets and Liabilities
Temporary differences which give rise to deferred tax
assets and liabilities are as follows as of December 31:
1997 1996
Current assets:
Allowance for doubtful
accounts, start-up,
warranty, inventory and $2,955 $3,627
other accruals
Unrealized gain on
marketable securities (1,380) (1,757)
Inventory costs 81 115
capitalized for tax
Other (243) (426)
------ ------
Total current deferred $1,413 $1,559
assets
Noncurrent liabilities:
Depreciation $3,718 $3,130
Other 721 486
------ ------
Total non-current deferred
tax liabilities $4,439 $3,616
13. Sales and Segment Information
All continuing operations for which geographic data is
presented below are in one principal industry (design,
manufacture and marketing of machines, systems,
instruments and components used in the processing of
fluids).
1997 1996 1995
Sales to unaffiliated
customers from:
United States $150,753 $141,124 $116,964
Foreign operations 14,152 14,822 13,819
Transfers from (to)
geographic areas:
United States 7,818 7,890 7,936
Foreign operations (7,818) (7,890) (7,936)
$164,905 $155,946 $130,783
Income from continuing
operations before income
taxes:
United States $10,847 $18,225 $16,190
Foreign operations 1,543 1,683 643
$12,390 $19,908 $16,833
Identifiable assets:
United States $155,592 $144,609 $134,408
Foreign operations 8,891 7,567 8,011
$164,483 $152,176 $142,419
NOTE: Transfers are made at market value.
Sales by United States operations to unaffiliated
customers in foreign geographic areas are as follows:
Year ended December 31,
1997 1996 1995
Asia/Pacific $18,643 $14,661 $10,915
Europe 13,752 9,181 7,798
Rest of the World 13,849 9,222 9,641
------- ------- -------
$46,244 $33,064 $28,354
Total international sales for the Company were as
follows:
1997 - $60,396; 1996 - $47,886; and 1995 - $42,173.
14.Commitments and Contingencies
The Company leases facilities for sales, service or
manufacturing purposes in Wisconsin, Massachusetts,
California, Florida, Iowa, Switzerland, Hong Kong,
Japan, Singapore, and Thailand.
Future minimum lease payments on all operating leases of
$5,291 are payable as follows: 1998 - $1,512; 1999 -
$1,108; 2000 - $964; 2001 - $743; 2002 - $604; and
beyond 2002 - $360. Rent expense for the three years
ended December 31 was: 1997 - $1,633; 1996 - $1,100;
and 1995 - $1,718.
The Company is involved in certain legal actions arising
in the ordinary course of business. In the opinion of
management, based on the advice of legal counsel, such
litigation and claims will be resolved without a
material effect on the Company's financial position or
results of operations.
15.Employee Benefit Plans
The Company has a noncontributory discretionary profit
sharing plan covering certain employees meeting age and
length of service requirements. The Company contributes
annually to the plan an amount established at the
discretion of the Board of Directors.
Total expense recognized by the Company under these
plans amounted to $1,300, $1,435, and $996 in 1997,
1996, and 1995, respectively.
16.Earnings Per Share
Effective December 31, 1997, the Company adopted
Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (SFAS No. 128). Earnings per share
amounts presented for 1996 and 1995 have been restated
for the adoption of SFAS No. 128. The following table
reflects the calculation of basic and diluted earnings
per share from continuing operations.
1997 1996 1995
Earnings per share - basic
Income from continuing
operations available
to common stockholders $8,463 $13,467 $11,879
Weighted average shares
outstanding 14,031 14,145 14,058
Income from continuing
operations per share
- basic $0.60 $0.95 $0.84
Earnings per share _ assuming
dilution
Income from continuing
operations available
to common stockholders $8,463 $13,467 $11,879
Weighted average shares
outstanding 14,031 14,145 14,058
Dilutive impact of stock
options outstanding 282 313 307
Weighted average shares and
potential dilutive shares
outstanding 14,313 14,458 14,365
Income from continuing
operations per share
- assuming dilution $0.59 $0.93 $0.83
Options to purchase 128,800 shares of common stock at a
range of $17.50 to $22.38 were outstanding during 1997
but were not included in the computation of diluted
earnings per share because the options' exercise price
was greater than the average market price of the common
share.
17.Subsequent Events
On February 17, 1998, the Company completed the purchase
of all of the equity interest in Micron Separations,
Inc. (MSI) of Westborough, Massachusetts, for a total
consideration of approximately $25,000. MSI's product
will be sold through existing Osmonics distribution
channels, offering a more complete line of microfilter
membrane products for diagnostic, laboratory and
industrial use. The revenues of MSI were less than
$15,000 in each of the last three years. The
acquisition will be recorded under the purchase method
of accounting.
On March 20, 1998, the Company signed a definitive
agreement to purchase all of the equity interest in
Membrex Corp. of Fairfield, New Jersey, subject to
Membrex shareholder approval. The acquired products
give the Company the most hydrophilic UF membrane in the
market, which is used to separate oil from water in a
variety of applications, including biotechnology,
laboratory and chemical processes.
Effective March 18, 1998, the Company expanded its
financing arrangements in the form of a $30,000
revolving line of credit from a commercial bank, and
$20,000 of long-term loans from an insurance company.
The long-term loans include $5,000 at a fixed rate of
6.72%. The balance of the financing is at floating
rates that could vary from 30 to 150 basis points over
the 90-day LIBOR.
EXHIBIT (21)
SUBSIDIARIES OF OSMONICS, INC.
Percentage
Ownership
100% VAPONICS, INC. A Massachusetts Corp.
100% AQUA MEDIA INTERNATIONAL A Delaware Corporation
100% PORETICS CORPORATION A Delaware Corporation
100% OSMONICS ASIA/PACIFIC LTD. A Hong Kong Corporation
100% OSMONICS EUROPA, S.A. A Switzerland Corp.
100% OSMONICS INTERNATIONAL LTD. A Jamaica Corporation
100% OSMONICS INTERNATIONAL, INC. A Minnesota Corporation
100% OZONE RESEARCH &
EQUIPMENT CORP. An Arizona Corporation
100% GHIA, INC. A Nevada Corporation
100% AUTOTROL CORPORATION A Wisconsin Corporation
100% NIPPON OSMONICS LTD. A Japan Corporation
100% AUTOTROL S.A. A France Corporation
100% OSMONICS INT'L SALES CORP. A Virgin Is. Corp.
100% MICROL SYSTEMS, LTD. An England Corporation
100% PETECO CORPORATION A Minnesota Corporation
100% DESALINATION SYSTEMS, INC. A California Corp.
100% DESALINATION SYSTEMS
INTERNATIONAL INC. A Virgin Islands Corp.
50% NIPPON AUTOTROL K.K. A Japan Corporation
100% AQUAMATIC, INC. A Delaware Corporation<PAGE>
INDEPENDENT AUDITORS CONSENT
Osmonics, Inc.
We consent to the incorporation by reference in Registration
Statements No. 33-25228 and No. 33-537 of Osmonics, Inc. on
Form S-8 and Registration Statement No. 33-05029 filed on
Form S-3 of our reports dated February 19, 1998 (March 20, 1998
as to Note 17) appearing and incorporated by reference in this
Annual Report on Form 10-K of Osmonics, Inc. for the year
ended December 31, 1997.
DELOITTE AND TOUCHE
Minneapolis, Minnesota
MARCH 26, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10-K
for the year ended December 31, 1997, and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
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<INCOME-PRETAX> 12390
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<EPS-PRIMARY> .70
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</TABLE>
OSMONICS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(In thousands)
Years Ended December 31, 1997, 1996 and 1995
Column A Column B Column C Column D Column E
Additions
Balance Charged Charged Balance
At Beg. to Cost to at
of and Other Deduct- End of
Period xpensed Accts ions Period
Description
Year Ended Dec. 31, 1997:
Current Operations:
Allowance for Doubtful
Accounts $ 907 $ 139 $ 158 $ 888
Warranty and Start-up
Reserve $1,802 $2,343 $2,245 $1,900
Discont. Operations:
Warranty Reserve $1,957 $1,957(D) $0
Year Ended December 31,
1996:
Current Operations:
Allowance for Doubtful
Accounts $1,177 $ 59 $ 329(A) $ 907
Warranty and Start-up
Reserve $1,868 $2,414 $2,480(B) $1,802
Discont. Operations:
Warranty Reserve $1,957 $1,957
Year Ended December 31,
1995:
Current Operations:
Allowance for Doubtful
Accounts $1,329 $ 80 $109(C) $ 341(A) $1,177
Warranty and Start-up
Reserve $1,981 $1,406 $1,519 $1,868
Discont. Operations:
Allowance for Doubtful
Accounts $ 46 $ 46(A) $ 0
Warranty Reserve $1,961 $ 4(B) $1,957
Reserve for Discont.
Operations $ 127 $ 127 $ 0
(A) Uncollectible accounts charged against allowance.
(B) Actual warranty claims and start-up costs charged against
reserve.
(C) Addition due to acquisition.
(D) Company determined that the reserve was no longer required.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Form 10-K
for the year ended December 31, 1997 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
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<MULTIPLIER> 1,000
<S> <C> <C> <C> <C>
<PERIOD-TYPE> YEAR YEAR 3-MOS 3-MOS
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<PERIOD-START> JAN-01-1996 JAN-01-1995 JAN-01-1996 APR-01-1996
<PERIOD-END> DEC-31-1996 DEC-31-1995 MAR-31-1996 JUN-30-1996
<CASH> 5392 4729 2346 2160
<SECURITIES> 19028 26307 23119 20907
<RECEIVABLES> 29107 24729 20794 20752
<ALLOWANCES> 907 1177 878 884
<INVENTORY> 32322 28973 26226 28059
<CURRENT-ASSETS> 88527 87749 77490 76965
<PP&E> 86126 73087 66138 68369
<DEPRECIATION> 34332 30598 28596 29445
<TOTAL-ASSETS> 152176 142419 125027 125732
<CURRENT-LIABILITIES> 34521 34055 25961 24749
<BONDS> 15900 20919 12473 12441
0 0 0 0
0 0 0 0
<COMMON> 142 141 129 129
<OTHER-SE> 97801 84132 81411 83699
<TOTAL-LIABILITY-AND-EQUITY> 152176 142419 125027 125732
<SALES> 155946 130783 33229 31176
<TOTAL-REVENUES> 155946 130783 33229 31176
<CGS> 92523 74670 19667 18228
<TOTAL-COSTS> 92523 74670 19667 18228
<OTHER-EXPENSES> 46016 40776 9206 9695
<LOSS-PROVISION> 0 0 0 0
<INTEREST-EXPENSE> 1594 1565 236 234
<INCOME-PRETAX> 19908 16833 4582 4078
<INCOME-TAX> 6441 4954 1420 1265
<INCOME-CONTINUING> 13467 11879 3162 2813
<DISCONTINUED> 0 0 0 0
<EXTRAORDINARY> 0 0 0 0
<CHANGES> 0 0 0 0
<NET-INCOME> 13467 11879 3162 2813
<EPS-PRIMARY> .95 .84 .26 .22
<EPS-DILUTED> .93 .83 .25 .21
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