UNITED STATES
SECURITIES 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
For Quarter Ended March 31, 1999
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 41-0955759
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
5951 CLEARWATER DRIVE
MINNETONKA, MN 55343 612-933-2277
(Address of principal executive offices) (Registrant's telephone number)
NOT APPLICABLE
(Former name, former address and former
fiscal year, if changed since last report)
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 at least the past 90 days.
YES [X] NO [ ]
Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date. At April 30,
1999, 14,179,621 shares of the issuer's Common Stock, $0.01 par value,
were outstanding.
OSMONICS, INC.
INDEX
PART I. FINANCIAL INFORMATION PAGE
ITEM I. FINANCIAL STATEMENTS
Consolidated Statements of Income - 2
For the Three Months Ended
March 31, 1999 and 1998
Consolidated Balance Sheets - 3
March 31, 1999 and December 31, 1998
Consolidated Statements of Cash Flows 4
For the Three Months Ended
March 31, 1999 and 1998
Notes to Consolidated Financial Statements 5
ITEM II. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 6-11
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 11
SIGNATURES 12
PART I - FINANCIAL INFORMATION
ITEM I - FINANCIAL STATEMENTS
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
(UNAUDITED)
Three Months Ended
March 31,
1999 1998
--------------------
Sales $44,521 $42,150
Cost of sales 29,152 26,043
------- -------
Gross profit 15,369 16,107
Less:
Selling, general and administrative 10,332 9,874
Research, development and engineering 1,735 2,328
------- -------
Income from operations 3,302 3,905
Other income (expense) (905) (576)
------- -------
Income before income taxes 2,397 3,329
Income taxes 815 1,165
------- -------
Net income $ 1,582 $ 2,164
======= =======
Earnings per share
Net Income - basic $0.11 $0.16
Net Income - assuming dilution $0.11 $0.15
Average shares outstanding
Basic 14,002 13,949
Assuming dilution 14,140 14,210
OSMONICS, INC.
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share Data)
(UNAUDITED)
March 31, December 31,
1999 1998
------------------------
ASSETS
Current assets
Cash and cash equivalents $ 2,865 $ 576
Marketable securities 12,989 14,271
Trade accounts receivable, net of
allowance for doubtful accounts of
$1,021 in 1999, and $1,057 in 1998 37,759 34,767
Inventories 27,577 28,123
Deferred tax assets 6,974 6,610
Other current assets 2,066 5,034
-------- --------
Total current assets 90,230 89,381
Property and equipment, at cost
Land and land improvements 5,677 5,606
Building 30,630 30,568
Machinery and equipment 69,627 69,510
-------- --------
105,934 105,684
Less accumulated depreciation (49,468) (48,871)
-------- --------
56,466 56,813
Other assets 47,836 47,855
-------- --------
Total assets $194,532 $194,049
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Accounts payable $ 10,782 $ 9,156
Notes payable and current portion
of long-term debt 27,104 28,177
Other accrued liabilities 17,357 18,072
-------- --------
Total current liabilities 55,243 55,405
Long-term debt 31,763 31,665
Other liabilities 16 18
Deferred income taxes 4,798 4,806
Shareholders' equity
Common stock, $0.01 par value
Authorized -- 50,000,000 shares
Issued -- 1999: 14,024,929 and
1998: 13,991,291 shares 140 140
Capital in excess of par value 20,992 20,733
Retained earnings 80,657 79,075
Other comprehensive income 923 2,207
-------- --------
Total liabilities and shareholders' equity $194,532 $194,049
======== ========
OSMONICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(UNAUDITED)
Three Months Ended
March 31,
1999 1998
--------------------
Cash flows from operations:
Net income $ 1,582 $ 2,164
Non-cash items included in net income:
Depreciation and amortization 2,068 1,794
Deferred income taxes 142 333
Gain on sale of investments (43) (105)
Changes in assets and liabilities:
(net of business acquisitions)
Accounts receivable (2,992) (353)
Inventories 546 (1,258)
Other current assets 2,968 (807)
Accounts payable and other liabilities 909 2,416
------- -------
Net cash provided by operations 5,180 4,184
Cash flows from investing activities:
Business acquisitions (net of cash acquired) - (23,452)
Purchase of investments (1,675) (268)
Sale of investments 1,535 1,074
Purchase of property and equipment (1,241) (1,932)
Sales of property and equipment - 73
Other (461) (146)
------- -------
Cash provided by (used in) investing activities (1,842) (24,651)
Cash flows from financing activities:
Proceeds from notes payable and debt 98 20,076
Reduction of debt (1,073) (96)
Issuance of common stock 259 184
------- -------
Net cash provided by (used in) financing
activities (716) 20,164
Effect of exchange rate changes on cash (333) (111)
Increase (decrease) in cash and cash equivalents 2,289 (414)
Cash and cash equivalents - beginning of year 576 4,872
------- -------
Cash and cash equivalents - end of quarter $ 2,865 $ 4,458
======= =======
OSMONICS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Thousands)
(UNAUDITED)
The accompanying unaudited condensed financial statements have been
prepared in accordance with the instructions to Form 10-Q and do not
include all the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included.
Effective January 1, 1999, the Company adopted Statement of Position (SOP)
98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" which did not have a material impact on
operating results or financial position.
Statement of Financial Accounting Standards ("SFAS"), No. 133
"Accounting for Derivative Instruments and Hedging Activities" was
issued recently. The Company anticipates no material impact on operating
results or financial position.
The Company has the following components of comprehensive income:
1st Qtr. 1st Qtr.
1999 1998
-------------------
Net income $1,582 $2,164
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustments (333) 69
Unrealized gains / (losses) on securities (951) (111)
------ ------
Other comprehensive income (loss), net of tax (1,284) (42)
------ ------
Comprehensive income $ 298 $2,122
====== ======
In 1998, the Company recorded special charges of $875 for corporate
restructuring and consolidation of operations. For the three months ended
March 31, 1999, the Company expended $150 for workforce reductions and $50
for facility closing/consolidation costs.
Operating results for the three months ended March 31, 1999, are not
necessarily indicative of the results that may be expected for the full
year 1999.
These statements should be read in conjunction with the financial
statements and related notes included in the Company's Annual Report to
shareholders and Form 10-K for the year ended December 31, 1998.
ITEM II. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
(Dollars in thousands, except share data)
As an aid to understanding the Company's operating results, the following
table shows the percentage of sales that each income statement item
represents for the three months ended March 31, 1999 and 1998, respectively.
Percent of Sales
Three Months Ended
March 31,
1999 1998
------------------
Sales 100.0% 100.0%
Cost of sales 65.5 61.8
----- -----
Gross profit 34.5 38.2
Selling, general and administrative 23.2 23.4
Research, development and engineering 3.9 5.5
----- -----
Operating expenses 27.1 28.9
Income from operations 7.4 9.3
Other income (expense) (2.0) (1.4)
Income from continuing operations ----- -----
before income taxes 5.4 7.9
Income taxes 1.8 2.8
----- -----
Net income 3.6% 5.1%
===== =====
SALES
Sales for the first quarter ended March 31, 1999 of $44,521 increased 5.6%
from sales for the first quarter of 1998. Equipment and Consumables
segment sales were 55.7% and 44.3% of total sales, respectively. The 1999
sales increase is attributed to the acquisition of Micron Separations Inc.
(MSI) during the first quarter of 1998 and Membrex Corp. during the second
quarter of 1998. Existing business sales were down slightly during the
first quarter of 1999 due to continued slower equipment sales, both in the
United States as well as Asia/Pacific.
GROSS MARGIN
Gross margin for the first quarter of 1999 was 34.5% versus 38.2% for the
corresponding period in 1998. Gross margins have been affected by a lower
level of plant utilization at several locations, product mix, and market
price pressures in equipment and membrane elements. The Company took
action in the third quarter of 1998 to reduce its manufacturing capacity
and staffing levels. Employment on June 30, 1998 of 1,559 was reduced to
1,350 at March 31, 1999. Three manufacturing facilities were closed by
December 31, 1998 and the Company is currently analyzing the possibility
of additional facility consolidations.
OPERATING EXPENSES
Operating expenses decreased to 27.1% in the first quarter of 1999 from
28.9% in the first quarter of 1998. The first quarter of 1999 result is
also an improvement from the 30.0% operating expense (excluding special
charges) experienced in calendar year 1998. This improvement is a result
of expense control efforts in response to continued weak top-line sales
growth. The first quarter 1999 Research & Development expense decrease of
$593 compared to first quarter 1998 is related to the elimination of
duplicate research efforts, development project rationalization, and an
increased direction of engineering activity towards sustaining engineering
and production activity.
OTHER EXPENSE
Other expense increased by $329 in the first three months of 1999 versus
the same period for 1998. The increase is primarily the result of an
increase in interest expense of $335 related to the additional borrowing
of $18,000 for the acquisition of Membrex Corp. in the second quarter of
1998.
INCOME TAXES
The effective tax rate for the three months ended March 31, 1999 was 34.0%
based on the forecast for the full year. This rate is comparable to 35.0%
in the same period of 1998. However, this represents a significant change
from the tax benefit percentage recognized in calendar year 1998, due
primarily to the non-deductibility of the Micron Separations, Inc. in-
process R&D that was written off in the second quarter of 1998.
NET INCOME
Net income for the quarter ended March 31, 1999 was $1,582 versus $2,164
for the quarter ended March 31, 1998. Net income per common share
assuming dilution for the quarter was $0.11 versus $0.15 for the same
period last year.
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 1999, the Company had cash, cash equivalents and
marketable securities of $15,854 versus $14,847 at December 31, 1998. The
current ratio was 1.6 at March 31, 1999 and at year end 1998.
The Company's long-term and current debt remained relatively consistent
from December 31, 1998 to March 31, 1999. As of March 31, 1999, the
Company had borrowings outstanding of $25,000 against its $35,000
revolving line of credit.
In February 1999, the Company entered into a Letter of Intent to acquire
all equity interest of another company. Revenues of such company were
less than $15 million in 1998 and 1997. Upon finalization, the
acquisition will be recorded under the purchase method of accounting.
The Company believes that its current cash and investments position, its
cash flow from operations, and amounts available from bank credit will be
adequate to meet its anticipated cash needs for working capital, capital
expenditures, and potential acquisitions during the foreseeable future.
REVIEW OF INDUSTRY SEGMENTS
The Company designs, manufactures and markets equipment, systems and
components used in the processing and handling of fluids. The Company
sells through five marketing units each comprised of related product
lines. Certain marketing units have similar economic characteristics and
have been aggregated under Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related
Information," (SFAS No. 131). As a result of aggregation, the Company
has two reportable business segments - Consumables and Equipment.
The Consumables segment, comprised of two marketing units, includes
products such as filter cartridges, membrane elements, membrane,
instruments, and laboratory products. The Equipment segment, comprised of
three marketing units, includes products such as pumps, housings, valves,
controls, reverse osmosis/ultrafiltration (RO/UF) machines, ozonators,
stills, and water treatment systems. Each segment is currently supported
by several manufacturing facilities, a similar sales force and various
corporate functions. The segments do not have separate accounting,
customer service, administration, or purchasing functions.
The marketing unit structure was established to provide strategic
leadership for related products. It was implemented on July 1, 1998.
Restatement of prior period results under this method of reporting has
been deemed impracticable due to the costs and unavailability of certain
financial information. As a result, comparable financial information is
not available for the two reportable business segments for first and
second quarters 1998.
The reportable segment information for the first quarter of 1999 is as
follows:
Consolidated
Consumables Equipment Total
-------------------------------------
Sales $19,734 $24,787 $44,521
Cost of sales 12,083 17,069 29,152
------- ------- -------
Gross profit 7,651 7,718 15,369
Gross margin % 38.8% 31.1% 34.5%
Operating expenses 5,296 6,771 12,067
------- ------- -------
Operating income 2,355 947 3,302
======= ======= =======
Operating Income % 11.9% 3.8% 7.4%
Lower plant utilization, aggressive pricing and continued slow sales in
Asia/Pacific effected gross margins in both segments. The custom
equipment marketing unit is the only marketing unit which incurred an
operating loss for the first quarter of 1999. This loss of $(221) was
principally due to variability in production demands and lower utilization
of certain production facilities.
Currently, management does not report the balance sheet or any cash-
generating measurements by such segments.
YEAR 2000 READINESS DISCLOSURE
STATE OF READINESS
Osmonics is currently working to fully determine and resolve the potential
impact of the Year 2000 on the processing of date-sensitive information by
its computerized information systems. The Year 2000 problem is the result
of computer programs being written using two digits (rather than four) to
define the applicable year. Any of Osmonics' programs that have time-
sensitive software may recognize a date using "00" as the Year 1900
rather than the Year 2000, which could result in miscalculations or system
failures.
Osmonics' Year 2000 Project (the Project) began in 1994 with reviews of
the Company's business information systems. The objective was to improve
access to business information through an integrated, company-wide system
which is also Year 2000 compliant.
The Company is using a multi-step approach in conducting the Project.
These steps include: needs analysis, resource requirements, remediation
and testing, and implementation. The Project plan identified the major
issues and alignment of priorities, resources, and contingency plans. The
remediation and testing phases will continue through third quarter 1999.
The Project scope includes all computing systems hardware, software,
information technology (IT) infrastructure (such as networks and
telecommunications), and all third-party suppliers and vendors. The
Company has completed the needs analysis phase of the Project. The
Company has not yet completed, corrected and/or tested for all possible
Year 2000 compliance issues. The Company is utilizing the services of
consulting firms to assist in dealing with Year 2000 issues.
An integral part of the Project is the implementation of SAP, a company-
wide integrated business information and accounting system. The Company
began implementing SAP as its primary information system in 1996. SAP is
being implemented in a two-phase approach. Phase I, the conversion of the
previous primary computing system at the Company's headquarters and
primary manufacturing facility, in Minnetonka, MN was completed in 1997.
Phase II is the business process re-engineering within SAP, and the
rollout to other plants. The existing software at three other plants has
also been upgraded with Year 2000 compliant versions on an interim basis.
At the end of the first quarter, the Company implemented SAP at its
Phoenix Operation. As of March 31, 1999, the Company is approximately 80%
complete on converting or upgrading its systems to be Year 2000 compliant.
The remaining two plants are scheduled to be completed by September 30,
1999.
Very few of the Company's products contain software or embedded
microprocessors. The Company has reviewed all of these products and
identified only a few that will be impacted by the year 2000. In all
cases, the effect will be in the retrieval and display of logged data and
not in the correct operation of the product. A solution for each of the
products identified has either been made available, or will be made
available to our customers prior to the year 2000.
Customers and vendors could be disrupted with their own Year 2000 issues,
which could affect their ability to buy Osmonics products or supply
Osmonics with raw materials. However, the Company believes this is
unlikely, since no single customer or vendor represents more than 5
percent of the Company's present business. Alternative sources of supply
are also currently available and the Company believes will be available if
needed. The Company is in the process of seeking assurances from its
material suppliers that their ability to sell to the Company will not be
materially impacted by any Year 2000 issue. For those that have not
provided assurances, the Company is identifying alternative suppliers for
critical parts and materials.
COST
As of March 31, 1999, the Company has invested over $6,000 during the
years 1995-1999 to upgrade its information systems. The remaining cost
associated with required modifications just to become Year 2000 compliant
is not expected to be material to the Company's financial position. The
estimated total external cost to accelerate the replacement of certain
hardware, software, and infrastructure is not expected to exceed $500.
The remaining SAP implementation costs and the related business process
improvements, which would be incurred in any case, are excluded from the
figure above.
RISKS
The Company believes that it will be able to correct all material Year
2000 problems prior to January 1, 2000. However, the Company's ability to
correct its Year 2000 problems is dependent upon its ability to obtain and
retain adequate resources. The failure to correct a material Year 2000
problem could result in an interruption in, or a failure of, certain
normal business activities or operations. Such failures could materially
and adversely affect the Company's results of operations and financial
condition. For example, the failure to update its business information
system could result in delayed performance on contracts, loss of
contracts, or lawsuits for failure to perform.
The Project is expected to significantly reduce the Company's level of
uncertainty regarding the Year 2000 problem. The Company believes that,
with the implementation of new business systems and completion of the
Project as scheduled, the possibility of significant interruptions of
normal operations should be minimal.
The failure of the Company's customers to be Year 2000 Compliant could
materially reduce or delay the Company's sale of water systems because of
budget constraints and the diversion of customer resources to fixing the
customers' Year 2000 problems. At this time, the Company does not believe
that its customers' Year 2000 problems will materially impact the
Company's business.
Readers are cautioned that forward-looking statements contained in the
Year 2000 update should be read in conjunction with the Company's
disclosures under the heading - "Private Securities Litigation Reform
Act" - that follows.
CONTINGENCY PLANS
The Company has developed and put in place contingency plans to address
internal and external issues specific to the Year 2000 problem, to the
extent practicable. For example, the Company is considering modification
of existing computer programs in lieu of implementing SAP at one of its
remaining two plants.
The Company believes that due to the widespread nature of potential Year
2000 issues, the contingency planning process may require further
modifications as the Company obtains additional information regarding:
(1) the Company's internal systems and equipment during the remediation
and testing phases of its Year 2000 program; and (2) the status of third
party Year 2000 readiness.
PRIVATE SECURITIES LITIGATION REFORM ACT
The Private Securities Litigation Reform Act provides a "safe harbor"
for forward-looking statements. Certain information included in this Form
10-Q and other materials filed or to be filed with the Securities and
Exchange Commission (as well as information included in statements made or
to be made by the Company) contains statements that are forward looking.
Such statements may relate to plans for future expansion and acquisitions,
business development activities, capital spending, financing, or the
effects of regulation, competition and Year 2000 compliance. Such
information involves important risks and uncertainties that could
significantly affect results in the future. Such results may differ from
those expressed in any forward-looking statements made by the Company.
These risks and uncertainties include, but are not limited to, those
relating to product development activities, computer systems
implementation, Year 2000 compliance, dependence on existing management,
global economic and market conditions, and changes in federal or state
laws. Investors are referred to the discussion of certain risks and
uncertainties associated with forward looking statements contained in the
Company's report on Form 10-K filed with the Securities and Exchange
Commission for the year ended December 31, 1998.
PART II - OTHER INFORMATION
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) (27) Financial Data Schedule
(b) During the quarter ended March 31, 1999 the Registrant did
not file a Form 8-K report.
SIGNATURES
Pursuant to the requirements 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.
Dated: May 13, 1999
OSMONICS, INC.
(Registrant)
/s/ L. Lee Runzheimer
L. Lee Runzheimer
Chief Financial Officer
/s/ Howard W. Dicke
Howard W. Dicke
Treasurer and Vice President
Corporate Development
/s/ D. Dean Spatz
D. Dean Spatz
Chief Executive Officer
<TABLE> <S> <C>
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<LEGEND>
This schedule contains summary financial information extracted from Form 10-Q
for the quarter ended March 31, 1999 and is qualified in its entirety by
reference to such financial statements.
</LEGEND>
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