Volume 44 Number 3
Back to Value with Osmonics’ Spatz
In a plain-spoken manner, Dean Spatz clears his throat and describes how he and wife Carol launched Osmonics in their home, rolling reverse osmosis (RO) membranes in the garage in 1969.
Several years earlier, the Dartmouth graduate had enlisted the inventor of the "new" technology, Dr. Sourirajan, to work as a consultant on a project he’d gotten in college for a contract to develop low-pressure membranes for home water treatment.
With an investment of $75,000 and $1,000 of their own money, they started the business, putting their first units into a car wash, a nickel plating operation, and the Mayo Clinic for kidney dialysis. A year later, they moved into a 5,000-square-foot facility in St. Louis Park, Minn., to cut down on truck traffic in their neighborhood.
In 1971, Osmonics went public, selling 100,000 shares at $5 apiece. With that, it invested in manufacturing its own membranes and related equipment, instead of assembling from components. And, a year later, it moved into a 15,000-square-foot building that was expanded to 45,000 square feet by 1980. In 1981, it opened a new 100,000-square-foot building at its current site in Minnetonka, Minn. That has since been expanded to a 300,000-square-feet complex.
Spatz jokes about how in 1981, his fourth employee ever, Fran Lightly, a chemist, decided to leave because the company -- then at 110 employees and $7 million in sales -- had gotten too big. Today, after several retrenchments where the company refocused itself, sales are up to about $207 million, with fourth-quarter 2001 figures expected to give last year’s results a healthy boost.
For the past few years, however, Osmonics has been on the rebound. With its stock back from a low of $6.80 to the $15 range, it still has a way to go before its high of $21 a share. His goal is to get internal growth up to 10 percent a year with 5 percent more from new acquisitions. He’d also like operating income as a percentage of sales to rise from 9-10 percent to 14-15 percent.
Spatz points out, though, that since its initial public offering, Osmonics’ stock has split 15-1, so the original value now is roughly $225 a share without the splits. It likely would be higher, he noted, if not for the impact of a series of foreign financial crises in the late-‘90s, the high value of the dollar, SEC-mandated computer-related expenses from Y2K, and the flight of capital from value stocks to highly speculative telecommunication and dot.com stocks. He discussed the last point with WC&P in a December 1998 “Viewpoint” column.
“I’ve since been vindicated,” Spatz said. “A lot of the investment folks kind of looked at me funny when I would tell them that. Now, they’re saying, ‘Yeah, you were right. That’s what was happening.’ ”
Still, he readily admits that, caught up in the acquisition frenzy of the mid-‘90s, Osmonics needed the time over the past few years to step back and reintegrate the company for better efficiency and profitabilty. That’s meant consolidating facilities and spinning off operations that don’t fit its primary focus of having technologies that cover the range of the filtration spectrum. Key players there: Ed Fierko, president and COO, and chief technical officer Phil Rolchigo, brought on in 1998, and CFO Keith Robinson, who joined in 1999. Spatz offers particular credit to Fierko, former head of Marmon Water Group and EcoWater.
Osmonics is now the third largest manufacturer of membranes in the world, behind Dow-Filmtec and Hydranautics. It’s No. 1 in filtration systems for kidney dialysis machines, a market that’s taken some knocks because of problems with rival Baxter Healthcare’s units in the field. And it's offering new opportunities through its recent AvantaPure dealer program. Things are looking up.
Before getting to the interview itself, here are a few details on Osmonics:
Employees: 1,400 at 7* facilities
* Down from 11 three years ago; Also announced in December that Syracuse, N.Y., home RO plant would move to Minnetonka.
Revenue: $207.4 million, compared to $200 million in 2000, with sales up 3.6% and net income up 14%
Business split: Process water equipment, 40%; filters/membranes, 40%; household valves, filters, ROs, 20%; international, 35%
And now for the interview:
WC&P: Why don’t you fill us in a little on your background and how you got into the industry?
Spatz: I personally got into the water industry way back probably in my Ninth Grade science project when I did a distillation unit for the science fair. But the second time was when I was in college at Dartmouth College. The project we had to work on in my sophomore engineering class was how to give people, in this case in South Dakota, that had bad drinking water, how to give them reasonable, quality water so they could improve their way of life. And reverse osmosis technology had just been invented in 1959. This was about 1963, so it was shortly after the invention. We had about five companies and our company decided to look at RO; whereas, of the others, one looked at ion exchange, one looked at freezing for desalting and a couple looked at distillation. As we got into it and came up with a prototype, we actually came up with a prototype whole-house RO system. And, as we were finishing the course, another fellow and I got pretty interested in the idea of furthering that technology. At that point, it kind of got me into the reverse osmosis area and, as I got into my senior year and graduate studies, I got some contracts from the Office of Saline Water/Department of Interior to develop low-pressure RO membranes.
WC&P: This was about when roughly?
Spatz: This was 1965.
WC&P: So most people in the world didn’t even know what RO was?
Spatz: Oh, nobody. Only the technical people did. Most people had no idea what RO was. American Machine & Foundry (AMF) Corp. was kind of into things then. They had a little bit of work on it. Culligan had just started to think about it. So, I got this contract to develop low-pressure because most people felt you had to use 600 pounds of pressure, psi. We thought that you wouldn’t. And I actually was able to get Dr. Sourirajan, who’s the inventor RO membrane, to act as our consultant. He took the position that it would be no problem to run under line pressure. We developed membranes and then membrane elements in a package for home drinking water. This was in 1966 that I put the first ones in the field. It was in New England, so you may wonder how you get salty water; but interestingly enough, there was a lot of salt contamination from road salt in some of the wells. We had two or three installations there. Then, there was a salt intrusion case down in Connecticut that I had an installation on. I had this package and continued that work through the spring of 1968, when I got my master’s degree. I did my thesis, both master’s and bachelor’s thesis, on reverse osmosis. At that point, I decided I’d like to take a position where I could build a company, or actually a division of a company, into a reverse osmosis business. I got the opportunity with a company that was headquartered in Miami that was called Ecological Sciences. They had just bought the Meadowbrook Water Softener Company and the Stover Water Softener Company and they’d moved them together into their plant in Minneapolis. They said, “Well, we’d like to invest in reverse osmosis; we think it’s a great way to go. Why don’t you do it in Minneapolis?” That sounded find to me. I’d never been there. I grew up in Albuquerque, so I kind of understood the importance of water better than maybe some people -- being in that high desert country.
WC&P: Very highly saline water and not a whole lot of it.
Spatz: Especially in Roswell, where we used to go play football once in a while. I could never understand why the water tasted so bad.
WC&P: I’ve been camping there.
Spatz: In Roswell.
WC&P: Oh, yeah.
Spatz: The Albuquerque water’s not too bad, but you have to be kind of picky as to where you get better water. So, I came out here to Minneapolis and worked for this company. It was a boom stock market back in the late ‘60s, kinda like the one we just finished. So, I spent some time selling the idea of reverse osmosis to investors and such, which was kind of fun. But these fellows were not putting money into the company to develop RO. So, after about a year, I told them that either they needed to put in the money they promised me they were going to put in or I’d go and start the business myself. They said they didn’t have any money at that point because the stock market had started to fall and they really didn’t have any cash. So, I said, “OK, I’ll just go out on my own.” I incorporated Osmonics in about June or July of 1969. This would be about a year after I came out here. And it actually started up in about August of 1969.
WC&P: How did you start up? How big was the company at that time? Did you start it in your house? Did you have an office?
Spatz: My wife and I were the only employees, my wife, Carol. She was helping me roll some membrane elements in the garage. And we put together a brochure and did a mailing. We built a pilot machine that we had a picture of in the mailing. We sent it to about 1,000 magazines and had about 250 actually run the release, which was kind of fantastic.
WC&P: I take Jerry was one of those.
Spatz: Jerry was.
WC&P: For the reader’s sake, Jerry Peterson was the founder of WC&P.
Spatz: The Peterson Family and I have known each other for years, of course, and Jerry was very supportive as were a number of other editors. This was new technology. We even got carried in Sunset Magazine in Arizona. So, there was all kinds of exposure.
WC&P: You started this in Minnesota?
Spatz: We started it in Minneapolis -- well, the town of Minnetonka was where our house was, which is where we are now. I started to get some interest. The first machine I sold was down at the Mayo Clinic for kidney dialysis, which was a brand new application and which we’re really the leader in still. And the second was a car wash rinse water system. I think the third one was for metal finishing for recovery of plating salts in nickel plating. But we started to make some of these machines in the garage there and getting big trucks pulling in wasn’t real good, because it was a small street. I decided we’d better get a facility. About March ’70, we moved into a facility in what’s called St. Louis Park, which is actually the post office of Minneapolis. It’s kind of halfway between our present facility and downtown. We stayed there until ’72, building the technology, pioneering the technology, developing all sorts of applications. But the one thing I did realize at that point, even though my original business plan was for undersink RO units, the HRO, was that was way too far ahead of its time.
WC&P: It didn’t really take off until the mid- to late-‘80s, correct?
Spatz: Yeah, it didn’t take off until 20 years later. I’d say it didn’t really take off until the late-‘80s or early-‘90s, as far as really getting accepted. People were starting to make some money by the mid-‘80s.
WC&P: As I understood it, it was pretty much the Milwaukee outbreak that really made people much more aware and therefore created much more of a market for products like that.
Spatz: It may. I think there were always certain pockets, in Southern California, for instance, where the salt content is quite high from the Colorado River water. There was always a pocket there. But certainly the Cryptosporidium problem has definitely boosted the sensitivity. And, of course in the beverage area, where we’re quite strong, the Cryptosporidium problem in Milwaukee was really the thing that got that moving.
WC&P: What were some other milestones?
Spatz: If you kind of go back to the kind of historical record, the first 13 years, we really spent most of our effort pioneering the uses of reverse osmosis and ultrafiltration, both in water purification and other processes and in wastewater treatment. We built the company up to where it was about $7 million in sales then.
WC&P: This would have been what year?
Spatz: About 1981.
WC&P: How many people did you employ then do you think?
Spatz: I wasn’t prepared for that question. Oh, I know, it was my fourth employee, Fran Lightly, who was a chemist and worked with me, decided he was going to quit. Because in ’81, we moved to this new building that we’re in now. He decided that we were about 110 people and that was too many people -- it was too big a company for him. So, it was right in that range. We worked through manufacturer’s reps and distributors at that time. We had really built the technology and done a lot in waste treatment because pollution control was quite strong in the ‘70s, but really dropped around ‘82-’83 in that recession. It never really has recovered. It’s a little stronger now than it was. As we went into that recession in ‘81-’82 was about the same time as we were building this plant here in Minnetonka. Actually, in ’72, we moved from the first facility to a second facility in Minnetonka, but it was a leased facility. We went from 5,000 square feet in the one in St. Louis Park to 15,000 and then we added on another 10,000 and some more -- we were up to about 45,000 square feet in 1980. Then, this building was about 100,000 square feet in this first building here in Minnetonka. We about doubled our space. We had the recession. We saw sales drop by about 20 percent, which is the first time we’d had any sales decrease. We really stepped back and did some reevaluation on what we wanted to do with the business. I might comment at this point that we went public in 1971, when we were very small. I did that because the guy that put the money into the company -- my wife Carol and I put in the sweat, blood and tears -- but the guy who put the money in the company, Ralph Crump, was out of Connecticut. He’d gone public early with a company that he had started, so it was kind of a precedent and fairly easy for us to do at that time.
WC&P: Real quick, who was Ralph Crump?
Spatz: Ralph was a guy the dean of the engineering school, Myron Tribus, introduced us. They were classmates at UCLA. Ralph was an entrepreneur. He was about 20 years older than I am. When I started the company, I went back to him and said, “You said you might be interested in some investments. Here’s what I’d like to do.” He eventually put in the $75,000 dollars that I said I needed initially to get started. So, we started on about $75,000 with about $1,000 from Carol and myself.
WC&P: What are we at today? You just released some financial numbers for the past year.
Spatz: We will have sales of about $207 million.
WC&P: Pretty good investment.
Spatz: Yeah, he’s done quite well. We went public at $5 a share and we’ve had 15-1 splits on that, so that’s $75, say 3 times 5… It’s about the equivalent of $225 a share when you take out splits. If you bought a $5 share, it’s worth about $225 now. He’s done well and other investors have done well. We’ve had a little bit more of a difficult time in the previous few years, with money going into the dot.coms and the telecommunications. But last year, we started to see a rebound into water and more infrastructure-type businesses.
WC&P: As investors look for more value to their buck?
Spatz: Yeah, more value-type investments instead of the hype that was going on at the time.
WC&P: I remember us talking about that very topic in a “Viewpoint” that I wrote a couple of years ago.
Spatz: Right. So, anyway, we got here and had this downturn and really stepped back and evaluated. I decided we were too much into reverse osmosis and ultrafiltration. We needed to broaden our base. That’s when I started working on the concept of the filtration spectrum.
WC&P: Describe that concept, if you could, please.
Spatz: You remember seeing the document, the illustration we put together of the filtration spectrum. The concept is to have basic technologies and basic products that fill out the entire spectrum of filtration from the reverse osmosis, which is the finest filtration known to man, through nanofiltration, ultrafiltration, microfiltration and finally the large filtration, or particle filtration. We had been working some with the Celanese Corp., which as you know was a fairly good-sized chemical company at that time. They were acquired by Hoechst in Germany. We were working with them on some new membranes and they said, “By the way, we happen to have a filter business that’s doing OK, but it’s kind of small for us.” We looked at it and decided we’d like to buy it. We bought what’s now the Hytrex filter business from them and about 24 patents.
WC&P: When was that?
Spatz: It was about early ’84. These are blown microfiber polypropylene cartridge filters. We packed that up. It was in Columbus, Ohio. We moved it here. So, it was really lucky that we had the extra space available. We moved it in and about filled up the whole building at that point. That kicked our sales from $7 million to $12 million. It was a big step in our life.
WC&P: There’s got to be lots of logistics that would, I imagine, come into play in making a jump like that.
Spatz: There were. It was a big gamble. There were some ways they were doing things for which we had to make technical decisions to switch from what’s called dowtherm to electric heat on the polypropylene. It was a big step. If it had not worked, we would have been in big trouble. But, it did work and it really saved the day. We were up and running in about three months, which was amazing. That gave us the particle filtration. And our first movement into microfiltration, which is where the big Pall and Millipore business is, was a startup company called Poretics in about 1985-6. This is in the track-etch type membrane. We continued to grow and pioneer the RO business; but, at that point, kind of stepped back and said “People aren’t spending a lot of money on environmental control and pollution control, we better put more of our emphasis toward water treatment,” which we did. Just to back up a bit, when I was at Dartmouth, we made membranes and we made elements. As a matter of fact, we were rolling spiral elements then. They were kind of crude, but we were doing it. In 1971, after we went public, at that point we were rolling elements, using membranes that we were buying from Kodak. In ’71, we took the money from the offering and built our first membrane manufacturing machine. By late-’72, we were making our own membrane as well. That was the other big decision point for Osmonics. We decided we were going to be basic in membrane elements and machinery, which sets us kind of apart from the other companies that are in RO/UF. We also, unlike most of our competitors at that time…
WC&P: How much did you get for your first public offering anyway?
Spatz: We got $500,000, sold 100,000 shares at $5. At that time, most of our competitors -- actually, I think all of them -- would have an outside job shop build their RO frame and machine and then buy membranes from somebody and then put it in the field. We looked at that, but weren’t happy with the quality we were getting when we would do it outside. And, also, it took a long time to get things shipped on a comparative basis. So, we started to make our own frames and do our own painting and then develop the stainless steel housings, using tools that we owned. We became very vertically integrated, which is again a significant difference between Osmonics and other companies in the field.
WC&P: It put you in a position to compete moreso with say, somebody that’s got the economies of scale like Dow.
Spatz: Right, we can compete with Dow without having to go head to head with them on their membrane element, for instance. Now, just again to put timing into this, in 1974, we made our first UF membrane. We actually made that in cooperation with North Star Research, which is actually the entity that invented the PA membrane. And John Cadotte, who is the inventor of the PA membrane, used our ultrafiltration membrane to put his thin film composite membrane onto the first time he did it. John is the one who invented what we refer to now as the TFC or the polyamide membrane. They then started a company called Filmtec, which Dow bought a little bit less than 10 years later. So, we were actually on a good cooperative relationship with them in the late-‘70s/early-‘80s. And about ’77, we were having a lot of difficulty getting good quality pumps. Goulds would not ship on time and the Weber pumps were having problems because the bearings were going out, since they were using the motor bearings only for all the thrust. And, so, we took a secondary stock offering, which was a small one, and used that money to develop the Tonkaflo™ pump. That’s how we got into the pump business as well. Like I say, then in ’83, with the acquisition of Hytrex, at that point, we really stepped back and did some serious thinking about the best way to grow the business. We felt that acquiring not only products to give us the complete filtration spectrum, but also make us a one-stop shop from the standpoint of water purification was the right way to go.
WC&P: Did things take off from there?
Spatz: That’s when our higher growth rates occurred. A lot of that was in acquisitions. We acquired approximately one company a year, starting in about 1984 (about 16 companies in all). Of course, there were a couple of them one year and then none on other years. This culminated with acquiring Micron Separations, that’s MSI, which gave us very broad microfiltration capability.
WC&P: When was that?
Spatz: That was in ’98. And then Membrex, also in ’98, which gave us the next major invention in membranes, which is a hydrophilic membrane that’s made differently than the PA or the original membrane, the CA membrane. Our last acquisition was of Zyzatech in 1999. Along the way, we made a number of other acquisitions that were instrumental. One of the main ones from the standpoint of your readers would be the Autotrol acquisition in ’94.
WC&P: Yes, it’s almost synonymous with Osmonics now.
Spatz: Well, that’s what we were trying to do. And then the Desalination Systems in 1996. Desal was started about the same time as Osmonics by Don Bray and Don actually has the original patent on the spiral membrane element. He started the business I think a year before I did, maybe ’68. But he was with what was at that time called ROGA, which is now Fluid Systems. He had done it under government contract. That’s why it became public property, even though he invented it. Desal had developed their business just selling membrane elements. They were about half pure water and half processing applications, similar to Osmonics. He and I had always had a good working relationship. And he’s about 20 years older than I was too. So, as he was getting into his early ‘70s, he agreed to sell the business to us. That gave us a very strong position in membranes to where we’re the third largest in the world in membrane elements now.
WC&P: Who else is in that mix?
Spatz: You’ve got Dow-Filmtec is first. Hydranautics, which is part of Nitto Denko, is second. And then Osmonics and then, I think, Koch Membrane Systems. I don’t know for sure who would be next -- maybe Toray.
WC&P: From starting the business with your wife in your house to a vertically integrated global business, you’ve worked with just about everyone out there. I know at least two of our current or former Technical Review Committee members were former Osmonics employees, Paul Overbeck and Peter Cartwright.
Spatz: Right, I hired Peter -- I can’t remember how long ago, it had to be in the mid-‘70s -- to be a sales manager. He worked with us I know through the time we were in this new building. And, interestingly enough, his son Tom is working for us now. Tom’s primarily in the HRO activity. And Paul is a native of St. Paul and came with us directly out of the University of Minnesota as an application engineer. He later was a regional manager. He left and came back and ran our ozone business in Phoenix for a few years.
WC&P: So, you acquired that ozone business?
Spatz: Yes, I think it was ’89. It was an individual. He was not very active in the trade activities, but was a very intelligent guy, kind of a loner, recluse-type guy.
WC&P: We’ve got a lot of those out here in Arizona.
Spatz: He actually sold it to us when he was 65 and he left Phoenix and never ever set foot back there again. He moved to the Dayton, Ohio, area. I think he’s still doing OK. He actually married a young woman and has four kids I think after that.
WC&P: There’s something to be said for that.
Spatz: I dunno. I can’t imagine going to the school play when you’re as old as he is. But he’s a very charming guy once you get to know him. So, we built our ozone business off of that. It was pretty small.
WC&P: Paul left and started his own business, GDT, in Phoenix.
Spatz: Yes, he continued in ozone and we still work with Paul on systems and use some of his stuff. So, we still have a good relationship.
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