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March 2002: Volume 44, Number 3

Part 2, Back to Value with Osmonics’ Spatz
by Carlos David Mogollón, WC&P Executive Editor

The following is a continuation of our interview with Osmonics' Dean Spatz:

WC&P: Let’s talk about the last few years, because it’s been, well, interesting is kind of an understatement. When we spoke in either ’98 or ’99 about the whole issue of the financial market, funds and investments, going into this area that wasn’t really turning a profit, the dot.com craze. That somewhat drained dollars away from this industry and others where “value” was the buzzword nobody could hear, I believe was your point.

Spatz: And I think I was totally correct on that. I’ve since been vindicated. A lot of the investment folks kind of look at me funny when I would tell them that. Now, they’re saying, “Yeah, you were right. That’s what was happening.” A couple things happened that put the whole water business into kind of a three-year doldrums. We were doing a number of acquisitions along the way. Of course, Dick Heckmann, with USFilter, was doing even more.

WC&P: Another understatement, but…

Spatz: But, the middle of ’97 came and you had the Asian crisis. And I think all of us in the United States in the water business were shipping more product to Asia than we realized. Our sales to Asia directly were about 11 percent of total sales, about the same as they are now. But I think we had another 11-15 percent of products like our control valves that were going to other people, other companies in the United States, who were then putting together a system and shipping that to Asia. So, we really had probably 25 percent of our business exposed.

WC&P: Without directly realizing it?

Spatz: Yes. We had no idea we were going to get hit as hard when the money in Asia kind of went to half of its value and people just stopped buying.

WC&P: That was when Indonesia had its economic meltdown and the Asian flu spread from there.

Spatz: Thailand, Korea, and I think it was really the crowning blow for Japan too. They had been starting to make a recovery and come out of their slump. China’s really the only one that held up. But we’d also made a decision that we needed a new computer system to meet the Year 2000 requirements from the SEC, which is I guess one of the big disadvantages of being public is you sometimes get forced into things that you don’t necessarily agree with. So, we started putting in the SAP system, which is an enterprise resources planning system, ERP system. We had nowhere near the realization of how difficult that was going to be on top of everything else. As we went into early ’98, we really didn’t have good financial information to work off of because the SAP system wasn’t working right, a lot of our shipments were slow because we couldn’t get the inventory right. There were just a number of problems.

WC&P: On top of the suddenly lower revenues, you were having these other difficulties related to Y2K requirements.

Spatz: And we had these two acquisitions that we’d been working on and really wanted to finish because they gave us the base to the technology spectrum that we wanted, MSI and Membrex. We held in there on that even though our stock price was going down, so we decided to use cash. And that’s about when Heckmann realized things were going sour and he got Vivendi to buy USFilter. Maybe I should have done the same thing. But, we didn’t. And when you and I talked about that time, you know, there was just no interest in old-line companies. Everybody wanted to be in high-tech. I thought it would change in 1999, but I was wrong because it just lasted a lot longer than I expected to see it last.

WC&P: Correct me if I’m wrong, but in ’98 was also when the Russian financial crisis occurred.

Spatz: Right, and we actually had three big projects in Russia that we’d just shipped and we were expecting to get more and then all of a sudden the Russian crisis came, so that business dried up too.

WC&P: And then in ’99, everybody was worried about whether Brazil was going to have problems or if Argentina would.

Spatz: That one didn’t hurt us so bad because we don’t have as much business in Latin America. And Russia is just now coming back. We just shipped a couple large systems there and expect to see more. Anyway, at that point, we really had to step back and, again, realize that we’ve acquired all of these companies and we hadn’t integrated them as well as we’d wanted to. They weren’t considered Osmonics in some cases. In some cases, they were kind of running independently.

WC&P: Autonomous subsidiaries?

Spatz: Well, we weren’t getting the real value out of it that we’d hoped.

WC&P: There were similar charges among financial analysts about problems like that at USFilter about that time too.

Spatz: Right, and they still have them. At that point, Ed Fierko became available. He was running EcoWater. He and I talked and hit it off pretty well, so I brought him in to be the chief operating officer. I actually brought him into Autotrol first and then decided that we’d move him up to COO where he would be responsible to help consolidate these plants and reduce the number of plants to get our efficiency up and our operations tighter. And I’d put more time into R&D and new developments and public contact. So, really, we’ve gone from 11 plants down to, well, seven now, but we’re moving Syracuse here and will close that down, so actually, we’ll have six. And in order to try and reduce overhead and get more focused on our manufacturing, we did move Phoenix here because a lot of the manufacturing you do to make an ozonator is very similar to an RO so we decided we’d just do it in this facility. We added additional space here in late-’96. We have 300,000 square feet here in Minnetonka now. That’s three times what we had in ’81; and, in ’81, we really only used 50,000, which would make it really six times what we were using. I brought in a new chief financial officer, Keith Robinson, in late-’98, too. And then in the acquisition of Membrex, I picked up our chief technology officer, Phil Rolchigo, who’s one of the smartest chemists/chem-engineering people I know that still has the ability to manage. That really changed the entire team at the top. They’ve been working real hard along with our three global business unit managers. We call them GBUs. One is Dick Elliot…

WC&P: Another EcoWater expatriate.

Spatz: Yes. Another is Curt Weitnauer, who actually started with us just about the same time as Paul Overbeck did, maybe a little after, and right out of school. And Roger Miller, who’s running our filtration/separation area. Curt’s running our equipment business; we call it process water equipment. Dick’s running the household water business; that’s Autotrol, HRO, cartridge filters for home, and the Aquamatic valves.

WC&P: It’s kind of funny because now you’ve got the two top guys at EcoWater now in similar positions at Osmonics.

Spatz: Ed was over at EcoWater and then he got promoted to run their entire Marmon Water Group. He hired Dick to run EcoWater. When they changed Ed, I think the new guy wanted to have his own guy at EcoWater. It’s one of those things that happens. So, the team has done a great job in helping us to reduce costs, implement the SAP system, which is now finally in place and get our profits coming back up again.

WC&P: I noticed in your most recent statements that you’ve shown a pretty good rebound over the past year.

Spatz: Right, and fourth quarter will be even stronger. It was a good fourth quarter. We’ll have good numbers there, so it’ll actually show a little better than what it looks at this time.

WC&P: Well, your stock hit a low of what?

Spatz: The low was about $7; I think it was $6.80, actually.

WC&P: And now it’s been up around $15…

Spatz: Plus or minus, I think yesterday it was $13, but it’s been up to $16.25.

WC&P: How do you interpret that as far as market support and a perspective on the industry? When you go to talk to analysts, what kind of questions are you getting?

Spatz: They’re pleased to see that we’ve consolidated and we’ve got profits back up. And they’re saying, “If you can continue to get those profits up, you’ll be at a price/earnings ratio of 20-21 times minimum.” So, it’s really key to get those profits up. If you look at the forecast for next year, by the analysts, they’ve got us pegged at about that. So, we’re seeing much more support. However, the high for the stock was about $21 and so we’re still a ways from that. But we’re pushing toward it and I think we’re making good progress on it.

WC&P: What are some of the goals that you have right now for the company?

Spatz: Our goal is to get 10 percent organic growth -- you know, internal growth -- with say another five coming in as acquisitions. But that’s more one year you do one, you maybe don’t do anything for a year or two and then you do another one.

WC&P: To allow you to absorb everything efficiently.

Spatz: Right. So, we’re looking at an average of 15 percent per year growth. And then we really want to get our operating income as a percentage of sales back into the 14-15 percent range, which is where we were in the mid-‘90s.

WC&P: Where’s it at now?

Spatz: We’re say about 9-10 percent now. We’ve got a ways to go. It’s a big step to go from 9 to 15 percent, but we feel we can get there. We’re doing that by reducing expenses and trying to cut costs by standardizing a lot of our RO machines. We’re making membranes a lot more efficiently, making elements more efficiently.

WC&P: And you’re reducing I assume the problems that may pop up with products occasionally in the marketplace.

Spatz: We have those definitely. I think by standardizing, you reduce the number of problems because you can engineer the product better. That’s what we’re doing.

WC&P: Have you had any issues as far as new products coming out? I was scanning your news releases on your website and Osmonics has released a lot of new products over the last year/year and a half.

Spatz: We have. Actually, things like the new 1-inch valve have just done fantastically.

WC&P: This would be the Performa?

Spatz: The Performa, it’s done fantastically. And we haven’t had one technical problem on it. The AvantaPure concept, we think is going to work well.

WC&P: I was going to ask you about that as far as what the goal was with the AvantaPure program?

Spatz: Well, we felt there were dealers and OEMs out there that wanted to actually buy complete RO packages, you know, complete systems, and wanted to tie in with a company like Osmonics and at least use our name. And in the case of the softeners, they’re buying our valves and putting together the softener, but they do it in a certain style and a certain layout so they become an AvantaPure dealer in that case or an AvantaPure OEM. We’ve found good interest in that.

WC&P: I’ve spoken with a number of people through this column in a variety of levels in the industry. And one person was mentioning that, in the last couple years, there’s been a lack of commitment to really developing a dealer base for a dealer network.

Spatz: You mean with us or…?

WC&P: In general, in the industry.

Spatz: Yeah, you know the big problem you have in that industry right now -- and I say that one because I’m talking more the point-of-entry and point-of-use -- is the question of how is the consumer going to buy. Is the consumer going to buy through the dealer or are they going to buy through a water store? Or are they going to buy from a mass merchandiser? And a lot of our customers have decided that the water store’s maybe the way they’re going to buy. So, I think there has been maybe a reduced push on dealers and maybe a little bit more toward the water store concept where they’re trying to be a specialized appliance company.

WC&P: What’s an example of a water store in your mind?

Spatz: I’ll give you two of them nearby here. One is John Commers company that just put one up not too far away. They put in one of our RO systems with the ozonator to produce water so people can come in and buy water gallon by gallon. They sell salt to people that want to drive by and have it put in their trunk for them. They have all sorts of water softeners on display. But they also have a lot of other water-related things on display, chemicals and test kits and stuff. It’s on a main road and people stop by like they would stop by a specialty retail store of some sort. His company is called Commers. He’s an old WQA guy. Now at Surge, it’s Gary Capone; he’s not too far away from Commers. Commers is almost totally dedicated to Autotrol. Surge is maybe 50/50. He’s got a very similar store. He’s got Osmonics RO and sells the water, but interestingly enough, he has a lot of other water products, like fountains, birdfeeders and dog dishes for water -- all kinds of stuff.

WC&P: Do they also have simple filtration and pour-through pitchers?

Spatz: They have filtration, yeah, and pitchers, but they don’t push the pitchers as much.

WC&P: This is where you think things are going to go?

Spatz: I think what’s happened, what I see happening is you’re either going to have that or you’re going to have the mass merchandisers, the Home Depots, the Menards, those guys. Because with people working during the day and not necessarily wanting to be interrupted at night, you have less willingness for people to have somebody stop by their house.

WC&P: They do say that with the increase in U.S. productivity, that’s come with the average person working a lot more hours. That would make it seem likely they’d be less willing to give up quality time with their families for a presentation, some might say.

Spatz: Again, I don’t know if these are going to be the answer, but I think that’s why there’s a general feeling that the dealer approach is being downplayed -- because of this other approach.

WC&P: Well, this actually could be an evolution in the dealer network.

Spatz: I think it could be. If you get up this way, both these stores are worth seeing and they’re only about 10 miles apart.

WC&P: Well, we’ve done profiles of people like Curt Abendroth up in Wisconsin who has somewhat that concept going in his store. Then also, you have Jamie Wakem down in Florida, the former WQA president, is doing something similar. It could be a trend in not so much the phase-out of the dealer so much as the evolution of the dealer, in that sense. What are other trends that you see going on? Let’s break this up in say the retail-dealer network, the assembler-distributor level and then even in the larger manufacturing sector with say U.S. vs. international.

Spatz: We’re doing about 35 percent international and I’d like to see that increase. I don’t know if it will or not for a few years until the dollar changes in value; so right now, that’s our biggest impediment internationally in all of our businesses -- the strong dollar. What do I see on the consumer POE/POU, I still think our sensor control is the way to go to reduce salt usage. But there’s a problem there because a lot of the good OEMs and dealers sell salt; and they really don’t have a strong interest in reducing salt usage. Whether that’s going to take off, I don’t know -- but I still think it’s the way to go.

WC&P: It may be something that’s going to be more regulatory driven.

Spatz: I think it will be regulatory driven, by California probably. I think the whole area of HPCs with the conference coming up is going to be interesting to watch.

WC&P: You’re referring to the WHO/NSF HPC Conference in Geneva.

Spatz: Yes. If there’s a stronger feeling about HPCs being a problem, then the whole area of chlorine and HRO is going to be a bigger and bigger problem; HRO being household RO.

WC&P: How would you encapsulate the HPC issue from your perspective?

Spatz: That’s why I’m going to the meeting. I think I shouldn’t comment at this point, because I don’t know enough about it. I need to learn more about it.

WC&P: It’s been portrayed as a threat to the water treatment industry because…

Spatz: I don’t agree with that necessarily but I really shouldn’t make any other comments at this point. I would be happy to talk about it after I go to the meeting. But one of our big pushes is to get more chlorine resistant home RO systems. We have that coming. I do think the softeners are going to have to seriously look at that too. And we have that in our Italian operation. Some areas of the country might put that in.

WC&P: i.e., disinfection?

Spatz: Yeah, some type of disinfection.

WC&P: Kind of like what Water-Right does up in Wisconsin?

Spatz: Well, I’m not quite sure what they’re doing, but I wanna wait ‘til I go to that meeting.

WC&P: When you brought up chlorine, it’s an issue on a number of levels from THMs to the issue of chlorine itself in California.

Spatz: I’ve got some opinions on that but, again, I’d like to see where things are coming down on the rest of the regulatory stuff before we get too much further into that. In answer to your question on where I see other things going, we see a lot of potential for water softener type OEMs to get into small ROs and even middle-sized ROs and I think that’s going to be a huge growth area for them. Just a lot of people from florists to somebody that wants to have good water in their plant for their employees are going to be putting in small- to medium-sized ROs. We think we’ve got some good products in that area that aren’t being exposed as well as they should and that’s something we’re going to be pushing pretty hard.

WC&P: Would say R&Ms opening a distribution center in Wisconsin and Applied Membranes opening an office in San Antonio kind of be trends toward that?

Spatz: Could be. With R&M, we have some agreements and they’re actually exclusive on the Technetic valve now. I think they’ve got kind of a broad-based approach. Applied Membrane, I’m not sure. I haven’t talked to him in a while and I don’t know what exactly his objective is there, but it could be similar. I think there’s just a lot of demand in these medium-sized areas where people see RO. It’s like with Dasani and Aquafina, that we supply almost all of the machines for Dasani and about half those for Aquafina, if you look at that, the bottle says it’s RO water. That just gets people to thinking, “Well, why don’t I have RO water on this application?” We think that’s really going to drive the market. And we’re very strong in the beverage area. In fact, we did some calculations and determined that our machinery is producing about four million cases of bottled water per hour.

WC&P: Wow.

Spatz: And that’s just the tip of the iceberg -- 10-20 percent of the demand, I think.

WC&P: There’s also been a big push to meld what has traditionally been the POU/POE industry into he C&I industry. You’ve played a pretty proactive role at the WQA meetings in trying to help that along.

Spatz: Yeah, I think it’s got to all be one total water industry. These artificial division lines I think are just slowing people down. It’ll come. We see guys that were only doing residential valves that are now doing our Magnum and Aquamatic industrial valves. It’s coming fairly quickly. It does take time, but it is coming.

WC&P: Where do you see the most growth for Osmonics in some of these different areas?

Spatz: Well, our household was off year-over-year this year, but fourth quarter it’ll be back up. So, we could see some pretty good growth, but that’s partially because we were down. Other than that, we’re seeing beverage and municipal applications. I think point-of-use could grow very nicely with this arsenic ruling, so I’m optimistic on that. And we’ve been engrossed in just the whole membrane area because, I tell you, people are realizing what it can do and deciding to go ahead and do it.

WC&P: I thought it was interesting that Culligan just recently reached this agreement to get a lock on the granular ferric hydroxide media, GFH, since you brought up the issue of arsenic.

Spatz: You know I haven’t kept on top of that.

WC&P: Everybody seems to be looking for the new magic media on arsenic.

Spatz: Right.

WC&P: Since Osmonics does have 35 percent of its business internationally, where do you see the most promise?

Spatz: Europe has always been strong and will continue to be for us, especially Eastern Europe. The Middle East has been problematic recently for obvious reasons. China is big on our radar. If Russia can get its act together, we see a lot of potential there. Argentina, with all its economic troubles recently, has never been strong for us so I don't see much impact there. We've got a good distributor/OEM in Chile; and Brazil and Mexico are attractive. But it's been tough to sell down there because the money's so low. And now, with Argentina's problems, that just makes it worse.

###

Next month in this column, read our interview with Gary Kruse, who is president of Krudico Inc. of Auburn, Iowa, which was founded in 1966.