10-Q 1 l02057be10vq.txt WATERLINK, INC. 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) (X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Quarterly Period Ended June 30, 2003 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 Number 1-13041 WATERLINK, INC. (Exact Name of Registrant as Specified in its Charter) Delaware 34-1788678 (State or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) --------------------------------- 835 North Cassady Avenue Columbus, Ohio 43219 (Address of Principal Executive Offices) (Zip Code) --------------------------------- 614-258-9501 (Registrant's Telephone Number, Including Area Code) ---------------------------------------------------------- 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 [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes [ ] No [X] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common Stock, $.001 par value - 19,665,149 shares outstanding as of July 31, 2003 ================================================================================ INDEX WATERLINK, INC. AND SUBSIDIARIES

2 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS-UNAUDITED

See notes to consolidated financial statements 3 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS-UNAUDITED (CONTINUED)

See notes to consolidated financial statements 4 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED

See notes to consolidated financial statements 5 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS-UNAUDITED

See notes to consolidated financial statements 6 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2003 (INFORMATION AS OF JUNE 30, 2003 AND FOR THE THREE AND NINE -MONTH PERIODS ENDED JUNE 30, 2002 AND 2003 IS UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of 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. Operating results for the three and nine-month periods ended June 30, 2003 are not necessarily indicative of the results that may be expected for the fiscal year ending September 30, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2002. 2. VOLUNTARY PETITION TO FILE BANKRUPTCY Bankruptcy Proceedings. On June 27, 2003 (the "Petition Date"), the Company and four of its direct, wholly owned subsidiaries (collectively, the "Debtors") filed voluntary petitions for relief under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"). The bankruptcy cases are being jointly administered under Case No. 03-11989 (the "Chapter 11 Cases"). Included in the Consolidated Financial Statements are subsidiaries that are not party to the Chapter 11 Cases and are not Debtors. The Debtors continue to operate their businesses as "debtors-in-possession" under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code, the Federal Rules of Bankruptcy Procedure and applicable court orders. All vendors are being paid for all goods furnished and services provided after the Petition Date. However, under Section 362 of the Bankruptcy Code, the filing of the bankruptcy petition automatically stays most actions against a debtor, including most actions to collect pre-petition indebtedness or to exercise control over the property of the debtor's estate. The Debtors are currently funding their operations through the use of cash collateral pursuant to Order entered by the Bankruptcy Court pursuant to Section 363 of the Bankruptcy Code. The Debtors believe that the use of cash collateral will support current operations and satisfy all customer needs. The Debtors currently have authority to use cash collateral until September 26, 2003. The Bankruptcy Court has scheduled a hearing to consider the further use of cash collateral for September 25, 2003. The Debtors expect to file a motion for further use of 7 cash collateral prior to the September 25, 2003 and to request authorization for further use of cash collateral beyond September 26, 2003. Pursuant to an Order entered in the Chapter 11 Cases, the Debtors have employed NatCity Investments, Inc. to act as their investment bankers to assist the Debtors in the investigation and consideration of their strategic alternatives. Among the strategic alternatives being investigated and considered by the Debtors is the possibility of a sale of all or substantially all of their assets either through a motion or the confirmation of a plan. The timing of any of the foregoing actions will depend on the timing and outcome of the investigation and consideration of strategic alternatives being performed by NatCity Investments, Inc. and numerous other ongoing matters in the Chapter 11 Cases. The debtors believe that it is possible that a sale or other transaction will be presented to the Bankruptcy Court for approval prior to the end of the calendar year. The United States Trustee for the District of Delaware (the "U.S. Trustee") has appointed an Official Committee of Unsecured Creditors (the "Creditors' Committee"). The Creditors' Committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court with respect to the Debtors. There can be no assurance that the Creditors' Committee or the Debtors' secured creditors will support the Debtors' positions. Disagreements among the Debtors, the Creditors' Committee and the Debtors' secured creditors could protract the Chapter 11 Cases, negatively impact the Debtors' ability to operate during the Chapter 11 Cases and delay the conclusion of the Chapter 11 Cases. In order to successfully exit Chapter 11, the Debtors will need to propose, and obtain confirmation by the Bankruptcy Court of, a plan that satisfies the requirements of the Bankruptcy Code. A plan would resolve, among other things, the Debtors' pre-petition obligations, set forth the revised capital structure of the newly reorganized entity and provide for its corporate governance subsequent to exit from bankruptcy. The timing of filing a plan of reorganization by the Company will depend on the timing and outcome of numerous other ongoing matters in the Chapter 11 Cases. There can be no assurance at this time that a plan will be filed in the Chapter 11 Cases, confirmed by the Bankruptcy Court, or that any such plan will be implemented successfully. At this time, it is not possible to predict accurately the effect of the Chapter 11 process on the Company's business or when it may emerge from Chapter 11. The rights and claims of various creditors and security holders may be determined by the plan as well. No assurance can be given as to what values, if any, will be ascribed in the bankruptcy proceedings to each of these constituencies, and it is possible that the Company's equity or other securities will be restructured in a manner that will reduce substantially or eliminate any remaining value. Accordingly, the Company urges that appropriate caution be exercised with respect to existing and future investments in any of such securities and claims. Pursuant to the Bankruptcy Code, the Debtors have filed schedules with the Bankruptcy Court setting forth the assets and liabilities of the Debtors as of the Petition Date. Differences between amounts recorded by the Debtors and claims filed by creditors will be investigated and resolved as part of the Chapter 11 Cases. A deadline for filing proofs of claim has not been established. Accordingly, the ultimate number and allowed amounts of such claims are not presently known. 8 Financial Statement Presentation. The accompanying consolidated financial statements have been prepared in accordance with American Institute of Certified Public Accountants' Statement of Position 90-7 ("SOP 90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," and on a going-concern basis, which contemplates continuity of operations, realization of assets and satisfaction of liabilities in the ordinary course of business. SOP 90-7 requires that the financial statements for periods subsequent to the filing of a Chapter 11 petition distinguish transactions and events that are directly associated with the reorganization from the operations of the business. Accordingly, revenues, expenses (including professional fees), realized gains and losses, and provisions for losses directly associated with the reorganization and restructuring of the business are reported separately in the financial statements. No material amounts were incurred or earned through June 30, 2003. The Statements of Consolidated Financial Position distinguish pre-petition liabilities subject to compromise both from those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Liabilities subject to compromise are reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, as a result of the Chapter 11 filing, the realization of assets and satisfaction of liabilities, without substantial adjustments and/or changes in ownership, are subject to uncertainty. While operating as debtors-in-possession under the protection of Chapter 11 of the Bankruptcy Code and subject to approval of the Bankruptcy Court or otherwise as permitted in the ordinary course of business, the Debtors, or some of them, may sell or otherwise dispose of assets and liquidate or settle liabilities for some amounts other than those reflected in the consolidated financial statements. Further, a plan in the Chapter 11 cases could materially change the amounts and classifications in the historical consolidated financial statements. Liabilities Subject to Compromise. Liabilities subject to compromise refers to liabilities incurred prior to the Petition Date. These amounts represent the Company's estimate of known or potential pre-petition claims to be resolved in connection with the Chapter 11 Cases. Such claims remain subject to future adjustments. Adjustments may result from negotiations, actions of the Bankruptcy Court, rejection of executory contracts and unexpired leases, the determination as to the value of any collateral securing claims, proofs of claim or other events. It is anticipated that such adjustments, if any, would be material. Payment terms for these amounts will be established in connection with the Chapter 11 Cases. Bankruptcy Items. In connection with the Company's bankruptcy filing, the Company has paid $600,000 of retainers to professionals for in reorganization expenses, the majority of which will related to costs to be incurred before September 30, 2003. With regard to these payments, approximately $580,000 is included in other current assets at June 30, 2003. Condensed Balance Sheet Information. Condensed balance sheet information with respect to Debtors at June 30, 2003 is as follows (in thousands): Assets: Current assets $19,901 Other assets 5,513 Liabilities: Current liabilities 3,875 Liabilities subject to compromise 43,313 Long-term liabilities 741

9 The assets listed above do not include a note receivable from Waterlink UK Holdings Limited to Waterlink, Inc. of approximately $8,401,000. This note receivable is eliminated upon consolidation for purposes of the consolidated balance sheet at June 30, 2003. 3. DISCONTINUED OPERATIONS In May 2002, the Company sold substantially all of the assets of its Pure Water Division for approximately $15.6 million in cash, $12.9 million of which was received at closing and $2.7 million of which has either been placed in escrow or has been held back by the purchaser, subject to reduction for any indemnification claims made on or before May 30, 2004. There will not be any gain or loss recorded in connection with the sale of the Pure Water Division until such time as all indemnification periods have expired and the amounts have been released from escrow. Accordingly, the results of operations for the Pure Water Division have been presented within discontinued operations in the accompanying consolidated financial statements for all periods presented. The Company allocates interest expense to its discontinued operations based on the expected net proceeds from the sale of its assets. Information regarding discontinued operations for the three and nine-month periods ended June 30, 2002 is presented below (in thousands):

The remaining escrows and holdbacks related to the sale of the Pure Water Division have been classified either as current or long-term assets on the consolidated balance sheets at September 30, 2002 and June 30, 2003 based on the anticipated timing of their release. 4. CUMULATIVE EFFECT OF ACCOUNTING CHANGE In June 2001 the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 142 (SFAS No. 142), "Goodwill and Other Intangible Assets". This statement requires that goodwill and intangible assets deemed to have an indefinite life not be amortized. Instead of amortizing goodwill and intangible assets deemed to have an indefinite life, the statement requires a test for impairment to be performed annually, or immediately if conditions indicate that such impairment could exist. The Company adopted the provisions of SFAS No. 142 effective October 1, 2002, and as a result, no longer records goodwill amortization, which was $160,000 and $476,000 for the three and nine-months ended June 30, 2002, respectively. During the quarter ended December 31, 2002, the Company completed the initial goodwill impairment review as required under SFAS No. 142 and determined that an impairment 10 condition did exist. Using a discounted cash flow analysis prepared by management, supported by an independent assessment of what a market comparable valuation might be, the Company determined it was necessary to reduce the goodwill balance at October 1, 2002 by $20,500,000. Had we accounted for goodwill under SFAS No. 142 for all periods presented, our results from continuing operations and related per share amounts would have been as follows (in thousands, except per share data):

There was no income tax effect related to the elimination of goodwill amortization, since goodwill amortization with regard to the reporting units is non-deductible for income tax purposes based on the nature of the acquisition. Per share amounts for basic and assuming dilution are identical, as all common stock equivalents are anti-dilutive for both periods presented. 5. INVENTORIES Inventories consisted of the following (in thousands):

11 6. CONTRACT BILLING STATUS Information with respect to the billing status of contracts in process is as follows (in thousands):

The above amounts are included in the accompanying consolidated balance sheets as follows (in thousands):

7. CAPITALIZATION Debt obligations consisted of the following (in thousands):

With regard to the above debt obligations, the $34,681,000 of senior debt, the $1,000,000 of subordinated notes to related parties, and the $2,250,000 of convertible subordinated notes payable are all subject to compromise and have been classified accordingly on the balance sheet as of June 30, 2003. The Company's senior credit facility is with Bank of America, NA, as agent, and with five other participating banks. Effective October 1, 2002, the Company entered into an amendment to its senior credit facility that extended the maturity date of the facility from October 1, 2002 to October 1, 2003, assuming the Company maintains a certain level of earnings before interest and taxes and maintains certain balance sheet ratios through September 30, 2003. The amendment also required the Company to present to the senior lenders on or before June 30, 2003 a 12 plan to repay the senior debt obligations. Concurrent with the amendment to the senior credit facility, the maturity dates of all subordinated notes payable were extended until October 15, 2003. In December 2002, Sutcliffe Speakman Limited, Waterlink's wholly-owned operating subsidiary in England, entered into a credit facility with The Royal Bank of Scotland, with availability based on a percentage of eligible accounts receivable, with a maximum borrowing amount of 1,250,000 pounds sterling. In connection with this facility, certain accounts receivable in England were pledged as collateral. In connection with entering into this credit facility, Waterlink remitted $1 million of the proceeds to our senior bank group as required by the October 1, 2002 amendment to the senior credit facility. Comprehensive income for the three months ended June 30, 2002 and 2003 was $969,000 and $768,000, respectively. The comprehensive loss for the nine months ended June 30, 2002 and 2003 was $324,000 and $20,051,000, respectively. The only significant component of comprehensive income or loss, other than net income or loss, was the effect of foreign currency translation adjustments. 8. GOING CONCERN CONSIDERATIONS The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As indicated in Note 2 Waterlink filed a petition for bankruptcy on June 27, 2003; and, as indicated in Note 7, all of Waterlink's outstanding debt obligations are classified as current liabilities. These factors raise substantial doubt about Waterlink's ability to continue as a going concern for a reasonable period of time. The financial statements do not include any adjustments relating to the recoverability and classification of assets or the amounts and classification of liabilities that might be necessary should Waterlink be unable to continue as a going concern. The Company's continuation as a going concern is dependent on its ability to: generate sufficient cash flows to operate its business; and to ultimately confirm a plan in the Chapter 11 Cases. At this time, Waterlink can give no level of assurance that we will be successful in developing confirmation and executing a plan in the Chapter 11 Cases. If it is unable to do so, then Waterlink would need to examine all alternatives, including, without limitation, a possible liquidation. 9. EARNINGS PER SHARE The computation of weighted average common shares outstanding, basic and assuming dilution, for the three-months ended June 30, 2003 follows (in thousands): Average shares outstanding-basic 19,665 Effect of dilutive common stock warrants 409 ------ Average shares outstanding-assuming dilution 20,074 ======

The adjustment to earnings related to cash generated from the exercise of dilutive common stock warrants was less than $1,000 and did not impact the computation of earnings per share for either period presented. 13 10. STOCK BASED COMPENSATION The Company accounts for employee stock options using the intrinsic value method. The Company has no current plans to change accounting methods. If the fair value recognition provisions of SFAS No. 123, "Accounting for Stock Based Compensation" had been applied to all stock based awards, the results would have been (in thousands, except for per share data):

The fair value of each award granted was estimated using a Black Scholes option-pricing model. 14 PART I, ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Waterlink is an international provider of integrated water and air purification solutions for both industrial and municipal customers. Waterlink was incorporated in Delaware on December 7, 1994. The continuing operations of Waterlink are comprised of Barnebey Sutcliffe Corporation in the United States, Sutcliffe Speakman Limited in England, and the corporate office. CHAPTER 11 Bankruptcy Proceedings. On June 27, 2003, the Debtors filed voluntary petitions for relief under Chapter 11 of the United States Bankruptcy Code. For further details regarding the Chapter 11 Cases, see "Voluntary Chapter 11" in the Notes to Consolidated Financial Statements. CRITICAL ACCOUNTING POLICIES Revenue Recognition Waterlink considers its accounting policy regarding revenue recognition on long-term contracts to be a critical accounting policy. The majority of revenue relates to carbon sales and services and is recognized when title passes upon shipment. The systems and equipment produced by Waterlink are custom designed and can take a number of months to produce. Revenues from systems and equipment contracts are recognized using the percentage of completion method of accounting in the proportion that costs incurred bear to total estimated costs at completion. Waterlink believes that this method of accounting best measures revenue earned as progress is made toward completion of the contract. Revisions of estimated costs are recognized in the period in which they are determined. Provisions are made currently for all known or anticipated losses. Variations from estimated contract performance could result in a material adjustment to operating results for any fiscal quarter or year. Claims for extra work or changes in scope of work are included in revenues when collection is probable. Retirement Plans Waterlink sponsors two defined benefit pension plans that cover substantially all of our employees. The accounting for pensions is determined by standardized accounting and actuarial methods that include critical assumptions; which include discount rates, expected return on plan assets and future compensation increases. Waterlink considers these assumptions to be critical as they can impact periodic pension expense as well as the minimum pension liability. During the year ended September 30, 2002, Waterlink increased the additional minimum pension liability by $2,219,000 and reduced equity by the corresponding amount. At June 30, 2003, Waterlink's accrued pension liabilities totaled $3,815,000. BACKLOG In the past Waterlink has experienced quarterly fluctuations in operating results due to the contractual nature of its business and the consequent timing of these orders. In addition, certain of the contracts will be subject to the customer's ability to finance, or fund from government sources, the actual costs of completing the project as well as the ability to receive any necessary permits to commence the project. Therefore, Waterlink expects that its future operating results 15 could fluctuate, especially on a quarterly basis, due to the timing of the awarding of such contracts, the ability to fund project costs, and the recognition by Waterlink of revenues and profits. In addition, Waterlink has historically operated with a moderate backlog. As of June 30, 2003, Waterlink's total backlog from continuing operations was approximately $16.3 million, consisting of $12.1 million of firm commitments to purchase carbon and related services and $4.2 million of written purchase orders for systems and equipment. Quarterly sales and operating results will be affected by the volume and timing of contracts received and performed within the quarter, which are difficult to forecast. Any significant deferral or cancellation of a contract could have a material adverse effect on Waterlink's operating results in any particular period. Because of these factors, Waterlink believes that period-to-period comparisons of its operating results are not necessarily indicative of future performances. RESULTS OF CONTINUING OPERATIONS The following table sets forth, for the periods indicated, statements of operations data as a percentage of net sales. In an effort to enhance comparability between the two periods, goodwill amortization has been excluded from the three and six-month periods ended March 31, 2002.

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002 Net Sales: Net sales for the three months ended June 30, 2003 were $18,074,000, an increase of $1,967,000, or 12.2%, from the $16,107,000 in net sales reported in the comparable prior period. On a consolidated basis, sales of carbons and related services increased by 13.0%, with increase realized both in England and in the United States. Capital equipment sales increased by 8.9% in the current quarter, with the increase coming in the United States. 16 Gross Profit: Gross profit for the three months ended June 30, 2003 was $4,130,000, an increase of $349,000 from the comparable prior period, due to the increase in net sales. The gross margin decreased from 23.5% in 2002 to 22.9% in 2003 as a result of product mix and classification of certain manufacturing costs as compared to the prior year quarter. Selling, General and Administrative Expenses: Selling, general and administrative expenses for the three months ended June 30, 2003 were $2,702,000, an increase of $248,000, or 10.1%, from the comparable prior period. This increase reflects $250,000 of costs recorded at the corporate office with regard to professionals engaged to assist the Company with the evaluation of its financial alternatives with regard to its leverage situation. Selling, general and administrative expenses as a percentage of net sales were 15.0% for the three months ended June 30, 2003 as compared to 15.2% for the comparable prior period. Interest Expense: Interest expense for the three months ended June 30, 2003 was $792,000, a decrease of $131,000 from the comparable prior period. This decrease reflects both a decrease in interest rates and principal reductions made over the last year. Amortization of Financing Costs: Amortization of financing costs was $100,000 for the three months ended June 30, 2003 and $127,000 for the three months ended June 30, 2002. Nine Months Ended June 30. 2003 Compared to Nine Months Ended June 30, 2002 Net Sales: Net sales for the nine months ended June 30, 2003 were $48,137,000, an increase of $1,007,000, or 2.1%, from the $47,130,000 in net sales reported in the comparable prior period. On a consolidated basis, sales of carbons and related services increased by 6.1%, represented by a 35.7% increase in England that was partially offset by a 2.3% decrease in the United States. This overall growth in sales of carbon and related services was more than offset by a 12.8% decrease in sales of capital equipment. Sales of capital equipment were down in both the United States and England as compared to the prior year. Sales of capital equipment were impacted by the lack of spending in the marketplace. Gross Profit: Gross profit for the nine months ended June 30, 2003 was $10,761,000, a decrease of $165,000 from the comparable prior period, due to a reduction in the gross margin from 23.1% to 22.4%. The decrease in the gross margin reflects product mix and the classification of certain manufacturing costs as compared to the prior year quarter. Selling, General and Administrative Expenses: Selling, general and administrative expenses for the nine months ended June 30, 2003 were $7,740,000, an increase of $229,000, or 3.0%, from the comparable prior period. This increase reflects $358,000 of costs recorded at the corporate office with regard to professionals engaged to assist the Company with the evaluation of its financial alternatives with regard to its leverage situation. Absent this special expense, selling, general and administrative expense decreased by $129,000, or 1.7%. Selling, general and administrative expenses as a percentage of net sales were 16.1% for the three months ended June 30, 2003 as compared to 15.9% for the comparable prior period. Interest Expense: Interest expense for the nine months ended June 30, 2003 was $2,488,000, a decrease of $296,000 from the comparable prior period. This decrease reflects both a decrease in interest rates and principal reductions made over the last year. 17 Amortization of Financing Costs: Amortization of financing costs was $232,000 for the nine months ended June 30, 2003 and $503,000 for the nine months ended June 30, 2002. The amount in the prior year period reflects the amortization of fees relating to two separate bank amendments entered into from September 30, 2001 to March 31, 2002. LIQUIDITY AND CAPITAL RESOURCES Since its inception, Waterlink's primary sources of liquidity have been: -- borrowings available under credit facilities -- net proceeds from the sale of Waterlink's common and preferred stock -- net proceeds from the sale of businesses in connection with the strategic alternative process -- issuance of common stock and seller financing incurred in connection with Waterlink's completed acquisitions -- cash flow from certain profitable operations Historically, Waterlink's primary uses of capital have been: -- the funding of its acquisition program -- working capital requirements including the funding for growth at certain operations -- the funding required for certain under-performing acquisitions -- the funding of interest on borrowings and the repayment of borrowings In May 2000 Waterlink announced that its board of directors had instructed management to explore various strategic alternatives, including the sale of all or part of Waterlink. To date, Waterlink has sold four of its five operating divisions: the biological division in two separate transactions in September and December 2000; the separations division in February 2001; the European water and wastewater division in a series of transactions during the fourth quarter of our fiscal year ended September 30, 2001, and the pure water division in May 2002. At June 30, 2003, Waterlink has recorded $2,217,000 of net assets of discontinued operations that represents amounts either placed in escrow or held back by the purchaser of the pure water division. These assets are subject to reduction for indemnification claims made on or before May 30, 2004. In September 2001 the Board of Directors of Waterlink determined the corporate office should be relocated to its Columbus, Ohio facility. This consolidation resulted in personnel reductions and the disposition of certain fixed assets. Accordingly, Waterlink recorded a special charge of $2,560,000 in 2001 relating to severance obligations to eight individuals and the write-off of certain fixed assets. At June 30, 2003, approximately $1,241,000 remains accrued for severance obligations relating to two of these individuals and is currently being paid at a rate of approximately $24,000 per month. For the nine months ended June 30, 2003, net cash provided by operating activities was $8,204,000 and purchases of equipment totaled $956,000. During the nine months ended June 30, 2003, Waterlink collected $250,000 of proceeds related to the sale of the European water and wastewater division that was previously held back. This entire amount was remitted to our senior lenders as required by the domestic senior credit facility. 18 Waterlink is currently funding their operations through the use of cash collateral pursuant to Order entered by the Bankruptcy Court pursuant to Section 363 of the Bankruptcy Code. The Debtors believe that the use of cash collateral will support current operations and satisfy all customer needs. The Debtors currently have authority to use cash collateral until September 26, 2003. The Bankruptcy Court has scheduled a hearing to consider the further use of cash collateral for September 25, 2003. The Debtors expect to file a motion fur further use of cash collateral prior to the September 25, 2003 hearing date and to ask the court for further use of cash collateral at the hearing. Credit Availability As of June 30, 2003, Waterlink's credit facilities were comprised of (1) a $34,681,000 domestic senior credit facility with Bank of America, NA, as agent, which expires on October 1, 2003, and (2) a 1,250,000 pounds sterling revolving credit facility in England with The Royal Bank of Scotland. At June 30, 2003 there were no borrowings available under the domestic senior credit facility in the United States and approximately $536,000 of borrowings available in England with The Royal Bank of Scotland. Effective October 1, 2002, Waterlink entered into an amendment to our domestic senior credit facility that extended the maturity date of the facility from October 1, 2002 to October 1, 2003, assuming Waterlink maintains a certain level of earnings before interest and taxes and maintains certain balance sheet ratios through September 30, 2003. The amendment also required Waterlink to present to the senior lenders on or before June 30, 2003 a plan to repay the senior debt obligations, as well as additional strategic milestone obligations arising on or before July 31, 2003 and August 31, 2003 relating to said plan. Without an amendment to our domestic senior credit facility that would further extend the maturity date, an infusion of additional capital, or the sale of significant assets, Waterlink will not be able to meet its scheduled payment obligations under the domestic senior credit facility. Since the filing of the Chapter 11 Cases, Waterlink has not made any payments under the domestic senior credit facility. At this time, Waterlink can give no level of assurance that we will be successful in developing and executing a plan to repay the domestic senior credit facility. In December 2002, Sutcliffe Speakman Limited, Waterlink's wholly-owned operating subsidiary in England, entered into a credit facility with The Royal Bank of Scotland, with availability based on a percentage of eligible accounts receivable, with a maximum borrowing amount of 1,250,000 pounds sterling. In connection with this facility certain accounts receivable were pledged as collateral. In connection with entering into this credit facility, Waterlink remitted $1 million of the proceeds to our senior bank group as required by the October 1, 2002 amendment to the domestic senior credit facility. The balance outstanding on the facility with The Royal Bank of Scotland in England was approximately $867,000 at June 30, 2003. The terms of the credit facilities restrict or prohibit Waterlink from taking many actions, including paying dividends and incurring or assuming other indebtedness or liens. Waterlink's obligations under the domestic senior credit facility are secured by liens on a substantial portion of Waterlink's domestic assets, including equipment, inventory, accounts receivable and general intangibles and the pledge of most of the stock of Waterlink's subsidiaries. 19 The Debtors are currently funding their operations through the use of cash collateral pursuant to Order entered by the Bankruptcy Court pursuant to Section 363 of the Bankruptcy Code. The Debtors believe that the use of cash collateral will support current operations and satisfy all customer needs. The Debtors currently have authority to use cash collateral until September 26, 2003. The Bankruptcy Court has scheduled a hearing to consider the further use of cash collateral for September 25, 2003. The Debtors expect to file a motion for further use of cash collateral prior to the September 25, 2003 and to request authorization for further use of cash collateral beyond September 26, 2003. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS In August 2001, FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS No. 144), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", and the accounting and reporting provisions of Accounting Principles Board ("APB") Opinion No. 30, Reporting the Results of Operations for a disposal of a segment of a business. SFAS No. 144 is effective for fiscal years beginning after December 15, 2001. Waterlink adopted SFAS No. 144 as of October 1, 2002 and the adoption of SFAS No. 144 did not have an impact on Waterlink's financial position or results from operations. In July 2002, FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS No. 146 is to be applied prospectively to exit or disposal activities initiated after December 31, 2002 and, accordingly, Waterlink can only determine prospectively the impact, if any, SFAS No. 146 would have on Waterlink's financial position and results of operations. In December 2002, FASB issued SFAS No. 148 "Accounting for Stock-Based Compensation-Transition and Disclosure." SFAS No. 148 amends SFAS 123 "Accounting for Stock-Based Compensation" and APB Opinion No. 28, "Interim Financial Reporting." Companies reporting stock-based compensation on the intrinsic value method, as does Waterlink, are now required to include in interim financial statements, as well as annual financial statements, certain disclosures of stock-based compensation cost and pro forma net income and earnings per share information as if the fair value method of accounting for stock-based compensation had been applied to all periods. SFAS No. 148's amendment of annual disclosure requirements is effective for Waterlink's fiscal year ending September 30, 2003, whiles its impact on interim financial information became effective for Waterlink's quarter ended March 31, 2003. SFAS No. 148 had no impact on consolidated net income or net worth of Waterlink upon implementation, but did add pro forma information, which is shown in Note 10 to the financial statements for the three and nine-month periods ended June 30, 2003. In May 2003, FASB issued SFAS No. 150 "Accounting for Certain Financial Instruments with Characteristics of both Liability and Equity" which requires that certain classes of financial instruments previously classified in equity be classified in the liability section of the balance 20 sheet. The Statement is effective for contracts created or modified after May 31, 2003 and for existing contracts at the beginning of the first interim period beginning after June 15, 2003. Waterlink did not enter into any such contracts between May 31, 2003 and June 30, 2003. The Company has not determined the financial reporting effects of implementing this Statement as of July 1, 2003. FORWARD LOOKING STATEMENTS With the exception of historical information, the matters discussed in this report may include forward-looking statements that involve risks and uncertainties. While forward-looking statements are sometimes presented with numerical specificity, they are based on a variety of assumptions made by management regarding future circumstances over which Waterlink has little or no control. A number of important factors, including those identified in this section as well as factors discussed elsewhere herein, could cause Waterlink's actual results to differ materially from those in forward-looking statements or financial information. Actual results may differ from forward-looking results for a number of reasons, including the following: - the ability to negotiate with creditors payment terms - the ability to continue as a going concern - the ability to continue to obtain further Bankruptcy Court authority to use cash collateral - the ability to obtain court approval with respect to motions in the Chapter 11 cases prosecuted by it from time to time - the ability to develop, prosecute, confirm and consummate one or more plans in the Chapter 11 Cases - risks associated with third parties seeking and obtaining court approval for the appointment of a Chapter 11 trustee or to convert the Chapter 11 cases to Chapter 7 cases - the ability to obtain and maintain normal terms with vendors and service providers - the ability to maintain contracts that are critical to its operations - the potential adverse impact of the Chapter 11 Cases on the Debtors' liquidity or results of operations - the ability to execute its business plan - the ability to attract, motivate and/or retain key employees - the ability to attract and retain customers - changes in world economic conditions, including - instability of governments and legal systems in countries in which Waterlink conducts business - significant changes in currency valuations - recessionary environments - the effects of military conflicts - changes in customer demand and timing of orders as they affect sales and product mix, including - the effect of strikes at a customer's facilities - variations in backlog - the impact of changes in industry business cycles - changes in environmental laws 21 - competitive factors, including - changes in market penetration - introduction of new products by existing and new competitors - changes in operating costs, including - changes in Waterlink's and its subcontractors' manufacturing processes - changes in costs associated with varying levels of operations - changes resulting from different levels of customers demands - effects of unplanned work stoppages - changes in cost of labor and benefits - the cost and availability of raw materials and energy - the cost of capital, including interest rate increases - unanticipated litigation, claims or assessments Readers are referred to the "Forward-Looking Statements" and "Risk Factors" sections, commencing on page 16, in Waterlink's 2002 Annual Report on Form 10-K filed on December 10, 2002, which identifies important risk factors that could cause actual results to differ from those contained in the forward-looking statements herein. Item 4. Controls and Procedures (a) Evaluation of disclosure controls and procedures. As of the end of the fiscal quarter ended June 30, 2003, an evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO"), and the Chief Financial Officer ("CFO"), of the effectiveness of the design and operation of the Company's disclosure controls and procedures to ensure that the information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. Based on that evaluation, the Company's management, including the CEO and CFO, concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this report. (b) Changes in internal controls. There was no change in the Company's internal control over financial reporting that occurred during the fiscal quarter ended June 30, 2003 that has materially affected, or is reasonably likely to materially affect, internal control over financial reporting. 22 PART II - OTHER INFORMATION Item 1. Legal Proceedings. On June 27, 2003 (the "Petition Date"), Waterlink filed a voluntary petition for reorganization under Chapter 11 of Title 11 of the United States Code (the "Bankruptcy Code") in the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court"), Case No. 03-11989. Four of Waterlink's subsidiaries, Barnebey Sutcliffe Corporation, an Ohio corporation (Case No. 03-11993), Waterlink Technologies, Inc., a Delaware corporation (Case No. 03-11990), Waterlink Management, Inc., an Ohio corporation (Case No. 03-11992), and C'Treat Offshore, Inc., a Texas corporation (Case No. 03-11991) also filed voluntary petitions for reorganization under the provisions of Chapter 11 of the Bankruptcy Code in the Bankruptcy Court. Waterlink and the foregoing companies are collectively referred to as the "Filing Companies," and the bankruptcy cases of the Filing Companies are collectively referred to herein as the "Bankruptcy Cases." Pursuant to a Bankruptcy Court order dated July 2, 2003, the Bankruptcy Cases are being jointly administered under Case No. 03-11989. Item 3. Defaults Upon Senior Securities. On the Petition Date, the Debtors commenced the Chapter 11 Cases. Under the terms of the senior credit facility with Bank of America, NA, as agent, Waterlink was obligated to make a scheduled principal repayment of $150,000 and a scheduled interest payment of approximately $177,000 on June 30, 2003, which payment has not been made. As a result of the filing of the Chapter 11 Cases and the non-payment, Waterlink is in default under the domestic senior credit facility, with the total arrearage thereunder as of the date of this filing being approximately $35,558,000, although enforcement of the lenders' remedies is currently stayed as a result of the Chapter 11 Cases. Item 5. Other Information At a hearing conducted on July 31, 2003, NatCity Investments, Inc. disclosed some of the terms of a non-binding letter of intent submitted with respect to a possible acquisition of substantially all of the Debtors' assets, which was reported in the August 1, 2003 edition of Daily Bankruptcy Review Small-Cap, published by DowJones Newsletters. Due to, among other things, the non-binding nature of the referenced draft letter of intent and the Debtors' decision to retain NatCity Investments, Inc. to consider strategic alternatives, the Debtors made the determination not to execute the draft letter of intent. 23 Item 6. Exhibits and Reports on Form 8-K (a) Exhibits - The following exhibits are filed as part of this Form 10-Q. 31.1 Section 302 Certification of the Company's Chief Executive Officer 31.2 Section 302 Certification of the Company's Chief Financial Officer 32.1 Section 906 Certification of the Company's Chief Executive Officer 32.2 Section 906 Certification of the Company's Chief Financial Officer (b) Reports on Form 8-K. (i) On May 5, 2003 Waterlink filed a Current Report on Form 8-K reporting under item 5 the resignation of Dr. R. Gary Bridge from our Board of Directors. (ii) On May 12, 2003 Waterlink filed a Current Report on Form 8-K reporting under item 7 and item 9 the issuance of a press release concerning second quarter operating results and including under item 7(c) a copy of the press release. (iii) On June 13, 2003 Waterlink filed a Current Report on Form 8-K reporting under item 5 the resignation of Peter G. Kleinhenz from our Board of Directors. (iv) On June 27, 2003 Waterlink filed a Current Report on Form 8-K reporting under item 5 and item 7 the issuance of a press release announcing that Waterlink filed a voluntary petition for reorganization under Chapter 11 of Title 11 of the United States Bankruptcy Code. 24 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. Waterlink, Inc. (Registrant) By: /s/ William W. Vogelhuber ---------------------------------- William W. Vogelhuber President and Chief Executive Officer By: /s/ Donald A. Weidig ---------------------------------- Donald A. Weidig Chief Financial Officer Dated: August 19, 2003 25

WATERLINK INC 10-Q