10-Q 1 l00965ae10vq.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 March 31, 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 Identification No.) of Incorporation or Organization) --------------------------------- 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 April 30, 2003 ================================================================================ INDEX WATERLINK, INC. AND SUBSIDIARIES
PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Consolidated balance sheets - September 30, 2002 and March 31, 2003 3 - 4 Consolidated statements of operations - Three months ended March 31, 2002 and 2003; Six months ended March 31, 2002 and 2003 5 Consolidated statements of cash flows - Six months ended March 31, 2002 and 2003 6 Notes to consolidated financial statements 7 - 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 - 18 Item 4. Controls and Procedures 19 PART II - OTHER INFORMATION Item 4. Submission of Matters to Vote of Security Holders 19 Item 6. Exhibits and Reports on Form 8-K 19 Signatures 20 Certifications 21 - 22
2 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS-UNAUDITED
September 30, March 31, 2002 2003 ------------- ----------- (In thousands) ASSETS Current assets: Cash and cash equivalents $ 2,530 $ 1,986 Trade accounts receivable, net 11,210 11,711 Inventories 10,528 9,592 Costs in excess of billings 1,783 851 Other current assets 1,130 752 Net assets of discontinued operations 640 390 ------- ------- Total current assets 27,821 25,282 Property, plant and equipment, at cost: Land, buildings and improvements 1,626 1,689 Machinery and equipment 6,538 7,086 Office equipment 717 810 ------- ------- 8,881 9,585 Less accumulated depreciation 3,723 4,173 ------- ------- 5,158 5,412 Other assets: Goodwill 24,250 3,730 Other assets 85 125 Net assets of discontinued operations 2,170 2,170 ------- ------- 26,505 6,025 ------- ------- Total assets $59,484 $36,719 ======= =======
See notes to consolidated financial statements 3 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS-UNAUDITED (CONTINUED)
September 30, March 31, 2002 2003 -------------- ------------- (In thousands, except share data) LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Trade accounts payable $ 6,848 $ 5,087 Accrued expenses 5,988 6,148 Billings in excess of cost 232 1,218 Accrued income taxes 313 309 Current debt obligations 39,674 38,319 --------- --------- Total current liabilities 53,055 51,081 Accrued pension costs 3,787 3,815 Shareholders' equity (deficit): Preferred Stock, $.001 par value, 10,000,000 shares authorized, none issued and outstanding -- -- Common Stock, voting, $.001 par value, authorized - 40,000,000 shares, issued and outstanding - 19,659,694 shares at September 30, 2002 and 19,665,149 shares at March 31, 2003 20 20 Additional paid-in capital 92,174 92,174 Accumulated other comprehensive loss (6,314) (6,323) Accumulated deficit (83,238) (104,048) --------- --------- Total shareholders' equity (deficit) 2,642 (18,177) --------- --------- Total liabilities and shareholders' equity $ 59,484 $ 36,719 ========= =========
See notes to consolidated financial statements 4 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
Three Months Ended Six Months Ended March 31, March 31, 2002 2003 2002 2003 -------- -------- -------- -------- (In thousands, except per share data) Net sales $ 16,143 $ 15,768 $ 31,023 $ 30,063 Cost of sales 12,353 12,277 23,878 23,432 -------- -------- -------- -------- Gross profit 3,790 3,491 7,145 6,631 Selling, general and administrative expenses 2,461 2,496 5,057 5,038 Amortization 158 -- 316 -- -------- -------- -------- -------- Operating income 1,171 995 1,772 1,593 Other expense: Interest expense (902) (826) (1,862) (1,696) Amortization of financing costs (117) (56) (376) (132) Other items-net (22) (1) (41) 2 -------- -------- -------- -------- Income (loss) before income taxes 130 112 (507) (233) Income taxes 3 55 6 77 -------- -------- -------- -------- Income (loss) from continuing operations 127 57 (513) (310) Loss from discontinued operations (120) -- (219) -- -------- -------- -------- -------- Loss before cumulative effect of accounting change 7 57 (732) (310) Cumulative effect of accounting change -- -- -- (20,500) -------- -------- -------- -------- Net income (loss) $ 7 $ 57 $ (732) $(20,810) ======== ======== ======== ======== Per share data: Basic and assuming dilution: Continuing operations $ 0.01 $ 0.00 $ (0.03) $ (0.02) Discontinued operations (0.01) -- (0.01) -- Cumulative effect of accounting change -- -- -- (1.04) -------- -------- -------- -------- $ 0.00 $ 0.00 $ (0.04) $ (1.06) ======== ======== ======== ======== Weighted average common shares outstanding: Basic 19,660 19,664 19,660 19,662 Assuming dilution 20,111 20,092 19,660 19,662
See notes to consolidated financial statements 5 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS-UNAUDITED
Six Months Ended March 31, 2002 2003 ----------- ----------- (In thousands) OPERATING ACTIVITIES Loss from continuing operations $ (513) $ (310) Adjustments to reconcile loss from continuing operations to net cash provided by operating activities: Depreciation and amortization 1,151 567 Deferred income taxes -- 47 Changes in working capital: Accounts receivable 453 (468) Inventories 890 957 Costs in excess of billings (341) 938 Other assets (65) 440 Accounts payable (1,449) (1,792) Accrued expenses (64) (65) Billings in excess of cost 37 985 Accrued income taxes (67) (5) ------- ------- Net cash provided by operating activities 32 1,294 INVESTING ACTIVITIES Proceeds from sale of divisions 66 250 Purchases of equipment (233) (672) ------- ------- Net cash used by investing activities (167) (422) FINANCING ACTIVITIES Proceeds from long-term borrowings 422 189 Payments on long-term borrowings (591) (1,543) ------- ------- Net cash used by financing activities (169) (1,354) Effect of exchange rate changes on cash (49) 23 ------- ------- Cash flows used by continuing operations (353) (459) Cash flows used in discontinued operations (867) (85) ------- ------- Decreases in cash and cash equivalents (1,220) (544) Cash and cash equivalents at beginning of period 1,646 2,530 ------- ------- Cash and cash equivalents at end of period $ 426 $ 1,986 ======= =======
See notes to consolidated financial statements 6 PART I, ITEM I - FINANCIAL STATEMENTS WATERLINK, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2003 (INFORMATION AS OF MARCH 31, 2003 AND FOR THE THREE AND SIX -MONTH PERIODS ENDED MARCH 31, 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 six-month periods ended March 31, 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. 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 six-month periods ended March 31, 2002 is presented below (in thousands):
Three Six Months Months Ended Ended March 31, 2002 ------------------------------ Net sales $ 3,342 $ 6,871 Operating income 115 243 Allocated interest expense (235) (462) Income tax expense - - ------------------------------ Loss from operations $ (120) $ (219) ==============================
7 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 March 31, 2003 based on the anticipated timing of their release. 3. 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 $158,000 and $316,000 for the three and six-months ended March 31, 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 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 balance of goodwill 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):
Three Months Ended Six Months Ended March 31, March 31, 2002 2003 2002 2003 -------------------------------------------------- Reported income (loss) from continuing operations $ 127 $ 57 $ (513) $ (310) Add back goodwill amortization 158 -- 316 -- -------------------------------------------------- Adjusted income (loss) from continuing operations $ 285 $ 57 $ (197) $ (310) ================================================== Reported income (loss) per share from continuing operations $ 0.01 $ 0.00 $ (0.03) $ (0.02) Add back goodwill amortization 0.01 -- 0.02 -- -------------------------------------------------- Adjusted income (loss) per share from continuing operations $ 0.02 $ 0.00 $ (0.01) $ (0.02) ==================================================
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. 8 4. INVENTORIES Inventories consisted of the following (in thousands):
September 30, March 31, 2002 2003 --------------------------------------- Raw materials and supplies $ 6,279 $ 6,143 Work in process 203 296 Finished goods 4,046 3,153 --------------------------------------- $ 10,528 $ 9,592 =======================================
5. CONTRACT BILLING STATUS Information with respect to the billing status of contracts in process is as follows (in thousands):
September 30, March 31, 2002 2003 --------------------------------------- Contract costs incurred to date $ 20,664 $ 10,666 Estimated profits 8,753 4,578 --------------------------------------- Contract revenue earned to date 29,417 15,244 Less billings to date 27,866 15,611 --------------------------------------- Costs and estimated earnings in excess of (less than) billings, net $ 1,551 $ (367) =======================================
The above amounts are included in the accompanying consolidated balance sheets as follows (in thousands):
September 30, March 31, 2002 2003 --------------------------------------- Costs in excess of billings $ 1,783 $ 851 Billings in excess of cost (232) (1,218) --------------------------------------- $ 1,551 $ (367) =======================================
6. CAPITALIZATION Debt obligations consisted of the following (in thousands):
September 30, March 31, 2002 2003 ----------------------------------------- Senior credit facility with a group of banks $36,424 $34,881 Revolving facility in England with a bank - 188 Subordinated notes to related parties 1,000 1,000 Convertible subordinated notes payable to former shareholders of acquired business 2,250 2,250 ----------------------------------------- $39,674 $38,319 =========================================
9 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 requires the Company to present to the senior lenders on or before June 30, 2003 a 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. The comprehensive loss for the three months ended March 31, 2002 and 2003 was $327,000 and $222,000, respectively. The comprehensive loss for the six months ended March 31, 2002 and 2003 was $1,293,000 and $20,819,000, respectively. The only significant component of comprehensive income or loss, other than net income or loss, was the effect of foreign currency translation adjustments. 7. 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 6, all of Waterlink's outstanding debt obligations are classified as current liabilities, causing a working capital deficiency of $25,799,000. This raises 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; meet its debt covenant requirements; and develop and execute a plan to repay the senior credit facility obligations on or prior to the maturity date. At this time, Waterlink can give no level of assurance that we will be successful in developing and executing a plan to repay the senior credit facility on or prior to the maturity date. If we are unable to successfully satisfy requisite conditions and to repay the senior credit facility, then Waterlink would be in default at that time under the terms of the credit agreement. If there is such an event of default the senior lenders could declare that all borrowings under the senior credit facility are then immediately due and payable. In such event, Waterlink would need to examine all alternatives, including, without limitation, possible protection under the bankruptcy laws. 10 8. EARNINGS PER SHARE The following table sets forth the computation of weighted average common shares outstanding, basic and assuming dilution, for the three-month periods ended March 31, 2002 and 2003 (in thousands):
Three Month Ended March 31 2002 2003 ------------------------------- Average shares outstanding-basic 19,660 19,664 Effect of dilutive common stock warrants 451 428 ------------------------------- Average shares outstanding-assuming dilution 20,111 20,092 ===============================
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. 9. 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):
Three Months Ended Six Months Ended March 31, March 31, 2002 2003 2002 2003 -------------------------------------------------------- PRO FORMA IMPACT OF FAIR VALUE METHOD Reported net income (loss) $ 7 $ 57 $ (732) $(20,810) Stock-based employee compensation determined under fair value based method, net of taxes 109 (11) 251 (26) -------------------------------------------------------- Pro forma net income (loss) $ 116 $ 46 $ (481) $(20,836) ======================================================== EARNINGS (LOSS) PER COMMON SHARE Basic and assuming dilution-as reported $ 0.00 $ 0.00 $ (0.04) $ (1.06) Basic and assuming dilution-pro forma $ 0.01 $ 0.00 $ (0.02) $ (1.06)
The fair value of each award granted was estimated using a Black Scholes option-pricing model. 11 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. 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 March 31, 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 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 March 31, 2003, Waterlink's total backlog from continuing operations was approximately $17.9 million, consisting of $12.9 million of firm commitments to purchase carbon and related services and 12 $5.0 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 Six Months Ended March 31, March 31, 2002 2003 2002 2003 ------------- -------------- ------------ ------------ Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 76.5 77.9 77.0 77.9 ------------- -------------- ------------ ------------ Gross profit 23.5 22.1 23.0 22.1 Selling, general and administrative expenses 15.3 15.8 16.3 16.8 ------------- -------------- ------------ ------------ Operating income 8.2 6.3 6.7 5.3 Other expense: Interest expense (5.6) (5.2) (6.0) (5.6) Amortization of financing costs (0.7) (0.4) (1.2) (0.5) Other items - net (0.1) (0.0) (0.1) 0.0 ------------- -------------- ------------ ------------ Income (loss) before income taxes 1.8 0.7 (0.6) (0.8) Income taxes 0.0 0.3 - 0.2 ------------- -------------- ------------ ------------ Income (loss) from continuing operations 1.8 0.4 (0.6) (1.0) Discontinued operations (0.8) - (0.7) - ------------- -------------- ------------ ------------ Income (loss) before cumulative effect of accounting change 1.0 0.4 (1.3) (1.0) Cumulative effect of accounting change - - - (68.2) ------------- -------------- ------------ ------------ Net income (loss) 1.0% 0.4% (1.3)% (69.2)% ============= ============== ============ ============
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002 Net Sales: Net sales for the three months ended March 31, 2003 were $15,768,000, a decrease of $375,000, or 2.3%, from the $16,143,000 in net sales reported in the comparable prior period. On a consolidated basis, sales of carbons and related services increased by 6.8%, represented by a 59.5% increase in England that was partially offset by a 7.2% decrease in the United States. This overall growth in sales of carbon and related services was more than offset by a 38.6% 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. During the quarter ended March 31, 2003, orders totaling over $4.9 million were received for capital equipment items, which increased backlog for capital equipment to $5.0 at March 31, 2003. 13 Gross Profit: Gross profit for the three months ended March 31, 2003 was $3,491,000, a decrease of $299,000 from the comparable prior period, due to the decrease in net sales and a reduction in the gross margin from 23.5% to 22.1%. 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 three months ended March 31, 2003 were $2,496,000, an increase of $35,000, or 1.4%, from the comparable prior period. Selling, general and administrative expenses as a percentage of net sales were 15.8% for the three months ended March 31, 2003 as compared to 15.3% for the comparable prior period. Interest Expense: Interest expense for the three months ended March 31, 2003 was $826,000, a decrease of $76,000 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 $56,000 for the three months ended March 31, 2003 and $117,000 for the three months ended March 31, 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. Six Months Ended March 31. 2003 Compared to Six Months Ended March 31, 2002 Net Sales: Net sales for the six months ended March 31, 2003 were $30,063,000, a decrease of $960,000, or 3.1%, from the $31,023,000 in net sales reported in the comparable prior period. On a consolidated basis, sales of carbons and related services increased by 5.7%, represented by a 52.0% increase in England that was partially offset by a 6.7% decrease in the United States. This overall growth in sales of carbon and related services was more than offset by a 34.4% 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. During the quarter ended March 31, 2003, orders totaling over $4.9 million were received for capital equipment items, which increased backlog for capital equipment to $5.0 at March 31, 2003. Gross Profit: Gross profit for the six months ended March 31, 2003 was $6,631,000, a decrease of $514,000 from the comparable prior period, due to the decrease in net sales and a reduction in the gross margin from 23.0% to 22.1%. 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 six months ended March 31, 2003 were $5,038,000, a decrease of $19,000, or 0.4%, from the comparable prior period. Selling, general and administrative expenses as a percentage of net sales were 16.8% for the three months ended March 31, 2003 as compared to 16.3% for the comparable prior period. Interest Expense: Interest expense for the six months ended March 31, 2003 was $1,696,000, a decrease of $166,000 from the comparable prior period. This decrease reflects both a decrease in interest rates and principal reductions made over the last year. 14 Amortization of Financing Costs: Amortization of financing costs was $132,000 for the six months ended March 31, 2003 and $376,000 for the six months ended March 31, 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 that could maximize our shareholders' investment in 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 March 31, 2003, Waterlink has recorded $2,560,000 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 March 31, 2003, approximately $1,300,000 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. Waterlink does not currently anticipate making significant capital investments in plant and equipment because we believe our current businesses do not require such investments as well as our current financial position. 15 For the six months ended March 31, 2003, net cash provided by operating activities was $1,294,000 and purchases of equipment totaled $672,000. During the six months ended March 31, 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. Credit Availability As of March 31, 2003, Waterlink's credit facilities were comprised of (1) a $34,881,000 domestic senior credit facility with Bank of America, NA, as agent, which expires on October 1, 2003, (2) a 1,250,000 pounds sterling revolving credit facility in England with The Royal Bank of Scotland, and (3) a $200,000 credit facility for our operating subsidiary in England with Bank of America to support duty bonds and other similar instruments. The credit facilities will be utilized primarily to fund operating activities of Waterlink. At March 31, 2003 there were no borrowings available under the domestic senior credit facility in the United States and approximately $1,615,000 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 requires 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. 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 on or prior to the maturity date. If we are unable to successfully satisfy requisite conditions and to repay the domestic senior credit facility, then Waterlink would be in default at that time under the terms of the credit agreement. If there is such an event of default the senior lenders could declare that all borrowings under the credit agreement are then immediately due and payable. In such event, Waterlink would need to examine all alternatives, including, without limitation, possible protection under the bankruptcy laws. 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 $188,000 at March 31, 2003. The credit facilities restrict or prohibit Waterlink from taking many actions, including paying dividends and incurring or assuming other indebtedness or liens. The banks that participate in the domestic senior credit facility also must approve acquisitions and dispositions. Waterlink's obligations under the domestic senior credit facility are secured by liens on substantially all of 16 Waterlink's domestic assets, including equipment, inventory, accounts receivable and general intangibles and the pledge of most of the stock of Waterlink's subsidiaries. In addition, Waterlink has guaranteed the payment by our operating subsidiary in England of its obligations under the $200,000 facility with Bank of America. 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 9 to the financial statements for the three and six-month periods ended March 31, 2003. 17 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 its senior lenders amended repayment terms and with other debt holders, additional amended repayment terms - the ability to obtain additional credit availability to support working capital requirements - 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 - 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. 18 Item 4. Controls and Procedures -------------------------------- (a) Evaluation of disclosure controls and procedures. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of May 8, 2003, the evaluation date. Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the evaluation date, our disclosure controls and procedures are effective in timely alerting them to the material information relating to us required to be included in our periodic SEC filings. (b) Changes in internal controls. There were no significant changes made in our internal controls during the period covered by this report or, to our knowledge, in other factors that could significantly affect these controls subsequent to the date of their evaluation. PART II - OTHER INFORMATION Item 4. Submission of Matters to Vote of Security Holders ---------------------------------------------------------- At the annual meeting of stockholders of Waterlink held on February 13, 2003, the following directors were elected as Class III directors whose term expire in 2006: For Against Withheld --- ------- -------- Peter G. Kleinhenz 17,678,356 115,132 0 Robert P. Pinkas 17,678,356 115,132 0 In addition, the following directors' terms of office continued after the meeting: Dr. R. Gary Bridge B. Bruce Cummings Kenneth Ch'uan-k'ai Leung William W. Vogelhuber Item 6. Exhibits and Reports on Form 8-K ----------------------------------------- (a) Exhibits 99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by William W. Vogelhuber. 99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by Donald A. Weidig. (b) Reports on Form 8-K. None. 19 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: May 13, 2003 20 CERTIFICATIONS I, William W. Vogelhuber, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Waterlink, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. May 13, 2003 By: /s/ WILLIAM W. VOGELHUBER ----------------------------- President and Chief Executive Officer 21 CERTIFICATIONS-(CONTINUED) I, Donald A. Weidig, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Waterlink, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report (the "Evaluation Date"); and c. presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. May 13, 2003 By: /s/ DONALD A. WEIDIG ------------------------ Chief Financial Officer 22