WATERLINK INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

(X) Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Fiscal Year Ended September 30, 2001

( ) 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
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(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)

835 NORTH CASSADY AVENUE
COLUMBUS, OHIO 43219
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(Address of principal executive offices) (Zip Code)

Registrant's Telephone Number, Including Area Code: (614) 258-9501

Securities registered pursuant to Section 12(b) of the Act:

TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
Common Stock, $.001 par value None

Securities registered pursuant to Section 12(g) of the Act:

NONE

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 and (2) has been subject to such filing requirements for
the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

As of November 30, 2001 the aggregate market value of Waterlink's voting Common
Stock held by non-affiliates of Waterlink was approximately $1,509,000.

As of November 30, 2001 there were 19,659,694 shares of the registrant's Common
Stock, $.001 par value outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for the Annual Meeting of
Stockholders to be held on March 7, 2002 are deemed to be incorporated by
reference in Part III of this Form 10-K.

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PART I

ITEM 1. BUSINESS

GENERAL

Waterlink is an international provider of integrated water and air
purification solutions for both industrial and municipal customers. Our
principal executive offices are located at 835 North Cassady Avenue, Columbus,
Ohio 43219 and our telephone number is (614) 258-9501.

Waterlink was incorporated in Delaware on December 7, 1994 to participate
in the consolidation of the highly fragmented water purification and wastewater
treatment industry. Waterlink grew rapidly through acquisitions from 1995
through 1998, having made 13 acquisitions. 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
three of its five operating divisions: the biological division in two separate
transactions in September and December 2000, the separations division in
February 2001, and the european water and wastewater division in a series of
transactions during the fourth quarter of our fiscal year ended September 30,
2001.

As of September 30, 2001 the two remaining divisions were the specialty
products and the pure water divisions. Accordingly, the operations of all
divisions except for the specialty products and pure water divisions are
reported as discontinued operations for each period presented. A brief
description of the two divisions that comprise Waterlink's continuing operations
follows.

SPECIALTY PRODUCTS DIVISION

The specialty products division and its predecessors have specialized in
the development and production of highly sophisticated activated carbons for
more than 80 years. Activated carbon is used to purify air, water and gases by
retaining impurities in carbon granules. The division is a worldwide supplier of
activated carbon for liquid, air and gas filtration systems and is a leading
manufacturer of specialty impregnated carbons used in applications where the
capacity of activated carbons can be significantly increased. A full range of
activated carbons manufactured from coconut shell, coal, wood, along with other
adsorbents such as modified clay media, bone char, and anthracite are offered
for use in:

- adsorption equipment, both standard and custom configurations,
primarily for separation of solvents from air

- bioreactors and bioscrubbers in which contaminants are destroyed using
biological microbes

- corrosive gas control systems to protect expensive electronic operated
controls

- distillation equipment for separation applications

- systems that control emissions from volatile organic compounds

- area filtration systems for the removal of both vapor phase and
particulate contaminants

- indoor air quality systems

- odor control systems

- soil vapor extraction systems

- solvent recovery systems engineered and installed on a turn-key basis,
to recover valuable solvents

The specialty products division's products and systems are sold worldwide
using a combination of direct sales and sales representatives. For the year
ended September 30, 2001, net sales for this division were approximately $65.2
million.

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PURE WATER DIVISION

The pure water division sells products and solutions to the residential,
municipal and industrial water and process water markets through our Waterlink
Technologies, Inc. and C'treat Offshore, Inc. subsidiaries.

Waterlink Technologies is an international provider of membrane-based
solutions focusing on:

- membrane technology with standard reverse osmosis system solutions
which can treat tap water to sea water for the production of high
purity water

- nanofiltration systems, which can be used to decolor, soften and remove
harmful pathogenic organisms

- desalination systems for the purification of sea water to drinking
water for resorts, municipal and governmental installations

- custom engineered microfiltration systems that can be used for the
clarification and removal of harmful organisms from surface water as
well as pre-treatment for other membrane technology in wastewater
applications

- custom designed ultra pure water treatment systems for the power,
electronic and pharmaceutical industries

- the manufacture of pleated membrane sediment filtration cartridges
which are used for removal of suspended solids

- the distribution of other major lines of filter housings, filters and
components

C'treat is a provider of reverse osmosis desalination equipment and
services to the worldwide energy industry. C'treat equipment provides fresh
water for offshore drilling rigs and production platforms. C'treat enjoys a
significant market presence through a sales organization that includes
representatives and technical licensees in 12 countries.

For the year ended September 30, 2001, net sales for the pure water
division were approximately $19.0 million.

OPERATING AND SALES STRATEGY

Waterlink has adopted a decentralized approach to the operational
management of our divisions. While functions such as strategic planning,
financial reporting, treasury, communications and risk management are
centralized in Waterlink's corporate headquarters, local management at each of
our principal locations is primarily responsible for the day-to-day operation of
the location's business.

We sell our systems, equipment and services primarily through
approximately 37 direct sales personnel and approximately 70 independent sales
organizations. To a lesser extent, Waterlink sells through water treatment
distributors, which take title to equipment for resale to the end-user.
Waterlink seeks to have a single sales organization within a particular market
in order to foster a close relationship with its sales representatives and
present a cohesive image to the marketplace. The independent sales
representatives typically will identify sales opportunities, and then work
together as a team with Waterlink's direct sales force, which has greater
technical and product knowledge, to complete the sale and service the customer.

While we have received contract awards in excess of $3 million, Waterlink
is primarily focusing its marketing efforts on contract awards of up to
approximately $2 million. We believe that competition is fiercer for larger
contract awards and the timing of these awards is more unpredictable.

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COMPETITION

Despite some large competitors, the water and air purification industry
remains fragmented and highly competitive due to the large number of competitors
within each product area. Waterlink has a significant number of competitors,
including a number of integrated suppliers and equipment manufacturers, some of
which are larger and have greater resources than Waterlink. We believe that
success in this market is based on the ability to offer appropriate technology,
influence specifications, have strong distribution, maintain respect within the
consulting and engineering community, finance and bond projects awarded, provide
timely delivery, and maintain a reputation for service and parts support after
the sale. Additionally, in the municipal arena, the ability to meet bid
specifications and the ability to set pricing are often primary considerations.
Waterlink believes that its technologies and cost structures as well as its
strong local presence in certain international markets enable it to compete
effectively against these companies; however, our highly leveraged financial
condition has hurt our competitive position to finance and bond large projects.

Waterlink's primary competitors include operating subsidiaries of
Vivendi, including Compagnie Generale des Eaux and U.S. Filter Corporation; Suez
de Lyonaise des Eaux; Calgon Carbon Corporation; Ionics, Incorporated; and
Osmonics, Inc.

STRATEGIC ALTERNATIVE PROCESS

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 we have sold three of our five divisions. While
we are still exploring the possibility of selling one or both of our remaining
divisions, at this time we can give no assurance that any further sales will
take place.

CUSTOMERS

Waterlink markets its products and services primarily to industrial
customers. Waterlink's industrial customers include many "Fortune 500" companies
and their counterparts outside of the United States. Industries served include
the pharmaceutical, electronic and microelectronic, pulp and paper, chemical,
petrochemical, food, beverage, printing, automotive and other heavy
manufacturing industries. For the year ended September 30, 2001 approximately
96.9% of Waterlink's net sales from continuing operations were derived from
industrial sales. The percentage of net sales to industrial customers was
approximately 97.1% in 2000 and 94.5% in 1999.

The municipal market is highly competitive, and municipal markets in the
United States are more regulatory driven than municipal markets in other
regions. Waterlink focuses its efforts on smaller municipal projects, which
Waterlink believes its product lines are best suited to serve. Waterlink
believes that municipal business is an important factor in the growth of its
pure water division. For the year ended September 30, 2001 approximately 3.1% of
Waterlink's net sales from continuing operations were derived from municipal
sales. The percentage of net sales to municipal customers was approximately 2.9%
in 2000 and 5.5% in 1999.

BACKLOG FROM CONTINUING OPERATIONS

Total backlog from continuing operations as of September 30, 2001 was
$22.8 million as compared to total backlog from continuing operations of $21.3
million at September 30, 2000. Waterlink had a backlog, consisting of written
purchase orders for capital goods equipment of $9.7 million as of September 30,
2001 as compared to $10.4 million as of September 30, 2000. In addition, at
September 30, 2001, Waterlink had $13.1 million of firm commitments to purchase
recurring revenue products, principally from our specialty products division, as
compared to $10.9 million as of September 30, 2000. Waterlink expects that a
significant portion of our backlog at the beginning of a fiscal year will be
filled during that year. Backlog, and therefore sales, may vary from
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quarter to quarter as a result of large projects being booked during any quarter
and varying project delivery schedules. In addition, the orders have varying
delivery schedules and Waterlink's backlog as of any particular date may not be
representative of actual net sales for any succeeding period.

PROCESS AND PRODUCT WARRANTY AND PERFORMANCE GUARANTEES

Consistent with industry practices, we generally offer a warranty on
finished products for one year or in some cases 18 months from sale and 12
months from installation. The costs associated with warranty expense have not
been material. In connection with providing certain products and design/build
services to our customers, Waterlink is sometimes required to guarantee that our
products or services will attain specified levels of quality or performance. If
a product fails to perform according to a warranty, or a project fails to attain
the guaranteed level of quality, and if we are unable to effect a satisfactory
replacement or cure within the prescribed period of time, Waterlink could incur
financial penalties, in the form of liquidated damages, or could be required to
remove and replace the equipment or repeat the service in order to meet the
specifications. To date, Waterlink has not incurred any material payment or
other obligations pursuant to such performance guarantees.

RAW MATERIAL AND SUPPLIES

The raw materials and components used in Waterlink's products are
commonly available commodities such as stainless steel, carbon steel, plastic,
tubing, wiring, electrical components, pumps, valves, compressors, pressure
vessels, oleophilic media, and reverse osmosis membranes. Waterlink's systems
are fabricated from these materials and assembled together with products bought
from other companies to form an integrated system. In addition, the specialty
products division is dependent on the importation of coconut shell carbon from
Asia and the supply of coal based carbon from domestic and Asian sources.
Waterlink is not dependent upon any single supplier, and if any supplier were to
become unable to perform, Waterlink believes a substitute source could readily
be found. Waterlink attempts to pass on price increases for raw materials and
components to its customers as market conditions allow. Waterlink is not a party
to any material long-term fixed price supply contracts.

GOVERNMENT REGULATION

Federal, state, local and foreign environmental laws and regulations
necessitate substantial expenditures and compliance with water quality standards
by generators of wastewater and wastewater by-products and impose liabilities on
such entities for noncompliance. Environmental laws and regulations and their
enforcement are, and will continue to be, a significant factor affecting the
marketability of the solutions, systems and equipment provided by Waterlink.

Many of the countries in which Waterlink operates or in which our
customers are located, including the United States, countries in western Europe,
Latin America, and the Asia-Pacific region, have adopted requirements that
govern water quality, wastewater treatment, and wastewater by-products and the
solutions, systems and equipment provided by Waterlink. These requirements and
their enforcement vary by country, but in general establish water quality, use
and disposal standards, set wastewater effluent discharge limits, and prescribe
standards for the protection of human health and safety and the environment. In
each country, Waterlink monitors the status and impact of local environmental
regulation and enforcement as it relates to the marketability of the solutions,
systems and equipment provided by Waterlink.

Any changes in applicable environmental standards and requirements or
their enforcement may affect the operations of Waterlink by imposing additional
regulatory compliance costs on Waterlink's customers, requiring the modification
of and/or affecting the market for Waterlink's solutions, systems and equipment.
To the extent that demand for Waterlink's solutions, systems and equipment is
created by the need to comply with these enhanced standards and requirements or
their enforcement, any

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modification of the standards and requirements or their enforcement may reduce
demand, thereby adversely affecting Waterlink's business prospects. Conversely,
changes in applicable environmental laws imposing additional regulatory
compliance standards and requirements or causing stricter enforcement of these
laws or regulations could increase the demand for Waterlink's systems, equipment
and services.

PATENTS, TRADEMARKS AND LICENSES

We currently own a number of United States and foreign patents, and
registrations for United States service marks and trademarks. While each is of
value, Waterlink generally does not consider any of them to be material to our
business, although, as Waterlink has grown and its presence has been extended,
our Waterlink(SM) mark has become more widely known.

EMPLOYEES

At September 30, 2001, Waterlink had approximately 337 employees at our
various locations. Approximately 54 people are covered under collective
bargaining agreements in the United States. We believe that our relationship
with our employees is good.

ITEM 2. PROPERTIES

The corporate office of Waterlink is located within the Columbus, Ohio
facility of the specialty products division. We also lease approximately 1,000
square feet located in Canton, Ohio. Our subsidiaries own or lease facilities
for office space and manufacturing as follows:

- Specialty Products Division

- Columbus, Ohio (own)

- Napa and Santa Fe Springs, California (lease)

- Addison, Illinois (lease)

- Sulphur, Louisiana (lease)

- Worcester, Massachusetts (lease)

- Sparks, Nevada (lease)

- Downington, Pennsylvania (lease)

- Morgantown, West Virginia (lease)

- Lancashire, England (lease)

- Pure Water Division

- Clearwater and West Palm Beach, Florida (lease)

- The Woodlands, Texas (lease)

The expiration dates for these leased properties range from one-month
notice to September 2008, with the ability to reduce the term to September 2003
with one-years' notice. We believe that each of our facilities is in adequate
condition and will continue to remain suitable for its current purpose. We may
add improvements to the properties listed above. We anticipate using our
properties for purposes consistent with their present use. In the event any of
the facilities becomes unavailable upon termination of the existing lease, we
believe we would be able to find a suitable alternative facility without any
significant adverse impact to our operations or us. We believe our properties
are adequately covered by insurance.

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ITEM 3. LEGAL PROCEEDINGS

From time to time in the normal course of our business, we become a party
to litigation. Most of this litigation involves claims for personal or
employment related injury or property damage incurred in connection with our
operations. We are not a party to any material litigation and believe that none
of our litigation will have a material adverse effect on our business or
financial results.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

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PART II

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS

MARKET INFORMATION

Our common stock is listed on the OTC Bulletin Board under the symbol
"WLKN". The following table sets forth the high and low composite sales prices
for the fiscal quarters indicated. Until April 25, 2001 our common stock was
listed on The New York Stock Exchange under the symbol "WLK". With regard to
information subsequent to April 25, 2001 the quotations may reflect inter-
dealer prices, without retail mark-up, mark-down or commission, and may not
represent actual transactions.

The number of holders of record of our common stock as of November 30,
2001 was approximately 241.

DIVIDENDS

We have not paid or declared any dividends on our common stock since our
inception. We anticipate that any earnings will be retained to support the
growth of our business and will not be distributed to stockholders as dividends.
The declaration and payment of any future dividends and the amount of any
dividend will be determined by our board of directors and will depend upon our
results of operations, financial condition, cash requirements, future prospects,
limitations imposed by bank credit and debt agreements and other factors deemed
relevant by our board of directors. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital Resources."

Pursuant to our bank credit agreement, we may not declare or make, or
agree to declare or make, directly or indirectly, any dividends, except that we
may declare and pay dividends with respect to our capital stock payable solely
in additional shares of our common stock or options, warrants or other rights to
purchase our common stock.

RECENT SALES OF UNREGISTERED SECURITIES

During fiscal 2001, Waterlink granted warrants to purchase 50,000 shares
of common stock at a purchase price of $0.01 per share to Brantley Venture
Partners III, L.P. and also to CID Equity Capital V, L.P. The warrants were
issued in connection with the issuance of Waterlink's subordinated notes on
January 18, 2001 to each such party in the amount of $500,000. The warrants
expire on January 17, 2006. In such transactions, Waterlink did not engage any
underwriter, broker or placement agent. In such transactions, appropriate
disclosure was provided to each investor to support Waterlink's reliance on the
exemption from registration provided by Section 4(2) of the Securities Act. In

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connection with such transactions, Waterlink obtained appropriate investment
representations supporting its reliance on such exemption from registration.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected historical consolidated financial
data of Waterlink over the last five fiscal years. The financial data presented
for the five fiscal years ended September 30, 2001 have been derived from
Waterlink's audited financial statements with reclassifications made to reflect
discontinued operations as presented below. The financial data includes the
operating results of each acquired business from the date of acquisition in
accordance with the purchase method of accounting.

You should read the selected historical consolidated financial data in
conjunction with, and they are qualified by, our historical consolidated
financial statements and the related notes and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," contained elsewhere
in this report.

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(1) For the year ended September 30, 1999, selling, general and administrative
expenses included $255,000, or $0.02 per share, relating to the write off of
costs associated with acquisition activity that ceased during the year.

(2) Waterlink incurred special charges relating to continuing operations as
follows:

- During the fiscal year ended September 30, 1997, Waterlink incurred a
special charge to operations of $2,630,000, or $0.21 per share, assuming
dilution, resulting primarily from the issuance, concurrent with our
initial public offering, of a ten year option to purchase 100,000 shares of
common stock at a price of $0.10 per share to an officer of Waterlink
pursuant to terms of an employment agreement. Of this amount, approximately
$1,138,000 was non-cash and the remainder represented cash obligations
related principally to the reimbursement of income taxes resulting from the
stock option issuance.

- During the fiscal year ended September 30, 1998, Waterlink incurred special
charges of $3,113,000, or $0.25 per share. These special charges are
comprised of the following two components:

- Waterlink recorded a charge of $1,619,000, or $0.13 per share, primarily
related to termination benefits and costs associated with the exiting of
certain facilities to implement our 1999 plan.

- Waterlink incurred special charges of $1,494,000, or $0.12 per share,
primarily attributable to contractual obligations to a former chief
executive officer, who resigned in June 1998, and costs necessary to
recruit executives to Waterlink.

- During the year ended September 30, 1999, Waterlink incurred special
charges of $563,000, or $0.04 per share, for continuing costs associated
with the implementation of Waterlink's 1999 plan, primarily related to
termination benefits.

- During the year ended September 30, 2001, Waterlink incurred special
charges of $2,560,000, or $0.13 per share, related to the closing of its
corporate office, primarily related to termination benefits.

(3) Interest expense for the years ended September 30, 1999 and 2000 include
financing charges of $870,000, or $0.07 per share, and $217,000, or $0.01
per share, respectively, related to the amortization of the value assigned
to warrants issued to purchase up to 283,637 shares of common stock at an
exercise price of $0.01 per share in 1999 and 100,000 shares of common stock
at an exercise price of $0.01 in 2000.

(4) Net income for fiscal 1997 reflects an extraordinary item. Waterlink used a
portion of the proceeds from its initial public offering to repay
substantially all of its outstanding indebtedness. In addition, concurrent
with the initial public offering Waterlink canceled a note purchase
agreement. In connection with the early retirement of certain indebtedness
and the cancellation of the note purchase agreement, Waterlink realized an
extraordinary charge of $385,000, net of taxes of $257,000, or $0.05 per
share, assuming dilution, related to the write off of unamortized debt
issuance costs and discounts associated with this indebtedness.

(5) At September 30, 2000 Waterlink was in violation of certain of its financial
covenants with respect to its senior credit facility. Accordingly, the
entire balance of the senior credit facility was classified as current at
September 30, 2000. Based on certain conditions of Waterlink's senior credit
facility and other indebtedness that could accelerate the maturity date of
such indebtedness to May 31, 2002, all debt was classified as current at
September 30, 2001.

(6) Total assets exclude net assets of discontinued operations for all periods
presented.

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ITEM 7. 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 to participate in the
consolidation of the highly fragmented water purification and wastewater
treatment industry. Waterlink grew rapidly through acquisitions from 1995
through 1998, having made 13 acquisitions. 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
three of its five operating divisions: the biological division in two separate
transactions in September and December 2000, the separations division in
February 2001, and the european water and wastewater division in a series of
transactions during the fourth quarter of our fiscal year ended September 30,
2001. Waterlink's continuing operations are comprised of the specialty products
division and the pure water division.

Excluding recurring revenue, the majority of the systems and equipment
produced by Waterlink are custom designed and can take a number of months to
produce. Revenues from large contracts are recognized using the percentage of
completion method of accounting in the proportion that costs incurred bear to
total estimated costs at completion. Revisions of estimated costs or potential
contract losses, if any, 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. Revenues from carbon sales and services, and the remaining systems and
equipment sales are recognized when title passes upon shipment.

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 significantly, 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
September 30, 2001, Waterlink's total backlog from continuing operations was
approximately $22.8 million, consisting of $9.7 million of written purchase
orders for capital goods equipment and $13.1 million of firm commitments to
purchase recurring revenue products, principally from our specialty products
division. 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.

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RESULTS OF CONTINUING OPERATIONS

The following table sets forth for the periods indicated, statements of
operations data as a percentage of net sales:

Year Ended September 30, 2001 Compared to Year Ended September 30, 2000

Net Sales: Net sales for the year ended September 30, 2001 were
$84,535,000; an increase of $2,012,000, or 2.4%, from the prior year. Net sales
at the pure water division increased by $1,242,000, or 7.0%; and net sales at
the specialty products division increased by $484,000, or 0.7%, from the prior
year. The increase at the pure water division is reflective of the division's
success in obtaining customer orders. With regard to the specialty products
division, they experienced a slow first quarter of fiscal 2001, principally in
the point of use market, but recovered during the last part of the fiscal year
to show modest growth over the prior year.

Gross Profit: Gross profit for the year ended September 30, 2001 was
$21,206,000, a decrease of $1,475,000 from the prior year. The gross margin for
2001 was 25.1% as compared to 27.5% in the prior year. The gross margin at the
specialty products division decreased from 24.4% in 2000 to 22.1% in 2001
principally due to product mix within the carbons side of the business during
the first half of the current year. At the pure water division, the gross margin
decreased from 38.7% in 2000 to 35.8% in 2001 primarily due to higher parts
sales in 2000 where margins are typically higher than those realized on systems
sales.

Selling, General and Administrative Expenses: Selling, general and
administrative expenses for the year ended September 30, 2001 were $15,302,000,
an decrease of $971,000 from the prior year, primarily due to cost reductions in
the corporate office. Selling, general and administrative expenses as a
percentage of net sales were 18.1% in 2001 as compared to 19.7% for the prior
year, which reflects the decrease in expense.

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Special Charges: Special charges of $2,560,000 were recorded during the
year ended September 30, 2001 in connection with the closing of the corporate
office, relating primarily to severance obligations.

Amortization: Amortization expense for the year ended September 30, 2001
and 2000 was $871,000 and $855,000, respectively.

Interest Expense: Interest expense for the year ended September 30, 2001
was $5,043,000, as compared to $5,046,000 in the prior year. Interest expense
for 2001 and 2000 include non-cash charges related to amortization of expense
recognized in connection with the issuance of common stock warrants of $87,000
and $217,000, respectively.

Amortization of Financing Costs: Amortization of financing costs for the
year ended September 30, 2001 was $1,386,000 as compared to $401,000 for prior
year. The increase in 2001 reflects the accelerated amortization of deferred
financing costs resulting from the maturity date of our senior credit facility
being moved from May 23, 2003 to October 1, 2001. By amendment, the senior
credit facility maturity date has been extended to October 1, 2002.

Income Taxes: Waterlink recorded income taxes of $12,000 on a pre-tax
loss of $4,265,000 for the year ended September 30, 2001, which represented
state income taxes on certain domestic earnings. For the year ended September
30, 2000, income taxes of $386,000 were recorded on pre-tax income of $117,000.
The income taxes in 2000 were recorded on earnings outside the United States and
in certain states domestically.

Year Ended September 30, 2000 Compared to Year Ended September 30, 1999

Net Sales: Net sales for the year ended September 30, 2000 were
$82,523,000; an increase of $7,284,000, or 9.7%, from the prior year. Internal
growth rates at the specialty products and pure water divisions were 11.4% and
3.9%, respectively.

Gross Profit: Gross profit for the year ended September 30, 2000 was
$22,681,000, an increase of $1,252,000 from the prior year as a result of the
increase in sales during 2000. The gross margin for 2000 was 27.5% as compared
to 28.5% in the prior year. The gross margin at the specialty products division
decreased from 25.3% in 1999 to 24.4% in 2000 principally due to the mix of
higher carbon sales that have lower overall gross margins as compared to systems
sales. At the pure water division, the gross margin decreased slightly from
39.1% in 1999 to 38.7% in 2000.

Selling, General and Administrative Expenses: Selling, general and
administrative expenses for the year ended September 30, 2000 were $16,273,000,
an increase of $1,265,000 from the prior year. This increase was resulted from
the expansion into regional service centers domestically within the specialty
products division and from an expanded sales effort within the pure water
division. Selling, general and administrative expenses as a percentage of net
sales were 19.7% in 2000 and 20.0% in 1999.

Special Charges: Special charges of $563,000 were realized during the
year ended September 30, 1999 related primarily to severance obligations.

Amortization: Amortization expense was $855,000 for the year ended
September 30, 2000 as compared to $902,000 for the year ended September 30,
1999.

Interest Expense: Interest expense for the year ended September 30, 2000
was $5,046,000, as compared to $5,297,000 in the prior year. Interest expense
for 2000 and 1999 include non-cash charges related to amortization of expense
recognized in connection with the issuance of common stock warrants of $217,000
and $870,000 respectively.

Income Taxes: Waterlink recorded income taxes of $386,000 on pre-tax
income of $117,000 for the year ended September 30, 2000 and income taxes of
$707,000 on a pre-tax loss of $562,000 for

- 13 -

the year ended September 30, 1999. These income taxes were recorded on earnings
outside the United States and in certain states domestically.

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 three of its five operating
divisions: the biological division in two separate transactions in September and
December 2000, the separations division in February 2001, and the european water
and wastewater division in a series of transactions during the fourth quarter of
our fiscal year ended September 30, 2001. While we are still exploring the
possibility of selling one or both of our remaining divisions, at this time we
can give no assurance that any additional sales will take place. Under
Waterlink's senior credit facility, the final maturity date for Waterlink's
payment obligations changes from October 1, 2002 to May 31, 2002 unless on or
before May 31, 2002 Waterlink has entered into a definitive agreement to sell
Waterlink's pure water division, which agreement must contain terms approved by
the senior bank group.

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.

For the year ended September 30, 2001, net cash used by operating
activities was $95,000. In addition, purchases of equipment totaled $461,000
during the year. Borrowings available under our senior credit facilities funded
the operating and investing activities during the current year. During fiscal
2001 Waterlink realized net proceeds totaling $20,360,000 from the sale of three
of its divisions. All of these net proceeds were used to repay senior
indebtedness.

Credit Availability: As of September 30, 2001, Waterlink's credit
facilities were comprised of (1) a $49,122,000 domestic facility with Bank of
America National Trust & Savings Association as agent, which expires on October
1, 2002 and (2) a $500,000 facility within our overseas subsidiaries. The credit
facilities will be utilized to primarily fund operating activities of Waterlink.

Effective January 15, 2002 Waterlink entered into an amendment to our
senior credit facility that extended the maturity date of the senior credit
facility from January 15, 2002 to October 1, 2002, assuming Waterlink maintains
a certain level of earnings before interest and taxes and maintains certain
balance sheet ratios through September 30, 2002. Without an amendment to our
senior credit facility that would further extend the maturity date, an infusion
of additional capital, or the sale of

- 14 -

significant assets, Waterlink will not be able to meet its scheduled obligations
under the senior credit facility. No assurance can be given as to whether a
satisfactory further amendment to the senior credit facility will be obtained
from our senior bank group. If we are unable to negotiate a such further
amendment to 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 lenders could declare that all borrowings under the credit agreement
are then immediately due and payable. In addition, under Waterlink's senior
credit facility, the final maturity date for Waterlink's payment obligations
changes from October 1, 2002 to May 31, 2002 unless on or before May 31, 2002
Waterlink has entered into a definitive agreement to sell Waterlink's pure water
division, which agreement must contain terms approved by the senior bank group.
If Waterlink has not entered into an approved agreement to sell Waterlink's pure
water division on or before May 31, 2002, all borrowings under the senior credit
facility will become immediately due and payable. Since in either of these
instances we would be unable to pay these amounts the lenders could proceed to
foreclose on their security interest, which comprises substantially all of our
assets. In such event, Waterlink would need to examine all alternatives,
including, without limitation, possible protection under the bankruptcy laws.

Availability for future borrowings was approximately $338,000 at
September 30, 2001 under the senior credit facility.

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 credit facilities also must approve
acquisitions and dispositions. Waterlink's obligations under the credit
facilities are secured by liens on substantially all 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.
Waterlink has guaranteed the payment by our overseas subsidiaries of their
obligations under the overseas facilities. The overseas subsidiaries have given
the lenders an assurance that the subsidiaries would not pledge their assets to
any other party.

Market Risk: Waterlink's earnings are affected by changes in interest
rates charged on our domestic facility. If the market rates for borrowings
increased by 1% on our domestic facility, the impact would be an increase to
interest expense of $487,000 with a corresponding decrease to income before
income taxes. This amount was determined by considering the impact of
hypothetical interest rates on the balance of Waterlink's domestic facility at
September 30, 2001. This analysis does not consider the effects of the overall
economic environment associated with such a change nor does it assume any change
to Waterlink's current financial structure.

Waterlink occasionally has exposure to currency rate fluctuations related
primarily to the purchases of inventory and the collection of accounts
receivable. In these situations Waterlink utilizes a limited number of foreign
exchange instruments, primarily forward contracts, to manage this exposure.
Waterlink had no significant hedging contracts outstanding at September 30,
2001.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In June 2001, the Financial Accounting Standards Board issued Statements
of Financial Accounting Standards No. 141, "Business Combinations", and No. 142,
"Goodwill and Other Intangible Assets", effective for fiscal years beginning
after December 15, 2001, with earlier adoption permitted for certain companies
with years ending after March 15, 2001. Under the new rules, goodwill and
intangible assets deemed to have indefinite lives will no longer be amortized
but will be subject to annual impairment tests in accordance with the
Statements. Other intangible asset will continue to be amortized over their
useful lives.

At the latest, Waterlink is required to apply the new rules on accounting
for goodwill and other intangible assets beginning in the first quarter of
fiscal 2003, or as of October 1, 2002. Waterlink could also elect to early adopt
the standards as of October 1, 2001 under the transition rules. Application of

- 15 -

the nonamortization provisions of the Statement is expected to result in an
increase in income from continuing operations and net income of approximately
$871,000, or $0.04 per share, on an annual basis. Waterlink has not yet
determined whether it will elect early adoption of this standard. Waterlink will
perform the first of the required impairment tests of goodwill and indefinite
lived intangible assets as of the adoption date and has not yet determined what
the effect of these tests will be on the earnings and financial position of
Waterlink.

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 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 success of Waterlink's exploration of strategic alternatives
including the timely execution of a satisfactory definitive agreement
to sell Waterlink's pure water division

- 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

i. instability of governments and legal systems in countries in
which Waterlink conducts business
ii. significant changes in currency valuations
iii. recessionary environments
iv. the effects of military conflicts

- changes in customer demand and timing of orders as they affect sales
and product mix, including

i. the effect of strikes at customer's facilities
ii. variations in backlog
iii. the impact of changes in industry business cycles
iv. changes in environmental laws

- competitive factors, including

i. changes in market penetration
ii. introduction of new products by existing and new competitors

- changes in operating costs, including

i. changes in Waterlink's and its subcontractors' manufacturing
processes
ii. changes in costs associated with varying levels of
operations
iii. changes resulting from different levels of customers demands
iv. effects of unplanned work stoppages
v. changes in cost of labor and benefits
vi. the cost and availability of raw materials and energy

- 16 -

- the cost of capital, including interest rate increases

- unanticipated litigation, claims or assessments

RISK FACTORS

We May be Unsuccessful in Complying with Our Obligations Under our Senior Credit
Facility or in Negotiating an Additional Amendment to Our Senior Credit Facility
and Other Debt Instruments

The maturity date of our senior credit facility is October 1, 2002 and
other debt instruments also mature in October 2002. If we are unable to
negotiate satisfactory amendments to the senior credit facility and the other
debt instruments to extend such maturities, and in the absence of other sources
of funds to repay the indebtedness outstanding under the senior credit facility,
the senior lenders and the other lenders could declare that all borrowings under
the senior credit facility and the other debt instruments, respectively, are
immediately due and payable. In addition, under Waterlink's senior credit
facility, the final maturity date for Waterlink's payment obligations changes
from October 1, 2002 to May 31, 2002 unless on or before May 31, 2002 Waterlink
has entered into a definitive agreement to sell Waterlink's pure water division,
which agreement must contain terms approved by the senior bank group. If
Waterlink has not entered into an approved agreement to sell Waterlink's pure
water division on or before May 31, 2002, all borrowings under the senior credit
facility will become immediately due and payable. In either of these instances,
the senior lenders could proceed to foreclose on their security interest, which
comprises substantially all of our assets. In such event, Waterlink would need
to examine all alternatives, including, without limitation, possible protection
under the bankruptcy laws.

Our Ability to Fund Operations or Provide Value to Shareholders Will be
Dependent on the Degree of Success of the Strategic Alternative Process

In May 2000 Waterlink announced that our board of directors had
authorized management to explore various strategic alternatives to maximize
shareholders' value. This strategic alternative to date has resulted in the sale
of three divisions. Given our high level of debt, we are unable to appropriately
fund the operations of all of our divisions. Depending on the amount of net
proceeds and which stock or assets are sold, we may need to obtain additional
capital to be able to operate our remaining businesses, the terms of which could
result in dilution to our existing shareholders. We can give no assurance as to
the ultimate success of our strategic alternative process.

Our Quarterly Results of Operations Could Fluctuate Significantly Which Could
Result in Defaults Under Our Senior Credit Facility and in Volatility in the
Market Price of Our Common Stock

We need to finalize complicated contracts and orders with our customers
before we produce our revenues. Often, the timing of those contracts and orders
is also subject to our customers receiving financing, various permits and other
aspects outside our control. A delay in finalizing any of these contracts could
have a significant negative impact on our operating results in any fiscal
quarter. We believe that period-to-period comparisons of our operating results
are not necessarily meaningful and should not necessarily be relied upon as
indicators of our future performance. If we are able to successfully negotiate
an amendment to our senior credit facility, there will likely be some form of
financial covenant that will be based on our monthly operating performance.
Given the fluctuations in our operating results, this could result in our
needing to negotiate further amended terms or being in default of our senior
credit facility. Also, these fluctuations in our quarterly results could lead to
our failure to meet expectations of securities analysts and investors and could
seriously harm the market price of our common stock. Quarterly operating results
have varied significantly in the past and will likely vary significantly in the
future.

- 17 -

Our Substantial Amount of Debt Could Limit Our Growth and Imposes Restrictions
on Our Business

We have incurred substantial indebtedness. Our level of debt and our
recent operating performance, including the impact of special charges and the
loss from discontinued operations to our income, limit our ability to:

- obtain additional financing and bonding capabilities to fund or support
our strategy, capital expenditures, sales and other general corporate
purposes;

- use operating cash flow in other areas of our business since we must
dedicate a substantial portion of these funds to pay interest and
retire debt; and

- react to changing market conditions and economic downturns.

At September 30, 2001, our total indebtedness was $51,936,000. Our debt
agreements contain numerous financial and operating covenants that limit our
discretion which respect to certain business matters. These covenants place
significant restrictions on, among other things, our ability to:

- incur additional indebtedness, both under the bank credit agreement and
other debt agreements;

- merge or consolidate with other entities;

- repay our obligations; and

- pay dividends and other distributions.

Availability for future borrowings was approximately $338,000 at
September 30, 2001 under the senior credit facility.

The Demand for Our Products is Cyclical

Much of our water and air purification equipment requires significant
capital expenditures by our customers. As such, the timing of customer purchases
from us is affected by various economic factors, including interest rate and
business cycle fluctuations, the timing and process of government funding and
the setting of rates by regulators, all of which are beyond our control. The
cyclical nature of capital equipment sales could have an adverse affect on our
revenues and profitability in general and on our revenues and profitability in
any particular quarterly financial reporting period.

Our Industry is Highly Competitive

Our industry, the water and air purification industry is fragmented and
highly competitive due to the large number of businesses within certain product
areas. We compete with many companies, several of which have greater market
penetration, depth of product line, resources and access to capital, which could
be competitive advantages in securing projects. While we believe we are well
positioned to deliver technology and services at a fair price, some of our
competitors have developed product and service integration capabilities beyond
our current scope.

We are Dependent on Key Personnel

Our business depends on our ability to hire and retain our executive
officers and senior management. Our business could be adversely affected if for
any reason any of our executive officers or senior managers cease to be employed
by us. In addition, we will be dependent on the senior managers of any
significant businesses we may acquire in the future and on our ability to
attract and retain qualified managers to support future expansion, if any.

- 18 -

The Current Members of Our Board of Directors and Management Own Approximately
27.6% of Our Common Stock and Can Exercise Significant Influence over Our
Affairs. Also, Several Institutional Investors Own Substantial Percentages of
Our Common Stock

At November 30, 2001, our current directors and management own or
control, in the aggregate, approximately 27.6% of our common stock. In addition,
several large institutional investors own or control a significant percentage of
our common stock. Accordingly, these individuals and institutional investors, if
acting together or even alone, can exercise significant influence over our
affairs including the election of our directors, appointment of our management
and approval of actions requiring the approval of our stockholders, which may
include the adoption of amendments to our certificate of incorporation, the
approval of mergers or sales of all or substantially all our assets, and similar
items. The concentration of voting power of these stockholders, if they act
together, could, under certain circumstances, have the effect of delaying or
preventing a change in control of Waterlink.

Our Foreign Operations Are Subject to Political and Economic Risks and We May Be
Adversely Affected by Foreign Currency Fluctuation

We sell a substantial proportion of our systems, equipment and services
in Western Europe, the Middle East, Latin America and other regions outside the
United States. Also, we have two subsidiaries that operate outside of the United
States. Our net sales outside the United States were approximately 35.0% of our
net sales for the year ended September 30, 2001. Political, economic, regulatory
and social conditions in foreign countries in which we operate may change. Risks
associated with sales and operations in foreign countries include risks of:

- war

- expropriation or nationalization of assets

- renegotiation or nullification of existing contracts

- changing political conditions

- changing laws and policies affecting trade, taxation and investment

- overlap of different tax structures

- the general hazards associated with the assertion of sovereignty over
certain areas in which operations are conducted

Because our reporting currency is the United States dollar, our
operations outside the United States sometimes face the additional risks of
fluctuating currency values and exchange rates, hard currency shortages and
controls on currency exchange. We are subject to the impact of foreign currency
fluctuations and exchange rate charges on our reporting for results from those
operations in our financial statements.

We May Be Subject to Liability Under Environmental Laws

In the United States, the Comprehensive Environmental Response,
Compensation and Liability Act of 1980, as amended, and comparable state laws,
impose liability without fault for the releases of hazardous substances into the
environment. Potentially responsible parties include (a) owners and operators of
a site, (b) parties which create the hazardous substances released at a site,
and (c) parties which arrange for the transportation or disposal of hazardous
substances. We could face claims by governmental authorities, private
individuals and other persons alleging that hazardous substances were released
during the treatment process or from the use or disposal of end products and by-
products of the treatment process in violation of law. We are also subject to
environmental laws in countries outside the United States where we operate or in
which our customers are located. These

- 19 -

requirements and their enforcement may vary by country but in general prescribe
standards for the protection of human health, safety and the environment.

Changes in Environmental Laws Could Affect Our Business

Federal, state, local and foreign environmental laws and regulations
impose substantial standards for properly purifying water and treating
wastewater, and impose liabilities for noncompliance. Environmental laws and
regulations are, and will continue to be, a significant factor affecting our
ability to sell our solutions, systems and equipment. To the extent that demand
for our solutions, systems and equipment is created by the need to comply with
environmental laws and regulations, any modification of the standards imposed by
these laws and environmental laws and regulations may reduce demand for our
products and services, thereby adversely affecting our business and prospects.

Our Business is Subject to Potential Warranty and Performance Guarantee Claims

Some of our customers require us to guarantee that our services and
products will be of a specified level of quality or performance. If a product or
service fails to attain that level of quality or performance, we could incur
significant financial penalties.

Provisions of Our Corporate Documents Could Delay or Prevent a Change in Control
of Waterlink

Our certificate of incorporation and bylaws contain certain provisions
which may have anti-takeover effects and may discourage, delay, or prevent a
takeover attempt that a stockholder might consider in his best interest. These
documents allow our board of directors to authorize the issuance of preferred
stock, which could adversely affect the voting and other rights of the holders
of our common stock, provide that our directors are classified into three
classes with staggered terms, and contain a "fair price provision" which imposes
restrictions in the event of certain business combinations.

ITEM 7(a). QUALITATIVE AND QUANTITATIVE DISCLOSURES REGARDING MARKET RISK

The disclosures required under this item are included in Management's
Discussion and Analysis of Financial Condition and Results of Operations on page
15.

- 20 -

[THIS PAGE INTENTIONALLY LEFT BLANK]

- 21 -

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CONTENTS

Report of Independent Auditors.............................. 23
Consolidated Balance Sheets at September 30, 2001 and
2000...................................................... 24
Consolidated Statements of Operations for the years ended
September 30, 2001, 2000 and 1999......................... 26
Consolidated Statements of Shareholders' Equity for the
years ended September 30, 2001, 2000 and 1999............. 27
Consolidated Statements of Cash Flows for the years ended
September 30, 2001, 2000 and 1999......................... 28
Notes to Consolidated Financial Statements.................. 29

- 22 -

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders of
Waterlink, Inc.

We have audited the accompanying consolidated balance sheets of
Waterlink, Inc. and subsidiaries as of September 30, 2001 and 2000, and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended September 30, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Waterlink, Inc. and subsidiaries at September 30, 2001 and 2000, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended September 30, 2001, in conformity with
accounting principles generally accepted in the United States.

The accompanying consolidated financial statements have been prepared
assuming that the Company will continue as a going concern. As more fully
described in Note 3, the Company has incurred operating losses and has a working
capital deficiency based on the maturity date of its Senior Credit Facility.
These conditions raise substantial doubt about the Company's ability to continue
as a going concern. Management's plans in regard to these matters are also
described in Note 3. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that might result from
the outcome of this uncertainty.

/s/ Ernst & Young LLP
Canton, Ohio
November 2, 2001, except for Note 6, as to which
the date is January 15, 2002

- 23 -

WATERLINK, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------

The accompanying notes are an integral part of these statements.
- 24 -

WATERLINK, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
- --------------------------------------------------------------------------------

The accompanying notes are an integral part of these statements.
- 25 -

WATERLINK, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
- --------------------------------------------------------------------------------

The accompanying notes are an integral part of these statements.
- 26 -

WATERLINK, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------

The accompanying notes are an integral part of these statements.
- 27 -

WATERLINK, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
- --------------------------------------------------------------------------------

The accompanying notes are an integral part of these statements.
- 28 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2001

- --------------------------------------------------------------------------------

1. ACCOUNTING POLICIES

PRINCIPLES OF CONSOLIDATION -- The consolidated financial statements
include the accounts of Waterlink, Inc. and its wholly-owned subsidiaries (the
"Company"). All significant intercompany accounts and transactions have been
eliminated upon consolidation.

FISCAL YEAR END -- The Company's fiscal year ends on September 30th.
References in the notes to the financial statements to the years 2001, 2000 and
1999 refer to the fiscal years ended September 30, 2001, 2000 and 1999,
respectively.

CASH EQUIVALENTS -- The Company considers all highly liquid investments
with a maturity of three months or less when purchased to be cash equivalents.

CONTRACTS AND REVENUE RECOGNITION -- The majority of the Company's
systems and equipment are custom designed and take a number of months to
produce. Revenues from large contracts are recognized using the percentage of
completion method of accounting in the proportion that costs bear to total
estimated costs at completion. Revisions of estimated costs or potential
contract losses 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.

Contract costs include all material and labor costs, as well as
applicable overheads related to contract performance. General and administrative
expenses are charged to expense as incurred.

Revenues from the remaining equipment and product sales are recognized
when title passes upon shipment.

INVENTORIES -- Inventories are valued at the lower of cost or market.
Cost is determined using the first-in, first-out (FIFO) method.

CONCENTRATIONS OF CREDIT RISK -- Financial instruments, which potentially
subject the Company to concentrations of credit risk, consist principally of
cash equivalents, trade receivables and notes receivable. The Company places its
cash equivalents with major financial institutions.

Concentrations of credit risk with respect to trade receivables are
limited due to the Company's large number of customers and their dispersion
across many different regions and industries. The Company grants credit to
customers based on an evaluation of their financial condition and collateral is
generally not required. Losses from credit sales are provided for in the
financial statements and have historically been within management's
expectations.

PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment is valued
at cost. Expenditures for repairs and maintenance are charged to operations as
incurred, while expenditures for additions and improvements are capitalized.
Depreciation is computed principally using the straight-line method over the
estimated useful lives of assets. The useful lives range from 30 to 40 years for
building and improvements; 5 to 10 years for machinery and equipment and 3 to 7
years for office equipment.

GOODWILL -- Goodwill represents costs in excess of net assets of acquired
businesses, which are amortized using the straight-line method over a period of
40 years. The Company evaluates the

- 29 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

realizability of goodwill based on the undiscounted cash flows of the applicable
businesses acquired over the remaining amortization period. Should the review
indicate that goodwill is not recoverable, the Company's carrying value of
goodwill would be reduced by the estimated shortfall of the cash flows. In
addition, the Company assesses long-lived assets for impairment under Financial
Accounting Standards Board's (FASB) Statement of Financial Accounting Standards
(SFAS) No. 121, "Accounting for the Impairment of Long-Lived Assets to Be
Disposed Of." Under those rules, goodwill associated with assets acquired in a
purchase business combination is included in impairment evaluations when events
or circumstances exist that indicate the carrying amount of those assets may not
be recoverable.

FOREIGN CURRENCY TRANSLATION -- Assets and liabilities of subsidiaries
are translated at the rate of exchange in effect on the balance sheet date;
income and expenses are translated at the average rates of exchange prevailing
during the year. The related translation adjustments are reflected in
accumulated other comprehensive loss in shareholders' equity. Foreign currency
gains and losses resulting from transactions included in the results of
continuing operations amounted to net gains of $17,000 in 2001, $163,000 in 2000
and $44,000 in 1999.

ACCUMULATED OTHER COMPREHENSIVE LOSS -- At September 30, 2001 accumulated
other comprehensive loss consists of a loss of $2,895,000 relating to a minimum
pension liability adjustment and a loss of $2,246,000 relating to accumulated
foreign currency translation adjustments. In previous periods the accumulated
other comprehensive loss related entirely to foreign currency translation
adjustments.

LOSS PER SHARE -- Loss per share is computed by dividing the net loss by
the weighted-average number of common shares outstanding during the year. Loss
per share -- assuming dilution is computed by dividing the net loss by the
weighted-average number of common shares outstanding adjusted for any dilutive
impact of potential common shares for options, warrants and convertible
subordinated debt. Because the Company recognized losses for all periods
presented, the effect of outstanding common stock equivalents are anti-dilutive
and have therefore been excluded from the computation of loss per share-assuming
dilution.

USE OF ESTIMATES -- The preparation of financial statements in conformity
with accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.

IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS -- In June 2001, the
Financial Accounting Standards Board issued Statements of Financial Accounting
Standards No. 141, Business Combinations, and No. 142, Goodwill and Other
Intangible Assets, effective for fiscal years beginning after December 15, 2001,
with early adoption permitted for certain companies with years ending after
March 15, 2001. Under the new rules, goodwill and intangible assets deemed to
have indefinite lives will no longer be amortized but will be subject to annual
impairment tests in accordance with the Statements. Other intangible assets will
continue to be amortized over their useful lives.

Waterlink is required to apply the new rules on accounting for goodwill
and other intangible assets beginning in the first quarter of fiscal 2003, or as
of October 1, 2002. Waterlink could also elect to adopt early the standards as
of October 1, 2001 under the transition rules. Application of the
nonamortization provisions of Statement No. 142 is expected to result in an
increase in income from continuing operations and net income of approximately
$871,000, or $0.04 per share, on an annual

- 30 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

basis. Waterlink has not yet determined whether it will elect early adoption of
this standard. Waterlink will perform the first of the required impairment tests
of goodwill and indefinite lived intangible assets as of the adoption date and
has not yet determined what the effect of these tests will be on the earnings
and financial position of Waterlink.

RECLASSIFICATIONS -- Certain amounts reported in the 2000 and 1999
financial statements have been reclassified to conform to the 2001 presentation.

2. DISCONTINUED OPERATIONS

In two separate transactions in September and December 2000, the Company
sold a combination of stock and assets of all the companies that comprised its
Biological Division for a combined sales price of approximately $4.1 million.
During the year ended September 30, 2000 the Company recorded a loss on the
disposal of the Biological Division of $16,151,000, which included a provision
of $832,000 for operating losses during the phase-out period.

In February 2001 the Company sold substantially all of the assets of its
Separations Division for approximately $18.8 million in cash, $17.3 million of
which was received at closing and $1.5 million of which was placed in escrow.
With regard to the amount placed in escrow, $500,000 has been received and the
remaining amount receivable of $1,000,000 is subject to reduction for any
indemnification claims made on or before February 28, 2002. In addition, in a
series of transactions during the fourth quarter of fiscal 2001, the Company
sold the stock of all of its companies that comprised its European Water and
Wastewater Division to three separate purchasers for aggregate gross proceeds of
$4.7 million. With regard to one of the transactions, $500,000 is being held
back for any indemnification claims made on or before August 31, 2002. In
connection with the sale of these two divisions, the Company recorded a net loss
on disposal totaling $17,475,000 during fiscal 2001, of which $3,891,000 related
to the sale of the Separations Division and $13,584,000 related to the sale of
the companies that comprised the European Water and Wastewater Division. With
regard to this loss recorded on the disposal of the European Water and
Wastewater Division, $6,416,000 related to the write-off of the cumulative
translation adjustment component of equity.

Accordingly, the results of operations for the Biological, Separations,
and European Water and Wastewater Divisions 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. The amount of
interest allocated to and included in the operating loss from discontinued
operations was $1,178,000 in 2001, $2,422,000 in 2000 and $1,945,000 in 1999.
The loss from discontinued operations for each period is presented below.

- 31 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

3. 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 shown in the
financial statements, the Company incurred losses from continuing operations
during each of the three years in the period ended September 30, 2001, and
recorded net losses of $22,977,000, $38,356,000 and $4,182,000 in 2001, 2000 and
1999, respectively. In addition, at September 20, 2001 the Company has a working
capital deficiency of $33,514,000. These factors raise substantial doubt about
the Company's ability to continue as a going concern for a reasonable period of
time.

In May 2000, the Board of Directors authorized management of the Company
to explore all strategic alternatives that could maximize shareholder value,
including the sale of certain of its divisions or the entire Company. The
Company is currently in discussions with parties regarding the possible sale of
its Pure Water Division. At this time, the Company can give no level of
assurance that it will be successful in selling this division.

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 the Company be unable to continue as
a going concern. The Company's continuation as a going concern is dependent on
its ability to negotiate with its senior lenders repayment terms that the
Company can satisfy in accordance with its strategic alternative process, its
ability to successfully continue its strategic alternative process, and the
ability to generate sufficient cash flows to operate its business.

4. INVENTORIES

Inventories consisted of the following:

5. CONTRACT BILLING STATUS

Information with respect to the billing status of contracts in process is
as follows:

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WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

The above amounts are included in the accompanying consolidated balance
sheet at:

6. LONG-TERM OBLIGATIONS

Long-term obligations consisted of the following:

The Company's Senior Credit Facility is with Bank of America National
Trust & Savings Association as agent, with five other participating banks.
Effective January 15, 2002, the Company entered into an amendment to its Senior
Credit Facility that extended the maturity date of the facility from January 15,
2002 to October 1, 2002, assuming the Company maintains a certain level of
earnings before interest and taxes and maintains certain balance sheet ratios
through September 30, 2002. Under Waterlink's senior credit facility, the final
maturity date for Waterlink's payment obligations changes from October 1, 2002
to May 31, 2002 unless on or before May 31, 2002 Waterlink has entered into a
definitive agreement to sell Waterlink's pure water division, which agreement
must contain terms approved by the senior bank group.

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WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

The Senior Credit Facility restricts or prohibits the Company from taking
many actions, including paying dividends and incurring or assuming other
indebtedness or liens. The Company's obligations under the senior credit
facility are secured by liens on substantially all of the Company's domestic
assets, including equipment, inventory, accounts receivable and general
intangibles and the pledge of most of the stock of the Company's subsidiaries.
Effective with the signing of the amendment to the Senior Credit Facility,
approximately $338,000 was available for future borrowings at September 30,
2001.

In May 2001, the maturity date of the $2,250,000 of convertible
subordinated notes payable to former shareholders of C'treat was extended from
March 2, 2001 to October 31, 2001, and the interest rate was increased from
5.54% to 11% per annum, with interest to be paid monthly. The maturity date of
these notes has been further extended to October 15, 2002. The conversion rate
on these notes to Common Stock is $15.63 per share.

In January 2001, the Company issued $1,000,000 of subordinated notes to
two related parties, the proceeds from which were to be used for working capital
purposes. These subordinated notes carry an interest rate of 13.0% per annum,
payable quarterly. In connection with this indebtedness, the Company issued
warrants to purchase up to 100,000 shares of Waterlink common stock at an
exercise price of $.01 per share. The value of these warrants totaling $92,000
is being amortized on a straight-line basis through the original maturity date
of the notes, January 18, 2002. The warrants will expire on January 17, 2006.
Effective January 15, 2002 the maturity date of these notes was extended until
October 15, 2002.

In connection with various financing activities, the Company has issued
warrants to purchase shares of Common Stock, 839,137 of which are outstanding at
September 30, 2001. The warrants carry exercise prices ranging from $0.01 to
$4.50 with expiration dates ranging from February 2002 to January 2006.

7. LEASES

The Company leases certain facilities and equipment under operating
leases. Rent expense totaled $1,641,000 in 2001, $1,220,000 in 2000 and
$1,069,000 in 1999. Aggregate future minimum lease payments under noncancelable
operating leases at September 30, 2001 are as follows (in thousands):

Year ending September 30, 2002 $1,111
Year ending September 30, 2003 794
Year ending September 30, 2004 279
Year ending September 30, 2005 168
Year ending September 30, 2006 99
Thereafter 197
------
$2,648
======

8. SPECIAL CHARGES

The Company incurred special charges in 1999 of $563,000 primarily
relating to severance and contractual obligations to former executives. At
September 30, 2001, approximately $77,000 remains accrued to be paid by January
2002 with regard to this special charge.

- 34 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

In September 2001, based on the status of the strategic alternative
process, the Board of Directors of the Company determined the corporate office
of Waterlink should be relocated to its Columbus facility. This consolidation
resulted in personnel reductions and the disposal of certain fixed assets.
Accordingly, the Company recorded a special charge of $2,560,000 in 2001
relating to severance obligations and the write off of certain fixed assets. The
amount relating to severance obligations of $2,367,000 has been accrued at
September 30, 2001 and will be paid through September 30, 2003.

9. INCOME TAXES

The provision for income taxes consists of the following:

Income (loss) before income taxes consists of the following:

Following is the reconciliation between the provision for income taxes
and the amount computed by applying the statutory U.S. federal income tax rate
of 34% to income (loss) before income taxes:

Deferred income taxes reflect the net effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax

- 35 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

purposes. The tax effects of the net operating loss carryforward and temporary
differences are as follows:

In connection with acquisitions made in 1998, the Company recorded
deferred tax asset valuation reserves as part of purchase price allocations
totaling $7,417,000 in the United Kingdom and $509,000 in the United States due
primarily to net operating loss carryforwards existing in these tax
jurisdictions. The benefit of net operating loss carryforwards realized in the
future will be recorded as a reduction of goodwill rather than as a credit to
income tax expense during that period. The amount of income taxes recorded which
resulted in a corresponding decrease in goodwill was $310,000 in 2000 and
$546,000 in 1999. No such amounts were recorded in 2001.

For tax purposes, the Company has U.S. federal loss carryforwards of
$59,560,000 that expire in varying years through 2016, and net operating loss
carryforwards in the United Kingdom of $18,026,000 that have no expiration
dates. A valuation allowance has been established for the entire amount of the
net operating loss carryforwards since the realization is uncertain.

The Company plans to reinvest the undistributed earnings of its non-U.S.
subsidiaries. The amount of undistributed earnings considered to be indefinitely
reinvested for this purpose was approximately $5,131,000 at September 30, 2001.
Accordingly, no provisions have been made for U.S. income tax purposes on such
undistributed earnings. While the amount of any U.S. income taxes on these
undistributed earnings, if distributed in the future, is not determinable, it is
expected that they would be reduced by the utilization of tax credits or
deductions. A distribution of these earnings would be subject to withholding
taxes.

10. STOCK OPTION PLANS

During 1998, the shareholders approved the Omnibus Incentive Plan (the
"Omnibus Plan"), which provides for compensatory equity based awards to officers
and certain other key employees of the Company. Awards may be granted for no
consideration and consist of stock options, stock awards, SARs, dividend
equivalents, other stock based awards (such as phantom stock) and performance
awards consisting of any combination of the foregoing.

The Company's 1995 Stock Option Plan (the "Stock Option Plan") provides
grants to officers, certain other key employees, and directors of awards
consisting of "incentive stock options" as defined under the provisions of
Section 422 of the Internal Revenue Code and non-qualified stock

- 36 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

options. All options granted under the Stock Option Plan expire ten years after
the date of grant (see Note 11).

The Company's 1997 Non-Employee Director Stock Option Plan (the "Director
Plan") is authorized to issue up to 150,000 shares of Common Stock. Each
non-employee director is automatically granted an option to purchase 3,000
shares of Common Stock. In addition, on each anniversary date of the Director
Plan, each of the Company's then non-employee directors who have served at least
six-months shall automatically be granted an option to purchase 5,000 shares of
Common Stock. The per share exercise price of options granted under the Director
Plan will be the fair market value of the Common Stock on the date of grant.
Options granted under the Director Plan expire ten years after the date of grant
(see Note 11).

Collectively, 2,750,000 shares of Common Stock are available for granting
of awards under the above plans at September 30, 2001.

Under the Company's Employee Stock Purchase Plan (the "Stock Purchase
Plan"), the Company is authorized to issue up to 500,000 shares of Common Stock.
Under the terms of the Stock Purchase Plan, employees can choose to have up to
20% of their annual compensation, but no more that $25,000 per year, withheld to
purchase Common Stock. The exercise price for shares subject to purchase under
options granted shall be 85% of the fair market value of the Common Stock on the
first day of the purchase period, unless otherwise determined by the
compensation committee. On the last day of the purchase period of any offering
of shares made under the Stock Purchase Plan, each outstanding option shall
automatically be exercised. At any time prior to the end of the purchase period
applicable to each offering, an employee is permitted to terminate or reduce his
or her payroll deductions, to reduce his or her options to purchase or to
withdraw all or part of the amount in his or her account. The employee has the
right to receive in cash the amount accumulated in such account. In connection
with the Stock Purchase Plan, 55,493 shares of Common Stock were issued in 2000.
The Stock Purchase Plan will terminate in 2007.

11. STOCK BASED COMPENSATION

It is the Company's policy to generally grant stock options for a fixed
number of shares to employees with the exercise price approximating fair value.
The Company has elected to follow APB Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25"), and related interpretations and accordingly,
recognizes no compensation expense for stock options granted at fair value.
Management believes that the alternative fair value accounting provided for
under FASB Statement No. 123, "Accounting For Stock Based Compensation" ("SFAS
123"), requires use of option valuation methods that were not developed for use
in valuing employee stock options. Under APB 25, compensation expense has been
recognized for all options granted at less than the fair market value of the
Company's common shares on the date of grant.

Pro forma information regarding net income and earnings per share is
required by SFAS 123 and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that Statement. The
fair value of these options and the options granted as part of the Plan were
estimated at the date of grant using a Black-Scholes option-pricing model. The
Company assumed a dividend yield rate of 0% and a weighted-average expected life
of the options of 5 years for all periods presented. The risk-free interest
factor utilized was 6.3% in 2001, 5.5% in 2000 and 5.9% in 1999. Further, the
volatility factor of the expected market price of the Company's stock was 34% in

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WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

2001, 35% in 2000 and 32% in 1999. Following is the weighted-average grant-date
fair value of options granted during 2001, 2000 and 1999 using the Black-Scholes
model, with the weighted average exercise price for comparison purposes:

The weighted-average grant-date fair value of the shares granted under
the Stock Purchase Plan was $1.21 during 2000. No such shares were granted
during 1999 or 2001.

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated value of the options
is amortized to expense over the options' vesting period. The pro forma results
are not necessarily indicative of what would have occurred had the Company
adopted SFAS 123. The Company's pro forma information follows:

A summary of the Company's stock option activity and related information
follows:

- 38 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

The following table summarizes information concerning outstanding and
exercisable options at September 30, 2001:

The Company has reserved 2,285,000 shares of Common Stock for the
possible exercise of outstanding stock options.

12. RETIREMENT PLANS

The Company sponsors two defined benefit pension plans. One of the plans
is in the U.K., which covers substantially all of the employees of Sutcliffe
Speakman Carbons and Sutcliffe Croftshaw; and the other is a U.S. plan, which
covers substantially all of the employees of Barnebey Sutcliffe. Information
pertaining to the Company's defined benefit pension plans follows:

- 39 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

- 40 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

Amounts applicable to the Company's pension plan with projected or
accumulated benefit obligations in excess of plan assets are:

The Company also sponsors a defined contribution plan that covers
substantially all domestic employees. Company contributions to the Plan totaled
$58,000 in 2001, $69,000 in 2000 and $54,000 in 1999.

13. FINANCIAL INSTRUMENTS

The carrying values of cash, cash equivalents, accounts receivable and
accounts payable are a reasonable estimate of their fair value due to the
short-term nature of these instruments. Substantially all of the Company's
long-term debt obligations, except for the convertible subordinated notes to the
former shareholders of C'treat and to related parties, have variable rates and
cost approximates fair value at September 30, 2001. The convertible subordinated
notes do not have a ready market and cost is assumed to approximate fair value.
The aggregate carrying value of these notes is $3,250,000 at September 30, 2001,
with interest rates ranging from 11.00% to 13.00% and maturity dates in October
2002.

14. SEGMENT INFORMATION

Historically the Company's reportable segments were the five divisions
the Company established as part of its 1999 Strategic Operating Plan. As
described in Note 2 the Company completed the sale of three of its divisions
during 2001 and is reporting these three divisions as discontinued operations.
The two divisions that comprise the continuing operations are described below:

- The Specialty Products Division specializes in the development and
production of activated carbons used to purify air, water and gases.
The division is a worldwide supplier of activated carbon for liquid,
air and gas filtration systems and is a manufacturer of specialized
impregnated carbons. Its products include adsorption equipment,
bioreactors and bioscrubbers, corrosive gas control systems, solvent
recovery systems, and a variety of air, odor and vapor control and
filtration systems.

- The Pure Water Division sells products and solutions to the
residential, municipal and industrial water and process water markets.
Its products include membrane technology using reverse osmosis systems,
nanofiltration and microfiltration systems, desalination equipment to
purify seawater, and watermakers for the offshore oil industry.

The Company evaluates the performance of this division or segment based
on its revenue growth prospects, operating income performance, and return on
invested capital, or total assets. The accounting policies of the divisions, or
reporting segments, are the same as those described in Note 1.

- 41 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

The following table summarizes the Company's continuing operations, which
are comprised of its Specialty Products Division, Pure Water Division and
corporate.

- 42 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

A reconciliation of the reportable segments' operating income to
consolidated income (loss) before income taxes follows:

A reconciliation of the reportable segments' assets to consolidated
assets at September 30 follows:

Net sales are reflected in the country from which the sales are made.
Information with regard to revenues and long-lived assets by geographic areas
follows:

The Company did not derive more than 10% of its net sales from any
individual customer during any of the three years ended September 30, 2001.

- 43 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

15. SUPPLEMENTAL CASH FLOW DATA

Supplemental cash flow data is as follows:

16. CONTINGENCIES

The Company is subject to various lawsuits, claims and proceedings that
arise in the ordinary course of business. The Company accrues the cost
associated with legal matters when they become probable and reasonable
estimable. Management believes that any ultimate liability with respect to these
actions, in excess of the amount provided, will not materially affect the
Company's operations, cash flows or consolidated financial position.

17. QUARTERLY OPERATING RESULTS (UNAUDITED)

The following is a summary of unaudited quarterly results of operations
for the years ended September 30, 2001 and 2000.

The quarter ended September 30, 2001 includes a special charge of
$2,560,000 related to the closure of the corporate office.

- 44 -

WATERLINK, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- CONTINUED

- --------------------------------------------------------------------------------

- 45 -

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Information required by this item is located in Waterlink's definitive
Proxy Statement to be filed with the Securities and Exchange Commission within
120 days of the close of Waterlink's fiscal year ended September 30, 2001 and is
incorporated herein by reference thereto.

ITEM 11. EXECUTIVE COMPENSATION.

Information required by this item is located in Waterlink's definitive
Proxy Statement to be filed with the Securities and Exchange Commission within
120 days of the close of Waterlink's fiscal year ended September 30, 2001 and is
incorporated herein by reference thereto.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required by this item is located in Waterlink's definitive
Proxy Statement to be filed with the Securities and Exchange Commission within
120 days of the close of Waterlink's fiscal year ended September 30, 2001 and is
incorporated herein by reference thereto.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

None.

- 46 -

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) 1. FINANCIAL STATEMENTS

The following report and consolidated financial statements of Waterlink,
Inc. and Subsidiaries are included in Item 8, Part II of this report:

Report of Independent Auditors

Consolidated Balance Sheets at September 30, 2001 and 2000

Consolidated Statements of Operations for the years ended September 30,
2001, 2000 and 1999

Consolidated Statements of Shareholders' Equity for the years ended
September 30, 2001, 2000 and 1999

Consolidated Statements of Cash Flows for the years ended September 30,
2001, 2000 and 1999

Notes to Consolidated Financial Statements

(a) 2. FINANCIAL STATEMENT SCHEDULES

Schedules are omitted because of the absence of conditions under which
they are required or because the required information is given in the
Financial Statements or notes thereto.

(b) REPORTS ON FORM 8-K

(i) On August 9, 2001 Waterlink filed a Current Report on Form 8-K
reporting under Item 5 the issuance of an earnings press release on
August 7, 2001 and including under Item 7(c) a copy of the press release.

(ii) On November 2, 2001 Waterlink filed a Current Report on Form 8-K
reporting under Item 5 the issuance of a press release concerning
management changes on November 1, 2001 and including under Item 7(c) a
copy of the press release.

(c) EXHIBITS

The exhibits are set forth on the attached Exhibit Index which is
incorporated by reference. Exhibits are included only in the copies of
this Form 10-K filed with the Securities and Exchange Commission.

- 47 -

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Waterlink, Inc. has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.

WATERLINK, INC.

By: /s/ William W. Vogelhuber
--------------------------------------
Its President and Chief Executive
Officer

Date: January 18, 2002

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated:

/s/ Robert P. Pinkas /s/ Kenneth Ch'uan-k'ai Leung
- ------------------------------------------- -------------------------------------------
Robert P. Pinkas, Kenneth Ch'uan-k'ai Leung,
Director and Chairman of the Board Director
Date: January 18, 2002 Date: January 18, 2002

/s/ Dr. R. Gary Bridge /s/ William W. Vogelhuber
- ------------------------------------------- -------------------------------------------
Dr. R. Gary Bridge, William W. Vogelhuber,
Director Director, President and Chief Executive
Date: January 18, 2002 Officer
Date: January 18, 2002

/s/ B. Bruce Cummings /s/ Donald A. Weidig
- ------------------------------------------- -------------------------------------------
B. Bruce Cummings, Donald A. Weidig,
Director Chief Financial Officer
Date: January 18, 2002 (and principal accounting officer)
Date: January 18, 2002

/s/ Peter G. Kleinhenz
- -------------------------------------------
Peter G. Kleinhenz,
Director
Date: January 18, 2002

- 48 -

INDEX TO EXHIBITS

- 49 -

- 50 -

- 51 -

- ---------------

* Incorporated herein by reference as indicated.

- 52 -