AQUA CARE SYSTEMS INC /DE/, 10KSB40, 1998-03-30

AQUA CARE SYSTEMS INC /DE/
10KSB40, 1998-03-30
REFRIGERATION & SERVICE INDUSTRY MACHINERY

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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-KSB

[X] ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended DECEMBER 31, 1997

[ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ___________________

Commission File Number 0-22434

AQUA CARE SYSTEMS, INC.
--------------------------------------------
(Name of small business issuer in its charter)

DELAWARE 13-3615311
------------------------------ ---------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

11820 NW 37 STREET, CORAL SPRINGS, FL 33065
------------------------------------------------
(Address of principal executive offices)(Zip Code)

Issuers's telephone number: (954) 796-3338

Securities registered under Section 12(b) of the Exchange Act: NONE

Securities registered under Section 12(g) of the Exchange Act:

TITLE OF CLASSES

Common Stock, $.001 par value

Class A Redeemable Warrants

Class B Redeemable Warrants

Units (consisting of one share of
Common Stock, one Class A Warrant
and one Class B Warrant)

Page 1 of 40, (including pages F-1
through F-18) Index to Exhibits Page 21

<PAGE>

Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15 (d) of the Exchange Act during the past 12 months (or for such
shorter period that the Registrant was required to file such reports), and (2)
has been subject to such filing requirements for the past 90 days.

Yes [X] No [ ]

Check if disclosure of delinquent filers in response to Item 405 of
Regulation S-B is not contained in this Form, and no disclosure will 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-KSB
or any amendment to this Form 10-KSB. [ X ]

Issuer's revenues for its most recent fiscal year: $23,901,102

The aggregate market value of the voting stock held by non-affiliates of
the Registrant (computed by reference to the average bid and asked prices of
such stock) as of February 27, 1998 was approximately $5,703,628.

There were 2,722,013 shares of Common Stock, $.001 par value, outstanding
at February 27, 1998.

Transitional Small Business Disclosure Format (check one):

Yes [ ]; No [X]

DOCUMENTS INCORPORATED BY REFERENCE: See Item 13, Exhibits and Reports on
Form 8-K, for items incorporated by reference into this Annual Report on Form
10-KSB.

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PART I

ITEM 1. DESCRIPTION OF BUSINESS.

GENERAL

Aqua Care Systems, Inc., (the "Company" or "ACSI"), is a Florida-based
Delaware corporation. It was formed in 1990 for the purpose of pursuing
acquisitions, primarily in the non-chemical waste water treatment and water
filtration and purification industries. The Company acquired several businesses
from its inception through May 1995. As a result of these acquisitions and
developing the related operations, the Company sustained substantial operating
losses and expended significant cash.

In May 1995, the Company's Board of Directors replaced executive
management. New management developed and has implemented a consolidation and
restructuring plan for ACSI. For the year ended December 31, 1996, the Company
reduced annual operating expenses by in excess of $2 million while increasing
revenues by approximately 8%, to $15,987,147. For the year ended December 31,
1997, revenues increased by approximately 50%, to $23,901,102 from the prior
year, and the Company reported its first year of consolidated net income.

As a further step in ACSI's reemergence from its restructuring plan, the
Company has implemented a strategy to focus on the critical fluid handling needs
of the process industries. The Company believes there are excellent
opportunities for profitable growth in these markets. ACSI's ability to
successfully implement its strategy is supported by the acquisition of two
businesses in the fluid handling markets purchased from Durco International,
Inc. in June 1997. These businesses focus on providing added value to customers
through end user price and quality enhancement by providing specially designed
high end products to meet the technically demanding needs in their respective
markets. The Company has also recruited several senior executives from the
fluids handling market to various positions since the acquisition.

ACSI's plan is to substantially increase its presence in the fluid handling
markets. The Company intends to selectively invest in internal growth and pursue
additional acquisitions that may enhance its existing competencies, market
presence and overall profitability. Since the acquisition of the metering pump
and filtration systems businesses, the Company has increased the emphasis on its
respective sales and marketing organizations. In addition, the Company announced
the signing of a letter of intent to acquire The Williams Instrument Company in
January 1998. Williams Instrument Company considers itself to be a leader in
providing high-end pneumatic pumps to the oil and gas markets. The acquisition
is subject to, among other issues, the satisfactory completion of due diligence
procedures, financing arrangements and the execution of a definitive purchase
agreement by the Company.

In addition to the Company's focus on opportunities in the fluid handling
business, it continues to provide management services to its other operating
subsidiaries. The Company has organized its active, wholly owned subsidiaries
into three divisions; (a) fluid handling (b) residential water filtration and
purification and (c) car wash equipment and supplies.

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ACQUIRED SUBSIDIARIES

In June 1997, the Company acquired certain assets and assumed certain
liabilities of the Filtration Systems Division of Durco International, Inc.,
("FSDA"). Included in the FSDA acquisition were two operating businesses, a
filtration systems manufacturer and a metering pumps business. For the year
ended December 31, 1996, the businesses had combined revenues of $14,742,333 and
operating profit of $949,230. ACSI acquired these businesses because of their
engineering and manufacturing capabilities, profitable track records and market
presences. The Company believes with a more aggressive, comprehensive marketing
effort and the support of several new management personnel that have joined the
Company since the acquisition, that there are excellent opportunities for
profitable growth. However, there can be no assurance that such growth can be
achieved.

Prior to the May 1995 executive management change, the Company acquired
several businesses including Gravity Flow Systems, Inc., ("GFSI"), and
EnviroSystems Supply, Inc., ("ESSI"), in the waste water treatment industries;
KISS International, Inc., ("KISS"), Di-tech Systems, Inc., ("DTSI"), and Midwest
Water Technologies, Inc., ("MWTI"), in the water filtration and purification
industries and Car Wash Equipment & Supply, Ryko of South Florida, Inc.,
("CWES"), in the car wash equipment, supplies and service business.

The Company will continue to engage in an acquisition program which could
result in a substantial change in ACSI's business operations and financial
condition. As consideration for any acquisition, in addition to the payment of
cash (if any), ACSI may issue notes, common stock, preferred stock or other
securities. It is intended that key employees of acquired companies generally
will become employees of the subsidiaries and, as such, will hold management
positions in such subsidiaries. ACSI does not intend to seek stockholder
approval for any acquisitions unless required by applicable laws or regulations.

OPERATIONS

FLUID HANDLING.

FSDA encompasses two operating businesses that are located in Angola, New
York. Other than a shared administrative building, each business has its own
separate facilities. The two entities are now managed as a) the Filtration
Systems Division, ("FSD"), and b) the Metering Pump Division, ("MPD"). Both
divisions primarily serve the chemical, mining, pulp and paper, oil and gas,
food and water and waste water markets.

MPD's products add a liquid or gas to another liquid or gas process in
precise and reproducible volumetric requirements. MPD's metering pumps are
primarily used in the chemical and petro-chemical markets. This entity has three
main pump models which are available in numerous configurations. MPD offers one
of the market's most recently designed product lines, the development of which
was supported by the financial resources of the previous owner. Based on that
design advantage, MPD focuses on special application market segments for
solutions requiring highly engineered products. Management believes that the
growth of its market is driven by general economic growth and is enhanced by
clean air and clean water legislation, as well as industry cost efficiency
mandates. MPD sells through regional sales managers primarily to regional
distributors. The selling effort focuses on

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both engineering firms who typically purchase large quantities as part of major
systems installations and directly to end users. MPD has not historically relied
on marketing programs to sell its products, but intends to implement both
distributor marketing programs and selective direct marketing.

FSD manufactures a) filter presses, b) pressure leaf filters and c) tubular
filters. All three types of filters are large units used in industrial
applications. The demand for each filter is based on the solids concentration,
level of purification required and the flow rate of the liquid used in the
process. These manufactured products, along with the technical expertise of the
employee base, allow FSD to address the filtration and separation needs such as
those found in food and beverage processing, chemical manufacture, and oil and
gas refining. FSD has approximately 40 years of experience in supplying quality
systems and components to the process industries.

Filter presses are large, steel-framed structures with pneumatically driven
square filters used to separate solids from liquids that contain high solids
concentration. They are used to dewater sludge, separate chemicals such as dyes
and pigments from liquid in industrial applications and in food processing to
separate chemicals from liquids. Typically, liquid slurry is pumped into the
filter press. The liquid passes through the filter and flows to a discharge port
to be captured or disposed of. Pressure from a feed pump forces out more liquid.
The solids are compacted into a dry "cake" which is dropped into a handling
system. In manufacturing and food processing applications, the solid material
captured in dry form can be disposed of at a lower cost or reused.

Pressure leaf filters are large vessel type filters used for liquids
containing medium level solids concentration and for use when a high level of
clarification is desirable. Pressure leaf filters are used in chemical,
pharmaceutical and beverage applications to remove sub-micronic solids from a
liquid. Generally, a liquid is pumped into a closed vessel, which contains a
filter septum and out through a discharge pipe leaving behind the trapped
solids. As compared to a filter press, the leaf filters separate smaller
particles, down to one-tenth micron removal, can handle high flow rate and can
discharge wet or dry cakes.

Tubular filters are much smaller than filter presses or pressure leaf
filters and allow for the highest flow rate, although with the lowest solids
concentration. Tubular filters can be used for such applications as mineral
acids clarification and for the ultra pure water needs for applications such as
semiconductor manufacturing.

The management of FSD believes that the market for its products is driven
by global production growth and the increasing need/benefit for eliminating
unwanted contaminants to ensure safe and/or constant quality products. Specific
factors creating new application requirements include improved detection and
monitoring levels, environmental consciousness and cost savings to recycle
certain elements. Management's goal is to seek market opportunities where it
believes it has a competitive advantage through value added systems engineering
and demonstrated competence through a large base of successful installations.
FSD sells through regional sales managers who work with independent
representatives selling to engineering firms and directly to end-users. FSD
intends to support its sales effort with print advertising in trade journals,
trade show attendance, direct marketing and public relations. As a result of the
systems project nature of the business, revenues and operating income can vary
significantly on a month to month basis.

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GFSI's operations were relocated to the FSDA location in Angola, New York
in August 1997. Its product line is comprised of Wedgewater(TM) filter bed
systems for sludge de-watering, lateral flow sludge thickener systems and
Wedgewater(TM) sieve systems. The patented Wedgewater(TM) filter bed system
generally is utilized by municipalities servicing populations of 30,000 or less
and utilizes one-sixth to one-tenth the space and requires significantly less
time to de-water sludge as compared with conventional sand/gravel filter beds.
Several other advantages to this technology include, but are not limited to,
lower operating and maintenance costs, exceptional reliability and improved
operating environments. GFSI has sold and installed over 300 systems through 26
domestic and international representatives.

ESSI designs and assembles aerobic and anaerobic packaged and larger
field-erected waste water treatment plants. These systems incorporate either
aerobic or anaerobic biological treatment technologies. Such technologies
generally involve the conversion of organics in waste water into carbon dioxide,
water and new organics through the introduction of microorganisms. The aerobic
system (which functions in the presence of oxygen) is marketed under the
trademark CONTREAT(R), and is used primarily for pretreatment of industrial
waste water before such waste water is discharged into a municipal sewage system
or reused. ESSI faces intense competition and although it provides specialized
engineering services, it must compete primarily on pricing, and as such,
revenues have decreased from $3,777,932 for the year ended December 31, 1996 to
$2,201,078 for the year ended December 31, 1997.

RESIDENTIAL WATER FILTRATION AND PURIFICATION.

The Company owns three operating entities in the residential water
filtration and purification industries. KISS, which operates in southern
California, is a manufacturer and distributor of water filtration and
purification products primarily for residential applications. It owns its own
molds for various major components, such as filter housings, membrane housings
and control valves. KISS distributes its products through dealers, distributors
and wholesalers throughout the United States and internationally. DTSI, located
in the same facility as KISS, produces a line of water purification and ion
exchange cartridges that it markets under the Di-tech brand name through dealers
and distributors primarily to original equipment manufacturers. MWTI, which
operates primarily in the Midwestern United States, assembles and wholesales
various water conditioning equipment, parts and components and, to a lesser
extent, reverse osmosis drinking water systems. These businesses face intense
competition and must compete primarily on product pricing.

KISS, MWTI and DTSI assemble the majority of their product lines. Their
products are installed by the Company's dealers or shipped as finished goods to
wholesalers and retailers. KISS manufactures and sells its products to dealers
who in turn re-sell the products to customers. In most cases KISS and MWTI
bundle their respective products into a package and sell such packages as whole
house water solutions. ACSI offers consumers financing of their purchases from
ACSI's dealers through a third party. In the years ended December 31, 1997 and
1996, ACSI recognized approximately $779,000 and $692,000, respectively, in
revenues from this financing activity. Because of the competitive nature of the
businesses, the profits from the financing contribute a significant amount to
the entities' profits. ACSI does not assume any credit risk in such financings.
However, changes in the market for such credit could have a material adverse
effect on the businesses.

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<PAGE>

CAR WASH EQUIPMENT AND SUPPLIES.

CWES is the exclusive distributorship in the seven southern counties of
Florida for the sale, installation and continuing service contracts of the
equipment and supplies of Ryko Manufacturing Company, the largest manufacturer
of car wash equipment in the United States. The management of CWES believes that
it has in excess of an 80% share of its market. CWES' customers include, but are
not limited to, certain major national oil companies, independently owned and
operated gasoline distributorships and car wash companies.

SUPPLIERS

There are several manufacturers and suppliers of the components used in the
manufacturing and assembly of the Company's products. ACSI purchases raw
materials and supplies on terms, usually net 30 days, and to a lesser extent, on
a cash on delivery basis. The Company believes that it generally is not
dependent on any one supplier for products or components utilized by the
subsidiaries. CWES, however, is dependent on a single supplier, Ryko
Manufacturing Company ("Ryko"). CWES is the exclusive distributor in South
Florida for the sale, installation and service of Ryko's rollover car wash
equipment. Such exclusive distributorship prohibits CWES from selling,
installing and/or servicing any car wash equipment from another manufacturer or
supplier. The distributor agreement provides that CWES sells directly or
receives a commission on all Ryko equipment sold within its region. The
agreement is scheduled to expire in July 1999, however, it provides for
automatic renewal upon the achievement of certain sales goals. CWES expects to
meet such goals.

INSURANCE

The Company maintains limited product liability insurance. ACSI has not had
a significant product liability claim asserted against it since inception,
except one, which was successfully defended and settled in a manner satisfactory
to ACSI with no financial cost to it. A substantial successful products
liability claim could have a material adverse effect on the Company's operations
and financial condition.

BUSINESS SEGMENT INFORMATION

ACSI's operations consist of two business segments for financial reporting
purposes; a) fluid handling, filtration, purification and waste water treatment
and b) car wash equipment sales and service. See Note 10 of "Notes to
Consolidated Financial Statements" for a summary of selected consolidated
information for such business segments for the years ended December 31, 1997 and
1996.

GOVERNMENTAL REGULATION

The enactment and enforcement of Federal, state and local laws relating to
water and air quality standards may materially influence the level of sales of
some or all the Company's businesses. Some of the Company's customers utilize
ACSI's products and services in response to regulatory requirements affecting
their businesses. ACSI believes that, as a provider of such products and
services, the Federal or state environmental rules or regulations potentially
applicable to the Company's customers are not directly applicable to ACSI. While
the Company is not aware of any pending or proposed Federal

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legislation or regulation that would adversely affect its products or components
or limit the methods in which those products are manufactured, installed or
serviced, any such legislation or regulation could have a material adverse
impact on the Company. Certain states have enacted legislation, which requires
licensing, testing and labeling of flow control, fluid handling, water
filtration and purification and waste water treatment products, including those
offered by ACSI.

COMPETITION

In the filtration systems and metering pump markets, the Company's
management believes that there is a fragmented specialized approach to
satisfying customers' needs. The Company attempts to compete in market segments
characterized by demand for quality, technologically superior products and
service. However, the Company does compete against companies with substantially
greater resources including U.S. Filter and Milton Roy.

In the residential filtration and purification markets, the Company
believes that there are thousands of companies involved in various aspects of
water filtration and purification and that the market is highly competitive. The
Company competes with a number of significantly larger companies including
Culligan, EcoWater and Hague in the residential filtration and purification
market. Such market is served by an array of products that are either
"off-the-shelf" or custom-designed. These products range from small carbon
filtration systems to de-ionization systems, reverse osmosis systems,
de-gasifiers, scrubbers, ozone systems, ultra-violet systems and bio-remediation
systems. Many of the residential systems generally are marketed by local
operators across the country.

EMPLOYEES

As of February 27, 1998, ACSI and its subsidiaries had 153 full-time
employees, including two executive officers, 25 managerial and administrative
personnel, 16 design and engineering personnel, 89 manufacturing, assembly,
installation and service personnel, and 21 sales and telemarketing personnel.

As a result of the acquisition of FSDA, the Company became a party to a
collective bargaining agreement with the International Union of Electronic,
Electrical, Salaried, Machine and Furniture Workers, A.F.L. - C.I.O. The Company
negotiated changes to the existing agreement and in July 1997, a collective
bargaining agreement was ratified for the period covering July 17, 1997 through
July 21, 2000. Such agreement applies solely to certain of the employees of
FSDA. Neither the Company nor any of its subsidiaries are subject to any other
collective bargaining agreements.

ACSI believes its employee relations to be satisfactory.

ITEM 2. DESCRIPTION OF PROPERTY.

In connection with the acquisition of FSDA in June 1997, the Company
purchased land and three buildings encompassing approximately 110,000 square
feet on approximately 60 acres in Angola, New York. The buildings are comprised
of a) the manufacturing and assembly facility for the filtration products group,
(approximately 70,000 square feet), b) the manufacturing and assembly,
engineering and administrative facilities of the metering pump group and the
administrative and sales offices of

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GFSI, which were relocated there from previously leased facilities in Scranton,
Pennsylvania during 1997, (approximately 30,000 square feet), and c) the
administrative office building which contains divisional management and
purchasing, sales and engineering for the filtration operations, (approximately
10,000 square feet). The above noted properties are encumbered by a mortgage
covering the land and buildings securing a note bearing interest at prime plus
3%, (11.5% at December 31, 1997). The note is payable, principal and interest
monthly, with an estimated balloon payment of approximately $400,000 due June
2000. The note balance as of December 31, 1997 was $1,162,400.

ACSI purchased land and a building in Coral Springs, Florida in July 1996.
Such facility encompasses approximately 18,000 square feet of office and
warehouse area and houses ACSI's corporate office, as well as the entire
operations and administration of CWES and ESSI and a Southeastern office and
warehouse space for the water filtration and purification entities, KISS, DTSI
and MWTI. The property is encumbered by a first mortgage lien covering the land
and building. The secured note bears interest at the fixed rate of 9.25% and is
payable, principal and interest monthly, with an estimated balloon payment of
approximately $360,000 due June 2001. The mortgage balance at December 31, 1997
was $429,174.

Certain leased properties contain the offices, warehouse and
manufacturing/assembly facilities of KISS and DTSI in Vista, California and MWTI
in Fort Wayne, Indiana. Total leased space for these facilities aggregates
approximately 30,000 square feet. The Vista, California property is leased
through July 1999 and the Fort Wayne, Indiana facility is leased through July
2000, each from non-affiliated, third parties. The Company's aggregate monthly
lease expense for the above noted properties is approximately $14,000.

The Company believes that its premises are adequate to permit it and its
subsidiaries to conduct their businesses as they are currently conducted for the
reasonably foreseeable future.

ITEM 3. LEGAL PROCEEDINGS.

The Company and its subsidiaries are subject to claims and suits in the
ordinary course of business. The Company is not involved in any material
litigation and is not aware of any potential claims which would give rise to
material liability.

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

No matter was submitted during the fourth quarter of the fiscal year ended
December 31, 1997 to a vote of security holders of the Company, through the
solicitation of proxies, or otherwise.

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PART II

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

On September 12, 1997 at the Annual Meeting of Stockholders of Aqua Care
Systems, Inc., the Stockholders authorized the Company to effect a one for four
reverse stock split of all of the issued and outstanding Common Stock of the
Company. The reverse split was effected on February 10, 1998. As such, all
issued and outstanding Common Stock as of such date, 10,888,050, were reduced to
2,722,013 without a commensurate increase in the par value of the Common Stock.
The reverse stock split did not alter the number of authorized shares of the
Company's Capital Stock, which remains at 35,000,000, consisting of 30,000,000
shares of Common Stock and 5,000,000 shares of Preferred Stock. Additionally,
all of the Company's issued and outstanding options and warrants to purchase
Common Stock have been reduced by the one for four reverse stock split and
exercise prices were proportionately adjusted upward. All share and per share
amounts contained in this Form 10-KSB have been retroactively adjusted for the
reverse stock split.

The Company's Common Stock is traded and quoted under the symbol AQCR on
The Nasdaq SmallCap Market ("Nasdaq"). The Company's Units, Class A Warrants and
Class B Warrants are also traded and quoted on Nasdaq under the symbols AQCRU,
AQCRW and AQCRZ, respectively. Each Unit consists of one share of Common Stock,
one Class A Warrant and one Class B Warrant. Each Class A Warrant entitles the
holder thereof to purchase one share of Common Stock and one Class B Warrant for
an aggregate price of $28.68 (subject to adjustment) until October 14, 1998.
Each Class B Warrant entitles the holder thereof to purchase one share of Common
Stock for $43.04 (subject to adjustment) until October 14, 1998. The following
table sets forth the high and low bid prices for the Common Stock, as quoted on
Nasdaq, for the periods indicated, as adjusted for the Company's one for four
reverse stock split which became effective February 10, 1998. Quotations are
interdealer prices without retail markup, markdown or commission, and may not
necessarily represent actual transactions.

COMMON STOCK
HIGH LOW
---- ---
Quarter ended
March 31, 1996 $10 $5-1/2
June 30, 1996 $7-3/8 $2-3/4
September 30, 1996 $4 $2-3/8
December 31, 1996 $2-3/4 $1-1/2
March 31, 1997 $3 $1-1/2
June 30, 1997 $3 $1-1/2
September 30, 1997 $3 $1-3/4
December 31, 1997 $2-5/8 $1-5/8

Period ended
February 27, 1998 $2-5/16 $1-7/16

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The Company had 250 owners of record and, it believes, in excess of 2,000
beneficial owners of its Common Stock as of February 27, 1998.

DIVIDENDS

Since its inception, the Company has not paid any cash dividends on its
Common Stock. The Company intends to retain future earnings, if any, generated
from the Company's operations to help finance the operations and expansion of
the Company and accordingly does not plan, for the reasonably foreseeable
future, to pay cash dividends to holders of the Common Stock. Any decisions as
to the future payment of dividends will depend on the earnings and financial
position of the Company and such other factors as the Company's Board of
Directors deems relevant.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.

The following discussion and analysis should be read in conjunction with
the Company's consolidated financial statements and notes thereto appearing
elsewhere in this Annual Report on Form 10-KSB.

BUSINESS PLAN

As a result of acquisitions, the Company's revenues have gradually
increased. In achieving this growth, the Company has expended significant cash
in making the acquisitions and developing the operations of its wholly-owned
subsidiaries. See "Liquidity and Capital Resources" below.

RESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1997 AND 1996

Presented below are the condensed consolidated results of operations for
the Company for the years ended December 31, 1997 and 1996:

YEAR ENDED YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------

Revenues $ 23,901,102 $ 15,987,147
Cost of revenues 15,363,522 11,062,494
------------ ------------
Gross profit 8,537,580 4,924,653
Operating expenses (including
interest expense, net) 8,170,780 5,683,125
------------ -----------
Net income (loss) $ 366,800 $ (758,472)
=========== ============

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Revenues increased by $7,913,955 or 49.5% from $15,987,147 for the year
ended December 31, 1996, to $23,901,102 for the year ended December 31, 1997. Of
this increase, $9,552,789 was due to the addition of sales of filtration systems
and metering pumps generated by the Filtration Systems Division acquired from
Durco International, Inc. in June 1997. Such increase was offset by a $1,618,092
decrease in sales of municipal, industrial and commercial waste water treatment
equipment and waste water treatment plants of Gravity Flow Systems, Inc. and
EnviroSystems Supply Inc., a $13,376 decrease in sales of commercial and
residential water purification products and financing fees earned from KISS
International, Inc., Midwest Water Technologies, Inc. and Di-tech Systems, Inc.
and a $7,366 decrease in sales of car wash machines and ancillary equipment of
Car Wash Equipment and Supply, Ryko of South Florida, Inc.

Cost of revenues increased by $4,301,028 or 38.9% from $11,062,494 for the
year ended December 31, 1996, to $15,363,522 for the year ended December 31,
1997. As a percentage of revenues, these amounts represented 69.2% for 1996 as
compared to 64.3% for 1997. The decrease in cost of revenues as a percentage of
revenues primarily was due to the addition of the sales of the Filtration
Systems Division from June through December 1997. The cost of revenues of such
entity is comprised of lower materials and components costs than the aggregate
cost of revenues of the Company's other subsidiaries.

Gross profit increased by $3,612,927 or 73.4% from $4,924,653 for the year
ended December 31, 1996 to $8,537,580 for the year ended December 31, 1997. As a
percentage of revenues, this represented an increase from 30.8% to 35.7%
respectively, for such periods.

The Company's operating expenses (including other income and expenses)
increased $2,487,655 or 43.8%, from $5,683,125 for the year ended December 31,
1996 to $8,170,780 for the year ended December 31, 1997. As a percentage of
revenues, these expenses decreased from 35.5% for 1996 to 34.2% for 1997. The
$2,487,655 increase was attributable mainly to the addition of $3,129,795 in
operating, interest and other expenses, net due to the acquisition of the
Filtration Systems Division purchased June 1997 and an increase in selling and
related expenses ($228,259). This increase was partially offset by the
elimination of certain operating expenses, including other income and expenses
of the Company's other subsidiaries, mainly in the expense categories of payroll
and related expenses ($573,517), occupancy and related expenses ($159,626) and
an increase in other income ($130,163).

Principally as a result of the factors described above, the Company
achieved net income of $366,800 for the year ended December 31, 1997 as opposed
to a net loss of $(758,472) realized for the year ended December 31, 1996, an
improvement of $1,125,272.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1997, the Company had $654,932 of cash and cash equivalents
and working capital of $1,871,005. This compares to $561,219 of cash and cash
equivalents and working capital of $2,271,606 as of December 31, 1996. The
Company's operating activities provided $106,598 of cash, principally as a
result of decreases in inventory ($1,207,056), costs and estimated earnings in
excess of billings ($271,310), prepaids and other ($69,922), other assets
($48,836) and depreciation and amortization ($681,221), the net income
($366,800), and the provision for doubtful accounts and notes ($36,000);
partially offset by an increase in accounts receivable ($2,004,536) and a
decrease in accounts

- 12 -

<PAGE>

payable and accrued expenses ($468,488). Investing activities used $95,680 due
to payments for the acquisition of FSDA, net of cash acquired, ($204,031) and
capital expenditures ($136,449); offset by property and plant disposed of in
conjunction with Settlement Agreement ($150,000) and payments received on notes
receivable ($94,800). Financing activities provided $82,795 from net proceeds
from issuance of notes payable and long-term debt ($8,967,522); offset by
repayment of notes payable and long-term debt ($8,722,952) and payments of
deferred loan costs ($161,775).

Management expects to continue to make acquisitions to expand the Company's
markets. As consideration for an acquisition, the Company may issue Common
Stock, Preferred Stock, or other securities, notes or cash. Since cash will be
required either to consummate acquisitions, or to fund the operations of new or
existing businesses, including approximately $2,900,000 of current maturities of
long-term debt and indebtedness to related parties, management is investigating
and pursuing various types of financing that are available to the Company. These
include, but are not limited to, private placements, conversion of warrants,
secondary offerings, bridge financing, debentures, lines of credit and
asset-based loans. While management believes that financing will be available
for the Company to not only fund its current operations, but also to fund its
acquisition program, there can be no assurances such financing will be on terms
reasonably acceptable to the Company.

A portion of the revenues of the Company, particularly through FSDA and
ESSI, have been, and are expected to continue to be, generated from foreign
countries. Notwithstanding the fact that the Company expects its foreign
contracts to be denominated in U.S. dollars, the Company is subject to the risks
associated with fluctuations in the U.S. and foreign currencies and political
instability. In particular, if the U.S. dollar increases significantly as
compared to foreign currencies, this could adversely impact the ability of the
Company to secure orders and generate revenues in foreign countries.

CAPITAL EXPENDITURE REQUIREMENTS

The Company does not presently anticipate any significant capital
expenditures other than those relating to future acquisitions.

The Company is presently in the process of evaluating the conversion of its
computer systems to "Year 2000" compliant software. The Company does not expect
the cost of such conversion to be material to its financial condition or results
of operations, nor does it anticipate any material disruption in its operations
with respect thereto.

NEW ACCOUNTING STANDARDS

Statement of Financial Accounting Standards (SFAS) No. 130, Reporting
Comprehensive Income, establishes standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, SFAS
No. 130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements.

- 13 -

<PAGE>

establishes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS 131 defines operating segments as
components of a company about which separate financial information is available
that is evaluated regularly by the chief operating decision maker in deciding
how to allocate resources and in assessing performance.

These new standards are effective for financial statements for periods
beginning after December 15,1997 and require comparative financial information
for earlier years to be restated. Due to the recent issuance of these standards,
management has been unable to fully evaluate the impact, if any, they may have
on future financial statement disclosures.

INFLATION

The Company has not been materially affected by the impact of inflation.

ITEM 7. FINANCIAL STATEMENTS.

See the consolidated financial statements and notes related thereto,
beginning on page F-1, included prior to the signature page of this Annual
Report on Form 10-KSB.

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

- 14 -

<PAGE>

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS,
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.

The names and ages, along with certain biographical information (based
solely on information supplied by them), of the directors and executive officers
of the Company are as follows:

NAME AGE POSITION
---- --- --------

William K. Mackey(1)(4) 46 Chairman of the Board of
Directors, President, Chief
Executive Officer and Treasurer

Norman J. Hoskin(1)(2)(3)(4) 63 Secretary, Director

James P. Cefaratti(2)(3) 55 Director

David K. Lucas(2)(3) 57 Director

- ----------------------------
(1) Member of the Executive Committee.
(2) Member of the Audit Committee.
(3) Member of the Compensation Committee.
(4) Member of the Nominating Committee.

Directors of the Company are elected to serve for a term of one year or
until their successors are elected and qualify, or until their earlier death,
resignation or removal. The Company's officers are appointed annually by, and
serve at the pleasure of, the Board of Directors, subject to the terms of any
employment agreements. Mr. Mackey has entered into an employment agreement with
the Company (See Item 10, "Executive Compensation").

William K. Mackey has served as a director of the Company since July 1993
and as Chairman of the Board, President and Chief Executive Officer and
Treasurer of the Company since May 1995. From 1993 to May 1995, he was an
entrepreneur and investor in and a consultant to several public and private
companies. From August 1989 to May 1993, Mr. Mackey served as a director of
Infonow Corporation, a publicly-held software distribution company. From March
1991 to November 1992, Mr. Mackey served as President and a director of Docucon,
Incorporated, a publicly-held company engaged in the document conversion
business. From December 1988 to March 1991, Mr. Mackey served as President of
Avondale Specialty Products, an ink manufacturer.

Norman J. Hoskin currently serves as the Secretary and has served as a
director of the Company since June 1995. He has acted as Chairman of Atlantic
Capital Group, a venture capital company based in Boca Raton, Florida, since
1989. Mr. Hoskin previously served as Senior Vice President of Rentar
Industries, a large transportation, warehousing and banking conglomerate and
currently sits on the Boards of Directors of Consolidated Technologies,
Trinitech Systems, JHS Group, Expandez Canada International Ltd./Shanghai,
P.R.C. and JF Hotels of Florida.

- 15 -

<PAGE>

James P. Cefaratti has been a Director of the Company since January 1992.
From June 1995 to December 1996, Mr. Cefaratti was President of Globalvision,
Inc., a provider of laser radial keratotomy. From July 1993 until June 1995, he
was a private investor. He served as President, CEO and director of Home
Intensive Care, Inc., a home infusion and dialysis company, from December 1989
to June 1993. From May 1989 to December 1989, he served as Senior Executive Vice
President of Home Intensive Care, Inc.

David K. Lucas has performed sales and marketing consulting for various
entities within the fluid filtration and treatment industries since 1988. From
1982 to 1988, Mr. Lucas served as the Vice President of Sales and Marketing of
JWI, Inc. a filter press equipment manufacturing company. He was employed in the
capacity of Corporate Marketing Manager of Parkson Corporation, a manufacturer
of water pollution control capital equipment products from 1973 to 1981. Mr.
Lucas has been a Director of the Company since September 1997.

Each Director of the Company is currently remunerated at the rate of $1,000
per month which covers all meetings attended in person and telephonically. In
addition, each Director is granted options under the terms of the 1994 Outside
Directors' Stock Option Plan to purchase 2,500 shares of Common Stock on the
last business day of the year preceding the first Board of Directors meeting of
each new calendar year at the then current bid price, subsequent to serving one
full calendar year as a Director. Such options are exercisable over the
subsequent ten years and fully vest over a one-year period from the date of
grant. Pursuant to this program, the Company has granted options under the
aforementioned Plan as follows:

NUMBER OF SHARES OPTION PRICE RANGE
---------------- ------------------

Outstanding at January 1, 1996 76,250 $8.00 - $20.00
Granted 10,000 $1.76
------

Outstanding at December 31, 1996 86,250 $1.76 - $20.00
Granted 35,000 $1.76 - $2.60
Cancelled (38,750) $1.76 - $15.00
------

Outstanding at December 31, 1997 82,500 $1.76 - $20.00
======

ITEM 10. EXECUTIVE COMPENSATION.

SUMMARY COMPENSATION TABLE

The following table sets forth information for the years ended December 31,
1997, 1996 and 1995, representing compensation earned by the Chief Executive
Officer of the Company as of the end of the fiscal year 1997 (the "Named
Executive Officer"), in all capacities in which he served.

- 16 -

<PAGE>

<TABLE>
<CAPTION>
LONG-TERM
ANNUAL COMPENSATION COMPENSATION
OTHER ANNUAL OTHER NUMBER OF
NAME AND PRINCIPAL POSITIONS YEAR SALARY COMPENSATION COMPENSATION OPTIONS GRANTED
- ---------------------------- ---- -------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C>
William K. Mackey(1) 1997 $160,962 $7,200(2) -- 150,000(4)
Chairman of the Board, President 1996 $147,250 $4,200(2) -- 12,500(4)
Chief Executive Officer and
Treasurer 1995 $81,673 -- $107,379(3) 77,500(4)

</TABLE>

STOCK OPTION GRANTS IN 1997

The following table contains information concerning the grant of stock
options to the Named Executive Officer in 1997:

INDIVIDUAL GRANTS
---------------------------------------------------------------------------------------------
% OF TOTAL OPTIONS
NUMBER OF SECURITIES GRANTED TO EMPLOYEES EXERCISE PRICE EXPIRATION
NAME UNDERLYING OPTIONS GRANTED IN FISCAL YEAR PER SHARE DATE
---- -------------------------- ------------------------ ------------------ ------------

<S> <C> <C> <C> <C>
William K. Mackey 25,000(4) 10.6% $1.64(4) January 24, 2007
125,000(4) 53.2% $2.36(4) August 7, 2007

</TABLE>

STOCK OPTION EXERCISES IN 1997 AND OPTION VALUES AT DECEMBER 31, 1997

The following table provides information with respect to options exercised
by the Named Executive Officer during 1997 and the number and value of
securities underlying unexercised options held by the Named Executive Officer at
December 31, 1997:

NUMBER OF SECURITIES VALUE OF UNEXERCISED
SHARES UNDERLYING UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
ACQUIRED VALUE AT DECEMBER 31, 1997 AT DECEMBER 31, 1997
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- -------- ----------- ------------- ----------- -------------

<S> <C> <C> <C> <C> <C> <C>
William K. Mackey -- -- 108,750(4) 156,250(4) $133,250 $51,250

<FN>
- -----------------------------
(1) Mr. Mackey was appointed as President, Chief Executive Officer and
Treasurer by the Board of Directors in May 1995.
(2) Represents a monthly auto expense allowance of $600 for all of 1997 and for
the period from June 1996 through December 1996.
(3) Represents finders fees paid to Mr. Mackey by the Company during fiscal
year 1995 in connection with a series of offshore private placements
undertaken by the Company. All of these fees were paid to Mr. Mackey prior
to him becoming Chief Executive Officer of the Company in May 1995.
(4) Adjusted for the one for four reverse stock split effected on February 10,
1998.
</FN>
</TABLE>

EMPLOYMENT ARRANGEMENTS

On August 7, 1997, the Company entered into a five-year employment
agreement with William K. Mackey, Chairman of the Board, President, Chief
Executive Officer and Treasurer. The Agreement provides that Mr. Mackey will
receive an annual base salary of $155,000, plus a bonus, if any, as determined
by the Board of Directors. The employment agreement entitles Mr. Mackey to
terminate the agreement in the event of a change of control of the Company and
receive severance payments equal to the greater of the base salary due for the
remaining term of the employment agreement or an amount equal to three times his
base salary then in effect, plus bonus. If Mr. Mackey is terminated

- 17 -

<PAGE>

without cause, he is entitled to receive a severance payment equal to the
greater of the remaining base salary payments due for the remaining term of the
employment agreement or one year's base salary. If Mr. Mackey terminates the
employment agreement because of a material default by the Company, he is
entitled to receive a severance payment equal to the greater of the base salary
payments due under the remaining term of the employment agreement or three times
the sum of the base salary then in effect and his last bonus.

The above-described employment agreement contains certain non-disclosure
and non-compete provisions.

OUTSIDE DIRECTORS' PLAN AND PERFORMANCE EQUITY PLAN

At December 31, 1997 the Company has two stock option plans, which are
described below.

OUTSIDE DIRECTORS' PLAN. The Company's shareholders have adopted the 1994
Outside Directors' Stock Option Plan (the "Outside Directors' Plan") for the
Company's Directors who are not employees or officers of the Company or its
subsidiaries ("Eligible Directors") and for consultants rendering advisory
service to the Board of Directors. The Outside Directors' Plan has reserved an
aggregate of 400,000 shares of Common Stock and provides for the grant of
non-qualified stock options ("NQSOs") which have an exercise period extending
for ten years from the date of the grant. The purchase price of the shares of
Common Stock covered by each option granted under the Outside Directors' Plan is
the fair market value of the shares as of the date of grant. Each Eligible
Director who is newly-elected after the effective date of the Outside Directors'
Plan shall be granted an option to purchase not less than 2,500 and not more
than 12,500 shares of the Common Stock of the Company on the date such Director
is initially elected or otherwise selected to the Board of Directors. The exact
amount is determined by the Directors serving prior to the effective date of the
Outside Directors' Plan. All Eligible Directors (including those serving on the
Board of Directors prior to the effective date of the Outside Directors' Plan)
are granted options to purchase 2,500 shares of the Common Stock of the Company
on each December 31, if such Eligible Director has completed a full year of
service as a member of the Board of Directors of the Company.

PERFORMANCE EQUITY PLAN. On May 13, 1991, the Company's stockholders
adopted the 1991 Performance Equity Plan (the "Performance Equity Plan"). There
are 2,000,000 shares of Common Stock reserved pursuant to the Performance Equity
Plan. The Performance Equity Plan provides for the grant of a variety of
incentive awards to officers, key employees, consultants and independent
contractors of the Company.

The Performance Equity Plan authorizes the grant of incentive awards for up
to 2,000,000 shares of Common Stock subject to adjustment in certain events.
Incentive awards may consist of stock options, restricted stock awards, deferred
stock awards, stock appreciation rights and other stock-based awards. The
Performance Equity Plan expires at the close of business on May 13, 2001, unless
sooner terminated. Officers, directors, and other key employees and prospective
employees and consultants and independent contractors who perform services for
the Company or any of its subsidiaries, (but excluding members of the stock
option committee and any person who serves as a director only), ("Eligible
Persons"), are eligible to receive awards under the Plan. The Performance Equity
Plan is administered by the Board of Directors or the Compensation and Stock
Option

- 18 -

<PAGE>

Committee (the "Committee") appointed by the Board of Directors, which
determines the persons to whom awards will be granted, the number of awards to
be granted and the specific terms of each grant, subject to the provisions of
the Performance Equity Plan.

OUTSTANDING AWARDS. Options to purchase an aggregate of 520,608 shares have
been granted and are outstanding as of February 27, 1998, under the Outside
Directors' Plan and Performance Equity Plan as follows:

NUMBER OF SHARES OPTION PRICE RANGE
---------------- ------------------

OUTSTANDING AT JANUARY 1, 1996 301,396 $5.00 - $20.00
Granted 96,500 $1.76 - $9.00
Cancelled (78,375) $3.00 - $15.00
-------

OUTSTANDING AT DECEMBER 31, 1996 319,521 $1.76 - $20.00
Granted 270,125 $1.64 - $2.60
Cancelled (95,688) $1.64 - $15.00

OUTSTANDING AT DECEMBER 31, 1997 493,958 $1.64 - $20.00
Granted 30,650 $1.75
Cancelled (4,000) $1.64
------

OUTSTANDING AT FEBRUARY 27, 1998 520,608 $1.64 - $20.00
======

At December 31, 1997 and 1996, respectively, 200,169 and 181,148 options
with an average option price of $6.71 and $12.36 were exercisable.

In January 1997, the Company's Board of Directors approved a repricing of
all granted and outstanding options to purchase Common Stock issued pursuant to
the 1991 Performance Equity Plan. On January 24, 1997, all issued and
outstanding options were repriced at approximately $1.64 per share, the market
price per share of the Company's Common Stock on such date.

In February 1998, certain employees of the Company were granted options to
purchase a total of 30,650 shares of Common Stock at $1.75 per share (market
value at the date of grant). The above options expire ten years from the date of
grant, and are exercisable one-third each year beginning one year from the date
of grant.

401(K) PLAN

In January 1994, the Company adopted a 401(k) employee savings and
retirement plan. Under the provisions of the Plan, the Company may elect to
match each employee's contribution to the Plan at the rate of 50% in Company
Common Stock. The Common Stock is restricted stock and vests over a two-year
period on a quarterly basis. During 1997 and 1996, the Company contributed
18,393 and 15,447 shares of restricted Common Stock valued at $18,165 and
$20,592, respectively.

- 19 -

<PAGE>

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT.

The following table sets forth information as to the number of shares of
Common Stock beneficially owned as of February 27, 1998, by (i) each person who
is believed by the Company to be a beneficial owner of more than 5% of the
outstanding Common Stock of the Company; (ii) each Director of the Company;
(iii) the Named Executive Officer; and (iv) all Directors and executive officers
of the Company as a group. Beneficial ownership has been determined in
accordance with the rules promulgated under Section 13(d) of the Securities and
Exchange Act of 1934. All shares of Common Stock are owned both of record and
beneficially unless otherwise indicated.

=====================================================================
Number of Percentage of
Name and Address of Beneficial Owner(1) Shares Owned Common Stock
- ---------------------------------------------------------------------
William K. Mackey (2) 111,500 3.9%
- ---------------------------------------------------------------------
Norman J. Hoskin (3) 14,000 *
- ---------------------------------------------------------------------
James P. Cefaratti (4) 18,750 *
- ---------------------------------------------------------------------
David K. Lucas -- --
- ---------------------------------------------------------------------
Directors and executive officers as a group
(four persons) 144,250 5.0%
=====================================================================

(1) The address for all of these persons is the same as the Company's.
(2) Includes options to purchase 96,250 shares of Common Stock granted by the
Company and additional options to purchase an aggregate of 12,500 shares of
Common Stock granted by Kinder Investments, L.P. and Peter N. Christos
which are presently exercisable.
(3) Includes options to purchase 13,750 shares of Common Stock granted by the
Company which are presently exercisable.
(4) Includes options to purchase 18,750 shares of Common Stock which are
presently exercisable.
(*) Less than 1%.

ESCROW SHARES AND ESCROW OPTIONS

In connection with the Company's initial public offering, substantially all
of the common stockholders and option holders of the Company at the date of the
offering, agreed to place into escrow 50% of their shares of Common Stock and
50% of their options to purchase Common Stock equalling 243,750 shares of Common
Stock (the "Escrow Shares") and options to purchase 29,063 shares of Common
Stock (the "Escrow Options"). Such Escrow Shares and Options were contributed to
the Company on December 31, 1997.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

None.

- 20 -

<PAGE>

PART IV

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

2.1 Asset Purchase Agreement between Durco International, Inc. and ACS
Acquisition Corp. as previously filed with the Company's Statement
on Form 8-K filed during 1997.
3.1 Certificate of Incorporation of the Registrant filed as Exhibit
(3)-1 to the Company's Registration Statement on Form SB-2
(Registration No. 33-67252) is hereby incorporated herein by
reference.
3.2 By-laws of the Registrant filed as Exhibit 3.2 to the Company's
Registration Statement on Form SB-2 (Registration No. 33-67252) is
hereby incorporated by reference.
4.1 Form of Warrant Agreement (with Warrant Certificates) filed as
Exhibit 4.2 to the Company's Registration Statement on Form SB-2
(Registration No. 33-67252) is hereby incorporated by reference.
27.1 Financial Data Schedule.

- 21 -

<PAGE>

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Coral Springs, State of
Florida, on March 26, 1998.

AQUA CARE SYSTEMS, INC.

/s/ WILLIAM K. MACKEY
-------------------------
William K. Mackey
Chairman of the Board, President,
Chief Executive Officer and Treasurer

KNOWN ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints William K. Mackey and George J. Overmeyer, and
each of them, his attorney-in-fact with power of substitution for him in any and
all capacities, to sign any amendments and supplements relating to this Annual
Report on Form 10-KSB, or other instructions he deems necessary or appropriate,
and to file the same, with exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, hereby ratifying and
confirming all that said attorney-in-fact or his substitute may do or cause to
be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons in the capacities and on the
dates indicated.

SIGNATURE TITLE DATE
- --------- ----- ----

/s/ WILLIAM K. MACKEY Chairman of the Board, President March 26, 1998
- ---------------------- Chief Executive Officer, Treasurer
William K. Mackey and Principal Accounting Officer

/s/ GEORGE J. OVERMEYER Corporate Controller March 26, 1998
- -----------------------
George J. Overmeyer

/s/ NORMAN J. HOSKIN Secretary, Director March 26, 1998
- -----------------------
Norman J. Hoskin

/s/ JAMES P. CEFARATTI Director March 26, 1998
- -----------------------
James P. Cefaratti

/s/ DAVID K. LUCAS Director March 26, 1998
- -----------------------
David K. Lucas

- 22 -

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

PAGE
NUMBER
------

Report of Independent Certified Public Accountants F-2

Consolidated Balance Sheets
as of December 31, 1997 and 1996 F-3

Consolidated Statements of Operations
for the years ended December 31, 1997 and 1996 F-4

Consolidated Statements of Stockholders' Equity
for the years ended December 31, 1997 and 1996 F-5

Consolidated Statements of Cash Flows
for the years ended December 31, 1997 and 1996 F-6

Notes to Consolidated Financial Statements F-7

F-1

<PAGE>

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Board of Directors of
Aqua Care Systems, Inc.

We have audited the accompanying consolidated balance sheets of Aqua Care
Systems, Inc. and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended. 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 generally accepted auditing
standards. 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 financial position of Aqua Care
Systems, Inc. and subsidiaries at December 31, 1997 and 1996, and the results of
their operations and their cash flows for the years then ended, in conformity
with generally accepted accounting principles.

Miami, Florida BDO Seidman, LLP
February 26, 1998

F-2

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Current assets
Cash and cash equivalents ........................ $ 654,932 $ 561,219
Accounts receivable, net of allowance
for doubtful accounts of $135,000 and $99,000 . 3,398,593 1,430,057
Costs and estimated earnings in excess of billings 153,443 424,753
Inventory ........................................ 3,007,468 1,903,583
Current maturities of notes receivable ........... 77,175 94,800
Prepaids and other ............................... 109,736 179,658
------------ ------------

Total current assets ................................ 7,401,347 4,594,070

Property, plant and equipment, net .................. 4,939,202 1,539,486
Intangible assets, net .............................. 4,452,916 4,067,208
Notes receivable, less current maturities ........... 51,975 129,150
Other assets ........................................ 243,169 90,230
------------ ------------

Total assets ........................................ $ 17,088,609 $ 10,420,144
============ ============

LIABILITIES
Current liabilities
Accounts payable ................................. $ 1,788,140 $ 1,447,324
Accrued expenses ................................. 843,486 478,984
Current maturities of long-term debt ............. 2,773,716 271,156
Indebtedness to related party .................... 125,000 125,000
------------ ------------

Total current liabilities ........................... 5,530,342 2,322,464

Long-term debt, less current maturities ............. 3,733,665 781,873
------------ ------------

Total liabilities ................................... 9,264,007 3,104,337
------------ ------------

COMMITMENTS, CONTINGENCIES AND SUBSEQUENT EVENTS

STOCKHOLDERS' EQUITY
Preferred stock, $.001 par; 5,000,000 shares
authorized, none outstanding .................. -- --
Common stock, $.001 par; 30,000,000 shares
authorized, 2,703,782 and 2,924,389 shares
issued and outstanding ........................ 2,704 2,924
Additional paid-in capital ....................... 16,787,794 16,645,579
Deficit .......................................... (8,965,896) (9,332,696)
------------ ------------

Total stockholders' equity .......................... 7,824,602 7,315,807
------------ ------------

Total liabilities and stockholders' equity .......... $ 17,088,609 $ 10,420,144
============ ============

</TABLE>

See accompanying notes to consolidated financial statements.

F-3

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEAR ENDED
DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
Revenues ......................................... $ 23,901,102 $ 15,987,147

Cost of revenues ................................. 15,363,522 11,062,494
------------ ------------

Gross profit ..................................... 8,537,580 4,924,653
------------ ------------

Operating expenses:
Selling, general and administrative ........... 7,022,380 5,032,940
Depreciation and amortization ................. 681,221 498,346
Provision for doubtful accounts and notes ..... 36,000 59,154
------------ ------------

Total operating expenses ......................... 7,739,601 5,590,440
------------ ------------

Income (loss) from operations .................... 797,979 (665,787)

Interest expense, net ............................ (561,342) (92,685)

Other income, principally settlement of litigation 130,163 --
------------ ------------

Net income (loss) ................................ 366,800 (758,472)
------------ ------------

Earnings (loss) per common share - basic ......... $ 0.14 $ (0.32)
============ ============

Earnings (loss) per common share - diluted ....... $ 0.13 $ (0.32)
============ ============

</TABLE>

See accompanying notes to consolidated financial statements.

F-4

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

COMMON STOCK ADDITIONAL
PAID-IN
SHARES AMOUNT CAPITAL DEFICIT TOTAL
---------- ------- ------------ ----------- -----------

<S> <C> <C> <C> <C> <C>
Amounts at January 1, 1996 2,245,036 $ 2,245 $ 16,373,737 $(8,574,224) $ 7,801,758

Common Stock issued in connection
with the acquisition of KISS
International, Inc.: 593,940 594 (594) -- --

Common Stock issued in connection
with the acquisition of
Midwest Water Technologies, Inc.: 2,762 3 3,967 -- 3,970

Conversion of convertible subordinated
notes to Common Stock: 67,204 67 247,892 -- 247,959

Contribution to Employee Benefit Plan: 15,447 15 20,577 -- 20,592

Net loss: -- -- -- (758,472) (758,472)
---------- ------- ------------ ----------- -----------

Amounts at December 31, 1996 2,924,389 2,924 16,645,579 (9,332,696) 7,315,807

Common Stock issued in connection
with the acquisition of
Midwest Water Technologies, Inc.: 4,750 5 3,825 -- 3,830

Warrants issued in connection
with the acquisition of
The Filtration Systems Division of
Durco International, Inc.: -- -- 120,000 -- 120,000

Contribution to Employee Benefit Plan: 18,393 18 18,147 -- 18,165

Reversion of shares to the Company: (243,750) (243) 243 -- --

Net income: -- -- -- 366,800 366,800
---------- ------- ------------ ----------- -----------

Amounts at December 31, 1997 2,703,782 $ 2,704 $ 16,787,794 $(8,965,896) $ 7,824,602
========== ======= ============ =========== ===========

</TABLE>

See accompanying notes to consolidated financial statements

F-5

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEAR ENDED
DECEMBER 31,
1997 1996
----------- ---------

<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss) ..................................... $ 366,800 $(758,472)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Gain on disposal of property and plant ............. (123,518) --
Provision for doubtful accounts and notes .......... 36,000 59,154
Depreciation and amortization ...................... 681,221 498,346
Purchase price adjustments for acquisitions expensed 3,830 3,970
Pension contribution paid through issuance of
Common Stock .................................... 18,165 20,592
Changes in assets and liabilities
net of effects of acquired business:
(Increase) decrease in accounts receivable ......... (2,004,536) 526,906
Decrease (increase) in costs and estimated
earnings in excess of billings .................. 271,310 (356,779)
Decrease in inventory .............................. 1,207,056 46,515
Decrease (increase) in prepaids and other .......... 69,922 (104,169)
Decrease in other assets ........................... 48,836 10,886
Decrease in accounts payable and accrued
expenses ........................................ (468,488) (12,703)
----------- ---------

Net cash provided by (used in) operating activities ... 106,598 (65,754)
----------- ---------

INVESTING ACTIVITIES:
Payments received on notes receivable .............. 94,800 590,592
Property and plant disposed of in conjunction with
Settlement Agreement ............................ 150,000 --
Capital expenditures ............................... (136,449) (944,161)
Payments for acquisition of business, net of cash
acquired ........................................ (204,031) --
Addition to intangible assets ...................... -- (15,327)
----------- ---------
Net cash used in investing activities ................. (95,680) (368,896)
----------- ---------

FINANCING ACTIVITIES:
Proceeds from issuance of notes payable and
long-term debt .................................. 8,967,522 725,855
Repayment of notes payable and
long-term debt .................................. (8,722,952) (451,749)
Payments of deferred loan costs .................... (161,775) --
----------- ---------
Net cash provided by financing activities ............. 82,795 274,106
----------- ---------

Net increase (decrease) in cash and cash equivalents .. 93,713 (160,544)
Cash and cash equivalents, beginning of year .......... 561,219 721,763
----------- ---------

Cash and cash equivalents, end of year ................ $ 654,932 $ 561,219
=========== =========

</TABLE>

See accompanying notes to consolidated financial statements.

F-6

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS

Aqua Care Systems, Inc. and subsidiaries (the "Company") is engaged in the
design, manufacturing, assembly, sales, marketing and distribution of filtration
systems and products, flow control systems and products, water filtration and
purification products, waste water treatment systems and car wash equipment
sales and service. Currently, it provides services and equipment sales and
construction and installation of waste water treatment plants for clients in the
United States and abroad. For the years ended December 31, 1997 and 1996, export
sales, aggregated approximately $3,600,000 and $1,100,000, respectively. At
December 31, 1997, substantially all accounts receivable were due from customers
within the United States.

PRINCIPLES OF CONSOLIDATION

The accompanying consolidated financial statements include the accounts of
all subsidiaries. All material intercompany transactions and accounts have been
eliminated in consolidation.

PREPARATION OF FINANCIAL STATEMENTS

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

INVENTORY

Inventory consists principally of materials, purchased parts and work in
process. Inventory is valued at the lower of cost (first-in, first-out method)
or market.

PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment are recorded at cost. Depreciation is
provided using the straight-line method over the estimated useful lives of the
assets, ranging from five to thirty years.

INTANGIBLE ASSETS

The excess of the cost over the fair value of net assets of purchased
businesses is recorded as goodwill and is amortized on a straight-line basis
over 15 years. The cost of other intangibles is amortized on a straight-line
basis over their estimated useful lives, ranging from seven to fifteen years.
The Company continually evaluates the carrying value of goodwill and other
intangible assets. Impairments are recognized when the expected future
undiscounted operating cash flows to be derived from such intangible assets are
less than their carrying values.

F-7

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

REVENUE RECOGNITION

The Company recognizes revenue on waste water treatment system construction
contracts on the percentage of completion method, based generally on the ratio
of costs incurred to date on the contract to the total estimated contract cost.
Costs incurred and revenues recognized in excess of amounts billed are
classified under current assets as costs and estimated earnings in excess of
billings. Amounts billed in excess of revenues recognized are classified under
current liabilities as billings in excess of costs and estimated earnings.
Losses on construction contracts are recognized at the time they become
estimatable. Equipment and parts sales and rental and service revenues are
accounted for on the accrual method.

INCOME TAXES

Income taxes are accounted for using the liability approach under the
provisions of Financial Accounting Standards No. 109.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company's financial instruments consist principally of cash and cash
equivalents, accounts receivable, notes receivable, accounts payable, accrued
expenses and long-term debt. The carrying amounts of such financial instruments
as reflected in the consolidated balance sheets approximate their estimated fair
value as of December 31, 1997 and 1996. The estimated fair value is not
necessarily indicative of the amounts the Company could realize in a current
market exchange or of future earnings or cash flows.

EARNINGS (LOSS) PER SHARE

Effective December 31, 1997, the Company adopted Financial Accounting
Standards (SFAS) No. 128, Earnings Per Share, which simplifies the computation
of earnings per share and requires the restatement of all prior periods
presented.

Basic earnings per share are computed on the basis of the weighted average
number of common shares outstanding during each year.

Diluted earnings per share are computed on the basis of the weighted
average number of common shares and dilutive securities outstanding. Dilutive
securities having an antidilutive effect on diluted earnings per share are
excluded from the calculation.

The weighted average number of common shares outstanding for all periods
presented retroactively reflects the effects of the Company's one-for-four
reverse stock split which was effected as of February 10, 1998.

STATEMENTS OF CASH FLOWS

For purposes of the statements of cash flows, the Company considers all
highly liquid investments with initial maturities of three months or less to be
cash equivalents.

F-8

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NEW ACCOUNTING STANDARDS

Statement of Financial Accounting Standards (SFAS) No. 131, Disclosures
about Segments of an Enterprise and Related Information, supersedes SFAS No. 14,
Financial Reporting for Segments of a Business Enterprise. SFAS 131 establishes
standards for the way that public companies report information about operating
segments in annual financial statements and requires reporting of selected
information about operating segments in interim financial statements issued to
the public. It also establishes standards for disclosures regarding products and
services, geographic areas and major customers. SFAS 131 defines operating
segments as components of a company about which separate financial information
is available that is evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing performance.

2. ACQUISITION

In June 1997, the Company, pursuant to an Asset Purchase Agreement,
acquired certain assets and assumed certain liabilities of the Filtration
Systems Division, ("FSDA"), of Durco International, Inc., formerly known as the
Duriron Company, Inc., ("DURCO"). The purchase price for the acquisition of FSDA
consisted of the sum of (i) approximately $4,800,000 in cash and notes payable
(ii) approximately $1,200,000 in assumed obligations, and (iii) 100,000 warrants
to purchase Common Stock, (62,500 warrants having an exercise price of $4.00
each and 37,500 having an exercise price approximating fair market value of the
Company's Common Stock as of the closing date, $2.00, valued at fair value of
$61,000). In conjunction with this acquisition, the Company issued 50,000
warrants to purchase Common Stock to Fidelity Funding Financial Group having an
exercise price of $2.00 each, valued at fair value of $40,000. The Company
incurred approximately $204,000 in acquisition costs and issued 37,500
additional warrants having an exercise price of $2.36, valued at fair value of
$19,000. The Company assumed operational control of FSDA on June 1, 1997. FSDA
operations include manufacturing and systems integration of fluid filtration and
treatment systems and components.

F-9

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The transaction was recorded as follows:

Fair value of net assets acquired $ 6,060,941
Costs in excess of net assets acquired 730,196
Debt and obligations under acquisition agreement (5,333,300)
Acquisition costs (204,031)
Warrants issued in connection with acquisition (80,000)
-----------
Liabilities assumed $ 1,173,806
===========

The following unaudited pro forma summary presents the consolidated results
of operations of the Company as if the acquisition had occurred on January 1,
1997 and 1996:

YEAR ENDED DECEMBER 31, 1997 1996
- -------------------------------------------------------------------------------

Revenue $ 29,842,313 $30,729,480
============ ===========
Net income (loss) $ 203,231 $ (643,375)
============ ===========
Net income (loss) per common share - basic $ 0.08 $ (0.27)
============ ===========
Net income (loss) per common share - diluted $ 0.07 $ (0.27)
============ ===========

The above transaction was accounted for by the purchase method, and
accordingly, the results of operations of the acquired business have been
included in the accompanying consolidated financial statements from the date the
Company assumed operational control of the acquired entity.

3. CONTRACTS IN PROGRESS

COSTS AND ESTIMATED EARNINGS IN EXCESS OF BILLINGS DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
<S> <C> <C>
Costs and estimated earnings................... $1,580,176 $1,114,418
Less billings.................................. (1,426,733) (689,665)
---------- ----------

Total.......................................... $ 153,443 $ 424,753
========== ==========

</TABLE>

All receivables on contracts in progress are considered to be collectible
within twelve months. Retainages receivable totalling $194,676 and $170,444 are
included in accounts receivable at December 31, 1997 and 1996, respectively.

F-10

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4. PROPERTY, PLANT AND EQUIPMENT
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------

Land and buildings.................... $ 2,745,427 $ 894,633
Machinery and equipment............... 2,267,638 883,239
Furniture and fixtures................ 785,428 284,754
Leasehold improvements................ 51,314 50,732
Autos and trucks...................... 17,906 17,906
----------- ---------

5,867,713 2,131,264
Less accumulated depreciation......... (928,511) (591,778)
----------- -----------
Net property, plant and equipment..... $ 4,939,202 $ 1,539,486
=========== ===========

5. INTANGIBLE ASSETS
DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------

Goodwill............................ $ 5,506,601 $ 4,776,405
License agreement, customer
list and other ................. 149,169 149,169
----------- -----------

5,655,770 4,925,574
Less accumulated amortization....... (1,202,854) (858,366)
----------- -----------

Net intangible assets............... $ 4,452,916 $ 4,067,208
=========== ===========

6. LONG-TERM DEBT

DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
<S> <C> <C>
Prime plus 2.50%, (11% at December 31, 1997), revolving credit
lines, providing for borrowings, subject to certain collateral
requirements and loan covenants, of up to $3,500,000 through
June 2000, principally collateralized by accounts receivable
and inventory of FSDA ..................................................... $1,370,620 --

Prime plus 3%, (11.50% at December 31, 1997), note payable, principal and
interest payable monthly with an estimated balloon payment of approximately
$400,000 due June 2000, principally collateralized by property and plant
of FSDA ................................................................... 1,162,400 --

Prime plus 3%, (11.50% at December 31, 1997), note payable, principal and
interest payable monthly with an estimated balloon payment of approximately
$130,000 due June 2000, principally collateralized by machinery and equipment
of FSDA ................................................................... 417,600 --

</TABLE>

F-11

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

<S> <C> <C>
18% note payable, principal and interest payable monthly through
May 1998, collateralized by certain of the assets of FSDA ................. 250,000 --

11% note payable, principal and interest payable monthly with an estimated
balloon payment of approximately $1,250,000 due June
2000, collateralized by all the assets of FSDA ............................ 2,321,397 --

10% note payable, principal and interest payable monthly through
November 1998, collateralized by 115,556 restricted, unregistered
shares of the Company's Common Stock ...................................... 239,476 --

9.25% mortgage note payable, principal and interest payable monthly with an
estimated balloon payment of approximately $360,000 due
June 2001, collateralized by land and building ............................ 429,174 444,231

Prime plus 1%, (9.50% at December 31, 1997), notes payable, issued in
connection with the acquisition of CWES, payable in equal quarterly
principal payments of $40,000, plus interest, through April 1999,
principally collateralized by the accounts receivable, inventory and
property and equipment of CWES ............................................ 240,000 400,000

9.50% note payable, principal and interest payable monthly through
June 2002, collateralized by substantially all of the assets of GFSI ...... 76,714 84,084

Prime plus 2%, mortgage note payable, retired March 1997 .................. -- 124,714
---------- ---------
6,507,381 1,053,029
Less current maturities.................................................... (2,773,716) (271,156)
---------- ---------
Total long-term debt....................................................... $3,733,665 $ 781,873
========== ==========
</TABLE>

At December 31, 1997, maturities of long-term debt, are:

1998 $2,773,716
1999 1,074,740
2000 2,256,488
2001 390,472
2002 11,965
----------
$6,507,381
==========

F-12

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7. RELATED PARTY BALANCES AND TRANSACTIONS

INDEBTEDNESS TO RELATED PARTY DECEMBER 31, 1997 DECEMBER 31, 1996
- ----------------------------- ----------------- -----------------

10% unsecured notes payable to a former
affiliated entity, matured October 1994...... $ 125,000 $ 125,000
========= =========

Interest expense on related party indebtedness aggregated $12,500 for each
of the years ended December 31, 1997 and 1996.

8. INCOME TAXES

At December 31, 1997 and 1996, the Company has approximately $6,300,000 and
$7,100,000, respectively, of net operating loss carryforwards expiring through
2011, for both financial reporting and income tax purposes. Changes in ownership
of greater than 50% occurred as a result of the Company's issuances of Common
Stock which resulted in an approximate $760,000 annual limitation being imposed
upon the future utilization of approximately $4,000,000 of the Company's net
operating losses for tax purposes. Realization of the approximate $2,500,000 and
$2,750,000 deferred tax asset at December 31, 1997 and 1996, respectively,
resulting mainly from the available net operating loss carryforwards, is not
considered more likely than not and accordingly, a valuation allowance has been
recorded for the full amount of such assets.

The reconciliation of the effective income tax rate to the Federal and
State statutory rate is as follows:

1997 1996
- -------------------------------------------------------------------------------

Federal and State income tax rate 37.63% 0.0%
Effect of net operating loss carryfoward and
valuation allowance (37.63%) (0.0%)
------ ----
Effective income tax rate 0.0% 0.0%
====== ====

9. EQUITY TRANSACTIONS

(a) On September 12, 1997, the stockholders authorized the Board of
Directors to effectuate a one-for-four reverse stock split. The one-for-four
reverse split was effected as of February 10, 1998. All share and per share data
in the accompanying financial statements reflect the effects of the reverse
stock split for all periods presented.

(b) In connection with the Company's initial public offering, all then
holders of shares of the Company's Common Stock and substantially all holders of
options to acquire such shares agreed to place into escrow 50% of their Common
Stock (243,750 shares) and options to purchase Common Stock (29,063 options).
The escrow shares and options were to be released from escrow upon the
attainment of specified net income or Common Stock price levels through 1997.
Such levels were not attained through December 31, 1997, and as such, the shares
reverted to the Company and the options were cancelled.

(c) At December 31, 1996 the Company has two stock option plans, which are
described below. The Company applies APB Opinion 25, ACCOUNTING FOR STOCK ISSUED
TO EMPLOYEES, and related Interpretations in accounting for

F-13

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

options granted to employees. Under APB Opinion 25, because the exercise price
of the Company's employee stock options equals the market price of the
underlying stock on the date of grant, no compensation cost is recognized.

Under the 1991 Performance Equity Plan, the Company may grant options to
its employees and certain consultants for up to 2,000,000 shares of Common
Stock. Under the 1994 Outside Directors' Plan, the Company may grant options to
its directors for up to 400,000 shares of Common Stock. For both plans, the
exercise price of each option equals the market price of the Company's stock on
the date of grant and an option's maximum term is 10 years.

FASB Statement 123, ACCOUNTING FOR STOCK-BASED COMPENSATION, requires the
Company to provide pro forma information regarding net income and earnings per
share as if compensation cost for the Company's stock option plans has been
determined in accordance with the fair value based method prescribed in FASB
Statement 123. The Company estimates the fair value of each stock option at the
grant date by using the Black-Scholes option-pricing model with the following
weighted-average assumptions used for grants in 1997 and 1996, respectively: no
dividend yield for all years; expected volatility of 50 and 57 to 60 percent,
respectively; risk-free interest rates of 5.8 to 6.4 and 5.5 to 6.7 percent for
the 1991 Plan options and 5.7 to 6.6 and 6.1 percent for the 1994 Plan options
in 1997 and 1996, respectively; and expected lives of 10 years for the 1991 Plan
options in 1997 and 1996 and from 7 to 10 and 10 years for the 1994 Plan options
in 1997 and 1996, respectively.

Under the accounting provisions of FASB Statement 123, the Company's net
income (loss) and net income (loss) per common share would have been as follows:

1997 1996
-------- -----------

Net income (loss) As reported $366,800 $ (758,472)
Proforma $(33,712) $(1,650,558)

Net income (loss) per As reported $ 0.14 $ (0.32)
common share - basic Proforma $ (0.01) $ (0.70)

Net income (loss) per As reported $ 0.13 $ (0.32)
common share - diluted Proforma $ (0.01) $ (0.70)

A summary of the status of the Company's two fixed stock option plans as of
December 31, 1997 and 1996, and changes during the years ending on those dates
is presented below:

DECEMBER 31, 1997 DECEMBER 31, 1996
----------------- -----------------
WEIGHTED-AVERAGE WEIGHTED-AVERAGE
SHARES EXERCISE PRICE SHARES EXERCISE PRICE
------ ---------------- ------ ----------------

<S> <C> <C> <C> <C>
Outstanding at beginning of year 319,521 $ 9.96 301,396 $ 11.40
Granted 270,125 $ 2.16 96,500 $ 5.48
Forfeited (95,688) $ 8.07 (78,375) $ 11.00
------- -------

Outstanding at end of year 493,958 $ 4.00 319,521 $ 9.96
======= =======

Options exercisable at year-end 200,169 $ 6.71 181,148 $ 12.36
======= =======
Weighted-average fair value of options
granted during the year $ 1.48 -- $ 4.04 --
======= =======
</TABLE>

F-14

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following table summarizes information about fixed stock options
outstanding at December 31, 1997.

OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------------- ----------------------------------
NUMBER WEIGHTED-AVERAGE NUMBER
RANGE OF OUTSTANDING REMAINING WEIGHTED-AVERAGE EXERCISABLE WEIGHTED-AVERAGE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE EXERCISE PRICE AT 12/31/97 EXERCISE PRICE
- --------------- ----------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>

$ 1.64-3.99 413,958 8.2 years $ 1.99 120,169 $ 1.64
$ 4.00-15.99 33,750 4.1 years $ 11.00 33,750 $ 11.00
$16.00-20.00 46,250 2.9 years $ 16.76 46,250 $ 16.76
------- ------
$ 1.64-20.00 493,958 7.4 years $ 4.00 200,169 $ 6.71
======= ======

</TABLE>

On January 24, 1997, the Board of Directors authorized the repricing of all
granted and outstanding options to purchase Common Stock issued pursuant to the
1991 Performance Equity Plan at $0.41 per share, the market price per share of
the Company's Common Stock on such date.

(d) As of December 31, 1997 and 1996, respectively, the Company has
reserved an aggregate 2,600,318 and 2,445,685 shares of Common Stock for
issuance upon exercise of options and warrants.

(e) The following reconciles the components of the earnings per share (EPS)
computation:

FOR THE YEARS ENDED DECEMBER 31, 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------
INCOME SHARES PER-SHARE LOSS SHARE PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT (NUMERATOR) (DENOMINATOR) AMOUNT
--------- ----------- --------- --------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C>
Earnings (loss) per common share
Net income (loss) $366,800 2,692,737 $0.14 $(758,472) 2,369,339 $(0.32)
Effect of Dilutive Securities ===== ======
Options -- 53,017 -- --
Warrants -- 4,640 -- --
-------- --------- -------- --------
Earnings (loss) per common share -
assuming dilution
Net income (loss) $366,800 2,750,394 $0.13 $(758,472) 2,369,339 $(0.32)
======== ========= ===== ========= ========= ======

</TABLE>

Options to purchase 319,521 shares of common stock at exercise prices
ranging from $1.76 to $20.00 per share were not included in the computation of
loss per share assuming dilution for 1996 as they would have an antidilutive
effect. Options to purchase 327,438 shares of common stock at exercise prices
ranging from $2.36 to $20.00 per share were not included in the computation of
earnings per share assuming dilution for 1997 because the options exercise
prices were greater than the average market price of the common shares for that
year. 493,958 options which expire through 2007, are still outstanding at
December 31,1997. Warrants to purchase 1,871,565 shares of common stock at
exercise prices ranging from $28.68 to $43.04 per share were not included in the
computation of loss per common share assuming dilution for 1996 as they would
have an antidilutive effect. Warrants to purchase 1,938,698 shares of common
stock at exercise prices ranging from $2.36 to $43.04 per share were not
included in the computation of earnings per share assuming dilution for 1997
because the warrants exercise prices were greater than the average market price
of the common shares for that year. 2,026,198 warrants, which expire at various
times through 2007, are still outstanding at December 31, 1997.

F-15

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

10. BUSINESS SEGMENTS

The Company's operations by business segments were as follows:
<TABLE>
<CAPTION>

FLUID HANDLING,
FILTRATION,
PURIFICATION
AND WASTE WATER CAR WASH EQUIPMENT
REVENUES TREATMENT SALES AND SERVICE CORPORATE TOTAL
- ------------------------ --------------- ------------------- ----------- -----------
<S> <C> <C> <C> <C>
1997 $20,331,164 $3,569,938 -- $23,901,102
1996 $12,409,843 $3,577,304 -- $15,987,147

OPERATING INCOME (LOSS)
- -----------------------
1997 $ 1,454,497 $ 266,634 $ (923,152) $ 797,979
1996 $ 240,405 $ 82,163 $ (988,355) $ (665,787)

IDENTIFIABLE ASSETS
- -------------------
1997 $13,923,041 $1,901,199 $1,264,369 $17,088,609
1996 $ 7,132,469 $1,989,343 $1,298,332 $10,420,144

DEPRECIATION AND AMORTIZATION
- -----------------------------
1997 $ 507,912 $ 124,059 $ 49,250 $ 681,221
1996 $ 332,932 $ 118,014 $ 47,400 $ 498,346

CAPITAL EXPENDITURES
- ---------------------
1997 $ 109,931 $ 10,486 $ 16,032 $ 136,449
1996 $ 90,173 $ 67,132 $ 786,856 $ 944,161

</TABLE>

11. FINANCING FEES

The Company offers a retail financing program for the purpose of assisting
its subsidiaries' water purification customers (dealers) in obtaining financing
through an arrangement with an unrelated lending company. As compensation for
its services, the Company receives fees based on amounts financed. Net fees for
the years ended December 31, 1997 and 1996 aggregated approximately $779,000 and
$692,000, respectively, and are included in revenues.

12. OTHER INCOME

On July 22, 1996, the Company filed a complaint against Vincent Spaulding,
Robert Langman and Robert Farry, former employees of one of the Company's
subsidiaries, in the United States District Court for the Southern District of
Florida. The complaint alleged, among other matters, breach of express warranty
and specific performance of certain of

F-16

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the parameters of the Stock Purchase Agreement effective July 1994 entered into
by the Company for the purchase of Gravity Flow Systems, Inc., FLS Specialty
Manufacturing, Inc. and the name and certain assets of TOPCO International, Inc.
During January 1997, the Company agreed to a Settlement Agreement which, among
other things, provided for the payment of $150,000 in cash to the Company along
with the transfer of land and building and a mortgage note payable to the
Defendants having carrying values of $150,000 and $124,714, respectively, as of
December 31, 1996. The result of the above transaction was a net gain of
approximately $124,000 recognized in March 1997.

13. SUPPLEMENTAL CASH FLOW INFORMATION

For the years ended December 31, 1997 and 1996, the Company paid $451,932
and $89,319, respectively, for interest. Non-cash investing and financing
activities are as follows:

The Company acquired certain assets and assumed certain liabilities of FSDA
during the year ended December 31, 1997. In conjunction with this acquisition,
liabilities were assumed as follows:

Fair value of net assets acquired $ 6,060,941
Costs in excess of net assets acquired 730,196
Debt and obligations under acquisition agreement (5,333,300)
Acquisition costs (204,031)
Warrants issued in conneciton with acquisition (80,000)
-----------
Liabilities assumed $ 1,173,806
===========

During January 1996, $247,959 of subordinated convertible notes were
converted into 67,204 shares of the Company's Common Stock.

During 1997, in connection with the acquisition of FSDA, the Company issued
187,500 warrants valued at $120,000.

During 1997 and 1996, the Company contributed 18,393 and 15,447 shares of
restricted Common Stock pursuant to the terms of the Company's 401(k) employee
savings and retirement plan valued at $18,165 and $20,592, respectively.

14. COMMITMENTS AND CONTINGENCIES

(a) The Company leases vehicles and office/warehouse space under operating
leases which expire through 2001. Total rent expense aggregated approximately
$237,000 and $394,000, including approximately $110,000 and $145,000 to related
parties, for the years ended December 31, 1997 and 1996, respectively.

Approximate future annual minimum lease payments under operating leases at
December 31, 1997 are as follows:

1998 $280,372
1999 209,062
2000 50,023
2001 3,360
--------
$542,817
========

(b) The Company has entered into a distribution agreement with Ryko
Manufacturing Company ("Ryko"). Under the terms of the agreement, the Company is
the exclusive distributor of Ryko car wash equipment in the South Florida
region. The distribution agreement provides that the Company sells directly or
receives a commission on all Ryko equipment sold within its region. The two year
agreement was renewed in July 1997 and remains in place through July 1999.

F-17

<PAGE>

AQUA CARE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(c) In January 1994, the Company adopted a 401(k) employee savings and
retirement plan. Under the provisions of the Plan, the Company may elect to
match each employee's contribution to the Plan at the rate of 50% in Company
Common Stock. The Common Stock is restricted stock and vests over a two year
period on a quarterly basis. During 1997 and 1996, the Company contributed
18,393 and 15,447 shares of restricted Common Stock valued at $18,165 and
$20,592, respectively.

(d) The Company is or may become involved in various lawsuits, claims and
proceedings in the normal course of its business including those pertaining to
product liability, environmental, safety and health, and employment matters. The
Company records liabilities when loss amounts are determined to be probable and
reasonably estimatable. Insurance recoveries are recorded only when claims for
recovery are settled. Although generally the outcome of litigation cannot be
predicted with certainty and some lawsuits, claims or proceedings may be
disposed of unfavorably to the Company, management believes, based on facts
presently known, that the outcome of such legal proceedings and claims will not
have a material adverse effect on the Company's financial position, liquidity,
or future results of operations.

15. SUBSEQUENT EVENTS

(a) In January 1998, the Company, pursuant to the 401(k) employee savings
and retirement plan, contributed 18,232 shares of restricted Common Stock valued
at $14,813.

(b) In January 1998, the Company entered into a non-binding letter of
intent in which it endeavors to purchase all the assets and assume certain of
the liabilities of Williams Instrument Company, Inc. principally for cash and
Common Stock. The acquisition is subject to, among other things, the
satisfactory completion of due diligence procedures, financing arrangements and
the execution of a definitive purchase agreement by the Company.

(c) In February 1998, certain employees of the Company were granted options
to purchase a total of 30,650 shares of Common Stock at $1.75 per share (market
value at the date of grant). The above options expire ten years from the date of
grant, and are exercisable one-third each year beginning one year from the date
of grant.

F-18

<PAGE>

EXHIBIT INDEX

EXHIBIT DESCRIPTION
- ------- -----------

27.1 Financial Data Schedule

<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 654,932
<SECURITIES> 0
<RECEIVABLES> 3,533,593
<ALLOWANCES> 135,000
<INVENTORY> 3,007,468
<CURRENT-ASSETS> 7,401,347
<PP&E> 5,867,713
<DEPRECIATION> 928,511
<TOTAL-ASSETS> 17,088,609
<CURRENT-LIABILITIES> 5,530,342
<BONDS> 6,632,381
0
0
<COMMON> 2,704
<OTHER-SE> 7,821,898
<TOTAL-LIABILITY-AND-EQUITY> 17,088,609
<SALES> 23,901,102
<TOTAL-REVENUES> 23,901,102
<CGS> 15,363,522
<TOTAL-COSTS> 15,363,522
<OTHER-EXPENSES> 7,573,438
<LOSS-PROVISION> 36,000
<INTEREST-EXPENSE> 561,342
<INCOME-PRETAX> 366,800
<INCOME-TAX> 0
<INCOME-CONTINUING> 366,800
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 366,800
<EPS-PRIMARY> 0.14
<EPS-DILUTED> 0.13

</TABLE>