SECURITIES AND EXCHANGE
COMMISSION

Washington, DC 20549

# FORM
10-Q

# [X] QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For
the quarterly period ended: March 31, 2003

or

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

For the transition
period from ______ to ______

Commission File Number:
1-7211

# IONICS, INCORPORATED(Exact
name of registrant as specified in its charter)

|Massachusetts(State
or other jurisdiction of incorporation or organization) |  | 04-2068530(IRS
Employer Identification Number)
|--------------------------------------------------------------------------- |  | ----------------------------------------------

|65 Grove StreetWatertown, MA(Address of principal
executive offices) |  | 02472-2882
(Zip Code)
|-------------------------------------------------------------------- |  | ---------------------

Registrant's telephone number,
including area code: (617) 926-2500

Former name, former address and former fiscal
year, if changed since last report: None

Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceeding 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

# Yes
   X    No

Indicate the number of shares
outstanding of each of the issuers classes of common stock, as of the latest
practicable date.  At April 30, 2003 the Company had
17,555,046 shares of Common Stock, par value $1.00 per share, outstanding.

---

# IONICS, INCORPORATEDFORM
10-Q

# FOR QUARTER ENDED
MARCH 31, 2003

INDEX

PAGE

|PART I |  | FINANCIAL INFORMATION
|------ |  | ---------------------

| | Item 1.   Financial Statements | 2
| | ------------------------------ | -

| | Consolidated Statements of Operations
                   Three Months Ended March 31, 2003 and 2002 | 2
| | --------------------------------------------------------------------------------------------------- | -

| | Consolidated Balance
Sheets                   March 31, 2003 and December 31, 2002 | 3
| | ---------------------------------------------------------------------------------- | -

| | Consolidated Statements of Cash Flows
                   Three Months Ended March 31, 2003 and 2002 | 4
| | --------------------------------------------------------------------------------------------------- | -

| | Notes to Consolidated Financial Statements | 5
| | ------------------------------------------ | -

| | Item 2.  Management's Discussion and Analysis of Financial Condition                   and Results of Operations | 13
| | ---------------------------------------------------------------------------------------------------------------- | --

| | Item 3.  Quantitative and Qualitative Disclosures about Market Risk | 21
| | ------------------------------------------------------------------- | --

| | Item 4.  Controls and Procedures | 22
| | -------------------------------- | --

|PART II | OTHER INFORMATION | 24
|------- | ----------------- | --

| | Item 1.  Legal Proceedings | 24
| | -------------------------- | --

| | Item 6.  Exhibits and Reports on Form 8-K | 24
| | ----------------------------------------- | --

| | SIGNATURES | 25
| | ---------- | --

| | CERTIFICATIONS | 26
| | -------------- | --

| | EXHIBIT INDEX | 28
| | ------------- | --

---

# PART I - FINANCIAL
INFORMATION

Item 1.  FINANCIAL
STATEMENTS

IONICS, INCORPORATED
           CONSOLIDATED STATEMENTS OF OPERATIONS   (Unaudited)       (Amounts in
thousands, except per share amounts)

|                                                                                       | Three months ended
|-------------------------------------------------------------------------------------- | ------------------
|
|
|
|Revenues:                                                                              |                   
|Equipment Business Group                                                               |                   
|Ultrapure Water Group                                                                  |                   
|Consumer Water Group                                                                   |                   
|Instrument Business Group                                                              |                   
|Affiliated companies                                                                   |                   
|                                                                                       |                   
|                                                                                       |                   
|                                                                                       |                   
|Costs and expenses:                                                                    |                   
|Cost of sales of Equipment Business Group                                              |                   
|Cost of sales of Ultrapure Water Group                                                 |                   
|Cost of sales of Consumer Water Group                                                  |                   
|Cost of sales of Instrument Business Group                                             |                   
|Cost of sales to affiliated companies                                                  |                   
|Research and development                                                               |                   
|Selling, general and administrative                                                    |                   
|                                                                                       |                   
|                                                                                       |                   
|                                                                                       |                   
|Income from operations                                                                 |                   
|Interest income                                                                        |                   
|Interest expense                                                                       |                   
|Equity (loss) income                                                                   |                   
|                                                                                       |                   
|Income before income taxes and minority interest expense                               |                   
|Income tax expense                                                                     |                   
|                                                                                       |                   
|Income before minority interest expense                                                |                   
|Minority interest expense                                                              |                   
|                                                                                       |                   
|Net income                                                                             |                   
|                                                                                       |                   
|Basic earnings per share                                                               |                   
|                                                                                       |                   
|Diluted earnings per share                                                             |                   
|                                                                                       |                   
|Shares used in basic earnings per share calculations                                   |                   
|                                                                                       |                   
|Shares used in diluted earnings per share calculations                                 |                   
|                                                                                       |                   
|The accompanying notes are an integral part of these consolidated financial statements |                   

---

IONICS, INCORPORATED
                   CONSOLIDATED BALANCE SHEETS              (Unaudited)          (Amounts
in thousands, except share and par value amounts)

|                                                                                       | March 31,
2003 | December 31,
2002
|-------------------------------------------------------------------------------------- | -------------- | -----------------
|
|ASSETS                                                                                 |                |                  
|Current assets:                                                                        |               
|Cash and cash equivalents                                                              |                | $ 135,525        
|Restricted cash                                                                        |                | --               
|Short-term investments                                                                 |                | 994              
|Accounts receivable, net                                                               |                | 95,567           
|Notes receivable, current                                                              |                | 4,472            
|Receivables from affiliated companies                                                  |                | 24,586           
|Inventories:                                                                           |               
|Raw materials                                                                          |                | 21,227           
|Work in process                                                                        |                | 8,580            
|Finished goods                                                                         |                | 6,445            
|                                                                                       |                |                  
|                                                                                       |                | 36,252           
|Deferred income taxes                                                                  |                | 14,664           
|Other current assets                                                                   |                | 11,200           
|                                                                                       |                |                  
|Total current assets                                                                   |                | 323,260          
|Receivables from affiliated companies, long-term                                       |                | 13,798           
|Notes receivable, long-term                                                            |                | 25,151           
|Investments in affiliated companies                                                    |                | 21,463           
|Property, plant and equipment:                                                         |               
|Land                                                                                   |                | 6,121            
|Buildings                                                                              |                | 46,613           
|Machinery and equipment                                                                |                | 280,461          
|Other, including furniture, fixtures and vehicles                                      |                | 31,590           
|                                                                                       |                |                  
|                                                                                       |                | 364,785          
|Less accumulated depreciation                                                          |                | 183,787          
|                                                                                       |                |                  
|                                                                                       |                | 180,998          
|Goodwill                                                                               |                | 20,297           
|Deferred income taxes, long-term                                                       |                | 12,591           
|Other assets                                                                           |                | 7,860            
|                                                                                       |                |                  
|Total assets                                                                           |                | $ 605,418        
|                                                                                       |                |                  
|LIABILITIES AND STOCKHOLDERS' EQUITY                                                   |               
|Current liabilities:                                                                   |               
|Notes payable and current portion of long-term debt                                    |                | $     3,911      
|Accounts payable                                                                       |                | 29,493           
|Deferred revenue from affiliated companies                                             |                | 3,256            
|Income taxes payable                                                                   |                | 28,248           
|Other current liabilities                                                              |                | 42,372           
|                                                                                       |                |                  
|Total current liabilities                                                              |                | 107,280          
|Long-term debt and notes payable                                                       |                | 9,910            
|Deferred income taxes                                                                  |                | 35,913           
|Deferred revenue from affiliated companies                                             |                | 5,169            
|Other liabilities                                                                      |                | 7,023            
|Commitments and contingencies                                                          |               
|Stockholders' equity:                                                                  |               
|Common stock, par value $1, authorized                                                 |               
|shares: 55,000,000 at March 31, 2003 and December 31, 2002;                            |               
|issued: 17,555,046 at March 31, 2003 and December 31, 2002                             |                | 17,555           
|Additional paid-in capital                                                             |                | 190,417          
|Retained earnings                                                                      |                | 247,685          
|Accumulated other comprehensive loss                                                   |                | (15,534          
|                                                                                       |                |                  
|Total stockholders' equity                                                             |                | 440,123          
|                                                                                       |                |                  
|Total liabilities and stockholders' equity                                             |                | $ 605,418        
|                                                                                       |                |                  
|The accompanying notes are an integral part of these consolidated financial statements |               

---

IONICS,
INCORPORATED            CONSOLIDATED STATEMENTS OF CASH FLOWS  (Unaudited)
       (Amounts in thousands)

|                                                                                       | Three months ended March 31,
|-------------------------------------------------------------------------------------- | ----------------------------
|
|Operating activities:                                                                  |                             
|Net income                                                                             |                             
|Adjustments to reconcile net income to net cash provided by                            |                             
|(used in) operating activities:                                                        |                             
|Depreciation                                                                           |                             
|Amortization of intangibles                                                            |                             
|Increase (decrease) to provision for losses on accounts and notes receivable           |                             
|Equity in losses (earnings) of affiliates                                              |                             
|Changes in assets and liabilities:                                                     |                             
|Notes receivable                                                                       |                             
|Accounts receivable                                                                    |                             
|Receivables from affiliated companies                                                  |                             
|Inventories                                                                            |                             
|Other current assets                                                                   |                             
|Investments in affiliated companies                                                    |                             
|Deferred income tax assets                                                             |                             
|Accounts payable and accrued expenses                                                  |                             
|Customer deposits                                                                      |                             
|Deferred revenue from affiliates                                                       |                             
|Income taxes payable                                                                   |                             
|Other                                                                                  |                             
|                                                                                       |                             
|Net cash provided by (used in) operating activities                                    |                             
|                                                                                       |                             
|Investing activities:                                                                  |                             
|Additions to property, plant and equipment                                             |                             
|Disposals of property, plant and equipment                                             |                             
|Additional investments in affiliates                                                   |                             
|Sales (purchases) of short-term investments                                            |                             
|                                                                                       |                             
|Net cash used in investing activities                                                  |                             
|                                                                                       |                             
|Financing activities:                                                                  |                             
|Restricted cash                                                                        |                             
|Principal payments on current debt                                                     |                             
|Proceeds from borrowings of current debt                                               |                             
|Principal payments on long-term debt                                                   |                             
|Proceeds from borrowings of long-term debt                                             |                             
|Proceeds from stock option plans                                                       |                             
|                                                                                       |                             
|Net cash provided by (used in) financing activities                                    |                             
|                                                                                       |                             
|Effect of exchange rate changes on cash                                                |                             
|                                                                                       |                             
|Net change in cash and cash equivalents                                                |                             
|Cash and cash equivalents at beginning of period                                       |                             
|                                                                                       |                             
|Cash and cash equivalents at end of period                                             |                             
|                                                                                       |                             
|The accompanying notes are an integral part of these consolidated financial statements |                             

---

# IONICS, INCORPORATED

# NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

# (Unaudited)

# 1. Basis of Presentation

The consolidated quarterly financial
statements of Ionics, Incorporated (the Company) are unaudited; however, in
the opinion of the management of the Company, all adjustments have been made that are
necessary for a fair statement of the consolidated financial position of the Company, the
consolidated results of its operations and the consolidated cash flows for each period
presented. The consolidated results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the full year or
any future period.

The accompanying financial statements
have been prepared with the assumption that users of the interim financial information
have either read or have access to the Companys financial statements for the year
ended December 31, 2002. Accordingly, footnote disclosures that would substantially
duplicate the disclosures contained in the Companys December 31, 2002 audited
financial statements have been omitted from these financial statements. These financial
statements have been prepared in accordance with the instructions to Form 10-Q and the
rules and regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in accordance with
generally accepted accounting principles have been condensed or omitted pursuant to such
instructions, rules and regulations. These financial statements should be read in
conjunction with the Companys 2002 Annual Report as filed on Form 10-K (the
2002 Form 10-K) with the Securities and Exchange Commission. Certain prior
year amounts have been reclassified to conform to the current year presentations with no
impact on net income.

# 2. Restatement of
Quarterly Financial Statements

The Companys consolidated
financial statements for the three months ended March 31, 2002 and June 30, 2002 and the
six months ended June 30, 2002 were restated in November, 2002, primarily as a result of
intercompany transactions including transactions between the Company and its French
subsidiary that were erroneously recorded at the subsidiary level. The restatement
resulted primarily from the French subsidiarys failure to properly record
intercompany adjustments necessary to correct errors on its books, which became apparent
to the Companys corporate management during the preparation of the Companys
consolidated financial statements for the three- and nine-month periods ended September
30, 2002. These adjustments primarily affected accounting entries related to revenues from
sales of spare parts and expenses related to project cost overruns, sales support costs
and severance costs. These adjustments, which increased the historical pre-tax loss at the
French subsidiary in the quarters ended March 31, 2002 and June 30, 2002 and the forecast
of the French subsidiarys pre-tax losses for the year ended December 31, 2002,
resulted in the Companys determination that it was more likely than not that the
Company would not fully realize future tax benefits associated with the French
subsidiarys net operating losses. Accordingly, the Companys income tax expense
and its effective annual tax rate for the three months ended June 30, 2002 were increased.
In addition, the restatement reflected other adjustments that primarily consisted of
corrections to various otherwise immaterial accounting errors that were identified during
the preparation of the Companys consolidated financial statements for the quarters
ended March 31, 2002, June 30, 2002 and September 30, 2002. The restatement did not
materially impact any items on the Companys consolidated balance sheet as of March
31, 2002 and June 30, 2002. The following table presents a summary of the impact of the
restatements on the Companys consolidated statements of operations for the three
months ended March 31, 2002:

---

|                                                         | (Amounts in thousands, except per share amounts)
|-------------------------------------------------------- | ------------------------------------------------
|
|
|
|Revenues                                                 |                                                 
|Costs and expenses                                       |                                                 
|Income from operations                                   |                                                 
|Income before income taxes and minority interest expense |                                                 
|Income tax expense                                       |                                                 
|Minority interest expense                                |                                                 
|Net income                                               |                                                 
|Basic earnings per share                                 |                                                 
|Diluted earnings per share                               |                                                 

# 3. Accounting for
Stock-Based Compensation

The Company applies the recognition
and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees, and related interpretations in accounting for its
stock-based compensation plans. Accordingly, for any options with an exercise price less
than the fair market value of the stock at the date of grant, stock-based compensation is
measured as the difference between the option exercise price and fair market value of the
stock at the date of grant and is charged to operations over the expected period of
benefit to the Company. For the three months ended March 31, 2003 and 2002, no stock-based
compensation expense is reflected in net income.

The following table illustrates the
pro forma effect on net income and earnings per share if the Company had applied the fair
value method of accounting for stock options and other equity instruments as defined by
Statement of Financial Accounting Standards (SFAS) No. 123, Accounting
for Stock-Based Compensation.

(Amounts
in thousands, except per share amounts)

|                                                                   | For the three months ended
|------------------------------------------------------------------ | --------------------------
|
|
|
|Net income, as reported                                            |                           
|Less:  Stock-based employee compensation expense determined        |                           
|under fair value method for all awards, net of related tax effects |                           
|                                                                   |                           
|Pro forma net income (loss)                                        |                           
|                                                                   |                           
|                                                                   |                           
|Earnings (loss) per basic share, as reported                       |                           
|                                                                   |                           
|Earnings (loss) per basic share, pro forma                         |                           
|                                                                   |                           
|                                                                   |                           
|Earnings (loss) per diluted share, as reported                     |                           
|                                                                   |                           
|Earnings (loss) per diluted share, pro forma                       |                           
|                                                                   |                           

Since the options vest over several
years and because additional option grants are expected to be made in future years, the
pro forma results are not representative of the pro forma results for future periods.

The fair value of each option granted
during the first three months of 2003 and 2002 is estimated on the date of grant using the
Black-Scholes option-pricing model with the following assumptions:

|                                                         | 2003 | 2002
|-------------------------------------------------------- | ---- | ----
|Expected term (years)                                    |      | 6   
|Volatility                                               |      | 40  
|Risk-free interest rate (zero coupon U.S. treasury note) |      | 3   
|Dividend yield                                           |      | None

---

# 4. Commitments and
Contingencies

Litigation

The Company was notified in 1992 that
it is a potentially responsible party (PRP) at a Superfund Site, Solvent Recovery Services
of New England in Southington, Connecticut. Ionics share of assessments to date for
site work and administrative costs totals approximately $77,000. The United States
Environmental Protection Agency (EPA) has not yet issued a decision regarding
clean-up methods and costs. However, based upon the large number of PRPs identified, the
Companys small volumetric ranking (approximately 0.5%) and the identities of the
larger PRPs, the Company believes that its liability in this matter will not have a
material effect on the Companys financial position, results of operations or cash
flows.

In 2002, Sievers Instruments, Inc.
(Sievers), a wholly owned subsidiary of the Company, filed a patent
infringement suit in the United States District Court for the District of Colorado against
Anatel Corporation and against Anatels acquiring company, Hach Company
(Anatel). The suit alleges that Anatels manufacture and sale of its
Model 643 organic carbon analyzer unlawfully copied and interfered with sales of
Sievers TOC 400 total organic carbon analyzer in that the Model 643 infringes
certain claims of Sievers U.S. patents No. 5,976,468 and No. 6,271,043. The suit
further asserts that the continuing sale of calibration standards by Anatel constitutes
infringement. The defendants have raised certain defenses, withdrawn the accused product
from the market, and introduced a redesigned analyzer. Defendants have asked the Court to
rule that their redesigned analyzer does not infringe, and the Court has not yet issued
its decision.

The Company and its Chief Executive
Officer and Chief Financial Officer have been named as defendants in a class action
lawsuit captioned Jerome Deckler v. Ionics, Inc., et al., filed in the U.S.
District Court, District of Massachusetts in March 2003. Plaintiff alleges violations of
the federal securities laws relating to the restatement of the Companys financial
statements for the first and second quarters of 2002 announced in November 2002. The
Company believes the allegations in the lawsuit are without merit and intends vigorously
to defend the litigation. While the Company believes that the litigation will have no
material adverse impact on its financial condition, results of operations or cash flows,
the litigation process is inherently uncertain and the Company can make no assurances as
to the ultimate outcome of this matter.

The Company is involved in the normal
course of its business in various other litigation matters, some of which are in the
pre-trial discovery stages. The Company believes that none of the other pending matters
will have an outcome material to the Companys financial position, results of
operations or cash flows.

Other

From time to time, the Company enters
into joint ventures with respect to specific projects, including the projects in Trinidad,
Kuwait and Israel described below. Each joint venture arrangement is independently
negotiated based on the specific facts and circumstances of the project, the purpose of
the joint venture company related to the project, as well as the rights and obligations of
the other joint venture partners. Generally, the Company has structured its project joint
ventures so that the Companys obligation to provide funding to the underlying
project or to the joint venture entity is limited to its proportional capital
contribution, which can take the form of equity or subordinated debt. Except in situations
that are negotiated with a specific joint venture entity as discussed below, the Company
has no other commitment to provide for the joint ventures working capital or other
cash needs. In addition, the joint venture entity typically obtains third-party debt
financing for a substantial portion of the projects total capital requirements. In
these situations, the Company is typically not responsible for the repayment of the
indebtedness incurred by the joint venture entity. In connection with certain joint
venture projects, the Company may also enter into contracts for the supply and
installation of the Companys equipment during the construction of the project, for
the operation and maintenance of the facility once it begins operation, or both. These
commercial arrangements do not require the Company to commit to any funding for working
capital or any other requirements of the joint venture company. As a result, the
Companys exposure with respect to its joint ventures is typically limited to its
debt and equity investments in the joint venture entity, the fulfillment of any
contractual obligations it has to the joint venture entity and the accounts receivable
owing to the Company from the joint venture entity.

In the second quarter of 2002,
construction was completed on the first four (out of five) phases of the Trinidad
desalination facility owned by Desalination Company of Trinidad and Tobago Ltd.
(Desalcott), in which the Company has a 40% equity interest, and the facility
commenced water deliveries to its customer, the Water and Sewerage Authority of Trinidad
and Tobago. In 2000, the Company acquired 200 ordinary shares of Desalcott for $10 million
and loaned $10 million to Hafeez Karamath Engineering Services Ltd. (HKES),
the founder of Desalcott and promoter of the Trinidad desalination project, to enable HKES
to acquire an additional 200 ordinary shares of Desalcott. Prior to those investments,










HKES owned 100 ordinary shares of Desalcott. As a result, the Company currently owns a 40%
equity interest in Desalcott, and HKES currently owns a 60% equity interest in Desalcott.

The Companys $10 million loan
to HKES is included in notes receivable, long-term on the Companys Consolidated
Balance Sheets. The loan bears interest at a rate equal to 2% above the London Interbank
Offered Rate (LIBOR), with interest payable starting October 25, 2002 and every six months
thereafter and at maturity. Prior to maturity, however, accrued interest payments (as well
as principal payments) are payable only to the extent dividends or other distributions are
paid by Desalcott on the ordinary shares of Desalcott owned by HKES and pledged to the
Company. Principal repayment is due in 14 equal installments commencing on April 25, 2004
and continuing semiannually thereafter. The loan matures and is payable in full on April
25, 2011. The loan is secured by a security interest in the shares of Desalcott owned by
HKES and purchased with the borrowed funds, which is subordinate to the security interest
in those shares in favor of the Trinidad bank that provided the construction financing for
Desalcott. In addition, any dividends or other distributions paid by Desalcott to HKES
must be applied to loan payments to the Company.

In 2000, Desalcott entered into a
bridge loan agreement with a Trinidad bank providing $60 million in
construction financing. Effective November 8, 2001, the loan agreement was amended to
increase maximum borrowings to $79.9 million. The Company is obligated to lend up to $10
million to Desalcott as an additional source of funds for project completion costs once
all bridge loan proceeds have been expended. However, the bridge loan of $79.9 million and
the $20 million equity provided to Desalcott (together with the additional $10 million
dollars the Company is obligated to lend to Desalcott) have not provided sufficient funds
to pay all of Desalcotts obligations in completing construction and commissioning of
the project prior to receipt of long-term financing. Included in Desalcotts
obligations is approximately $30.1 million payable to the Companys Trinidad
subsidiary for equipment and services purchased in connection with the construction of the
facility. The Company currently intends to convert $10 million of this amount into a loan
to Desalcott to satisfy the Companys loan commitment described above. The terms of
this loan are currently being negotiated with Desalcott. Although the Company currently
anticipates that Desalcott will pay its remaining outstanding obligations to the
Companys subsidiary partially out of cash flow from the sale of water and from the
proceeds from new long-term debt financing, Desalcott has disputed certain amounts payable
under the construction contract, and this matter is now subject to the dispute resolution
procedures of the contract. The Company does not believe resolution of these matters will
have a material impact on its results of operations or cash flows. Desalcott has received
proposals for new long-term debt financing, including a term sheet and a draft term loan
agreement from the Trinidad bank which provided the bridge loan and is currently
negotiating the terms of the financing. Such new long-term debt financing may not be
completed on terms acceptable to Desalcott, or at all. Moreover, although the Trinidad
bank that made the bridge loan to Desalcott has not required repayment of the bridge loan,
which matured on September 1, 2002, pending completion of the long-term debt financing,
there can be no assurance that the bank will not exercise its rights and foreclose on its
collateral, in which event the Companys equity investment in, and receivable from,
Desalcott as well as the loan receivables from HKES would all be at risk.

During 2001, the Company acquired a
25% equity interest in a Kuwaiti project company, Utilities Development Company W.L.L.
(UDC), which was awarded a concession agreement by an agency of the Kuwaiti
government for the construction, ownership and operation of a wastewater reuse facility in
Kuwait. During the second quarter of 2002 UDC entered into agreements for the long-term
financing of the project. At March 31, 2003, the Company had invested a total of $4.6
million in UDC as equity contributions and subordinated debt. The Company is committed to
make additional contributions of equity or subordinated debt to UDC of approximately $14.0
million over the next two years.

In 2001, the Company entered into
agreements with an Israeli cooperative society and an Israeli corporation for the
establishment of Magan Desalination Ltd. (MDL) as an Israeli project company
in which the Company has a 49% equity interest. In August 2002, MDL entered into a
concession contract with a state-sponsored water company for the construction, ownership
and operation of a brackish water desalination facility in Israel. At March 31, 2003, the
Company had not yet made an equity investment in MDL, and had deferred costs of
approximately $0.6 million relating to the design and development work on the project. The
Company currently anticipates that it will invest approximately a total of $1.2 million in
MDL for its 49% equity interest. MDL is currently seeking approximately $7.2 million of
debt financing for the project and is in the process of negotiating a loan agreement with
an Israeli bank. If MDL is unable to obtain such debt financing, the Company would expense
all its deferred costs relating to the project and any investment the Company may have
made in MDL, but would incur no other liability, inasmuch as no performance bond has been
issued for the project.

---

In January 2002, the Company entered
into agreements with two Israeli corporations giving the Company the right to a one-third
ownership interest in an Israeli project company, Carmel Desalination Ltd.
(CDL). On October 28, 2002, CDL was awarded a concession agreement by the
Israeli Water Desalination Agency (established by the Ministry of Finance and the Ministry
of Infrastructure) for the construction, ownership and operation of a major seawater
desalination facility in Israel. At March 31, 2003, the Company made an equity investment
of $0.2 million in CDL, and had deferred costs of approximately $0.6 million relating to
the engineering design and development work on the project. If CDL obtains long-term
project financing, the Companys total equity investment to be made in CDL would be
approximately $8.0 million. The timing of such investment will depend upon the terms of
the long-term financing agreement. The terms of the concession agreement originally
required that long-term financing be obtained by April 2003. CDL has been granted an
extension to June 15, 2003 and has requested a further extension to obtain such financing.
Although the Company currently anticipates that CDL will obtain long-term financing for
the project, if CDL is unable to obtain such financing, the Company would expense all its
deferred costs relating to the project and any investment the Company may have made in CDL
(estimated to be approximately $0.8 million by the time of the closing of the long-term
financing). Additionally, the Company could incur its one-third proportionate share ($2.5
million) of liability under a $7.5 million performance bond issued on behalf of CDL.

On December 31, 2001, the Company
completed the sale of its Aqua Cool Business in the United States, United Kingdom and
France to affiliates of Perrier-Vittel S.A., a subsidiary of Nestle S.A. (Nestle). As a
result of final purchase price adjustments based on the number of customers and working
capital levels, and the resolution of certain claims made by Nestle, the Company and
Nestle reached final agreement on a purchase price of approximately $207.0 million in the
first quarter of 2003. As a result of such adjustments, the Company realized an additional
net pre-tax gain of $8.2 million in 2002. The 2002 pre-tax gain is net of direct and
incremental costs of the transaction including approximately $3.4 million of non-recurring
management and employee compensation. In connection with the final resolution, the $10
million held in escrow pursuant to the divestiture agreement and approximately $2.9
million in cash from the Company were transferred to Nestle on March 31, 2003.

Guarantees and
Indemnifications

In November 2002, the Financial
Accounting Standards Board (FASB) issued Interpretation No. 45
Guarantors Accounting and Disclosure Requirements for Guarantees, Including
Indirect Guarantees of Indebtedness of Others an interpretation of FASB Statements No. 5,
57, and 107 and rescission of FASB Interpretation No. 34 (FIN 45). The
Interpretation requires that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation undertaken by issuing the guarantee. The
Interpretation also requires additional disclosures to be made by a guarantor in its
interim and annual financial statements about its obligations under certain guarantees it
has issued. The accounting requirements for the initial recognition of guarantees became
applicable on a prospective basis for guarantees issued or modified after December 31,
2002. The disclosure requirements are effective for all guarantees outstanding, regardless
of when they were issued or modified as of December 15, 2002. The adoption of FIN 45 did
not have a material effect on the Companys consolidated financial statements. The
following is a summary of the Companys agreements that have determined to be within
the scope of FIN 45.

Under its By-laws, the Company has an
obligation to indemnify its directors and officers to the extent legally permissible
against liabilities reasonably incurred in connection with any action in which such
individual may be involved by reason of such individual being or having been a director or
officer of the Company. The Company has obtained director and officer liability insurance
policies that may limit its exposure and enable it to recover a portion of any future
amounts paid. As a result of this insurance policy coverage, the estimated fair value of
this indemnification is not material. This obligation to indemnify its directors and
officers is grandfathered under the provisions of FIN 45 as it existed prior to December
31, 2002. Accordingly, the Company has not recorded any liabilities for these obligations
as of March 31, 2003.

In the normal course of business, the
Company issues letters of credit to customers, vendors and lending institutions as
guarantees for payment, performance or both under various commercial contracts into which
it enters. Bid bonds are also sometimes obtained by the Company as security for the
Companys commitment to proceed with a project if it is the successful bidder.
Performance bonds are typically issued for the benefit of the Companys customers as
financial security for the completion or performance by the Company of its contractual
obligations under certain commercial contracts. In the past, the Company has not incurred
significant liabilities or expenses as a result of the use of these instruments.
Approximately $123.7 million of these instruments were outstanding at March 31, 2003. Based
on the Companys experience with respect to letters of credit, bid bonds and









performance bonds, the Company believes the estimated fair value of the instruments
entered into during the first quarter of 2003 is not material. Accordingly, the Company
has not recorded any liabilities for these instruments as of March 31, 2003.

As part of past acquisitions and
divestitures of businesses or assets, the Company made a variety of warranties and
indemnifications to the sellers and purchasers that are typical for such transactions. The
Company only provides such warranties or indemnifications after considering the economics
of the transaction and the liquidity and credit risk of the other party in the
transaction. Typically certain of the warranties and the indemnifications expire after a
defined period of time following the transaction, but others may survive indefinitely. The
warranty and indemnification obligations noted above were grandfathered under the
provisions of FIN 45 as they were in effect prior to December 31, 2002. In addition, the
Company has not made any similar warranty or indemnification obligations during the first
quarter of 2003. Accordingly, the Company has not recorded any liabilities for these
obligations as of March 31, 2003.

Warranty Obligations

The Companys products generally
include warranty obligations and the related estimated costs are included in cost of sales
when revenue is recognized. While the Company engages in extensive product quality
programs and processes, the Companys estimated costs to satisfy its warranty
obligations are based upon historical product failure rates and the costs incurred in
correcting such product failures. If actual product failure rates or the costs associated
with fixing such product failures differ from historical rates, adjustments to the
warranty obligations may be required in the period in which determined. The changes in
accrued warranty obligations for the three months ended March 31, 2003 are as follows:

|                                                        | (Amounts in thousands)
|------------------------------------------------------- | ----------------------
|
|
|
|Balance at December 31, 2002                            |                       
|Accruals for warranties issued during the period        |                       
|Accruals related to pre-existing warranties             |                       
|Settlements made (in cash or in kind) during the period |                       
|                                                        |                       
|Balance at March 31, 2003                               |                       
|                                                        |                       

# 5. Earnings Per Share
(EPS) Calculations

|                    | (Amounts in thousands, except per share amounts)
|------------------- | ------------------------------------------------
|
|
|
|
|
|Basic EPS           |                                                 
|Income available to |                                                 
|common stockholders |                                                 
|Effect of dilutive  |                                                 
|stock options       |                                                 
|                    |                                                 
|Diluted EPS         |                                                 
|                    |                                                 

The effect of dilutive stock options
excludes those stock options for which the impact would have been antidilutive based on
the exercise price of the options. The number of options that were antidilutive at March
31, 2003 and 2002 was 3,245,167 and 604,250, respectively.

---

# 6. Comprehensive Income
(Loss)

The Company has adopted SFAS No. 130,
Reporting Comprehensive Income, which establishes standards for the reporting
and display of comprehensive income and its components. The table below sets forth
comprehensive income (loss) as defined by SFAS No. 130 for the three-month
periods ended March 31, 2003 and 2002.

|                                         | (Amounts in thousands)
|---------------------------------------- | ----------------------
|
|
|
|
|Net income                               |                       
|Other comprehensive income,              |                       
|net of tax:                              |                       
|Change in value of foreign exchange      |                       
|contracts designated as cash flow hedges |                       
|Translation adjustments                  |                       
|                                         |                       
|Comprehensive income (loss)              |                       
|                                         |                       

# 7. Segment Information

The Company has four reportable
segments corresponding to a business group structure. The following table
summarizes the Companys operations by the four business group segments and
Corporate. Corporate includes legal and research and development expenses not
allocated to the business groups, certain corporate administrative and insurance costs,
foreign exchange gains and losses on corporate assets, as well as the elimination of
intersegment transfers.

|                                 | For the three months ended March 31, 2003
|-------------------------------- | -----------------------------------------
|
|
|(Amounts in thousands)           |                                          
|Revenue - unaffiliated           |                                          
|Revenue - affiliated             |                                          
|Inter-segment transfers          |                                          
|Gross profit - unaffiliated      |                                          
|Gross profit - affiliated        |                                          
|Equity income (loss)             |                                          
|Earnings (loss) before interest, |                                          
|tax and minority interest        |                                          
|Interest income                  |                                          
|Interest expense                 |                                          
|Income before income taxes and   |                                          
|minority interest                |                                          
|Identifiable assets              |                                          
|Goodwill                         |                                          
|Other intangible assets          |                                          

---

|                                 | For the three months ended March 31, 2002 (as restated)
|-------------------------------- | -------------------------------------------------------
|
|
|(Amounts in thousands)           |                                                        
|Revenue - unaffiliated           |                                                        
|Revenue - affiliated             |                                                        
|Inter-segment transfers          |                                                        
|Gross profit - unaffiliated      |                                                        
|Gross profit - affiliated        |                                                        
|Equity income (loss)             |                                                        
|Earnings (loss) before interest, |                                                        
|tax and minority interest        |                                                        
|Interest income                  |                                                        
|Interest expense                 |                                                        
|Income before income taxes and   |                                                        
|minority interest                |                                                        
|Identifiable assets              |                                                        
|Goodwill                         |                                                        
|Other intangible assets          |                                                        

# 8. Accounting
Pronouncements

In June 2001, the Financial
Accounting Standards Board (FASB) issued SFAS No. 143, Accounting for
Obligations Associated with the Retirement of Long-Lived Assets. SFAS No. 143
provides the accounting requirements for retirement obligations associated with tangible
long-lived assets. SFAS No. 143 is effective for financial statements for fiscal years
beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact
on the Companys financial position or results of operations.

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure which amended SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
compensation. It also amends the disclosure provisions to require prominent disclosure
about the effects on reported net income of an entitys accounting policy decisions
with respect to stock-based employee compensation. The provisions of SFAS No. 148 are to
be applied to financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS No. 148 did not have an impact on the Companys financial position
or results of operations.

In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of
ARB No. 51" (FIN 46). This interpretation addresses the consolidation of certain variable
interest entities (VIEs) for which a controlling financial interest exists. FIN 46 applies
immediately to financial interests obtained in VIEs after January 31, 2003. It applies in
the first fiscal year or interim period beginning after June 15, 2003, to VIEs in which a
financial interest was obtained before February 1, 2003. FIN 46 may be applied
prospectively with a cumulative-effect adjustment or by restating previously issued
financial statements with a cumulative-effect adjustment as of the beginning of the first
year restated. The Company has a financial interest in certain entities that may be
considered VIEs under FIN 46. The Company is currently evaluating the impact of FIN 46 on
its Investments in Affiliated Companies and if the Company determines that it has a
controlling financial interest in any of these entities, consolidation may be required.
The ultimate effect of adopting FIN 46 on the Companys financial position or results
of operations has not yet been determined.

In April 2003, the FASB issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies the accounting guidance on (1)
derivative instruments, including certain derivative instruments embedded in other
contracts, and (2) hedging activities that fall within the scope of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 amends
SFAS No. 133 and certain other existing pronouncements to provide for more consistent
reporting of contracts that are derivatives in their entirety or that contain embedded
derivatives that warrant separate accounting. SFAS No. 149 is effective (1) for contracts
entered into or modified after June 30, 2003, with certain exceptions, and (2) for hedging
relationships designated after June 30, 2003. The guidance is to be applied prospectively.
The ultimate effect of adopting SFAS No. 149 on the Companys financial position or
results of operations has not yet been determined.

---

# 9. Goodwill and
Intangible Assets

The Companys intangible assets
are included in other assets in the Consolidated Balance Sheets and consist principally of
patents and trademarks. At March 31, 2003 and 2002 the gross carrying value of these
intangible assets was approximately $2.9 million and $2.0 million, respectively, and the
accumulated amortization was $0.8 million and $0.5 million, respectively. The
Companys intangible assets are amortized on a straight-line basis over a period
ranging up to 20 years. Amortization expense for intangible assets is estimated to be
approximately $0.3 million in 2003 through 2005, $0.2 million in 2006 and $0.1 million in
2007. The change in the goodwill balance from December 31, 2002 to March 31, 2003 is
principally due to foreign currency translation adjustments.

# 10. Derivative Financial
Instruments and Hedging Activity

On December 31, 2002, the Company
entered into a series of U.S. dollar/euro forward foreign exchange contracts with the
intent of offsetting the foreign exchange risk associated with the forecasted revenues
related to an ongoing project. At March 31, 2003, the notional amount of outstanding
forward foreign exchange contracts to exchange U.S. dollars for euros, which were
designated as forecasted cash flow hedging instruments, was $11.3 million. The fair values
of the forward contracts, based upon dealer quotations, are recorded as components of
other current assets or other current liabilities, depending upon the amount of the
valuation. At March 31, 2003 the fair value of these forward contracts of $0.4 million was
recorded as a component of other current assets. The net unrealized gain of $0.4 million
on the forward contracts that qualified as cash-flow hedging instruments was included in
accumulated other comprehensive income. The Company expects these instruments to affect
earnings over the next twenty-four months. As these instruments have been effective
through March 31, 2003, no gains or losses have been recorded as components of other
income and expense.

As of March 31, 2003, the Company has
also entered into U.S. dollar/Taiwan dollar foreign forward exchange contracts to hedge
the balance sheet exposure related to an intercompany loan. At March 31, 2003, the
notional amount of outstanding forward contracts to exchange Taiwan dollars for U.S.
dollars, which were designated as fair value hedging instruments, was $1.5 million. The
fair values of these forward contracts, based upon dealer quotations, are recorded as
components of other current assets or current liabilities, depending on the amount of the
valuation. At March 31, 2003, the fair value of these hedging instruments, which was
immaterial, was recorded as a component of other current assets. The net unrealized gain
on the instruments, which was immaterial, was recorded in income.

At March 31, 2002, the Companys
Italian subsidiary had outstanding U.S.dollar/euro options contracts with a notional
amount of $10.5 million. The contracts were not entered into for trading purposes. In
accordance with the restrictions set forth in SFAS No. 133, the contracts did not qualify
for hedge accounting treatment. The fair value of the contracts was recorded as a
liability of $1.4 million as a component of other current liabilities in the Consolidated
Balance Sheet at March 31, 2002. These options contracts were closed in May 2002.

# 11. Subsequent Event

In April 2003, the Company reinstated
and amended its domestic unsecured working capital credit facility with Fleet Bank. The
terms of the facility, which expires on April 30, 2004, are substantially the same as that
of the expired facility, except that at the request of the Company the maximum borrowings
under the facility were reduced from $30.0 million to $15.0 million. Loans against the
facility bear interest at the prime rate or LIBOR plus 1.25%, at the discretion of the
Company. The facility includes certain financial covenants relating to liquidity
levels, capital expenditures and consolidated tangible net worth.

The following discussion of the
financial condition and results of operations of the Company should be read in conjunction
with the consolidated financial statements and the related notes thereto included
elsewhere in this Form 10-Q and the audited consolidated financial statements and notes
thereto and Managements Discussion and Analysis of Financial Condition and Results
of Operations included in our Annual Report on Form 10-K for the year ended December 31,
2002, which has been filed with the Securities and Exchange Commission. The Company
continues to have the same critical accounting policies and estimates as described in the
Annual Report on Form 10-K for the year ended December 31, 2002. The following discussion
and analysis describes material changes in the Companys financial condition since









December 31, 2002. The analysis of results of operations compares the three month period
ended March 31, 2003 with the comparable period of the prior fiscal year.

# Overview

The Company is a leading water
purification company engaged worldwide in the supply of water and related activities and
the supply of water treatment equipment through the use of proprietary separations
technologies and systems. The Companys products and services are used by the Company
or its customers to desalt brackish water and seawater, recycle and reclaim process water
and wastewater, to treat water in the home, to manufacture and supply water treatment
chemicals and ultrapure water, to process food products, and to measure levels of
waterborne contaminants and pollutants. The Companys customers include industrial
companies, consumers, municipalities and other governmental entities and utilities. The
following discussion and analysis of financial condition and results of operations refers
to the activities of the Companys four business groups, which comprise the
Companys reportable operating segments. These groups are the Equipment Business
Group (EBG), Ultrapure Water Group (UWG), Consumer Water Group (CWG) and Instrument
Business Group (IBG). Within the existing business group structure, the Company has
instituted a matrix-type organization which became effective at the beginning of 2002.
Within each business group, the Company has begun to focus on centers of
excellence, which represent the application of treatment or separation technologies
contained in The Ionics Toolbox® to solve certain application problems. The Company
utilizes its water treatment and liquids separation expertise by employing its own
proprietary products and other commodity products in the best integrated combination to
solve customers application problems. These centers of excellence include
desalination, reuse, surface water, microelectronics, pharmaceuticals and instruments,
among others, and each represents a range of technology solutions to solve a related
applications problem.

The EBG segment provides products and
services for seawater and brackish water desalination, water reuse and recycle, surface
water treatment, and zero liquid discharge. Significant factors influencing the
desalination market include worldwide water shortages, the need for better quality water
in many parts of the world, and the reduced cost of operating modern desalination
facilities. These factors have driven a trend toward larger plants, and toward the
purchase of water supply and operating and maintenance contracts. Trends impacting the
water reuse and recycle market are similar, with membrane technology becoming proven in
reuse and recycling applications. The surface water market has been influenced primarily
by regulatory pressures to reduce contaminants in water supplies. The use of membrane
technology is also becoming more accepted in surface water applications. The zero liquid
discharge market, which consists of equipment and services for the minimization of liquid
waste through such techniques as evaporation, concentration and crystallization, has been
influenced by regulatory pressures on utilities to eliminate discharge of process water.
The Company believes that it is positioned to be able to compete successfully in these
applications, although it frequently faces substantially larger competitors.

The UWG segment provides equipment
and services for the microelectronics, power, pharmaceutical, and other industries, where
high quality ultrapure (i.e. very highly purified) water is required for use in production
processes, and is critical to ultimate product quality and yield. The UWG segment has
historically been heavily reliant upon the microelectronics industry, and the continued
softness in that industry has adversely impacted both revenue and profitability. The UWG
segment has been pursuing applications in other markets, such as power, pharmaceuticals
and flat panel display, to lessen its reliance upon the microelectronics market. The UWG
segment has recently begun to engage in water reuse projects for industrial applications.

The CWG segment provides home water
units for the treatment of residential water. Prior to the divestiture of the Aqua Cool
Pure Bottled Water business in the U.S., U.K. and France on December 31, 2001, it was also
engaged in the home and office delivery market for bottled water. The CWG segment also
produces bleach-based cleaning products and automobile windshield wash solution. Trends in
the consumer water market include increased consumer awareness of and the need for
improved water quality, and reduced confidence in the quality of existing water supplies.

The IBG segment manufactures and
sells instruments and related products for the measurement of impurities in water. The
segment serves the pharmaceutical, microelectronics and power markets where the
measurement of water quality, including levels and types of contaminants in process water,
is critical to production processes. The IBG segment has established a strong position in
the pharmaceutical industry, providing products and services that facilitate compliance
with both domestic and foreign regulatory requirements. Like the UWG segment, the
performance of the IBG segment has been impacted by the downturn in the microelectronics
industry, although to a lesser extent than the UWG segment.

---

The EBG and UWG segments have
historically supplied equipment and related membranes. Starting in the mid-1980s,
these groups also began to own and operate facilities that sell desalted or otherwise
treated water directly to customers under water supply agreements. The revenues and cost
of sales associated with equipment sales are recorded in the revenue and cost of sales
lines on the Companys Consolidated Statement of Operations in the periods in which
the revenues are realized. Equipment contracts are generally accounted for under the
percentage completion accounting method, and the period of time over which costs are
incurred and revenues are realized may vary between six months and two years, depending on
the nature and amount of equipment being supplied. For water supply agreements, with
respect to smaller projects, of which the Company is the sole owner, the initial cost of
the equipment becomes part of the Companys depreciable fixed asset base, and the
revenues and cost of sales recorded by the Company are those that are associated with the
supply of water under the water supply agreement. These contracts typically vary in length
between 5 and 15 years.

In the EBG segment, which more
recently has begun to pursue large-scale, long-term water treatment projects, the Company
has been utilizing a business model for participating in such projects typically through
joint venture project companies in which the Company will hold a minority ownership
interest. Such project companies are formed to own and operate larger scale desalination,
reuse, or other projects in which the Company may participate in several ways, including:
having an ownership interest (typically a minority interest) in the project company;
selling the desalination, reuse, or other treatment system to the project company; and
providing operating and maintenance services to the project company once the project
facility commences operations. These projects often exceed $100 million in total cost and
may involve multiple equity participants in the project company. The Companys
participation in major projects through a minority interest in a project company structure
mitigates the risks of engaging in such activities, and also provides the Company with
potential long-term equity income from such investments, because these project companies
typically enter into long-term concession agreements with the customer entity.

# Restatement of Quarterly
Financial Statements

The Companys consolidated
financial statements for the three months ended March 31, 2002 have been restated
primarily as a result of intercompany transactions, including transactions between the
Company and its French subsidiary that were erroneously recorded at the subsidiary level.
See Note 2 to Notes to Consolidated Financial Statements.

# Results of Operations

Comparison of the Three
Months Ended March 31, 2003 with the Three Months Ended March 31, 2002

The Company reported consolidated
revenues of $88.2 million and net income of $0.6 million for the first quarter of 2003,
compared to consolidated revenues of $80.0 million and net income of $1.5 million for the
first quarter of 2002. Results for the first quarter of 2002 included the results of the
Companys majority-owned Malaysian subsidiary, Ionics Enersave
(Enersave), which was divested in May 2002.

Revenues

Total Company revenues of $88.2
million for the first quarter of 2003 increased $8.2 million or 10.2% from revenues of
$80.0 million for the first quarter of 2002. Revenues during the first quarter of 2002
included $2.6 million of revenues from the Companys majority-owned Malaysian
subsidiary, Enersave, which was divested in May 2002.

EBG revenues of $32.7 million in the
first quarter of 2003 decreased $2.4 million, or 6.7%, compared to revenues of $35.0
million in the first quarter of 2002. The decrease in revenues was primarily attributable
to reduced revenues from the Zero Liquid Discharge (ZLD) business, partially
as a result of the Companys business strategy to not pursue the civil construction
scope on ZLD projects. This decrease was partially offset by new sales of capital
equipment to several domestic municipalities for surface water applications.

UWG revenues of $25.2 million for the
first quarter of 2003 increased $0.5 million, or 2.0%, compared to revenues of $24.7
million for the first quarter of 2002. Included in UWGs revenues for the first
quarter of 2002 were $2.6 million in revenue associated with Enersave, which was divested
in May 2002. The increase in revenues related primarily to the continued growth in
UWGs operations in Asia and Australia.

---

CWG revenues of $10.8 million for the
first quarter of 2003 increased $0.3 million, or 2.5%, compared to revenues of $10.6
million for the first quarter of 2002. Revenue associated with CWGs automobile
windshield wash solution increased as a result of a severe winter in the Northeast, and
consumer chemical product revenues also increased due to the addition of several new
customers. The increase in sales of consumer chemical products offset lower demand for home
water treatment equipment as a result of the general downturn in the domestic economy.

IBG revenues of $7.7 million in the
first quarter of 2003 increased $1.1 million, or 17.4%, compared to revenues of $6.5
million in the first quarter of 2002. The increase in revenues primarily resulted from
increased sales volume to the pharmaceutical industry driven by regulatory requirements in
that industry, as well as continued growth in sales of the Companys after-market
products.

Revenues from sales to affiliated
companies of $11.8 million in the first quarter of 2003 increased $8.7 million compared to
revenues from sales to affiliated companies of $3.1 million in the first quarter of 2002.
The increase in revenues from affiliated companies primarily resulted from the sale of
capital equipment to the Companys Kuwait joint venture company, Utility Development
Company WLL (UDC), for the Kuwait wastewater treatment project.

The Company has entered into a number
of large contracts, which are generally categorized as either equipment sale
contracts or build, own and operate (BOO) contracts. The Company believes that
the remaining duration on its existing sale of equipment contracts ranges from less than
one year to three years and the remaining duration on its existing BOO contracts ranges
from one year to 25 years. The time to completion of any of these contracts, however, is
subject to a number of variables, including the nature and provisions of the contract and
the industry being served. Historically, as contracts are completed, the Company has
entered into new contracts with the same or other customers. In the past, the completion
of any one particular contract has not had a material effect on the Companys
business, results of operations or cash flows.

Cost of Sales

The Companys total cost of
sales as a percentage of revenue was 71.5% in both the first quarter of 2003 and the first
quarter of 2002, and the resulting gross margin was 28.5% in both periods. Cost of sales
as a percentage of revenue decreased in the first quarter of 2003 compared to the first
quarter of 2002 for EBG, UWG, and IBG segments and increased in the CWG segment.

EBGs cost of sales as a
percentage of revenue decreased to 71.8% in the first quarter of 2003 from 73.0% in the
first quarter of 2002. The decrease in cost of sales as a percentage of revenue in the
first quarter of 2003 compared to the comparable period of 2002 related to the elimination
of losses incurred at the Companys French subsidiary, as well as improved
performance by domestic operations due to increased volume levels associated with the
several domestic surface water projects.

UWGs cost of sales as a
percentage of revenue decreased to 74.4% in the first quarter of 2003 from 76.8% in the
first quarter of 2002. The decrease in cost of sales as a percentage of revenue partially
reflects the change in product mix to higher margin industrial chemical supply and the
elimination of costs associated with Enersave, the Companys Malaysian subsidiary,
which was divested in May 2002.

CWGs cost of sales as a
percentage of revenue increased to 69.5% in the first quarter of 2003 from 64.7% in the
first quarter of 2002. The increase in the first quarter of 2003 cost of sales as a
percentage of revenue compared to the comparable percentage for the first quarter of 2002
was primarily attributable to lower margin levels in consumer chemical product lines. The
Elite Consumer products line continues to face pricing pressure due to increased
competition in the local domestic markets.

IBGs cost of sales as a
percentage of revenue decreased to 40.5% in the first quarter of 2003 from 42.1% in the
first quarter of 2002, primarily as a result of a shift in product mix to higher margin
pharmaceutical industry software revenue and improved operating efficiencies in the
after-market business.

Cost of sales to affiliated companies
as a percentage of revenue decreased to 86.8% in the first quarter of 2003 from 97.5% in
the first quarter of 2002. The decrease in 2003 was primarily due to lower revenues from
sales to Desalination Company of Trinidad and Tobago Limited (Desalcott). For
accounting purposes, all intercompany profit on sales to Desalcott has been deferred. The
decrease in the percentage was also due to the increase in equipment sales to UDC, in
connection with which the Company defers intercompany profit equal to its 25% equity
ownership in UDC.

---

Operating Expenses

Research and development expenses of
$1.8 million increased by $0.2 million during the first quarter of 2003 compared to the
first quarter of 2002. The Company currently expects to continue to invest in new products
and technologies at approximately the same level as in prior quarters.

Selling, general and administrative
expenses increased $2.7 million to $22.5 million in the first quarter of 2003 from $19.9
million in the first quarter of 2002. The increase in selling, general and administrative
expenses in the first quarter of 2003 compared to the first quarter of 2002 is primarily
attributable to post-retirement obligations of approximately $0.9 million incurred in
connection with the announced retirement of the Companys Chief Executive Officer,
increased pension costs due to amendments to the Companys retirement plans and
changes in plan assumptions, as well as increased professional services fees.

Interest Income and
Interest Expense

Interest income totaled $0.8 million
in the first quarter of 2003 compared to $1.0 million in 2002. Interest expense was $0.2
million in the first quarter of 2003 and $0.6 million in the first quarter of 2002.

Equity (Loss) Income

The Companys proportionate
share of the earnings and losses of affiliated companies in which it holds a minority
equity interest is included in equity income.

The Companys equity income is
derived primarily from its 20% equity interest in a Mexican joint venture company which
owns two water treatment plants in Mexico, its 40% equity interest in Desalcott, its 43%
equity interest in Toray Membrane America Inc., (TMA), which manufactures and
distributes certain types of membranes, its equity interests in several joint ventures in
the Middle East which engage in bottled water distribution, and to a lesser extent from
its other equity investments in affiliated companies. Equity losses in affiliated
companies amounted to $0.1 million in the first quarter of 2003 compared to equity income
in the first quarter of 2002 of $0.9 million. The decrease in equity income of $1.0
million in the first quarter of 2003 compared to the first quarter of 2002 reflected
increased losses recorded in the first quarter of 2003 relating to the Companys
investment in Desalcott as a result of higher interest charges and lower production
volumes, lower earnings of the Mexican joint venture company as compared to a higher than
the usual level of earnings in the first quarter of 2002, and losses incurred by TMA due
to lower membrane sales volume.

Income Taxes

The Companys effective tax rate
for the first quarter of 2003 was 38.0% compared to 33.2% in the first quarter of 2002.
The Companys 2003 and 2002 tax rates were primarily affected by the geographic mix
of income earned in various jurisdictions throughout the world.

Net Income

Net income amounted to $0.6 million
in the first quarter of 2003 compared to $1.5 million for the first quarter of 2002.

# Financial Condition

Net working capital increased $1.4
million during the first quarter of 2003 to $216.0 million and the Companys current
ratio increased to 3.0 during the first quarter of 2003 from 2.9 at the end of 2002.

At March 31, 2003, the Company had
total assets of $605.4 million, compared to total assets of $608.0 million at December 31,
2002. Cash, cash equivalents and restricted cash decreased $4.8 million during the first
quarter of 2003, primarily reflecting payments of current accounts payable. At December
31, 2002, the Company had $4.3 million in restricted cash reflecting advance payments for
work to be performed on the Kuwait wastewater treatment facility, the restrictions on
which expired in the first quarter of 2003.

Net cash provided by operating
activities amounted to $0.5 million during the first quarter of 2003 primarily reflected
cash used for payments of accounts payable and accrued expenses offset by depreciation
charges. Net cash used in investing activities amounted to $5.5 million in the first
quarter of 2003, reflected additions to property, plant and equipment, primarily related
to investments made in the UWG segment for a build, own and operate facility in the power
industry. Net cash provided by financing activities totaled $3.9 million during the first
quarter of 2003, primarily reflected the expiration of the restriction on the use of cash
which existed at December 31, 2002.

---

From time to time, the Company enters
into joint ventures with respect to specific projects, including the projects in Trinidad,
Kuwait and Israel described below. Each joint venture arrangement is independently
negotiated based on the specific facts and circumstances of the project, the purpose of
the joint venture company related to the project, as well as the rights and obligations of
the other joint venture partners. Generally, the Company has structured its project joint
ventures so that the Companys obligation to provide funding to the underlying
project or to the joint venture entity is limited to its proportional capital
contribution, which can take the form of equity or subordinated debt. Except in situations
that are negotiated with a specific joint venture entity as discussed below, the Company
has no other commitment to provide for the joint ventures working capital or other
cash needs. In addition, the joint venture entity typically obtains third-party debt
financing for a substantial portion of the projects total capital requirements. In
these situations, the Company is typically not responsible for the repayment of the
indebtedness incurred by the joint venture entity. In connection with certain joint
venture projects, the Company may also enter into contracts for the supply and
installation of the Companys equipment during the construction of the project, for
the operation and maintenance of the facility once it begins operation, or both. These
commercial arrangements do not require the Company to commit to any funding for working
capital or any other requirements of the joint venture company. As a result, the
Companys exposure with respect to its joint ventures is typically limited to its
debt and equity investments in the joint venture entity, the fulfillment of any
contractual obligations it has to the joint venture entity and the accounts receivable
owing to the Company from the joint venture entity.

In the second quarter of 2002,
construction was completed on the first four (out of five) phases of the Trinidad
desalination facility owned by Desalination Company of Trinidad and Tobago Ltd.
(Desalcott), in which the Company has a 40% equity interest, and the facility
commenced water deliveries to its customer, the Water and Sewerage Authority of Trinidad
and Tobago. In 2000, the Company acquired 200 ordinary shares of Desalcott for $10 million
and loaned $10 million to Hafeez Karamath Engineering Services Ltd. (HKES),
the founder of Desalcott and promoter of the Trinidad desalination project, to enable HKES
to acquire an additional 200 ordinary shares of Desalcott. Prior to those investments,
HKES owned 100 ordinary shares of Desalcott. As a result, the Company currently owns a 40%
equity interest in Desalcott, and HKES currently owns a 60% equity interest in Desalcott.

The Companys $10 million loan
to HKES is included in notes receivable, long-term on the Companys Consolidated
Balance Sheets. The loan bears interest at a rate equal to 2% above the London Interbank
Offered Rate (LIBOR), with interest payable starting October 25, 2002 and every six months
thereafter and at maturity. Prior to maturity, however, accrued interest payments (as well
as principal payments) are payable only to the extent dividends or other distributions are
paid by Desalcott on the ordinary shares of Desalcott owned by HKES and pledged to the
Company. Principal repayment is due in 14 equal installments commencing on April 25, 2004
and continuing semiannually thereafter. The loan matures and is payable in full on April
25, 2011. The loan is secured by a security interest in the shares of Desalcott owned by
HKES and purchased with the borrowed funds, which is subordinate to the security interest
in those shares in favor of the Trinidad bank that provided the construction financing for
Desalcott. In addition, any dividends or other distributions paid by Desalcott to HKES
must be applied to loan payments to the Company.

In 2000, Desalcott entered into a
bridge loan agreement with a Trinidad bank providing $60 million in
construction financing. Effective November 8, 2001, the loan agreement was amended to
increase maximum borrowings to $79.9 million. The Company is obligated to lend up to $10
million to Desalcott as an additional source of funds for project completion costs once
all bridge loan proceeds have been expended. However, the bridge loan of $79.9 million and
the $20 million equity provided to Desalcott (together with the additional $10 million
dollars the Company is obligated to lend to Desalcott) have not provided sufficient funds
to pay all of Desalcotts obligations in completing construction and commissioning of
the project prior to receipt of long-term financing. Included in Desalcotts
obligations is approximately $30.1 million payable to the Companys Trinidad
subsidiary for equipment and services purchased in connection with the construction of the
facility. The Company currently intends to convert $10 million of this amount into a loan
to Desalcott to satisfy the Companys loan commitment described above. The terms of
this loan are currently being negotiated with Desalcott. Although the Company currently
anticipates that Desalcott will pay its remaining outstanding obligations to the
Companys subsidiary partially out of cash flow from the sale of water and from the
proceeds from new long-term debt financing, Desalcott has disputed certain amounts payable
under the construction contract, and this matter is now subject to the dispute resolution
procedures of the contract. The Company does not believe resolution of these matters will
have a material impact on its results of operations or cash flows. Desalcott has received
proposals for new long-term debt financing, including a term sheet and a draft term loan
agreement from the Trinidad bank which provided the bridge loan and is currently
negotiating the terms of the financing. Such new long-term debt financing may not be
completed on terms acceptable to Desalcott, or at all. Moreover, although the Trinidad









bank that made the bridge loan to Desalcott has not required repayment of the bridge loan,
which matured on September 1, 2002, pending completion of the long-term debt financing,
there can be no assurance that the bank will not exercise its rights and foreclose on its
collateral, in which event the Companys equity investment in, and receivable from,
Desalcott as well as the loan receivables from HKES would all be at risk.

During 2001, the Company acquired a
25% equity interest in a Kuwaiti project company, Utilities Development Company W.L.L.
(UDC), which was awarded a concession agreement by an agency of the Kuwaiti
government for the construction, ownership and operation of a wastewater reuse facility in
Kuwait. During the second quarter of 2002 UDC entered into agreements for the long-term
financing of the project. At March 31, 2003, the Company had invested a total of $4.6
million in UDC as equity contributions and subordinated debt. The Company is committed to
make additional contributions of equity or subordinated debt to UDC of approximately $14.0
million over the next two years.

In 2001, the Company entered into
agreements with an Israeli cooperative society and an Israeli corporation for the
establishment of Magan Desalination Ltd. (MDL) as an Israeli project company
in which the Company has a 49% equity interest. In August 2002, MDL entered into a
concession contract with a state-sponsored water company for the construction, ownership
and operation of a brackish water desalination facility in Israel. At March 31, 2003, the
Company had not yet made an equity investment in MDL, and had deferred costs of
approximately $0.6 million relating to the design and development work on the project. The
Company currently anticipates that it will invest approximately a total of $1.2 million in
MDL for its 49% equity interest. MDL is currently seeking approximately $7.2 million of
debt financing for the project and is in the process of negotiating a loan agreement with
an Israeli bank. If MDL is unable to obtain such debt financing, the Company would expense
all its deferred costs relating to the project and any investment the Company may have
made in MDL, but would incur no other liability, inasmuch as no performance bond has been
issued for the project.

In January 2002, the Company entered
into agreements with two Israeli corporations giving the Company the right to a one-third
ownership interest in an Israeli project company, Carmel Desalination Ltd.
(CDL). On October 28, 2002, CDL was awarded a concession agreement by the
Israeli Water Desalination Agency (established by the Ministry of Finance and the Ministry
of Infrastructure) for the construction, ownership and operation of a major seawater
desalination facility in Israel. At March 31, 2003, the Company made an equity investment
of $0.2 million in CDL, and had deferred costs of approximately $0.6 million relating to
the engineering design and development work on the project. If CDL obtains long-term
project financing, the Companys total equity investment to be made in CDL would be
approximately $8.0 million. The timing of such investment will depend upon the terms of
the long-term financing agreement. The terms of the concession agreement originally
required that long-term financing be obtained by April 2003. CDL has been granted an
extension to June 15, 2003 and has requested a further extension to obtain such financing.
Although the Company currently anticipates that CDL will obtain long-term financing for
the project, if CDL is unable to obtain such financing, the Company would expense all its
deferred costs relating to the project and any investment the Company may have made in CDL
(estimated to be approximately $0.8 million by the time of the closing of the long-term
financing). Additionally, the Company could incur its one-third proportionate share ($2.5
million) of liability under a $7.5 million performance bond issued on behalf of CDL.

On December 31, 2001, the Company
completed the sale of its Aqua Cool Business in the United States, United Kingdom and
France to affiliates of Perrier-Vittel S.A., a subsidiary of Nestle S.A. (Nestle). As a
result of final purchase price adjustments based on the number of customers and working
capital levels, and the resolution of certain claims made by Nestle, the Company and
Nestle reached final agreement on a purchase price of approximately $207.0 million in the
first quarter of 2003. As a result of such adjustments, the Company realized an additional
net pre-tax gain of $8.2 million in 2002. The 2002 pre-tax gain is net of direct and
incremental costs of the transaction including approximately $3.4 million of non-recurring
management and employee compensation. In connection with the final resolution, the $10
million held in escrow pursuant to the divestiture agreement and approximately $2.9
million in cash from the Company were transferred to Nestle on March 31, 2003.

In April 2003, the Company reinstated
and amended its domestic unsecured working capital credit facility with Fleet Bank. The
terms of the facility, which expires on April 30, 2004, are substantially the same as that
of the expired facility, except that at the request of the Company the maximum borrowings
under the facility were reduced from $30.0 million to $15.0 million. Loans against the
facility bear interest at the prime rate or LIBOR plus 1.25%, at the discretion of the
Company. The facility includes certain financial covenants relating to liquidity
levels, capital expenditures and consolidated tangible net worth. The Company also
maintains several foreign lines of credit. The Company may borrow a total of $22.4 million









under its domestic and international unsecured credit facilities. At March 31, 2003, the
Companys total borrowings under all its existing credit facilities was $2.9 million.

In addition, the Company maintains a
$25.0 million credit line with another bank under which letters of credit are issued from
time to time under commercial transactions for the benefit of customers and other parties
with whom the Company does business. In the normal course of business, the Company issues
letters of credit to customers, vendors and lending institutions as guarantees for
payment, performance or both under various commercial contracts into which it enters. Bid
bonds are also sometimes obtained by the Company as security for the Companys
commitment to proceed with a project if it is the successful bidder. Performance bonds are
typically issued for the benefit of the Companys customers as financial security for
the completion or performance by the Company of its contractual obligations under certain
commercial contracts. In the past, the Company has not incurred significant liabilities or
expenses as a result of the use of these instruments. Approximately $123.7 million of
these instruments were outstanding at March 31, 2003. Based on the Companys
experience with respect to letters of credit, bid bonds and performance bonds, the Company
believes the estimated fair value of the instruments entered into during the first quarter
of 2003 is not material. Accordingly, the Company has not recorded any liabilities for
these instruments as of March 31, 2003.

The Company believes that its future
capital requirements will depend on a number of factors, including the amount of cash
generated from operations and its capital commitments to new own and operate
projects, either directly or through joint ventures, that the Company may be successful in
obtaining. The Company believes that its existing cash and cash equivalents, cash
generated from operations, lines of credit and foreign exchange facilities will be
sufficient to fund its capital expenditures, working capital requirements and contractual
obligations and commitments beyond the next twelve months, based on its current business
plans and projections.

# Recent Accounting
Pronouncements

In June 2001, the FASB issued
Statement of Financial Accounting Standard (SFAS) No. 143, Accounting for
Obligations Associated with the Retirement of Long-Lived Assets. SFAS No. 143
provides the accounting requirements for retirement obligations associated with tangible
long-lived assets. SFAS No. 143 is effective for financial statements for fiscal years
beginning after June 15, 2002. The adoption of SFAS No. 143 did not have a material impact
on the Companys financial position or results of operations.

In December 2002, the FASB issued
SFAS No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure which amended SFAS No. 123, Accounting for Stock-Based
Compensation. SFAS No. 148 provides alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
compensation. It also amends the disclosure provisions to require prominent disclosure
about the effects on reported net income of an entitys accounting policy decisions
with respect to stock-based employee compensation. The provisions of SFAS No. 148 are to
be applied to financial statements for fiscal years ending after December 15, 2002. The
adoption of SFAS No. 148 did not have an impact on the Companys financial position
or results of operations.

In January 2003, the FASB issued
Interpretation No. 46, "Consolidation of Variable Interest Entities, an interpretation of
ARB No. 51" (FIN 46). This interpretation addresses the consolidation of certain variable
interest entities (VIEs) for which a controlling financial interest exists. FIN 46 applies
immediately to financial interests obtained in VIEs after January 31, 2003. It applies in
the first fiscal year or interim period beginning after June 15, 2003, to VIEs in which a
financial interest was obtained before February 1, 2003. FIN 46 may be applied
prospectively with a cumulative-effect adjustment or by restating previously issued
financial statements with a cumulative-effect adjustment as of the beginning of the first
year restated. The Company has a financial interest in certain entities that may be
considered VIEs under FIN 46. The Company is currently evaluating the impact of FIN 46 on
its Investments in Affiliated Companies and if the Company determines that it has a
controlling financial interest in any of these entities, consolidation may be required.
The ultimate effect of adopting FIN 46 on the Companys financial position or results
of operations has not yet been determined.

In April 2003, the FASB issued SFAS
No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging
Activities. SFAS No. 149 amends and clarifies the accounting guidance on (1)
derivative instruments, including certain derivative instruments embedded in other
contracts, and (2) hedging activities that fall within the scope of FASB Statement No.
133, Accounting for Derivative Instruments and Hedging Activities. SFAS No.
149 amends SFAS No. 133 and certain other existing pronouncements to provide for more









consistent reporting of contracts that are derivatives in their entirety or that contain
embedded derivatives that warrant separate accounting. SFAS No. 149 is effective (1) for
contracts entered into or modified after June 30, 2003, with certain exceptions, and (2)
for hedging relationships designated after June 30, 2003. The guidance is to be applied
prospectively. The ultimate effect of adopting SFAS No. 149 on the Companys
financial position or results of operations has not yet been determined.

# Forward-Looking
Information

Safe Harbor Statement
under Private Securities Litigation Reform Act of 1995

Certain statements contained in this
report, including, without limitation, statements regarding expectations as to the
Companys future results of operations, statements in the Notes to the
Consolidated Financial Statements and Managements Discussion and
Analysis of Financial Condition and Results of Operations constitute forward-looking
statements. Such statements are based on managements current views and assumptions
and are neither promises or guarantees but involve risks, uncertainties and other factors
that could cause actual results to differ materially from managements current
expectations as described in such forward-looking statements. Among these factors are the
matters described under Risks and Uncertainties contained in the
Managements Discussion and Analysis of Financial Condition and Results of
Operations section of the Companys Annual Report on Form 10-K for the year
ended December 31, 2002, as well as overall economic and business conditions; competitive
factors, such as acceptance of new products and pricing pressures and competition from
companies larger than the Company; risk of nonpayment of accounts receivable, including
those from affiliated companies; risks associated with foreign operations; risks
associated with joint venture entities, including their respective abilities to arrange
for necessary long-term project financing; risks involved in litigation; regulations and
laws affecting business in each of the Companys markets; market risk factors, as
described below under Quantitative And Qualitative Disclosures About Market
Risk; fluctuations in the Companys quarterly results; and other risks and
uncertainties described from time to time in the Companys filings with the
Securities and Exchange Commission. Readers should not place undue reliance on any such
forward looking statements, which speak only as of the date they are made, and the Company
disclaims any obligation to update, supplement or modify such statements in the event the
facts, circumstances or assumptions underlying the statements change, or otherwise.

# Item 3. Quantitative and
Qualitative Disclosures About Market Risk

Derivative Instruments

In certain instances, the Company
enters into foreign exchange contracts including forwards, options and swaps. The
Companys policy is to enter into such contracts only for the purpose of managing
exposures and not for speculative purposes. The Company holds a series of U.S. dollar/euro
forward contracts that were executed to offset the foreign exchange risk associated with
forecasted revenues related to an ongoing project. As of March 31, 2003, the notional
amount of the contracts was $11.3 million. The fair value of the forward contracts, which
was $0.4 million at March 31, 2003, is recorded in the Other current assets section of the
Consolidated Balance Sheets. End of period changes in the market value of the contracts
are recorded as a component of other comprehensive income in the stockholders equity
section of the Consolidated Balance Sheets. Currently, the Company also maintains foreign
exchange forward contracts to hedge the balance sheet exposure related to an intercompany
loan. At March 31, 2003, the fair value of the forward contracts, which was immaterial, was
recorded in the Other current assets section of the Consolidated Balance Sheets. The end
of period change in the fair market value of the contracts, which was immaterial, was
recorded in selling, general and administrative expenses. At March 31, 2003, a
hypothetical change of 10% in exchange rates would change the fair value of the
Companys portfolio of foreign exchange contracts by approximately $1.0 million.

Market Risk

The Companys primary market
risk exposures are in the areas of interest rate risk and foreign currency exchange rate
risk. The Companys investment portfolio of cash equivalents is subject to interest
rate risk fluctuations, but the Company believes the risk is not material due to the
short-term nature of these investments. At March 31, 2003, the Company had $3.9 million of
short-term debt and $9.9 million of long-term debt outstanding. The major portion of this
debt has fixed interest rates and is not subject to risk arising from interest rate
variability. A hypothetical increase of 10% in interest rates for a one year period would
result in additional interest expense that would not be material in the aggregate. The
Companys net foreign exchange currency gain was $0.3 million and $1.9 million for
the three months ended March 31, 2003 and 2002, respectively. The Companys exposure
to foreign currency exchange rate fluctuations is mitigated by the fact that the
operations of its international subsidiaries are primarily conducted in their respective
local currencies. Also, in certain situations, the Company enters into foreign exchange
contracts to mitigate the impact of foreign exchange fluctuations.

---

# Item 4. Controls and
Procedures

As part of the Companys
continuing efforts to ensure that information required to be disclosed by the Company in
its Securities and Exchange Commission filings is appropriately accumulated and
disseminated to allow timely decisions regarding required disclosure, the Company has been
taking various actions to strengthen its system of internal controls and disclosure
controls and procedures. Such actions were also taken to enhance the processes by which
the Company manages its various divisions and subsidiaries, because managing a large
number of relatively small, locally managed businesses around the world presents
significant challenges.

Prior to the evaluation of the
Companys disclosure controls and procedures made in connection with the filing of
its Annual Report on Form 10-K for the year ended December 31, 2002, the Company made
changes in its internal controls and took other actions designed to enhance the
Companys internal controls, which consisted of the following:

| | o |  | the
hiring of new personnel including, two new segment controllers in April and July of 2002,
three new divisional controllers in May and September of 2002, a corporate director of
accounting in July 2002, and a new consolidation accountant in September 2002, to enhance
the quality of its accounting capabilities;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
replacement of the senior operating executive at the Companys French subsidiary and
the reassignment of much of the operational responsibility for that subsidiary to the
Companys Italian subsidiary;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
implementation of a new financial consolidation software package (which became
operational in September 2002);
| | - |  | ------------------------------------------------------------------------------------------------------------------

| | o |  | the
implementation of a centralized bid and proposal review and approval process at the
beginning of 2002;
| | - |  | ----------------------------------------------------------------------------------------------------------

| | o |  | the
expansion of the internal audit function through the use of outside resources beginning
in March 2002;
| | - |  | ----------------------------------------------------------------------------------------------------------

| | o |  | the
formalization of certain accounting and information technology policies and procedures at
various times throughout the year;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
hiring of a Director of Project Management in October 2002 to oversee project-related
procedures and to train project managers at locations to enable them to better comply
with Company goals, policies and procedures;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
institution of procedures requiring written quarterly certifications and representations
from the head of each business group and the local controller of each business location;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
formation of a disclosure committee to oversee the effectiveness of the Companys
disclosure controls and procedures;
| | - |  | -------------------------------------------------------------------------------------------------------------------------

| | o |  | in
furtherance of the centralized bid and proposal review and approval process, the
establishment of formal, systematic procedures for reviewing all major commercial
projects being undertaken by the Company, including monthly participation by senior
management;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
finalization of a project database to facilitate the tracking and analysis of project
performance throughout the Company in December 2002;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
hiring of a senior financial manager into a newly created position as European Controller
in December 2002, who is responsible for providing financial oversight and control for
the Equipment Business Groups European operations; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | the
conduct of a conference, and other educational activities, for the Companys segment
and divisional controllers and corporate accounting staff, which included programs
regarding, among other topics, inter-company transactions, key policies under U.S.
generally accepted accounting principles (e.g., SAB 101, SOP 81-1), the Sarbanes-Oxley
Act of 2002, internal controls, U.S. regulation of international transactions, and key
responsibilities of the local controllers.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

In connection with the audit of its
financial statements for 2002, the Company was advised by its independent auditor that
certain of its internal controls had deficiencies and material control weaknesses.
Consequently, and with the goal of further improving the quality and timeliness of the
information available to management, the Company is continuing to implement measures
designed to address those deficiencies and weaknesses as follows:

| | o |  | to
evaluate and strengthen its financial and accounting staff and their knowledge and
understanding of key policies under      U.S. generally accepted accounting principles
and of their responsibilities;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | to
improve monitoring controls to assure the prevention or detection of material accounting
errors on a timely basis;
| | - |  | ---------------------------------------------------------------------------------------------------------------------

---

| | o |  | to
reduce the time necessary to collect and report financial and operating data by improving
the timing and accuracy of forecasting and emphasizing more frequent reviews of the
Companys balance sheets and reconciliation of intercompany balances; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | o |  | to
continue to update its accounting policies and procedures.
| | - |  | -------------------------------------------------------------

In May 2003, the Company carried out
an evaluation, under the supervision and with the participation of the Companys
management, including the Companys Chief Executive Officer and Chief Financial
Officer, of the effectiveness of the Companys disclosure controls and
procedures. The SEC defines disclosure controls and procedures as a
companys controls and other procedures that are designed to ensure that information
required to be disclosed by the company in the reports it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within
the time periods specified in the SECs rules and forms. Based on their evaluation of
the Companys disclosure controls and procedures, the Companys Chief Executive
Officer (principal executive officer) and Chief Financial Officer (principal financial
officer) concluded that the Companys disclosure controls and procedures were
substantially effective for these purposes as of the date of the evaluation.

Other than the on-going measures
described above, there have been no significant changes in the Companys internal
controls or in other factors that could significantly affect the Companys internal
controls subsequent to the date of the most recent evaluation of such controls.

---

# PART II  OTHER
INFORMATION

# Item 1. Legal Proceedings

The Company and its Chief Executive
Officer and Chief Financial Officer have been named as defendants in a class action
lawsuit captioned Jerome Deckler v. Ionics, Inc., et al., filed in the U.S.
District Court, District of Massachusetts in March 2003. Plaintiff alleges violations of
the federal securities laws relating to the restatement of the Companys financial
statements for the first and second quarters of 2002 announced in November 2002. The
Company believes the allegations in the lawsuit are without merit and intends vigorously
to defend the litigation. While the Company believes that the litigation will have no
material adverse impact on its financial condition, results of operations or cash flows,
the litigation process is inherently uncertain and the Company can make no assurances as
to the ultimate outcome of this matter.

# Item 6. Exhibits and
Reports on Form 8-K

a)    
          Exhibits

Exhibit
No.           Description

|10.1 |  | Ionics,
Incorporated 1997 Stock Incentive Plan, as amended through
                                    March 27, 2003.
|---- |  | ----------------------------------------------------------------------------------------------------------------------

|10.2 |  | Ionics,
Incorporated 1979 Stock Option Plan, as amended through
                                    March 27, 2003.
|---- |  | -------------------------------------------------------------------------------------------------------------------

|10.3 |  | First
Amendment to Ionics, Incorporated Supplemental Executive
                                    Retirement Plan, effective April 1, 2003.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------------------

|10.4 |  | Third
Amendment and Waiver to Third Amended and Restated Revolving Credit Agreement between the
Company and Fleet National Bank dated as of April 14, 2003.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|10.5 |  | Ionics,
Incorporated 2003 Non-Employee Directors Stock Option Plan.
|---- |  | -------------------------------------------------------------------

|10.6 |  | Form
of Stock Option Agreement Issued Pursuant to the Ionics,Incorporated 2003 Non-Employee
Directors Stock Option Plan.
|---- |  | ------------------------------------------------------------------------------------------------------------------------

b)    
          Reports on Form 8-K

| | No
reports on Form 8-K were filed by the Company with the Securities and Exchange Commission
during the three-month period ended March 31, 2003.
| | ------------------------------------------------------------------------------------------------------------------------------------------------

---

# 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.

|May 15, 2003 |     | IONICS,
INCORPORATED                                                                                                                                                                                                                    
|------------ | --- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             | By: | /s/Arthur L. GoldsteinArthur L. Goldstein
                                                              Chairman and Chief Executive Officer
                                                              (duly authorized officer)    
|May 15, 2003 | By: | /s/Daniel M. KuzmakDaniel M. Kuzmak
                                                              Vice President and Chief Financial Officer
                                                              (principal financial officer)

---

# CERTIFICATIONS

I, Arthur L. Goldstein, certify that:

|1. |  | I have reviewed this quarterly report on Form 10-Q of Ionics, Incorporated;
|-- |  | ---------------------------------------------------------------------------

|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
               statement of a material fact or omit to state a material fact necessary to make
               the statements made, in light of the circumstances under which such statements
               were made, not misleading with respect to the period covered by this quarterly
               report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. |  | Based on my knowledge, the financial statements, and other financial information
               included in this quarterly report, fairly present in all material respects the
               financial condition, results of operations and cash flows of the registrant as
               of, and for, the periods presented in this quarterly report;
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. |  | The registrants other certifying officers and I are responsible for
               establishing and maintaining disclosure controls and procedures (as defined in
               Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|a) |  | designed such disclosure controls and procedures to ensure that material
               information relating to the registrant, including its consolidated subsidiaries,
               is made known to us by others within those entities, particularly during the
               period in which this quarterly report is being prepared;
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|b) |  | evaluated the effectiveness of the registrants disclosure controls and
               procedures as of a date within 90 days prior to the filing of this quarterly
               report (the Evaluation Date); and
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|c) |  | presented in this quarterly report our conclusions about the effectiveness of
               the disclosure controls and procedures based on our evaluation as of the
               Evaluation Date;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. |  | The registrants other certifying officers and I have disclosed, based on
               our most recent evaluation, to the registrants auditors and the audit
               committee of registrants board of directors (or persons performing the
               equivalent function):
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|a) |  | all significant deficiencies in the design or operation of internal controls
               which could adversely affect the registrants ability to record, process,
               summarize and report financial data and have identified for the
               registrants auditors any material weaknesses in internal controls; and
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|b) |  | any fraud, whether or not material, that involves management or other employees
               who have a significant role in the registrants internal controls; and
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. |  | The registrants other certifying officers and I have indicated in this
               quarterly report whether or not there were significant changes in internal
               controls or in other factors that could significantly affect internal controls
               subsequent to the date of our most recent evaluation, including any corrective
               actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: May 15,
2003

/s/Arthur L.
Goldstein

---

I, Daniel M. Kuzmak, certify that:

|1. |  | I have reviewed this quarterly report on Form 10-Q of Ionics, Incorporated;
|-- |  | ---------------------------------------------------------------------------

|2. |  | Based on my knowledge, this quarterly report does not contain any untrue
               statement of a material fact or omit to state a material fact necessary to make
               the statements made, in light of the circumstances under which such statements
               were made, not misleading with respect to the period covered by this quarterly
               report;
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. |  | Based on my knowledge, the financial statements, and other financial information
               included in this quarterly report, fairly present in all material respects the
               financial condition, results of operations and cash flows of the registrant as
               of, and for, the periods presented in this quarterly report;
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. |  | The registrants other certifying officers and I are responsible for
               establishing and maintaining disclosure controls and procedures (as defined in
               Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|a) |  | designed such disclosure controls and procedures to ensure that material
               information relating to the registrant, including its consolidated subsidiaries,
               is made known to us by others within those entities, particularly during the
               period in which this quarterly report is being prepared;
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|b) |  | evaluated the effectiveness of the registrants disclosure controls and
               procedures as of a date within 90 days prior to the filing of this quarterly
               report (the Evaluation Date); and
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|c) |  | presented in this quarterly report our conclusions about the effectiveness of
               the disclosure controls and procedures based on our evaluation as of the
               Evaluation Date;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. |  | The registrants other certifying officers and I have disclosed, based on
               our most recent evaluation, to the registrants auditors and the audit
               committee of registrants board of directors (or persons performing the
               equivalent function):
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|a) |  | all significant deficiencies in the design or operation of internal controls
               which could adversely affect the registrants ability to record, process,
               summarize and report financial data and have identified for the
               registrants auditors any material weaknesses in internal controls; and
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|b) |  | any fraud, whether or not material, that involves management or other employees
               who have a significant role in the registrants internal controls; and
|-- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. |  | The registrants other certifying officers and I have indicated in this
               quarterly report whether or not there were significant changes in internal
               controls or in other factors that could significantly affect internal controls
               subsequent to the date of our most recent evaluation, including any corrective
               actions with regard to significant deficiencies and material weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Date: May 15, 2003

/s/Daniel M.
Kuzmak

---

# EXHIBIT INDEX

Exhibit
No.      Description

|10.1 |  | Ionics,
Incorporated 1997 Stock Incentive Plan, as amended through March 27, 2003.
|---- |  | ----------------------------------------------------------------------------------

|10.2 |  | Ionics,
Incorporated 1979 Stock Option Plan, as amended through March 27, 2003
|---- |  | ------------------------------------------------------------------------------

|10.3 |  | First
Amendment to Ionics, Incorporated Supplemental Executive Retirement Plan,
                        effective April 1, 2003.
|---- |  | --------------------------------------------------------------------------------------------------------------------------------

|10.4 |  | Third
Amendment and Waiver to Third Amended and Restated Revolving Credit Agreement between the
Company and Fleet National Bank dated as of April 14, 2003.
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------

|10.5 |  | Ionics,
Incorporated 2003 Non-Employee Directors Stock Option Plan.
|---- |  | -------------------------------------------------------------------

|10.6 |  | Form
of Stock Option Agreement Issued Pursuant to the Ionics, Incorporated 2003
                        Non-Employee Directors Stock Option Plan.
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------