Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on May 20, 2005

Registration No.             


UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933


Flow International Corporation

(Exact name of registrant as specified in its charter)

 

Washington   3569   91-1104842
(State or other jurisdiction of
incorporation or organization)
  (Primary Standard Industrial
Classification Code Number)
  (I.R.S. Employer
Identification Number)

 

Stephen R. Light

President and Chief Executive Officer

23500 64th Avenue South

Kent, WA 98032

(253) 850-3500

(Address, including zip code and telephone number, including area code, of Registrant’s principal executive offices)

 

PTSGE Corp.

925 Fourth Avenue, Suite 2900

Seattle, WA 98104

(206) 623-7580

(Name, address, including zip code and telephone number, including area code, of agent for service)

 

Copies to:

 

Robert S. Jaffe

William Gleeson

Preston Gates & Ellis LLP

925 Fourth Avenue, Suite 2900

Seattle, WA 98104

(206) 623-7580


Approximate date of commencement of proposed sale to the public:

From time to time after the effective date of this registration statement,

as determined by market conditions and other factors.


If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box:  x

 

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

 

If delivery of the prospectus is expected to be made pursuant to Rule 434, please check the following box:  ¨

 

CALCULATION OF REGISTRATION FEE


Title of Each Class of
Securities to Be
Registered
   Amount to Be
Registered(1)
  Proposed Maximum
Offering Price Per
Security(4)
   Proposed Maximum
Aggregate Offering
Price(4)
   Amount of
Registration Fee

Common Stock, $0.01 par value.

   17,473,116 Shares(2)   $6.76    $118,118,264.16    $13,902.52

Common Stock, $0.01 par value.

   3,219,245(3)   $6.76    $21,762,096    $2,561.40

(1) In accordance with Rule 416(a), the registrant is also registering hereunder an indeterminate number of shares that may be issued and resold resulting from stock splits, stock dividends or similar transactions.
(2) Represents shares of the registrant’s common stock being registered for resale that have been issued to the selling shareholders named in this registration statement.
(3) Represents shares of the registrant’s common stock being registered for resale that have been or may be acquired upon the exercise of warrants issued to the selling shareholders named in this registration statement.
(4) Estimated pursuant to Rule 457(c) under the Securities Act of 1933, solely for the purposes of calculating the registration fee, upon the basis of the average high and low prices of our common stock as reported on the Nasdaq National Market on May 16, 2005.

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.



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PRELIMINARY PROSPECTUS

 

Shares

 

LOGO

 

Common Stock

 


 

This prospectus relates to the offer and sale of up to 17,473,116 outstanding shares of the common stock of Flow International Corporation, a Washington corporation, and up to 3,219,245 shares that may be issued on the exercise of outstanding warrants. Such shares may be offered and sold from time to time by the persons described in this prospectus under the heading “Selling Shareholders” or by pledgees, donees, transferees, assignees or other successors-in-interest of such persons (collectively, the “Selling Shareholders”). As used in this prospectus, we, us, our and similar expressions refer to Flow International Corporation and its subsidiaries.

 

The Selling Shareholders may offer their shares from time to time through or to one or more underwriters, brokers or dealers, on the NASDAQ Stock National Market at market prices prevailing at the time of sale, in one or more negotiated transactions at prices acceptable to the Selling Shareholders or in private transactions. We will not receive any proceeds from the sale of shares by the Selling Shareholders. In connection with any sales, the Selling Shareholders and any underwriters, agents, brokers or dealers participating in such sales may be deemed to be “underwriters” within the meaning of the Securities Act.

 

We will pay the expenses related to the registration of the shares covered by this prospectus. The Selling Shareholders will pay commissions and selling expenses, if any, incurred by them.

 

Our common stock trades on the NASDAQ National Market under the symbol “FLOW.” On May 16, 2005, the closing price of one share of our common stock was $6.55.

 

On March 21, 2005, in a Private Investment in Public Equity Transaction (“PIPE Transaction”), we sold 17,473,116 equity units at $3.72 per unit for gross proceeds of $65 million, and net proceeds of $59.5 million. A unit consists of one share of our common stock and one warrant to buy 1/10th of a share of our common stock. Ten warrants give the holder the right to purchase one share of common stock for $4.07. Proceeds of the PIPE were used to pay down existing debt of $59.5 million, including all of our subordinated debt. Under the terms of warrants previously issued to our senior and subordinated lenders, we are obligated to issue additional warrants if shares of our common stock are issued for prices less than market price. Because the market price of the common stock on March 21, 2005 was greater than $3.70, the date the PIPE Transaction agreement was executed, we have issued approximately 304,000 anti-dilutional warrants to our lenders. These warrants have a Black-Scholes value of approximately $1.1 million. The majority of the charges resulting from the issuance of the additional 304,000 warrants, $1.0 million, will be charged to interest expense in the fourth quarter of fiscal 2005 as the underlying debt associated with these warrants will be retired in the fourth quarter of fiscal 2005. The remainder, $82,000, will be capitalized and amortized to interest expense through August 1, 2005.

 

Under EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (EITF 00-19”), the fair value of the warrants sold to the PIPE investors will be reported initially as a liability due to liquidated damages of 1% of the gross proceeds per month ($650,000) which will be payable in the event that this Form S-1 not be declared effective prior to September 17, 2005. Upon effectiveness of the Form S-1, the fair value of the warrants will be reclassified into Capital in Excess of Par in the Equity section of the Consolidated Balance Sheet. The warrants sold to the PIPE investors have been valued at $3.5 million using the Black-Scholes method, and the shares have been recorded at $56.0 million, or the difference between the net proceeds and the value of the warrants. The warrants sold to the PIPE investors are considered a derivative financial instrument and will be marked to fair value quarterly until this Form S-1 is declared effective. Any changes in fair value of the warrants will be recorded through the Consolidated Statement of Operations.

 

Investing in our securities involves risks. See “ Risk Factors” beginning on page 5 of this prospectus.

 

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR DETERMINED IF THIS PROSPECTUS IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.

 

The date of this prospectus is                     , 2005.


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You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with different information. An offer to sell these securities is not being made in any state where the offer is not permitted. You should not assume that the information contained in this prospectus or any prospectus supplement is accurate as of any date other than the date of such documents. Our business, financial condition, results of operations and prospects may have changed since that date.

 

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

The Company

   1

The Offering

   2

Historical Stock Price

   3

Summary Financial Data

   3

Risk Factors

   5

Cautionary Note Regarding Forward-Looking Statements

   9

Use of Proceeds

   10

Dividend Policy

   10

Capitalization

   11

Selected Financial Data

   17

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   18

Business

   51

Information Concerning Directors and Executive Officers

   56

Board Structure, Committees, Compensation and Composition

   60

Executive Compensation

   63

Market Information

   68

Stock Ownership of Management and Principal Shareholders

   69

Selling Shareholders

   72

Description of Capital Stock

   75

Plan of Distribution

   77

Legal Matters

   78

Experts

   78

Where You Can Find More Information

   79

Index to Consolidated Financial Statements

   80

 

ABOUT THIS PROSPECTUS

 

This prospectus is part of a registration statement that we filed with the Securities and Exchange Commission using the SEC’s shelf registration rules. Under the shelf registration rules, using this prospectus and, if required, one or more prospectus supplements, the Selling Shareholders may sell from time to time, in one or more offerings, the shares of common stock covered by this prospectus. The shares covered by this prospectus include 17,473,116 outstanding shares of common stock and 3,219,245 shares of common stock issuable upon the exercise of warrants.

 

This prospectus also covers any shares of common stock that may become issuable pursuant to anti-dilution adjustment provisions that would increase the number of shares issuable upon exercise of the warrants as a result of stock splits, stock dividends or similar transactions.

 

A prospectus supplement may add, update or change information contained in this prospectus. We recommend that you read carefully this entire prospectus, especially the section entitled “Risk Factors” beginning on page 5, together with any supplements before making a decision to invest in our common stock.


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PROSPECTUS SUMMARY

 

This summary highlights key aspects of the information contained elsewhere in this prospectus. This summary does not contain all the information you should consider before investing in our common stock. You should read this entire prospectus carefully, especially the risks of investing in our common stock discussed under “Risk Factors” beginning on page 5, recent developments beginning on page 18 and our consolidated financial statements and the notes to those consolidated financial statements beginning on page F-1, before making an investment decision.

 

THE COMPANY

 

We design, develop, manufacture, market, install and service ultrahigh-pressure, or UHP, water pumps and UHP water management systems. Our core competency is the design and manufacture of UHP water pumps. Our UHP water pumps pressurize water from 40,000 to over 100,000 pounds per square inch (psi) and are integrated with water delivery systems so that water can be used to cut or clean material or pressurize food. Our products include both standard and specialized waterjet cutting and cleaning systems and the Fresher Under Pressure® food processing products. In addition to UHP water pumps and related systems, we provide non UHP automation and articulation systems, primarily to the automotive industry, and isostatic and flexform press systems which produce and strengthen advanced materials for the aerospace, automotive and medical industries.

 

Our UHP technology has three broad applications: cutting, cleaning and Fresher Under Pressure or food processing. In cutting and cleaning applications, the ultrahigh-pressure created by our pumps is released through a small orifice to create a jet of water. In Fresher Under Pressure, we utilize “contained” pressure. Food is put into a pressure vessel and UHP water is pumped into the vessel. This pressurized water is used to kill both spoilage bacteria and pathogens in the food.

 

The primary application of our UHP water pumps is cutting. In cutting applications, pressures from 50,000 to 87,000 psi create a thin stream of water traveling at three or more times the speed of sound which can cut both metallic and nonmetallic materials. UHP water pumps are used in aerospace, automotive, disposable products, food, glass, job shop, sign, metal cutting, marble, tile and other stone cutting, and paper slitting and trimming applications. Waterjet cutting is recognized as a more flexible alternative to traditional cutting methods such as lasers, saws or plasma. It is often faster, has greater versatility in the types of materials it can cut and eliminates the need for secondary processing operations. We also manufacture a waterjet product line used in cleaning, where pressures in the range of 40,000 to 55,000 psi are used in industrial cleaning, surface preparation, construction, and petro-chemical and oil field applications. In the food pressurization applications, pressures of between 87,000 to 100,000 psi are used for our Fresher Under Pressure food processing technology to provide food safety, quality and productivity enhancements for food producers.

 

We analyze our business based on the utilization of UHP, either as released pressure or contained pressure, as follows: Flow Waterjet Systems, or Waterjet, for released pressure applications and Avure Technologies Incorporated, or Avure, for contained pressure applications. In addition to the cutting and cleaning operations, the Waterjet operation also includes the automotive and articulation applications while Avure includes the Fresher Under Pressure technology, and the General Press operations.

 

Our principal executive offices are at 23500 64th Avenue South, Kent, WA 98032 and our telephone number is (253) 850-3500. We maintain a website at www.flowcorp.com. The contents of our website are not incorporated into this prospectus.

 


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The Offering

 

Common Stock offered by the Selling Shareholders

   20,692,361 Shares(1)

Offering

   The Selling Shareholders may offer their shares from time to time through one or more underwriters, brokers or dealers, on the NASDAQ Stock National Market at market prices prevailing at the time of sale, in one or more negotiated transactions at prices acceptable to the Selling Shareholders or in private transactions.

Use of Proceeds

   The proceeds from the sale of the shares covered by this prospectus will be received by the Selling Shareholders. We will not receive any of the proceeds from the sales by the Selling Shareholders of the shares covered by this prospectus.

Nasdaq National Market symbol

   “FLOW”

Risk Factors

   See “Risk Factors” beginning on page 5 for a discussion of factors that you should consider carefully before deciding to purchase our common stock.

(1) Includes 3,219,245 shares of common stock issuable upon the exercise of outstanding warrants to purchase common stock.

 

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Historical Stock Price

 

Our stock is traded on the NASDAQ National Market under the symbol “FLOW.” The range of high and low sales prices for our common stock for the first quarter of fiscal 2006 through May 19, 2005 and the four quarters for fiscal 2005, 2004 and 2003 is set forth in the following table.

 

     Fiscal Year 2006

   Fiscal Year 2005

   Fiscal Year 2004

   Fiscal Year 2003

     High

   Low

   High

   Low

   High

   Low

   High

   Low

First Quarter

   $ 7.21    $ 5.84    $ 3.66    $ 1.90    $ 1.94    $ 1.13    $ 10.90    $ 5.05

Second Quarter

                   3.75      2.54      3.11      1.36      5.60      2.12

Third Quarter

                   3.20      2.57      4.11      2.40      3.80      2.13

Fourth Quarter

                   6.90      2.85      3.74      2.20      3.28      1.08

 

We have not paid dividends to common shareholders in the past. Our Board of Directors intends to retain future earnings, if any, to finance development and expansion of our business and reduce debt and does not expect to declare dividends to common shareholders in the near future. Furthermore, our current Senior Credit Agreement does not allow for payment of dividends to our shareholders.

 

Summary Financial Data

 

The following table provides summary historical financial data for the periods indicated. You should read this information in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our financial statements and the related notes included elsewhere in this prospectus.

 

The summary statement of operations data for each of the fiscal years ended April 30, 2002, 2003 and 2004 and the summary balance sheet data as of April 30, 2003 and 2004 are derived from our audited financial statements, which are included elsewhere in this prospectus. The summary statement of operation data for each of the fiscal years ended April 30, 2000 and 2001 and the summary balance sheet data as of April 30, 2000, 2001 and 2002 are derived from our unaudited financial statements which are not included in this prospectus. The selected statement of operations data for each of the nine month periods ended January 31, 2004 and 2005 and the selected balance sheet data as of January 31, 2005 are derived from unaudited financial statements, which are included elsewhere in this prospectus.

 

    Year Ended April 30,

  Nine Months Ended
January 31,


 
(In thousands, except
per share amounts)
  2004(1)

    2003(1)(3)

    2002(1)(2)

    2001(1)

  2000(1)

  2005

    2004(1)

 
                      (unaudited)   (unaudited)   (unaudited)     (unaudited)  
  (restated)     (restated)     (restated)     (restated)   (restated)         (restated)  

Statement of Operations Data:

                                                   

Sales

  $ 177,609     $ 144,115     $ 176,890     $ 204,854   $ 193,638   $ 154,321     $ 123,253  

Income (Loss) Before Discontinued Operations

    (12,048 )     (69,464 )     (8,244 )     4,038     1,252     (6,115 )     (8,443 )

Net Loss

    (11,522 )     (69,987 )     (7,853 )     1,630     1,255     (6,115 )     (7,917 )

Basic Income (Loss) Per Share Before Discontinued Operations

    (0.78 )     (4.53 )     (0.54 )     0.27     0.09     (0.39 )     (0.55 )

Diluted Income (Loss) Per Share Before Discontinued Operations

    (0.78 )     (4.53 )     (0.54 )     0.27     0.08     (0.39 )     (0.55 )

Basic Income (Loss) Per Share

    (0.75 )     (4.56 )     (0.52 )     0.11     0.09     (0.39 )     (0.52 )

Diluted Income (Loss) Per Share

    (0.75 )     (4.56 )     (0.52 )     0.11     0.08     (0.39 )     (0.52 )

 

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     April 30,

      
     2004(1)

    2003(1)

    2002(1)

   2001(1)

   2000(1)

   January 31,
2005


 
                 (unaudited)    (unaudited)    (unaudited)    (unaudited)  
     (restated)     (restated)     (restated)    (restated)    (restated)       

Balance Sheet Data:

                                             

Working Capital

   $ (9,060 )   $ (6,709 )   $ 84,532    $ 91,750    $ 87,552    $ (3,146 )

Total Assets

     135,071       147,701       208,674      209,309      198,893      136,226  

Short-Term Debt

     48,727       61,056       5,237      8,464      9,216      26,442  

Long-Term Obligations, net

     38,081       29,023       83,453      85,652      70,397      45,958  

Shareholders’ (Deficit) Equity

     (9,552 )     4,872       71,054      68,755      68,521      (11,958 )

(1) As described in Note 2 to the Consolidated Financial Statements, we revised our consolidated financial statements for the years ended April 30, 2004, 2003 and 2002 to reflect charges associated with reconciliations of inter-company transactions, as well as to correct the classification of foreign exchange revaluation gains and losses on inter-company balances from Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets to Other Income (Expense), net in the Consolidated Statement of Operations in accordance with FAS 52. In addition, we have corrected the reporting in our Consolidated Statements of Cash Flows for the effects of foreign exchange rate changes on cash for each of the three years in the period ended April 30, 2004. We have reduced the debt discount on our subordinated debt in May 2001 and have thereby reduced the related amortization of this amount to Interest Expense, net for the years ended April 30, 2004, 2003 and 2002. In addition, we have recorded the related tax effects of these adjustments. We have also revised the classification, from long-term to current, of our senior credit facility. Lastly, at April 30, 2004, we have reclassified $1.2 million in debt to long-term obligations that was originally reported as a current liability under Notes Payable in the Consolidated Balance Sheets. These restatements were applied to all other financial information presented for earlier years, as appropriate.
(2) The Statement of Operations for fiscal 2002 includes the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”, (“FAS 142”). See Note 1 to the Consolidated Financial Statements for the year ended April 30, 2004 for further discussion of the impact of this adoption.
(3) The Statement of Operations for fiscal 2003 includes the impact of management’s launch of its restructuring program and resulting focus on cash generation. See the ‘Fiscal 2003 Comprehensive Financial Review’ at the end of the ‘Fiscal 2004 Compared to Fiscal 2003’ financial analysis in the Management’s Discussion and Analysis section for further discussion of the impact on our financial results.

 

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RISK FACTORS

 

An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with the financial and other information contained in this prospectus, before making a decision to buy our common stock from the Selling Shareholder. If any of the following risks actually occur, our business, financial condition and results of operations could suffer. In these circumstances, the market price of our common stock could decline, and you may lose all or part of your investment in our common stock.

 

We have incurred losses in recent years and we may be unable to achieve profitability.

 

Our net losses for the fiscal years ended April 30, 2003 and 2004 were $70.0 million and $11.5 million, respectively. Our net losses for the nine months ended January 31, 2005 and 2004 were $6.1 million and $7.9 million, respectively. In May 2003, we began a two year plan to significantly restructure our operations, a plan which is now substantially complete, and in recent quarters we have seen an improvement in our financial performance as well as indications of strengthening in the economy. We believe this restructuring and the related cost-cutting initiatives will reduce overall spending relative to our revenue. However, if the anticipated benefits from our restructuring efforts fail to adequately reduce costs, or if our sales are less than we project, we may continue to incur losses in future periods.

 

Economic weakness in our served markets may adversely affect our financial results.

 

The products we sell are capital goods with individual system prices ranging from $150,000 to several million dollars. Many of our customers depend on long term financing from a financial institution to purchase our equipment. Economic weakness in the capital goods market and or a credit tightening by the banking industry would reduce our sales and accordingly affect our financial results.

 

If we fail to comply with our financing arrangements our ability to continue operations would be seriously impaired.

 

We are operating under an amended credit agreement which expires August 1, 2005 and which sets forth specific default financial covenants levels. In the event of default, our senior lenders (the “Lenders”) may limit our access to borrow funds as needed. Our ability to continue operating is dependent on the Lenders’ willingness to grant access to funds.

 

When we execute a new senior credit agreement, we may not receive terms as favorable as we have in our current senior credit agreement, which would result in an increase in our interest expense.

 

We are operating under an amended credit agreement which expires August 1, 2005. We are in discussions with a number of potential lenders regarding a new, multi-year credit agreement extending beyond August 1, but we do not have an agreement in place and do not know what the terms of such an agreement would be. We expect that we will enter into a long term credit agreement with terms and conditions similar to our existing agreement. However, completion of a new lending agreement is not certain and if we are unable to obtain terms as favorable as we have now with respect to amounts, covenants and interest, our interest expense levels could increase and our operations and cash flows would be adversely affected. If a replacement credit facility is not obtained prior to August 1, 2005, we may be unable to pay the outstanding amounts related to the senior credit facility that are due on that date.

 

If the registration statement of which this prospectus is a part becomes ineffective for more than 40 days, we may be subject to significant financial penalties.

 

Under terms of a Registration Rights Agreement with the purchasers in the PIPE Transaction, if the registration statement of which this prospectus is a part becomes ineffective for more than 40 days (not necessarily consecutive) then we will be subject to a cash penalty of up to $650,000 per month for each month the registration statement is not effective. Certain factors that could cause the registration statement to become or remain ineffective are not within our control.

 

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If we are unable to retain the current members of our senior management team and other key personnel, our future success may be negatively impacted.

 

Our success to date has been based in part on the efforts of our senior management team. If we lose any of those key management personnel, our future success could be jeopardized. We may have to incur greater costs to attract replacement personnel.

 

Our inability to protect our intellectual property rights, or our possible infringement on the proprietary rights of others, and related litigation could be time consuming and costly.

 

We defend our intellectual property rights because unauthorized copying and sale of our proprietary equipment and consumables represents a loss of revenue to us. From time to time we also receive notices from others claiming we infringe their intellectual property rights. The number of these claims may grow in the future, and responding to these claims may require us to stop selling or to redesign affected products, and or to pay damages which could adversely affect our financial results. We are engaged in litigation relating to our intellectual property rights with OMAX Corporation. See Legal Proceedings.

 

Fluctuations in our quarterly operating results may cause our stock price to decline and limit our shareholders’ ability to sell our common stock in the public market.

 

In the past, our operating results have fluctuated significantly from quarter to quarter and we expect them to continue to do so in the future due to a variety of factors, many of which are outside of our control. Our operating results may in some future quarter fall below the expectations of securities analysts and investors. In this event, the trading price of our common stock could decline significantly. In addition to the risks disclosed elsewhere in this prospectus, factors outside of our control that have caused our quarterly operating results to fluctuate in the past and that may affect us in the future include:

 

    fluctuations in general economic conditions;

 

    demand for UHP pumps and UHP water management systems generally;

 

    fluctuations in the capital budgets of customers; and

 

    development of superior products and services by our competitors.

 

In addition, factors within our control, such as our ability to deliver equipment in a timely fashion, have caused our operating results to fluctuate in the past and may affect us similarly in the future.

 

The factors listed above may affect both our quarter-to-quarter operating results as well as our long-term success. Given the fluctuations in our operating results, you should not rely on quarter-to-quarter comparisons of our results of operations as an indication of our future performance or to determine any trend in our performance. Fluctuations in our quarterly operating results could cause the market price of and demand for our common stock to fluctuate substantially, which may limit your ability to sell our common stock on the public market.

 

We do business in industries that are cyclical, which may result in weakness in demand for our products.

 

Our products are sold in many industries, including machine tool, automotive and aerospace, that are highly cyclical. The machine tool industry, in particular from 1998 through 2003, experienced a significant decline in global demand. Cyclical weaknesses in the industries that we serve could lead to a reduced demand for our products.

 

We may be affected by rising costs or lack of availability of materials, which could negatively impact our operations.

 

We have experienced and may continue to experience significant increases in the costs of materials we use in the manufacture of our products, such as steel, and we may not be able to either achieve corresponding increases in the prices of our products or reduce manufacturing costs to offset these increases, or if we do increase prices, we may experience lower sales. Any of the foregoing may adversely affect our financial results.

 

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If we cannot develop technological improvements to our products through continued research and engineering, our financial results may be adversely affected.

 

In order to maintain our position in the market, we need to continue to invest in research and engineering to improve our products and technologies and introduce new products and technologies. If we are unable to make such investment, if our research and development does not lead to new and/or improved products or technologies, or if we experience delays in the development or acceptance of new and/or improved products, our financial results will be adversely affected.

 

We have received notice of material weaknesses. Consequently, there is more than a remote likelihood that a material misstatement of our financial statements will not be prevented or detected in the current or any future period. Additionally we may conclude that our system of internal controls under Section 404 of Sarbanes-Oxley is not effective.

 

In December 2004, in connection with the restatement of our fiscal 2002, 2003 and 2004 financial statements, our independent registered public accounting firm reported to our Audit Committee two matters involving internal controls which our independent registered public accounting firm considered to be material weaknesses in our financial reporting process, as defined by the Public Company Accounting Oversight Board (“PCAOB”) in Auditing Standard No. 2. As defined by the PCAOB, a material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Our management and Audit Committee agreed with the report and we responded to our independent registered public accounting firm on each matter raised in their report and agreed to address each of the deficiencies.

 

The material weaknesses identified by our independent registered public accounting firm were as follows:

 

    Insufficient analysis, a documentation and review of the consolidation of the financial statements of subsidiaries. Inadequate processes to ensure the accuracy of the reconciliation of inter-company accounts. Also, we must improve the consolidation process and controls surrounding adequate monitoring and oversight of the work performed by accounting and financial reporting personnel.

 

    Insufficient staffing of the accounting and financial reporting function. The financial and accounting function requires additional personnel with appropriate skills and training to identify and address the application of technical accounting literature of our transactions and activities.

 

These deficiencies in both design and operational effectiveness of our system of internal controls helped lead to the restatement of fiscal years 2004, 2003 and 2002 and delays in the completion and filing of our July 31, 2004 and October 31, 2004 Forms 10-Q, as described in Note 2 to the Condensed Consolidated Financial Statements, as well as in our Form 10-K/A.

 

As of January 31, 2005, we have not completed all the necessary corrective actions to fully correct the material weaknesses described above, and accordingly, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of January 31, 2005. However, we have put in place compensating procedures which allow us to affirm the reliability of our financial statements as of our most recent reporting period, January 31, 2005.

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires the Company to assess the design and effectiveness of the Company’s internal control systems effective April 30, 2006. The Company’s independent registered public accounting firm is required to render an attestation report on managements’ assessment and the effectiveness of our system of internal control over financial reporting. We must complete the documentation, evaluation and remediation of our systems of internal control. The costs associated with such compliance are likely to be substantial and will negatively impact our financial results. In addition, there is no assurance that we will be able to conclude that our systems are appropriately designed or effective, which could result in a material misstatement of the financial statements in the future and a decline in the stock price.

 

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We have outstanding options and warrants that have the potential to dilute the return of our existing common shareholders and cause the price of our common stock to decline.

 

We grant stock options to our employees and other individuals. At April 30, 2004, we had options outstanding to purchase 2,089,412 shares of our common stock, at exercise prices ranging from $2.69 to $12.25 per share. In addition, we currently have outstanding 3,219,245 warrants, for which we are registering the resale of the underlying shares hereby. The exercise price of the warrants range from $.008 to $4.07 per share.

 

As a result of accounting regulations, which become applicable to us on May 1, 2006, requiring companies to expense stock options, our expenses will increase and our stock price may decline.

 

A number of publicly traded companies have recently announced that they will begin expensing stock option grants to employees. In addition, the Financial Accounting Standards Board (FASB) has adopted rule changes with an effective date as of the beginning of fiscal years beginning after June 15, 2005 requiring expensing of stock options. Currently we include such expenses on a pro forma basis in the notes to our financial statements in accordance with accounting principles generally accepted in the United States, but do not include stock option expense for employee options in our reported financial statements. This change in accounting standards will require us to expense stock options, and as a result our reported expenses may increase significantly.

 

Washington law and our charter documents may make an acquisition of us more difficult.

 

Provisions in Washington law and in our articles of incorporation, bylaws, and rights plan could make it more difficult for a third-party to acquire us, even if doing so would benefit our shareholders. These provisions:

 

    Establish a classified board of directors so that not all members of our board are elected at one time;

 

    Authorize the issuance of “blank check” preferred stock that could be issued by our board of directors (without shareholder approval) to increase the number of outstanding shares (including shares with special voting rights), each of which could hinder a takeover attempt;

 

    Provide for a Preferred Share Rights Purchase Plan or “poison pill;”

 

    Impose restrictions on certain transactions between a corporation and certain significant shareholders.

 

    Provide that directors may be removed only at a special meeting of shareholders and provide that only directors may call a special meeting;

 

    Require the affirmative approval of a merger, share exchange or sale of substantially all of the Corporation’s assets by 2/3 of the Corporation’s shares entitled to vote; and

 

    Provide for 60 day advance notification for shareholder proposals and nominations at shareholder meetings.

 

Market risk exists in our operations from potential adverse changes in foreign exchange rates relative to the U.S. dollar in our foreign operations.

 

A significant portion of our sales take place outside of the United States, and we transact business in various foreign currencies, primarily the Canadian dollar, the Eurodollar, the Japanese yen, the New Taiwan dollar, and the Swedish Krona. In addition, our foreign divisions may have customer receivables and vendor obligations in currencies other than their local currency which exposes us to near-term and longer term currency fluctuation risks. The assets and liabilities of our foreign operations, with functional currencies other than the U.S. dollar, are translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the period. Aggregate net foreign exchange gains included in the determination of net loss amounted to $1.2 million for the nine months ended January 31, 2005. Based on our annualized results for the nine months ended January 31, 2005 for our foreign subsidiaries, and based on the net position of foreign assets less liabilities, a near-term 10% appreciation or depreciation of the U.S. dollar in all currencies we operate could impact operating income by $1 million and other income (expense) by $1.5 million. Our financial position and cash flows could be similarly impacted.

 

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Current year foreign sales have benefited from a weak U.S. dollar. If the dollar were to strengthen against certain foreign currencies, such as the euro and yen, our margins may be negatively affected.

 

A significant portion of our products sold outside the United States are manufactured domestically. The weaker U.S. dollar, relative to the local currency of many of the countries we sell into, has made our products less expensive, on a relative basis, when compared to locally manufactured products and products manufactured in certain other countries. If the U.S. dollar were to gain in value relative to these foreign currencies, our products would increase in cost to the customer relative to locally produced product and products manufactured in certain other countries, which could negatively impact sales.

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

SAFE HARBOR STATEMENT:

 

Statements made in this prospectus that are not historical facts are forward-looking statements that involve risks and uncertainties. These forward-looking statements include guidance on revenues for fiscal 2005. Forward-looking statements typically are identified by the use of such terms as may, will, expect, believe, anticipate, estimate, plan, potential, continue or similar words, although some forward-looking statements are expressed differently. We caution investors that forward-looking statements are only predictions based on our current expectations about future events. These forward-looking statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. You should be aware that our actual results could differ materially from those contained in any forward-looking statement due to a number of factors, which include, but are not limited to the following: our belief that the existing cash and credit facilities at January 31, 2005 are adequate to fund our operations through July 31, 2005 and that if we fail to achieve its planned revenues, costs and working capital objectives, management has the ability to curtail capital expenditures and reduce costs to levels that will be sufficient to enable the Company to meet its cash requirements and debt covenants through July 31, 2005; our belief that our new control policies and procedures, when implemented, will eliminate material weaknesses in our internal accounting controls; our ability to enter into a long term senior debt agreement prior to August 1, 2005; our expectations that the benefits from our restructuring activities should continue for the remainder of fiscal 2005 and that these changes should help us to achieve our forecasts; our expectation that long-term debt, notes payable and lease commitments will be met from working capital provided by operations and, if necessary, by borrowings; our expectation that funds necessary for capital spending will be generated internally and through available credit facilities; our realization of assets and discharge of liabilities in the ordinary course of business; the accuracy of our estimated costs for any future warranty obligations, bad debts, and obsolete or excess inventory; our continued ability to invest in research and development to improve current products and introduce new products; that our waterjets are experiencing growing acceptance in the marketplace for their flexibility and superior machine performance; that future consumables sales should be positively impacted by the increased number of operating systems and by sales of our proprietary productivity enhancing kits and the introduction of Flowparts.com; our ability to continue to improve our customer’s profitability through investment in the development of innovative products and services; the continued increase of spare parts sales; our expectation that we will focus our marketing efforts on specific target industries, applications and markets; our ability to successfully develop and sell products in the competitive markets that we serve; our ability to continue gaining market share in the machine cutting tool market; our belief that waterjet technology is in the early adoption phase of its product life and will continue to grow as a result of increasing awareness of the technology; our belief that the market acceptance of waterjet cutting systems in the aerospace, automotive and machining industries will encourage other manufacturers, in the same and in other industries, to adopt waterjet technologies; the ability of our UHP technology to provide benefits to an array of food products; the accuracy of our estimate of the worldwide waterjet cutting system market size at $350 million, and worldwide waterjet cleaning market at $335 million; our belief that we are the leader in the global waterjet cutting system markets with a market share of 40%; our belief that we are a major competitor in the ultrahigh-pressure segment of the waterjet cleaning systems market with an estimated global share of 27%; our access to capital; our ability to maintain satisfactory relationships with our

 

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lending partners; the overall level of consumer spending on capital equipment; the strengthening of global economies; our use of derivative instruments to manage foreign currency exchange rate risks; our expectation of a manufacturing agreement with the purchasers of any potentially divested businesses; our ability to retain a technical lead over our competitors through non-patented proprietary trade secrets and know-how in UHP applications; the ability of the patents we hold and have in process, as well as proprietary applications and manufacturing know-how, to act as a barrier to entry for competitors in the UHP technology field; our belief that the patents we hold protect our intellectual property; our belief that our patents and know-how make us the world-leader in UHP processing technology; the belief that Omax’s claims are without merit and out intent to contest Omax’s allegations. Additional information on these and other factors that could affect our financial results is set forth above and in our Form 10-K/A for the year ended April 30, 2004. We assume no obligation to update any forward-looking statements as a result of new information, future events or developments, except as required by federal securities laws.

 

All references to fiscal years are references to our fiscal year end of April 30.

 

USE OF PROCEEDS

 

The proceeds from the sale of the shares covered by this prospectus will be received by the Selling Shareholders. We will not receive any of the proceeds from the sales by the Selling Shareholders of the shares covered by this prospectus.

 

We originally received gross proceeds of $65 million and net proceeds of $59.5 million on March 21, 2005 when we sold 17,473,116 equity units at $3.72 per unit in the PIPE Transaction. A unit consists of one share of our common stock and one warrant to buy 1/10th of a share of our common stock. Ten warrants give the holder the right to purchase one share of common stock for $4.07. We will receive an aggregate of up to $7.1 million if the selling shareholders who participated in the PIPE Transaction, exercise all of their warrants to purchase common stock.

 

We used the gross proceeds to pay the entire balance of our subordinated debt and accrued interest totalling $48.9 million in April 2005. The remaining proceeds were used to repay borrowings on our senior credit facility.

 

1,471,933 shares are issuable on the exercise of warrants issued to lenders, including approximately 304,000 warrants issued for antidilution. The exercise price of such warrants is $0.008 per share.

 

We would expect to use any such proceeds for general corporate purposes.

 

DIVIDEND POLICY

 

We have not paid dividends to common shareholders in the past. Our Board of Directors intends to retain future earnings, if any, to finance development and expansion of our business and reduce debt and does not expect to declare dividends to common shareholders in the near future. Furthermore, our current Senior Credit Agreement does not allow for payment of dividends to our shareholders.

 

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CAPITALIZATION

 

The following table sets forth our cash and cash equivalents and certain other assets and liabilities, as well as our capitalization as of January 31, 2005 as follows:

 

    On an actual basis

 

    On a pro-forma basis giving effect to our sale of 17,473,116 shares of common stock and 1,747,312 warrants to purchase Flow common stock. After deducting offering expenses the net proceeds were $59.5 million

 

    As further described below, the pro-forma capitalization reflects application of all of the net proceeds to pay down debt. Our subordinated debt and related accrued interest was paid off in its entirety and the remaining net proceeds were used to pay down our Senior debt. In addition, for the pro-forma presentation the accumulated deficit has been charged for the expensing of the related capitalized debt fees and the write-off of the subordinated debt discount.

 

    In addition, the pro-forma capitalization includes the issuance of approximately 304,000 anti-dilutional warrants. The warrants were issued to our senior and subordinated lenders. The fair value of these warrants was $1.1 million. Charges for the portion of the warrants ($970,000) issued to our subordinated lender and those senior lenders who did not participate in the New Senior Credit Agreement were charged to the accumulated deficit as expenses for pro-forma purposes.

 

New Senior Debt Agreement –

 

On April 28, 2005 we entered into a new senior debt agreement with Bank of America N.A. and U.S. Bank N.A. Certain other participants in the senior debt agreement did not participate in this new agreement. The agreement provides a $30 million commitment which expires August 1, 2005. This expiration date is consistent with our previous agreement. The new agreement however gave us the ability to pay off our subordinated debt in its entirety, which we did on April 28, 2005. This new senior debt agreement, including covenants, is very similar to the previous senior debt agreement except for the following provisions:

 

    Requires the complete pay-off of subordinated debt

 

    The interest rate has been reduced from prime + 6% to LIBOR + 2.5%

 

    The annualized cost of Letters of Credit has been reduced from 5% to 2.5% of the face amount

 

    The total commitment increased to $30 million, up from the prior debt agreement commitment level of $25.1 million.

 

As the expiration of this new senior debt agreement is August 1, 2005, we have begun negotiations to complete a long term senior debt agreement prior to August 1, 2005.

 

The following comments explain the changes between the January 31, 2005 reported amounts and the pro-forma amounts:

 

The PIPE Transaction gross proceeds of $65 million, less investment banking fees of $5.1 million and other costs of $375,000, result in net cash proceeds of $59.5 million. The PIPE Transaction includes the sale of 17,473,116 shares of FLOW common stock and warrants to purchase 1,747,312 shares of FLOW common stock. Under EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (EITF 00-19”), the fair value of the warrants will be reported initially as a liability due to the requirement to make liquidated damages payments of 1% of the gross proceeds per month ($650,000) should this Form S-1 not be declared effective prior to September 17, 2005. Our PIPE Transaction placement agent has agreed to share one half of the first $1 million of cash payment penalties arising from our failure to have this registration become effective prior to September 17, 2005. Upon effectiveness of the Form S-1, the fair value of the warrants will be reclassified into Capital in Excess of Par in the Equity section of the Consolidated Balance Sheet. The warrants have been valued at $3.5 million using the Black-Scholes method, and the shares have been recorded at $56.0 million, or the difference between the net proceeds and the value of the warrants.

 

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The warrants are considered a derivative financial instrument and will be marked to fair value quarterly until this Form S-1 is declared effective. Any changes in fair value of the warrants will be recorded through the Statement of Operations.

 

The net proceeds of the PIPE Transaction have been applied to debt on a pro-forma basis as of January 31, 2005 as follows:

 

In Thousands     

Repayment of subordinated debt

   $ 44,500

Payment of accrued interest on subordinated debt

     2,705

Repayment of senior debt

     12,333
    

Total application of proceeds

   $ 59,538
    

 

The pro-forma information includes the following adjustments to accumulated deficit to reflect certain charges to income to be incurred as a result of the PIPE Transaction:

 

In Thousands     

Expensing of capitalized loan costs on debt

   $ 1,616

Expensing of discount on subordinated debt

     4,260

Charge to expense for additional anti-dilutional warrants

     1,031
    

Total pro forma adjustment to accumulated deficit

   $ 6,907
    

 

You should read this information together with the sections of this prospectus entitled “Selected Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes appearing elsewhere in this prospectus.

 

    

Actual

January 31, 2005

(unaudited; in thousands,

except share amounts)


   

Pro-Forma

January 31, 2005

(unaudited; in thousands,

except share amounts)


 

Cash and Cash Equivalents

   $ 12,210     $ 12,210  

Other Current Assets(1, 8)

     8,047       7,238  

Other Assets (Long Term)(1)

     4,377       3,652  

Other Accrued Liabilities(2)

     13,510       10,805  

Warrants(3)

     —         3,529  

Capitalization:

                

Notes Payable

     4,155       4,155  

Current Portion of Long Term Obligations(4)

     22,287       9,954  

Long-Term Obligations, Net(5)

     45,958       5,718  

Shareholders’ Deficit

                

Series A 8% Convertible Preferred Stock—$.01 par value, 1,000,000 shares authorized, none issued

     —         —    

Common Stock—$.01 par value, 49,000,000 shares authorized, 15,967,662 shares outstanding at January 31, 2005 and 33,440,778 pro-forma shares outstanding at January 31, 2005(6)

     160       335  

Capital in Excess of Par(7)

     57,021       113,968  

Accumulated Deficit(8)

     (66,080 )     (72,987 )

Accumulated Other Comprehensive Loss:

                

Cumulative Translation Adjustment

     (3,237 )     (3,237 )

Unrealized Gains on Cash Flow Hedges, Net of Income tax of $69 and $69

     178       178  
    


 


Total Shareholders’ (Deficit) Equity

   $ (11,958 )   $ 38,257  
    


 


Total Capitalization

   $ 60,442     $ 58,084  
    


 


 

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Notes:

(1) Represents the charge to expense of all previously capitalized costs related to the subordinated debt, as well as previously capitalized costs on the Senior Credit Agreement under EITF 98-14, “Debtor’s Accounting for Changes in Line-of Credit or Revolving-Debt Arrangements” (EITF 98-14). These costs total $1,616,000, of which $891,000 is classified as current and $725,000 is long term. In addition, the current balance increases by $82,000 for the portion of the value of the anti-dilutional warrants issued to Bank of America that are capitalized under EITF 98-14. These additional fees will be amortized to expense through August 1, 2005.
(2) Represents the payment of the accrued interest as of January 31, 2005 on the Subordinated debt.
(3) Represents the value of the 1,747,312 warrants issued in the PIPE transaction. The valuation was computed using the Black-Scholes method. See above for further discussion of classification on the Balance Sheet. The assumptions utilized in computing the fair value of the warrants were as follows:

 

Contractual life

   5 years  

Estimated volatility

   63 %

Risk Free interest rate

   4.34 %
(4) Represents net pay down of Senior debt of $12,333,000, on a pro-forma basis.
(5) The principal balance of the Subordinated debt as of January 31, 2005 was $44,500,000. The amount reflected in the actual balance sheet is reduced by unamortized debt discount of $4,260,000. The pro forma adjustment of $40,240,000 represents the reduction in the balance resulting from the pay-off of the subordinated debt and the write-off of the remaining unamortized discount.
(6) Represents the increase in par value associated with the common shares sold in the PIPE Transaction.
(7) Represents the net proceeds of $59.5 million less the value ascribed to the warrants of $3.5 million, plus the fair value of approximately 304,000 anti-dilutional warrants to current warrant holders. The fair value of the anti-dilutional warrants is estimated to be $1.1 million based on the following assumptions:

 

Contractual life

   5 years  

Estimated volatility

   62 %

Risk Free interest rate

   4.34 %

 

Of this total fair value, $1,031,000 is assumed to be charged to expense as it either related to warrants issued to the subordinated debt holders, and the subordinated debt is retired in the pro-forma, or it relates to warrants issued to senior debt holders who are not participating in the New Senior Credit Agreement. The remaining $82,000 relates to warrants issued to the senior creditor that participated in both the Current and New Senior Credit Agreement and accordingly this value is capitalized in Other Current Assets under EITF 98-14.

(8) Represents the write-off of the balance of the discount on Subordinated Debt as of January 31, 2005 of $4,260,000 as well as all previously capitalized costs related to the subordinated debt of $891,000 and previously capitalized costs on the Senior Credit Agreement under EITF 98-14 of $725,000. In addition, the pro-forma includes a charge to expense for $1,031,000 related to the value of anti-dilutional warrants issued to warrant holders prior to the PIPE Transaction.
(9) Pro-forma earnings per share –

 

As a result of these transactions, on a pro-forma basis, our interest expense and earnings (loss) per share for the first nine months of fiscal 2005 and for the year ended April 30, 2004 would have been reduced and our income or (loss) per share would have been increased (reduced) as follows:

 

In Thousands, except per share data   

Nine Months Ended
January 31, 2005

Actual


   

Nine Months Ended
January 31, 2005

Pro-Forma


  

Year Ended
April 30, 2004

Actual


   

Year Ended
April 30, 2004

Pro-Forma


 

Interest Expense

   $ 10,632     $ 3,362    $ 13,171     $ 4,778  

Net (Loss) Income

     (6,115 )     1,155      (11,522 )     (3,129 )

Net (Loss) Income per share:

                               

Basic

   $ (0.39 )   $ 0.03    $ (0.75 )   $ (0.10 )

Diluted

   $ (0.39 )   $ 0.03    $ (0.75 )   $ (0.10 )

 

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In Thousands, except per share data   

Nine Months Ended
January 31, 2005

Actual


  

Nine Months Ended
January 31, 2005

Pro-Forma


  

Year Ended
April 30, 2004

Actual


  

Year Ended
April 30, 2004

Pro-Forma


Weighted Average Shares Outstanding:

                   

Basic

   15,847    33,320    15,415    32,888

Diluted

   15,847    34,665    15,415    32,888

Note:

 

The subordinated debt and accrued interest at May 1, 2003 was $36.6 million. The pro-forma earnings per share information assumes the proceeds of the PIPE Transaction were used first to pay off the balance of the subordinated debt and accrued interest and the remaining net proceeds were used to pay-down Senior Credit Facility borrowings throughout the periods presented. The reduction between the “Actual” and ‘Pro-Forma’ amounts of interest expense is attributable to the reduced levels of senior and subordinated borrowings. Because the interest expense on the subordinated borrowings was all accrued and did not require cash payments, the pro-forma proceeds applied to reduce senior borrowings are the full difference between net proceeds of $59.5 million and $36.6 million of subordinated borrowing and accrued interest or $22.9 million. In addition, the pro-forma amounts exclude the amortization of the Debt Discount on the Subordinated debt of approximately $.9 million per year. Because we have provided full valuation allowances for our deferred tax assets in the United States, the reductions to our interest expense would not effect our income tax provision. Therefore we have not adjusted the impact of these pro-forma items to reflect any tax effect.

 

The pro-forma does not include the write off of unamortized debt discount, write-off of any capitalized fees or the value of warrants issued to the debt holders as part of the PIPE transaction. These fees will be written off when the under lying debt is retired. At January 31, 2005 this would amount to $6.9 million in additional charges.

 

The pro-forma interest expense includes the following adjustments:

 

In Thousands    Nine Months
Ended
January 31, 2005


   Year Ended
April 30,
2004


Reduced interest expense on subordinated debt

   $ 5,691    $ 6,607

Reduced interest expense on senior debt

     1,579      1,786
    

  

Total pro forma adjustment to interest expense

   $ 7,270    $ 8,393
    

  

 

The pro-forma weighted average shares outstanding includes the following adjustments:

 

     Nine Months Ended
January 31, 2005


   Year Ended
April 30, 2004


In Thousands    Basic

   Diluted

   Basic

   Diluted

Common shares issued in PIPE Transaction

   17,473    17,473    17,473    17,473

Dilutive potential common shares from warrants

   —      1,345    —      —  
    
  
  
  

Total additional shares included in weighted average shares outstanding

   17,473    18,818    17,473    17,473

Note:

 

The weighted average shares are adjusted for the additional shares issued in the PIPE Transaction, as if they were issued May 1, 2003. Diluted earnings (loss) per share takes into consideration the warrants issued to purchasers of stock in the PIPE Transaction, as well as the anti-dilutional warrants issued to then current warrant holders prior to the PIPE Transaction where their inclusion would be dilutive.

 

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The Company’s potential common stock equivalents on an actual and pro-forma basis were:

 

     January 31, 2005

   April 30, 2004

In Thousands    Actual

   Pro forma

   Actual

   Pro forma

Common stock options

   2,121    2,121    2,089    2,089

Warrants

   1,168    3,219    868    3,219
    
  
  
  

Total

   3,289    5,340    2,957    5,308
    
  
  
  

 

Controls and Procedures

 

In December 2004, in connection with the restatement of our fiscal 2002, 2003 and 2004 financial statements, our independent registered public accounting firm reported to our Audit Committee two matters involving internal controls which our independent registered public accounting firm considered to be material weaknesses in our financial reporting process, as defined by the Public Company Accounting Oversight Board (“PCAOB”) in Auditing Standard No. 2. As defined by the PCAOB, a material weakness is a significant deficiency, or a combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Our management and Audit Committee agreed with the report and we responded to our independent registered public accounting firm on each matter raised in its report and agreed to address each of the deficiencies.

 

The material weaknesses identified by our independent registered public accounting firm were as follows:

 

    Insufficient analysis, documentation and review of the consolidation of the financial statements of subsidiaries. Inadequate processes to ensure the accuracy of the reconciliation of inter-company accounts. Also, we must improve the consolidation process and controls surrounding adequate monitoring and oversight of the work performed by accounting and financial reporting personnel.

 

    Insufficient staffing of the accounting and financial reporting function. The finance and accounting function requires additional personnel with appropriate skills and training to identify and address the application of technical accounting literature to our transactions and activities.

 

These deficiencies in both design and operational effectiveness helped lead to the restatement of fiscal years 2004, 2003 and 2002 and delays in the completion and filing of our July 31, 2004 and October 31, 2004 Forms 10-Q, as described in Note 2 to the Condensed Consolidated Financial Statements, as well as in our Form 10-K/A.

 

Our management and Audit Committee dedicated significant resources to assessing the underlying issues giving rise to the restatements. Management and the Audit Committee reviewed the inter-company account reconciliations, the oversight procedures related to the balancing of inter-company accounts and consolidation and the documentation and monitoring of compliance with the requirements of technical accounting pronouncements. Management and the Audit Committee concluded that our accounting, financial reporting and internal control functions were not sufficient. Accordingly, management presented to the Audit Committee a plan to remedy the issues raised by our independent registered public accounting firm. Management and the Audit Committee are ensuring that proper steps have been and are being taken to improve our control environment and to ensure that we have assigned the highest priority to the correction of these deficiencies.

 

As of January 31, 2005, we had not completed all the necessary corrective actions to fully correct the material weaknesses described above, and accordingly, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective as of January 31, 2005. However, we had put in place compensating procedures which allow us to affirm the reliability of our financial statements as of our most recent reporting period, January 31, 2005.

 

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Management and the Audit Committee remain committed to strong control policies and procedures and will ensure that the ‘tone at the top’ is committed to accuracy and completeness in all financial reporting. In connection with the corrective actions, in addition to utilizing internal resources, the Audit Committee authorized the engagement of a third party financial consulting firm to assist in the detail reconciliation work as well as reviewing current processes and controls and providing assistance in the development of our prospective processes and controls over the inter-company reconciliation process. To date, our corrective actions have included the hiring of two additional accounting staff with appropriate skill levels in order to improve the reconciliation process and increase the oversight ability thereof. We still have one open additional position that has not yet been filled. Additionally, we have increased the level of the documentation surrounding the implementation of accounting rules, and we will perform periodic reviews of the appropriateness of accounting policies and related documentation. Our new controls and procedures are designed to ensure that the reconciliation and elimination of intercompany balances as part of the preparation of our consolidated financial statements, are in accordance with US GAAP, as well as to ensure the proper application of technical accounting literature in the preparation of our financial statements.

 

Specific initiatives that have been implemented with respect to remediating the identified control weaknesses include the following:

 

    Employed two additional accounting staff

 

    Continued training of staff on the application of technical accounting pronouncements, such as FAS 52, pronouncements applicable to financing transactions, and inter-company reconciliations

 

    Created standardized reconciliation templates to assist in the reconciliation process

 

    Created a quarterly review process of those reconciliations by the Chief Financial Officer

 

    Developed a new standard template for completion of the Statement of Cash Flows

 

    Modified our divisional monthly close checklist to help ensure complete and appropriate inter-company reconciliations

 

In addition, the Company is undertaking the following:

 

    Prepare sufficient documentation to support our application of complex accounting standards

 

    Adopt a policy of periodic review of existing accounting policies to ensure continued compliance

 

    Increase review of adherence to corporate polices and procedures

 

While we have hired two additional corporate finance staff, we intend to hire at least one more for the corporate finance department. In addition, we continue to monitor all divisions within the Company and anticipate hiring additional finance personnel in the near future.

 

Management and the Audit Committee will periodically assess the progress and sufficiency of these initiatives and make adjustments as and when necessary. As of the date of this report, management believes that the plan we have implemented, when complete, will eliminate the material weaknesses in internal accounting control as described above. However, management and the Audit Committee do not expect that our disclosure controls or internal controls over financial reporting will prevent all errors or all instances of fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control gaps and instances of fraud have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and any design may not succeed in achieving its stated goals under all potential future conditions.

 

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SELECTED FINANCIAL DATA

 

The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes, which are included elsewhere in this prospectus. The selected consolidated statement of operations data for each of the fiscal years ended April 30, 2002, 2003 and 2004 and the selected consolidated balance sheet data as of April 30, 2003 and 2004 are derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. The selected statement of operations data for each of the fiscal years ended April 30, 2000 and 2001 and balance sheet data as of April 30, 2002, 2001 and 2000 are derived from our unaudited financial statements which are not included in this prospectus. The selected statement of operations data for each of the nine month periods ended January 31, 2004 and 2005 and the selected balance sheet data as of January 31, 2005 are derived from unaudited financial statements, which are included elsewhere in this prospectus.

 

(In thousands, except per share
amounts)
  Year Ended April 30,

  Nine Months Ended

 
  2004(1)

    2003(1)(3)(4)

    2002(1)(2)(4)

    2001(1)

  2000(1)

  January 31,
2005


    January 31,
2004(1)(5)


 
    (restated)     (restated)     (restated)    

(unaudited)

(restated)

 

(unaudited)

(restated)

  (unaudited)     (unaudited)
(restated)
 

Statement of Operations Data:

                                                   

Sales

  $ 177,609     $ 144,115     $ 176,890     $ 204,854   $ 193,638   $ 154,321     $ 123,253  

Operating Income (Loss)

    (1,883 )     (46,657 )     112       14,389     13,298     5,160       (3,559 )

Income (Loss) Before Provision for Income Taxes

    (6,851 )     (56,861 )     (11,367 )     5,635     1,516     (4,408 )     (6,368 )

Income (Loss) Before Discontinued Operations

    (12,048 )     (69,464 )     (8,244 )     4,038     1,252     (6,115 )     (8,443 )

Net Income (Loss)

    (11,522 )     (69,987 )     (7,853 )     1,630     1,255     (6,115 )     (7,917 )

Basic Income (Loss) Per Share Before Discontinued Operations

    (0.78 )     (4.53 )     (0.54 )     0.27     0.09     (0.39 )     (0.55 )

Diluted Income (Loss) Per Share Before Discontinued Operations

    (0.78 )     (4.53 )     (0.54 )     0.27     0.08     (0.39 )     (0.55 )

Basic Income (Loss) Per Share

    (0.75 )     (4.56 )     (0.52 )     0.11     0.09     (0.39 )     (0.52 )

Diluted Income (Loss) Per Share

    (0.75 )     (4.56 )     (0.52 )     0.11     0.08     (0.39 )     (0.52 )

 

    April 30,

  January 31,
2005


 
(In thousands)   2004(1)

    2003(1)

    2002(1)

  2001(1)

  2000(1)

 
    (restated)     (restated)    

(unaudited)

(restated)

 

(unaudited)

(restated)

 

(unaudited)

(restated)

  (unaudited)  

Balance Sheet Data:

                                         

Working Capital

  $ (9,060 )   $ (6,709 )   $ 84,532   $ 91,750   $ 87,552   $ (3,146 )

Total Assets

    135,071       147,701       208,674     206,309     198,893     136,226  

Short-Term Debt

    48,727       61,056       5,237     8,464     9,216     26,442  

Long-Term Obligations, net

    38,081       29,023       83,453     85,652     70,397     45,958  

Shareholders’ (Deficit) Equity

    (9,552 )     4,872       71,054     68,755     68,521     (11,958 )

(1)

We have revised our consolidated financial statements for the years ended April 30, 2004, 2003 and 2002 to reflect charges associated with reconciliations of inter-company transactions, as well as correct the classification of foreign exchange revaluation gains and losses on inter-company balances from Accumulated Other Comprehensive Loss in the Consolidated Balance Sheets to Other Income (Expense), net in the Consolidated Statement of Operations in accordance with FAS 52. In addition, we have corrected the reporting in our Consolidated Statements of Cash Flows for the effects of foreign exchange rate changes on cash for each of the three years in the period ended April 30, 2004. We have reduced the debt discount on our subordinated debt in May 2001 and have thereby reduced the related amortization of this amount to Interest Expenses, net for the years ended April 30, 2004, 2003 and 2002. In addition, we have recorded the

 

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related tax effects of these adjustments. We have also revised the classification, from long-term to current, of our senior credit facility. Lastly, at April 30, 2004, we have reclassified $1.2 million in debt to long-term obligations that was originally reported as a current liability under Notes Payable in the Consolidated Balance Sheets. These restatements were applied to all other financial information presented for earlier years, as appropriate.

(2) The Statement of Operations for fiscal 2002 includes the adoption of Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets”. See Note 1 to the Consolidated Financial Statements for the year ending April 30, 2004 for further discussion of the impact of this adoption.
(3) The Statement of Operations for fiscal 2003 includes the impact of management’s launch of its restructuring program and resulting focus on cash generation. See the ‘Fiscal 2003 Comprehensive Financial Review’ at the end of the ‘Fiscal 2004 Compared to Fiscal 2003’ financial analysis in the Management’s Discussion and Analysis section for further discussion of the impact on our financial results.
(4) See Note 1 to the April 30, 2004 Consolidated Financial Statements for certain reclassifications made to fiscal 2003 and 2002 amounts.
(5) See Note 1 to the January 31, 2005 Condensed Consolidated Financial Statements for certain reclassifications made to the January 31, 2004 amounts.

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Recent Developments:

 

New Senior Debt Agreement –

 

On April 28, 2005 we entered into a new senior debt agreement with Bank of America N.A. and U.S. Bank N.A. Certain other participants in the senior debt agreement did not participate in this new agreement. The agreement provides a $30 million commitment which expires August 1, 2005. This expiration date is consistent with our previous agreement. The new agreement however gave us the ability to pay off our subordinated debt in its entirety, which we did on April 28, 2005. This new senior debt agreement, including covenants, is very similar to the previous senior debt agreement except for the following provisions:

 

    Requires the complete pay-off of subordinated debt

 

    The interest rate has been reduced from prime + 6% to LIBOR + 2.5%

 

    The annualized cost of Letters of Credit has been reduced from 5% to 2.5% of the face amount

 

    The total commitment increased to $30 million, up from the prior debt agreement commitment level of $25.1 million.

 

As the expiration of this new senior debt agreement is August 1, 2005, we have begun negotiations to complete a long term senior debt agreement prior to August 1, 2005.

 

General Press –

 

With authorization from the Board of Directors in September 2004, we engaged the services of Danske Markets, Inc., which is working in Europe in cooperation with CloseAssociates to assist us in the sale of our General Press operations. These businesses are comprised of the North America Press and International Press segments. As these segments do not utilize ultrahigh-pressure water pumps, they are not considered core to our business, and it is our intent to divest ourselves of these operations and use the proceeds, in part, to pay down debt. In January 2005 we began to market these segments by distributing confidential information memorandums. We have received several indications of interest for our General Press business and we have made several management presentations to potential purchasers. Detailed due diligence by one or more potential purchasers has not yet begun. There can be no assurance we will receive an offer acceptable to us for the sale of these segments. If we do divest these businesses, it is anticipated that we will enter into a manufacturing

 

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agreement providing that the purchaser will continue to provide some of the non-high pressure pump components, such as the pressure vessel, used in the Fresher Under Pressure business, which is considered part of the core UHP pump business. These segments do not meet the accounting criteria to be considered assets held for sale and accordingly the results of operations are shown as continuing operations and the related assets have not been reported as held for sale in our financial statements.

 

Operational and Financial

 

Restructuring –

 

Since May 2003, we have been executing a plan intended to return us to profitability through reductions in headcount, consolidation of facilities and operations, and closure or divestiture of selected operations. We further evaluated the workforce and skill levels necessary to satisfy the expected future requirements of the business. As a result, we have implemented plans to eliminate redundant positions and realign and modify certain roles based on skill assessments. We have recorded restructuring charges of $3.3 million and $239,000 for the year ended April 30, 2004 and nine months ended January 31, 2005, respectively, which are shown in the table below (in thousands):

 

    

Year Ended

April 30, 2004


  

Nine Months Ended

January 31, 2005


Severance benefits

   $ 652    $ 120

Facility exit costs

     1,058      119

Inventory write-down

     1,546      —  
    

  

     $ 3,256    $ 239
    

  

 

These charges included employee severance related costs for approximately 50 individuals. The fiscal 2004 reductions in the global workforce were made across manufacturing, engineering and general and administrative functions. We have also recorded facility exit costs for the year ended April 30, 2004 primarily as a result of consolidating our two Kent facilities into one facility, vacating the manufacturing warehouse portion of our Flow Europe facility and reducing the space utilized in our Swedish manufacturing facility. In addition, we scrapped some obsolete parts, returned surplus parts to vendors and sold parts to third parties, in conjunction with the shutdown of our manufacturing operation in Europe and standardization of our product line. The fiscal 2005 restructuring relates to employee reductions in the Food segment as well as closure of our Memphis sales office. See restructuring accrual information in Note 16 to Consolidated Financial Statements for the year ended April 30, 2004 and Note 4 to the Consolidated Financial Statements for the nine months ended January 31, 2005.

 

We incurred professional fees associated with the restructuring of our debt which amounted to $1.5 million during the year ended April 30, 2004 and $623,000 for the nine months ended January 31, 2005.

 

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Table of Contents

Operational Data as a Percentage of Sales

 

     Year Ended April 30,

    Nine Months Ended
January 31,


 
     2004(1)

    2003(1)(2)

    2002(1)(2)

    2005

    2004(1)(2)

 
     (restated)     (restated)     (restated)     (unaudited)     (unaudited)
(restated)
 

Sales

   100 %   100 %   100 %   100 %   100 %

Cost of Sales

   63 %   75 %   62 %   65 %   63 %
    

 

 

 

 

Gross Margin

   37 %   25 %   38 %   35 %   37 %
    

 

 

 

 

Expenses:

                              

Marketing

   16 %   26 %   18 %   16 %   16 %

Research & Engineering

   6 %   9 %   8 %   4 %   7 %

General & Administrative

   13 %   16 %   10 %   12 %   14 %

Restructuring Charges

   2 %   —   %   —   %   —   %   2 %

Financial Consulting Charges

   1 %   —   %   —   %   —   %   —   %

Impairment Charges

   —   %   8 %   2 %   —   %   1 %
    

 

 

 

 

     38 %   59 %   38 %   32 %   40 %
    

 

 

 

 

Operating (Loss) Income

   (1 )%   (34 )%   0 %   3 %   (3 )%

Interest Expense

   (7 )%   (8 )%   (5 )%   (7 )%   (8 )%

Interest Income

   —   %   —   %   —   %   —   %   —   %

Other Income (Expense), net

   4 %   3 %   (1 )%   1 %   6 %
    

 

 

 

 

Loss Before (Provision) Benefit for Income Taxes

   (4 )%   (39 )%   (6 )%   (3 )%   (5 )%

(Provision) Benefit for Income Taxes

   (3 )%   (9 )%   2 %   (1 )%   (2 )%
    

 

 

 

 

Loss Before Discontinued Operations

   (7 )%   (48 )%   (4 )%   (4 )%   (7 )%

Discontinued Operations, Net of Tax

   —   %   (1 )%   —   %   —   %   1 %
    

 

 

 

 

Net Loss

   (7 )%   (49 )%   (4 )%   (4 )%   (6 )%
    

 

 

 

 

 

Operational Overview:

 

     Nine months ended January 31, 2005

   Nine months ended January 31, 2004(2)

 
Dollars in thousands, unaudited    Waterjet

   Avure

   Consolidated

   Waterjet

    Avure(1)

    Consolidated(1)

 
                          (restated)     (restated)  

Sales

   $ 124,136    $ 30,185    $ 154,321    $ 97,859     $ 25,394     $ 123,253  

Cost of Sales

     79,296      20,261      99,557      62,034       15,836       77,870  
    

  

  

  


 


 


Gross Margin

     44,840      9,924      54,764      35,825       9,558       45,383  

Operating Expenses

     39,774      9,830      49,604      37,071       11,871       48,942  
    

  

  

  


 


 


Operating Income (Loss)

   $ 5,066    $ 94    $ 5,160    $ (1,246 )   $ (2,313 )   $ (3,559 )
    

  

  

  


 


 


 

    Year ended April 30, 2004

    Year ended April 30, 2003(2)

    Year ended April 30, 2002(2)

 
Dollars in thousands   Waterjet

    Avure(1)

    Consolidated(1)

    Waterjet

    Avure

    Consolidated

    Waterjet(1)

    Avure(1)

  Consolidated(1)

 
          (restated)     (restated)                       (restated)     (restated)   (restated)  

Sales

  $ 132,861     $ 44,748     $ 177,609     $ 121,833     $ 22,282     $ 144,115     $ 127,763     $ 49,127   $ 176,890  

Cost of Sales

    83,604       28,778       112,382       88,620       19,454       108,074       79,844       29,285     109,129  
   


 


 


 


 


 


 


 

 


Gross Margin

    49,257       15,970       65,227       33,213       2,828       36,041       47,919       19,842     67,761  

Operating Expenses

    50,934       16,176       67,110       60,335       24,405       84,740       49,558       18,318     67,876  
   


 


 


 


 


 


 


 

 


Operating (Loss) Income

  $ (1,677 )   $ (206 )   $ (1,883 )   $ (27,122 )   $ (21,577 )   $ (48,699 )   $ (1,639 )   $ 1,524   $ (115 )
   


 


 


 


 


 


 


 

 



(1) As described in Note 2 to the Consolidated Financial Statements, we have restated our consolidated financial statements for the years ended April 30, 2004, 2003, and 2002 to reflect charges associated with reconciliations of inter-company transactions and other adjustments.
(2) See Notes 1 to the Consolidated Financial Statements as of April 30, 2004 and January 31, 2005 for certain reclassifications made to fiscal 2003, 2002 and January 31, 2004 amounts.

 

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Sales Summary:

 

     Nine Months Ended January 31,

 
Dollars in thousands    2005

   2004

   % Change

 

Operational breakdown:

                    

Waterjet:

                    

Systems

   $ 86,541    $ 62,091    39 %

Consumable parts and services

     37,595      35,768    5 %
    

  

      

Total

     124,136      97,859    27 %

Avure:

                    

Fresher Under Pressure

     8,881      9,159    (3 )%

General Press

     21,304      16,235    31 %
    

  

      

Total

     30,185      25,394    19 %
    

  

      
     $ 154,321    $ 123,253    25 %
    

  

      

Geographic breakdown:

                    

United States

   $ 90,230    $ 64,463    40 %

Rest of Americas

     13,900      13,166    6 %

Europe

     31,510      30,414    4 %

Asia

     18,681      15,210    23 %
    

  

      
     $ 154,321    $ 123,253    25 %
    

  

      

 

    Year ended April 30,

    Year ended April 30,

 
Dollars in thousands   2004

  2003

  % Change

    2003

  2002

  % Change

 

Operational breakdown:

                                   

Waterjet:

                                   

Systems

  $ 85,015   $ 76,346   11 %   $ 76,346   $ 88,995   (14 )%

Consumable parts and services

    47,846     45,487   5 %     45,487     38,768   17 %
   

 

 

 

 

     

Total

    132,861     121,833   9 %     121,833     127,763   (5 )%

Avure:

                                   

Fresher Under Pressure

    15,296     4,851   215 %     4,851     11,917   (59 )%

General Press

    29,452     17,431   69 %     17,431     37,210   (53 )%
   

 

 

 

 

     

Total

    44,748     22,282   101 %     22,282     49,127   (55 )%
   

 

 

 

 

     
    $ 177,609   $ 144,115   23 %   $ 144,115   $ 176,890   (19 )%
   

 

       

 

     

Geographic breakdown:

                                   

United States

  $ 97,546   $ 79,450   23 %   $ 79,450   $ 95,853   (17 )%

Rest of Americas

    13,004     15,673   (17 )%     15,673     13,364   17 %

Europe

    46,557     31,326   49 %     31,326     52,757   (41 )%

Asia

    20,502     17,666   16 %     17,666     14,916   18 %
   

 

 

 

 

     
    $ 177,609   $ 144,115   23 %   $ 144,115   $ 176,890   (19 )%
   

 

       

 

     

 

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Results of Operations

 

We analyze our business based on the utilization of ultrahigh-pressure, either as released pressure or contained pressure. The released pressure portion of our UHP business which we call Waterjet, is comprised of the following segments: North America Waterjet, Asia Waterjet, Other International Waterjet and Other. The contained pressure operation which is what we call Avure, is made up of the Food, North America Press and International Press segments.

 

Nine Months Ended January 31, 2005 Compared to Nine Months Ended January 31, 2004 (Restated—See Note 2 to the January 31, 2005 Consolidated Financial Statements). See Note 1 to the Condensed Consolidated Financial Statements for certain reclassifications made to the nine months ended January 31, 2004 amounts. (Tabular amount in thousands)

 

Sales.

 

Our sales by segment for the periods noted below is summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

   2004

   Difference

    %

 

Sales

                            

Waterjet:

                            

North America

   $ 57,967    $ 42,656    $ 15,311     36 %

Asia

     18,681      15,210      3,471     23 %

Other International

     23,686      21,155      2,531     12 %

Other

     23,802      18,838      4,964     26 %
    

  

  


     

Waterjet Total

     124,136      97,859      26,277     27 %

Avure:

                            

Food

     8,881      9,159      (278 )   (3 )%

North America Press

     11,215      4,784      6,431     134 %

International Press

     10,089      11,451      (1,362 )   (12 )%
    

  

  


     

Avure Total

     30,185      25,394      4,791     19 %
    

  

  


     

Consolidated Total

   $ 154,321    $ 123,253    $ 31,068     25 %
    

  

  


     

 

Waterjet. The Waterjet operation includes cutting and cleaning operations, which are focused on providing total solutions for the aerospace, automotive, job shop, surface preparation (cleaning) and paper industries. It is comprised of four reporting segments: North America Waterjet, Asia Waterjet, Other International Waterjet and Other. The North America, Asia and Other International Waterjet segments primarily represent sales of our standard cutting and cleaning systems throughout the world, as well as sales of our custom designed systems into the aerospace industry. The ‘Other’ segment represents sales of our automation and robotic waterjet cutting cells which are sold primarily into the North American automotive industry. For the nine months ended January 31, 2005, we reported a $26.3 million, or 27%, increase to $124.1 million versus the prior year comparative period. All four segments reported an increase in revenue; however $15.3 million of the $26.3 million increase was recognized in our North America Waterjet segment. At the end of fiscal 2004, we believed the market awareness of waterjet technology was low and addressed this through an increase in marketing and tradeshow activity, including attendance at the bi-annual International Manufacturing Technology Show in early September, as well as increasing the number of domestic waterjet cutting direct sales staff from 10 to 15, adding two machine tool distributors and increasing domestic technical services staff from 12 to 24 persons. The growth in revenue in North America is a result of an increase in unit sales stemming from our increased sales and marketing activity.

 

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Table of Contents

There were no significant price increases year over year. Aerospace sales, which are also included in the North America segment, were $2.4 million for the nine months ended January 31, 2005, down $.9 million from the prior year nine month period. The growth in our ‘Other’ segment results from improved demand in the domestic automotive industry. We have not increased our marketing and sales staff in this segment year over year. Our waterjets are experiencing growing acceptance in the marketplace because of their flexibility and superior machine performance.

 

Outside the U.S., Waterjet revenue growth was positively influenced by growth in Asia Waterjet sales which were $18.7 million, up $3.5 million or 23% for the nine months ended January 31, 2005. This increase was driven largely by sales in China where we experienced strong demand for shapecutting and cutting cell systems from a strengthening automotive industry.

 

Our Other International Waterjet segment represents primarily sales into Europe and South America. Revenues from our European operations have improved by $2.5 million for the nine months ended January 31, 2005 to $21.4 million. Market specific pricing including some price reductions, standardization of system offerings, improved delivery and a recovering European marketplace have helped to increase our European sales. Sales into South America of $2.3 million for the nine months ended January 31, 2005 is comparable to the respective prior year period. The economic conditions in the South America region make it difficult to grow sales. We are typically able to sell our products at higher prices outside the U.S. due to the costs of servicing these markets. As much of our product is manufactured in the U.S., the weakness of the U.S. dollar also has helped strengthen our foreign revenues.

 

We also analyze our Waterjet revenues by looking at system sales and consumable sales. Systems revenues for the nine months ended January 31, 2005 were $86.5 million, an increase of $24.4 million or 39%, compared to the prior year same period due to both strong domestic and global sales from recovering economic conditions. The majority, $18.1 million, of the increase was generated domestically. Consumables revenues recorded an increase of $1.8 million or 5% to $37.6 million for the nine months ended January 31, 2005. The majority of the increase in spares sales is domestic and is the result of the increasing number of operating systems, increasing sales of our proprietary productivity enhancing kits, improved parts availability, as well as increased customer acceptance of Flowparts.com, our easy-to-use internet order entry system. We believe that spare parts sales should continue to increase as more systems are put into operation.

 

Avure. The Avure operation includes the Fresher Under Pressure technology (Food segment) as well as General Press operations (North America Press and International Press segments). Revenue in the Avure operations is recorded on the percentage of completion basis. Fresher Under Pressure meets the increasing demand in the U.S. for a post packaging, terminal pasteurization-like step (e.g. packaged ready-to-eat meats); the demand for high quality, minimally processed foods (e.g. fresh guacamole and salsas); and the demand to utilize the productivity enhancing capabilities of UHP in food processing (e.g. shellfish shucking), while the General Press business manufactures systems which produce and strengthen advanced materials for the aerospace, automotive and medical industries. For the nine months ended January 31, 2005, sales for the Food segment decreased $.3 million or 3%, respectively. Revenues for the nine month year to date period are comparable to the prior year.

 

As outlined in the table above, North American Press sales have grown in the nine months ended January 31, 2005 as compared to the prior year period. This growth is the result of revenue recognized under two large contracts obtained in fiscal 2004 and manufactured in fiscal 2005.

 

International Press sales for the nine months ended January 31, 2005 decreased $1.4 million as compared to the like period in the prior year. The International Press sales are almost exclusively large contract sales in excess of $2 million per contract and accordingly revenue will vary depending on the number and stage of manufacture of these contracts. The sales and production cycle on a General Press can range from one to four years in length.

 

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Table of Contents

Cost of Sales and Gross Margins.

 

Our gross margin by segment for the periods noted below is summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

   2004

   Difference

    %

 

Gross Margin

                            

Waterjet:

                            

North America

   $ 25,985    $ 17,833    $ 8,152     46 %

Asia

     8,533      7,214      1,319     18 %

Other International

     8,063      7,205      858     12 %

Other

     2,259      3,573      (1,314 )   (37 )%
    

  

  


     

Waterjet Total

     44,840      35,825      9,015     25 %

Avure:

                            

Food

     1,372      842      530     63 %

North America Press

     1,304      780      524     67 %

International Press

     7,248      7,936      (688 )   (9 )%
    

  

  


     

Avure Total

     9,924      9,558      366     4 %
    

  

  


     

Consolidated Total

   $ 54,764    $ 45,383    $ 9,381     21 %
    

  

  


     

 

Our gross margin as a percent of sales by segment for the periods noted below is summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

    2004

 

Gross Margin Percentage

            

Waterjet:

            

North America

   45 %   42 %

Asia

   46 %   47 %

Other International

   34 %   34 %

Other

   9 %   19 %

Waterjet Total

   36 %   37 %

Avure:

            

Food

   15 %   9 %

North America Press

   12 %   16 %

International Press

   72 %   69 %

Avure Total

   33 %   38 %

Consolidated Total

   35 %   37 %

 

Gross margin for the nine months ended January 31, 2005 amounted to $54.8 million or 35% of sales as compared to gross margin of $45.3 million or 37% of sales in the prior year same period. Generally, gross margin rates will vary period over period depending on the mix of sales, which includes special system, standard system and consumables sales. Gross margin rates on our systems sales are typically less than 45% as opposed to consumables sales which are in excess of 50%. On average, standard systems which are included in the North America, Asia and Other International Waterjet segments carry higher margins than the custom engineered systems, which are represented by the Other, Food, North America Press and International Press segments. In addition, gross margin as a percent of sales will vary amongst segments due to inter-company sales and the related inter-company transfer pricing.

 

For the nine months ended January 31, 2005, waterjet margins represented $44.8 million of the overall consolidated margin or 36% of Waterjet sales. Waterjet operations gross margin percentage decreased from 37% of sales in fiscal 2004 to 36% in fiscal 2005. The primary driver of this decrease was the 10 percentage point

 

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decrease in margins in the Other segment to 9% of sales in fiscal 2005. This weakness stems from a number of very low margin contracts built in the first nine months of the year including several loss contracts which totaled $.8 million. We have consolidated the management of this division within the Other segment and current contracts appear to be in line with historical gross margins in the automotive industry, between 15% and 25%. This weakness was partially offset by an improved margin percent in North America Waterjet related to increased sales.

 

Avure margins amounted to $9.9 million of the overall consolidated margin or 33% of Avure sales. Food segment margin percentages improved in the current year as the prior year included several strategic sales at almost a zero margin. These sales represented the initial sale of equipment into the Ready-to Eat meat industry made in an effort to try and accelerate market adoption and the sale of a development project into the seafood industry that has other industry applications. The North America Press segment margin dollars have increased; however, the margin percentage has decreased for the nine months ended January 31, 2005 compared to the prior year period. This is the result of a shift in product mix in fiscal 2005 towards equipment manufactured by the International Press segment, for which the margins recognized by North America Press are lower due to our inter-company transfer pricing policies. International Press segment margins increased slightly to 72%. The International Press margin is the result of gross profit on external sales and gross profit on inter-company sales. Our segment reporting excludes inter-company sales, but not the related margins. On a year to date basis however, inter-company production is up which has resulted in an increase in the International Press margin percentage to 72%. Gross margin percentages on similar type projects remain the same year over year.

 

Marketing Expenses.

 

Our marketing expenses by segment for the periods noted below are summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

   2004

   Difference

    %

 

Marketing

                            

Waterjet:

                            

North America

   $ 10,686    $ 6,856    $ 3,830     56 %

Asia

     2,678      2,134      544     25 %

Other International

     6,021      5,575      446     8 %

Other

     1,242      1,268      (26 )   (2 )%
    

  

  


     

Waterjet Total

     20,627      15,833      4,794     30 %

Avure:

                            

Food

     1,054      1,111      (57 )   (5 )%

North America Press

     468      349      119     34 %

International Press

     1,767      2,401      (634 )   (26 )%
    

  

  


     

Avure Total

     3,289      3,861      (572 )   (15 )%
    

  

  


     

Consolidated Total

   $ 23,916    $ 19,694    $ 4,222     21 %
    

  

  


     

 

Marketing expenses increased $4.2 million or 21% to $23.9 million for the nine months ended January 31, 2005 as compared to the prior year same period. Waterjet increased $4.8 million or 30% and Avure decreased $.6 million or 16% as compared to the prior year period. Waterjet experienced the increase in North America as a result of improved sales and the market awareness programs being put in place. Fiscal 2005 also includes over $.5 million in costs associated with the bi-annual International Manufacturing Technology Show held during the second quarter ended October 31, 2004. Asia and Other International Waterjet recorded cost increases in line with changes in sales and the Other segment held marketing costs constant. Within Avure, all of the decrease is attributable to International Press, due to both cost cutting and lower sales. Expressed as a percentage of revenue, consolidated marketing expenses were 15% for the nine months ended January 31, 2005. This compares to 16% of sales for the prior year same period.

 

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Table of Contents

Research and Engineering Expenses.

 

Our research and engineering expenses by segment for the periods noted below are summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

   2004

   Difference

    %

 

Research and Engineering

                            

Waterjet:

                            

North America

   $ 3,068    $ 3,804    $ (736 )   (19 )%

Asia

     254      211      43     20 %

Other International

     536      605      (69 )   (11 )%

Other

     99      275      (176 )   (64 )%
    

  

  


     

Waterjet Total

     3,957      4,895      (938 )   (19 )%

Avure:

                            

Food

     1,270      1,174      96     8 %

North America Press

     —        —        —       %

International Press

     1,450      2,721      (1,271 )   (47 )%
    

  

  


     

Avure Total

     2,720      3,895      (1,175 )   (30 )%
    

  

  


     

Consolidated Total

   $ 6,677    $ 8,790    $ (2,113 )   (24 )%
    

  

  


     

 

Research and engineering expenses decreased $2.1 million or 24% for the nine months ended January 31, 2005 as compared to the prior year same period. Waterjet generated $.9 million of the decrease while Avure decreased $1.2 million. These decreases are related to the timing of research and development work, the increased use of engineers on revenue generating projects and continued cost cutting across most segments, most notably, North America Waterjet and International Press. Expressed as a percentage of revenue, research and engineering expenses were 4% for the nine months ended January 31, 2005, as compared to 7% for the nine months ended January 31, 2004.

 

General and Administrative Expenses.

 

Our general and administrative expenses by segment for the periods noted below are summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

   2004

   Difference

    %

 

General and Administrative

                            

Waterjet:

                            

North America

   $ 10,393    $ 8,994    $ 1,399     16 %

Asia

     896      813      83     10 %

Other International

     1,891      1,983      (92 )   (5 )%

Other

     1,387      1,457      (70 )   (5 )%
    

  

  


     

Waterjet Total

     14,567      13,247      1,320     10 %

Avure:

                            

Food

     801      998      (197 )   (20 )%

North America Press

     563      497      66     13 %

International Press

     2,218      2,102      116     6 %
    

  

  


     

Avure Total

     3,582      3,597      (15 )   %
    

  

  


     

Consolidated Total

   $ 18,149    $ 16,844    $ 1,305     8 %
    

  

  


     

 

General and administrative expenses increased $1.3 million or 8% for the nine months ended January 31, 2005, as compared to the prior year same period. The North America Waterjet segment accounts for $1.4 million

 

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of the $1.3 million increase in expense. This includes increased professional fees of $750,000 associated with patent litigation and our accounting restatement and an increase in incentive compensation accruals of $505,000. As a percent of sales, however, North America Waterjet general and administrative expenses decreased from 21% to 18%. Expressed as a percentage of revenue, consolidated general and administrative expenses were 12% as compared to 14% for the prior year period.

 

Restructuring Expenses. During the nine months ended January 31, 2005, we incurred $.2 million of severance benefits and facility exit costs in the Food segment. During the nine months ended January 31, 2004, we incurred $2.3 million of restructuring costs. These costs, which represent both severance and facility exit costs, were recognized in the Waterjet operations, primarily in Other International and Other Waterjet.

 

The following table summarizes accrued restructuring activity (in thousands):

 

    North
America
Waterjet


    Other
Inter-
national
Waterjet


    Food

    International Press

    Consolidated

 
    Facility
Exit
Costs


   

Facility

Exit

Costs


    Severance
Benefits


   

Facility

Exit

Costs


    Severance
Benefits


   

Facility

Exit

Costs


    Severance
Benefits


   

Facility

Exit

Costs


    Total

 

Balance, April 30, 2004

  $ 139     $ 333     $ —       $ —       $ 244     $ 191     $ 244     $ 663     $ 907  

Q1 restructuring charge

    0       0       0       0       0       —         0       0       0  

Q1 cash payments

    (9 )     (4 )     0       —         (68 )     (3 )     (68 )     (16 )     (84 )
   


 


 


 


 


 


 


 


 


Balance, July 31, 2004

    130       329       —         —         176       188       176       647       823  

Q2 restructuring charge

    0       0       0       —         —         0       0       0       0  

Q2 cash payments

    (9 )     (4 )     —         —         (64 )     (3 )     (64 )     (16 )     (80 )
   


 


 


 


 


 


 


 


 


Balance, October 31, 2004

    121       325       —         0       112       185       112       631       743  

Q3 restructuring charge

    0       0       120       119       0       0       120       119       239  

Q3 cash payments

    (9 )     (10 )     (17 )     (39 )     (39 )     (3 )     (56 )     (61 )     (117 )
   


 


 


 


 


 


 


 


 


Balance, January 31, 2005

  $ 112     $ 315     $ 103     $ 80     $ 73     $ 182     $ 176     $ 689     $ 865  

 

Financial Consulting Expenses. During the nine months ended January 31, 2005, we incurred $.6 million of financial consulting costs. For the nine months ended January 31, 2004 we incurred $1.2 million of similar costs associated with refinancing attempts in fiscal 2004.

 

Operating Income (Loss).

 

Our operating income (loss) by segment for the periods noted below are summarized as follows:

 

     Nine Months Ended January 31,

 
     2005

    2004

    Difference

    %

 

Operating Income (Loss)

                              

Waterjet:

                              

North America

     1,215       (3,806 )     5,021     (132 )%

Asia

     4,705       4,056       649     16 %

Other International

     (385 )     (1,970 )     1,585     (80 )%

Other

     (469 )     474       (943 )   (199 )%
    


 


 


     

Waterjet Total

     5,066       (1,246 )     6,312     NM  

Avure:

                              

Food

     (1,992 )     (2,567 )     575     (22 )%

North America Press

     273       (66 )     339     NM  

International Press

     1,813       320       1,493     NM  
    


 


 


     

Avure Total

     94       (2,313 )     2,407     (104 )%
    


 


 


     

Consolidated Total

   $ 5,160     $ (3,559 )   $ 8,719     NM  
    


 


 


     

NM = Not Meaningful

 

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Table of Contents

Our operating income for the nine months ended January 31, 2005 was $5.2 million as compared to an operating loss of $3.6 million for the nine months ended January 31, 2004. The reasons for the changes in operating profit or loss by segment have been described in the paragraphs above addressing changes in sales, gross margin and operating expenses.

 

Interest and Other Income (Expense), net. Current interest expense, net increased to $10.6 million for the nine months ended January 31, 2005. This net amount included $88,000 of interest income. The fiscal 2005 interest expense, net increased $1 million for the nine months ended January 31, 2005 as compared to the prior year. This increase results from higher interest rates and increased fee amortization associated with the July 2004 amendments to both the senior and subordinated credit agreements, offset in part by a lower average debt balance outstanding. During the nine months ended January 31, 2005, we recorded Other Income, net of $1.1 million. This compares to Other Income, net of $6.8 million in the prior year nine month period. Other income in fiscal 2005 is comprised primarily of net foreign exchange gains and losses. Other income, net in fiscal 2004 includes a $2.6 million gain on the sale of investment securities we held and net foreign exchange gains and losses.

 

The following table shows the detail of Other Income (Expense), net, in the accompanying Consolidated Statements of Operations:

 

     Nine Months Ended
January 31,


 
     2005

    2004

 

Net realized foreign exchange gains

   $ 2,993     $ 842  

Net unrealized foreign exchange gains (losses)

     (1,838 )     3,527  

Realized gain on sale of equity securities

     —         2,618  

Minority interest in joint venture

     (153 )     10  

Other

     62       (181 )
    


 


Total

   $ 1,064     $ 6,816  
    


 


 

Income Taxes. For the nine months ended January 31, 2005 and 2004, the tax provision consists of current expense related to operations in foreign jurisdictions which are profitable, primarily in Taiwan and Japan. In addition, operations in certain jurisdictions (principally Germany and the United States) reported net operating losses for which no tax benefit was recognized as it is more likely than not that such benefit will not be realized. During the fourth quarter of fiscal 2004, as a result of foreign asset collateral requirements and our amended credit agreements, we were no longer able to permanently defer foreign earnings and recorded a $1.9 million liability for withholding taxes payable on future repatriation of foreign earnings. We also recorded a U.S. tax liability of $6.7 million on foreign earnings which we have decided to no longer permanently defer. The total $6.7 million tax liability was offset by a reduction of the valuation allowance. In addition, we continue to assess our ability to realize our net deferred tax assets. Recognizing the continued losses generated during fiscal 2005 and in prior periods, we have determined it appropriate to continue to maintain a valuation allowance on our domestic net operating losses, certain foreign net operating losses and certain other deferred tax assets based on the expected reversal of both deferred tax assets and liabilities. The domestic net operating losses can be carried forward 20 years to offset domestic profits in future periods and expire in fiscal 2023 if not used. Our foreign net operating losses currently do not have an expiration date. We provided a full valuation allowance against the deferred tax assets associated with the losses recorded during fiscal 2005.

 

Net Loss. For the nine months ended January 31, 2005, our consolidated net loss was $6.1 million or $.39 per basic and diluted loss per share as compared to a net loss of $7.9 million, or $.52 basic and diluted loss per share in the prior year same period.

 

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Table of Contents

Fiscal 2004 Compared to Fiscal 2003 (Restated—See Note 2 to the April 30, 2004 Consolidated Financial Statements) See Note 1 to the Consolidated Financial Statements for certain reclassifications made to fiscal 2003 amounts. (Tabular amounts in thousands)

 

Sales.

 

Our sales by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

  

Dollar

Change


   

Percent

Change


 
     2004

   2003

    

Sales

                            

Waterjet:

                            

North America

   $ 59,044    $ 53,995    $ 5,049     9 %

Asia

     20,502      17,667      2,835     16 %

Other International

     28,160      23,279      4,881     21 %

Other

     25,155      26,892      (1,737 )   (6 )%
    

  

  


     

Waterjet Total

     132,861      121,833      11,028     9 %

Avure:

                            

Food

     15,296      4,851      10,445     215 %

North America Press

     7,445      7,668      (223 )   -3 %

International Press

     22,007      9,763      12,244     125 %
    

  

  


     

Avure Total

     44,748      22,282      22,466     101 %
    

  

  


     

Consolidated Total

   $ 177,609    $ 144,115    $ 33,494     23 %
    

  

  


     

 

Waterjet. For the year ended April 30, 2004, total Waterjet revenue increased $11.1 million or 9% to $132.9 million from $121.8 million in the prior year. All of this growth was recorded in the North America, Asia and Other International Waterjet segments, driven by market demand for our dynamic waterjet cutting head and improved global market conditions in the primary industries we serve. This growth was all volume related as we did not increase prices during fiscal 2004.

 

Included in the $5.0 million increase in fiscal 2004 in North American waterjet sales is a $3.3 million or 6% revenue increase over the prior year period for sales of our domestic standard waterjet cutting systems, as compared to the domestic machine cutting tool market, which recorded a year over year improvement of 12%, according to the Association for Manufacturing Technology (“AMT”). We do not believe that our shapecutting equipment business is as subject to cyclical fluctuations as the traditional methods tracked by the AMT. The broader machine tool market is recovering from historical lows. Our waterjets are experiencing continued acceptance in the marketplace from their flexibility and superior machine performance. The remainder of the North America Waterjet increase relates to an increase in our aerospace business, which totalled $4.1 million in fiscal 2004 driven by the manufacture of the Airbus A380. North American automotive and automation (our ‘Other’ segment) sales decreased 6% or $1.7 million in fiscal 2004 as compared to fiscal 2003 due to the cyclical nature of the automotive industry.

 

Outside the U.S., Waterjet revenue growth was positively influenced by growth in Asian revenues which were up $2.8 million or 16% for the year ended April 30, 2004 to $20.5 million, compared to $17.7 million in the prior year. These increases were driven largely by sales in Japan where we experienced strong demand for our surface preparation and shapecutting systems, due in part to the refurbishment program for U.S. Navy ships based in Japan.

 

Our Other International Waterjet segment represents primarily sales into Europe and South America. Revenues from our European operations have improved by $3.0 million or 14% to $24.6 million during fiscal 2004. Market specific pricing and standardization of system offerings and a recovering European marketplace contributed to this improvement. Sales into South America are up $1.9 million due to improvements in sales of surface preparation equipment.

 

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Table of Contents

We also analyze our Waterjet revenues by looking at system sales and consumable sales. Systems revenues for the year ended April 30, 2004 were $85.0 million, an increase of $8.7 million or 11%, compared to the prior fiscal year due to strong global sales from recovering economic conditions driven by a weaker U.S. dollar. Consumables revenues also recorded an improvement of 5% or $2.3 million to $47.8 million for the year ended April 30, 2004, compared to the prior year consumable revenue of $45.5 million. This is due to increased machine utilization by our customers in North and South America and Asia, all of which led to higher parts consumption. Consumables revenue continues to be positively impacted by our proprietary productivity enhancing kits and improved parts availability as well as the introduction of Flowparts.com, our easy-to-use internet order entry system.

 

Avure. For the year ended April 30, 2004, revenues for the Food segment were $15.3 million, representing a $10.4 million, or 215% improvement, compared to the prior year’s revenue of $4.9 million. A portion of this increase can be attributed to the reversal in the prior year of $4.3 million of percentage of completion revenue previously recognized on three food systems (one customer) based on the customer’s failure to fulfill its obligations under the contract terms. Additionally, in fiscal 2004, we were able to record revenue of $3.7 million on fiscal 2003 orders where we delivered already-completed systems. These orders did not qualify for percentage of completion accounting and the corresponding revenue was recognized upon delivery and acceptance in fiscal 2004 of the systems that were sold. Increased acceptance of the technology drove the remainder of the growth.

 

For the year ended April 30, 2004, North America Press sales were essentially flat with the prior year at $7.4 million.

 

International Press revenues for the year ended April 30, 2004 increased 117% or $11.9 million from $10.1 million for the prior year to $22.0 million, on stronger order volume and production. Order and production volumes were significantly weaker in 2003 due to lower demand for industrial products following the September 2001 attacks. The majority of this revenue increase occurred in Europe and, accordingly, net consolidated revenues in Europe have increased over the prior year.

 

Cost of Sales and Gross Margins.

 

Our gross margin by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

             
     2004

   2003

   

Dollar

Change


   

Percent

Change


 

Gross Margin

                             

Waterjet:

                             

North America

   $ 25,170    $ 21,408     $ 3,762     18 %

Asia

     9,762      7,702       2,060     27 %

Other International

     9,890      1,782       8,108     NM  

Other

     4,435      2,321       2,114     91 %
    

  


 


     

Waterjet Total

     49,257      33,213       16,044     48 %

Avure:

                             

Food

     1,788      (5,099 )     6,887     135 %

North America Press

     1,109      1,375       (266 )   (19 )%

International Press

     13,073      6,552       6,521     100 %
    

  


 


     

Avure Total

     15,970      2,828       13,142     NM  
    

  


 


     

Consolidated Total

   $ 65,227    $ 36,041     $ 29,186     81 %
    

  


 


     

NM=Not meaningful

 

30


Table of Contents

Our gross margin percentage by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

 
     2004

    2003

 

Gross Margin Percent

            

Waterjet:

            

North America

   43 %   40 %

Asia

   48 %   44 %

Other International

   35 %   8 %

Other

   18 %   9 %
    

 

Waterjet Total

   37 %   27 %

Avure:

            

Food

   12 %   -105 %

North America Press

   15 %   18 %

International Press

   59 %   67 %
    

 

Avure Total

   36 %   13 %
    

 

Consolidated Total

   37 %   25 %
    

 

 

Gross margin for the year ended April 30, 2004 amounted to $65.2 million or 37% of revenues, as compared to gross margin of $36.0 million or 25% of revenues in the prior year. Fiscal 2003 gross margin was negatively impacted by a number of adjustments posted during the third quarter of that year which totalled $11.1 million. Waterjet margins represented $49.2 million of the overall margin or 37% of Waterjet revenues. We experienced improvement in the gross margin as a percent of revenues in each of the four segments that comprise the Waterjet operations. This gross margin improvement of 10 percentage points, 37% of revenues in fiscal 2004 compared to 27% of revenues in the prior year, was a result of better overhead absorption in light of higher sales volumes of $11 million in the year and on fiscal 2003 inventory valuation adjustments of $6.2 million which did not recur in 2004.

 

The Avure margins amounted to $16.0 million or 36% of Avure revenues, up from $2.8 million or 13% of revenues in the prior year. This improvement in margin of $13.1 million was achieved in both the Food segment and International Press segment of Avure. In fiscal 2004 the Food gross margin was $1.8 million or 12% of revenues, up from a gross loss of $5.1 million in the prior year. This improvement resulted from increased production volumes and $4.9 million in prior year adjustments related to percentage of completion and inventory valuation in the Food segment. While gross margin dollars increased in International Press due to higher volumes, the gross margin percentages in both the North America Press and International Press declined slightly in fiscal 2004 as compared to fiscal 2003. The decrease in North America Press is related to slightly declining sales and change in product mix. The International Press margin is the result of gross profit recognized on external as well as inter-company sales. The Company’s segment reporting excludes inter-company sales but not the related gross profit margins. The decrease in margin on International Press results from increases on external sales at a greater rate than the increase in inter-company gross profit. Gross margins on International Press external sales were constant in 2004 and 2003.

 

Marketing Expenses.

 

Our marketing expense by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

            
     2004

   2003

   Dollar Change

    Percent Change

 

Marketing

                            

Waterjet:

                            

North America

   $ 10,109    $ 12,713    $ (2,604 )   (20 )%

Asia

     3,022      3,008      14     0 %

Other International

     7,750      10,684      (2,934 )   (27 )%

Other

     1,822      2,780      (958 )   (34 )%
    

  

  


 

Waterjet Total

     22,703      29,185      (6,482 )   (22 )%

 

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Table of Contents
     Year Ended April 30,

            
     2004

   2003

   Dollar Change

    Percent Change

 

Avure:

                            

Food

     1,658      3,644      (1,986 )   (55 )%

North America Press

     499      655      (156 )   (24 )%

International Press

     3,562      3,914      (352 )   (9 )%
    

  

  


 

Avure Total

     5,719      8,213      (2,494 )   (30 )
    

  

  


 

Consolidated Total

   $ 28,422    $ 37,398    $ (8,976 )   (24 )%
    

  

  


 

 

Marketing expenses decreased $9.0 million or 24% to $28.4 million for the year ended April 30, 2004, as compared to the prior year marketing expenses of $37.4 million. The majority of this decrease, $6.5 million, was achieved in the Waterjet operations, while $2.5 million of the decrease was recognized in Avure.

 

Fiscal 2003 included a $4.1 million charge, in the Waterjet operations, to the allowance for doubtful accounts based on our assessment of the financial conditions of our individual customers and general marketplace conditions. The predominance of this increase in the allowance was recorded in the Other International Waterjet segment. The remainder of the reduction in Waterjet marketing expenses over the prior year results from the implementation of cost cutting measures during fiscal 2004 aimed at providing return on invested marketing dollars, as well as the fact that the fiscal 2003 North America Waterjet segment includes the costs of participation at the 2003 bi-annual IMTS tradeshow of approximately $500,000.

 

Within Avure, the Food segment expense in fiscal 2003 included a $1.2 million discount provided to a customer for early pay-off of long-term notes. All segments experienced decreases in expenses as a result of cost cutting measures in fiscal 2004. Expressed as a percentage of revenue, marketing expenses were 16% and 26% for the years ended April 30, 2004 and 2003, respectively.

 

Research and Engineering Expenses.

 

Our research and engineering expense by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

            
     2004

   2003

   Dollar Change

    2004

 

Research and Engineering

                            

Waterjet:

                            

North America

   $ 4,082    $ 4,332    $ (250 )   (6 )%

Asia

     295      278      17     6 %

Other International

     737      951      (214 )   (23 )%

Other

     337      688      (351 )   (51 )%
    

  

  


 

Waterjet Total

     5,451      6,249      (798 )   (13 )%
    

  

  


 

Avure:

                            

Food

     1,583      2,523      (940 )   (37 )%

North America Press

     —        —        —       —   %

International Press

     3,617      4,729      (1,112 )   (24 )%
    

  

  


 

Avure Total

     5,200      7,252      (2,052 )   (28 )%
    

  

  


 

Consolidated Total

   $ 10,651    $ 13,501    $ (2,850 )   (21 )%
    

  

  


 

 

Research and engineering expenses decreased $2.8 million or 21% to $10.7 million for the year ended April 30, 2004, as compared to the prior year’s research and engineering expenses of $13.5 million. Approximately $2 million of this decrease was achieved in the Avure segments: $.9 million in Food and $1.1 million in International Press. The remaining $.8 million decrease in Waterjet is spread evenly throughout all segments within Waterjet except Asia, which was flat with the prior year. The reductions in all segments, relate to the

 

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timing of research and development work and the increased use of engineers on revenue generating projects, where costs are charged to Cost of Sales. Expressed as a percentage of revenue, research and engineering expenses were 6% and 9% for the years ended April 30, 2004 and 2003, respectively.

 

General and Administrative Expenses.

 

Our general and administrative expense by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

            
     2004

   2003

   Dollar
Change


    2004

 

General and Administrative

                            

Waterjet:

                            

North America

   $ 12,767    $ 10,835    $ 1,932     18 %

Asia

     1,146      983      163     17 %

Other International

     3,064      3,614      (550 )   (15 )%

Other

     1,842      2,324      (482 )   (21 )%
    

  

  


 

Waterjet Total

     18,819      17,756      1,063     6 %

Avure:

                            

Food

     1,245      1,522      (277 )   (18 )%

North America Press

     601      620      (19 )   (3 )%

International Press

     2,596      3,128      (532 )   (17 )%
    

  

  


 

Avure Total

     4,442      5,270      (828 )   (16 )%
    

  

  


 

Consolidated Total

   $ 23,261    $ 23,026    $ 235     1 %
    

  

  


 

 

General and administrative expenses increased $235,000 or 1% to $23.3 million for the year ended April 30, 2004, as compared to the prior year’s general and administrative expenses of $23.0 million. All segments experienced a decrease in general and administrative expense, except for the North America Waterjet segment, up $1.9 million (18%) and the Asia Waterjet segment, up $.2 million (17%). The decreases represent cost cutting measures put in place by management. The increase in North America Waterjet is attributable to higher costs of doing business as a public company following the enactment by Congress of the Sarbanes-Oxley Act of 2002 and include increased directors’ and officers’ liability insurance of $.9 million as well as higher consulting costs for internal control work and other special projects of $.2 million. In addition, we resumed the compensation of our Board members in fiscal 2004 and implemented a performance-based bonus plan for management which together amounted to an increase of $2.9 million. These increases in the North America Waterjet segment were offset in part to general ‘across the board’ cost reductions. The increase in Asia Waterjet is the addition of staff. Expressed as a percentage of revenue, general and administrative expenses were 13% and 16% for the years ended April 30, 2004 and 2003, respectively.

 

Restructuring and Impairment Charges.

 

Our restructuring and impairment charges by segment for 2004 and 2003 is summarized as follows:

 

     Year Ending
April 30, 2004
Restructuring


   Year Ending
April 30, 2003
Impairment


Waterjet:

             

North America

   $ 1,082    $ —  

Asia

             

Other International

     1,260      2,113

Other

     99      5,032
    

  

Waterjet Total

     2,441      7,145

 

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Table of Contents
     Year Ending
April 30, 2004
Restructuring


   Year Ending
April 30, 2003
Impairment


Avure:

             

Food

     189      3,670

North America Press

             

International Press

     626      —  
    

  

Avure Total

     815      3,670

Consolidated Total

   $ 3,256    $ 10,815
    

  

 

    North America
Waterjet


    Other International
Waterjet


    Other
Waterjet


    International
Press


  Consolidated

 
   

Facility

Exit
Costs


    Other

    Severance
Benefits


   

Facility

Exit
Costs


    Other

    Severance
Benefits


    Severance
Benefits


    Facility
Exit
Costs


  Severance
Benefits


    Facility
Exit
Costs


    Other

    Total

 

Q1 restructuring charge

  $ —       $ —       $ 248     $ —       $ —       $ —       $ —       $ —     $ 248     $ —       $ —       $ 248  

Q1 cash payments

    —         —         (128 )     —         —         —         —         —       (128 )     —         —         (128 )
                   


                                       


                 


Balance, July 31, 2003

    —         —         120       —         —         —         —         —       120       —         —         120  

Q2 restructuring charge

    —         178       (120 )     105       302       —         201       191     81       296       480       857  

Q2 cash payments

    —         (178 )     —         —         (47 )     —         —         —       —         —         (225 )     (225 )

Q2 charge-offs

    —                 —         —         (255 )     —         —         —       —         —         (255 )     (255 )
                                   


                                       


 


Balance, October 31, 2003

    —         —         —         105       —         —         201       191     201       296       —         497  

Q3 restructuring charge

    407       170       —         85       484       89               —       89       492       654       1,235  

Q3 cash payments

    (270 )     (160 )     —         (14 )             —         (121 )     —       (121 )     (284 )     (160 )     (565 )

Q3 charge-offs

    —         (10 )     —         (85 )     (484 )     —         —         —       —         (85 )     (494 )     (579 )
           


         


 


                               


 


 


Balance, January 31, 2004

    137       —         —         91       —         89       80       191     169       419       —         588  

Q4 restructuring charge

    15       412       —         255               —         234       —       234       270       412       916  

Q4 cash payments

    (13 )     (126 )             (13 )             (89 )     (70 )     —       (159 )     (26 )     (126 )     (311 )

Q4 charge-offs

    —         (286 )     —         —                 —         —         —       —         —         (286 )     (286 )
           


                                                               


 


Balance, April 30, 2004

  $ 139     $ —       $ —       $ 333     $ —       $  —       $ 244     $ 191   $ 244     $ 663     $ —       $ 907  
   


                 


                 


 

 


 


         


 

Restructuring Charges.

 

There were no restructuring charges in fiscal 2003. During the year ended April 30, 2004, we incurred $3.2 million of restructuring-related costs, including severance, lease termination and inventory related charges , primarily in the U.S., Germany and Sweden. The most significant of this total being incurred in the North America Waterjet segment, $1.1 million, Other International Waterjet, $1.3 million and International Press, $.8 million.

 

Impairment Charges.

 

There were no impairment charges in fiscal 2004. During fiscal 2003, we conducted a selected review of the carrying value of our goodwill. Statement of Financial Accounting Standard No. 142 (“FAS 142”), “Goodwill and Other Intangible Assets,” requires a company to perform impairment testing when certain “triggering” events affecting a business unit have taken place. The triggering events were the expectation of a sale or full or partial disposal of certain of our divisions and the continuing deterioration of the economic climate. Our review resulted in impairment charges of $7.1 million during the quarter ended January 31, 2003, $5 million was recorded in the Other segment and $2.1 million was recorded in the Other International Waterjet segment. The impairment resulted primarily from continued weakness in the automotive industry, as well as weakness in our European operations. We also prepared an analysis of the fair value of the Company’s reporting units for our required FAS

 

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142 annual assessment. This assessment, performed as of April 30, 2003, revealed no further impairment. At April 30, 2003, we also conducted an impairment review of our long-lived assets in accordance with Statement of Financial Accounting Standard No. 144 (“FAS 144”), “Accounting for the Impairment or Disposal of Long-Lived Assets.” This review led to a $3.7 million impairment charge related primarily to the carrying value of the depreciable assets of the Food segment.

 

Financial Consulting Charges.

 

During the year ended April 30, 2004, we incurred $1.5 million of professional fees associated with the restructuring of our debt in July 2003. These costs were evaluated under EITF 98-14, “Debtor’s Accounting for Changes in Line-of-Credit or Revolving—Debt Arrangements”, and as they were either expenses related to potential senior debt financing with lenders that did not occur, or they related to expenses associated with our subordinated debt and did not result in increase in the facility and accordingly they were expensed. No such costs were incurred for the year ended April 30, 2003.

 

Operating Income (Loss).

 

Our operating income (loss) by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

             
     2004

    2003

    Dollar
Change


    Percent
Change


 

Operating income (loss)

                              

Waterjet:

                              

North America

   $ (4,390 )   $ (6,472 )   $ 2,082     (32 )%

Asia

     5,299       3,433       1,866     54 %

Other International

     (2,921 )     (15,580 )     12,659     (81 )%

Other

     335       (8,503 )     8,838     (104 )%
    


 


 


     

Waterjet Total

     (1,677 )     (27,122 )     25,445     (94 )%

Avure:

                              

Food

     (2,887 )     (16,458 )     13,571     (82 )%

North America Press

     9       100       (91 )   (91 )%

International Press

     2,672       (5,219 )     7,891     (151 )%
    


 


 


     

Avure Total

     (206 )     (21,577 )     21,371     (99 )%
    


 


 


     

Consolidated Total

   $ (1,883 )   $ (48,699 )   $ 46,816     (96 )%
    


 


 


     

 

We recorded an operating loss of $1.9 million for the year ended April 30, 2004, as compared to a loss of $48.7 million in the prior year. All segments of our business except for North America Press recorded either increases in operating profit or a decrease in the operating loss as compared to fiscal 2003. The reasons for the changes in operating-profit or loss have been described in the paragraphs above addressing changes in sales, gross margin and operating expenses.

 

Interest and Other Income (Expense), net. Fiscal 2004 interest expense increased $1.3 million or 11% to $13.2 million compared to the prior year of $11.8 million due to increased amounts of amortization of fees from our credit facilities and a higher weighted average cost of capital from interest charged on the deferred and capitalized semi-annual interest payments to our subordinated lender. Included in Other Income, net is a $2.6 million gain from the sale of our investment in WGI Heavy Minerals. In addition, the weaker dollar has positively impacted our foreign transactions and we have thus realized net currency gains of $2.2 million, as well as unrealized currency gains of $2.8 million in fiscal 2004. As the U.S. dollar remains weak, this has also caused other changes in our balance sheet, including an increase in our goodwill and intangible assets due to the translation from foreign currencies. Included in Other Income, net for the year ended April 30, 2003, are $2.1

 

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million of net realized foreign exchange transaction losses offset by $5.3 million of unrealized currency gains. Below is the detail of Other Income (Expense), net.

 

     Year Ended April 30,

 
     2004

    2003

 

Net realized foreign exchange gains (losses)

   $ 2,155     $ (2,089 )

Net unrealized foreign exchange gains (losses)

     2,827       5,307  

Realized gain on sale of equity securities

     2,618       —    

Write-off of investment and other assets

     —         (35 )

Minority Interest in joint venture

     (35 )     (79 )

Other

     252       (104 )
    


 


Total

   $ 7,817     $ 3,000  
    


 


 

Income Taxes. We are providing for income taxes in jurisdictions where we have generated taxable income. During fiscal 2004, as a result of foreign asset collateral requirements and the amended credit agreements discussed in Note 9 to Consolidated Financial Statements, we were no longer able to permanently defer foreign earnings and recorded a $1.9 million liability for withholding taxes payable on future repatriation of foreign earnings. We also recorded a U.S. tax liability of $6.7 million on foreign earnings which we have decided to no longer permanently defer. The total $6.7 million tax liability is offset by a release of the valuation allowance. In addition, we continue to assess our ability to realize our net deferred tax assets. Recognizing the continued losses generated during the quarter and in prior periods, we have determined it appropriate to continue to maintain a valuation allowance on our domestic net operating losses, certain foreign net operating losses and certain other deferred tax assets based on the expected reversal of both deferred tax assets and liabilities. As of April 30, 2004, we had approximately $24.8 million of domestic net operating loss carryforwards to offset certain earnings for federal income tax purposes. All of these net operating loss carryforwards expire in fiscal 2023. Net operating loss carryforwards in foreign jurisdictions amount to $35.1 million and do not expire. See Note 10 to Consolidated Financial Statements for discussion of tax components.

 

Discontinued Operations, Net of Tax. As of April 30, 2003, we held one of our service subsidiaries for sale and consequently showed its results of operations as discontinued operations for all periods presented. The sale of this subsidiary was consummated May 16, 2003 and resulted in cash proceeds of $1.8 million and a gain of approximately $650,000.

 

The weighted average number of shares outstanding used for the calculation of basic and diluted loss per share is 15,415,000 for fiscal 2004 and 15,348,000 for fiscal 2003.

 

Net Loss. Our consolidated net loss for fiscal 2004 amounted to $11.5 million, or $.75 basic and diluted loss per share as compared to a net loss of $70.0 million, or $4.56 basic and diluted loss per share in the prior year.

 

Fiscal 2003 Comprehensive Financial Review. During fiscal 2003, we revised our approach to receivable collection, inventory reduction and investigated other cash-generating initiatives in response to the continued decline in the economy and our highly leveraged position. We reviewed the carrying values of those assets that we expected to convert to cash in the short-term, as well as long-lived tangible and intangible assets and adjusted the carrying value of such assets to reflect their estimated current net realizable value. In addition, we conducted a review of potential liabilities. The total adjustments for the year ended April 30, 2003 are included in the Consolidated Statement of Operations. These adjustments, which are summarized below, were highly influenced by the economic environment our customers and we are facing.

 

    We increased our allowance for doubtful accounts by $4.1 million. This increase was based on extensive collection efforts and the results of a worldwide receivable-by-receivable review, including evaluation of the impact of current economic conditions, which had restricted customers’ ability to pay their account balances.

 

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Table of Contents
    We evaluated our ability to convert inventories, including evaluation and demonstration units, into cash in the short term by their sale or disposition. This evaluation led to a total adjustment of $5.4 million to arrive at the estimated net realizable value of our inventories.

 

    We conducted a detailed review of the carrying value of our goodwill in accordance with FAS 142. The triggering events were the expectation of sale or full or partial disposal of certain of our divisions, the continuing deterioration of the economic climate, and our operating losses. Our review resulted in impairment charges of $7.1 million during the third quarter of fiscal 2003. The impairment resulted primarily from continued weakness in the automotive industry, as well poor performance at our European operations. Our required annual FAS 142 review as of April 30, 2003 led to no further impairment charges.

 

    We determined that no significant future services would be required of our former CEO. Therefore we accrued and charged to operations all remaining contractual fees and related benefits aggregating approximately $1.1 million.

 

    During fiscal 2003, we sold $9.7 million of long-term notes receivable for $8.6 million. This discount of $1.1 million plus an additional accrual of $0.1 million on potential future notes available for sale were recorded in Marketing Expense.

 

    We accrued an additional $1.5 million for potential losses related to several recourse/repurchase obligations on European sales. We have from time to time entered into recourse obligations with third party leasing companies. In response to continued concerns about the financial health of several customers, we revised our estimate of potential future exposure. Included in the $1.5 million accrual was $760,000 for the estimated loss on the repurchase and subsequent sale of a flex form press system, where we had a recourse obligation for a bankrupt customer. We sold this unit to an unrelated party in fiscal 2004.

 

    We had deferred $0.8 million in professional fees associated with previous ongoing strategic transactions, consisting of a planned equity offering and spin-off of Avure. We have abandoned these plans and accordingly expensed all of these fees.

 

    We reversed percentage of completion revenue previously recognized on three food systems (one customer) based on the customer’s failure to fulfil its obligations under the contract terms. The total revenue reversed in the third quarter of fiscal 2003 was $4.3 million with an associated gross margin of $2.3 million. We received new orders for which we plan to deliver already-completed systems from inventory. Accordingly, these specific contracts did not qualify for percentage of completion accounting and the corresponding revenue was recognized upon delivery and acceptance in fiscal 2004.

 

    We assessed our ability to realize our net deferred tax assets. Recognizing the magnitude of the losses generated during the fiscal year, we determined it appropriate to establish a valuation allowance for our net deferred tax assets, with the exception of our Swedish operations, amounting to $12.7 million as well discontinuing, in the near term, any future recognition of deferred tax assets resulting from losses.

 

    Based upon our proposed strategy to downsize and streamline our operations and convert non-core or excess assets to cash, we adjusted various other asset values and reserves to appropriately reflect their net realizable value on a prospective basis, in accordance with FAS 144. These adjustments totalled $9.1 million for the year.

 

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Table of Contents

Fiscal 2003 Compared to Fiscal 2002 (Restated—See Note 2 to the April 30, 2004 Consolidated Financial Statements. See Note 1 to the Consolidated Financial Statements for certain reclassifications made to fiscal 2003 and 2002 amounts.) (Tabular amounts in thousands)

 

Sales.

 

Our sales by segment for 2003 and 2002 is summarized as follows:

 

     Year Ended April 30,

            
     2003

   2002

   Dollar
Change


    Percent
Change


 

Sales

                            

Waterjet:

                            

North America

   $ 53,995    $ 59,254    $ (5,259 )   (9 )%

Asia

     17,667      14,916      2,751     18 %

Other International

     23,279      31,113      (7,834 )   (25 )%

Other

     26,892      22,480      4,412     20 %
    

  

  


     

Waterjet Total

     121,833      127,763      (5,930 )   (4 )%

Avure:

                            

Food

     4,851      11,087      (6,236 )   (56 )%

North America Press

     7,668      12,648      (4,980 )   (39 )%

International Press

     9,763      25,392      (15,629 )   (62 )%
    

  

  


     

Avure Total

     22,282      49,127      (26,845 )   (55 )%
    

  

  


     

Consolidated Total

   $ 144,115    $ 176,890    $ (32,735 )   (19 )%
    

  

  


     

 

Waterjet. For the year ended April 30, 2003, total Waterjet revenue decreased $6.0 million or 4%, to $121.8 million from $127.8 million in the prior year. This decrease was primarily in the North America and Europe Waterjet market and was offset by strength in the Asia Waterjet market as well as in the North America automotive market.

 

Included in the $5.3 million decrease in fiscal 2003 in North American Waterjet sales is a $2.2 million, or 4%, decrease over the prior year period for sales of our domestic standard waterjet cutting systems, as compared to the domestic machine cutting tool market, which recorded a year over year decline of 19%, according to the Association for Manufacturing Technology (“AMT”). Our shapecutting equipment business outperformed the broader domestic market which demonstrates the ongoing application expansion that Flow waterjets are experiencing resulting from their flexibility and superior machine performance. This decrease in domestic revenues was further exacerbated by weak demand in the domestic aerospace sector which accounted for the remainder of the $5.3 million decrease. North American automotive and automation (our ‘Other’ segment) sales increased 20% or $4.5 million in fiscal 2003 as compared to fiscal 2002 due to the cyclical nature of the automotive industry.

 

Outside the U.S., Waterjet revenue growth was positively influenced by growth in Asian revenues which were up $2.8 million, or 18%, for the year ended April 30, 2003 to $17.7 million, compared to $14.9 million in the prior year. These increases were driven largely by sales into China. Additionally, in Korea, changes in lending policies have provided capital to small and mid-sized businesses—Flow’s traditional customers, which positively impacted our sales.

 

Our Other International Waterjet segment represents primarily sales into Europe and South America. Our European operations were negatively impacted during fiscal 2003 by the continued slowing of the overall economy and weakening customer financial stability. These marketplace conditions resulted in a significant decrease in Europe revenues as compared to the prior fiscal year posting a decrease of $5.8 million, or 21%, to $21.2 million compared to $26.8 million in 2002. In an effort to offset any additional future impact, we put in place a new general manager, changed our pricing structure and accelerated payment terms. Sales into South America were down $2.0 million due to weak sales of surface preparation equipment.

 

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Table of Contents

We also analyze our Waterjet revenues by looking at system sales and consumable sales. Systems revenues for the year ended April 30, 2003 were $76.3 million, a decrease of $12.6 million or 14%, compared to the prior fiscal year due to the impact of revenue decreases in the US and Europe. Consumables revenues, on the other hand, recorded a 17% or $6.7 million improvement to $45.5 million for the year ended April 30, 2003, compared to the prior year consumable revenue of $38.8 million. This is due to increased machine utilization by our customers which has led to higher parts consumption.

 

Avure. As expected, a portion of the fiscal 2003 decrease in Avure’s revenues resulted from reduced International and North America Press revenues. For the year ended April 30, 2003, International and North America Press revenues were down 54% from $38.0 million for the prior year to $17.4 million. The majority of this revenue decrease, or $15.6 million, occurred in International Press. Order and production volumes were significantly weaker in 2003 due to lower demand for industrial products following the September 2001 attacks. The sales and production cycle on a Press can range from one to four years.

 

Similarly, North America Press revenues for the year ended April 30, 2003 decreased 39% or $5.0 million from $12.7 million for the prior year to $7.7 million, on weaker order volume and production.

 

For the year ended April 30, 2003, revenues for the Food segment were $4.9 million, representing a $7.1 million, or 59% decline, compared to the prior year’s revenue of $11.9 million. A portion of this decrease was attributed to the $4.3 million reversal of percentage of completion revenue previously recognized on three food systems (one customer) based on the customer’s failure to fulfil its obligations under the contract terms. In addition, we received some orders for which we plan to deliver already-completed systems. Accordingly, these specific orders did not qualify for percentage of completion accounting and the corresponding revenue was recognized upon delivery and acceptance in a later period.

 

Cost of Sales and Gross Margins.

 

Our gross margin by segment for 2003 and 2002 is summarized as follows:

 

     Year Ended April 30,

    Dollar
Change


    Percent
Change


 
     2003

    2002

     

Gross Margin

                              

Waterjet:

                              

North America

   $ 21,408     $ 30,899     $ (9,491 )   (31 )%

Asia

     7,702       6,772       930     14 %

Other International

     1,782       5,352       (3,570 )   (67 )%

Other

     2,321       4,896       (2,575 )   (53 )%
    


 


 


     

Waterjet Total

     33,213       47,919       (14,706 )   (31 )%

Avure:

                              

Food

     (5,099 )     (439 )     (4,660 )   NM  

North America Press

     1,375       2,183       (808 )   (37 )%

International Press

     6,552       18,098       (11,546 )   (64 )%
    


 


 


     

Avure Total

     2,828       19,842       (17,014 )   (86 )%
    


 


 


     

Consolidated Total

   $ 36,041     $ 67,761     $ (31,720 )   (47 )%
    


 


 


     

NM = Not Meaningful

 

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Table of Contents

Our gross margin percentage by segment for 2003 and 2002 is summarized as follows:

 

     Year Ended April 30,

 
     2003

    2002

 

Gross Margin Percent

            

Waterjet:

            

North America

   40 %   52 %

Asia

   44 %   45 %

Other International

   8 %   17 %

Other

   9 %   22 %

Waterjet Total

   27 %   38 %

Avure:

            

Food

   (105 )%   (4 )%

North America Press

   18 %   17 %

International Press

   67 %   71 %

Avure Total

   13 %   40 %

Consolidated Total

   25 %   38 %

 

Gross margin for the year ended April 30, 2003 amounted to $36.0 million or 25% of revenues, as compared to gross margin of $67.8 million or 38% of revenues in the prior year. Fiscal 2003 gross margin was negatively impacted by a number of adjustments posted during the third quarter of that year which totalled $11.1 million and are described above in the Fiscal 2004 to Fiscal 2003 comparison. Waterjet margins represented $33.2 million of the overall margin or 27% of Waterjet revenues which is typically lower than our historical margins of 37% as a result of the adjustments made during the third quarter of Fiscal 2003. Waterjet gross margin was further depressed by weak sales in the automotive and aerospace business which resulted in under absorption of overhead costs. In addition, the weakened European economy has led to a change in estimate on several revenue projects in which we had a financial obligation to a third party. Gross margins were negatively impacted by $1.0 million due to increased revenue reserves based on this change in estimate.

 

The Avure margins amounted to $2.8 million or 13% of Avure revenues, down from $19.8 million or 40% in the prior year. This decline in margin of $17.0 million related to all segments of Avure. The North America Press segment margin dollar decrease of 37% is the direct result of the decline in revenue of 39% from weaker order and production volumes. North America Press segment margin percentage improved slightly to 18% for fiscal 2003 from 17% in the prior year due to changes in product mix. The International Press segment margin dollars decreased 64% on a 62% revenue decline. The decrease in margin percentage on International Press from 71% in Fiscal 2002 to 67% in Fiscal 2003 resulted from an accrual for the anticipated loss of a general press unit on which the customer defaulted as well as increases on external sales at a greater rate than the increase in inter-company gross profit. Gross margins on International Press external sales were constant in 2003 and 2002. The decrease in the Food segment gross margins dollars and percentage resulted from the revenue reversal of three units due to the customer’s failure to fulfil contractual obligations and from an adjustment made to the carrying value of Food inventories to net realizable value.

 

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Table of Contents

Marketing Expenses.

 

Our marketing expense by segment for 2003 and 2002 is summarized as follows:

 

     Year Ended April 30,

   Dollar
Change


    Percent
Change


 
     2003

   2002

    

Marketing

                            

Waterjet:

                            

North America

   $ 12,713    $ 12,248    $ 465     4 %

Asia

     3,008      3,158      (150 )   (5 )%

Other International

     10,684      8,114      2,570     32 %

Other

     2,780      1,916      864     46 %
    

  

  


     

Waterjet Total

     29,185      25,436      3,749     15 %

Avure:

                            

Food

     3,644      2,026      1,618     80 %

North America Press

     655      697      (42 )   (6 )%

International Press

     3,914      3,245      669     21 %
    

  

  


     

Avure Total

     8,213      5,968      2,245     38 %
    

  

  


     

Consolidated Total

   $ 37,398    $ 31,404    $ 5,994     19 %
    

  

  


     

 

Marketing expenses increased $6.0 million or 19% to $37.4 million for the year ended April 30, 2003, as compared to the prior year marketing expenses of $31.4 million. The majority of this decrease, $3.7 million, stemmed from the Waterjet operations, while $2.3 million of the increase was recognized in Avure.

 

Fiscal 2003 included a $4.1 million charge, in the Waterjet operations, to the allowance for doubtful accounts based on our assessment of the financial conditions of our individual customers and general marketplace conditions. The predominance of this increase in the allowance was recorded in the Other International Waterjet segment.

 

Within Avure, the Food segment experienced increases in expenses stemming from the discount awarded to a customer of $1.2 million for the early pay-off of long-term notes receivable and completion of the investment in its sales and marketing organization and infrastructure. The increase in International Press is the result of increased efforts to generate sales. Expressed as a percentage of revenue, marketing expenses were 26% and 18% for the years ended April 30, 2003 and 2002, respectively.

 

Research and Engineering Expenses.

 

Our research and engineering expense by segment for 2003 and 2002 is summarized as follows:

 

     Year Ended April 30,

   Dollar
Change


    Percent
Change


 
     2003

   2002

    

Research and Engineering

                            

Waterjet:

                            

North America

   $ 4,332    $ 4,814    $ (482 )   (10 )%

Asia

     278      357      (79 )   (22 )%

Other International

     951      817      134     16 %

Other

     688      1,087      (399 )   (37 )%
    

  

  


     

Waterjet Total

     6,249      7,075      (826 )   (12 )%

Avure:

                            

Food

     2,523      2,175      348     16 %

North America Press

     —        50      (50 )   (100 )%

International Press

     4,729      5,589      (860 )   (15 )%