Final Prospectus
Table of Contents

File Pursuant to Rule 424(b)(3)

Registration Statement No. 333-125113

19,987,270 Shares

 

LOGO

 

Common Stock

 


 

This prospectus relates to the offer and sale of up to 17,799,179 outstanding shares of the common stock of Flow International Corporation, a Washington corporation, and up to 2,188,091 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 February 22, 2006, the closing price of one share of our common stock was $10.60.

 

Investing in our securities involves risks. See “ Risk Factors” beginning on page 7 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 February 22, 2006.


Table of Contents

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

   4

Risk Factors

   7

Cautionary Note Regarding Forward-Looking Statements

   14

Use of Proceeds

   15

Dividend Policy

   15

Pro Forma Information

   16

Selected Financial Data

   22

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

   24

Business

   54

Information Concerning Directors and Executive Officers

   59

Board Structure, Committees and Compensation and Composition

   62

Executive Compensation

   65

Market Information

   70

Stock Ownership of Management and Principal Shareholders

   71

Selling Shareholders

   74

Certain Relationships and Related Transactions

   77

Description of Capital Stock

   78

Plan of Distribution

   80

Legal Matters

   82

Experts

   82

Where You Can Find More Information

   82

Index to Consolidated Financial Statements

   83

 

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 17,799,179 outstanding shares of common stock and 2,188,091 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 7, 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 6, current events beginning on page 22 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 standard and specialized waterjet cutting and cleaning systems. In addition to UHP water pumps and related systems, we provide non-UHP automation and articulation systems, primarily to the automotive industry.

 

Our UHP technology has three broad applications: cutting, cleaning and 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 food processing, we supply UHP pumps to Avure Technologies, Inc., a company we recently sold, which uses pressure to kill spoilage bacteria and pathogens in food products placed inside a pressure vessel.

 

On October 31, 2005, consistent with our strategy to divest operations that are not part of our core UHP water pump business, we sold our General Press operations and the non UHP portion of our Food reportable segment (the “Avure Disposition”). Included in the Avure Disposition were our Avure Technologies, Incorporated, Flow International FPS AB, Avure Technologies AB subsidiaries, and our 51% interest in Flow Autoclave Systems (together, the “Avure Business”). The Avure Business became a discontinued operation in accordance with FAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets at the time it was sold and has been represented that way in the Consolidated Statements of Operations in the financial statements. In connection with the sale we agreed to continue to supply UHP pumps to the Avure Business.

 

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.

 

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

19,987,270 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 6 for a discussion of factors that you should consider carefully before deciding to purchase our common stock.

 

Offering-related Information

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 $59.3 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. The closing price of our stock on Nasdaq National Market on the day before the agreement between the Company and the Selling Shareholders relating to the PIPE Transaction was entered into $3.70 per share. On the day that the agreement was entered into, the closing price was $4.28 per share. The exercise price of the warrants is a negotiated price.

 

 

Proceeds of the PIPE were used to pay down existing debt of $59.3 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 issuance price of the common stock of the PIPE Transaction ($3.70) was less than market price ($4.28), we issued approximately 304,000 anti-dilution $0.01 warrants to our lenders. These warrants had a Black-Scholes value of approximately $1.7 million. The majority of the charges resulting from the issuance of the additional warrants, $1.6 million, were charged to interest expense in the fourth quarter of fiscal 2005 as the underlying debt associated with these warrants was retired in the fourth quarter of fiscal 2005. The remainder, $126,000, was capitalized and amortized to interest expense through August 1, 2005.

 

 


(1) Includes 2,188,091 shares of common stock issuable upon the exercise of outstanding warrants to purchase common stock.

 

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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 is not be declared effective prior to December 31, 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. As of March 21, 2005, the warrants sold to the PIPE investors were valued at $6.4 million using the Black-Scholes method, and the shares have been recorded at $52.9 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.

 

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, second, and third quarter of fiscal 2006 and the fourth quarter of fiscal 2006 through February 22, 2006 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

   $ 7.74    $ 5.98    $ 3.66    $ 2.15    $ 1.94    $ 1.13    $ 10.90    $ 5.05

Second Quarter

     9.13      7.40      3.55      2.70      3.11      1.36      5.60      2.12

Third Quarter

     10.49      6.89      3.18      2.71      4.11      2.40      3.80      2.13

Fourth Quarter

     10.60      9.46      6.60      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. The credit agreement entered into on July 8, 2005 does permit us to pay dividends, however. Prior to this date however, our credit agreements contained restrictions on our ability to pay dividends to our shareholders.

 

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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, 2005, 2004 and 2003 and the summary balance sheet data as of April 30, 2005 and 2004 are derived from our audited financial statements, which are included elsewhere in this prospectus. The summary statement of operations data for the fiscal years ended April 30, 2002 and 2001 and the summary balance sheet data as of April 30, 2003, 2002, and 2001 are derived from our unaudited financial statements which are not included in this prospectus. The summary statement of operations data for the six months ended October 31, 2005 and the summary balance sheet data as of October 31, 2005 are derived from our unaudited financial statements which are included in this prospectus.

 

    

Six

Months Ended
October 31,
2005

(restated)(4)(5)


   Year Ended April 30,

(In thousands, except per
share amounts)
     

2005

(restated)(4)(5)


   

2004(5)

(restated)(4)


   

2003(3)(5)

(restated)(4)


   

2002(2)(5)

(restated)(4)


   

2001(1)(5)

(restated)(4)


     (unaudited)                      (unaudited)     (unaudited)

Statement of Operations Data:

                                             

Sales

   $ 92,671    $ 172,966     $ 132,861     $ 121,833     $ 116,386     $ 132,797

Income (Loss) Before Cumulative Effect of Change in Accounting Principles and Discontinued Operations

     1,221      (12,174 )     (10,668 )     (43,965 )     (7,966 )     1,882

Net Income (Loss)

     1,040      (21,197 )     (11,274 )     (67,813 )     (8,024 )     1,304

Basic Income (Loss) Per Share Before Cumulative Effect of Change in Accounting Principles and Discontinued Operations

     0.04      (0.69 )     (0.69 )     (2.86 )     (0.52 )     0.13

Basic Earnings (Loss) Per Share

     0.03      (1.19 )     (0.73 )     (4.42 )     (0.53 )     0.09

Diluted Income (Loss) Per Share Before Cumulative Effect of Change in Accounting Principles and Discontinued Operations

     0.03      (0.69 )     (0.69 )     (2.86 )     (0.52 )     0.12

Diluted Income (Loss) Per Share

     0.03      (1.19 )     (0.73 )     (4.42 )     (0.53 )     0.09
    

October 31,

2005

(restated)(4)


   April 30,

       

2005

(restated)(4)


   

2004

(restated)(4)


   

2003

(restated)(4)


   

2002

(restated)(4)


   

2001

(restated)(4)


     (unaudited)                (unaudited)     (unaudited)     (unaudited)

Balance Sheet Data:

                                             

Working Capital

   $ 35,343    $ 6,154     $ (8,757 )   $ (6,709 )   $ 84,556     $ 95,322

Total Assets

     108,862      118,467       129,272       147,088       205,572       206,270

Short-Term Debt

     1,437      13,443       48,727       61,056       5,237       8,464

Long-Term Obligations, net

     23,538      5,704       38,081       29,023       83,453       85,652

Shareholders’ Equity (Deficit)

     28,499      29,464       (8,217 )     5,959       69,967       67,839

(1) The Statement of Operations for fiscal 2001 includes the adoption of SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB101A and 101B. We reflected this change in policy as a Cumulative Effect of Change in Accounting Principle.

 

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(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, 2005 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) As described in Note 2 to the April 30, 2005 Consolidated Financial Statements included elsewhere in this prospectus, we have restated our consolidated financial statements for the year ended April 30, 2005 in Amendment No. 1 to our April 30, 2005 Form 10-K to reflect additional charges in the Consolidated Statement of Operations associated with 1) the impairment of goodwill, 2) the revised valuation of anti-dilution warrants issued to our senior and subordinated lenders, 3) the revision of estimated losses on long-term contracts, 4) the correction of compensation expense for performance based equity awards and stock awards for services and 5) straight-line rent expense for leases with escalating rents. We identified errors in the Consolidated Financial Statements related to the presentation of percentage-of-completion related balances on the Consolidated Balance Sheet. Specifically, we noted inconsistencies between our divisions in the balance sheet presentation of accounts receivable and cash receipts relating to contracts accounted for using the percentage-of-completion method. We have, therefore, adjusted the financial statements to reflect a consistent presentation and comply with the provisions of SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” for all years presented. In addition, we restated certain balances for incorrect classification on our Consolidated Balance Sheet as of April 30, 2005 and 2004 and Consolidated Statement of Operations for the year ended April 30, 2005. We also restated our consolidated financial statements for all years presented in Amendment No. 2 to our April 30, 2005 Form 10-K to reflect corrections to our consolidated income tax provisions and recording of minority interest. These errors also resulted in a restatement of our interim financial statements as of and for the six months ended October 31, 2005.

 

The restated amounts above reflect the adjustments enumerated in Note 2 to the Consolidated Financial Statements in our Form 10-K/A Amendment No. 2 and the following adjustments for years prior to fiscal 2004;

     2002

    2001

    

As

previously

reported


   

As

Restated


   

Reclassified for

Discontinued

Operations


   

As

previously

reported


 

As

Restated


 

Reclassified for

Discontinued

Operations


Statement of Operations Data:

                                          

(Loss) Income Before Cumulative Effect of Change in Accounting Principle and Discontinued Operations

   $ (8,244 )   $ (8,415 )   $ (7,966 )   $ 4,038   $ 3,713   $ 1,882

Net (Loss) Income

     (7,853 )     (8,024 )     (8,024 )     1,630     1,304     1,304

Net (Loss) Income per share:

                                          

Basic & Diluted

                                          

Net Loss

     (0.52 )     (0.53 )     (0.53 )     0.11     0.09     0.09

 

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    2003

    2002

  2001

   

As

previously

reported


   

As

Restated


   

As

previously

reported


 

As

Restated


 

As

previously

reported


 

As

Restated


Balance Sheet Data:

                                       

Working Capital

  $ (6,709 )   $ (6,709 )   $ 84,532   $ 84,556   $ 91,750   $ 95,322

Total Assets

    147,701       147,088       208,674     205,572     209,309     206,270

Total Shareholders’ Equity

    4,872       5,959       71,054     69,967     68,755     67,839

 

(5) Our consolidated statements of operations for all periods has been recast to give effect to the sale of the Avure Business and present the results for the Avure Business as discontinued operations.

 

Pro forma financial information is included in this prospectus to reflect the closing of the PIPE transaction on March 21, 2005. The following pro forma financial information is excerpted from the detailed presentation found on pages 14-17.

 

(In thousands, except per share amounts)   

Year
Ended
April 30,

2005


     (unaudited)

Pro forma Statement of Operations Data:

      

Sales

   $ 172,966

Income from Continuing Operations

     3,874

Basic Income Per Share from Continuing Operations

     0.12

Diluted Income Per Share from Continuing Operations

     0.11

 

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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.

 

While we had income from continuing operations of $1.2 million for the six months ended October 31, 2005, our losses from continuing operations for each of the fiscal years ended April 30, 2005, 2004 and 2003 were $12.2 million, $10.7 million and $44.0 million, respectively. We believe our recently completed restructuring and related cost-cutting initiatives will reduce overall spending. If our restructuring efforts fail to adequately reduce costs, or if our sales are less than we project, we will continue to incur losses in future periods. Economic weakness in our served markets may adversely affect our ability to meet our sales projections.

 

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 impaired.

 

Under the Current Senior Credit Agreement (entered into on July 8, 2005), we are operating under a credit agreement with our senior lenders which expires July 8, 2008 and sets forth specific financial covenants to be attained on a quarterly basis. In addition, our agreement includes subjective acceleration clauses which permit the lenders to demand payment on the determination of a material adverse change in the business. In the event of default, the senior lenders may limit our access to borrow funds as needed. Our ability to continue operating is dependent on the senior lenders’ willingness to grant access to funds. If we are unable to obtain the necessary funds, our ability to continue operations would be seriously impaired unless we are able to obtain alternative financing from another source. In the event of a default, obtaining alternative financing may be difficult and may be at less favorable terms. We may be unable to achieve our projected operating results and maintain compliance with the loan covenants which would trigger an event of default with our lenders. In an event of default, the lenders would be in the position to exercise default remedies which include applying a default interest rate and acceleration of payment schedules for our outstanding debt. Our lenders may pursue any number of plans to reduce the outstanding debt, including, in certain circumstances, a liquidation of some or all of our assets.

 

If our Form S-1 registration statement becomes ineffective for more than 40 days, after having gone effective, we may be subject to significant financial penalties.

 

Under terms of a Registration Rights Agreement entered into on March 20, 2005, as part of a Private Investment in Public Equity transaction (“PIPE Transaction”), we were required not to have the Form S-1, which registers the shares sold in the PIPE Transaction, become ineffective for more than 40 days (not necessarily consecutive). If this event occurs, 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.

 

We may lose key management personnel and encounter difficulties replacing these positions. 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, or to pay damages. On November 18, 2004, Omax Corporation (“Omax”) filed suit against us alleging that our products infringe on Omax’s patents. The suit also seeks to have a specific patent we hold declared invalid. Although the suit seeks damages of over $100 million, we believe Omax’s claims are without merit and we intend not only to contest Omax’s allegations of infringement but also to vigorously pursue our claims against Omax with regard to our own patent. See Note 15 to our April 30, 2005 and interim October 31, 2005 Consolidated Financial Statements for further discussion of contingencies.

 

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

 

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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.

 

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 in internal controls. 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 2004, 2003 and 2002 financial statements, and in November 2005 and January 2006, in connection with the restatement of our fiscal 2005, 2004 and 2003 financial statements, our former independent registered public accounting firm reported to management and to the Audit Committee material weaknesses in internal control over financial reporting. A material weakness is a control deficiency, or a combination of control 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. Management agrees with and has responded to the Audit Committee with our plans to remediate the material weaknesses communicated by our former independent registered public accounting firm. Remediation of these material weaknesses is ongoing.

 

The material weaknesses in our internal control over financial reporting are as follows:

 

    The Company did not maintain effective controls over the financial reporting process due to an insufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with its financial reporting requirements and the complexity of the Company’s operations and transactions. Specifically, the Company incorrectly applied generally accepted accounting principles for (i) the impairment of goodwill, (ii) the classification of deferred tax balances, (iii) the valuation of anti-dilution warrants, (iv) the accrual of costs on contracts and balance sheet presentation of accounts receivable and cash receipts relating to contracts accounted for using the percentage-of-completion method, (v) leases with rent escalation clauses, (vi) the recording of minority interest, and (viii) the computation of the provision for income taxes, affecting receivables, deferred income taxes, prepaid expenses, goodwill, other accrued liabilities, other long-term liabilities and taxes payable, customer deposits, minority interest, capital in excess of par, accumulated deficit, cost of sales, general and administrative expenses, impairment charge, interest expense and other income, net and the provision for income taxes. This material weakness contributed to the material weakness discussed below.

 

   

The Company did not maintain effective controls to ensure there is adequate (i) analysis, documentation, reconciliation and review of accounting records, and supporting data, and (ii) monitoring and oversight of the work performed by accounting and financial reporting personnel to ensure the accuracy and completeness of the consolidated financial statements in accordance with generally accepted accounting principles. Specifically, the Company did not have effective controls designed and in place over the consolidation of the financial statements of subsidiaries and the computation of minority interest, the reconciliation of inter-company accounts, the valuation of anti-dilution warrants, the accrual of costs on contracts and balance sheet presentation of accounts receivable and cash receipts relating to contracts accounted for using the percentage-of-completion method, the

 

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classification of technical service expenses, the accounting for performance based equity awards and the computation of income tax provisions, affecting receivables, prepaid expenses, other accrued liabilities, taxes payable, customer deposits, capital in excess of par, minority interest, accumulated deficit, cost of sales, marketing expense, research and engineering, general and administrative expense, interest expense, other income, net, and the provision for income taxes.

 

 

A review of the remediation process to date, as well as the steps remaining, can be found on page 21 under the heading “Remediation of Material Weakness”.

 

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to assess the design and effectiveness of our internal control systems effective April 30, 2006. Our 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.

 

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 January 31, 2006, we had options outstanding to purchase 1,395,884 shares of our common stock, at exercise prices ranging from $2.00 to $12.25 per share. In addition, we currently have outstanding 2,188,091 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.

 

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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. Based on our results for the quarter ended October 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 on an annualized basis by $1.4 million and other income (expense) by $740,000. Our financial position and cash flows could be similarly impacted.

 

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. As the U.S. dollar gains in value relative to these foreign currencies, our products will increase in cost to the customer relative to locally produced product and products manufactured in certain other countries, which could negatively impact sales.

 

Sales of registered stock could exert downward pressure on the market price of our stock and could encourage short selling that could exert further downward pressure.

 

To the extent that shareholders who have acquired or may acquire shares of our common stock (either directly or through the exercise of warrants, which are exercisable at $0.01 per share or less) in the PIPE Transaction or in connection with certain loans (the “Selling Shareholders”) acquired their shares at prices less than the then current trading price of our common stock, they may have an incentive to immediately resell material amounts of such shares in the market which may, in turn, cause the trading price of our common stock to decline. Significant downward pressure on our stock price caused by the sale of stock registered in an offering could encourage short sales by the Selling Shareholders (and in particular short sales by warrant holders in anticipation of exercising their warrants) or third parties that would place further downward pressure on our stock price. In an ordinary or “uncovered” short sale, a seller causes his or her executing broker to borrow the shares to be delivered at the completion of the sale from another broker, subject to an agreement to return them upon request, thereby avoiding the need to deliver any shares actually owned by the seller stockholder on the settlement date for the sale. Since the seller does not own the shares that are sold, the seller must subsequently purchase an equivalent number of shares in the market to complete or “cover” the transaction. The seller stockholder will realize a profit if the market price of the shares declines after the time of the short sale, but will incur a loss if the market price rises and he or she is forced to buy the replacement shares at a higher price. Accordingly, a declining trend in the market price of our common stock may stimulate short sales.

 

Under the terms of certain outstanding warrants, we could be required to make antidilution adjustments.

 

Certain of the Selling Shareholders (as defined above) hold warrants to purchase our common stock at a price of $.01 per share. Such warrants were originally issued to our lenders (“Lender Warrants”). While such Lender Warrants are outstanding customary anti-dilution adjustments will be made in the Lender Warrants, if we issue common stock (other than pursuant to the exercise of warrants or other rights or convertible securities) at a price less than then current market price, or we issue warrants or other rights or convertible securities to purchase

 

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or acquire common stock exercisable or convertible, at a price less than then current market price when the warrants, rights or convertible securities are issued. The customary anti-dilution adjustments will be made in the purchase price of the common stock under the Lender Warrants (multiplying the exercise price before the issuance by a fraction in which the numerator is the number of shares outstanding prior to the issuance and the denominator is the number of shares outstanding after the issuance) and the number of shares of common stock issuable in exercise of the Lender Warrants (multiplying the current number of shares subject to the warrants by a fraction in which the numerator is the purchase price before the issuance and the denominator is the purchase price after the issuance). The exercise of any currently outstanding warrants will not trigger any adjustments in the Lender Warrants because adjustments made to the extent required on the issuance of such warrants. We have no plans to issue any common stock, or warrants to purchase common stock exercisable, at a price below the then current market price, except to the extent we may be required to issue Common Stock under currently outstanding warrants.

 

Current Events

 

Avure Disposition.    On October 31, 2005, consistent with our strategy to divest operations that are not part of our core UHP water pump business, we sold our General Press operations and the non UHP portion of our Food reportable segment (the “Avure Disposition”). Included in the Avure Disposition were our Avure Technologies, Incorporated, Flow International FPS AB, Avure Technologies AB subsidiaries, and our 51% interest in Flow Autoclave Systems (together, the “Avure Business”). The Avure Business became a discontinued operation in accordance with FAS 144 Accounting for the Impairment or Statements of operations in the Disposal of Long-Lived Assets at the time it was sold and has been presented as a discontinued operation in the Statements of Operations in the financial statements. In connection with the sale we agreed to continue to supply UHP pumps to the Avure Business.

 

Current Senior Credit Agreement.    Until April 28, 2005, our long-term financing consisted of a senior credit agreement (originally entered into on July 28, 2004) whose maturity date was August 1, 2005 (“Senior Credit Agreement”) and a subordinated debt agreement (“Subordinated Debt Agreement”). On April 28, 2005, we entered into a new senior debt agreement (“April Senior Credit Agreement”) for the purpose of being able to pay off the Subordinated Debt Agreement, which was done. The April Senior Credit Agreement also had a maturity date of August 1, 2005. On July 8, 2005, we entered into a new senior credit agreement, with a maturity date of July 8, 2008 (“Current Senior Credit Agreement”). At certain places in this report, we refer to “Senior Credit Arrangements” referring to one or more of the senior credit agreements when identification of a particular agreement is not important. The Current Senior Credit Agreement is a $30 million, three year agreement with Bank of America N.A. and U.S. Bank N.A. It bears interest at Bank of America’s prime rate (5.75% at April 30, 2005) or is linked to LIBOR plus a percentage depending on our leverage ratios, at our option. The agreement sets forth specific financial covenants to be attained on a quarterly basis, which we believe, based on our financial forecasts, are achievable. The financial covenants in the Current Senior Credit Agreement are less restrictive than in the earlier Senior Credit Arrangements.

 

Restructuring.    In fiscal 2005, we completed 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 evaluated the workforce and skill levels necessary to satisfy the expected future requirements of the business. As a result, we implemented plans to eliminate redundant positions and realign and modify certain roles based on skill assessments. We recorded restructuring charges of $2.5 million (excluding discontinued operations) for the year ended April 30, 2004 which are shown in the table below (in thousands):

 

    

Year Ended

April 30, 2004


Severance benefits

   $ 217

Facility exit costs

     867

Inventory write-down

     1,384
    

     $ 2,468
    

 

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These charges included employee severance related costs for approximately 35 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 and vacating the manufacturing warehouse portion of our Flow Europe 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. See restructuring accrual information in Note 17 to Consolidated Financial Statements.

 

The Avure Business incurred restructuring charges of $239,000 and $788,000 for the years ended April 30, 2005 and 2004, respectively, which included employee severance costs for 15 individuals. In addition, the Avure Business reduced the space utilized in its Swedish manufacturing facility and closed the Memphis sales office for the food portion of the business.

 

During the year ended April 30, 2005 and 2004, we incurred $.6 million and $1.5 million, respectively, of professional fees associated with the restructuring of our debt in July 2004 and July 2003, respectively. 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 Credit Arrangement with lenders that did not occur, or they related to expenses associated with our subordinated debt and did not result in an increase in the facility and accordingly they were expensed.

 

Robotics Division.    In an effort to control costs and to focus on our core UHP waterjet systems, on June 2, 2005, we announced that we had expanded our strategic relationship with Motoman Inc., to deliver standard, pre-engineered robotic waterjet cutting solutions to the automotive industry. The relationship means that Motoman, Inc. will be the primary sales contact with the end user for standard systems and we will sell UHP pumps and parts to Motoman, Inc. to be integrated into the pre-engineered robotic cutting system. At the same time we announced that, in order to re-align our resources with this new strategic direction, our custom robotic waterjet cutting system manufacturing would be relocated from Wixom, Michigan to Burlington, Ontario. The Company terminated 25 employees and recorded associated severance benefits of $175,000 which were paid in the six month period ended October 31, 2005. The Company also wrote off $24,000 of inventory with no future value. In October 2005, once the facility was vacated, the Company recorded restructuring charges related to lease termination costs of $278,000, net of expected sublease income, and wrote-off leasehold improvements of $108,000 related to this leased space.

 

We have also retained a broker to assist us in evaluating various opportunities for the Applications Group, our “Other” segment.

 

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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. Forward-looking statements typically are identified by the use of such terms as “may,” “will,” “expect,” “believe,” “anticipate,” “estimate,” “plan” and similar words, although some forward-looking statements are expressed differently. 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: the special risk factors and uncertainties set forth in this document; our striving to continue to improve our customer’s profitability through investment in the development of innovative products and services; our ability to absorb cyclical downturns through the flexibility of our UHP technology and market diversity; our confidence that we can continue to gain market share; our conclusion that waterjet technology is in the early adoption phase of its product life cycle; 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 our patents to act as a barrier to entry for competitors in the UHP technology field; increased market acceptance of waterjet cutting systems by the aerospace, automotive, and machine (Job shop) industries will encourage other manufacturers, including those in other industries, to adopt waterjet solutions; our intent to contest Omax’s allegations; our belief that the estimated cost of probable legal claims resolutions will not have an adverse effect on our consolidated financial position; our belief that the appropriate actions to remedy our material weakness are to implement new control policies and procedures and to hire additional accounting staff with appropriate levels of experience in order to improve the reconciliation process; our belief that our restructuring activities and related cost-cutting initiatives will reduce overall spending; our belief that the benefits of our restructuring activities will continue into fiscal 2006; spare parts sales will continue to increase as more systems are put into operation; expected severance and relocation costs; our belief that our existing cash and credit facilities at October 31, 2005 are adequate to fund our operations through April 30, 2006; our belief that compliance with covenants in the current senior credit agreement is achievable; our expectation that the funds necessary for capital expenditures will be generated internally and through available credit facilities; the strengthening of global economies; and global economic conditions and additional threatened terrorist attacks and responses thereto, including war. Additional information on these and other factors that could affect our financial results is set forth below. Finally, there may be other factors not mentioned above or included in our SEC filings that may cause our actual results to differ materially from those in any forward-looking statement. You should not place undue reliance on these forward-looking statements. 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.

 

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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 $59.3 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 totaling $42.3 million in April 2005. The remaining proceeds were used to repay borrowings on our senior credit facility.

 

481,081 shares are issuable on the exercise of warrants issued to lenders at an exercise price of $0.08 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. Our previous credit agreements contained restrictions on our ability to pay dividends to our shareholders. However, the Current Senior Credit Agreement does permit us to pay dividends.

 

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PRO FORMA INFORMATION

 

The unaudited pro forma consolidated statement of operations for the fiscal year ended April 30, 2005 gives effect to the PIPE Transaction. The PIPE Transaction, as described on page 2, was completed in March 2005, and the transaction was reported in the Company’s financial statements for the year ended April 30, 2005. In the PIPE Transaction, as described on page 2, we sold 17,473,116 shares of common stock and warrants to purchase 1,747,310 shares of common stock. The PIPE Transaction gross proceeds of $65 million, less investment banking fees of $5.1 million and other costs of $626,000 resulted in net cash proceeds of $59.3 million. The pro forma presentation reflects application of all of the net proceeds to pay down debt as if the transaction occurred on May 1, 2004. In this presentation, we have assumed that 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. We issued 304,000 anti-dilution warrants to our senior and subordinated lenders in connection with the PIPE transaction. The fair value of these warrants was $1.7 million. The pro forma presentation includes the amortization of these debt issue costs as if the transaction occurred on May 1, 2004.

 

These unaudited pro forma financial statements should be read in conjunction with the accompanying notes to unaudited pro forma financial statements, our historical financial statements and related notes, 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.

 

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Unaudited Pro Forma Consolidated Statements of Operations for the Year Ended April 30, 2005

(In thousands, except share amounts)

 

    

Restated

Consolidated(1)


    PIPE
Transaction


    Pro Forma
Consolidated


 

Sales

   $ 172,966             $ 172,966  

Cost of Sales

     106,943               106,943  
    


 


 


Gross Margin

     66,023       —         66,023  

Operating Expenses:

                        

Marketing

     28,371               28,371  

Research and Engineering

     5,889               5,889  

General and Administrative

     22,849               22,849  

Financial Consulting Charges

     623               623  
    


 


 


       57,732       —         57,732  
    


 


 


Operating Income

     8,291       —         8,291  

Interest Expense

     (20,342 )     16,048 (a)     (4,294 )

Interest Income

     106               106  

Other Income, net

     1,705               1,705  
    


 


 


(Loss) Income from Continuing Operations Before Income Taxes

     (10,240 )     16,048       5,808  

Provision for Income Taxes

     (1,934 )     —   (b)     (1,934 )
    


 


 


(Loss) Income from Continuing Operations

   $ (12,174 )   $ 16,048     $ 3,874  
    


 


 


(Loss) Income Per Share from Continuing Operations

                        

Basic

   $ (0.69 )           $ 0.12  
    


         


Diluted

   $ (0.69 )           $ 0.11  
    


         


Weighted Average Shares Used in Computing (Loss) Income per Share from Continuing Operations

                        

Basic

     17,748               33,402  (c)

Diluted

     17,748               35,427  (c)

(1) As described in Note 2 to the Consolidated Financial Statements, we restated our consolidated financial statements for the year ended April 30, 2005.

 

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Notes to Unaudited Pro Forma Consolidated Statements of Operations

 

(a) To record the interest expenses reduced due to the PIPE Transaction.

 

The subordinated debt and accrued interest at May 1, 2004 (the beginning of fiscal 2005) was $42.3 million. The pro forma interest expense, net income and 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. 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 $59.3 million and $42.3 million of subordinated borrowing and accrued interest or $17.0 million. In addition, the pro-forma amounts exclude the amortization of the Debt Discount on the Subordinated debt of approximately $1.1 million per year. No pro forma impact was ascribed to the antidilution warrants issued in conjunction with the PIPE Transaction as such impact is not determinable. The pro-forma interest expense includes the following adjustments:

 

In Thousands    Year Ended
April 30,
2005


Reduced interest expense on subordinated debt

   $ 7,724

Reduced interest expense on senior debt

     1,509

Exclude write-off of capitalized fees and debt discount

     5,281

Exclude charges for the antidilution warrants

     1,534
    

Total pro forma adjustment to interest expense

   $ 16,048
    

 

The pro forma presentation also excludes the write off of unamortized debt discount, write-off of any capitalized fees. These fees were expensed in the fourth quarter of fiscal 2005 when the underlying debt was retired. They amounted to $5.3 million in additional charges. Charges taken in the fourth quarter of fiscal 2005 for the portion of the warrants ($1,534,000) issued to our subordinated lender and those senior lenders who did not participate in an ongoing senior credit agreement are excluded from the pro forma results.

 

(b) Because we have provided for 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.

 

(c) The pro forma weighted average number of shares outstanding includes the following adjustments:

 

     Year Ended
April 30, 2005


In Thousands    Basic

   Diluted

Common shares issued in PIPE Transaction

   15,654    15,654

Dilutive potential common shares from warrants and options

   —      2,025
    
  

Total additional shares included in weighted average shares outstanding

   15,654    17,679
    
  

 

The weighted average shares are adjusted for the additional shares issued in the PIPE Transaction, as if they were issued May 1, 2004. Diluted income (loss) per share takes into consideration the warrants issued to purchasers of stock in the PIPE Transaction, as well as the anti-dilution 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 were:

 

     April 30,
2005


In Thousands    Actual

Common stock options

   2,035

Warrants

   3,219
    

Total

   5,254
    

 

1,982,046 options are excluded from dilutive potential common shares in the pro forma presentation because they are out-of-the-money.

 

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Controls and Procedures

 

In December 2004, in connection with the restatement of our fiscal 2004, 2003 and 2002 financial statements, in November 2005 and January 2006, in connection with our restatement of our fiscal 2005, 2004 and 2003 financial statements, our former independent registered public accounting firm reported to management and to the Audit Committee material weaknesses in internal control over financial reporting. A material weakness is a control deficiency, or a combination of control 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. Management agrees with and has responded to the Audit Committee with our plans to remediate the material weaknesses communicated by our former independent registered public accounting firm. Remediation of these material weaknesses is ongoing.

 

The material weaknesses in our internal control over financial reporting are as follows:

 

    The Company did not maintain effective controls over the financial reporting process due to an insufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles commensurate with its financial reporting requirements and the complexity of the Company’s operations and transactions. Specifically, the Company incorrectly applied generally accepted accounting principles for (i) the impairment of goodwill, (ii) the classification of deferred tax balances, (iii) the valuation of anti-dilution warrants, (iv) the accrual of costs on contracts and balance sheet presentation of accounts receivable and cash receipts relating to contracts accounted for using the percentage-of-completion method, (v) leases with rent escalation clauses, (vi) the recording of minority interest, and (viii) the computation of the provision for income taxes, affecting receivables, deferred income taxes, prepaid expenses, goodwill, other accrued liabilities, other long-term liabilities and taxes payable, customer deposits, minority interest, capital in excess of par, accumulated deficit, cost of sales, general and administrative expenses, impairment charge, interest expense and other income, net and the provision for income taxes. This material weakness contributed to the material weakness discussed below.

 

    The Company did not maintain effective controls to ensure there is adequate (i) analysis, documentation, reconciliation and review of accounting records, and supporting data, and (ii) monitoring and oversight of the work performed by accounting and financial reporting personnel to ensure the accuracy and completeness of the consolidated financial statements in accordance with generally accepted accounting principles. Specifically, the Company did not have effective controls designed and in place over the consolidation of the financial statements of subsidiaries and the computation of minority interest, the reconciliation of inter-company accounts, the valuation of anti-dilution warrants, the accrual of costs on contracts and balance sheet presentation of accounts receivable and cash receipts relating to contracts accounted for using the percentage-of-completion method, the classification of technical service expenses, the accounting for performance based equity awards and the computation of income tax provisions, affecting receivables, prepaid expenses, other accrued liabilities, taxes payable, customer deposits, capital in excess of par, minority interest, accumulated deficit, cost of sales, marketing expense, research and engineering, general and administrative expense, interest expense, other income, net, and the provision for income taxes.

 

These control deficiencies resulted in the restatement of the Company’s consolidated financial statements for the years ended April 30, 2005, 2004 and 2003, and certain quarters in these years and in the restatement of the condensed consolidated financial statements for the first and second quarters of fiscal 2006. Additionally, each of these control deficiencies could result in a material misstatement of the aforementioned account balances or disclosures that would result in a material misstatement to the annual or interim financial statements that would not be prevented or detected. Accordingly, management has determined that each of the above control deficiencies represents a material weakness.

 

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Remediation of Material Weakness

 

Our management and Audit Committee have dedicated significant resources to assessing the underlying internal control deficiencies giving rise to the restatements and to ensure that proper steps have been and are being taken to improve our internal control over financial reporting. We have assigned the highest priority to the correction of these deficiencies and have taken and will continue to take action to fully correct them. Management is committed to instilling strong control policies and procedures and ensuring that the ‘tone at the top’ is committed to accuracy and completeness in all financial reporting. The remedial measures include the following:

 

    Insufficient compliment of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles.

 

We have filled several positions in the corporate accounting and finance department with newly hired staff, including a financial planner, assistant controller and senior accountant. We have not completed the hiring process at corporate as we continue to assess our staffing needs. During August 2005, we hired a technical accounting manager to ensure compliance with all current and future accounting rules. Prior to that date the existing staff was addressing our application of technical accounting literature. We will continue to assess staffing needs at both corporate and our subsidiaries, and have identified the need for additional staff in the areas of accounting supervision and financial analysis. We have applied additional resources and time to improve the appropriateness and documentation of our conclusions on technical accounting issues. This will be enhanced with the addition of our technical accounting manager and other planned additions.

 

    Lack of effective controls to ensure adequate analysis, documentation, reconciliation and review of accounting records. Lack of effective controls to ensure adequate monitoring and oversight of work performed by accounting and financial reporting personnel.

 

We engaged a financial consulting firm to assist in both detail reconciliation work, as well as reviewing current processes and controls and assistance in the development of prospective processes and controls over the inter-company reconciliation process. We created a standardized template used in the reconciliation of all our inter-company accounts. These reconciliations are reviewed for accuracy and completeness by our Chief Financial Officer. Additionally, we have created a new template for use in generation of our Statement of Cash Flows. We have modified our monthly divisional close checklist to ensure all required reconciliations are completed, as well as help ensure adherence to corporate policies and procedures. We have begun to improve the documentation of our accounting policies and procedures to ensure that all transactions are recorded consistently and with the appropriate level of documentation. As is described in the above paragraph, we still need to hire additional experienced staff to provide enhanced review, analysis and documentation of accounting transactions and of the consolidated financial statements.

 

The implementation of the initiatives described above, are among our highest priorities. Our Audit Committee will continually 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 outlined above, when completed, will eliminate the material weaknesses in internal control over financial reporting as described above.

 

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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, 2005, 2004 and 2003 and the selected consolidated balance sheet data as of April 30, 2005 and 2004 are derived from our audited consolidated financial statements, which are included elsewhere in this prospectus. The selected consolidated statement of operations data of each of the fiscal years ended April 30, 2002 and 2001 and the balance sheet as of April 30, 2003, 2002 and 2001 are derived from our unaudited financial statements that are not included in this prospectus. The selected consolidated statement of operations data for the six months ended October 31, 2005 and the selected consolidated balance sheet data as of October 31, 2005 are derived from our unaudited condensed consolidated financial statements which are included in this prospectus. Our unaudited financial statements have been prepared on the same basis as our audited consolidated financial statements included elsewhere in this prospectus and, in the opinion of our management, reflect all adjustments, which include only normal recurring adjustments, necessary to state fairly our financial position and results of operations as of and for those periods.

 

(In thousands, except per share
amounts)
  Six Months
Ended
October 31,
2005
(restated)(4)(5)


  Year Ended April 30,

   

2005

(restated)(4)(5)


   

2004(5)

(restated)(4)


   

2003(3)(5)

(restated)(4)


   

2002(2)(5)

(restated)(4)


   

2001(1)(5)

(restated)(4)


    (unaudited)                     (unaudited)     (unaudited)

Statement of Operations Data:

                                           

Sales

  $ 92,671   $ 172,966     $ 132,861     $ 121,833     $ 116,386     $ 132,797

Income (Loss) Before Cumulative Effect of Change in Accounting Principles and Discontinued Operations

    1,221     (12,174 )     (10,668 )     (43,965 )     (7,966 )     1,882

Net Income (Loss)

    1,040     (21,197 )     (11,274 )     (67,813 )     (8,024 )     1,304

Basic Income (Loss) Per Share Before Cumulative Effect of Change in Accounting Principles and Discontinued Operations

    0.04     (0.69 )     (0.69 )     (2.86 )     (0.52 )     0.13

Basic Earnings (Loss) Per Share

    0.03     (1.19 )     (0.73 )     (4.42 )     (0.53 )     0.09

Diluted Income (Loss) Per Share Before Cumulative Effect of Change in Accounting Principles and Discontinued Operations

    0.03     (0.69 )     (0.69 )     (2.86 )     (0.52 )     0.12

Diluted Income (Loss) Per Share

    0.03     (1.19 )     (0.73 )     (4.42 )     (0.53 )     0.09
    October 31,
2005
(restated)(4)


  April 30,

(In thousands)    

2005

(restated)(4)


   

2004

(restated)(4)


   

2003

(restated)(4)


   

2002

(restated)(4)


   

2001

(restated)(4)


    (unaudited)               (unaudited)     (unaudited)     (unaudited)

Balance Sheet Data:

                                           

Working Capital

  $ 35,343   $ 6,154     $ (8,757 )   $ (6,709 )   $ 84,556     $ 95,322

Total Assets

    108,862     118,467       129,272       147,088       205,572       206,270

Short-Term Debt

    1,437     13,443       48,727       61,056       5,237       8,464

Long-Term Obligations, net

    23,538     5,704       38,081       29,023       83,453       85,652

Shareholders’ Equity (Deficit)

    28,499     29,464       (8,217 )     5,959       69,967       67,839

 

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(1) The Statement of Operations for fiscal 2001 includes the adoption of SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB101A and 101B. We reflected this change in policy as a Cumulative Effect of Change in Accounting Principle.
(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, 2005 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) As described in Note 2 to the April 30, 2005 Consolidated Financial Statements included elsewhere in this prospectus, we have restated our consolidated financial statements for the year ended April 30, 2005 to reflect additional charges in the Consolidated Statement of Operations associated with 1) the impairment of goodwill, 2) the revised valuation of anti-dilution warrants issued to our senior and subordinated lenders, 3) the revision of estimated losses on long-term contracts, 4) the correction of compensation expense for performance based equity awards and stock awards for services and 5) straight-line rent expense for leases with escalating rents. We have identified errors in the Consolidated Financial Statements related to the presentation of percentage-of-completion related balances on the Consolidated Balance Sheet. Specifically, we noted inconsistencies between our divisions in the balance sheet presentation of accounts receivable and cash receipts relating to contracts accounted for using the percentage-of-completion method. We have, therefore, adjusted the financial statements to reflect a consistent presentation and comply with the provisions of SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” for all years presented. In addition, we restated certain balances for incorrect classification on our Consolidated Balance Sheet as of April 30, 2005 and 2004 and Consolidated Statement of Operations for the year ended April 30, 2005. We also restated our consolidated financial statements in Amendment No. 2 to our April 30, 2005 Form 10-K to reflect corrections to our consolidated income tax provisions and recording of minority interest for all years presented. These errors also resulted in a restatement of our interim financial statements as of and for the six months ended October 31, 2005.

 

The restated amounts above reflect the adjustments enumerated in Note 2 to the Consolidated Financial Statements in our Form 10-K/A Amendment No. 2 and the following adjustments for years prior to fiscal 2004;

 

     2002

    2001

    

As

previously

reported


   

As

Restated


   

Reclassified for

Discontinued

Operations


   

As

previously

reported


 

As

Restated


 

Reclassified for

Discontinued

Operations


Statement of Operations Data:

                                          

(Loss) Income Before Cumulative Effect of Change in Accounting Principle and Discontinued Operations

   $ (8,244 )   $ (8,415 )   $ (7,966 )   $ 4,038   $ 3,713   $ 1,882

Net (Loss) Income

     (7,853 )     (8,024 )     (8,024 )     1,630     1,304     1,304

Net (Loss) Income per share:

                                          

Basic & Diluted

                                          

Net Loss

     (0.52 )     (0.53 )     (0.53 )     0.11     0.09     0.09

 

    2003

    2002

  2001

   

As

previously

reported


   

As

Restated


   

As

previously

reported


 

As

Restated


 

As

previously

reported


 

As

Restated


Balance Sheet Data:

                                       

Working Capital

  $ (6,709 )   $ (6,709 )   $ 84,532   $ 84,556   $ 91,750   $ 95,322

Total Assets

    147,701       147,088       208,674     205,572     209,309     206,270

Total Shareholders’ Equity

    4,872       5,959       71,054     69,967     68,755     67,839

 

(5) Our consolidated statement of operations for all periods has been recast to give effect to the sale of the Avure Business and present the results for the Avure Business as discontinued operations.

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Current Events

 

Avure Disposition –

 

On October 31, 2005, consistent with our strategy to divest operations that are not part of our core UHP water pump business, we sold our General Press operations and the non UHP portion of our Food reportable segment (the “Avure Disposition”). Included in the Avure Disposition were our Avure Technologies, Incorporated, Flow International FPS AB, Avure Technologies AB subsidiaries, and our 51% interest in Flow Autoclave Systems (together, the “Avure Business”). The Avure Business became a discontinued operation in accordance with FAS 144 Accounting for the Impairment or Disposal of Long-Lived Assets at the time it was sold and has been presented as a discontinued operation in the Statements of Operations in the financial statements.

 

Barton –

 

On August 26, 2005, we received $2.5 million for giving the exclusive right to Barton Mines Company to sell abrasive to our customers. Under a Purchase Agreement, we are also entitled to future annual payments of up to $250,000 for the next three years based on achievement of system sales targets and royalty payments for systems sold over the next 10 years.

 

Current Senior Credit Agreement –

 

Until April 28, 2005, our long-term financing consisted of a senior credit agreement (originally entered into on July 28, 2004) whose maturity date was August 1, 2005 (“Senior Credit Agreement”) and a subordinated debt agreement (“Subordinated Debt Agreement”). On April 28, 2005, we entered into a new senior debt agreement (“April Senior Credit Agreement”) for the purpose of being able to pay off the Subordinated Debt Agreement, which was done. The April Senior Credit Agreement also had a maturity date of August 1, 2005. On July 8, 2005, we entered into a new senior credit agreement, with a maturity date of July 8, 2008 (“Current Senior Credit Agreement”). At certain places in this report, we refer to “Senior Credit Arrangements” referring to one or more of the senior credit agreements when identification of a particular agreement is not important. The Current Senior Credit Agreement is a $30 million, three year agreement with Bank of America N.A. and U.S. Bank N.A. It bears interest at Bank of America’s prime rate (5.75% at April 30, 2005) or is linked to LIBOR plus a percentage depending on our leverage ratios, at our option. The agreement sets forth specific financial covenants to be attained on a quarterly basis, which we believe, based on our financial forecasts, are achievable. The financial covenants in the Current Senior Credit Agreement are less restrictive than in the earlier Senior Credit Arrangements.

 

Restructuring –

 

In fiscal 2005, we completed 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 evaluated the workforce and skill levels necessary to satisfy the expected future requirements of the business. As a result, we implemented plans to eliminate redundant positions and realign and modify certain roles based on skill assessments. We recorded restructuring charges of $2.5 million for the year ended April 30, 2004 which are shown in the table below (in thousands):

 

    

Year Ended

April 30, 2004


Severance benefits

   $ 217

Facility exit costs

     867

Inventory write-down

     1,384
    

     $ 2,468
    

 

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These charges included employee severance related costs for approximately 35 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 and vacating the manufacturing warehouse portion of our Flow Europe 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. See restructuring accrual information in Note 17 to Consolidated Financial Statements.

 

The Avure Business incurred restructuring charges of $239,000 and $788,000 for the years ended April 30, 2005 and 2004, respectively, which included employee severance costs for 15 individuals. In addition, the Avure Business reduced the space utilized in its Swedish manufacturing facility and closed the Memphis sales office for the food portion of the business.

 

During the year ended April 30, 2005 and 2004, we incurred $.6 million and $1.5 million, respectively, of professional fees associated with the restructuring of our debt in July 2004 and July 2003, respectively. 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 Credit Arrangement with lenders that did not occur, or they related to expenses associated with our subordinated debt and did not result in an increase in the facility and accordingly they were expensed.

 

Robotics Division –

 

In an effort to control costs and to focus on our core UHP waterjet systems, on June 2, 2005, we announced that we had expanded our strategic relationship with Motoman Inc., to deliver standard, pre-engineered robotic waterjet cutting solutions to the automotive industry. The relationship means that Motoman, Inc. will be the primary sales contact with the end user for standard systems and we will sell UHP pumps and parts to Motoman, Inc. to be integrated into the pre-engineered robotic cutting system. At the same time we announced that, in order to re-align our resources with this new strategic direction, our custom robotic waterjet cutting system manufacturing would be relocated from Wixom, Michigan to Burlington, Ontario. This closure was completed by the second quarter of fiscal 2006 with restructuring expenses of approximately $600,000. These expenses include severance payments for employees, exit expenses for the facility as well as logistical expenses for moving and disposing of equipment and assets.

 

Other –

 

We have also retained a broker to assist us in evaluating various opportunities for the Applications Group, our “Other” segment.

 

Three and Six Months Ended October 31, 2005 Compared to Three and Six Months Ended October 31, 2004

 

Changes in Financial Condition

 

We generated $9.2 million of cash from operating activities during the six months ended October 31, 2005 compared to $6.7 million of cash generated for the six months ended October 31, 2004. The current period’s operating cash flow includes $2.5 million of cash received related to the Purchase Agreement with Barton referred to earlier. Customer deposits increased $4.7 million further contributing to the cash flow from operations. These deposits provide the funding for the manufacturing of our systems and primarily relate to large aerospace contracts that we have been awarded. The revenue associated with these deposits is expected to be recognized in the next twelve months. Offsetting these inflow is a $1.2 million increase in Receivables, net from progress made on percentage-of-completion projects during the six months ended October 31, 2005. Trade receivables accounted for cash generation of $1.8 million in the year ago comparable period. Additionally, increases in inventory of $4.1 million during the six months ended October 31, 2005 offset the cash generated by the Barton transaction and customer deposits. These increases were the result of additional inventory purchases in our core business to meet upcoming demand in the third quarter of fiscal 2006 as well as inventory changes in the Avure business prior to the disposition.

 

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Table of Contents

Net receivables are comprised of trade accounts and unbilled revenues. At October 31, 2005, the net receivables balance decreased $10.2 million or 27% from April 30, 2005. The decrease in net receivables stemmed from the reduction in trade receivables of $8.9 million or 24% from $37.2 million at April 30, 2005 to $28.3 million at October 31, 2005 on sale of the Avure Business which reduced trade receivables by $7.5 million and on collection of standard waterjet system sales for the six months ended October 31, 2005. Receivables days sales outstanding (including unbilled revenues and excluding the Avure business for the comparative periods) increased to 55 days at October 31, 2005 from 49 as of April 30, 2005. This decrease in Trade Receivables was compounded by a reduction in unbilled revenues from $5.0 million at April 30, 2005 to $3.4 million at October 31, 2005, a $1.6 million or 32% decrease. The Avure Business accounted for $4.6 million of the decrease which was offset by an increase in the percentage complete on our aerospace contracts as well as a higher number of automation contracts being worked on. Our unbilled receivables relate to equipment and systems sales accounted for on a percentage of completion basis. Unbilled revenues fluctuate due to the scheduling of production and achievement of certain billing milestones. In general, receivables can be negatively affected by the traditionally longer payment cycle outside the United States and the timing of billings and payments on large special system orders. We do not believe these timing issues will present a material adverse impact on our short-term liquidity requirements. Because of the lead-time to build and deliver such equipment, ultimate collection of such accounts can be subject to changing customer business and economic conditions.

 

Inventories, net at October 31, 2005 decreased $4.8 million or 20% from April 30, 2005 driven by the sale of the Avure Business which accounted for $6.2 million. This was offset by an increase in Waterjet inventory of $1.3 million primarily related to some equipment for our aerospace contracts which we anticipate shipping in our fourth fiscal quarter of 2006.

 

Customer deposits were $7.6 million at October 31, 2005, versus the $10.6 million balance at April 30, 2005. The disposition of the Avure Business accounted for a decrease of $3.1 million which was offset by the receipt of milestone advances due under the significant aerospace contracts which we were awarded in fiscal 2005.

 

Liquidity and Capital Resources

 

Approximately $20.3 million of our cash and restricted cash is held by divisions outside the United States. The repatriation of offshore cash balances from certain divisions will trigger tax liabilities. In fiscal 2004, we recorded a $1.9 million liability for withholding taxes on future repatriation of historical foreign earnings. In fiscal 2005, we repatriated $4.8 million from certain foreign subsidiaries. During the six months ended October 31, 2005, we repatriated $1.4 million from a foreign subsidiary and we plan to continue repatriating additional funds in the future.

 

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 more than $59 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. If all the warrant holders opted to exercise their warrants, we would receive $7.1 million in cash proceeds.

 

Because the market price of the common stock was greater than $3.70, we issued approximately 304,000 anti-dilution warrants to current warrant holders prior to the PIPE Transaction which have a Black-Scholes value of approximately $1.7 million. Approximately $1.5 million of this amount relates to warrants issued under subordinated debt agreements and $0.2 million relates to warrants issued under senior debt agreements. Proceeds of the PIPE were used to pay down existing debt, including all of the subordinated debt.

 

Under terms of the PIPE Transaction, we were required to file an initial Form S-1 registration of the shares issued and issuable in the PIPE Transaction on or before May 20, 2005 and were required to cause the Form S-1 to become effective on or before September 17, 2005. We subsequently amended the Registration Rights

 

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Table of Contents

Agreement to grant us an extension until March 10, 2006 for the effective date of the registration of the shares and warrants issued in the PIPE Transaction. We are subject to liquidated damages of $650,000 per month, if we fail to meet the March 10, 2006 deadline.

 

Our domestic senior credit agreement (“Credit Agreement”) is our primary source of external funding. Effective July 8, 2005, we executed a new $30 million, three year senior credit agreement with Bank of America N.A. and U.S. Bank N.A. This credit agreement expires July 8, 2008 and bears interest at the bank’s prime rate (6.75% at October 31, 2005) or is linked to LIBOR plus a percentage depending on our leverage ratios, at our option. The agreement sets forth specific financial covenants to be attained on a quarterly basis, which we believe, based on our financial forecasts, are achievable. At October 31, 2005, the balance outstanding on the Credit Agreement was $18.5 million against a maximum borrowing of $30 million. Our available credit at October 31, 2005, net of $2.3 million in outstanding letters of credit, was $9.2 million.

 

We believe that our existing cash, cash from operations, and credit facilities at October 31, 2005 are adequate to fund our operations through April 30, 2006. If we fail to achieve our planned revenues, costs and working capital objectives, management believes it has the ability to curtail capital expenditures and reduce costs to levels that will be sufficient to enable us to meet our cash requirements and debt covenants through April 30, 2006.

 

On August 26, 2005, we received $2.5 million for giving the exclusive right to Barton Mines Company to sell abrasive to our customers. Under a Purchase Agreement, we are also entitled to future annual payments of up to $250,000 for the next three years based on achievement of system sales targets and royalty payments for systems sold over the next 10 years.

 

Since fiscal 2004, we had been investigating, with approval from our Board, alternatives for our non-core operations. On October 31, 2005, we completed the sale of our Avure Business with Gores Technology for estimated net proceeds of $14.4 million, comprised of cash and notes. The Avure Business was comprised of the International and North America Press reporting segments as well as the non ultrahigh-pressure portion of our Food reportable segment. The ultrahigh-pressure portion of our Food segment will be reported under North America Waterjet on a go-forward basis. The results of operations are shown as discontinued operations in our financial statements.

 

Off-Balance Sheet Arrangements

 

We do not have any special purpose entities or off-balance sheet financing arrangements.

 

Contractual Obligations

 

During the quarter ended October 31, 2005, there were no material changes outside the ordinary course of business in our contractual obligations and minimum commercial commitments as reported in Amendment No. 2 to our Annual Report on Form 10-K for the year ended April 30, 2005.

 

Critical Accounting Policies and Judgments and New Accounting Pronouncements

 

There are no material changes in our critical accounting policies as disclosed in Amendment No. 2 to our Annual Report on Form 10-K for the year ended April 30, 2005. New accounting pronouncements are disclosed in Note 16 to the Condensed Consolidated Financial Statements.

 

Results of Operations

 

Our ultrahigh-pressure (“UHP) business which we call Waterjet is comprised of the following segments: North America Waterjet, Asia Waterjet, Other International Waterjet and Other.

 

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Table of Contents

Sales Summary:

 

Dollars in thousands

 

     Three months ended October 31,

    Six months ended October 31,

 
     2005

   2004

   % Change

    2005

   2004

   % Change

 

Operational breakdown:

                                        

Waterjet:

                                        

Systems

   $ 36,950    $ 31,274    18  %   $ 65,671    $ 57,174    15  %

Consumable parts and services

     13,735      12,813    %     27,000      25,212    %
    

  

        

  

      
     $ 50,685    $ 44,087    15  %   $ 92,671    $ 82,386    13  %
    

  

        

  

      

Geographic breakdown:

                                        

United States

   $ 28,992    $ 25,308    15 %   $ 53,492    $ 45,826    17 %

Rest of Americas

     6,828      4,710    45 %     11,009      9,605    15 %

Europe

     7,397      7,616    (3 )%     14,934      14,151    6 %

Asia

     7,468      6,453    16 %     13,236      12,804    3 %
    

  

        

  

      
     $ 50,685    $ 44,087    15  %   $ 92,671    $ 82,386    13  %
    

  

        

  

      

 

Three and Six Months Ended October 31, 2005 Compared to Three and Six Months Ended October 31, 2004

 

(Tabular amounts in thousands)

 

Sales.

 

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

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
     2005

   2004

   Difference

    %

    2005

   2004

   Difference

    %

 

Sales

                                            

Waterjet:

                                            

North America

   28,644    20,663    7,981     39 %   51,571    36,563    15,008     41 %

Asia

   7,468    6,453    1,015     16 %   13,236    12,804    432     3 %

Other International

   8,789    8,396    393     5 %   17,242    15,532    1,710     11 %

Other

   5,784    8,575    (2,791 )   (33 )%   10,622    17,487    (6,865 )   (39 )%
    
  
  

       
  
  

     

Waterjet Total

   50,685    44,087    6,598     15 %   92,671    82,386    10,285     12 %
    
  
  

       
  
  

     

 

Our Waterjet business 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 sells which are sold primarily into the North American automotive industry.

 

For the three months ended October 31, 2005, total Waterjet sales of $50.6 million increased $6.6 million or 15% as compared to the prior year same period. For the six months ended October 31, 2005, total Waterjet sales of $92.7 million increased $10.3 million or 12% as compared to the prior year same period of which $15.0 million was recognized in our North America Waterjet segment. Last year 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 2004, as well as increasing the number of domestic waterjet cutting direct sales staff from 10 to 15, adding of two

 

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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 as well as increased revenue recognition on large percentage-of-completion aerospace contracts. There were no significant price increases year over year; however, a price increase of 4% on selected systems was instituted on February 1, 2005. Aerospace sales, which are also included in the North America segment, were $7.5 million and $9.6 million for the three and six months ended October 31, 2005, respectively, up $6.7 million and $8.4 million from the prior year same respective periods from work completed on aerospace contracts awarded in fiscal 2005.

 

For the three and six months ended October 31, 2005, Asia Waterjet segment revenue increased $1.0 million and $0.4 million, or 16% and 3% for the prior year same respective periods. This increase was fueled by expansion of waterjet systems into the electronics industry in Taiwan. Growth in the Other International Waterjet segment represents primarily sales into Europe and South America. Revenues from our European operations have declined $219,000 to $7.4 million during the three months ended October 31, 2005 on a strengthening dollar while improving by $783,000 for the six months ended October 31, 2005 to $14.9 million. Sales into South America of $1.4 million and $2.3 million for the three and six months ended October 31, 2005 improved $612,000 and $927,000 over the respective prior year same periods on higher standard shapecutting system sales as the Company focused its efforts in this area. We typically sell our products at higher prices outside the U.S. due to the costs of servicing these markets.

 

The growth in our North America, Asia Waterjet, and Other International Waterjet segments were offset by declines in the ‘Other’ segments. The ‘Other’ segment recorded a $2.8 million and a $6.9 million decline for the three and six months ended October 31, 2005 from the prior year same periods from a softness in the domestic automotive industry as well as from the closing and relocation of our Wixom, Michigan facility to our Burlington, Ontario facility. This shutdown was completed to combine like businesses and reduce operating costs.

 

We also analyze our Waterjet revenues by looking at system sales and consumable sales. Systems sales were $37.0 million, up $5.7 million or 18%, for the three months ended October 31, 2005 and up $8.5 million or 15%, for the six months ended October 31, 2005 due to strong domestic shapecutting sales as well as increased aerospace revenue. Consumables revenues recorded an increase of $922,000 or 7.2% to $13.7 million for the three months ended October 31, and $1.8 million or 7.1% to $27 million for the six months ended October 31, 2005, respectively. The majority of the increase in spares sales for the three and six months ended October 31, 2005 was recorded in Europe and South America. The increasing number of systems in service, our proprietary productivity enhancing kits and improved parts availability as well as the use of Flowparts.com, our easy-to-use internet order entry system, offset domestic spare parts declines resulting from the elimination of garnet revenue pursuant to the Barton transaction. We believe that spare parts sales should continue to increase as more systems are put into service.

 

Cost of Sales and Gross Margins. Our gross margin by segment for the periods noted below is summarized as follows:

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
     2005
(restated)


   2004
(restated)


   Difference

   %

    2005
(restated)


   2004
(restated)


   Difference

   %

 

Gross Margin

                                          

Waterjet:

                                          

North America

   13,878    9,616    4,262    44 %   24,865    17,586    7,279    41 %

Asia

   3,549    2,871    678    24 %   6,359    5,726    633    11 %

Other International

   3,281    2,671    610    23 %   6,542    5,051    1,491    30 %

Other

   1,626    233    1,393    598 %   2,501    1,200    1,301    108 %
    
  
  
        
  
  
      

Waterjet Total

   22,334    15,391    6,943    45 %   40,267    29,563    10,704    36 %
    
  
  
        
  
  
      

 

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

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
    

2005

(restated)


   

2004

(restated)


    2005
(restated)


    2004
(restated)


 

Gross Margin Percentage

                        

Waterjet:

                        

North America

   48 %   47 %   48 %   48 %

Asia

   48 %   44 %   48 %   45 %

Other International

   37 %   32 %   38 %   33 %

Other

   28 %   3 %   24 %   7 %

Waterjet Total

   44 %   35 %   43 %   36 %

 

Gross margin for the three and six months ended October 31, 2005 amounted to $22.3 million or 44% of sales and $40.3 million or 43%, respectively, as compared to gross margin of $15.4 million or 35% of sales and $29.6 million or 36% in the prior year same periods. Domestically, the gross margin improvements are attributable to cost reductions from global supply chain initiatives as well as improved cost absorption from higher sales volumes in standard shapecutting as well aerospace system sales. Asia Waterjet margins rose on strong product pricing and its improved product mix. The Other segment saw improved margins as the prior three and six month results included significant costs accrued on loss contracts at our Wixom, Michigan division which depressed margins to (18)% and (10)%, respectively. Current period margins in the Other segment are in line with margin expectations for this line of business. Generally, comparison of 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%. 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.

 

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

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
     2005
(restated)


   2004
(restated)


   Difference

    %

    2005
(restated)


   2004
(restated)


   Difference

    %

 

Marketing:

                                            

Waterjet:

                                            

North America

   4,329    3,822    507     13 %   8,355    6,828    1,527     22 %

Asia

   1,069    892    177     20 %   2,030    1,733    297     17 %

Other International

   2,241    1,869    372     20 %   4,505    3,841    664     17 %

Other

   234    473    (239 )   (51 )%   559    890    (331 )   (37 )%
    
  
  

       
  
  

     

Waterjet Total

   7,873    7,056    817     12 %   15,449    13,292    2,157     16 %
    
  
  

       
  
  

     

 

Marketing expenses increased $817,000 or 12% and $2.2 million or 16% for the three and six months ended October 31, 2005, respectively, as compared to the prior year same periods. All segments experienced increases in their Marketing expenses for both periods with the exception of the Other segment. The increases are due to increased expenses such as commissions on higher sales, as well as increased marketing and advertising costs directed at increasing waterjet technology awareness. The Other segment decreased its expenses as the Wixom division was closed in Q2 and all marketing activity was handled through our Burlington facility. Expressed as a percentage of revenue, consolidated marketing expenses were 16% and 17% for the three and six months ended October 31, 2005 and 16% for the three and six months ended October 31, 2004.

 

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

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
     2005
(restated)


   2004
(restated)


   Difference

    %

    2005
(restated)


   2004
(restated)


   Difference

    %

 

Research and Engineering Waterjet:

                                            

North America

   1,429    971    458     47 %   3,043    2,289    754     33 %

Asia

   129    80    49     61 %   235    158    77     49 %

Other International

   103    179    (76 )   (42 )%   242    349    (107 )   (31 )%

Other

   31    25    6     24 %   50    81    (31 )   (38 )%
    
  
  

       
  
  

     

Waterjet Total

   1,692    1,255    437     35 %   3,570    2,877    693     24 %
    
  
  

       
  
  

     

 

Research and engineering expenses increased $437,000 or 35% and $693,000 or 24% for the three and six months ended October 31, 2005, as compared to the prior year same periods. Increases of $458,000 and $754,000 were recorded in the North America Waterjet segment for the three and six months ended October 31, 2005. This is attributable to the addition of key engineering personnel related to our core UHP technology. Expressed as a percentage of revenue, research and engineering expenses were 3% and 4% for the three and six months ended October 31, 2005 compared to 3% for the prior year same periods.

 

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

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
     2005
(restated)


   2004
(restated)


   Difference

    %

    2005
(restated)


   2004
(restated)


   Difference

    %

 

General and Administrative Waterjet:

                                            

North America

   5,861    3,457    2,404     70 %   10,741    6,815    3,926     58 %

Asia

   335    320    15     5 %   733    592    141     24 %

Other International

   593    624    (31 )   (5 )%   1,168    1,259    (91 )   (7 )%

Other

   346    437    (91 )   (21 )%   708    830    (122 )   (15 )%
    
  
  

       
  
  

     

Waterjet Total

   7,135    4,838    2,297     47 %   13,350    9,496    3,854     41 %
    
  
  

       
  
  

     

 

General and administrative expenses increased $2.3 million or 47% and $3.9 million or 41% for the three and six months ended October 31, 2005, as compared to the prior year same periods. The increase was experienced primarily in the North America Waterjet segment which includes all of our corporate overhead costs. These costs were driven higher by legal costs of $936,000 and $1.8 million for the three and six months ended October 31, 2005 and public company-related costs such as Sarbanes-Oxley consulting fees of $838,000 and $1.4 million for the same respective periods. Expressed as a percentage of revenue, consolidated general and administrative expenses were 14% for the three and six months ended October 31, 2005, as compared to 11% and 12% for the prior year same periods.

 

Restructuring Expenses. During the three and six months ended October 31, 2005, we incurred $487,000 and $585,000 of severance benefits and other costs in the Other segment related to the closing and relocation of our Wixom, Michigan facility. No restructuring costs were incurred during the three and six months ended October 31, 2004.

 

Financial Consulting Expenses. No financial consulting costs were incurred in the six months ended October 31, 2005 compared with $623,000 in the prior year period associated with our efforts to refinance our subordinated debt. Because no new financing was obtained, these costs were charged to expense.

 

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

 

     Three Months Ended October 31,

    Six Months Ended October 31,

 
     2005
(restated)


   2004
(restated)


    Difference

   %

    2005
(restated)


   2004
(restated)


    Difference

   %

 

Operating Income (Loss)

                                            

Waterjet:

                                            

North America

   2,259    1,366     893    65 %   2,726    1,031     1,695    NM  

Asia

   2,016    1,579     437    28  %   3,361    3,243     118    4 %

Other International

   344    (1 )   345    NM     627    (398 )   1,025    NM  

Other

   528    (702 )   1,230    NM     599    (601 )   1,200    NM  
    
  

 
        
  

 
      

Waterjet Total

   5,147    2,242     2,905    130 %   7,313    3,275     4,038    123 %
    
  

 
        
  

 
      

NM = Not Meaningful

 

Our operating income for the three months ended October 31, 2005 was $5.3 million versus a $2.2 million in the prior year period. For the six months ended October 31, 2005, the operating income was $7.4 million versus $3.3 million in the prior year period. 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 (Expense) Income, net. Current interest expense, net decreased to $437,000 and $1,363,000 for the three and six months ended October 31, 2005. This net amount includes $19,000 and $55,000 of interest income for the three and six months ended October 31, 2005. This decrease results lower interest rates charged coupled with lower average debt on our balance owing with the paydown of the subordinated debt in April 2005 as well as lower amortization of debt issue costs. During the three and six months ended October 31, 2005, we recorded Other (Expense) Income, net of $(1,129,000) and ($2,914,000) compared to Other (Expense) Income, net of $2,655,000 and $2,561,000 in the prior year three and six month period. These changes are the result of changes in realized and unrealized foreign exchange gains and losses as described in the table below, offset by the $4,157,000 expense associated with the warrants used in the previously described PIPE transaction. The terms of these warrants require them to be marked-to-market at each reporting period with corresponding gains and losses reported on the Consolidated Statement of Operations. We also entered into a Purchase Agreement (the “Purchase Agreement”) with Barton Mines Company (“Barton”) to give Barton exclusive rights to sell abrasive to the Company’s customers for $2.5 million in cash which was recorded as Other Income for the three and six months ended October 31, 2005.

 

     Three Months
Ended October 31,


   Six Months Ended
October 31,


 
     2005

    2004

   2005

    2004

 

Realized Foreign Exchange (Losses) Gains, Net

   $ (237 )   $ 726    $ (220 )   $ 1,339  

Unrealized Foreign Exchange Gains (Losses), Net

     631       1,927      (458 )     1,251  

Fair Value Adjustment on Warrants Issued

     (4,157 )     —        (4,835 )     —    

Gain on Barton Sale

     2,500       —        2,500       —    

Other

     134       2      99       (29 )
    


 

  


 


     $ (1,129 )   $ 2,655    $ (2,914 )   $ 2,561  
    


 

  


 


 

Income Taxes. For the three and six months ended October 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 US) 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 $1.7 million liability or

 

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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 cumulative losses generated during the quarter ended October 31, 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 from fiscal 2022 through fiscal 2024 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 the quarter ended October 31, 2005.

 

Discontinued Operations, Net of Tax. In October 2005, we sold our Avure Business and have reacast our financial statements to reflect the Avure Business as discontinued operations for all historical periods presented. For the three months ended October 31, 2005 and 2004, loss from operations of discontinued operations was $184,000 and $1,004,000, respectively, primarily due to a significantly lower foreign exchange loss in the current quarter than the same quarter in the prior year. For the six months ended October 31, 2005, income from operations of discontinued operations was $966,000 compared to a loss of $673,000 in the same period in the prior year primarily due to a higher foreign exchange gain in the first quarter and a lower foreign exchange loss in the second quarter.

 

Net Income (Loss). Our consolidated net income in the three months ended October 31, 2005 amounted to $1.0 million, or $.03 basic and diluted income per share as compared to a net loss of $338,000, or $.02 basic and diluted loss per share in the prior year same periods. For the year-to-date period, our consolidated net income was $1.0 million or $.03 basic and diluted per share as compared to a net loss of $2.7 million, or $.17 basic and diluted loss per share in the prior year same period.

 

Operational and Financial Data—Fiscal 2005, 2004 and 2003

 

All operational and financial data in the following pages has been recast to give effect to the sale of the Avure Business and reflects the results of the Avure Business as discontinued operations for all periods presented.

 

Operational Data as a Percentage of Sales

 

     Year Ended April 30,

 
    

  2005  

(restated)


   

  2004  

(restated)


   

  2003  

(restated)


 

Sales

   100 %   100 %   100 %

Cost of Sales

   62 %   62 %   72 %
    

 

 

Gross Margin

   38 %   38 %   28 %
    

 

 

Expenses:

                  

Marketing

   16 %   17 %   24 %

Research & Engineering

   3 %   5 %   6 %

General & Administrative

   13 %   14 %   15 %

Restructuring Charges

   —   %   2 %   —   %

Financial Consulting Charges

   1 %   1 %   —   %

Impairment Charges

   —   %   —   %   6 %
    

 

 

     33 %   39 %   51 %
    

 

 

 

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Table of Contents
     Year Ended April 30,

 
    

  2005  

(restated)


   

  2004  

(restated)


   

  2003  

(restated)


 

Operating Income (Loss)

   5 %   (1 )%   (23 )%

Interest Expense

   (12 )%   (10 )%   (9 )%

Interest Income

   —   %   —   %   —   %

Other Income (Expense), net

   1 %   6 %   5 %
    

 

 

Loss Before Provision for Income Taxes

   (6 )%   (5 )%   (27 )%

Provision for Income Taxes

   (1 )%   (3 )%   (9 )%
    

 

 

Loss Before Discontinued Operations

   (7 )%   (8 )%   (36 )%

Discontinued Operations, Net of Tax

   (5 )%   —   %   (20 )%
    

 

 

Net Loss

   (12 )%   (8 )%   (56 )%
    

 

 

 

Sales Summary:

 

Dollars in thousands   Year ended April 30,

    Year ended April 30,

 
  2005

  2004

  % Change

    2004

  2003

  % Change

 

Operational breakdown:

                                   

Waterjet:

                                   

Systems

  $ 122,129   $ 85,015   44 %   $ 85,015   $ 76,346   11 %

Consumable parts and services

    50,837     47,846   6 %     47,846     45,487   5 %
   

 

       

 

     

Total

  $ 172,966   $ 132,861   30 %   $ 132,861   $ 121,833   9 %
   

 

       

 

     

Geographic breakdown:

                                   

United States

  $ 97,286   $ 70,058   39 %   $ 70,058   $ 66,931   5 %

Rest of Americas

    19,468     17,751   10 %     17,751     15,673   13 %

Europe

    30,707     24,550   25 %     24,550     21,563   14 %

Asia

    25,505     20,502   24 %     20,502     17,666   16 %
   

 

       

 

     
    $ 172,966   $ 132,861   30 %   $ 132,861   $ 121,833   9 %
   

 

       

 

     

 

Results of Operations—Fiscal 2005, 2004 and 2003

 

Our UHP business which we call Waterjet, is comprised of the following segments: North America Waterjet, Asia Waterjet, Other International Waterjet and Other.

 

Fiscal 2005 Compared to Fiscal 2004

(Tabular amount in thousands)

 

Sales.

 

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

 

     2005

   2004

   Difference

   %

 

Sales

                           

Waterjet:

                           

North America

   $ 82,381    $ 59,044    $ 23,337    40 %

Asia

     25,505      20,502      5,003    24 %

Other International

     34,530      28,160      6,370    23 %

Other

     30,550      25,155      5,395    21 %
    

  

  

      

Waterjet Total

   $ 172,966    $ 132,861    $ 40,105    30 %
    

  

  

      

 

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Table of Contents

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, as well as non-waterjet systems, which are sold primarily into the North American automotive industry. For the fiscal year ended April 30, 2005, we reported a $40.1 million, or 30%, increase in revenue to $173.0 million versus the prior year comparative period. All four segments reported an increase in revenue; however $23.3 million of the $40.1 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 2004, as well as increasing the number of domestic waterjet cutting direct sales staff from 10 to 15, adding two machine tool distributors, acting as agents, 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. There were no significant price increases year over year, however a price increase of 4% on selected systems was implemented on February 1, 2005. Aerospace sales, which are also included in the North America segment, were $5.5 million, up $1.4 million (33%) from the prior year. The growth in our ‘Other’ segment results from improved non-waterjet automated robotic system 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 $25.5 million, up $5.0 million or 24% for the year ended April 30, 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 in Europe and South America. Revenues from our European operations have improved by $6.2 million (25%) for the year ended April 30, 2005 to $30.7 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 in South America of $3.8 million for the year ended April 30, 2005 were comparable to the respective prior year period. The economic conditions in the South America region make it difficult to increase 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 year ended April 30, 2005 were $122.1 million, an increase of $37.1 million or 44%, compared to the prior year same period due to both strong domestic and global sales from recovering economic conditions. The majority, $21.4 million, of the increase was generated domestically. Consumables revenues recorded an increase of $3.0 million or 6% to $50.8 million for the year ended April 30, 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.

 

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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:

 

    

2005

(restated)


   2004

   Difference

    %

 

Gross Margin

                            

Waterjet:

                            

North America

   $ 38,768    $ 25,985    $ 12,783     49 %

Asia

     11,682      9,762      1,920     20 %

Other International

     12,034      9,876      2,158     22 %

Other

     3,539      4,435      (896 )   (20 )%
    

  

  


     

Waterjet Total

   $ 66,023    $ 50,058    $ 15,965     32 %
    

  

  


     

 

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

 

    

  2005  

(restated)


      2004  

 

Gross Margin Percentage

            

Waterjet:

            

North America

   47 %   44 %

Asia

   46 %   48 %

Other International

   35 %   35 %

Other

   12 %   18 %

Waterjet Total

   38 %   38 %

 

Gross margin for the year ended April 30, 2005 amounted to $66.0 million or 38% of sales as compared to gross margin of $50.1 million or 38% of sales in the prior year 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, segment. 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.

 

The increase in North American waterjet margins were offset in part by the decrease of five percentage points in the Other segment in fiscal 2005. This weakness stems from a number of very low margin contracts built in fiscal 2005, including several loss contracts which totaled $1.2 million in losses. All loss contracts were non-waterjet related systems. 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%.

 

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

 

    

2005

(restated)


   2004

   Difference

    %

 

Marketing

                            

Waterjet:

                            

North America

   $ 14,717    $ 10,159    $ 4,558     45 %

Asia

     3,704      3,022      682     23 %

Other International

     8,161      7,840      321     4 %

Other

     1,789      1,822      (33 )   (2 )%
    

  

  


     

Waterjet Total

   $ 28,371    $ 22,843    $ 5,528     24 %
    

  

  


     

 

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Table of Contents

Marketing expenses increased $5.5 million or 24% to $28.4 million for the year ended April 30, 2005 as compared to the prior year period. The Waterjet increase in North America was the result of improved sales and the market awareness programs. 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. Expressed as a percentage of sales, consolidated marketing expenses were 16% for fiscal 2005, compared to 17% of sales for fiscal 2004.

 

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

 

    

2005

(restated)


   2004

   Difference

    %

 

Research and Engineering

                            

Waterjet:

                            

North America

   $ 4,605    $ 4,504    $ 101     2 %

Asia

     348      295      53     18 %

Other International

     712      737      (25 )   (3 )%

Other

     224      337      (113 )   (34 )%
    

  

  


     

Waterjet Total

   $ 5,889    $ 5,873    $ 16     —   %
    

  

  


     

 

Research and engineering expenses increased $16,000 for fiscal 2005 as compared to fiscal 2004. Waterjet expenses were up slightly associated with our aerospace programs. The overall changes were related to the timing of research and development work, the use of engineers on revenue generating projects and continued cost cutting across most segments. Expressed as a percentage of revenue, research and engineering expenses were 3% in fiscal 2005, as compared to 5% in fiscal 2004.

 

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

 

     2005

   2004

   Difference

    %

 

General and Administrative

                            

Waterjet:

                            

North America

   $ 16,949    $ 13,096    $ 3,853     29 %

Asia

     1,381      1,146      235     21 %

Other International

     2,653      2,947      (294 )   (10 )%

Other

     1,866      1,842      24     1 %
    

  

  


     

Waterjet Total

   $ 22,849    $ 19,031    $ 3,818     20 %
    

  

  


     

 

General and administrative expenses increased $3.8 million or 20% for the year ended April 30, 2005, as compared to the prior year. The North America Waterjet segment increased $3.9 million. This includes increased professional fees of $900,000 associated with patent litigation, $600,000 for increased audit fees and Sarbanes Oxley consulting fees, increased incentive compensation of $1.5 million and increased labor and miscellaneous other costs associated with strengthening key corporate functions of $900,000. As a percent of sales, however, North America Waterjet general and administrative expenses decreased from 22% to 21% in fiscal 2005. Expressed as a percentage of revenue, consolidated general and administrative expenses were 13% in fiscal 2004 as compared to 14% for the prior year period.

 

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Table of Contents

Restructuring Charges. During fiscal 2004, we incurred $2.5 million of restructuring charges in loss from continuing operations, including severance, lease termination and inventory related charges, primarily in the U.S. and Germany. The most significant parts of this total being incurred in the North America Waterjet segment, $1.0 million and Other International Waterjet, $1.4 million. The Avure Business incurred restructuring charges of $239,000 and $788,000 for the years ended April 30, 2005 and 2004, respectively.

 

The following table summarizes accrued restructuring activity for fiscal 2004 and 2005 (in thousands):

 

    North America
Waterjet


    Other International
Waterjet


    Other
Waterjet


   

Discontinued

Operations


    Consolidated

 
    Facility
Exit
Costs


    Other

    Severance
Benefits


    Facility
Exit
Costs


    Other

    Severance
Benefits


    Severance
Benefits


    Facility
Exit
Costs


    Other

    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

    —         113       (120 )     105       302       —         201       191       65       81       296       480       857  

Q2 cash payments

    —         (113 )     —         —         (47 )     —         —         —         (65 )     —         —         (225 )     (225 )

Q2 charge-offs

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


 


 


 


 


 


 


 


 


 


 


 


 


Balance, October 31, 2003

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

Q3 restructuring charge

    407       109       —         85       484       89       —         —         61       89       492       654       1,235  

Q3 cash payments

    (270 )     (99 )     —         (14 )     —         —         (121 )     —         (61 )     (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       376       —         255       —         —         234       —         36       234       270       412       916  

Q4 cash payments

    (13 )     (90 )     —         (13 )     —         (89 )     (70 )     —         (36 )     (159 )     (26 )     (126 )     (311 )

Q4 charge-offs

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


 


 


 


 


 


 


 


 


 


 


 


 


Balance, April 30, 2004

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

Q1 restructuring charge

    —         —         —         —         —         —         —         —         —         —         —         —         —    

Q1 cash payments

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


 


 


 


 


 


 


 


 


 


 


 


 


Balance, July 31, 2004

    130       —         —         329       —         —         176       188       —         176       647       —         823  

Q2 restructuring charge

    —         —         —         —         —         —         —         —         —         —         —         —         —    

Q2 cash payments

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


 


 


 


 


 


 


 


 


 


 


 


 


Balance, October 31, 2004

    121       —         —         325       —         —         112       185       —         112       631       —         743  

Q3 restructuring charge

    —         —         —         —         —         —         120       119       —         120       119       —         239  

Q3 cash payments

    (9 )     —         —         (10 )     —         —         (56 )     (42 )     —         (56 )     (61 )     —         (117 )
   


 


 


 


 


 


 


 


 


 


 


 


 


Balance, January 31, 2005

    112       —         —         315       —         —         176       262       —         176       689       —         865  

Q4 restructuring charge

    —         —         —         —         —         —         —         —         —         —         —         —         —    

Q4 cash payments

    (9 )     —         —         (31 )     —         —         (89 )     (20 )     —         (89 )     (60 )     —         (149 )
   


 


 


 


 


 


 


 


 


 


 


 


 


Balance, April 30 2005

  $ 103     $ —       $ —       $ 284     $ —       $ —       $ 87     $ 242     $ —       $ 87     $ 629     $ —       $ 716  
   


 


 


 


 


 


 


 


 


 


 


 


 


 

38


Table of Contents

Financial Consulting Charges. During the years ended April 30, 2005 and 2004, we incurred $.6 million and $1.5 million, respectively, of professional fees associated with the restructuring of our debt in July 2004 and July 2003, respectively. These costs were either expenses related to potential Senior Credit Arrangements with lenders that did not occur, or they related to expenses associated with our subordinated debt and did not result in an increase in the facility, accordingly, they were expensed.

 

Operating Income (Loss).

 

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

 

    

2005

(restated)


    2004

    Difference

    %

 

Operating Income (Loss)

                              

Waterjet:

                              

North America

   $ 1,874     $ (4,403 )   $ 6,277     NM  

Asia

     6,249       5,299       950     18 %

Other International

     508       (2,908 )     3,416     NM  

Other

     (340 )     335       (675 )   NM  
    


 


 


     

Waterjet Total

   $ 8,291     $ (1,677 )   $ 9,968     NM  
    


 


 


     

NM = Not Meaningful

 

Our operating income for the year ended April 30, 2005 was $8.3 million as compared to an operating loss of $1.7 million for the year ended April 30, 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. Interest expense increased to $20.3 million for the year ended April 30, 2005, a $7.6 million increase as compared to the prior year. This increase includes the write-off of debt discount of $4.3 million associated with the pay-off of our subordinated debt, $1.6 million in write off of capitalized loan costs under EITF 98-14 “Debtor’s Accounting for Changes in Line-of Credit or Revolving-Debt Arrangements” (“EITF 98-14”) and $1.6 million related to the expensing of anti-dilution warrants provided to lenders whose underlying debt was retired in April 2005 under EITF 98-14. During fiscal 2005, we recorded Other Income, net of $1.7 million as outlined below. This compares to Other Income, net of $8.1 million in the prior year period. 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:

 

     2005

    2004

Net realized foreign exchange gains

   $ 2,826     $ 915

Net unrealized foreign exchange (losses) gains

     (772 )     3,960

Realized gain on sale of equity securities

     —         2,618

Other

     (349 )     628
    


 

Total

   $ 1,705     $ 8,121
    


 

 

Income Taxes. The fiscal 2005 and 2004 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

 

39


Table of Contents

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 $1.7 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. 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 between fiscal 2022 and fiscal 2024 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.

 

Discontinued Operations, Net of Tax. In October 2005, we sold our Avure Business and have recast our financial statements to reflect the Avure Business as discontinued operations for all historical periods presented. For the year ended April 30, 2005, loss from discontinued operations was $8.9 million compared to a loss of $733,000 for the year ended April 30, 2004 which includes a gain on the disposition of our HCS subsidiary of $650,000. Fiscal 2005 results included a $9.1 million goodwill impairment charge which caused the increase in the loss compared to fiscal 2004.

 

Net Loss. For the year ended April 30, 2005, our consolidated net loss was $21.2 million or $1.19 per basic and diluted loss per share as compared to a net loss of $11.3 million, or $.73 basic and diluted loss per share in the prior year period.

 

The weighted average number of shares outstanding used for the calculation of basic and diluted loss per share is 17,748,000 for fiscal 2005 and 15,415,000 for fiscal 2004. There were 2,034,546 and 2,089,412 of potentially dilutive common shares from employee stock options and 3,219,245 and 860,000 of potentially dilutive shares from warrants which have been excluded from the diluted weighted average share denominator for fiscal 2005 and 2004, respectively, as their effect would be anti-dilutive.

 

Fiscal 2004 Compared to Fiscal 2003. (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 %
    

  

  


     

 

Waterjet. For the year ended April 30, 2004, total Waterjet revenue increased $11.0 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. Our

 

40


Table of Contents

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 totaled $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.

 

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.

 

Cost of Sales and Gross Margins. Our gross margin by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended April 30,

  

Dollar

Change


  

Percent

Change


 
     2004

   2003

     

Gross Margin

                           

Waterjet:

                           

North America

   $ 25,985    $ 22,570    $ 3,415    15 %

Asia

     9,762      7,702      2,060    27 %

Other International

     9,876      1,782      8,094    NM  

Other

     4,435      2,321      2,114    91 %
    

  

  

      

Waterjet Total

   $ 50,058    $ 34,375    $ 15,683    46 %
    

  

  

      

NM=Not meaningful

 

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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

   44 %   42 %

Asia

   48 %   44 %

Other International

   35 %   8 %

Other

   18 %   9 %

Waterjet Total

   38 %   28 %

 

Gross margin for the year ended April 30, 2004 amounted to $50.1 million or 38% of revenues, as compared to gross margin of $34.4 million or 28% 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 totaled $6.9 million. 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, 38% of revenues in fiscal 2004 compared to 28% 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 charges of $4.4 million which did not recur in 2004.

 

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

 

     Year Ended April 30,

   Dollar
Change


    Percent
Change


 
     2004

   2003

    

Marketing

                            

Waterjet:

                            

North America

   $ 10,159    $ 12,763    $ (2,604 )   (20 )%

Asia

     3,022      3,008      14     —   %

Other International

     7,840      10,881      (3,041 )   (28 )%

Other

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

  

  


     

Waterjet Total

   $ 22,843    $ 29,432    $ (6,589 )   (22 )%
    

  

  


     

 

Marketing expenses decreased $6.6 million or 22% to $22.8 million for the year ended April 30, 2004, as compared to the prior year marketing expenses of $29.4 million.

 

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.

 

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Table of Contents

Research and Engineering Expenses. Our research and engineering expense by segment for 2004 and 2003 is summarized as follows:

 

     Year Ended
April 30,


   Dollar
Change


    Percent
Change


 
     2004

   2003

    

Research and Engineering

                            

Waterjet:

                            

North America

   $ 4,504    $ 4,754    $ (250 )   (5 )%

Asia

     295      278      17     6 %

Other International

     737      951      (214 )   (23 )%

Other

     337      688      (351 )   (51 )%
    

  

  


     

Waterjet Total

   $ 5,873    $ 6,671    $ (798 )   (12 )%
    

  

  


     

 

Research and engineering expenses decreased $798,000 or 12% to $5.9 million for the year ended April 30, 2004, as compared to the prior year’s research and engineering expenses of $6.7 million. The 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 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 5% and 6% 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,

   Dollar
Change


    Percent
Change


 
     2004

   2003

    

General and Administrative

                            

Waterjet:

                            

North America

   $ 13,096    $ 11,164    $ 1,932     17 %

Asia

     1,146      983      163     17 %

Other International

     2,947      4,313      (1,366 )   (32 )%

Other

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

  

  


     

Waterjet Total

   $ 19,031    $ 18,784    $ 247     1 %
    

  

  


     

 

General and administrative expenses increased $247,000 or 1% to $19.0 million for the year ended April 30, 2004, as compared to the prior year’s general and administrative expenses of $18.8 million. All segments experienced a decrease in general and administrative expense, except for the North America Waterjet segment, up $1.9 million (17%) 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 14% and 15% for the years ended April 30, 2004 and 2003, respectively.

 

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Table of Contents

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

   $ 1,020    $ —  

Asia

     —        —  

Other International

     1,359      2,113

Other

     89      5,032
    

  

Waterjet Total

   $ 2,468    $ 7,145
    

  

 

    North America
Waterjet


    Other International
Waterjet


    Other
Waterjet


    Discontinued Operations

    Consolidated

 
   

Facility

Exit
Costs


    Other

    Severance
Benefits


   

Facility

Exit
Costs


    Other

    Severance
Benefits


    Severance
Benefits


    Facility
Exit Costs


  Other

    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

    —         113       (120 )     105       302       —         201       191     65       81       296       480       857  

Q2 cash payments

    —         (113 )     —         —         (47 )     —         —         —       (65 )     —         —         (225 )     (225 )

Q2 charge-offs

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


 


 


 


 


 


 


 

 


 


 


 


 


Balance, October 31, 2003

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

Q3 restructuring charge

    407       109       —         85       484       89       —         —       61       89       492       654       1,235  

Q3 cash payments

    (270 )     (99 )     —         (14 )             —         (121 )     —       (61 )     (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       376       —         255       —         —         234       —       36       234       270       412       916  

Q4 cash payments

    (13 )     (90 )     —         (13 )     —         (89 )     (70 )     —       (36 )     (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 $2.5 million of restructuring-related costs, including severance, lease termination and inventory related charges , primarily in the U.S. and Germany. The most significant of this total being incurred in the North America Waterjet segment, $1.0 million and Other International Waterjet, $1.4 million.

 

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

 

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were either expenses related to potential Senior Credit Arrangements 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.

 

Impairment Charges. There were no impairment charges in fiscal 2004. During fiscal 2003, we conducted a 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 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 no impairment charges.

 

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

 

     Year Ended April 30,

    Dollar
Change


   Percent
Change


 
     2004

    2003

      

Operating income (loss)

                             

Waterjet:

                             

North America

   $ (4,403 )   $ (6,111 )   $ 1,708    28 %

Asia

     5,299       3,433       1,866    54 %

Other International

     (2,908 )     (16,476 )     13,568    82 %

Other

     335       (8,503 )     8,838    NM  
    


 


 

      

Waterjet Total

   $ (1,677 )   $ (27,657 )   $ 25,980    94 %
    


 


 

      

 

We recorded an operating loss of $1.7 million for the year ended April 30, 2004, as compared to a loss of $27.7 million in the prior year. All segments of our business 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.

 

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Interest and Other Income (Expense), net. Fiscal 2004 interest expense increased $1.4 million or 12% to $12.8 million compared to the prior year of $11.4 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 $915,000, as well as unrealized currency gains of $4.0 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 $624,000 of net realized foreign exchange transaction losses offset by $6.8 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)

   $ 915    $ (624 )

Net unrealized foreign exchange gains (losses)

     3,960      6,837  

Realized gain on sale of equity securities

     2,618      —    

Write-off of investment and other assets

     —        (35 )

Other

     628      (231 )
    

  


Total

   $ 8,121    $ 5,947  
    

  


 

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 $1.7 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 $42.9 million of domestic net operating loss carryforwards to offset certain earnings for federal income tax purposes. All of these net operating loss carryforwards expire between fiscal 2022 and 2023. Net operating loss carryforwards in foreign jurisdictions amount to $35.6 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. In addition, in October 2005, we sold our Avure Business and have recast our financial statements to reflect the Avure Business as discontinued operations for all historical periods presented. Results from discontinued operations amounted to a loss of $1.4 million for the year ended April 30, 2004 as compared to a loss of $23.8 million for the year ended April 30, 2003. Fiscal 2003 included a number of charges related to our comprehensive financial review which caused this loss to be so large.

 

Net Loss. Our consolidated net loss for fiscal 2004 amounted to $11.3 million, or $.73 basic and diluted loss per share as compared to a net loss of $67.8 million, or $4.42 basic and diluted loss per share in the prior year.

 

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.

 

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

 

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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.

 

    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. Of this amount, $1.8 million related to our Discontinued Operations.

 

    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 Discontinued Operations.

 

    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 from our Discontinued Operations, 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 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 fulfill 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. This reversal is shown in Discontinued Operations. 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.

 

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    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 totaled $9.1 million for the year. Of this amount, $3.7 million related to our Discontinued Operations.

 

Liquidity and Capital Resources

 

At April 30, 2005, approximately $12.3 million of our cash and restricted cash was held by divisions outside the United States. The repatriation of offshore cash balances from certain divisions will trigger tax liabilities. In fiscal 2004, we recorded a $1.9 million liability for withholding taxes on future repatriation of historical foreign earnings. In February 2005 and June 2004, we repatriated $1.3 million and $3.5 million, respectively, from certain foreign subsidiaries and we plan to continue repatriating additional funds in the future.

 

By April 30, 2005, we completed the execution of our restructuring plan, which resulted in total cash outlays of $9 million (including amounts accrued as restructuring charges in accordance with generally accepted accounting principles). We have funded the restructuring plan from our cash from operations and foreign debt. The $9 million outlay included completing the construction of our new $5.2 million Taiwanese facility, to which we had committed in July 2000. The facility construction was financed via three unsecured lines of credit with Taiwanese banks. We then obtained a collateralized long-term credit facility and borrowed $4.1 million on this facility in June 2004. We have used the proceeds to repay and reduce the senior credit facility by $3.5 million. The benefits from our restructuring activities are beginning to be reflected in our operating results for the year ended April 30, 2005 and, we believe, should continue into fiscal 2006.

 

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 more than $59 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. If the warrant holders opt to exercise their warrants, we would receive $7.1 million in additional cash.

 

Under terms of PIPE Transaction, we were required to file an initial Form S-1 registration of the shares issued and issuable in the PIPE Transaction on or before May 20, 2005 (which we did) and are required to cause the Form S-1 to become effective on or before September 17, 2005. We are subject to liquidated damages of $650,000 per month, if we fail to meet the September 17, 2005 date requirement. We have subsequently amended the Registration Rights Agreement to grant an extension until March 10, 2006 for the effective date of the registration of the shares and warrants issued in the PIPE transaction. Because the issuance price of the common stock of the PIPE Transaction was less than market value, we issued approximately 304,000 anti-dilution $0.01 warrants to our lenders. These warrants have a Black-Scholes value of approximately $1.7 million. Approximately $1.5 million of this amount relates to warrants issued under subordinated debt agreements and $222,000 relates to warrants issued under senior debt agreements. Proceeds of the PIPE were used to pay down existing debt, including all of the subordinated debt. Upon payoff of the subordinated debt, (on April 28, 2005) we also were required to charge to Interest Expense in the Consolidated Statement of Operations all remaining unamortized debt discount, which amounted to $4.3 million, plus $1.5 million related to the anti-dilution warrants issued to subordinated debt warrant holders prior to the PIPE. In addition, capitalized fees related to the Senior Agreement and anti-dilutional warrants provided to our senior lenders were amortized to interest expense through July 8, 2008.

 

Our domestic senior credit agreement (“Credit Agreement”) is our primary source of external funding. At April 30, 2005, the balance outstanding on the Credit Agreement was $9.7 million against a maximum borrowing of $30 million. Our available credit at April 30, 2005, net of $7.6 million in outstanding letters of credit, was $12.7 million.

 

On July 28, 2004, we signed an amendment to the then current credit agreement (the “Amendment”). The Amendment provided for a revolving line of credit of up to $42.7 million and an extension of the credit

 

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agreement through August 1, 2005. The commitment reduced to $41.0 million at April 30, 2005. Interest rates under the Senior Credit Agreement were at Bank of America’s prime rate in effect from time to time plus 4% and increased by one percentage point each quarter beginning November 1, 2004. The Amendment also required the issuance of 150,000 detachable $.01 warrants to the senior lender as a fee and a quarterly commitment fee of  1/2 of 1% (50 basis points) of the total commitment.

 

We also amended our Subordinated Debt Agreement effective July 28, 2004. The subordinated lenders agreed to defer the semi-annual interest remittances due on October 31, 2004 and April 30, 2005, which total $5.3 million. This deferred interest balance accrues additional interest at the rate of 15% per annum. The subordinated lenders also received 150,000 detachable $.01 warrants to purchase common stock as an amendment fee.

 

On April 28, 2005 we entered into a new senior debt agreement (“The April 28, 2005 Credit Agreement”) with Bank of America N.A. and U.S. Bank N.A. The agreement provided a $30 million commitment which was to expire August 1, 2005. This expiration date was consistent with our previous agreement. The April 28, 2005 Credit Agreement, however, gave us the ability to pay off our subordinated debt in its entirety, which we did on April 28, 2005. The April 28, 2005 Credit Agreement, including covenants, was very similar to the previous senior debt agreement except for the following provisions:

 

    Required the complete pay-off of subordinated debt

 

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

 

    The annualized cost of Letters of Credit were 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.

 

The April 28, 2005 Credit Agreement was collateralized by general liens on all of our assets. We were required to comply with certain covenants in the credit agreement, including restrictions on dividends and transactions with affiliates, limitations on additional indebtedness, capital expenditures, research and engineering expenses, and maintenance of EBITDA ratios and collateral values. We were in compliance with all covenants in the April 28, 2005 Credit Agreement as of April 30, 2005. In addition, the New Credit Agreement, similar to prior agreements, included a subjective acceleration clauses which permit the lenders to demand payment in the event of a material adverse change.

 

Effective July 8, 2005, we executed a new $30 million, three year senior credit agreement with Bank of America N.A. and U.S. Bank N.A. This credit agreement expires July 8, 2008 and bears interest at the bank’s prime rate (5.75% at April 30, 2005) or is linked to LIBOR plus a percentage depending on our leverage ratios, at our option. The agreement sets forth specific financial covenants to be attained on a quarterly basis, which we believe, based on our financial forecasts, are achievable.

 

We believe that our existing cash, cash from operations, and credit facilities at April 30, 2005 are adequate to fund our operations through April 30, 2006. If we fail to achieve our planned revenues, costs and working capital objectives, management believes it has the ability to curtail capital expenditures and reduce costs to levels that will be sufficient to enable us to meet our cash requirements and debt covenants through April 30, 2006.

 

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 Close Associates 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. These segments did not meet the accounting criteria to be considered assets held for sale as of April 30, 2005 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. On October 31, 2005, we completed the sale of the North America Press and International Press

 

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reportable segments, as well as the non ultrahigh-pressure portion of the Food reportable segment with the Gores Technology Group, LLC (“Gores”) for consideration of $14.4 million, comprised of cash and notes. At closing, we also entered into a Supply Agreement with Gores whereby we have agreed to supply certain high pressure pump products on an exclusive basis to Gores.

 

Presented below is a summary of contractual obligations and other minimum commercial commitments at April 30, 2005, by due date. See Notes 5, 10 and 15 to April 30, 2005 Consolidated Financial Statements for additional information regarding foreign currency contracts, long-term debt, and lease obligations, respectively.

 

     Maturity by Fiscal Year

     2006

   2007

   2008

   2009

   2010

   Thereafter

   Total

     (in thousands)

Foreign currency contracts(1)

   $ 12,639    $ —      $ —      $ —      $ —      $ —      $ 12,639

Inventory purchases(2)

     1,542      —        —        —        —        —        1,542

Operating leases(3)

     3,716      3,464      2,814      1,851      1,773      4,096      17,714

Other(4)

     778      293      40      40      40      —        1,191

Long-term debt and notes payable(5)

     3,649      1,978      10,505      832      855      1,328      19,147

Interest on long-term debt and notes payable(6)

     668      705      657      170      54      37      2,291
    

  

  

  

  

  

  

Total

   $ 22,992    $ 6,440    $ 14,016    $ 2,893    $ 2,722    $ 5,461    $ 54,524
    

  

  

  

  

  

  


(1) As these obligations were entered into as hedges, the majority of these obligations will be offset by losses/gains on the related assets, liabilities and transactions being hedged. As of April 30, 2005, the fair value of the transactions and related hedges amounts to a net loss of $50,000 which is included in Accumulated Other Comprehensive Loss on the Consolidated Balance Sheet. These amounts relate entirely to our Discontinued Operations.
(2) We have included inventory purchase commitments, which are legally binding and specify minimum purchase quantities. These purchase commitments do not exceed our projected requirements and are in the normal course of business. These commitments exclude open purchase orders.
(3) Amounts include commitments of $1,483,000, $1,115,000, $877,000, $146,000 and $71,000 for fiscal 2006, 2007, 2008, 2009 and 2010, respectively, related to our discontinued operations.
(4) These obligations include non-inventory vendor commitments, such as professional retainers and trade show commitments. Amounts include commitments of $158,000, $90,000, $40,000, $40,000 and $40,000 for fiscal 2006, 2007, 2008, 2009 and 2010, respectively, related to our discontinued operations.
(5) This table is reporting the contractual due dates of the long-term debt and notes payable balances. Fiscal 2006 includes a $2.5 million note balance payable by our discontinued operations.
(6) Interest payments are estimated based on the outstanding debt balances as of April 30, 2005 using the then interest rate in effect through the contractual maturity of the debt instrument. These estimates may change over time as we opt to refinance our debt instruments. See note above. Fiscal 2006 amount includes $56,000 of interest related to a debt instrument from our discontinued operations.

 

Long-term debt, notes payable and lease commitments are expected to be met from working capital provided by operations and, as necessary, by other borrowings.

 

Our capital spending plans currently provide for outlays of approximately $3 million in fiscal 2006, primarily related to information technology spending. It is expected that funds necessary for these expenditures will be generated internally and through available credit facilities. In fiscal 2005 and 2004, our investments in capital equipment were minimal as we were trying to conserve cash and were restricted by our debt agreements on the amount of capital spending we were allowed. Excluding spending on our Taiwan facility in 2004, our capital spending for fiscal 2005 and 2004 amounted to $1.8 million and $1.7 million, respectively. We are required to test our internal controls under Sarbanes-Oxley 404 for the year end April 2006. The external costs to achieve Sarbanes-Oxley compliance will exceed $1.5 million.

 

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Related Party Transactions

 

Arlen I. Prentice, a director, is Chief Executive Officer of Kibble & Prentice, Inc., a company that, together with its wholly owned subsidiary, provides insurance brokerage and employee benefits, administrative and consulting services to the Company. Payments by the Company to Kibble & Prentice, Inc. and such subsidiary for such services have totaled $1.0 million, $2.4 million and $2.1 million for the fiscal years ended April 2005, 2004 and 2003, respectively. Such payments were for various categories of insurance and included both the brokerage commissions and the premiums that Kibble & Prentice, Inc. passes on to the underwriter. Mr. Prentice abstains from participating in the approval of matters where he may have a conflict of interest.

 

Critical Accounting Estimates

 

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our financial statements. Actual results may differ from these estimates under different assumptions or conditions.

 

Critical accounting estimates are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. We believe that our critical accounting estimates are limited to those described below.