UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

Commission file number 0-12448

 

 

 

 

FLOW INTERNATIONAL CORPORATION

 

 

 

 

23500 - 64th Avenue South

Kent, Washington 98032

(253) 850-3500

 

 

 

 

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

None

 

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

Common Stock $.01 Par Value

Preferred Stock Purchase Rights

 

 

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o.

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes o     No þ

 

The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $305,081,732 as of October 31, 2007, the last business day of the registrant’s most recently completed second fiscal quarter, based on a closing price of $8.41 per share as quoted by the NASDAQ Stock Market as of such date. The determination of affiliate status is not necessarily a conclusive determination for other purposes.

 

The registrant had 37,591,478 shares of Common Stock, $0.01 par value per share, outstanding as of July 3, 2008.

 

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The registrant intends to file a definitive proxy statement pursuant to Regulation 14A within 120 days of the end of the fiscal year ended April 30, 2008 (the “2009 Proxy Statement”). Portions of such proxy statement are incorporated by reference into Part II and III of this Form 10-K. With the exception of such portions of the 2009 Proxy Statement expressly incorporated by into this Annual Report on Form 10-K by reference, such document shall not be deemed filed as part of this Annual Report on Form 10-K.

 

 

Explanatory Note:

 

This Form 10-K reflects the restatement of the Company’s Consolidated Financial Statements for the years ended April 30, 2007 and April 30, 2006 and the related Selected Financial Data in Item 6 herein and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 herein. The restatement is more fully described in Note 20 to the Consolidated Financial Statements under Item 8, “Financial Statements and Supplementary Data” herein.

 

In addition, as disclosed in Note 18 to the consolidated financial statements, certain restatement adjustments affected interim quarterly financial information for 2008 and 2007. Such restatement adjustments have been reflected in the unaudited selected quarterly financial data appearing herein and, with respect to 2008, will be reflected in our 2009 Quarterly Reports on Form 10-Q as they are filed during the fiscal year ending April 30, 2009.

 

We have not amended our previously filed Annual Report on Form 10-K or our Quarterly Reports on Form 10-Q for the periods affected by the restatement adjustments, and accordingly, the financial statements and related financial information contained in such reports should no longer be relied upon.

Table of Contents:

 

Forward-Looking Statements

 

Forward-looking statements in this report, including without limitation, statements relating to the Company’s plans, strategies, objectives, expectations, intentions, and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “may,” “expect,” “believe,” “anticipate,” “estimate,” “plan” and similar expressions are intended to identify forward-looking statements. These statements are no guarantee of future performance and involve certain risks, assumptions, and uncertainties that are difficult to predict. Therefore, actual outcome and results may differ materially from what is expressed or forecasted in such forward-looking statements.

 

We make forward-looking statements of our expectations which include but are not limited to:

 

 

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.

 

 

Business Overview

 

Flow International Corporation and its subsidiaries (hereinafter collectively referred to as “the Company”, “we”, or “our” unless the context requires otherwise) is a technology-based global company providing customer-driven waterjet cutting and cleaning solutions. Our ultrahigh-pressure water pumps generate pressures from 40,000 to over 87,000 pounds per square inch (psi) and power waterjet systems that are used to cut and clean materials. Waterjet cutting is a fast-growing alternative to traditional cutting methods and has uses in many applications from food and paper products to steel and carbon fiber composites.

 

This portion of our Form 10-K provides detailed information about who we are, what we do and where we are headed. Unless otherwise specified, current information reported in this Form 10-K is as of, or for the year ended April 30, 2008.

 

Our History

 

Flow International Corporation was incorporated in Delaware in 1983 as Flow Systems, Inc. and was reincorporated in Washington in October 1998. Our innovations and accomplishments through the years include:

 

 

Business Segments

 

We operate in four reportable segments, which are North America Waterjet, Asia Waterjet, Other International Waterjet and Applications. The North America, Asia, and Other International Waterjet segments include our cutting and cleaning systems using ultrahigh-pressure as well as parts and services further described below in the respective geographic areas. The Applications segment includes systems for robotic articulation applications and automation systems which may or may not use ultrahigh-pressure. These systems are primarily used in automotive applications. Effective September 2007, our Applications segment ceased the pursuit of sales of non-waterjet automation systems to focus on increasing revenue from systems that integrate waterjet cutting technology.

 

For further discussion on our business segments, see Note 16: Business Segments and Geographic Information of the Consolidated Financial Statements.

 

Sales Outside the United States

 

In fiscal year 2008, 55% — or $133.3 million — of our total consolidated sales were to customers outside the United States, this included:

 

 

Products and Services

 

Our mission is to provide the highest value customer-driven waterjet cutting and cleaning solutions. We strive to improve our customers’ profitability through the development of innovative products and services that expand our customers’ markets and increase their productivity. The primary components of our product line include versatile waterjet cutting and industrial cleaning systems. We provide total system solutions for various industries including aerospace, automotive, stone and tile, job shop, and industrial cleaning.

 

Our ultrahigh-pressure technology has two broad applications: cutting and cleaning.

 

Waterjet Cutting.  The primary application of our ultrahigh-pressure water pumps is cutting. In cutting applications, an ultrahigh-pressure pump pressurizes water from 40,000 to 87,000 psi, and forces it through a small orifice, generating a high-velocity stream of water traveling at three or more times the speed of sound. In order to cut metallic and other hard materials, an abrasive substance, usually garnet is added to the waterjet stream creating an abrasive jet. Our cutting systems typically include a robotic manipulator that moves the cutting head. Our systems may also combine waterjet with other applications such as conventional machining, pick and place handling, inspection, assembly, and other automated processes. Our waterjet cutting systems cut virtually any shape in a single step with edge quality that usually requires no secondary finishing and are the most productive solutions for cutting a wide range of materials from 1/16 inch to over 24 inches thick. We offer two different pump technologies: ultrahigh-pressure intensifier and direct drive pumps, ensuring our customers get the pump that is right for them and their unique application. Our intensifier pumps pressurize water up to 87,000 psi, and our direct drive pumps pressurize water up to 55,000 psi.

 

Waterjet cutting is recognized as a more flexible, cost effective and accurate alternative to traditional cutting methods such as lasers, saws or plasma. It has greater versatility in the types of products it can cut, and, because it cuts without heat or imparted energy, often reduces or eliminates the need for secondary processing operations and special fixturing. Therefore, waterjet cutting has applications in many industries, including aerospace, defense, automotive, semiconductors, disposable products, food, glass, job shop, sign, metal cutting, marble, tile and other stone cutting, and paper slitting and trimming.

 

Industrial Cleaning Products.  Our ultrahigh-pressure industrial cleaning systems are used in waterjet cleaning for fast surface preparation. These systems use direct drive pumps to create pressures in the range of 40,000 to 55,000 psi. Because only pure water is used to remove coatings, waterjetting costs less than grit blasting by eliminating the need for collection, containment, and disposal of abrasive. Removing coatings with water instead of grit allows for other work to be done during the waterjet operation. Steel, mechanical and electrical work, or painting, can be performed concurrently with waterjet industrial cleaning, which means projects are completed in less time and there are fewer environmental concerns than with traditional methods such as sandblasting.

 

Parts and Services.  We also offer consumable parts and services. Consumables represent parts used by the pump and cutting head during operation, such as seals and orifices. Many of the consumable or spare parts are proprietary in nature and are patent protected. We also sell various tools and accessories which incorporate ultrahigh-pressure technology, as well as aftermarket consumable parts and service for our products.

 

Marketing and Customers

 

Our marketing emphasizes a consultative application-oriented sales approach and is centered on increased awareness of the capabilities of our technology as we believe that waterjet technology is in the early adoption phase of its product life cycle. These efforts include increased presence at tradeshows, advertising in print media and other product placements and demonstration/educational events as well as an increase in domestic and international sales representation, including distributors. To enhance the effectiveness of sales efforts, our marketing staff and sales force gather detailed information on the applications and requirements in targeted market segments. We also utilize telemarketing and the Internet to generate sales leads in addition to lead generation through tradeshows and print media. This information is used to develop standardized and customized solutions using ultrahigh-pressure and robotics technologies.

We offer our spare parts and consumables through the Internet at our Flowparts.com website in the U.S. and Floweuropeparts.com in Europe where we strive to ensure that we are able to ship a large number of parts within 24 hours to our customers. We are currently evaluating this option for our other international markets.

 

We have established strong relationships with a diverse set of customers. No single customer or group of customers under common control accounted for 10% or more of our total consolidated sales in fiscal year 2008.

 

Our sales are affected by worldwide economic changes. However, we believe that our ability to gain market share in the machine cutting tool market due to the productivity enhancing nature of our ultrahigh-pressure technology and the diversity of our markets, along with the relatively early adoption phase of our technology, enable us to absorb cyclical downturns with less impact than conventional machine tool manufacturers.

 

Competition in Our Markets

 

Our major markets — both domestic and foreign — are highly competitive, with our products competing against other waterjet competitors as well as technologies such as lasers, saws, plasma, shears, routers, drills, and abrasive blasting techniques. Most of our waterjet competitors provide only portions of a waterjet system such as pumps or control systems. Other competitors integrate components from a variety of suppliers to provide a complete solution. Under the Flow brand, we compete in the high-end and mid-tier segments of the waterjet cutting market through product quality and superior service reliability, value, service and technology. Through our secondary brand, Waterjet Pro^tm, we compete in the lower priced segments of the market. Approximately 80 firms, other than Flow, have developed tools for cleaning and cutting based on waterjet technology. We believe we are the leader in the global waterjet cutting systems market.

 

Waterjet technology provides manufacturers with an alternative to traditional cutting or cleaning methods, which utilize lasers, saws, knives, shears, plasma, routers, drills and abrasive blasting techniques. Many of the companies that provide these competing methods are larger and more established than Flow.

 

Waterjet cutting systems offer manufacturers many advantages over traditional cutting machines including an ability to cut or machine virtually any material, in any direction, with improved manufacturing times, and with minimal impact on the material being cut. These factors, in addition to the elimination of secondary processing in many circumstances, enhance the manufacturing productivity of our systems.

 

We estimate that the waterjet cutting solutions market opportunity exceeds $1 billion in annual potential or twice the current level. The total market potential continues to grow as new applications are developed. The rapidly increasing global market for waterjet solutions while providing high growth opportunities is also attracting new market entrants which will increase competition.

 

In addition to pumps and systems, we sell spare parts and consumables. We believe our on-time delivery and technical service combine for the best all-around value for our customers but, we face competition from numerous other companies who sell non-proprietary replacement parts for our machines. While they generally offer a lower price, we believe the quality of our parts, coupled with our service, makes us the value leader in spares and consumables.

 

Raw Materials

 

We depend on the availability of raw materials, parts and subassemblies from our suppliers and subcontractors. Principal materials used to make waterjet products are metals, and plastics, typically in sheets, bar stock, castings, forgings and tubing. We also purchase many electrical and electronic components, fabricated metal parts, high-pressure fluid hoses, ball screws, seals and other items integral to our products. Suppliers are competitively selected based on cost, quality, and delivery. Our suppliers’ ability to provide timely and quality raw materials, components, kits and subassemblies affects our production schedules and contract profitability. We maintain an extensive qualification and performance surveillance system to control risk associated with this reliance on the supply chain. Most significant raw materials we use are available through multiple sources.

Our strategic sourcing initiatives seek to find ways of mitigating the inflationary pressures of the marketplace. In recent years, these inflationary pressures have affected the market for raw materials. The weakening dollar is also causing our supply chain to feel abnormal cost pressures. These factors may force us to renegotiate with our suppliers and customers to avoid a significant impact to our margins and results of operations. These macro-economic pressures may increase our operating costs with consequential risk to our cash flow and profitability. We currently do not employ forward contracts or other financial instruments to hedge commodity price risk, although we continuously explore supply chain risk mitigation strategies.

 

Intellectual Property

 

We have a number of patents related to our processes and products both domestically and internationally. While in the aggregate our patents are of material importance to our business, we believe that no single patent or group of patents is of material importance to our business as a whole. We also rely on non-patented proprietary trade secrets and knowledge, confidentiality agreements, creative product development and continuing technological advancement to maintain a technological lead on our competitors.

 

Product Development

 

Our research and development is focused on continued improvement of our existing products and the development of new products. During the year ended April 30, 2008, we expensed $8.3 million related to product research and development as compared to $8.7 million for 2007 and $6.7 million for 2006. Our future success depends on our ability to continue to maintain a robust research and development program that allows us to develop competitive new products and applications that satisfy customer requirements, as well as enhance our current product lines. Research and development costs were between 3% and 4% of total revenue during each of the years ended April 30, 2008, 2007, and 2006.

 

Backlog

 

Our backlog increased 14% from $31.0 million at April 30, 2007 to $35.3 million at April 30, 2008. The backlog at April 20, 2008 and 2007 represented 14% of our trailing twelve months sales in each of the respective periods.

 

Backlog includes firm orders for which written authorizations have been accepted and revenue has not yet been recognized. Generally our products, exclusive of the aerospace product line, can be shipped within a four to 16 week period. Aerospace systems typically have lead times of six to 18 months. The unit sales price for most of our products and services is relatively high (typically ranging from tens of thousands to millions of dollars) and individual orders can involve the delivery of several hundred thousand dollars of products or services at one time. The changes in our backlog are not necessarily indicative of comparable variations in sales or earnings. Due to possible customer changes in delivery schedules and cancellation of orders, our backlog at any particular date is not indicative of actual sales for any succeeding period. Delays in delivery schedules and/or a reduction of backlog during any particular period could have a material adverse effect on our business and results of operations.

 

Working Capital Practices

 

There are no special or unusual practices relating to our working capital items. We generally require advance payments as deposits on customized equipment and standard systems and require progress payments during the manufacturing of these products or prior to product shipment.

 

Employees

 

We had approximately 759 full time employees as of April 30, 2008 compared to 756 in the prior year. This number includes 59% located in the United States and 41% located in other foreign locations. Our success depends in part on our ability to attract and retain employees. None of our employees are covered by collective bargaining agreements. We continue to have satisfactory employee relations.

Available Information

 

The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge on the Company’s website at www.flowcorp.com as soon as is reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission.

 

The materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549 and can also be obtained by calling the SEC at 1-800-SEC-0330. Information available on our website is not incorporated by reference in and is not deemed a part of this Form 10-K.

 

 

We are subject to certain risks and events that, if one or more of them occur, could adversely affect our business, our financial condition and our results of operations, and the trading price of our common stock.

 

You should consider the following risk factors, in addition to the other information presented in this report and the matters described in our “Forward-Looking Statements” section, as well as other reports and registration statements we file from time to time with the SEC, in evaluating us, our business, and an investment in our securities.

 

Risks Related to our Industry and Business

 

We are experiencing increased competition in our markets, and the failure to complete effectively could have an adverse effect on our business, financial condition, and results of operations.

 

We are facing increased competition in a number of our served markets as a result of the entry of new competitors, some of which have greater financial resources or lower production costs than we do. In order to compete effectively, we must retain our relationships with existing customers, establish relationships with new customers, continually develop new products and services designed to maintain our leadership technology position and penetrate new markets. Our failure to compete effectively may reduce our revenues, profitability and cash flow, and pricing pressures may adversely impact our profitability.

 

Cyclical economic conditions may adversely affect our financial condition and results of operations or our growth rate could decline if the markets into which we sell our products decline or do not grow as anticipated.

 

Our products are sold in industries and end-user applications that have historically experienced periodic downturns, such as automotive, aerospace, paper, job shops and stone and tile. Cyclical weaknesses in the industries that we serve have led and could continue to lead to a reduced demand for our products and adversely affect our financial condition and results of operations. Any competitive pricing pressures, slowdown in capital investments or other downturn in these industries could adversely affect our financial condition and results of operations in any given period. Additionally, visibility into our markets is limited. Our quarterly sales and operating results depend substantially on the volume and timing of orders received during the quarter, which are difficult to forecast. Any decline in our customers’ markets would likely result in diminished demand for our products and services and would adversely affect our growth rate and profitability.

 

If we are unable to complete the upgrades to our information technology systems that are currently in process, or our upgrades are unsuccessfully implemented, our future success may be negatively impacted.

 

In order to maintain our leadership position in the market and efficiently process increased business volume, we are making a significant multi-year upgrade to our computer hardware, software and our Enterprise Resource Planning (“ERP”) system. Should we be unable to continue to fund this upgrade, or should the ERP system upgrade be unsuccessful or take longer to implement than anticipated, our ability to grow the business and our financial results could be adversely impacted.

International economic, political, legal and business factors could negatively affect our results of operations, cash flows and financial condition.

 

In 2008, approximately 55% of our sales were derived outside the U.S. Since our growth strategy depends in part on our ability to further penetrate markets outside the U.S., we expect to continue to increase our sales outside the U.S., particularly in emerging markets. In addition, two of our manufacturing operations and many of our suppliers are located outside the U.S. Our international business is subject to risks that are customarily encountered in non-U.S. operations, including:

 

 

Any of these risks could negatively affect our results of operations, cash flows, financial condition and overall growth.

 

Changes in our tax rates or exposure to additional income tax liabilities could affect our profitability. In addition, audits by tax authorities could result in additional tax payments for prior periods.

 

We are subject to income taxes in the U.S. and in various foreign jurisdictions. Domestic and international tax liabilities are subject to the allocation of income among various tax jurisdictions. Our effective tax rate can be affected by changes in the mix of earnings in countries with differing statutory tax rates (including as a result of business acquisitions and dispositions), changes in the valuation of deferred tax assets and liabilities, accruals related to unrecognized tax benefits, the results of audits and examinations of previously filed tax returns and changes in tax laws. Any of these factors may adversely affect our tax rate and decrease our profitability. The amount of income taxes we pay is subject to ongoing audits by U.S. federal, state and local tax authorities and by non-U.S. tax authorities. If these audits result in assessments different from our unrecognized tax benefits, our future results may include unfavorable adjustments to our tax liabilities.

 

We may not be able to retain or hire key personnel.

 

To operate successfully and manage potential future growth, the Company must attract and retain qualified managerial, sales, technical and other personnel. We face competition for and cannot assure that we will be able to attract and retain such qualified personnel. If we lose key personnel or are unable to hire and retain additional qualified personnel, our business, financial condition and operating results could be adversely affected.

 

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 potential 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 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 are contesting Omax’s allegations of infringement and also vigorously pursuing our claims against Omax with regard to our own patent. The outcome of this case is uncertain, and an unfavorable outcome is reasonably possible. We have and could continue to spend substantial amounts contesting Omax’s claims and pursuing our own except as discussed in Note 9: Commitments and Contingencies to the Consolidated Financial Statements.

 

Foreign currency exchange rates and commodity prices may adversely affect our results of operations and financial condition.

 

We are exposed to a variety of market risks, including the effects of changes in foreign currency exchange rates and commodity prices. We have substantial assets, liabilities, revenues and expenses denominated in currencies other than the U.S. dollar, and to prepare our consolidated financial statements, we must translate these items into U.S. dollars at the applicable exchange rates. In addition, we are a large buyer of steel, as well as other commodities required for the manufacture of products. As a result, changes in currency exchange rates and commodity prices may have an adverse effect on our results of operations and financial condition.

 

If we cannot obtain sufficient quantities of materials, components and equipment required for our manufacturing activities at competitive prices and quality and on a timely basis, or if our manufacturing capacity does not meet demand, our business and financial results will suffer.

 

We purchase materials, components and equipment from third parties for use in our manufacturing operations. Some of our businesses purchase their requirements of certain of these items from sole or limited source suppliers. If we cannot obtain sufficient quantities of materials, components and equipment at competitive prices and quality and on a timely basis, we may not be able to produce sufficient quantities of product to satisfy market demand, product shipments may be delayed or our material or manufacturing costs may increase. In addition, because we cannot always immediately adapt our cost structures to changing market conditions, our manufacturing capacity may at times exceed our production requirements or fall short of our production requirements. Any or all of these problems could result in the loss of customers, provide an opportunity for competing products to gain market acceptance and otherwise adversely affect our business and financial results.

 

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

 

In order to maintain our position in the market, we need to continue investment in research and development 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 efforts do 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 condition and results of operations could be adversely affected.

 

Our reputation and our ability to do business may be impaired by improper conduct by any of our employees, agents or business partners.

 

We cannot provide assurance that our internal controls will always protect us from reckless or criminal acts committed by our employees, agents or business partners that would violate U.S. and/or non-U.S. laws, including the laws governing payments to government officials, competition, money laundering and data privacy. Any such improper actions could subject us to civil or criminal investigations in the U.S. and in other jurisdictions, could lead to substantial civil or criminal, monetary and non-monetary penalties against us or our subsidiaries, and could damage our reputation.

Risks Related to Ownership of Our Common Stock

 

The price of our common stock may be volatile.

 

The market price of our common stock may be influenced by many factors, many of which are beyond our control, including those described above under “Risk Related to our Industry and Business” and the following:

 

 

In the past, our operating results have fluctuated significantly from quarter to quarter and may continue to do so in the future due to the factors above and others that are disclosed elsewhere in this Annual Report. 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, 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.

 

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

 

We have granted stock options to our employees and other individuals. At April 30, 2008, we had options outstanding to purchase 773,500 shares of our common stock, at exercise prices ranging from $5.71 to $12.13 per share. In addition, we have compensation plans with certain employees which granted those employees common stocks or restricted stock units totaling 296,773 shares in fiscal year 2008.

 

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:

 

 

Risks Related to the Pending Omax Transaction

 

Our proposed merger with Omax Corporation (“Omax”) may fail to close or there could be substantial delays and costs before the merger is completed, including the loss of the $6 million consideration paid for the exclusive option to purchase Omax.

 

On December 4, 2007, we entered into an option agreement that provides us with a period of exclusivity to negotiate the acquisition of Omax. The proposed transaction is subject to due diligence, the negotiation of a mutually acceptable definitive agreement and other customary closing conditions, including approval of the merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (the HSR Act”). On July 10, 2008, in connection with the pending merger with Omax referred to in Note 17, the Federal Trade Commission (“FTC”) accepted an Agreement Containing Consent Order (the “proposed consent order”) that will remedy competitive concerns about the proposed transaction alleged in the FTC’s simultaneously issued Complaint. The proposed consent order is subject to a 30 day public notice and comment period, following which the FTC will decide whether to make it final. The Company is permitted to close the transaction prior to the expiration of the 30 day public notice and comment period; however, the Company does not anticipate that other closing conditions of the transaction will be satisfied prior to such time. Furthermore, there can be no assurances that a mutually acceptable definitive agreement will be negotiated and that all other closing conditions will be satisfied and that the Omax merger will be consummated.

 

If the proposed merger with Omax is not closed, the continuation of the litigation could be time consuming and costly.

 

If the proposed transaction is consummated, the patent litigation between the parties, Omax Corporation v. Flow International Corporation, United States District Court, Western Division at Seattle, Case No. CV04-2334, will be terminated without any additional amounts being paid in settlement. If the transaction is not closed, the litigation may continue which could be time consuming and costly.

 

Our proposed merger with Omax may result in dilution to our existing shareholders.

 

Under the Option Agreement, 3.75 million shares of common stock (or if the Closing Share Price is less than $9.00, such greater number as is necessary so that the value of the shares delivered is $33.75 million) would be issued at closing and up to 1,733,334 additional shares of common stock based on the Average Share Price for the six months ending twenty four months after closing. The additional shares to be delivered will be determined using a sliding scale as follows: if the average share price is $13 or less, no additional shares are delivered; if the average share price is $15 or more, 1,733,334 shares will be delivered; provided that if the Closing Share Price at the time the transaction is consummated is less than $9.00, the additional shares will be reduced by the equivalent shares attributable to the difference between $9.00 and the Closing Share Price. These additional shares issued in connection with the merger with Omax will have a dilutive impact on the number of our shares outstanding and may also adversely affect the prevailing market price of our common stock. If more than 3.75 million shares are to be delivered, the Company has the right to deliver cash in the amount of the value of the shares rather than shares.

 

We may not be able to successfully integrate Omax into our existing business.

 

If the transaction is closed, there will be a significant risk relating to integration. The integration of Omax will be a time consuming and expensive process and may disrupt the combined company’s operations if it is not completed in a timely and efficient manner. If this integration effort is not successful, the combined company’s results of operations could be harmed, employee morale could decline, key employees could leave, and customers could cancel existing orders or choose not to place new ones. In addition, the combined company may not achieve anticipated synergies or other benefits of the merger. If the anticipated benefits of the merger are not realized or do not meet the expectations of financial or industry analysts, the market price of the Company’s common stock may decline.

We may assume unknown liabilities in the merger with Omax that could harm our financial condition and operating results.

 

The due diligence that we have and will be able to perform before the proposed merger may be limited and may not be sufficient to identify before the closing all possible breaches of representations and warranties. As a result, we may, among other things, assume unknown liabilities not disclosed by the seller or uncovered during pre-merger due diligence. These obligations and liabilities could harm our financial condition and operating results. Our rights to indemnification for breaches of representations and warranties will, except in certain limited circumstances, be limited to a maximum of $13.2 million.

 

We may incur significant indebtedness following the merger, which could adversely affect our liquidity.

 

In order to finance a portion of the cash consideration, we will incur additional indebtedness. As a result of this indebtedness, demands on our cash resources will increase, which could affect our liquidity and, therefore, could have important effects on an investment in our common stock. For example, while the impact of this increased indebtedness is expected to be addressed by the combined cash flows of the Company and Omax, the increased level of indebtedness could nonetheless create competitive disadvantages for us compared to other companies with lower debt levels.

 

 

There are no unresolved comments that were received from the SEC staff relating to our periodic or current reports under the Securities Exchange Act of 1934.

 

 

We occupied approximately 394 thousand square feet of floor space on April 30, 2008 for manufacturing, warehousing, engineering, administration and other productive uses, of which approximately 49% was located in the United States.

 

The following table provides a summary of the floor space by segment:

 

 

We have operations at the following locations:

 

 

We believe that our principal properties are adequate for our present needs and, supplemented by planned improvements and construction, expect them to remain adequate for the foreseeable future.

 

At any time, we may be involved in certain legal proceedings. Our policy is to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an analysis of historical experience. We record reserves related to certain legal matters for which it is probable that a loss has been incurred and the range of such loss can be estimated. With respect to other matters, management has concluded that a loss is only reasonably possible or remote and, therefore, no liability is recorded. Management discloses the facts regarding material matters assessed as reasonably possible and potential exposure, if determinable. Costs incurred with defending claims are expensed as incurred. As of April 30, 2008, we have recorded reserves related to certain legal matters for which it is probable that a loss has been incurred and the range of such loss can be estimated.

 

Omax Corporation (“Omax”) filed suit against us on November 18, 2004. The case, Omax Corporation v. Flow International Corporation, United States District Court, Western Division at Seattle, Case No. CV04-2334, was filed in federal court in Seattle, Washington. The suit alleges that our products infringe Omax’s Patent Nos. 5,508,596 entitled “Motion Control with Precomputation” and 5,892,345 entitled “Motion Control for Quality in Jet Cutting.” The suit also seeks to have our Patent No. 6,766,216 entitled “Method and System for Automated Software Control of Waterjet Orientation Parameters” declared invalid, unenforceable and not infringed. We have brought claims against Omax alleging certain of their products infringe our Patent No. 6,766,216. Omax manufactures waterjet equipment that competes with our equipment. Both the Omax and our patents are directed at the software that controls operation of the waterjet equipment. Although the Omax 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. The outcome of this case is uncertain and an unfavorable outcome ranging from $0 to $100 million is reasonably possible. We have spent, and could continue to spend, significant amounts on this case except as disclosed in Note 17: Pending Omax Transaction of the Notes to the Consolidated Financial Statements.

 

In litigation arising out of a June 2002 incident at a Crucible Metals’ (“Crucible”) facility, our excess insurance carrier notified us in December 2006 that it would contest its obligation to provide coverage for the property damage. We believe the carrier’s position is without merit and following the commencement of a declaratory judgment action, the carrier agreed to provide us a defense. The carrier has reserved its right to contest coverage at a future date, however. The unresolved claims relating to this incident total approximately $7 million and we may spend substantial amounts if the carrier chooses, at a future date, to withdraw its defense or contest coverage. We intend to vigorously contest this claim; however, the ultimate outcome or likelihood of this specific claim cannot be determined at this time and an unfavorable outcome is reasonably possible.

 

In June 2007, we received a claim seeking the return of amounts paid by Collins and Aikman Corporation, a customer, as preference payments. The amount sought as preference payments is approximately $1 million. We intend to vigorously contest this claim; however, the ultimate outcome or likelihood of this specific claim cannot be determined at this time and an unfavorable outcome ranging from $0 to $1 million is reasonably possible.

 

Other Legal Proceedings — For matters other than Omax, Crucible, and Collins and Aikman described above, we do not believe these proceedings will have a material adverse effect on our consolidated financial position, results of operations, or cash flows. See Note 9: Commitments and Contingencies of the Notes to the Consolidated Financial Statements for a description of our product liability claims and litigation.

 

 

No matter was submitted to a vote of security holders during the fourth quarter of the fiscal year ended April 30, 2008 through the solicitation of proxies or otherwise.

 

 

Market Information

 

Our stock is traded on the NASDAQ Stock Market under the symbol “FLOW”. The range of high and low sales prices for our common stock for the last two fiscal years is set forth in the following table.

 

 

Holders of the Company’s Common Stock

 

As of July 3, 2008, there were approximately 782 holders of record of our common stock.

 

Dividends

 

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 ability to pay cash dividends is restricted under our new senior credit agreement which was signed on June 9, 2008. Refer to Note 19: Subsequent Events to the Consolidated Financial Statements for further discussion on this credit facility.

 

Issuer Purchases of Equity Securities

 

On October 25, 2007, in a privately negotiated transaction, we repurchased from certain funds managed or advised by Third Point LLC (collectively, “Third Point”) outstanding warrants that gave Third Point the right until March of 2010 to purchase 403,300 of our common stock at an exercise price of $4.07 per share (the “Warrants”). Third Point purchased the Warrants, together with shares of common stock, in our March 2005 Private Investment Public Equity transaction (the “PIPE Transaction”). The Warrants were repurchased from Third Point in connection with our previously announced program to repurchase up to $45 million of our securities. The Warrants were repurchased at a price of $7.43 per Warrant for an aggregate purchase price of $3 million. Third Point was the last holder of warrants issued in the PIPE Transaction; all other warrants had been converted. See Note 10: Shareholders’ Equity of the Notes to the Consolidated Financial Statements for further discussion of this transaction.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

Information about the Company’s equity compensation plans as of April 30, 2008 is as follows:

 

 

For more detailed information regarding the Company’s equity compensation plans, see Note 11: Stock-based Compensation of the Notes to our Consolidated Financial Statements.

Comparison of Five-Year Cumulative Total Shareholder Return*

 

The graph below compares the cumulative 5-year total return of holders of Flow International Corporation’s common stock with the cumulative total returns of the S&P Smallcap 600 index, the NASDAQ Composite index, and the Dow Jones US Industrial Machinery index.

 

 

 

 

Performance Graph Assumptions

 

 

Recent Sales of Unregistered Securities

 

None.

 

The Company has restated its previously issued Consolidated Financial Statements for the fiscal years ended April 30, 2007 and 2006 as described in Note 20 to the accompanying Consolidated Financial Statements included in Item 8. All affected amounts included herein have been restated.

 

The following selected consolidated financial data should be read in conjunction with our audited consolidated financial statements, the related notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations, which are included in this Annual Report on Form 10-K.

 

 

 

 

 

 

We have restated our previously issued Consolidated Financial Statements for the fiscal years ended April 30, 2007 and 2006, as described in Note 20 to the accompanying Consolidated Financial Statements included in Item 8. Note 18 details the impact of the restatement on our previously reported unaudited quarterly financial data for interim periods in 2008 and 2007. All affected amounts and period-to-period comparisons described herein have been restated accordingly.

 

The following discussion and analysis should be read in conjunction with our Consolidated Financial Statements and accompanying notes included elsewhere in this Form 10-K.

 

Our MD&A includes the following major sections:

 

 

 

Executive Summary

 

Our objective is to deliver profitable dynamic growth by providing technologically advanced waterjet cutting and cleaning systems to our customers. To achieve this objective, we offer versatile waterjet cutting and industrial cleaning systems and we strive to:

 

 

Our ability to fully implement our strategies and achieve our objective may be influenced by a variety of factors, many of which are beyond our control. Refer to discussion under Item 1A: Risk Factors.

 

Certain factors may cause our results to vary year over year. For the three years ended April 30, 2008, we have identified such factors as follows:

 

Introduction of New Products

 

In fiscal year 2007, we introduced the 87,000 psi intensifier pump at the bi-annual International Manufacturing Technology Show (IMTS) in September 2006.

 

In fiscal year 2006, we introduced the Nanojet^tm system. This system was used in the semiconductor industry to cut flash memory chips and contributed to 3%, 14% and 28% of sales in the Asia Waterjet segment sales in fiscal years 2008, 2007 and 2006, respectively. Our 55,000 psi Husky pump used in cleaning applications and our Stonecrafter^tm machine were also introduced in fiscal year 2006.

 

Intercompany Transfer Pricing Policy

 

We updated our intercompany transfer pricing policy effective August 1, 2007 to ensure that transactions among our various subsidiaries involved in various aspects of our business were made on arm’s length terms. While the application of our new intercompany transfer pricing policy did not change our revenue or operating performance on a consolidated basis, it impacted the allocation of operating profit amongst our segments. The impact of the new transfer pricing methodology on segment revenues and operating performance will be discussed in the comparative discussion of fiscal year 2008 to fiscal year 2007 results of operations.

 

Allocation of Corporate Management Fees

 

During fiscal year 2008, we have allocated corporate management fees in total of $5.2 million from North America Waterjet to the Company’s other operating segments which is part of the reports evaluated by the chief operating decision maker during the current fiscal year. Fiscal year 2007 has been recast to reflect this methodology. We have not recast the results of operations of fiscal year 2006 as doing so would not be practical.

Exit or Disposal Activities

 

In April 2008, we decided to sell our CIS Technical Solutions division (“CIS” division), which was previously reported as part of our Applications segment. Accordingly, we have recast all periods presented to reflect the results of operating this division in discontinued operations. Operating income for this division totaled $673,000, $654,000, and $342,000 for the years ended April 30, 2008, 2007 and 2006, respectively.

 

On June 2, 2008, we committed to a plan to establish a single facility for designing and building our advanced waterjet systems at our Jeffersonville, Indiana facility and to close our manufacturing facility in Burlington, Ontario, Canada. We estimate that the costs associated with the closure of the Burlington facility and the costs associated with moving production to our Jeffersonville facility will range from $2.6 million to $2.8 million in fiscal 2009, including from $1.5 million to $1.7 million for severance and termination benefits and $1 million to $1.2 million for facility closure and relocation costs. Based on our plans to close our Burlington, Ontario manufacturing facility we recorded an impairment charge of $97,000 related to the impairment of 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.”

 

Results of Operations

 

Summary Consolidated Results for Fiscal Years 2008, 2007, and 2006

 

 

 

Fiscal year 2008 compared to fiscal year 2007

 

Sales growth of $30.8 million or 14% was primarily driven by increased adoption of waterjet cutting and cleaning technology in the global markets and increased sales of 87,000 psi systems. The strengthening of the Brazilian Real versus the U.S. dollar improved our competitive position in Latin America markets. Excluding the impact of foreign currency changes, sales increased $20.2 million or 10% in 2008.

 

Total system sales were up $21.3 million or 14%. Excluding sales to the aerospace industry and Applications segment, system sales increased 22%. Consumable parts sales increased $9.5 million or 16% due to the increased installed base of systems and improved parts availability as well as the use of Flowparts.com and Floweuropeparts.com, our easy-to-use internet order entry systems. Flowparts.com has been deployed in the United States for three years and Floweuropeparts.com has been deployed in Europe for approximately two years.

 

Operating income growth was primarily driven by the higher sales discussed above along with lower operating expenses related to the timing of new product launches. In the prior year, we incurred expenses related to new core product development such as Stonecrafter^tm, the 87,000 psi pump and the 55,000 psi Husky. Additionally, there were lower professional fees for legal, audit, and consulting fees for assistance with Sarbanes-Oxley compliance during the current fiscal year.

Fiscal year 2007 compared to fiscal year 2006

 

Sales growth was due to management’s focus on the core of our business — ultrahigh-pressure water pumps and the applications that integrate these pumps to cut and clean material. Improved global awareness of the benefits of waterjet cutting and cleaning technology over other traditional methods has resulted in increased global adoption of waterjet cutting and cleaning technology across multiple industries.

 

Operating income in fiscal year 2007 was negatively impacted by increased material and warranty costs, and the compensation expense incurred to amend the former CEO’s employment contract. Additionally, fiscal year 2007 operating expenses included legal, consulting fees, and losses totaling $3 million related to the Asia investigations which were discussed in previous filings. These investigations related to irregularities discovered in our Taiwan and Korean operations. In response to the investigations’ findings, we developed a remediation plan which has been implemented by senior management with the advice and counsel of the Audit Committee and its advisors. The remediation plan involved rebuilding the Flow Asia organization; including actions to assure clear and comprehensive policies, establish and communicate behavior standards and assure appropriate tone at the top.

 

Segment Results of Operations

 

We operate in four reportable segments, which are North America Waterjet, Asia Waterjet, Other International Waterjet and Applications. This section provides a comparison of net sales and operating expenses for each of our segments for the last three fiscal years. For further discussion on our business segments, refer to Note 16: Business Segments and Geographic Information of the Consolidated Financial Statements.

 

North America Waterjet Segment

 

Our North America Waterjet segment includes sales and expenses related to our cutting and cleaning systems using ultrahigh-pressure water pumps as well as parts and services to sustain these installed systems in our North America business units.

 

 

 

NM = Not Meaningful

 

 

Fiscal year 2008 compared to fiscal year 2007

 

In fiscal year 2008:

 

Sales increased $11.4 million or 10% over the prior year and constituted 53% of total sales primarily due to the following:

 

 

The positive factors above were offset by a $7.3 million or 36% decrease in aerospace sales over the prior year due to delayed aerospace contract awards.

 

Gross margin for the year ended April 30, 2008 amounted to $61.3 million or 47% of sales compared to $52.7 million or 44% of sales in the prior year. Generally, comparison of gross margin rates will vary period over period based on changes in our product sales mix and prices, which includes advanced systems, standard systems and consumables and levels of production volume. Margins in our North America Waterjet segment increased on improved product pricing and higher intercompany prices charged to foreign subsidiaries.

 

Operating expense changes consisted of the following:

 

 

Fiscal year 2007 compared to fiscal year 2006

 

In fiscal year 2007:

 

Sales increased $9.5 million or 9% over fiscal year 2006 primarily due to the following:

 

 

Aerospace sales decreased $484,000 or 2% from $20.8 million in fiscal year 2006 to $20.3 million in fiscal year 2007 due to delayed aerospace contract awards.

 

Gross margin for the year ended April 30, 2007, was $52.7 million or 44% of sales compared to $54.1 million or 50% of sales in the prior year. Margins in North America declined from the prior year due to higher material prices and warranty costs, and lower average margins on aerospace systems due to lower volume.

 

Operating expense changes consisted of the following:

 

 

 

Asia Waterjet Segment

 

Our Asia Waterjet segment includes sales and expenses related to selling activities of our cutting and cleaning systems using ultrahigh-pressure water pumps as well as parts and services to sustain these installed systems in our Asia-Pacific business units.

 

 

 

NM = Not Meaningful

 

Fiscal year 2008 compared to fiscal year 2007

 

In fiscal year 2008:

 

Sales decreased $106,000 or 0.3% over the prior year and constituted 13% of total sales due to a slowdown in sales to the semiconductor industry.

 

Gross margin for the year ended April 30, 2008 amounted to $13.8 million or 45% of sales compared to $17.5 million or 57% of sales in the prior year. Margins in Asia Waterjet segment declined due to changes in our product mix including lower sales to the semiconductor industry and higher intercompany transfer pricing in the current year.

 

Operating expense changes consisted of the following:

 

 

Fiscal year 2007 compared to fiscal year 2006

 

In fiscal year 2007:

 

Sales decreased $5.4 million or 15% due to the impact of the management disruption of the Asia investigations and a slowdown in sales to the semiconductor industry.

 

Gross margin for the year ended April 30, 2007 was $17.5 million or 57% of sales compared to $21.6 million or 60% of sales in the prior year. Margins in Asia Waterjet segment declined due to changes in our product mix including lower sales to the semiconductor industry.

 

Operating expense changes consisted of the following:

 

 

Other International Waterjet

 

Our Other International Waterjet segment includes sales and expenses related to selling activities of our cutting and cleaning systems using ultrahigh-pressure water pumps as well as parts and services to sustain these installed systems in our Europe and South America business units.

 

 

 

NM = Not Meaningful

 

Fiscal year 2008 compared to fiscal year 2007

 

In fiscal year 2008:

 

Sales increased $18.1 million or 36% over the prior year and constituted 28% of total sales. This increase was primarily as a result of stronger demand for our standard shapecutting systems and spare parts as well as the benefit of a favorable currency impact based on a stronger Euro and Brazilian Real versus the U.S. dollar.

 

Gross margin for the year ended April 30, 2008 amounted to $24.2 million or 36% of sales compared to $19 million or 38% of sales in the prior year. The comparative percentage margin decline is attributable to higher intercompany transfer pricing as a result of the policy implemented in fiscal year 2008.

Operating expense changes consisted of the following:

 

 

Fiscal year 2007 compared to fiscal year 2006

 

In fiscal year 2007:

 

Sales increased $11 million or 29% primarily as a result of stronger demand for our standard shapecutting systems and spare parts revenue as well as the benefit of a stronger Euro versus U.S. dollar.

 

Gross margin for the year ended April 30, 2007 was $19 million or 38% of sales compared to $13.7 million or 36% of sales in the prior year. Gross margin improvements in Other International Waterjet are attributable to strong product pricing, improved product mix, and a stronger Euro versus U.S. Dollar exchange rate.

 

Operating expense changes consisted of the following:

 

 

Applications Segment

 

Our Applications segment offers specialty engineered robotic systems designed for material removal and separation of various materials and for factory automation. Effective September 2007, our Applications segment ceased the pursuit of sales of non-waterjet automation systems and focused on increasing revenue from systems that integrate waterjet cutting technology.

 

In April 2008, we decided to sell our CIS Technical Solutions division which provided technical services to improve the productivity of automated assembly lines and was previously presented as part of our Applications segment. Technical services provided by this division include robot programming, process improvement, systems integration and production support.

 

 

 

NM = Not Meaningful

Fiscal year 2008 compared to fiscal year 2007

 

In fiscal year 2008:

 

Sales increased $1.4 million or 10% over the prior year and constituted 6% of total sales. This increase was primarily as a result of the benefit of a favorable foreign currency impact based on prior year average Canadian Dollar exchange rates.

 

Gross margin for the year ended April 30, 2008 amounted to $1.4 million or 9% of sales compared to $1.7 million or 13% of sales in the prior year. The comparative percentage margin decline is attributable to expenses mainly as a result of inventory write-downs of $399,000 and severance costs of $234,000 incurred related to the cessation of the pursuit of non-waterjet automation systems.

 

Operating expenses and changes consisted of the following:

 

 

Fiscal year 2007 compared to fiscal year 2006

 

Sales decreased $4.3 million or 24% over the prior year and constituted 7% of total sales. The decrease was due to an economic downturn in the domestic automotive industry. To counteract this market issue, we shifted our sales focus to systems that integrate waterjet cutting technology and deemphasized non-waterjet systems in non-automotive markets.

 

Gross margin for the year ended April 30, 2007 amounted to $1.7 million or 13% of compared to $3.7 million or 20% of sales in the prior year. The comparative percentage margin decline is mainly as a result of increased cost of certain automotive contracts during the first and second fiscal quarters of fiscal year 2007.

 

Operating expenses and changes consisted of the following:

 

 

Other (Income) Expense

 

Interest Income and Interest Expense

 

Our interest income over the last three years was:

 

 

The moderate decrease in interest income in fiscal year 2008 when compared to fiscal year 2007 results from a moderate decline in average cash balances during fiscal year 2008 while the increase in fiscal year 2007 when compared to fiscal year 2006 was primarily as a result of an increase in average invested cash balances in fiscal year 2007.

 

Our Interest Expense over the last three years was:

 

 

Interest expense remained unchanged in fiscal year 2008 when compared to fiscal year 2007. The significant decrease in interest expense when compared to fiscal year 2006 was due to the reduction of our Senior Debt.

 

Other Income (Expense), Net

 

Our other Income (Expense), net in the Consolidated Statement of Operations is comprised of the following:

 

 

During fiscal year 2008, we recorded Other Expense, Net of $1.8 million compared to Other Income, Net of $1.9 million and $310,000 in fiscal years 2007 and 2006, respectively. These changes result from the fluctuation in realized and unrealized foreign exchange gains and losses as shown in the table above.

 

Income Taxes

 

Our (benefit)/provision for income taxes for our continuing operations over the last three years was:

 

 

Under FASB Statement No. 109, Accounting for Income Taxes, we recognize a net deferred tax asset for items that will generate a reduction in future taxable income to the extent that it is “more likely than not” that these deferred assets will be realized. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the period in which the tax benefit will be realized. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which the tax benefit will be realized. In determining the realizability of these assets, we considered numerous factors, including historical profitability, estimated future taxable income and the industry in which we operate. Based on the cumulative results of operations in the United States for the fiscal years ended April 30, 2008, 2007, and 2006 and anticipated future profit levels, we believe that certain of our deferred tax assets are more likely than not to be realized. Accordingly, in the fiscal year ended April 30, 2008, we reversed approximately $17.2 million of valuation allowance against deferred tax assets related to U.S. net operating loss (NOL) carryforwards and other net deferred tax assets, which will more likely than

not, be realized in future periods. Additionally, during the first quarter of fiscal year 2008, after concluding that certain of our German deferred tax assets were more likely than not to be realized, we reversed approximately $1 million of valuation allowance related to net operating loss carryforwards and other net deferred tax assets in this jurisdiction. At April 30, 2008, the recorded amount of our deferred tax assets was $10 million, net of valuation allowance on certain foreign NOLs.

 

Our foreign tax provision consists of current and deferred tax expense. The United States tax provision consists of current and deferred tax expense (benefit), state taxes and foreign withholding taxes. We do not permanently defer undistributed earnings of certain foreign subsidiaries. In the current year we repatriated $9.8 million, net of $885,000 withholding tax from these foreign subsidiaries and we plan to continue repatriating additional funds in the future. We recorded a $304,000 liability for withholding taxes payable on future repatriation of these foreign earnings.

 

In fiscal year 2007, the foreign tax provision consisted of current and deferred tax expense. The United States tax provision consisted primarily of federal alternative minimum tax, state taxes, and accrued foreign withholding taxes. We recorded a $517,000 liability for withholding taxes payable on future repatriation of foreign earnings in fiscal year 2007. In fiscal year 2007, we repatriated $8.0 million, net of tax of $1.4 million from two foreign subsidiaries.

 

The fiscal year 2006 tax provision consisted of current and deferred expense related to operations in foreign jurisdictions which were profitable, primarily in Taiwan and Germany. In addition, operations in certain jurisdictions (principally Canada and the United States) reported net operating losses for which no tax benefit was recognized as it was more likely than not that such benefit will not be realized at that time. In fiscal year 2006, we repatriated $1.4 million from certain foreign subsidiaries.

 

Fourth Quarter Highlights

 

Summary

 

 

NM = Not Meaningful

 

 

The largest contributing factors to the improvement in sales were increased adoption of waterjet cutting and cleaning technology in the global markets and increased sales of 87,000 psi systems. The strengthening of the Brazilian Real versus the U.S. dollar improved our competitive position in Latin America markets. Excluding the impact of foreign currency changes, sales increased $7 million or 13% in the fourth quarter of fiscal year 2008 when compared to the prior year same period.

 

Operating income growth was primarily driven by the higher sales discussed above along with lower operating expenses due to decreases in corporate expenses including patent and legal fees related to Omax as litigation related expenditure has been stayed while the Company pursues the merger with Omax. Lower

operating expenses were also driven by lower professional fees related to audit and audit-related service fees and consulting fees which were $1.2 million in the fourth quarter of fiscal year 2008 compared to $4.1 million in the prior year same period. The fourth quarter of fiscal year 2007 also included $2.9 million of expenses related to compensation expenses to amend the former CEO’s employment contract.

 

Income from continuing operations also includes a net deferred tax benefit of $11.8 million resulting from the changes in our deferred tax assets in fiscal year 2008, as well as the reversal of our U.S. valuation allowance in the fourth quarter of fiscal year 2008 following the conclusion that it was more likely than not that our U.S. net operating loss (NOL) carryforwards and other net deferred tax assets will be realized in future periods.

 

Liquidity and Capital Resources

 

Cash Flow Summary

 

The following table summarizes our cash flows from operating, investing and financing activities for the periods noted below:

 

 

Operating Activities

 

Cash generated by operating activities before the effects of changes in working capital was $26.8 million in fiscal year 2008 compared to $10.1 million in fiscal year 2007. This increase was mainly attributable to the increase in net earnings and an increase in noncash benefits for deferred income taxes as a result of the valuation allowance release on U.S. net operating loss carryforwards, an increase in depreciation and amortization expense and inventory write-downs in fiscal year 2008 as well as an increase in unrealized foreign exchange losses in the current fiscal year. Cash generated by operating activities before the effects of changes in working capital was $22.6 million in fiscal year 2006. The decrease in fiscal year 2007 when compared to fiscal year 2006 was primarily due to lower net income. Fiscal year 2006 also included a noncash adjustment of $6.9 million related to a fair value adjustment on warrants issued which increased the cash generated from operating activities in that year.

 

Changes in our working capital resulted in a net $12.8 million use of cash in fiscal year 2008 compared to $5.9 million use of cash in fiscal year 2007. Accounts receivable increased by $6.1 million as a result of increases in our net sales; inventories increased by $2.9 million in order to meet the increased demand for our products as well as longer lead times quoted by our suppliers; customer deposits decreased by $1.7 million due to the timing of contract awards. The $4.1 million increase of cash used for working capital in fiscal year 2007 when compared to fiscal year 2006 was mainly attributable to decreases in operating liabilities as a result of timing of vendor payments offset by a significant reduction in accounts receivable.

Investing Activities

 

Net cash used in investing activities was $12.9 million in fiscal year 2008 compared to $7.7 million in fiscal year 2007. The increase in net cash used primarily resulted from payments of $7.5 million for the pending merger with Omax. For a detailed discussion on the pending merger, see Note 17: Pending Omax Transaction of our Notes to the Consolidated Financial Statements. In fiscal 2006, we generated $10.9 million of cash from investing activities mainly as a result of cash consideration received from the sale of certain of our non-core businesses; Avure Technologies Incorporated, Flow International FPS AB, Avure Technologies AB subsidiaries, and our 51% interest in Flow Autoclave Systems (together, the “Avure Business”).

 

Financing Activities

 

Net cash used in financing activities was $7.6 million during in fiscal year 2008 compared to net cash provided by financing activities of $5.7 million during the prior year. The increase in net cash used in financing activities was mainly due to the repayment of notes payable of $5.3 million in fiscal year 2008 that was borrowed at the end of fiscal year 2007, the repurchase of warrants of $3 million, and a reduction of $1.3 million of net cash provided from the exercise of stock options during fiscal year 2008 when compared to fiscal year 2007. The $6.7 million use of cash in financing activities in fiscal year 2006 was primarily attributable to cash payments on our subordinated debt.

 

Debt

 

We have an outstanding seven-year collateralized long-term variable rate loan, expiring in 2011, bearing interest at an annual rate of 3.67% as of April 30, 2008. The loan is collateralized by our manufacturing facility in Taiwan. The outstanding balance of $2.9 million at April 30, 2008 is included in Long-term Obligations.

 

We also have four unsecured credit facilities in Taiwan with a commitment totaling $6.5 million at April 30, 2008, bearing interest at rates ranging from 2.56% to 2.76% per annum. In April 2007, we borrowed $5.3 million against this facility for the repatriation of earnings. This amount was repaid in the first quarter of fiscal year 2008. At April 30, 2008, all the credit facilities will mature within one year and the balance outstanding under these credit facilities amounts to $1.1 million, which is shown under Notes Payable in the Consolidated Financial Statements.

 

Warrant Repurchase

 

In October 25, 2007, in a privately negotiated transaction, we purchased from certain funds managed or advised by Third Point LLC (collectively, “Third Point”) outstanding warrants that gave Third Point the right until March of 2010 to purchase 403,300 of the Company’s common stock at an exercise price of $4.07 per share (the “Warrants”). Third Point purchased the Warrants, together with shares of commons stock, our March 2005 Private Investment Public Equity transaction (the “PIPE Transaction”). The Warrants were repurchased from Third Point in connection with our previously announced program to repurchase up to $45 million of the Company’s securities. The Warrants were repurchased at a price of $7.43 per Warrant for an aggregate purchase price of $3 million. See Note 10: Shareholders’ Equity of the Notes to the Consolidated Financial Statements for a detailed discussion of this transaction.

 

Sources of Liquidity

 

Funds generated by operating activities, available cash and cash equivalents, and our credit facilities continue to be our most significant sources of liquidity. At April 30, 2008, we had total cash of $29.1 million, of which approximately $15 million was held by divisions outside the United States. The repatriation of offshore cash balances from certain divisions will trigger tax liabilities. In fiscal 2008, we repatriated $9.8 million, net of tax of $885,000 from three foreign subsidiaries and we plan to continue repatriating additional funds in future from these foreign subsidiaries. We repatriated $8.0 million of earnings in fiscal year 2007, net of tax of $1.4 million from two foreign subsidiaries.

Our domestic senior credit agreement (“Credit Agreement”) is our primary source of external funding. Effective July 19, 2007, we entered into a Second Amendment (the “Amendment”) to our Credit Agreement, which increased our revolving line of credit from $30 million to $45 million and permitted the use of the line of credit for the repurchase of stock. The amended credit agreement bore interest at the bank’s prime rate (5.00% at April 30, 2008) or was linked to LIBOR plus a percentage depending on our leverage ratios, at our option. The agreement set forth specific financial covenants to be attained on a quarterly basis, which we believed, based on our financial forecasts, were achievable. At April 30, 2008, we had $42.8 million of domestic unused line of credit available, net of $2.2 million in outstanding letters of credit. The extended credit line was expected to provide us with liquidity that could be used to make acquisitions or fund the repurchase of shares. We were in compliance with all financial covenants as of April 30, 2008

 

On June 9, 2008, we signed a new five-year senior secured credit facility with an aggregate principal amount of $100 million, which includes a $65 million revolving credit facility and a $35 million term loan that we may draw upon for the merger with Omax. This line of credit has a maturity date of June 9, 2013 and is collateralized by a general lien on all of our material assets, as defined within the credit agreement. Borrowings on the credit facility, if any, will be based on the bank’s prime rate or LIBOR rate plus a percentage spread depending on current leverage ratios, at our option. Refer to Note 19: Subsequent Events of the Notes to the Consolidated Financial Statements for a detailed discussion of this transaction.

 

Our capital spending plans currently provide for outlays of approximately $8.2 million over the next twelve months, primarily related to information technology spending and facility improvement. It is expected that funds necessary for these expenditures will be generated internally. Our capital spending for fiscal year ended April 30, 2008 and 2007 amounted to $6.3 million and $6.9 million, respectively.

 

We believe that our existing cash, cash from operations, and credit facilities at April 30, 2008 are adequate to fund our operations for at least the next twelve months.

 

Disclosures about Contractual Obligations and Commercial Commitments

 

The following table summarizes our known future payments pursuant to certain contracts as of April 30, 2008 and the estimated timing thereof. More detail about our contractual obligations and commercial commitments are in Note 7: Long-term Obligations and Note 9: Commitments and Contingencies of the Notes to the Consolidated Financial Statements.

 

 

 

 

Off-Balance Sheet Arrangements

 

We do not have off-balance sheet arrangements, financing or other relationships with unconsolidated entities or other persons. At April 30, 2008, there were no off-balance sheet arrangements.

 

Critical Accounting Estimates

 

Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these consolidated financial statements requires us to make assumptions and estimates about future events, and apply 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 consolidated financial statements. We base our assumptions, estimates, and judgment on historical experience, current trends and other factors which management believes to be relevant and appropriate at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates, and judgments to ensure that our consolidated financial statements are presented fairly. However, because future events cannot be determined with certainty, actual results may differ from our assumptions and estimates, and such differences could be material.

 

Our significant accounting policies are discussed in Note 1: The Company and Summary of Significant Accounting Policies of the Notes to the Consolidated Financial Statements. Management believes that the following accounting estimates require management’s most difficult, subjective or complex judgment, resulting from the need to make estimates about the effect of matters that are inherently uncertain and are the most critical to aid in fully understanding and evaluating our reported consolidated financial results.

 

Revenue Recognition

 

We recognize revenue for sales of ultrahigh-pressure waterjet pumps, consumables, services, and billing for freight charges, in accordance with SEC Staff Accounting Bulletin No. 104 (“SAB 104”), “Revenue Recognition in Financial Statements” and EITF Issue No. 00-21 (“EITF 00-21”), “Revenue Arrangements with Multiple Deliverables.” Additionally, because FlowMaster^tm software, our PC-based waterjet control, is essential to the functionality of our waterjet systems, we recognize revenue on sales of waterjet systems in accordance with Statement of Position 97-2 (“SOP 97-2”), “Software Revenue Recognition.” Specifically, the Company recognizes revenue when persuasive evidence of an arrangement exists, title and risk of loss have passed to the customer, the price is fixed or determinable, and collectibility is reasonably assured, or probable in the case of sale of waterjet systems. Generally, sales revenue is recognized at the time of shipment, receipt by customer, or, if applicable, upon completion of customer acceptance provisions.

 

Unearned revenue is recorded for products or services that have not been provided but have been invoiced under contractual agreements or paid for by a customer, or when products or services have been provided but all the criteria for revenue recognition have not been met.

 

For those arrangements with multiple elements, the arrangement is divided into separate units of accounting if certain criteria are met, including whether the delivered item has stand-alone value to the customer and whether there is vendor specific objective and reliable evidence of the fair value of the undelivered items. For contract arrangements that combine deliverables such as systems with embedded software, and installation, each deliverable is generally considered a separate unit of accounting or element. The consideration received is allocated among the separate units of accounting based on their respective fair values, and the applicable revenue recognition criteria are applied to each of the separate units. The amount

allocable to a delivered item is limited to the amount that we are entitled to bill and collect and is not contingent upon the delivery/performance of additional items. In cases where there is objective and reliable evidence of the fair value of the undelivered item in an arrangement but no such evidence for the delivered item, the residual method is used to allocate the arrangement consideration.

 

For complex aerospace and automation systems designed and manufactured to buyers’ specification, the Company recognizes revenues using the percentage of completion method in accordance with Statement of Position 81-1 (“SOP 81-1”), “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” Typical lead times can range from two to 18 months. Sales and profits on such contracts are recorded based on the ratio of total actual incurred costs to date to the total estimated costs for each contract (the “cost-to-cost” method). Losses on contracts are recognized in the period in which they are determined. The impact of revisions of contract estimates is recognized as a cumulative change in estimate in the period in which the revisions are made.

 

The complexity of the estimation process and judgments related to the assumptions, risks and uncertainties inherent with the application of the percentage-of-completion method of accounting affect the amounts of revenue and related expenses reported in our consolidated financial statements. A number of internal and external factors can affect our estimates, including labor rates, utilization, changes to specification and testing requirements and collectibility of unbilled receivables.

 

Significant management judgments and estimates are made in connection with the revenues recognized in any accounting period. We must assess whether the fee associated with a revenue transaction is fixed or determinable, whether or not collection is probable, whether VSOE exists for all elements of a transaction or multiple-element arrangement and the related revenue recognition impact of this and, for fixed-price contracts, make estimates of costs to complete. Material differences could result in the amount and timing of revenues for any period if management were to make different judgments or utilize different estimates.

 

Valuation of Obsolete/Excess Inventory

 

We currently write-down obsolete or excess parts and equipment inventory that is no longer used due to design changes to our products or lack of customer demand. We regularly monitor our inventory levels and, if we identify an excess condition based on our usage, we record a corresponding inventory reserve which establishes a new cost basis for our inventory. Subsequent changes in facts or circumstances do not result in the reversal of previously recorded markdowns or an increase in that newly established cost basis. The amount of inventory write-down requires the use of management judgment regarding technological obsolescence and forecasted customer demand. If estimates regarding consumer demand are inaccurate or changes in technology affect demand for certain products in an unforeseen manner, we may be exposed to losses that could be material.

 

Valuation of Deferred Tax Assets and Uncertain Tax Positions

 

We account for uncertain tax positions in accordance with FASB, Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”, or FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the consolidated financial statements. FIN 48 utilizes a two-step approach for evaluating tax positions. Recognition (Step 1) occurs when an enterprise concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination. Measurement (Step 2) is only addressed if Step 1 has been satisfied. Under Step 2, the tax benefit is measured at the largest amount of benefit, determined on a cumulative probability basis that is more likely than not to be realized upon settlement. As used in FIN 48, the term “more likely than not” means that the likelihood of an occurrence is greater than 50%. We adopted FIN 48 as of May 1, 2007. To the extent that we prevail in matters for which unrecognized tax benefits have been established, or are required to pay amounts in excess of our unrecognized tax benefits, our effective tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement would require the use of our cash and would result in an increase to

our effective income tax rate in the period of resolution. A favorable tax settlement would be recognized as a reduction in our effective income tax rate in the period of resolution.

 

Our annual effective tax rate is based on income, statutory tax rates and tax planning strategies available in various jurisdictions in which we operate. Tax laws are complex and subject to different interpretations by the taxpayer and respective governmental taxing authorities. Significant judgment is required in determining our tax expense and in evaluating tax positions. Tax positions are reviewed quarterly and balances are adjusted as new information becomes available. Deferred income tax assets and liabilities are recognized for the estimated future tax consequences attributable to temporary differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases. These assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the temporary differences are expected to reverse. Future tax benefits of tax losses and credit carryforwards are recognized to the extent that realization of these benefits is considered more likely than not. As of April 30, 2008, we had approximately $35.4 million of domestic net operating loss and $36.7 million of state net operating loss carryforwards to offset certain earnings for federal and state income tax purposes. These net operating loss carryforwards expire between fiscal year 2022 and fiscal year 2026. Net operating loss carryforwards in foreign jurisdictions amount to $39.3 million. Most of the foreign net operating losses can be carried forward indefinitely, with certain amounts expiring between fiscal years 2014 and 2017. The federal, state and foreign net operating loss carryforwards per the income tax returns filed include uncertain tax positions taken in prior years. Due to the application of FIN 48, the net operating loss carryforwards per the income tax returns are larger than the net operating loss deferred tax asset recognized for consolidated financial statement purposes. We also have a capital loss carryover of $4.3 million which expires in 2011. Utilization of net operating losses may be subject to limitation due to ownership changes and other limitations provided by the Internal Revenue code and similar state provisions. If such a limitation applies, the net operating loss may expire before full utilization.

 

Our income tax returns are periodically audited by domestic and foreign tax authorities. These audits include questions regarding our filing tax positions, including the timing and amount of deductions and the allocation of income among various tax jurisdictions. At any one time, multiple tax years are subject to audit by the various tax authorities.

 

Long-lived Assets and Goodwill

 

Goodwill and other acquired intangible assets with indefinite lives are not amortized but are tested for impairment annually, and when an event occurs or circumstances change such that it is reasonably possible that impairment may exist. Our annual testing date is April 30. We test goodwill for impairment by first comparing the book value of net assets to the fair value of the related operations. If the fair value is determined to be less than book value, a second step is performed to compute the amount of the impairment. In this process, an implied fair value for goodwill is estimated, based on the fair value of the operations, and is compared to its carrying value. The shortfall of the fair value below carrying value represents the amount of goodwill impairment.

 

In determining fair value of long-lived assets and whether impairment has occurred, we are required to estimate future cash flows and residual values. Key assumptions we use in developing these estimates include: probability of alternative outcomes; product pricing; product sales; and discount rate.

 

We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate the fair value of long-lived assets and goodwill. However, if actual results are not consistent with our estimates and assumptions used in estimating future cash flows and asset fair values, we may be exposed to losses that could be material.

 

Stock-based compensation

 

We have a stock-based compensation plan, which provides for the grant of stock options and restricted stock units. Refer to Note 1: The Company and Summary of Significant Accounting Policies, and

Note 11: Stock-based Compensation of the Notes to the Consolidated Financial Statements for a complete discussion of our stock-based compensation programs.

 

We determine the fair value of our stock option awards at the date of grant using the Black-Scholes option-pricing model. We determine cumulative expense related to performance-based nonvested awards based on our actual consolidated financial results to date and estimated future performance as of period-end.

 

Legal Contingencies

 

At any time, we may be involved in certain legal proceedings. Our policy is to routinely assess the likelihood of any adverse judgments or outcomes related to legal matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is made after thoughtful analysis of each known issue and an analysis of historical experience. We record reserves related to certain legal matters for which it is probable that a loss has been incurred and the range of such loss can be estimated. With respect to other matters, management has concluded that a loss is only reasonably possible or remote and, therefore, no liability is recorded. Management discloses the facts regarding material matters assessed as reasonably possible and potential exposure, if determinable. Costs incurred with defending claims are expensed as incurred. As of April 30, 2008, we have accrued our estimate of the probable liabilities for the settlement of these claims. Refer to Note 9: Commitments and Contingencies of the Notes to the Consolidated Financial Statements.

 

Because of inherent uncertainties related to these legal matters, we base our loss accruals on the best information available at the time. As additional information becomes available, we reassess our potential liability and may revise our estimates. Such revisions could have a material impact on future quarterly or annual results of operations.

 

Recently Issued Accounting Pronouncements

 

A summary of recently issued accounting pronouncements is in Note 2: Recently Issued Accounting Pronouncements of the Notes to the Consolidated Financial Statements.

 

Factors Affecting Future Operating Results

 

Looking forward to fiscal year 2009, we believe we are well positioned for continued success and profitable growth especially as our 87,000 psi product line continues to be positively received by the market. However, this positive market reception will be negatively impacted by the economic slowdown in North America which could also impact other markets around the world. The anticipated continued strength of foreign currencies against the U.S. dollar, particularly the Euro and Real, is expected to positively impact our business. Recent contract awards for large aerospace programs are also expected to positively impact our sales to the aerospace industry over the next two years.

 

Our manufacturing operations are prepared to take advantage of volume leverage and opportunities for cost reduction. On June 2, 2008, we committed to a plan to establish a single facility for designing and building our advanced waterjet systems at our Jeffersonville, Indiana facility and to close our manufacturing facility in Burlington, Ontario, Canada. We estimate that the costs associated with the closure of the Burlington facility and the costs associated with moving production to its Jeffersonville facility will range from $2.6 million to $2.8 million in fiscal year 2009, including from $1.5 million to $1.7 million for severance and termination benefits and $1 million to $1.2 million for facility closure and relocation costs.

 

In fiscal year 2009 and beyond, we intend to remain focused on our strategies of increasing market awareness of waterjet technology to drive increased market penetration and to improve our operational efficiency. We expect that these strategies and actions taken will help us achieve our long-term goals of compound annual revenue growth rate of 10% and operating income annual growth rate of at least 20%.

 

Market risk exists in our financial instruments related to an increase in interest rates, adverse changes in foreign exchange rates relative to the U.S. dollar, as well as financial risk management and derivatives. These exposures are related to our daily operations.

 

Interest Rate Exposure — At April 30, 2008, we had $4.0 million in interest bearing debt and notes payable. Of this amount, $2.9 million was variable rate debt with an interest rate of 3.67% per annum as of April 30, 2008 and $1.1 million was related to notes payable at fixed interest rates ranging from 2.56% to 2.76% as of April 30, 2008. See Note 8: Long-term Obligations and Notes Payable of the Consolidated Financial Statements for additional contractual information on our long-term obligations and notes payable. Market risk is estimated as the potential for interest rates to increase 10% on the variable rate debt. A 10% change in variable interest rates would impact the interest expense in fiscal 2008 by approximately $12,000, based on the debt balance and interest rate as of April 30, 2008. At April 30, 2008, we had no derivative instruments to offset the risk of interest rate changes. We may choose to use derivative instruments, such as interest rate swaps, to manage the risk associated with interest rate changes in future periods.

 

Foreign Currency Exchange Rate Risk — We transact business in a number of countries around the world and as a result are exposed to changes in foreign currency exchange rates. Costs in some countries are incurred, in part, in currencies other than the applicable functional currency. Our non-U.S. operations account for approximately 47% of consolidated revenue. Based on our results for the year ended April 30, 2008 for our foreign subsidiaries, and based on the net position of foreign assets less liabilities, a hypothetical near-term 10% appreciation of the U.S. dollar against all foreign currencies in the countries in which we operate in could positively impact operating income (expense) and other income (expense) by $599,000 and $(91,000), respectively. Conversely, a hypothetical 10% devaluation of the U.S. dollar against all foreign currencies in the countries in which we operate in could negatively impact operating income (expense) and other income (expense) by $(732,000) and $111,000, respectively. Our consolidated financial position and cash flows could be similarly impacted. We selectively utilize forward exchange rate contracts which we have not designated as cash flow hedges to protect against the adverse effect exchange rate fluctuations may have on foreign currency denominated accounts receivable and accounts payable (both trade and inter-company). At April 30, 2008, we marked these forward contracts to market, recording a net loss of approximately $118,000 as a component of net income for the year ended April 30, 2008. We may continue to utilize forward exchange rate contracts and other derivative instruments in the future to manage the risk associated with foreign currency exchange rate changes.

 

The following consolidated financial statements are filed as a part of this report:

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

Flow International Corporation

Kent, Washington

 

We have audited the accompanying consolidated balance sheets of Flow International Corporation and subsidiaries (the “Company”) as of April 30, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity (deficit) and comprehensive income (loss), and cash flows for each of the three years in the period ended April 30, 2008. Our audits also included the financial statement schedule listed in the index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

 

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

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of April 30, 2008 and 2007, and the results of its operations and its cash flows for each of the three years in the period ended April 30, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

 

As described in Note 1 to the consolidated financial statements, the Company adopted the provisions of Financial Accounting Standards Board Statement No. 123(R), Share-Based Payment, effective May 1, 2006.

 

As discussed in Note 20, the accompanying 2006 and 2007 consolidated financial statements have been restated.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of April 30, 2008, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated July 10, 2008, expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

/s/ Deloitte & Touche LLP

Seattle, Washington

July 10, 2008

FLOW INTERNATIONAL CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

FLOW INTERNATIONAL CORPORATION

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

FLOW INTERNATIONAL CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS