| FLOW INTERNATIONAL CORP Item 1A Risk Factors Following are significant risks which could negatively impact our financial condition or results of operations |
| If we fail to remediate the material weaknesses and deficiencies in our internal control over financial reporting, we may be unable to accurately report our financial results or prevent fraud which could result in a loss of investor confidence in our financial reports and have an adverse effect on our business, our operating results, and our stock price |
| Management has assessed the effectiveness of our internal control over financial reporting as of April 30, 2006, using the criteria described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (or the COSO criteria) |
| Based on its assessment of the design and related testing of our internal control over financial reporting, management has concluded that, as of April 30, 2006, we did not maintain effective internal control over financial reporting |
| Based on the COSO criteria, management has identified certain control deficiencies that represent material weaknesses |
| A material weakness is a control deficiency, or a combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected |
| Specifically, the material weaknesses identified were: • An insufficient complement of personnel with an appropriate level of accounting knowledge, experience and training in the application of generally accepted accounting principles (“GAAP”) |
| As a result, we did not consistently maintain effective controls to ensure there was adequate (i) analysis, documentation, reconciliation and review of accounting records, and supporting data, and (ii) monitoring and oversight of the work performed by accounting and financial reporting personnel to ensure the accuracy and completeness of the consolidated financial statements in accordance with GAAP This control deficiency resulted in errors and the restatement of our interim consolidated financial statements for each of the first two quarters of 2006 |
| 8 ______________________________________________________________________ [33]Table of Contents • A lack of adequate segregation of duties in certain locations |
| • An aggregation of certain significant deficiencies related to revenue |
| • An aggregation of certain significant deficiencies related to accounting for stock-based compensation |
| • An aggregation of certain significant deficiencies related to tax accounting and financial statement disclosure |
| The material weaknesses in our internal control over financial reporting that we identified as of April 30, 2006, as well as our remediation efforts to date, are more fully discussed under Item 9A “Controls and Procedures” of this Form 10-K While we are taking steps to address the identified material weaknesses, there is no guarantee that these remediation steps will be sufficient to remediate the identified material weaknesses and control deficiencies or to prevent additional material weaknesses or control deficiencies |
| We are experiencing significant growth in our markets, and if we are unable to respond, our business may suffer |
| Interest in our products is growing rapidly and, in order to meet this demand we must continuously improve our efficiency and increase our capacity |
| We may need to change our processes or add or change personnel, equipment or facilities |
| If we are unable to successfully make these changes, we may not be able to sustain our growth rate and consequently lose market share |
| We are experiencing increased competition in our markets, which may have an adverse effect on our financial results |
| There are an increasing number of waterjet competitors entering our markets |
| If these new competitors are successful or if we are unable to respond to this competition, we may lose market share or our margins may suffer which may have an adverse effect on our financial results |
| A significant portion of our new business has been derived from a few industries, and we could experience a reduction in the growth rate if conditions in one of those industries changed |
| Although we serve many different industries and market segments, we have experienced strong growth in the aerospace and semi-conductor industries |
| A market slowdown in either industry, a postponement of a major project, or a slowdown in the adoption of waterjet cutting in those industries could reduce revenue growth |
| Economic weakness in our served markets may adversely affect our financial results |
| The products we sell are capital goods with individual system prices ranging from dlra150cmam000 to several million dollars |
| Many of our customers depend on long term financing from a financial institution to purchase our equipment |
| Economic weakness in the capital goods market and/or a credit tightening by the banking industry could reduce our sales and accordingly affect our financial results |
| If we are unable to upgrade our information technology systems, our future success may be negatively impacted |
| In order to maintain our position in the market and efficiently process increased business volume we must make significant investments to upgrade our computer hardware and our Enterprise Resource Planning (“ERP”) system |
| Should we be unable to make these investments or the ERP system upgrades are unsuccessful or take longer to implement than anticipated, our ability to grow the business and our financial results could be adversely impacted |
| 9 ______________________________________________________________________ [34]Table of Contents If our Form S-1 registration statement is not effective for more than 40 days, we may be subject to significant financial penalties |
| Under terms of a Registration Rights Agreement entered into on March 20, 2005, as part of a Private Investment in Public Equity transaction (“PIPE Transaction”), we are required to have the Form S-1, which registers the shares sold in the PIPE Transaction remain effective |
| If there is a fundamental change in our business, we may be required to amend the Form S-1 |
| If the time required to prepare such amendments makes the registration statement unavailable for the sale of PIPE shares for more than 40 days (not necessarily consecutive), we will be subject to a cash penalty of up to dlra650cmam000 per month for each month the registration statement is not effective |
| Changes in the tax and regulatory rules or requirements in the countries in which we operate could impact our operations |
| We have offices in 13 countries and have manufacturing facilities in three of those countries |
| Changes in the local tax or regulatory rules could reduce our ability to ship our products cross-border profitably or operate our local businesses cost effectively, which could adversely impact our financial results |
| If we are unable to retain the current members of our senior management team and other key personnel or to recruit additional key personnel, our future success may be negatively impacted |
| We may lose key management personnel and encounter difficulties replacing these positions |
| We may also encounter difficulties in recruiting additional key personnel as our business grows |
| We may have to incur greater costs to attract replacement or additional personnel |
| Our inability to protect our intellectual property rights, or our possible infringement on the proprietary rights of others, and related litigation could be time consuming and costly |
| We defend our intellectual property rights because unauthorized copying and sale of our proprietary equipment and consumables represents a 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 dlra100 million, we believe Omax’s claims are without merit and we are contesting Omax’s allegations of infringement and also to vigorously pursuing our claims against Omax with regard to our own patent |
| We have and may continue to spend substantial amounts contesting Omax’s claims and pursuing our own |
| See Note 15 to Consolidated Financial Statements for further discussion of contingencies |
| Fluctuations in our quarterly operating results may cause our stock price to decline |
| In the past, our operating results have fluctuated significantly from quarter to quarter and we expect them to continue to do so in the future due to a variety of factors, many of which are outside of our control |
| Our operating results may in some future quarter fall below the expectations of securities analysts and investors |
| In this event, the trading price of our common stock could decline significantly |
| In addition to the risks disclosed elsewhere in this Annual Report, factors outside of our control that have caused our quarterly operating results to fluctuate in the past and that may affect us in the future include: • fluctuations in general economic conditions; • demand for UHP pumps and UHP water management systems generally; • fluctuations in the capital budgets of customers; and • development of superior products and services by our competitors |
| 10 ______________________________________________________________________ [35]Table of Contents 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 do business in industries that are cyclical, which may result in weakness in demand for our products |
| Our products are sold in many industries, including machine tool, which include job shops, automotive and aerospace, that are highly cyclical |
| The machine tool industry, from 1998 through 2003, experienced a significant decline in global demand |
| Cyclical weaknesses in the industries that we serve could lead to a reduced demand for our products |
| We may be affected by rising costs or lack of availability of materials, which could negatively impact our operations |
| We have experienced and may continue to experience (i) significant increases in the costs, and (ii) shortages of materials we use in the manufacture of our products, such as steel, and we may not be able to either achieve corresponding increases in the prices of our products or reduce manufacturing costs to offset these increases, or if we do increase prices, we may experience lower sales |
| We have experienced and may continue to experience longer lead times for certain materials we use in the manufacture of our products, such as steel, and we may not be able to deliver our products in a timely fashion which could lower our sales |
| Any of the foregoing may adversely affect our financial results |
| Our waterjet manufacturing capacity is concentrated within three locations and our ability to provide product to our customers would be impacted should one of the facilities be closed |
| We operate three main manufacturing facilities to cover the worldwide production of our waterjet equipment: two in the United States, and one in Taiwan |
| Should any of these facilities suffer damages caused by an act of nature or terrorism, our ability to provide products to our customers in a timely manner would be affected which may have a negative impact on our operating results |
| If we cannot develop technological improvements to our products through continued research and engineering, our financial results may be adversely affected |
| In order to maintain our position in the market, we need to continue investment in research and engineering to improve our products and technologies and introduce new products and technologies |
| If we are unable to make such investment, if our research and engineering 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 results could be adversely affected |
| 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, 2006, we had options outstanding to purchase 1cmam241cmam991 shares of our common stock, at exercise prices ranging from dlra2dtta00 to dlra12dtta25 per share |
| In addition, we have compensation plans with certain employees which grant those employees common stocks or restricted stock units totaling 580cmam200 shares in fiscal 2006 |
| 11 ______________________________________________________________________ [36]Table of Contents Washington law and our charter documents may make an acquisition of us more difficult |
| Provisions in Washington law and in our articles of incorporation, bylaws, and rights plan could make it more difficult for a third-party to acquire us, even if doing so would benefit our shareholders |
| These provisions: • Establish a classified board of directors so that not all members of our board are elected at one time; • Authorize the issuance of “blank check” preferred stock that could be issued by our board of directors (without shareholder approval) to increase the number of outstanding shares (including shares with special voting rights), each of which could hinder a takeover attempt; • Provide for a Preferred Share Rights Purchase Plan or “poison pill;” • Impose restrictions on certain transactions between a corporation and certain significant shareholders |
| • Provide that directors may be removed only at a special meeting of shareholders and provide that only directors may call a special meeting; • Require the affirmative approval of a merger, share exchange or sale of substantially all of the Corporation’s assets by 2/3 of the Corporation’s shares entitled to vote; and • Provide for 60 day advance notification for shareholder proposals and nominations at shareholder meetings |
| Market risk exists in our operations from potential adverse changes in foreign exchange rates relative to the US dollar in our foreign operations |
| A significant portion of our sales take place outside of the United States, and we transact business in various foreign currencies, primarily the Canadian dollar, the Eurodollar, the Japanese yen, the New Taiwan dollar, and the Swiss Franc |
| In addition, our foreign divisions may have customer receivables and vendor obligations in currencies other than their local currency which exposes us to near-term and longer term currency fluctuation risks |
| The assets and liabilities of our foreign operations, with functional currencies other than the US dollar, are generally translated into US dollars at exchange rates in effect at the balance sheet date |
| Aggregate net foreign exchange gains included in the determination of net income amounted to dlra74cmam000 for the year ended April 30, 2006 |
| Based on our results for the year ended April 30, 2006 for our foreign subsidiaries, and based on the net position of foreign assets less liabilities, a near-term 10prca appreciation or depreciation of the US dollar in all currencies we operate could impact operating income by dlra1dtta5 million and other income (expense) by dlra15cmam000 |
| Our financial position and cash flows could be similarly impacted |
| We have used derivative instruments in the past and may continue to use them in the future to manage the risk associated with foreign currency exchange rate changes |
| Moreover, the weaker US dollar, relative to the local currency of many of the countries we sell into, has made our products less expensive, on a relative basis, when compared to locally manufactured products and products manufactured in certain other countries |
| As the US dollar gains in value relative to these foreign currencies, our products will increase in cost to the customer relative to locally produced product and products manufactured in certain other countries, which could negatively impact sales |