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Flow International Corporation (NASDAQ:FLOW)

F2Q 2013 Earnings Call

December 6, 2012 5:00 p.m. EST

Executives

John Leness – General Counsel and Corporate Secretary

Charlie Brown – President and CEO

Allen Hsieh – CFO

Analysts

Eric Stine – Craig Hallum

Joe Maxa – Dougherty & Co.

[Joe Best] – ROTH Capital Partners

Tim Fronda – Sidoti & Co.

Bob Johnson – Satuit Capital

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Flow International fiscal 2013 second quarter financial results conference call.

During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. [Operator Instructions]. This conference is being recorded today, December 6, 2012.

I would now like to turn the conference over to Mr. John Leness with Flow International. Please go ahead, sir.

John Leness

I'm Flow's Secretary and General Counsel. With me this afternoon are Charlie Brown, both President and CEO, and Allen Hsieh, Chief Financial Officer.

This call will include forward-looking statement defined by the Private Securities Litigation Reform Act of 1995. During the call we will discuss selected financial results. Any statements that are future results, including trends, risks and plans, is considered as forward-looking. These are based on current expectations only. Actual results may differ from these forward-looking statements and are subject to risks and uncertainties as are detailed in our filings with the Securities and Exchange Commission. Flow takes no obligation to update any forward-looking statement whether as a result of new information, future events or otherwise.

I will now turn the call over to Charlie.

Charlie Brown

Thank you for joining us today for our discussion of Flow's results for the second quarter of fiscal year 2013. For the quarter, revenue was $67 million, yet another quarterly record. This is also an increase of 4% from the prior year comprised of 6% organic growth, offset by a 2% foreign exchange impact. The growth versus year ago came from most regions in our Standards business including our European theater which grew in local currency by more than 15% year over year.

In our Advanced segment, we are very pleased to report that in the past four months we have received a variety of commitments for orders totaling more than $30 million. We also reported one-time charges of $1.1 million in the quarter related to generating revenue in the segment, which I will explain in more detail in a moment.

Absent these charges, the company generated operating income of $5.1 million or 7.5% of sales and $0.06 of earnings per share. This compares to prior-year results of $5.2 million or 8% of sales and $0.06 of earnings per share. On a reported basis including the charge, operating income for the quarter came in at $4 million or 6% of sales with EPS of $0.04.

Breaking down our revenue, total Standards segment revenue also reached another all-time high, growing 7% versus the prior-year quarter to $63.2 million. Excluding the negative impact of foreign exchange rate, revenue growth in this segment was even stronger at 9%. Within this segment, Standard Systems revenue in Q2 reached its own new record level at $40.3 million, a 4% increase from the prior-year quarter. Our spares revenue was also the highest ever at $23 million, which is a 13% increase year over year and up 4% sequentially from Q1. The overall -- this overall growth came from some carryover promotional activity that started in Q1 as well as serving more installed systems.

Revenue from our Advanced segment at $3.8 million represented less than 6% of total sales in the quarter, was down 9% sequentially from Q1 and 28% from prior year. As we have previously discussed, annually this is roughly a $20 million to $25 million business for us, comprised of individual machines that often sell for $7 million or $8 million, and they're accounted for on a percent of completion basis. This brings a lot of variability to quarterly reporting in this small subset of Flow. Recent quarterly results have been poor in this segment as we are growing through a period of low revenue and associated low gross margin.

We've been working hard to land the orders we need to be successful in this segment. Recently we have made significant progress towards increasing our order book for this business so we can return to much more consistent levels of performance. Over the past four months or so, we've received commitments that in total exceed $30 million. This includes the $10 million orders that we discussed in our last call. Revenues from these projects should begin to be recognized in Q4 of this fiscal year, spanning five to six quarters in total.

As I mentioned previously, we had two items in the quarter totaling $1.1 million which negatively impacted our gross profit for this segment and our operating results overall. Both of these items are related to revenue-generating activities. First item, worth $700,000, helps secure a future order commitment. As part of the normal course of negotiating [inaudible] with an existing customer, we arrived at a discount off of list price similar to what's experienced in the aerospace industry. As part of the negotiation, we credited the discount against our existing receivable balance with this customer. The accounting rules require that we report this as a reduction to revenue in the current quarter.

Among all of the 30-plus million dollars of order-generating activity in recent months, there was one order that got away, at least for the time being, and only because the first machine this customer purchased a few years ago has turned out to be much more productive and anticipated. So they have deferred purchasing the next machine. This led to the other charge of $400,000 for costs incurred in anticipation of that second order. The appropriate accounting was to report this as a charge to COGS in the current quarter.

In addition to our quest to grow revenues in our Advanced business, we are also focused on returning our gross profit margins there to higher sustainable level. A full order book would certainly help, but we've been pushing beyond that. Absent the one-time charges, gross margins in this segment for the quarter were 26%, right in their normal range. To make sure this is sustainable with all of the new orders, we have assessed where we need to make improvements within the Advanced segment. As a result, we have recently partnered with external resource that provide incremental capabilities to augment ours. This will help us successfully deliver these sizable orders.

Additionally, we have reorganized and upgraded our internal organization to meet the customer demand of this business. These changes, along with our growing revenue base, should allow us to maintain gross profit margin similar to our adjusted Q2 level in the 25% range plus or minus a few points, depending on the project mix in a particular quarter.

I will now turn it over to Allen to discuss the details of our second quarter financial results and outlook for the upcoming third quarter.

Allen Hsieh

Thanks, Charlie. Operating income for the quarter was $4 million or 5.9% of sales as compared to $5.2 million in the prior-year quarter and $4.2 million in Q1 of this year. For the quarter we reported net income of $2.1 million or $0.04 per share as compared to $2.8 million in the prior-year quarter and $2.2 million in Q1.

As Charlie previously mentioned, we recorded certain items this quarter, aggregating $1 million to $1.1 million, that were directly tied to our pursuit of additional orders in our Advanced business, which negatively impacted our results. Excluding the effects of these items, operating income would have been $5.1 million or 7.5% of sales, and net income would have been $2.8 million or $0.06 per share.

For the quarter, we generated EBITDA of $6 million or 8.9% of sales. Excluding the impact of the items I just mentioned, EBITDA would have been $7.1 million or 10.4% of sales. This compares to EBITDA of $7.4 million in the prior-year quarter and $6.4 million in Q1.

Now, for the details. Starting with our segments, Standard segment revenues were $63.2 million, with gross profit margins of 40.1% in the quarter. Gross margins were slightly down compared to 40.9% in the prior quarter but up compared to 39.1% in Q1. Overall gross margins are at the midpoint of our stated range, which varies depending on product and geographic mix. On a year-over-year basis, our gross margins were negatively impacted by about a point from foreign exchange rate headwinds that we are experiencing since most of these products are produced in the US.

Our Advanced segment revenue, which represents less than 6% of our total business for the quarter was $3.8 million, with gross margins of 2%. Gross margins were lower compared to the prior-year quarter of 21% and sequentially lower compared to the 12.9% in Q1. The primary driver for the lower gross profit margins in the quarter was the impact of the one-off items that we previously discussed. Excluding those items, we would have reported more normalized gross margins of around 26%. We anticipate that gross margins will continue to be within a normal range of 25% plus or minus a few points going forward.

On an aggregate basis, total gross margins were 37.9%. Absent the effect of the charges taken to secure future business, our aggregate gross margins would have been 39.2%, within our normal range of 40% plus or minus 2 points.

Total operating expenses in the aggregate were $21.5 million, in line with our expectations. This was higher than the prior-year quarter of $20.2 million, primarily due to variable costs related to increased sales, the timing of trade shows and other lead-generation activities, as well as variability in personnel-related costs. Operating expenses were also higher compared to $20.6 million in Q1. As you may recall, in Q1, our operating expenses were offset by a reimbursement of approximately $800,000 for engineering costs. Excluding that reimbursement, operating expenses would have been in line on a sequential basis.

For the current quarter, we had a net other expense of $437,000, up compared to $293,000 in the prior-year quarter and slightly down compared to $550,000 in Q1. Net other expenses are primarily comprised of interest expense and foreign currency adjustments, partially offset by interest income. The comparative differences were primarily from the impact of foreign currency adjustments.

For the quarter we recorded net tax expense of $1.5 million and an effective tax rate of approximately 40%. Since we have an excess of $20 million in the NOL in the US and more than $10 million of NOLs in Germany, two of our more significant areas that we operate in, our cash taxes are expected to be less than two-thirds of our effective tax rate.

Now to the balance sheet. At the end of the quarter our net cash position, excluding our subordinated notes, was $15.3 million, with no outstanding balance on our $25 million credit facility. Including the subordinated notes, which come due in August of the upcoming year, our net cash position was $5.2 million at the end of the quarter. On that same basis, compared to the end of the year, our net cash position was $3.4 million.

At the end of the quarter, net accounts receivable were $47.6 million, up marginally compared to $46.8 million at the end of last year based on timing of cash receipts. Inventory at the end of the quarter of $41.7 million was up compared to $40.1 million at the end of last year.

Overall materials and parts have increased as we cycle through the inventory mix within new product -- new and older products. Capital expenditures were $2.3 million for the quarter and $3.8 million for the past six months, in line with our expected range of $6 million to $8 million on an annual basis. The majority of our capital expenditures continue to be for upgrading manufacturing equipment, subsequent phases of our ERP system, and investments in our intellectual property.

Lastly, at the end of the quarter, our Advanced segment backlog totaled $14.4 million, up from $12.2 million at the end of Q1. Including the recent commitments that Charlie discussed, our backlog exceeds $35 million.

Now, turning to our near-term outlook. We expect overall Q3 revenues to be in line with our Q2 record level. Please keep in mind that Q3 has fewer selling days, and as such, we anticipate that spares revenue will decrease sequentially from our Q2 record level. As a reference point, in the last fiscal year, there was a 6.6% sequential decrease from Q2 to Q3.

Additionally, we anticipate that revenues from our Advanced segment will be comparable to Q2. This implies revenues from our Standard Systems sales will be slightly up sequentially, which is consistent with our belief that we are seeing continued traction from our new products as well as our dual distribution channels, but all on a stable or stagnant macroeconomic environment. We expect that gross margins will be in our normal range of 40% plus or minus 2 points.

At this revenue level, our operating expenses are expected to be $21.5 million to $22 million in Q3. Overall we expect our Q3 operating profit margins to range between 7% and 8%. We also anticipate that our effective tax rate will remain at a normalized rate of 40% for the upcoming quarter.

With that, I'll turn the call back to Charlie.

Charlie Brown

Thanks, Allen. We often refer to Flow as a technology-driven growth company. I would like to update you briefly on those two topics, technology and growth. First, technology.

In recent months, the new products we have launched have aggressively pushed forward with what we call our technology waterfall. For example, the new Mach 2 product line introduces our smart stream dynamic waterjet technology at a new price point, below $200,000. This is possible because we previously had introduced a higher-end cutting technology called Dynamic XD. Before Dynamic XD, regular Dynamic waterjet cutting was the top-of-the-line cutting feature. Because we introduced an even higher-tech solution in Dynamic XD, we have now pushed regular Dynamic down the product range without compromising our ability to provide differentiation at higher price points. This has proven to be very popular in the marketplace.

We continue to develop and introduce additional technologies and features. For example, in September we introduced new features on the Mach 4, a product range that was only recently launched. One of these, for example, is a second cutting head that can be outfitted as either another waterjet or as a drill.

Mach 4 dual-versatile cutting head, Dynamic XD, if you combine our technologies and look what they bring to the market, you will see that this offering provides features and benefits that help make our customers more productive. Importantly, we are often able to provide features at price points lower than before, encouraging more adoption of waterjets around the world. In fact this has created a new challenge, so many more customers have higher-tech cutting now within their reach that we need to adjust and provide more technical support so they know how to use the products to their best advantage. This is certainly a nice problem to have. More on that in a moment.

In our Advanced segment, we have developed new cutting head that can fit in smaller spaces and cut at different angles. We've recently received notification from patent offices in the European Union and in the United States that patents have been granted to Flow for this technology. Additional patent pending technology has been under development to complement the now patented head. We recently implemented the combined solution in real cutting situations. The result, we increased cutting productivity on those cuts more than three-fold, a very significant achievement that helps our customers be even more productive.

It is a consistent theme. We are the technology leader in waterjet cutting and we relentlessly pursue and introduce breakthrough developments that provide real and meaningful benefits to our customers.

Now let's turn to growth. The new products we have launched to develop all of the technology continue to be very well-received all over the world. You may recall that this total transformation of our product range includes the Mach 4 and Mach 2 platforms and the high-plex prime pumps. In recent months we have attended five major trade shows globally, from Chicago to Shanghai, from Hanover to Tokyo. Our new products have literally been the stars of the shows. Their acceptance in the worldwide market is exceeding our high expectations.

In addition to technology-driven new products delivering growth, we have also continued to develop our dual-channel distribution strategy. As many of you know, three years ago we started with the best direct channel of distribution in the industry, comprised of more than 70 sales people as direct Flow employees. We then set out to blanket the world even further by building a second indirect channel of distributors and agents. We identified, signed on and trained more than 70 partners. In the past year or two, we have continued to develop that channel by providing additional training, by upgrading as needed, and by filling in any gaps we found.

I'm happy to share with you that we have continued to build that channel to its current level of more than 90 partner companies worldwide. In addition to our 70 Flow employees, these 90 companies combined have more than 300 sales people capable of selling Flow along with their other product line. This further expands upon our significant competitive advantage regarding accessibility of our products worldwide. We believe that advantage combined with the new products is driving the continued growth of our revenue stream.

As a technology-driven growth company, we plan for growth, we live for growth, and we constantly prepare for growth. Allow me to share one more example.

Our products are highly complex requiring prolonged installation that can take up to several weeks, while also requiring technical service calls and training. As we planned our growth curve, we knew it would be essential to build additional capacity in our technical installation, training and service teams, the part of our company we call technical service.

Much like our sales force, over the years we have built a core global group of experienced and knowledgeable Flow employees to handle these tasks. That team is made up of over 70 employees. Like the 70-plus direct sales people, these 70-plus direct technical service employees are highly-tenured, deeply knowledgeable and provide a significant customer-facing competitive advantage.

To handle our growth, however, we would need more capacity. So, over the past two years we have quietly but aggressively been building a team of independent service providers worldwide. These partners have been found, contracted and trained to do a variety of installation and repair tasks. Importantly, they work as a variable cost so we did not have to ramp up our overhead, yet we can accommodate significant growth. This force now has approximately 150 people worldwide working closely with our 70-plus employees to service our customers and help us grow.

Before taking your questions, I would like to link together all of this commercial progress with our operational progress. This link shows up in our financial statement and we summarized it in one word: execution.

Over the past several years we have been executing on many transformational initiatives within Flow, only some of which I have just mentioned. We have done this by carefully investing dollars in the right places along the way, choosing between fixed and variable cost and sometimes choosing between short-term pain and long-term gain, as with the charge taken this quarter regarding future business.

Transformations of the scale we have undertaken are very challenging on their own, but to do so and improve profitability along the way is even more challenging. If you look at our average performance over the past four quarters, you find a business running at a quarterly revenue rate of about $65 million to $66 million with a 10% EBITDA margin, already more than a full point better than before we began transforming the company.

As you will recall, our fiscal 2012, which ended in April, posted revenue growth of 17% but delivered a three-fold increase in operating income and a 10-fold increase in earnings per share. More recently this is a business that has set new revenue records in three of the past four quarters, while holding gross margins steady in a relatively tight range for several years now. Year to date, halfway through our fiscal year, on revenue growth of 7%, our operating income is up 30%. This has all taken place in an environment of sizable investment and significant projects that continue to prepare us for even more growth and profitability.

We have not finished transforming Flow but we have come a long way. Our next target is a $75 million quarter with $10 million in EBITDA, representing another 3 points of margin. To achieve this, we just need to hit the midpoint of our stated gross margin range, 40%. The rest of the incremental profitability comes from operating expense leverage from the 15% additional revenue.

To help us drive to those targets, we have added a new member to our senior management team, [Ron Cooper], who is now running operations and supply chain. [Ron] comes to us with 25 years of general management and CEO experience on top of 10 years of operations-oriented, high-level consulting engagements. We are very fortunate to have someone of his caliber on our team to help us drive our performance and execution to the next level.

So when we talk about execution, we are proud of the transformation at Flow, the improvement in profitability already achieved, and the foundation for additional margin enhancement that is clearly in place, 300 basis points as we continue to grow revenue another 15%. We recognize the need to continue driving profit margin even higher and we are executing against that task. We are very encouraged by the significant progress we have made and anxious to deliver the enhanced operating leverage that is now within our reach. Our order book is solid, our diversified markets balance each other well, our new products are a hit, and our outlook is very bright.

We will now be glad to address your questions. Operator?

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, we'll now begin the question-and-answer session. [Operator Instructions].

Our first question is from the line of Eric Stine with Craig Hallum. Please go ahead.

Eric Stine – Craig Hallum

Hi, Charlie; hi, Allen. Thanks for taking the questions.

Charlie Brown

Hi, Eric.

Allen Hsieh

Hi, Eric.

Eric Stine – Craig Hallum

You called out Europe being up 15% year over year. I'm wondering if you could just provide some color as far as the other regions in the world. And then maybe specific to North America, just wondering how we should view that business in this current quarter just given the economic uncertainty and bonus depreciation expiring and all the other factors.

Charlie Brown

Sure. The regional performance of the business, if I break it into spares and into standard systems, the spares business grew in every region around the world and totaled 13% growth rate. The standard systems business grew in all but one area, where we had some strong comps, and had a total of 4% growth, which was 6% on a local currency basis.

So if you look around the world and you look at the different markets, it's really a more textured story than just carving the world into four areas. So, to more specifically answer your question, in each of those geographic areas, there are some countries, some sub-regions that are doing well and some sub-regions that are not, and that comes back really to the strength of our business model of the ability to be in so many different end-markets, to be in so many different countries, more than 60 in a typical quarter, and to be at so many different price points, that we're able to balance each other against -- each different strength is balancing off maybe a weakness in any of those different variables.

Certainly some parts of the world, as you read about it in the newspapers, our results would be consistent with some of those reports. China is a little more challenged than it has been in the past. However, across the Europe, Middle East, Africa, some of the countries that you might read about and expect us to be down or not, and other countries we're flat. So it's really a very mixed bag around the world.

To the second part of your question in terms of the US marketplace, we continue to see good, steady orders. It is not robust and it is not soft. It's just sort of a continuing theme. And I guess I could speak really broadly for the whole world situation, we all know that the macroeconomic situation around the world is far from robust, it's relatively stagnant, and that's the environment we're in, and we feel that our ability to grow, outpace that a little bit because of the new products and our distribution channels and those things we've been discussing.

Eric Stine – Craig Hallum

Okay, that's helpful, and it's a good segue to the new products. I'm just wondering if there's any quantify, or did you get much of a benefit this quarter, and just given the orders that you've seen, whether it's at IMPS or out of other shows, how should we think about that playing out here over the next few quarters?

Charlie Brown

We are seeing meaningful orders and revenue, and that includes the second quarter, it has started to ramp up. It's not a steep ramp, it's a steady ramp, given the lead times around the world and shipping lanes and things like that. But we are receiving orders to some degree in all of our four regions for the new products and it's moving forward on a schedule that it's at least as good as we planned. The reception in the marketplace, as I said earlier, has exceeded our expectations just in terms of the general reaction. And now it's a matter of the order -- timing of the order cycle, turning those positive reactions and the actual order shipments and having them hit the income statement.

Eric Stine – Craig Hallum

Okay. So just to clarify though, I mean you did see some this -- the quarter you just reported, but not -- I mean, it's still pretty early in that process?

Charlie Brown

Yeah.

Eric Stine – Craig Hallum

Okay. Maybe one last one for me, just on the Advanced segment, definitely good to see those order levels. Just wondering if you could provide more color on the orders, maybe the end-market. Is it predominantly aerospace, or are there any others in there? And is it multiple customers?

Charlie Brown

It is predominantly aerospace, it is multiple customers. I think behind your question is sort of wondering, is this sort of just the major programs, what's going on? There's been a lot of questions over the last couple of years. Will there be orders coming for the ramp-up of the major Airbus A350 and the Boeing 787 programs? That is part of this wave of orders that we're seeing. But this wave of orders also includes other customers.

Eric Stine – Craig Hallum

Okay. Then I think I'm all set. Thanks, guys.

Charlie Brown

Thank you, Eric.

Allen Hsieh

Thanks, Eric.

Operator

Our next question is from the line of Joe Maxa with Dougherty & Co. Please go ahead.

Joe Maxa – Dougherty & Co.

Thank you. Hi, guys.

Charlie Brown

Hi, Joe.

Joe Maxa – Dougherty & Co.

Along the same lines on the Advanced segment, the $700,000 charge to secure the commitment. Have those orders been secured now or are you talking additional beyond the $30 million you talked about?

Allen Hsieh

We've received a commitment for it, it just hasn't turned into a full-on order yet. But it will be coming.

Charlie Brown

And as Allen mentioned, our backlog of in excess of $35 million, as you hit those high numbers, that would include an anticipation of this order as well.

Joe Maxa – Dougherty & Co.

Okay. So the $30 million you talked about since end of July is orders, and that -- and there's additional orders beyond that that you're looking for as part of the commitments as we understand that?

Charlie Brown

Let me clarify a little bit for you, Joe. We're talking about commitment, let's use the word commitment as opposed to orders because the commitments come in varying levels, whether it's an LOI or a purchase order or knowing timing of a project with a verbal commitment from a customer to really push hard and drive to those written commitment. So we've got good solid commitment that make up that in excess of $35 million of backlog that we mentioned.

Joe Maxa – Dougherty & Co.

Okay. Okay. That's helpful. And then on the -- along the same lines, are you willing to take a stab or give us an idea of the percent of your systems sales that come from your newer products? Are we [inaudible] like by 10% or have we -- we're ramping up beyond that?

Charlie Brown

I recognize that's a very interesting number for you to have, but those types of numbers are ones we're very hesitant to publish because we don't want our competitors to get wind of exactly what we're doing.

Joe Maxa – Dougherty & Co.

Okay. Lastly, the thought of bringing the Mach 3 and others into the new, you know, similar electronics package. Where are you along that process?

Charlie Brown

The architecture of the Mach 4 and Mach 2 in terms of the electronic architecture certainly supports that move. We have not yet pulled that trigger, if you will, as we continue to make sure that we ramped up the production in the supply chain and all the order quantities, et cetera on the existing ones. So we're taking it conservatively right now.

Joe Maxa – Dougherty & Co.

All right. Thank you.

Operator

Our next question is from the line of [Joe Best] with ROTH Capital Partners.

[Joe Best] – ROTH Capital Partners

Good afternoon.

Charlie Brown

Hi, [Joe].

[Joe Best] – ROTH Capital Partners

I was hoping you could touch on the Advanced segment and the orders that you received and how you kind of -- how we should think about that rolling out in 2014 in terms of revenue recognition? Should we thinking of it as the production on those ramp, that revenue will be increasing, or should be pretty steady?

Allen Hsieh

Yeah, I think it's going to be pretty steady, Joe. And as Charlie kind of mentioned in the fore part of his prepared remarks, I think that it's going to start in Q4 and get recognized over five to six quarters. So you could think of it fairly evenly, if you will. There will be some variability but I don’t expect it to be significant variability within those quarters.

[Joe Best] – ROTH Capital Partners

Okay. And then similar, should we expect on a sequential basis that it's kind of around this level and then see a nice kick-out in Q4?

Allen Hsieh

Yeah. As I mentioned earlier, I expect in Q3 Advanced revenues will be similar to Q2, and then you'll see an uptick there from -- in Q4.

[Joe Best] – ROTH Capital Partners

Okay, thank you. And then thinking about Asia, what are -- can you give us some thoughts on what you think might happen as the stimulus rolls out there and what you think that could do in terms of revenue?

Charlie Brown

That's a very hard one to predict. I think you're talking about stimulus in China, is that correct?

[Joe Best] – ROTH Capital Partners

Yes, yes.

Charlie Brown

That one is very hard predict. We've seen it in the past and we've seen the order level pick up in the past, but I think there's just way too much speculation on what will happen, if it will happen, how it will be implemented, that type of thing. So I don’t have a good enough crystal ball to be able to predict what that government policy will be.

[Joe Best] – ROTH Capital Partners

Okay. And then thinking about -- I guess asking a little bit differently, can you talk about the adoption rates that you've been seeing over there? Is it kind of lag -- or how do you kind of view the awareness of your product in China and their adoption of the technology of waterjets?

Charlie Brown

It's interesting because it is a little bit different underneath the surface than the rest of the world, but the overall curve is probably similar. Now what I mean by that is that the very, very low end of the marketplace is much more developed in China, a lot of very low-end competitors, very inexpensive machines that frankly don't perform very well. However, what they're doing is they're building awareness quickly of waterjets and driving adoption but in a very low price point. A lot of the machines don't work well, which then we believe long term plays into our hands because people realize they should spend a little bit more money to get a better Flow machine.

[Joe Best] – ROTH Capital Partners

Okay. Yeah, that's a good point. I was just kind of thinking that. How would you feel the technology in the low-end competitors and do you think that that has potential of kind of putting a bad taste in people's mouths and kind of pushing them in to a different product category in terms -- going with a different type of technology?

Charlie Brown

I guess theoretically there's that potential, but what we believe is that they see the potential with the inadequate machine, they real life understand what I can do, and then they say, rather than walk away from the technology, they say, boy, if I just had one that worked well, I would really have a great solution.

[Joe Best] – ROTH Capital Partners

Okay, great. Thank you.

Operator

[Operator Instructions].

Our next question is from the line of Tim Fronda with Sidoti & Co. Please go ahead.

Tim Fronda – Sidoti & Co.

Hi guys. Thanks for taking my questions.

Allen Hsieh

Hi, Tim.

Tim Fronda – Sidoti & Co.

Just with respect to the new products Mach 2 and Mach 4, where are you with respect to the full ramp-up in production? Do you feel you're still in the very stages of where you want to be with these?

Charlie Brown

There are two points that are important here. In terms of the throughput and the ability to continue to support the increased demand from the field, we're comfortable with our manufacturing capability and the supply chain ability to support that. Where we still need to do a lot of work is to continue to drive down the cost because we're still in the early stages of the cost curve.

Tim Fronda – Sidoti & Co.

Okay. And with these products rolled out, where does most of the research and engineering spend get allocated? Is it more about designing new applications for existing products, sort of add-on capabilities, or are there new products in mind that you want to be developed?

Charlie Brown

It's a combination. Certainly our engineering team stays with a new product as it goes out into the market and make sure that all the customers understand it and know how to use it and have the technical support all the way back up to stream and to the engineering ranks in our company. And as we move forward from there, then it's a blend, it's a combination of continuing to add features. I alluded earlier, mentioned a couple of those in my prepared remarks. There's certainly more things that could be done, because this is a very highly-configured product category, meaning that every order has a lot of different features and benefits that you could add or subtract. So we're always looking to add features to stay ahead of the competition. So there's certainly a fair amount of that.

And then we would move into things like spreading the electrical architecture across more of the line to get better synergies in our manufacturing and our supply chain, things like that. I call that value-added value engineering. And then certainly there's also a balance there of sort of what's next.

Tim Fronda – Sidoti & Co.

Okay. And final question, with the changes you mentioned earlier in the Advanced segment, do you want to make these projects a bigger part of your business and have more sales from the segment going forward, or is it more about just spreading out this work so it's not as lumpy for you?

Charlie Brown

I would steer a little more towards the latter point. We feel that this is a $20 million to $25 million business and it is an important business for us. It's also an important business that we do our best as much as we can with the sizable orders and the lumpy nature of it, but do the best we can to -- with the variables under our control, to make it a consistent business. It's difficult to make it consistent on a three-month to three-month basis, but as much as we can, that's really where we're driving at. Maintain our competitive advantage, maintain our competitive market position, maintain our ability to develop the technology and continue to be at the front edge of this very high, and thereby maintain the great benefit that it gives us in terms of our brand image through the rest of our product line, and do that with as much consistency as possible in an inherently lumpy business.

Tim Fronda – Sidoti & Co.

Understood. Thanks for your time.

Charlie Brown

Welcome.

Operator

Thank you. Our final question is from the line of Bob Johnson with Satuit Capital. Please go ahead.

Bob Johnson – Satuit Capital

Charlie, I wonder if you might help me to better understand a little bit in regards to the one-time charge. I may have a misperception, so maybe you can clarify it. But from what I inferred, you've got some contracts for products that are going to be delivered down the road and they'll be sold at a discount, but you've got a large customer that seems to have taken advantage of a relatively small company and forced you to take a charge for that discount before you've even shipped the product. I guess my question is, why were you forced to take a charge? And separate, why didn't you just wait and ship the product at a discounted price? It almost sounds as though you're getting hit over the head by the 2x4. And maybe I've misinterpreted what you've said, so hopefully you can clarify.

Charlie Brown

Sure. I think it's most important to put it in the context of the whole business, and a number of machines that we've been pushing hard in generating revenue orders for and commitments for across the more than $30 million that we've talked about, and each one of those is a highly negotiated situation with a number of different customers, some are bigger than others. And in the aggregate, on one of those situations was we decided to conclude the negotiation and seal the deal by pursuing the path that we'd described.

If you look at it in the context of 30-plus million dollars of business, we feel on balance that we came out well in booking all of that business, getting all those commitments in terms of the short-term pain versus the long-term gain.

Bob Johnson – Satuit Capital

All right. Then just the other question is, $400,000 in anticipation of an order that walked away because your first machine was so good. That seems to be a fairly large amount to be spending before you've even secured an order. Can you clarify that one for me?

Allen Hsieh

As Charlie mentioned, these project cost savings first, specifically first, you know, a particular order that we are anticipating. Given the higher productivity, we did not get the order in the timeframe we anticipated. However, we did -- in looking at this, we -- these were multiple machine orders that we're anticipating and we wanted -- so we had -- we wanted to leverage both these machines as we were going for the first machine. So we did incur some costs ahead of time.

Bob Johnson – Satuit Capital

Do you anticipate that you will get those orders or have they gone?

Charlie Brown

We anticipate that eventually it will come around but it will take longer for the demand of this customer from their customer to ramp to the point where now they've reached that new threshold of requiring the second machine. So we still have relationships there, we still have a machine on their floor, it's just that that timeframe got stretched out so far that the accounting rules required us to then book the $400,000.

Bob Johnson – Satuit Capital

Okay, fine. Thanks for your explanation.

Charlie Brown

You're welcome.

Operator

That does conclude the question-and-answer session for today. I would now like to turn the call back over to management for closing remarks.

Charlie Brown

We thank everybody for participating and wish you all happy holidays.

Operator

Ladies and gentlemen, this concludes the Flow International fiscal 2013 second quarter financial results conference call.

If you'd like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030, with the access code of 4577825.

ACT would like to thank you for your participation. You may now disconnect.

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