Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-looking Statements

Forward-looking statements in this report, including without limitation, statements relating to our 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 the following examples:

• statements regarding the effects of global financial and economic conditions, credit and equity market volatility and continued fluctuations in the global economy and the impact this may have on our business and financial condition;

• statements regarding our belief that the diversity of our products and geographic presence along with the expansion of our indirect sales channel and our unmatched customer access will continue to minimize the impact that any one country or economy has on our consolidated results;

• statements regarding our technological leadership position and our belief that our technological capabilities for developing products with superior characteristics provide us potential growth opportunities as well as a competitive advantage;

• statements regarding our continued investments in lead generation, product enhancements, new product development and in our employees which we believe are critical to achieving our strategic objectives;

• statements regarding our belief that we are well positioned to continue growing our business organically over the long-term by enhancing our product offerings and expanding our customer base through our global channels of distribution;

• statements regarding our expectation that our recently introduced Mach 4 and 2 series products, as well as our HyPlex Prime direct drive pump, will have strong contributions to our results in the second half of fiscal year 2013 and beyond;

• statements regarding our ability to mitigate the risk of higher commodity and fuel prices;

• statements regarding our belief that our channels of distribution are unparalleled in our industry and our ability to effectively manage them;

• statements regarding the reasons for variations in Advanced segment revenues and gross margins;

• statements regarding our use of cash, cash needs, generation of cash through operations, and ability to raise capital and/or use our Credit Facility;

• statements regarding our belief that our existing cash and cash equivalents, along with the expected proceeds from our operations and available amounts under our Credit Facility, will provide adequate liquidity to fund our operations through at least the next twelve months;

• statements regarding our ability to fund future capital spending through cash from operations and/or from external financing;

• statements regarding our ability to repay our subordinated notes in future periods;

• statements regarding our ability to meet our debt covenants in future periods;

• statements regarding anticipated results of potential or actual litigation; and

• statements regarding the realizability of our deferred tax assets and our expectation that our unrecognized tax benefits will not change significantly within the next twelve months.

Certain other statements in Management's Discussion and Analysis are forward-looking as defined in the Private Securities Litigation Reform Act of 1995. 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. For a detailed discussion of risk factors affecting our business and operations, see Item 1A, Risk Factors in our fiscal year 2012 Form 10-K. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise. These forward-looking statements

should not be relied on as representing our estimates or views as of any subsequent date.

In this discussion and analysis, we discuss and explain our financial condition and results of operations, including:
• Factors which might affect comparability of our results;

• Our earnings and costs in the periods presented;

• Changes in earnings and costs between periods;

• Impact of these factors on our overall financial condition;

• Expected future expenditures for capital projects; and

• Expected sources of cash for future operations and capital expenditures.

As you read this discussion and analysis, refer to our Condensed Consolidated Statements of Operations included in Item 1 - Condensed Consolidated Financial Statements, which presents the results of our operations for the three months ended July 31, 2012 and 2011. We analyze and explain the differences between the periods in the specific line items of our Condensed Consolidated Statements of Operations. This discussion and analysis has been organized as follows:
• Executive Summary, including overview and future outlook;

• Significant matters affecting comparability that are important to understanding the results of our operations and financial condition;

• Results of operations beginning with an overview of our results, followed by a detailed review of those results by reporting segment;

• Financial condition addressing liquidity position, sources and uses of cash, capital resources and requirements, commitments, and off-balance sheet arrangements; and

• Critical accounting policies which require management's most difficult, subjective or complex judgment.

Executive Summary

Overview
Flow is a global technology-based manufacturing company committed to providing a
world class customer experience. We offer technology leadership and exceptional
waterjet performance to a wide-ranging customer base. Our versatile technology
benefits many cutting and surface preparation applications, delivering
profitable waterjet solutions and dynamic business growth opportunities to our
customers.

First Quarter 2013 Highlights
During the first quarter of fiscal year 2013:
•         Overall revenues of $66.2 million for the three months ended July 31,
          2012 represent a new all-time quarterly high and a 10% increase from
          $60.0 million in the year-ago quarter;


•         Standard segment revenues also reached an all-time record on a
          quarterly basis at $62.0 million, a 17% improvement versus the year-ago
          quarter;


•         Sales from our global spare parts business also set a new quarterly
          record at $22.1 million, a 10% growth over the year-ago quarter, with
          strong demand across most of our markets;


•         Sales from our Advanced segment were $4.2 million for the three months
          ended July 31, 2012, a 40% decrease versus the year-ago quarter
          primarily due to the timing of contract execution;


•         Quarter-over-quarter, our Standard segment gross margins declined by
          approximately 200 basis points as a result of product and geographic
          mix. Our Advanced segment margins were lower primarily due to the
          effect of the comparative mix of projects for which we recognized
          revenue under the percentage of completion method and the capacity
          impact of lower throughput in our manufacturing plan;


•         Our operating income was $4.2 million, or just over 6% of sales for the
          quarter ended July 31, 2012, which represents a more than three-fold
          improvement from the year-ago quarter;


•         We generated net income of $2.2 million or earnings per share of $0.05
          which compares to net income of $0.7 million, or $0.01 per share in the
          comparative prior period;


•         Our consolidated adjusted earnings before interest, tax and
          depreciation ("Adjusted EBITDA") increased from $3.4 million in the
          year-ago quarter to $6.4 million in the current period. The increase in
          Adjusted EBITDA was a direct result of the significant improvement in
          sales. A reconciliation of Adjusted EBITDA to net income, which is the
          GAAP financial measure that is most directly comparable to our non-GAAP
          financial measure, is provided

below; and

•         We maintained a strong balance sheet with a net cash position of $10.6
          million as of July 31, 2012, and a current ratio of 2.1. We continue to
          maintain sufficient liquidity for our expected future operations and
          had $4.0 million in outstanding letters of credit against our $25.0
          million Credit Facility. We believe that future cash flows from
          operations and our borrowing capacity should provide adequate liquidity
          to fund our operations, the ability to repay our subordinated notes and
          capital for planned growth.

Looking Ahead
We continue to build significant and sustainable competitive advantages that
capitalize on the waterjet category growth opportunities. We believe that we are
well positioned to continue growing our business organically over the long-term
through product development, unmatched customer access and continued operating
leverage. Although other factors will likely impact us, including some that we
do not foresee, we believe that our performance for the remainder of fiscal year
2013 may be affected by the following:
•         Economic Climate. The current economic environment continues to affect
          our business in a number of direct and indirect ways including:
          consumer demand for our products, differences in customer demand in the
          different geographic regions in which we operate; profit margins
          subject to pricing in the different geographic regions, sales mix due
          to differing products; changes in currency exchange rates; lack of
          credit availability; inflation; and business disruptions due to
          difficulties experienced by suppliers and customers.


•         New Products. We continue to make strategic investments in research and
          development for existing and new products, and to invest in research
          and development of advanced and innovative technologies for future
          application. We believe that delivering innovative and high-value
          solutions is critical to meeting customer needs and achieving our
          future growth. We remain positive with regard to our recent global
          introduction of our Mach 4 and Mach 2 series products and we anticipate
          stronger contributions from these products in the second half of fiscal
          year 2013.


•         Distribution Channels. We intend to continue making significant
          investments to expand our access to potential customers by continued
          development of both our direct and indirect distribution channels,
          which we believe are unparalleled in the industry.


•         Operations and Manufacturing. We anticipate that commodity price
          pressure will continue in the near term. Mitigating the risk of higher
          commodity and fuel prices continues to be an area of focus. We intend
          to continue to pursue opportunities for streamlining of distribution,
          logistics and manufacturing operations, focus on improving inventory
          management, optimizing transportation costs, and providing a high level
          of service to our customers.

Management remains focused on creating long-term shareholder value. We believe that Adjusted EBITDA, which we define as net income (loss), as determined in accordance with accounting principles generally accepted in the United States of America ("GAAP"), excluding the effects of income taxes, depreciation, amortization of intangible assets, interest expense, and other non-cash charges, which includes such items as stock-based compensation expense, foreign currency gains or losses, and other allowable add backs pursuant to our Credit Facility Agreement, is a good measure of our core performance in creating this value. The following table reconciles our Adjusted EBITDA for the respective three months ended July 31, 2012 and 2011:

Reconciliation of Adjusted EBITDA to Net Income: (in

thousands)                                                       Three Months Ended
                                                                      July 31,
                                                               2012                2011
Net Income                                              $       2,221         $        711
Add Back:
Depreciation and Amortization                                   1,426                1,572
Income Tax Provision                                            1,477                  100
Interest Charges                                                  340                  311
Non-Cash Charges (i)                                              927                  666
Adjusted EBITDA                                         $       6,391         $      3,360

(i) Allowable Add backs Pursuant to Credit Facility Agreement

Adjusted EBITDA is a non-GAAP financial measure and the presentation of this non-GAAP financial measure is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. The items excluded from this non-GAAP financial measure are significant components of our financial statements and must be considered in performing a comprehensive analysis of our overall financial results. We use this measure, together with our

GAAP financial metrics, to assess our financial performance, allocate resources, evaluate our overall progress towards meeting our long-term financial objectives, and to assess compliance with our debt covenants. We believe that this non-GAAP financial measure is useful to investors and analysts in allowing for greater transparency with respect to the supplemental information used by us in our financial and operational decision making. Our calculation of Adjusted EBITDA may not be consistent with calculations of similar measures used by other companies.

Matters Affecting Comparability
Our financial performance over the past few years has been driven by several factors, principally the general economic conditions within our global markets, our product and project mix, the impact of strategic investments in our business, and fluctuations in the relationship of foreign currencies to the U.S. dollar. These key factors have impacted the comparability of our results of operations in the past and are likely to affect them in the future.

General Economic Conditions in our Global Markets Our products and services are available worldwide. Demand for our products depends on the level of new capital investment and planned maintenance by our customers. The level of capital expenditures depends, in turn, on the general economic conditions within that market as well as access to capital at reasonable cost. Our financial performance will continue to be affected by our ability to address a variety of challenges and opportunities that are a consequence of our global operations, including efficiently utilizing our global channels of distribution, manufacturing capabilities, the expansion of market opportunities, and successfully engineering innovative new product applications for end users in a variety of geographic markets. However, we believe that our geographic end markets and product diversification has and will continue to minimize the impact that any one country or economy has on our consolidated results.

Product and Project Mix
Our profit margins vary in relation to the relative product and geographic mix, including the market segments that we serve, the type of product we sell, the geographic location in which the product is sold, the end market for which the product is designed, and the relative percentage of total revenue represented by our Standard systems, Advanced systems, and aftermarket sales.

Investments in Business
We believe that continued investment in lead generation, product enhancements, new product development and in our employees is critical to achieving our strategic objectives in fiscal 2013 and beyond. Comparable period-over-period operating expenses will differ depending on the timing and magnitude of these investments. We expect that we will be able to leverage our overall operating expenses in future periods as our business continues to grow.

Currency Translation
The volatility in the global economic environment continues to result in significant volatility in the global currency markets. Since the majority of our international operations are conducted in currencies other than the U.S. dollar, currency fluctuations can have a significant impact on the translation of our international revenues and earnings into U.S. dollar amounts. During fiscal year 2013, the U.S. dollar strengthened against the average exchange rates for these currencies versus the comparable prior year period, negatively impacting the translation of our international revenues and earnings during the current fiscal year.

In addition, some of our transactions that occur in our international locations are denominated in U.S. dollars, exposing them to exchange rate fluctuations when converted to their local currencies. These transactions include U.S. dollar denominated purchases of inventory and intercompany liabilities. Fluctuations in exchange rates can impact the profitability of our foreign operations and reported earnings and are largely dependent on the transaction timing and magnitude during the period that the currency fluctuates.

Results of Operations
(Tabular amounts in thousands)

Summary of Consolidated Results                  Three Months Ended
                                                      July 31,              Increase (Decrease)
                                                 2012          2011            $              %
Sales                                         $  66,235     $ 60,030     $    6,205           10  %
Gross Margin                                     24,793       23,120          1,673            7  %
Selling, General, and Administrative Expenses    20,559       21,961         (1,402 )         (6 )%
Operating Income                                  4,234        1,159          3,075           NM
Expressed as a % of Sales:
Gross Margin                                         37 %         39 %                      (200 )  bpts
Selling, General, and Administrative Expenses        31 %         37 %                      (600 )  bpts
Operating Income                                      6 %          2 %                       400    bpts


_____________________
bpts = basis points
NM = not meaningful
Consolidated Sales by Category    Three Months Ended
                                       July 31,             Increase (Decrease)
                                   2012         2011            $             %
Standard System Sales          $    39,962    $ 32,978    $     6,984        21  %
Advanced System Sales                4,154       6,986         (2,832 )     (41 )%
Consumable Parts Sales              22,119      20,066          2,053        10  %
                               $    66,235    $ 60,030    $     6,205        10  %

Segment Results of Operations

We report our operating results to the chief operating decision maker based on market segments which are consistent with management's long-term growth strategy. Our reportable segments are Standard and Advanced. The Standard segment includes sales and cost of sales related to our cutting, surface preparation and cleaning systems using ultrahigh-pressure water pumps as well as parts and services to sustain these installed systems. Systems included in this segment do not require significant custom configuration. The Advanced segment includes sales and cost of sales related to our complex aerospace and automation systems which require specific custom configuration and advanced features, including robotics, to match unique customer applications as well as parts and services to sustain these installed systems. Segment results are measured based on revenue growth and gross margin.

This section provides a comparison of sales and gross margin for each of our reportable segments for the respective three months ended July 31, 2012 and 2011.

Standard Segment              Three Months Ended
                                   July 31,               Increase (Decrease)
                              2012          2011               $              %
Sales                      $  62,017     $ 53,004     $     9,013             17 %
% of total company sales          94 %         88 %            NM            600   bpts
Gross Margin                  24,247       21,647           2,600             12 %

For the three months ended July 31, 2012:

Sales in our Standard segment increased $9.0 million or 17% over the prior year comparative period. Excluding the impact of foreign currency changes, sales in the Standard segment increased $11.5 million or 22% for the three months ended July 31, 2012

when compared to the prior year comparative period. The quarter-to-date increase was primarily due to the following:

• Significant growth in system sales volume for select geographic regions for an aggregate growth of $7.0 million or 21% over the prior year comparative period; and

• Consumable parts sales for this segment also increased $2.0 million or 10% over the prior year comparative period based on higher system utilization by our customers and increased system sales volumes with significant demand across most of our markets.

Gross margin for the three months ended July 31, 2012 amounted to $24.2 million or 39% of sales compared to $21.6 million or 41% of sales in the prior year comparative period. Generally, comparison of gross margin rates will vary period over period based on changes in our product sales mix and prices, geographic mix and levels of production volume.

Advanced Segment              Three Months Ended
                                   July 31,             Increase (Decrease)
                               2012         2011            $             %
Sales                      $   4,218      $ 7,026     $    (2,808 )     (40 )%
% of total company sales           6 %         12 %            NM      (600 )  bpts
Gross Margin                     546        1,473            (927 )     (63 )%
Gross Margin as % of sales        13 %         21 %            NM      (800 )  bpts


_____________________
bpts = basis points
NM = not meaningful

Sales in the Advanced segment vary period over period for various reasons, such as the timing of contract awards, timing of project design and manufacturing schedules, the timing of shipments to customers, and timing of installation at customer sites.

For the three months ended July 31, 2012, sales in our Advanced segment decreased by $2.8 million or 40% over the prior year comparative period. The decrease in sales was primarily driven by the timing of our Advanced contracts in the current fiscal year.

Gross margin for the three months ended July 31, 2012 amounted to $0.5 million or 13% of sales as compared to $1.5 million and 21% of sales in the prior year comparative period. Gross margin as a percentage of sales in the Advanced segment was lower for the three months ended July 31, 2012 in part due to the impact of lower throughput in our manufacturing plan, and also as a result of the type of projects and the stages of the projects. Advanced segment gross margins will vary period over period based on changes in product mix, geographic mix and levels of production.

Selling, General, and Administrative Expenses       Three Months Ended
                                                         July 31,               Increase (Decrease)
                                                    2012           2011           $              %
Sales and Marketing                             $    12,479     $ 12,696          (217 )         (2 )%
Research and Engineering                              2,211        2,656          (445 )        (17 )%
General and Administrative                            5,869        6,609          (740 )        (11 )%
Total Operating Expenses                        $    20,559     $ 21,961        (1,402 )         (6 )%

Consolidated operating expenses decreased for the three months ended July 31, 2012 over the prior year comparative period. The movement was primarily the result of the following:

• higher commission expense of $0.4 million, based on comparatively higher sales volume;

• increased marketing and related support expenses of $0.1 million for the three months ended July 31, 2012 versus the prior year comparative period;

• benefit of a reimbursement for certain research and engineering costs of $0.8 million during the quarter;

• decreased labor and compensation related costs of $0.6 million for the three months ended July 31, 2012 versus the prior year comparative period; and

• lower investment in technology infrastructure for the three months ended July 31, 2012 which decreased $0.2 million over the prior year comparative period.

Interest Income (Expense), net Three Months Ended

                                       July 31,                Increase (Decrease)
                                   2012          2011                $               %
Interest Income                $      55       $   40     $       15                38 %
Interest Expense                    (340 )       (311 )           29                 9 %
Net Interest Expense           $    (285 )     $ (271 )   $       14                 5 %

Our net interest expense was $0.3 million for the three months ended July 31, 2012, in line with the prior year comparative period net interest expense of $0.3 million. Our interest expense primarily consists of imputed interest on two . . .