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

SAFE HARBOR STATEMENT:

Statements made in this quarterly report on Form 10-Q/A that are not historical facts are forward-looking statements that involve risks and uncertainties. Forward-looking statements typically are identified by the use of such terms as "may," "will," "expect," "believe," "anticipate," "estimate," "plan" and similar words, although some forward-looking statements are expressed differently. You should be aware that our actual results could differ materially from those contained in any forward-looking statement due to a number of factors, which include, but are not limited to the following: the special risk factors and uncertainties set forth in Part I, Item 1A of our Annual Report on Form 10-K/A Amendment No. 2 for the year ended April 30, 2006; our belief that the financial covenants in our credit facilities are achievable based on current financial forecasts and our belief that our existing cash, cash from operations, and credit facilities at October 31, 2006 are adequate to fund our operations for the next twelve months; our belief that timing issues related to our working capital will not have a material adverse impact on our short-term liquidity requirements and our plan to continue negotiating funds and to continue capital spending on information technology and facilities and our expectation that the necessary fund will be generated internally; our expectation that the upgrade of our ERP system will enhance our control environment; our position regarding our pending legal proceedings with Omax; our belief that Omax's claims are without merit and that we will incur considerable fees in this case; our belief that waterjets are experiencing growing acceptance in the marketplace because of their flexibility and superior machine performance; our belief that sales growth over the next few years will result from new product development and enhancements; our belief that Asian sales in the second half of this year will be affected by the investigation; our expectation of continued growth in western and central Europe from additional investments in staffing and marketing; our intent to file a post effective amendment to the Registration Statement on Form S-1; our expectation that short-term Aerospace sales will be lower and our plan to continue to invest in sales and marketing. 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.

Results of Operations

(Tabular amounts in thousands)

Sales.



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



                                      Three Months Ended October 31,                    Six Months Ended October 31,
                                  2006        2005      Difference       %         2006        2005      Difference       %
Sales
North America Waterjet         $   30,079   $ 28,644   $      1,435       5 %    $  61,588   $ 51,571   $     10,017      19 %
Asia Waterjet                       8,133      7,468            665       9 %       15,489     13,236          2,253      17 %
Other International Waterjet       11,943      8,789          3,154      36 %       22,584     17,242          5,342      31 %
Applications                        4,249      5,784         (1,535 )   (27 )%       8,153     10,622         (2,469 )   (23 )%

Total                          $   54,404   $ 50,685   $      3,719       7 %    $ 107,814   $ 92,671   $     15,143      16 %

The North America, Asia and Other International Waterjet segments primarily represent sales of our standard cutting and cleaning systems throughout the world, as well as sales of our custom designed systems into the

Aerospace industry. For the three and six months ended October 31, 2006, revenue from our three Waterjet segments increased $5.3 million or 12%, and $17.6 million or 21% as compared to the prior year same respective periods. Growth slowed in the three months ended October 31, 2006, due to the impact of the cancellation of a large Aerospace order. Excluding sales to the Aerospace industry, revenue in the three Waterjet segments increased 19% and 18% for the three and six months ended October 31, 2006, as compared to the prior same respective periods. We are continuing to build market awareness of waterjet technology through investments in marketing and tradeshow activity. Our waterjets are experiencing growing acceptance in the marketplace because of their flexibility and superior machine performance. We also continue to invest in direct sales and technical services staff adding new personnel to service potential and existing customers.

For the three and six months ended October 31, 2006, our revenue in North America segment experienced an overall increase of $1.4 million or 5%, and $10 million or 19% from the prior year respective periods. Shapecutting system sales in the US benefited from the continued increasing awareness of waterjet cutting technology, introduction of new products, and the seasonal concentration of trade shows in the second fiscal quarter. Sales to the Aerospace industry were down 23% and up 45% for the three and six month period ended October 31, 2006, as compared to the prior year respective periods. As previously disclosed, we reached a settlement in September 2006, with one of our customers for the cancellation of an order for two large Aerospace systems, and recognized $2.2 million in the second fiscal quarter due to the settlement. Sales to the Aerospace industry fluctuate quarter over quarter for various reasons such as the timing of the contract awards, timing of the project design and manufacturing schedule and finally shipment to the customer. We expect a lower revenue level in the following fiscal quarter because of the expected timing of orders for large systems. There were no significant price increases year over year. At the end of fiscal 2006, we announced the introduction of the StonecrafterTM, a system specifically designed for the stone and tile industry, and a new 87,000 psi pump which increases the cutting speed over the 60,000 psi currently in use. We expect new product development and enhancements such as these, and the increasing adoption of waterjet cutting, to drive sales growth over the next few years.

For the three and six months ended October 31, 2006, our revenue in Asia Waterjet segment increased $665,000 or 9%, and $2.3 million or 17% from the prior year respective periods. The Growth in Asia Waterjet was fueled by expansion of waterjet systems into the semiconductor industry, continued expansion of the standard shapecutting business across Asia, and strong aftermarket business. Growth in the second fiscal quarter was impacted by the disruption of the investigation in Asia and the three employees who left the Company subsequent to the investigation. We expect that this impact will negatively effect growth in the second half of the current fiscal year.

Growth in the Other International Waterjet segment represents primarily sales into Europe and South America. Revenues from our European operations have improved by $2.6 million or 36%, and $4.2 million or 28%, for the three and six months ended October 31, 2006 on strong demand for our shapecutting systems which have benefited from a stronger Euro versus US Dollar. We expect continued growth in western and central Europe as a result of the additional investments in staffing and marketing efforts. Sales in South America increased $506,000 and $1.2 million, respectively, for the three and six months ended October 31, 2006 compared to the prior year same respective periods on higher standard shapecutting system sales.

Our Applications segment represents sales of our automation and robotic waterjet cutting systems, as well as non-waterjet systems, which are sold primarily into the North American automotive industry. For the three and six months ended October 31, 2006, we reported a $1.5 million or 27%, and $2.5 million or 23%, decrease in revenue versus the prior year same respective period. This decline resulted from the continued softness in the domestic automotive industry. In addition, we have been increasing our sales focus on systems that integrate waterjet cutting cells and deemphasizing non-waterjet systems.

Systems vs. Spares. We also analyze our Waterjet revenues by looking at system sales and consumable sales as follows:

                                     Three Months Ended October 31,                   Six Months Ended October 31,
                                 2006           2005        Difference    %        2006        2005      Difference    %
Sales
Systems                       $    39,703    $    36,950   $      2,753   7 %   $   79,048   $ 65,671   $     13,377   20 %
Consumable parts                   14,701         13,735            966   7 %       28,766     27,000          1,766    7 %

Total                         $    54,404    $    50,685   $      3,719   7 %   $  107,814   $ 92,671   $     15,143   16 %

Systems sales went up $2.8 million or 7%, and $13.4 million or 20%, for the three and six months ended October 31, 2006. Excluding sales in the Aerospace industry and the Applications segment, system sales went up 22% and 20%, respectively for the three and six months ended October 31, 2006. Consumables revenues recorded an increase of $966,000 or 7%, and $1.8 million or 7% for the three and six months ended October 31, 2006. Increases in spares sales resulted from a growing number of systems in service, our proprietary productivity enhancing kits and improved parts availability as well as the use of Flowparts.com, our easy-to-use internet order entry system. Flowparts.com has been deployed in the U.S. for two years and was launched in Europe early this year which is experiencing faster customer adoption than we experienced in the U.S.

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

                                        Three Months Ended October 31,                    Six Months Ended October 31,
                                    2006        2005      Difference       %         2006       2005      Difference       %
Gross Margin
North America Waterjet           $   13,800   $ 13,878   $        (78 )    (1 )%   $ 27,930   $ 24,865   $      3,065      12 %
Asia Waterjet                         4,472      3,549            923      26 %       8,938      6,359          2,579      41 %
Other International Waterjet          4,807      3,281          1,526      47 %       8,796      6,542          2,254      34 %
Applications                            533      1,626         (1,093 )   (67 )%        979      2,501         (1,522 )   (61 )%

Total                            $   23,612   $ 22,334   $      1,278       6 %    $ 46,643   $ 40,267   $      6,376      16 %

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

                                       Three Months Ended October 31,                Six Months Ended October 31,
                                       2006                     2005                  2006                   2005
Gross Margin Percentage
North America Waterjet                        46 %                     48 %                 45 %                   48 %
Asia Waterjet                                 55 %                     48 %                 58 %                   48 %
Other International Waterjet                  40 %                     37 %                 39 %                   38 %
Applications                                  13 %                     28 %                 12 %                   24 %
Total                                         43 %                     44 %                 43 %                   43 %

Gross margin for the three and six months ended October 31, 2006 amounted to $23.6 million or 43% of sales, and $46.6 million or 43% of sales, respectively, as compared to gross margin of $22.3 million or 44% of sales and $40.3 million or 43% of sales in the prior year same periods. The gross margin improvements in our Asia and Other International Waterjet are attributable to the strong product pricing and improved product mix.

Margins in North America slightly declined from the prior year due to a higher mix of systems sales versus consumable sales, higher freight costs and material prices, and average lower margins on special systems due to mix. Generally, comparison of gross margin rates will vary period over period depending on the mix of sales, which includes special systems, standard systems and consumables sales. Gross margin rates on our systems sales are typically less than 45% as opposed to consumables sales which are in excess of 50%. On average, standard systems which are included in the North America, Asia and Other International Waterjet segments carry higher margins than the custom engineered systems, which are represented by the Applications segment. Our Applications segment recorded significant decreases in margins due to increased cost of certain automotive contracts. In addition, gross margin as a percent of sales will vary amongst segments due to inter-company sales and the related inter-company transfer pricing.

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

                                         Three Months Ended October 31,                    Six Months Ended October 31,
                                     2006           2005       Difference    %         2006         2005      Difference    %
Sales and Marketing
North America Waterjet            $     6,059    $    4,329   $      1,730   40 %   $   11,191    $  8,355   $      2,836   34 %
Asia Waterjet                           1,291         1,069            222   21 %        2,510       2,030            480   24 %
Other International Waterjet            2,783         2,241            542   24 %        5,434       4,505            929   21 %
Applications                              430           234            196   84 %        1,025         559            466   83 %

Total                             $    10,563    $    7,873   $      2,690   34 %   $   20,160    $ 15,449   $      4,711   30 %

Sales and marketing expenses increased $2.7 million or 34%, and $4.7 million or 30% for the three and six months ended October 31, 2006, as compared to the prior year same respective periods. This expense growth in the North America stemmed from increased investment in sales and marketing staff and higher trade show costs due to our attendance at the bi-annual International Manufacturing Technology Show held in Chicago in September 2006. Higher costs in Asia and Other International segments were due to investment in staff and higher commissions driven by higher sales. We plan to continue to invest in sales and marketing to build waterjet technology awareness globally and to increase coverage of a growing base of potential customers. During the first fiscal quarter, Applications reserved $215,000 against customer receivables due to an early termination because we believe the customer will be unable to pay the obligation under the contract. Expressed as a percentage of revenue, consolidated sales and marketing expenses were 19% and 19% for the three and six months ended October 31, 2006, compared to 16% and 17% for the prior year same respective periods.

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

                                        Three Months Ended October 31,                      Six Months Ended October 31,
                                   2006          2005       Difference       %         2006        2005      Difference       %
Research and Engineering
North America Waterjet          $    2,004    $    1,429   $        575      40 %    $   3,883    $ 3,043   $        840      28 %
Asia Waterjet                          195           129             66      51 %          414        235            179      76 %
Other International Waterjet            91           103            (12 )   (12 )%         210        242            (32 )   (13 )%
Applications                            49            31             18      58 %          126         50             76     152 %

Total                           $    2,339    $    1,692   $        647      38 %    $   4,633    $ 3,570   $      1,063      30 %

Research and engineering expenses increased $647,000 or 38%, and $1.1 million or 30% for the three and six months ended October 31, 2006, as compared to the prior year same respective periods. In North America, we added key engineering personnel related to our core UHP technology as well as additional engineering resources to support new core product development, such as Stonecrafter™, the 87,000 psi pump and the 55,000 psi Husky, as well as continued core enhancements such as FlowMaster version 6.0. In Asia, we added resources to support new product development, such as the next generation Nanojet™ system. The increase in Applications for the quarter is the result of the timing of work and utilization of engineering resources. Expressed as a percentage of revenue, consolidated research and engineering expenses were 4% and 4% for the three and six months ended October 31, 2006, compared to 3% and 4% for the prior year same respective periods.

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

                                        Three Months Ended October 31,                         Six Months Ended October 31,
                                  2006         2005        Difference        %          2006         2005       Difference        %
General and Administrative
North America Waterjet          $   5,998    $   5,861    $        137        2 %     $  11,613    $ 10,741    $        872        8 %
Asia Waterjet                       2,013          335           1,678      501 %         2,449         733           1,716      234 %
Other International Waterjet          669          593              76       13 %         1,322       1,168             154       13 %
Applications                          302          346             (44 )    (13 )%          618         708             (90 )    (13 )%

Total                           $   8,982    $   7,135    $      1,847       26 %     $  16,002    $ 13,350    $      2,652       20 %

General and administrative expenses increased $1.8 million or 26%, and $2.7 million or 20% for the three and six months ended October 31, 2006, as compared to the prior year same respective period. The increase was experienced primarily in the Asia Waterjet segment due to legal and professional fees related to the investigation conducted by the Audit Committee of the Board of Directors using independent counsel and an independent accounting firm in regards to fraudulent deferral of revenue recognition by certain former members of senior management in the Asia Waterjet segment. Expenses in the North America segment which includes all of our corporate overhead costs, increased mainly due to increased auditing and compliance costs for professional and consulting costs related to Sarbanes-Oxley compliance, audit fees, and legal expenses incurred for patent litigation and corporate transactions and filings. Expressed as a percentage of revenue, consolidated general and administrative expenses were 17% and 15% for the three and six months ended October 31, 2006, compared to 14% and 14% for the prior year same respective periods.

Restructuring Expenses. During the three and six months ended October 31, 2005, we incurred $487,000 and $585,000, respectively, of severance benefits and other costs in the Applications segment related to the closing and relocation of our Wixom, Michigan facility. No such expenses occurred in the current fiscal year same periods.

Gain on Barton Sale. On August 26, 2005, the Company entered into a Purchase Agreement with Barton Mines Company ("Barton") to give Barton exclusive rights to sell abrasive to the Company's customers for $2.5 million in cash at closing, future annual payments of up to $250,000 for the next three years based on achievement of system sales targets and royalty payments for systems sold over the next 10 years. The Company recorded the $2.5 million gain as an offset to operating expenses in the second fiscal quarter in 2006.

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

                                        Three Months Ended October 31,                     Six Months Ended October 31,
                                   2006          2005      Difference       %         2006        2005      Difference       %
Operating Income
North America Waterjet           $    (261 )    $ 4,759   $     (5,020 )    NM %    $  1,243     $ 5,226   $     (3,983 )   (76 )%
Asia Waterjet                          973        2,016         (1,043 )   (52 )%      3,565       3,361            204       6 %
Other International Waterjet         1,476          344          1,132     329 %       2,042         627          1,415     226 %
Applications                          (248 )        528           (776 )    NM          (790 )       599         (1,389 )    NM

Total                            $   1,940      $ 7,647   $     (5,707 )   (75 )%   $  6,060     $ 9,813   $     (3,753 )   (38 )%

Interest Income, Interest Expense, Fair Value Adjustment on Warrants Issued and Other Income (Expense), Net. Current Interest Income increased to $153,000 and $382,000 for the three and six months ended October 31, 2006, compared to $19,000 and $55,000 in the prior year same respective periods due to the higher average global cash balance over $34 million in fiscal 2007 versus less than $20 million in fiscal 2006 same periods. Interest Expense decreased to $46,000 and $181,000 for the three and six months ended October 31, 2006 compared to $456,000 and $1.4 million in the prior year same respective periods . The significant decrease in Interest Expenses results from lower interest rates and lower average debt balance outstanding with the payoff of the senior debt during fiscal 2006. During the three and six months ended October 31, 2006, we recorded Other Income, Net of $399,000 and $1.0 million compared to Other Income, Net of $528,000 and Other Expense, Net of $579,000 in the prior year same respective periods. This change results from the fluctuation in realized and unrealized foreign exchange gains and losses as described in the table below, as well as $206,000 related to hedges and their termination which is included in Other during the six months ended October 31, 2006. During the three and six months ended October 31, 2005, we incurred $4.2 million and $4.8 million of expense associated with the warrants which were required to be marked-to-market at each reporting period with corresponding gains and losses reported on the Condensed Consolidated Statement of Operations.

The following table shows the detail of Other Income (Expense), Net, in the accompanying Condensed Consolidated Statements of Income:

                                                Three Months Ended                 Six Months Ended
                                                    October 31,                       October 31,
                                              2006              2005             2006             2005
Realized Foreign Exchange (Losses)
Gains, Net                                  $    (382 )      $     (237 )     $     (343 )     $     (220 )
Unrealized Foreign Exchange Gains
(Losses), Net                                     848               631            1,690             (458 )
Hedges Termination                                (46 )              -              (206 )             -
Other                                             (21 )             134             (116 )             99

                                            $     399        $      528       $    1,025       $     (579 )

Income Taxes. For the three and six months ended October 31, the tax provision consists of current expense related to operations in foreign jurisdictions which are profitable primarily in Taiwan and Japan. In addition for the three and six months ended October 31, 2006, operations in certain jurisdictions (principally Germany)

reported net income against which we offset net operating losses related to these jurisdictions. However, because the operations in these jurisdictions have . . .