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KTEC > SEC Filings for KTEC > Form 10-Q on 9-May-2013All Recent SEC Filings

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Form 10-Q for KEY TECHNOLOGY INC


9-May-2013

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

From time to time, Key Technology, Inc. ("we", "us" or "our"), through its management, may make forward-looking public statements with respect to the company regarding, among other things, expected future revenues or earnings, projections, plans, future performance, product development and commercialization, and other estimates relating to our future operations. Forward-looking statements may be included in reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), in press releases or in oral statements made with the approval of an authorized executive officer of Key. The words or phrases "will likely result," "are expected to," "intends," "is anticipated," "estimates," "believes," "projects" or similar expressions are intended to identify "forward-looking statements" within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are subject to a number of risks and uncertainties, the occurrence of any of which could cause the price of our common stock to fluctuate significantly, making it difficult for shareholders to resell common stock at a time or price they find attractive. We caution investors not to place undue reliance on our forward-looking statements, which speak only as of the date on which they are made. Our actual results may differ materially from those described in the forward-looking statements as a result of various factors, including those listed below:

• changes in general economic conditions and disruption in financial markets may adversely affect the business of our customers and our business and results of operations;

• ongoing uncertainty and volatility in the financial markets related to the U.S. budget deficit, the European sovereign debt crisis and the state of the U.S. economic recovery may adversely affect our operating results;

• economic conditions in the food processing industry, either globally or regionally, may adversely affect our revenues;

• the loss of any of our significant customers could reduce our revenues and profitability;

• significant investments in unsuccessful research and development efforts could materially adversely affect our business;

• industry consolidation could increase competition in the food processing equipment industry;

• we are subject to price competition that may reduce our profitability;

• the significance of major orders could result in significant fluctuation in quarterly operating results;

• the failure of our independent sales representatives to perform as expected would harm our net sales;

• we may make acquisitions that could disrupt our operations and harm our operating results;

• our international operations subject us to a number of risks that could adversely affect our revenues, operating results and growth;

• fluctuations in foreign currency exchange rates could result in unanticipated losses that could adversely affect our liquidity and results of operations;

• advances in technology by competitors may adversely affect our sales and profitability;

• our existing and new products may not compete successfully in either current or new markets, which would adversely affect our sales and operating results;

• our expansion into new markets, increasingly complex projects and applications, and integrated product offerings could increase our cost of operations and reduce gross margins and profitability;

• our potential inability to obtain products and components from suppliers would adversely affect our ability to manufacture and market our products;

• our information systems, computer equipment and information databases are critical to our business operations, and any damage or disruptions could adversely affect our business and results of operations;

• our potential inability to retain and recruit experienced management and other key personnel, or the loss of key management personnel, may adversely affect our business and prospects for growth;

• the potential inability to protect our intellectual property, especially as we expand geographically, may adversely affect our competitive advantage;

• intellectual property-related litigation expenses and other costs resulting from infringement claims asserted against us by third parties may adversely affect our results of operations and our customer relations;

• our dependence on certain suppliers may leave us temporarily without adequate access to raw materials or products;

• our operating results are seasonal and may further fluctuate due to severe weather conditions affecting the agricultural industry in various parts of the world;

• the limited availability and possible cost fluctuations of materials used in our products could adversely affect our gross margins;

• compliance with recently-passed health care legislation and increases in the cost of providing health care plans to our employees may adversely affect our business;


• our reported results may be affected adversely by the implementation of new, or changes in the interpretation of existing, accounting principles or financial reporting requirements, which could require us to incur substantial additional expenses; and

• compliance with changing regulation of corporate governance and public disclosure will result in additional expenses to us and pose challenges for our management.

More information may be found in Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the fiscal year ended September 30, 2012 filed with the SEC on December 10, 2012, which item is hereby incorporated by reference.

Given these uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements. We disclaim any obligation subsequently to revise or update forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

Overview

General

We and our operating subsidiaries design, manufacture, sell and service automation systems that process product streams of discrete pieces to improve safety and quality. These systems integrate electro-optical automated inspection and sorting systems with process systems that include specialized conveying and preparation systems. We provide parts and service for each of our product lines to customers throughout the world. Industries served include food processing, as well as tobacco, plastics, pharmaceuticals and nutraceuticals. We maintain two domestic manufacturing facilities and two European manufacturing facilities located in Belgium and the Netherlands. We market our products directly and through independent sales representatives.

In recent years, 40% or more of our sales have been made to customers located outside the United States. In our export and international sales, we are subject to the risks of conducting business internationally, including unexpected changes in regulatory requirements; fluctuations in the value of the U.S. dollar, which could increase or decrease the sales prices in local currencies of our products; tariffs and other barriers and restrictions; and the burdens of complying with a variety of international laws.

The worldwide economy and economic uncertainty continue to challenge operating results. We continue to see customers seeking to retain cash and requiring higher returns on investment, price sensitivity, longer or delayed purchasing cycles, and more purchasing decisions at corporate levels rather than local operating locations. In addition, in response to the resulting excess capacity, the market continues to see very aggressive pricing efforts to stimulate demand, which has increased price competition for our products, particularly in automated inspection systems where pricing and competition are particularly aggressive. More recently, the markets have seen increased food production and increases in industrial spending, particularly in the potato industry.

In the second quarter of fiscal 2013, we continued to see strong quote activity, most significantly in our potato and processed fruit and vegetable markets. For the third consecutive quarter, we realized strong bookings, most significantly in the potato industry, including several significant french fry orders across multiple geographic regions. We believe this is partially the result of cyclical demand, but also the result of our customers looking to improve yields and reduce operating costs to remain competitive in their industry and meet demand in emerging markets, particularly in the potato markets. We remain encouraged by the potential opportunities in our core markets and primary geographic regions.

Acquisition

Effective February 28, 2013, we completed the acquisition of Visys NV ("Visys"), a Belgian supplier of high-end digital sensor-based optical sorters. We acquired 100% of the outstanding shares of Visys for approximately $21.3 million, consisting of $13.2 million in cash, 600,000 shares of our common stock and 250,000 warrants to purchase our common stock. The acquisition expands our product lines and augments our technological base and capacity, and is also expected to expand our addressable markets and accelerate our development of next generation sorting solutions. The acquisition implements several of the strategic initiatives we outlined in our annual report. Visys has been included in our operating results for the period from the date of acquisition. Further information regarding the acquisition is contained in Footnote 2 to the Unaudited Condensed Consolidated Financial Statements.

Current period - second quarter of fiscal 2013

Net sales of $35.5 million in the second fiscal quarter of 2013 were $8.2 million, or 30%, higher than net sales of $27.2 million in the corresponding quarter a year ago. The higher net sales in the second quarter of fiscal 2013 were primarily the result of the higher backlog entering the quarter, particularly for the Veo™, ADRฎ, Raptor and upgrade product lines. International sales were


42% of net sales for the second fiscal quarter of 2013, compared to 44% in the corresponding prior-year period. Backlog of $50.1 million at the end of the second fiscal quarter of 2013 represented a $15.4 million, or 45%, increase from the ending backlog of $34.7 million at the end of the corresponding quarter a year ago.

Orders in the second quarter of fiscal 2013 of $32.7 million were up $7.8 million, or 31%, compared to the orders of $24.9 million in the second quarter of fiscal 2012. Orders increased 43% for automated inspection system product lines, primarily in the Mantaฎ, Tegraฎ, Raptor and tobacco product lines, partially offset by decreases in Veo product orders due to timing. Process system orders were up 23%. Orders also increased most significantly in the North American potato and processed fruit and vegetable markets.

Gross margin percentages in the second quarter of fiscal 2013 increased significantly from the margins for the second quarter of fiscal 2012 due to a favorable product mix and effective factory utilization. Net earnings for the second quarter of fiscal 2013 were $2.1 million, or $0.38 per diluted share. The net loss for the corresponding three-month period last year was $726,000, or $0.13 per diluted share. The increase in net earnings in the more recent three-month period is primarily due to higher net sales and improved gross margins, offset by higher operating expenses as a result of higher net sales and acquisition related expenses. We anticipate gross margin dollars will be lower in the second half of fiscal 2013 compared to the second quarter of fiscal 2013 due to a less favorable product mix and the effects of acquisition related fair value adjustments to acquired inventory.

First six months of fiscal 2013

In the first half of fiscal 2013, net sales and net earnings increased compared to the corresponding period in the prior fiscal year. Net sales were up 14% in parts and service, 4% in process systems and essentially the same for automated inspection systems. Net sales for automated inspection systems increased significantly in the ADR and Veo product lines, offset by decreases in the Manta, Raptor and tobacco product lines. Net sales of $55.3 million for the first six months of fiscal 2013 were $2.1 million, or 4%, higher than net sales of $53.2 million in the corresponding period a year ago. International sales were 46% of net sales for the first six months of fiscal 2013 compared to 44% in the corresponding prior year period. Customer orders in the first half of fiscal 2013 of $70.8 million were up $19.3 million, or 38%, compared to the orders of $51.5 million in the first half of fiscal 2012. Customer orders increased 68% in automated inspection systems and 20% in both process systems and parts and service. Orders for automated inspection systems increased most significantly in the Manta, Tegra, Veo, Raptor and tobacco product lines. Orders for process systems increased in vibratory products in North America and Europe and other vibratory products, partially offset by decreases in rotary sizers and graders, freshcut product lines and third-party equipment. Orders also increased across the Company's major geographical regions, most significantly in the North American potato market. The net earnings for the first half of fiscal 2013 were $1.3 million, or $0.23 per diluted share. The net loss for the corresponding six-month period last year was $969,000, or $0.18 per diluted share. The increase in net earnings is primarily due to the increased net sales and higher gross margins due to favorable product mix.

Application of Critical Accounting Policies

We have identified our critical accounting policies, the application of which may materially affect our financial statements, either because of the significance of the financial statement item to which they relate, or because they require management judgment to make estimates and assumptions in measuring, at a specific point in time, events which will be settled in the future. The critical accounting policies, judgments and estimates which management believes have the most significant effect on the financial statements are set forth below:

• Revenue recognition

• Allowances for doubtful accounts

• Valuation of inventories

• Long-lived assets

• Allowances for warranties

• Accounting for income taxes

Management has discussed the development, selection and related disclosures of these critical accounting estimates with the audit committee of our board of directors.

Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectability is reasonably assured. Additionally, we sell our goods on terms which transfer title and risk of loss at a specified location, typically shipping point, port of loading or port of discharge, depending on the final destination of the goods. Accordingly, revenue recognition from product sales occurs when all


criteria are met, including transfer of title and risk of loss, which occurs either upon shipment by us or upon receipt by customers at the location specified in the terms of sale. Our newly acquired subsidiary Visys NV generally defers revenue recognition until after installation and training at the customer site. Sales of system upgrades are recognized as revenue upon completion of the conversion of the customer's existing system when this conversion occurs at the customer site. Revenue earned from services (maintenance, installation support, and repairs) is recognized ratably over the contractual period or as the services are performed. If any contract provides for both equipment and services (multiple deliverables), the sales price is allocated to the various elements based on the relative selling price. Each element is then evaluated for revenue recognition based on the previously described criteria. We typically have a very limited number of contracts with multiple deliverables and they are not material to the financial statements. Our sales arrangements provide for no other significant post-shipment obligations. If all conditions of revenue recognition are not met, we defer revenue recognition. In the event of revenue deferral, the sale value is not recorded as revenue to us, accounts receivable are reduced by any related amounts owed by the customer, and the cost of the goods or services deferred is carried in inventory. In addition, we periodically evaluate whether an allowance for sales returns is necessary. Historically, we have experienced few sales returns. We account for cash consideration (such as sales incentives) that are given to customers or resellers as a reduction of revenue rather than as an operating expense unless an identified benefit is received for which fair value can be reasonably estimated. We believe that revenue recognition is a "critical accounting estimate" because our terms of sale vary significantly, and management exercises judgment in determining whether to recognize or defer revenue based on those terms. Such judgments may materially affect net sales for any period. Management exercises judgment within the parameters of accounting principles generally accepted in the United States of America (GAAP) in determining when contractual obligations are met, title and risk of loss are transferred, the sales price is fixed or determinable and collectability is reasonably assured. At March 31, 2013, we had invoiced $7.3 million, compared to $2.4 million at September 30, 2012, for which we have not recognized revenue.

Allowances for doubtful accounts. We establish allowances for doubtful accounts for specifically identified, as well as anticipated, doubtful accounts based on credit profiles of customers, current economic trends, contractual terms and conditions, and customers' historical payment patterns. Factors that affect collectability of receivables include general economic or political factors in certain countries that affect the ability of customers to meet current obligations. We actively manage our credit risk by utilizing an independent credit rating and reporting service, by requiring certain percentages of down payments, and by requiring secured forms of payment for customers with uncertain credit profiles or located in certain countries. Forms of secured payment could include irrevocable letters of credit, bank guarantees, third-party leasing arrangements or EX-IM Bank guarantees, each utilizing Uniform Commercial Code filings, or the like, with governmental entities where possible. We believe that the accounting estimate related to allowances for doubtful accounts is a "critical accounting estimate" because it requires management judgment in making assumptions relative to customer or general economic factors that are outside our control. As of March 31, 2013, the balance sheet included allowances for doubtful accounts of $297,000 as compared to $190,000 at September 30, 2012. Amounts charged to bad debt expense for the six-month period ended March 31, 2013 and 2012, respectively, were $(5,000) and $(4,000). Actual charges to the allowance for doubtful accounts for the six-month period ended March 31, 2013 and 2012, respectively, were $6,000 and $(4,000). If we experience actual bad debt expense in excess of estimates, or if estimates are adversely adjusted in future periods, the carrying value of accounts receivable would decrease and charges for bad debts would increase, resulting in decreased net earnings.

Valuation of inventories. Inventories are stated at the lower of cost or market. Our inventory includes purchased raw materials, manufactured components, purchased components, service and repair parts, work in process, finished goods and demonstration equipment. Write downs for excess and obsolete inventories are made after periodic evaluation of historical sales, current economic trends, forecasted sales, estimated product lifecycles and estimated inventory levels. The factors that contribute to inventory valuation risks are our purchasing practices, electronic component obsolescence, accuracy of sales and production forecasts, introduction of new products, product lifecycles and the associated product support. We actively manage our exposure to inventory valuation risks by maintaining low safety stocks and minimum purchase lots, utilizing just in time purchasing practices, managing product end-of-life issues brought on by aging components or new product introductions, and by utilizing inventory minimization strategies such as vendor-managed inventories. We believe that the accounting estimate related to valuation of inventories is a "critical accounting estimate" because it is susceptible to changes from period to period due to the requirement for management to make estimates relative to each of the underlying factors ranging from purchasing to sales to production to after-sale support. At March 31, 2013, cumulative inventory adjustments to the lower of cost or market totaled $3.4 million compared to $2.1 million as of March 31, 2012. Amounts charged to expense to record inventory at lower of cost or market for the six-month period ended March 31, 2013 and 2012 were $951,000 and $635,000, respectively. Actual charges to the cumulative inventory adjustments upon disposition or sale of inventory were $247,000 and $447,000 for the six-month period ended March 31, 2013 and 2012, respectively. If actual demand, market conditions or product lifecycles are adversely different from those estimated by management, inventory adjustments to lower market values would result in a reduction to the carrying value of inventory, an increase in inventory write-offs, and a decrease to gross margins.


Long-lived assets. We regularly review all of our long-lived assets, including property, plant and equipment, and amortizable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If the total of projected future undiscounted cash flows is less than the carrying amount of these assets, an impairment loss based on the excess of the carrying amount over the fair value of the assets is recorded. In addition, goodwill is reviewed based on its fair value at least annually. As of March 31, 2013, we held $40.7 million of long-lived assets, net of depreciation and amortization. There were no material changes in our long-lived assets that would result in an adjustment of the carrying value for these assets. Estimates of future cash flows arising from the utilization of these long-lived assets and estimated useful lives associated with the assets are critical to the assessment of recoverability and fair values. In fiscal 2012, we evaluated our then existing $2.5 million of goodwill using the conventional market and income approaches to determine fair value. As part of that evaluation, estimates of fair value did not exceed the carrying value of its single reporting unit by more than 10%. The income approach employs a discounted cash flow model that takes into account (1) assumptions that market participants would use in their estimates of fair value, (2) current period actual results, and (3) budgeted results for future periods that have been vetted by senior management. The discounted cash flow model incorporates the same fundamental pricing concepts used to calculate fair value in the acquisition due diligence process and a discount rate that takes into consideration our estimated cost of capital adjusted for the uncertainty inherent in the acquisition. The market approach employs market multiples for comparable publicly traded companies. Estimates of fair value are established using current and forward multiples of both revenue and EBITDA adjusted for size and performance level relative to peer companies. As noted above, estimates of future cash flows are critical to this assessment and estimates and assumptions are required in applying the income and market approaches which by their nature have an implied degree of uncertainty. These estimates, assumptions and valuations could be adversely affected if there are significant further reductions in stock price, significantly less than estimated actual results of operations or changes in forecasted results of operations. We have not performed additional valuations since the acquisition of Visys NV but based on our internal estimates done in conjunction with the acquisition we believe the fair value of the Company far exceeds its carrying value. We believe that the accounting estimate related to long-lived assets is a "critical accounting estimate" because: (1) it is susceptible to change from period to period due to the requirement for management to make assumptions about future sales and cost of sales generated throughout the lives of several product lines over extended periods of time; and (2) the potential effect that recognizing an impairment could have on the assets reported on our balance sheet and the potential material adverse effect on reported earnings or loss. Changes in these estimates could result in a determination of asset impairment, which would result in a reduction to the carrying value and a reduction to net earnings in the affected period.

Allowances for warranties. Our products are covered by standard warranty plans included in the price of the products ranging from 90 days to five years, depending upon the product and contractual terms of sale. The majority of the warranty periods are for one year or less. We establish allowances for warranties for specifically identified, as well as anticipated, warranty claims based on contractual terms, product conditions and actual warranty experience by product line. Our products include both manufactured and purchased components and, therefore, warranty plans include third-party sourced parts which may not be covered by the third-party manufacturer's warranty. We actively manage our quality program by using a structured product introduction plan, process monitoring techniques utilizing statistical process controls, vendor quality metrics, and feedback loops to communicate warranty claims to designers and engineers for remediation in future production. We believe that the accounting estimate related to allowances for warranties is a "critical accounting estimate" because: (1) it is susceptible to significant fluctuation period-to-period due to the requirement for management to make assumptions about future warranty claims relative to potential unknown issues arising in both existing and new products, which assumptions are derived from historical trends of known or resolved issues; and (2) risks associated with third-party supplied components being manufactured using processes that we do not control. As of March 31, 2013, the balance sheet included warranty reserves of $2.4 million. Warranty charges of $1.6 million were incurred during the six-month period then ended. Warranty reserves were $1.8 million as of March 31, 2012 and warranty charges of $1.3 million were incurred during the six-month period then ended. If our actual warranty costs are higher than estimates, future warranty plan coverages are different, or estimates are adversely adjusted in future periods, reserves for warranty expense would need to increase, warranty expense would increase and gross margins would decrease.

Accounting for income taxes. Our provision for income taxes and the determination of the resulting deferred tax assets and liabilities involves a significant amount of management judgment. The quarterly provision for income taxes is based partially upon estimates of pre-tax financial accounting income for the full year and is affected by various differences between financial accounting income and taxable income. Judgment is also applied in determining whether the deferred tax assets will be realized in full or in part. In . . .

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