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KTEC > SEC Filings for KTEC > Form 10-K on 13-Dec-2013All Recent SEC Filings

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Form 10-K for KEY TECHNOLOGY INC


13-Dec-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.

Introduction

We and our wholly-owned subsidiaries design, manufacture and sell process automation systems integrating electro-optical inspection, sorting and process systems.

We own five subsidiaries: Key Technology Holdings USA LLC; Key Technology Australia Pty Ltd.; Productos Key Mexicana S. de R. L. de C.V.; Key Technology (Shanghai) Trading Co., Ltd.; and Key Technology Asia-Pacific Pte. Ltd. Key Technology Holdings USA LLC owns Visys N.V. and Suplusco Holding B.V., its European subsidiary, which owns Key Technology B.V. We manufacture products in Walla Walla, Washington; Redmond, Oregon; Beusichem, The Netherlands, and Hasselt, Belgium.

Overview

Sales increased $21.6 million, or 18.8%, to $136.8 million for the year ended September 30, 2013 compared with $115.2 million for fiscal 2012, while orders increased $18.0 million, or 16.5%, in fiscal 2013 over fiscal 2012. We reported net earnings for fiscal 2013 of $4.0 million, or $0.69 per diluted share, compared with net earnings of $449,000, or $0.08 per diluted share, for fiscal 2012. Net earnings increased in fiscal 2013 compared to fiscal 2012 as a result of a $10.2 million increase in gross profit, offset by higher operating expenses of $40.2 million, or 29.4% of net sales, compared to $34.9 million, or 30.3% of net sales, for fiscal 2012. The increase in gross margins to 33.7% in fiscal 2013 from 31.1% in fiscal 2012 was due to a higher mix of higher margin automated system sales and the product mix within automated inspection systems, and more efficient factory utilization, partially offset by higher warranty and customer support costs due in part to the increase in net sales and $1.0 million of acquisition related fair value adjustments to acquired inventory. Operating expenses increased $5.3 million, or 15.3%, in fiscal 2013 as compared to fiscal 2012 due to the acquisition of Visys, the results of which have been included since the acquisition date, February 28, 2013, higher commissions due to the increase in net sales; increased research and development expenses related to developing new technology solutions; and the increased expenses associated with amortization of intangible assets. Other expenses were $460,000 in fiscal year 2013 compared to $359,000 in fiscal year 2012.

Automated inspection systems sales increased 27%, process systems sales were up 13%, and parts and service sales increased 13% in fiscal 2013 compared to the prior fiscal year. Orders for automated inspection systems increased 48%, process system orders decreased 7%, and parts and service orders increased 15% in fiscal 2013 compared to the prior fiscal year. Export and international sales for the fiscal years ended September 30, 2013, 2012 and 2011 accounted for 45%, 45% and 41% of net sales in each year, respectively.

While the Company produced significantly improved operating results in fiscal 2013, our major business still serves seasonal and cyclical industries, and it remains typical for order and backlog quantities to vary on a quarter-by-quarter basis. While we have recently seen a softening in the European region, we remain positive regarding our overall international opportunities.

Our acquisition of Visys, completed on February 28, 2013, was a critical component of our long-term strategy. Visys has brought new technology, expertise and chute-fed solutions that complement our existing product portfolio. The Visys products have enabled us to add nuts and dried fruit as a new core market as well as expand our available product offerings and solutions in the processed fruit and vegetables and potato markets. The Visys team, now fully integrated within Key, adds capabilities and skill sets that augment our already talented and experienced team.

In fiscal 2013, we focused on our five strategic imperatives, which will continue in fiscal 2014. Those five strategic imperatives are as follows:

1. Developing and introducing new technology-leading platforms and solutions;

2. Increasing global market share in our core markets through new products, focused regional sales strategies, and leveraging our integrated solutions capability;

3. Expanding into new high-potential market adjacencies by leveraging new product platforms;

4. Continuing to strengthen and develop internal capabilities and third-party partnerships necessary for industry-leading solutions; and

5. Further strengthening a winning culture within Key Technology, driving our "innovation architecture."


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 warrants to purchase 250,000 shares of our common stock. Visys has been included in our operating results for the period from the date of acquisition. Further information regarding the acquisition of Visys is contained in Footnote 2 to our Consolidated Financial Statements as of September 30, 2013.

License and Distribution Agreements

In July 2013, we entered into an exclusive license agreement with EVK Di Kerschhaggl GmbH and Insort GmbH to deploy chemical imaging technology for potato processing applications and to integrate new hyperspectral developments into our automated inspection systems, and an exclusive distribution agreement to market Insort's complementary sorting solutions exclusively in North America and to strategic specified customers worldwide. These partnerships are expected to enhance our ability to offer high-performance digital sorting technologies in the potato industry, and facilitate our development of next-generation hyperspectral sorters for a variety of food processing applications.

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. 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. Certain other, less frequent, equipment sales are recognized as revenue upon completion of installation 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


September 30, 2013, we had invoiced $4.0 million, compared to $2.4 million at September 30, 2012, for which we have not recognized revenue.

Allowances for doubtful accounts. We have established 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 September 30, 2013, the balance sheet included allowances for doubtful accounts of $296,000 as compared to $190,000 at September 30, 2012. Amounts charged to bad debt expense for fiscal 2013 and 2012 were $2,000 and $24,000, respectively. Actual charges to the allowance for doubtful accounts for fiscal 2013 and 2012 were $26,000 and $84,000, respectively. 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 September 30, 2013, cumulative inventory adjustments to lower of cost or market totaled $3.5 million compared to $2.6 million as of September 30, 2012. Amounts charged to expense to record inventory at lower of cost or market for fiscal 2013 and 2012 were $1.7 million and $1.6 million, respectively. Actual charges to the cumulative inventory adjustments upon disposition or sale of inventory were $867,000 and $826,000 for fiscal 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 September 30, 2013, we held $40.1 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. 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, future results of operations, and market multiples used in valuation models; 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 September 30, 2013, the balance sheet included warranty reserves of $2.7 million, while $4.2 million of warranty charges were incurred during the fiscal year then ended, compared to warranty reserves of $2.0 million as of September 30, 2012 and warranty charges of $3.6 million for the fiscal year 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 management's judgment, when it is more likely than not that all or some portion of specific deferred tax assets will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. At September 30, 2013, we had valuation reserves of approximately $180,000 for deferred tax assets for capital loss carryforwards and changes in the carrying value of our investment in Proditec, and offsetting amounts for foreign deferred tax assets and U.S. deferred tax liabilities, primarily related to net operating loss carry forwards in the foreign jurisdictions that we believe will not be utilized during the carryforward periods. During fiscal 2013, we recorded net additional valuation reserves of $2,000 related to capital loss carryforwards and $3,000 as part of the acquisition of Visys related to net operating loss carryforwards. In addition, we reversed offsetting amounts of approximately $135,000 of valuation reserves for foreign deferred tax assets and U.S. deferred tax liabilities related to the utilization of net operating loss carryforwards in Europe in fiscal 2013. As these were offsetting amounts, these changes had no effect on net earnings. During fiscal 2012, we recorded net additional valuation reserves of $5,000 related to capital loss carryforwards. In addition, we recorded offsetting amounts of approximately $2.5 million of valuation reserves for foreign deferred tax assets and U.S. deferred tax liabilities related to net operating loss carryforwards in foreign jurisdictions that we believe will not be utilized during the carryforward periods. We also reversed offsetting amounts of approximately $700,000 of valuation reserves for Chinese deferred tax assets and U.S. deferred tax liabilities related to net operating loss carry forwards that were utilized in the foreign jurisdiction. As these were all offsetting amounts, these changes had no effect on net earnings. During fiscal 2011, we recorded $160,000 of valuation reserves related to net operating loss carryforwards in foreign jurisdictions offset by U.S. deferred tax liabilities and reversed $17,000 of valuation reserves for capital loss carryforwards that were utilized to offset capital gains on our corporate income tax return. There were no other valuation allowances at September 30, 2013 due to anticipated utilization of all the deferred tax assets as we believe we will have sufficient taxable income to utilize these assets. We maintain reserves for estimated tax exposures in jurisdictions of operation. These tax jurisdictions include federal, state and various international tax jurisdictions. Potential income tax exposures include potential challenges of various tax credits and deductions, and issues specific to state and local tax jurisdictions. Exposures are typically settled primarily through audits within these tax jurisdictions, but can also be affected by changes in applicable tax law or other factors, which could cause our management to believe a revision of past estimates is appropriate. At September 30, 2013, we had reserves of $126,000 for estimated tax exposures. During fiscal 2013 and 2012, there were no significant changes in these estimates. Management believes that an appropriate liability has been established for estimated exposures; however, actual results may differ materially from these estimates. We believe that the accounting estimate related to income taxes is a "critical accounting estimate" because it relies on significant management judgment in making assumptions relative to temporary and permanent timing differences of tax effects, estimates of future earnings, prospective application of changing tax laws in multiple jurisdictions, and the resulting ability to utilize tax assets at those future dates. If our operating results were to fall short of expectations, thereby affecting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of the valuation allowance required to be included in the financial statements in any given period. Establishing or increasing a valuation allowance would reduce the carrying value of the deferred tax asset, increase tax expense and reduce net earnings.

In fiscal 2013, the existing research and development tax credit was retroactively renewed and extended to December 31, 2013. Due to this change in tax law, the Company recorded approximately $192,000 of additional research and development credits in fiscal 2013 related to research and development expenditures incurred during fiscal 2012. The research and development credit was effective for the Company for only the first fiscal quarter of 2012 prior to its expiration date. Similarly, in fiscal 2011, an additional $72,000 of research and development credits were recorded which related to R&D expenditures in fiscal 2010. The research and development credit expires December 31, 2013 and, as of the date of this report, has not been renewed.


Comparison of Fiscal 2013 to Fiscal 2012
                                                    Fiscal Year Ended September 30,
                                              2013          2012        Change $    Change %
                                                             (in thousands)
Statement of Operations Data
Net sales                                  $ 136,783     $ 115,174     $ 21,609        18.8
Gross profit                                  46,044        35,835       10,209        28.5
Operating Expenses:
Sales and marketing                           18,976        17,439        1,537         8.8
Research and development                       9,647         8,343        1,304        15.6
General and administrative                    10,594         9,070        1,524        16.8
Amortization                                     996            15          981        N/M*
Total operating expense                       40,213        34,867        5,346        15.3
Gain (loss) on disposition of assets              42           (15 )         57        N/M*
Income from operations                         5,873           953        4,920       516.3
Other income (expense)                          (460 )        (359 )       (101 )      28.1
Income tax expense                             1,402           145        1,257       866.9
Net earnings                               $   4,011     $     449        3,562       793.3
Balance Sheet Data
Cash and cash equivalents                  $  17,601     $  23,755       (6,154 )     (25.9 )
Accounts receivable                           17,725        11,426        6,299        55.1
Inventories                                   27,921        23,166        4,755        20.5
Other Data (unaudited)
Orders for year ended September 30           126,930       108,976       17,954        16.5
Backlog at fiscal year end                    25,231        30,810       (5,579 )     (18.1 )


* Not Meaningful

Results of Operations

Fiscal 2013 compared to Fiscal 2012

Net sales for the year ended September 30, 2013 were $136.8 million, a 19% increase from the $115.2 million reported for fiscal 2012. International sales for fiscal 2013 were 45% of net sales and 45% in the corresponding prior year period. The increase in net sales occurred most significantly in North America and Europe, partially offset by decreases in net sales in Latin America. Sales in our automated inspection systems product line increased by 27% to $59.3 million in fiscal 2013, accounting for 43% of total revenues, compared to $46.6 million in fiscal 2012, or 40% of total revenues. The increase in automated inspection system sales was principally in the potato market, as well as other food markets, offset by decreases in the processed fruit and vegetable and fresh cut markets. The increase in automated inspection system sales occurred in the ADR, Tegra, VEO, Verisym and upgrade product lines, partially offset by decreases in Optyx, Raptor, Manta and tobacco sorter product lines. Process systems sales in fiscal 2013 were $50.7 million a 13% increase from the $44.9 million reported for fiscal 2012. Sales of process systems accounted for 37% of total revenues in fiscal 2013 compared to 39% in fiscal 2012. The increase in process systems sales related primarily to vibratory products in Europe and other process system equipment, partially offset by a decrease in rotary sizing and grading systems and third-party equipment. Parts and service sales increased from the prior year by $3.1 million or 13% to $26.7 million compared to $23.6 million in fiscal 2012. Parts and service sales represented 20% of sales in fiscal 2013 and 21% in fiscal 2012.

Orders increased 16%, or $17.9 million, to $126.9 million in fiscal 2013 from the $109.0 million of new orders received in fiscal 2012. Backlog at September 30, 2013 decreased 18% to $25.2 million compared to the $30.8 million reported at the end of fiscal 2012. The order mix for the more recent year changed from fiscal 2012. For fiscal 2013, our higher margin automated inspection systems orders increased by $18.0 million, or 48%, representing 44% of order volume in fiscal 2013 compared to 34% in the prior year. This increase occurred in almost all automated product inspection lines, except for Optyx and ADR systems. Automated inspection system orders increased in fiscal 2013 across most major markets, and most significantly in the potato market, and principally in the North American region. Orders for process systems decreased by $3.4 million, or 7%, and


represented 35% of order volume in fiscal 2013 compared to 44% in the prior year. The decrease in orders for process systems occurred primarily in . . .

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