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KTEC > SEC Filings for KTEC > Form 10-Q on 6-May-2014All Recent SEC Filings

Show all filings for KEY TECHNOLOGY INC

Form 10-Q for KEY TECHNOLOGY INC


6-May-2014

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 global financial markets may adversely affect our operating results;

discord, conflict, and lack of compromise within and between the executive and legislative branches of the U.S. government related to federal government budgeting, taxation policies, government expenditures, and U.S. borrowing/debt ceiling limits could adversely affect our business and 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 have made, or may make, acquisitions, or enter into distribution agreements or similar business relationships 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 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, 2013 filed with the SEC on December 13, 2013, 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, 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 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. In the last quarter of fiscal 2012 and first quarter of fiscal 2013, we saw increased capital spending, particularly in the potato market, for which we received several large orders. These large orders did not recur in fiscal 2014, which is reflective of the cyclical and seasonal nature of this market.

Current period - second fiscal quarter of 2014

Net sales of $31.6 million in the second quarter of fiscal 2014 were $3.9 million, or 11%, lower than net sales of $35.5 million in the corresponding quarter a year ago. The lower net sales in the second fiscal quarter of 2014 were due primarily to decreased sales of process systems. International sales were 46% of net sales for the second fiscal quarter of 2014, compared to 42% in the corresponding prior-year period. Net sales for the third quarter of fiscal 2014 are expected to be consistent with the net sales recorded in the second quarter of fiscal 2014. Backlog of $30.8 million at the end of the second fiscal quarter of 2014 represented a $19.3 million, or 39%, decrease from the ending backlog of $50.1 million at the end of the corresponding quarter a year ago. This decrease in backlog as compared to the prior year is due primarily to fewer large orders, primarily in the potato market, than were received in the fourth quarter of fiscal 2012 and the first quarter of fiscal 2013. These large orders, which did not recur in fiscal 2014, are reflective of the cyclical and seasonal industries included in our markets.

Orders in the second fiscal quarter of 2014 of $25.5 million were down $7.2 million, or 22%, compared to the orders of $32.7 million in the second fiscal quarter of 2013. Orders decreased as compared to the same period in the prior year for both automated inspection systems and process systems.

Gross margin percentages in the second fiscal quarter of 2014 decreased from the margins for the second fiscal quarter of 2013 due to less effective factory utilization. Gross margins are expected to be slightly lower in the third quarter of fiscal 2014 as compared with the second quarter of fiscal 2014.


The net loss for the second fiscal quarter of 2014 was $0.7 million, or $0.11 per diluted share. The net earnings for the corresponding three-month period in fiscal 2013 were $2.1 million, or $0.38 per diluted share. The net loss in the most recent three-month period is primarily due to lower gross margins and higher operating expenses due to increased spending on research and development, the inclusion of Visys N.V. results for the full fiscal quarter, and the settlement of the Visys N.V. litigation.

First six months of fiscal 2014

In the first six months of fiscal 2014, net sales and net earnings decreased compared to the corresponding period in the prior fiscal year. Net sales of $54.3 million for the first six months of fiscal 2014 were $1.0 million, or 2%, lower than net sales of $55.3 million in the corresponding period a year ago. International sales were 46% of net sales for the first six months of fiscal 2014 which was the same as the corresponding prior year period. Net sales were down 18% in process systems and were partially offset by a 7% increase in automated inspection systems and a 7% increase in parts and service. Customer orders in the first six months of fiscal 2014 of $59.6 million were down $11.2 million, or 16%, compared to the orders of $70.8 million in the first six months of fiscal 2013. Customer orders decreased 39% in process systems, decreased 3% in automated inspection systems, and increased 2% in parts and service. Orders for process systems decreased across all product lines, primarily in vibratory products in North America and Europe. Orders decreased most significantly in North America, primarily in the potato market, partially offset by increases in the nuts and dried fruit and other foods markets.

The net loss for the first six months of fiscal 2014 was $3.3 million, or $0.53 per diluted share. Net earnings for the corresponding six-month period last year was $1.3 million, or $0.23 per diluted share. The decrease in net earnings is primarily due to lower gross margins due to less effective factory utilization and a less favorable product mix, and higher operating expenses. Due to the results of the first half of fiscal 2014, we anticipate that we will not be profitable for fiscal year 2014.

Outlook

Subsequent to the end of the second quarter of fiscal 2014, we disclosed our business model for the next two-to-three years that we believe is reasonably attainable through organic growth. Our current expectations are as follows for the revenue, gross margin, operating income margin and EBITDA that may be reasonably achieved during the fiscal 2015-2017 period:

Revenue: $160 million - $170 million

Gross Margin: 36+%

Operating Income Margin: 8+%

EBITDA: $18 million - $19+ million

We anticipate these forward-looking statements will be effective through the end of fiscal 2014, should be considered historical as of such time, and are not subject to update before or after such time. We expect that our officers may, from time-to-time, meet publicly or privately with investors or others, and may reiterate such forward-looking statements.

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 March 31, 2014, we had invoiced $3.1 million, compared to $4.0 million at September 30, 2013, 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, 2014, the balance sheet included allowances for doubtful accounts of $346,000 as compared to $296,000 at September 30, 2013. Amounts charged to bad debt expense for the six months ended March 31, 2014 and 2013, respectively, were $47,000 and $(5,000). Actual charges to the allowance for doubtful accounts for the six months ended March 31, 2014 and 2013, respectively, were $(1,000) and $6,000. 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, 2014, cumulative inventory adjustments to the lower of cost or market totaled $3.7 million compared to $3.4 million as of March 31, 2013. Amounts charged to expense to record inventory at lower of cost or market for the three months ending March 31, 2014 and 2013 were $607,000 and $951,000, respectively. Actual charges to the cumulative inventory adjustments upon disposition or sale of inventory were $381,000 and $247,000 for the six months ending March 31, 2014 and 2013, 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, 2014, we held $38.9 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; 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, 2014, the balance sheet included warranty reserves of $2.3 million. Warranty charges of $1.7 million were incurred during the six-month period then ended. Warranty reserves were $2.4 million as of March 31, 2013 and warranty charges of $1.6 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 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 March 31, 2014, we had valuation reserves of approximately $178,000 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 carryforwards in the foreign jurisdictions that we believe will not be utilized during the carryforward periods. During the six months ended March 31, 2014, there were no material changes in our valuation reserves. There were no other material valuation allowances at March 31, 2014 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 uncertain tax positions 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. Thus far, during fiscal 2014, there have been 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 . . .

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