UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
---------------------------------------------
FORM 10-Q
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
for the quarterly period ended June 30, 2003
or
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
for the transition period from ____ to ____
Commission File No. 0-21820
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KEY TECHNOLOGY, INC.
(Exact name of Registrant as specified in its charter)
Oregon 93-0822509
(State of Incorporation) (I.R.S. Employer Identification No.)
150 Avery Street, Walla Walla, Washington 99362
(Address of principal executive offices) (Zip Code)
(509) 529-2161
(Registrant's telephone number, including area code)
---------------------------------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
----- -----
The number of shares outstanding of the Registrant's common stock, no par
value, on July 31, 2003 was 4,781,788 shares.
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE THREE MONTHS ENDED JUNE 30, 2003
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed unaudited consolidated balance sheets, June 30, 2003
and September 30, 2002......................................................................3
Condensed unaudited consolidated statements of earnings for the
three months ended June 30, 2003 and 2002...................................................4
Condensed unaudited consolidated statements of earnings (loss) for the
nine months ended June 30, 2003 and 2002....................................................5
Condensed unaudited consolidated statements of cash flows for
the nine months ended June 30, 2003 and 2002...............................................7
Notes to condensed unaudited consolidated financial statements..................................8
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................................................12
Item 3. Quantitative and Qualitative Disclosures About Market Risk.....................................19
Item 4. Controls and Procedures........................................................................20
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K...............................................................20
SIGNATURES.......................................................................................................21
EXHIBIT INDEX....................................................................................................22
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED UNAUDITED CONSOLIDATED BALANCE SHEETS
JUNE 30, 2003 AND SEPTEMBER 30, 2002
- ------------------------------------------------------------------------------------------
June 30, September 30,
2003 2002
------------ -------------
(in thousands)
Assets
- --------------------------------------------------------
Current assets:
Cash and cash equivalents $ 1,569 $ 1,707
Trade accounts receivable, net 11,316 7,556
Inventories:
Raw materials 7,327 6,416
Work-in-process and sub-assemblies 6,131 5,320
Finished goods 2,122 2,233
------------ -------------
Total inventories 15,580 13,969
Other current assets 2,579 3,207
------------ -------------
Total current assets 31,044 26,439
Property, plant and equipment, net 5,812 6,407
Deferred income taxes 1,687 3,472
Intangibles and other assets, net 12,262 13,502
------------ -------------
Total $ 50,805 $ 49,820
============ =============
Liabilities and Shareholders' Equity
- --------------------------------------------------------
Current liabilities:
Short-term borrowings $ - $ 6,596
Accounts payable 2,843 1,437
Accrued payroll liabilities and commissions 4,214 2,769
Accrued customer support and warranty costs 1,117 999
Other accrued liabilities 2,703 1,969
Customers' deposits 4,423 3,328
Current portion of long-term debt 1,112 1,668
------------ -------------
Total current liabilities 16,412 18,766
Long-term debt 3,502 3,747
Deferred income taxes 213 238
Mandatorily redeemable preferred stock and warrants 2,003 3,467
Total shareholders' equity 28,675 23,602
------------ -------------
Total $ 50,805 $ 49,820
============ =============
See notes to condensed unaudited consolidated financial statements.
3
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS
FOR THE THREE MONTHS ENDED JUNE 30, 2003 AND 2002
- -----------------------------------------------------------------------------------------------
2003 2002
---------- ----------
(in thousands, except per share data)
Net sales $ 25,013 $ 19,890
Cost of sales 14,030 11,607
---------- ----------
Gross profit 10,983 8,283
Operating expenses:
Selling 2,907 2,875
Research and development 1,320 1,104
General and administrative 2,105 1,953
Amortization of intangibles 331 331
---------- ----------
Total operating expenses 6,663 6,263
Gain on sale of assets - 884
---------- ----------
Earnings from operations 4,320 2,904
Other expense (20) (741)
---------- ----------
Earnings before income taxes 4,300 2,163
Income tax expense 1,298 773
---------- ----------
Net earnings 3,002 1,390
Accretion of mandatorily redeemable preferred stock - (189)
---------- ----------
Net earnings available to common shareholders $ 3,002 $ 1,201
========== ==========
Earnings per share
- basic $ 0.63 $ 0.25
========== ==========
- diluted $ 0.60 $ 0.25
========== ==========
Shares used in per share calculations - basic 4,776 4,762
Shares used in per share calculations - diluted 5,031 5,570
See notes to condensed unaudited consolidated financial statements.
4
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
- -----------------------------------------------------------------------------------------------
2003 2002
---------- ----------
(in thousands, except per share data)
Net sales $ 61,335 $ 52,684
Cost of sales 35,932 31,444
---------- ----------
Gross profit 25,403 21,240
Operating expenses:
Selling 8,574 8,244
Research and development 3,732 3,365
General and administrative 5,487 5,275
Amortization of intangibles 992 992
---------- ----------
Total operating expenses 18,785 17,876
Gain on sale of assets 2 931
---------- ----------
Earnings from operations 6,620 4,295
Other expense (238) (1,401)
---------- ----------
Earnings from continuing operations 6,382 2,894
Income tax expense 2,006 1,004
---------- ----------
Net earnings from continuing operations 4,376 1,890
Net earnings from discontinued operation, net of tax - 39
---------- ----------
Net earnings before change in accounting principle 4,376 1,929
Change in accounting principle, net of tax - (4,302)
---------- ----------
Net earnings (loss) 4,376 (2,373)
Accretion of mandatorily redeemable preferred stock - (582)
---------- ----------
Net earnings (loss) available to common shareholders $ 4,376 $ (2,955)
========== ==========
Net earnings from continuing operations per share
- basic $ 0.92 $ 0.27
========== ==========
- diluted $ 0.88 $ 0.27
========== ==========
Net earnings from discontinued operation per share
- basic and diluted $ - $ 0.01
========== ==========
Continued
See notes to condensed unaudited consolidated financial statements.
5
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
- -----------------------------------------------------------------------------------------------
2003 2002
---------- ----------
(in thousands, except per share data)
Net earnings before change in accounting principle
per common share
- basic $ 0.92 $ 0.28
========== ==========
- diluted $ 0.88 $ 0.28
========== ==========
Net loss from change in accounting principle per common
share - basic and diluted $ - $ (0.90)
========== ==========
Earnings (loss) per share
- basic $ 0.92 $ (0.62)
========== ==========
- diluted $ 0.88 $ (0.62)
========== ==========
Shares use in per share calculations - basic 4,771 4,757
Shares use in per share calculations - diluted 4,984 4,757
Concluded
See notes to condensed unaudited consolidated financial statements.
6
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONDENSED UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED JUNE 30, 2003 AND 2002
- -----------------------------------------------------------------------------------------------
2003 2002
---------- ----------
(in thousands)
Net cash provided by operating activities $ 9,247 $ 7,702
Cash flows from investing activities:
Cash proceeds from sale of discontinued operation - 3,577
Proceeds from sale of property 3 4,337
Additions to property, plant and equipment (686) (464)
---------- ----------
Net cash provided by (used in) investing activities (683) 7,450
---------- ----------
Cash flows from financing activities:
Repayment of short-term borrowings (6,650) (2,000)
Additions to long-term debt 500 6,500
Repayment of long-term debt (1,431) (17,965)
Prepayment penalty on retirement of debt - (516)
Redemption of preferred stock (1,196) -
Redemption of warrants (268) (78)
Proceeds from issuance of common stock 65 39
---------- ----------
Net cash used in financing activities (8,980) (14,020)
---------- ----------
Effect of exchange rates on cash 278 125
Net increase (decrease) in cash and cash equivalents from
continuing operations (138) 1,257
Net decrease in cash and cash equivalents from
discontinued operation - (177)
Cash and cash equivalents, beginning of the period 1,707 738
---------- ----------
Cash and cash equivalents, end of the period $ 1,569 $ 1,818
========== ==========
Supplemental information:
Cash paid during the period for interest $ 377 $ 700
Cash paid (refunded) during the period for income taxes $ 160 $ (674)
Equipment obtained through lease financing $ - $ 100
See notes to condensed unaudited consolidated financial statements.
7
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. Condensed unaudited consolidated financial statements
Certain information and note disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP) have been omitted from
these condensed unaudited consolidated financial statements. These
condensed unaudited consolidated financial statements should be read in
conjunction with the financial statements and notes thereto included in the
Company's Form 10-K for the fiscal year ended September 30, 2002. The
results of operations for the three- and nine-month periods ended June 30,
2003 are not necessarily indicative of the operating results for the full
year.
In the opinion of management, all adjustments, consisting only of normal
recurring accruals, have been made to present fairly the Company's
financial position at June 30, 2003 and the results of its operations for
the three- and nine-month periods ended June 30, 2003 and 2002 and its cash
flows for the nine-month periods ended June 30, 2003 and 2002.
2. Stock Compensation
The Company has elected to account for its stock-based compensation plans
under Accounting Principles Board Opinion No. 25 ("APB 25"). If the Company
had accounted for its stock-based compensation plans under Statement of
Financial Accounting Standards ("SFAS") No. 123, the Company's net earnings
and earnings per share would approximate the pro forma disclosures below
(in thousands, except per share amounts):
Nine months ended
-----------------
June 30, 2003 June 30, 2002
------------------------- ---------------------------
As Reported Pro Forma As Reported Pro Forma
------------- ----------- ------------- -------------
Net earnings (loss) $ 4,376 $ 4,150 $ (2,373) $ (2,634)
Earnings (loss) per share
- basic $ 0.92 $ 0.88 $ (0.62) $ (0.68)
- diluted $ 0.88 $ 0.84 $ (0.62) $ (0.68)
Three months ended
------------------
June 30, 2003 June 30, 2002
------------------------- ---------------------------
As Reported Pro Forma As Reported Pro Forma
------------- ----------- ------------- -------------
Net earnings $ 3,002 $ 2,904 $ 1,390 $ 1,275
Earnings per share
- basic $ 0.63 $ 0.62 $ 0.25 $ 0.23
- diluted $ 0.60 $ 0.58 $ 0.25 $ 0.23
8
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
During the nine-month period ending June 30, 2003, the Company granted
162,500 stock options. The weighted average fair value of the options
granted, using the Black-Scholes methodology, was $5.36 per share. The
total value of these options was $872,000 which would be amortized over a
vesting period of approximately five years. The option prices range from
$5.62 to $9.70 per share. These options expire on dates beginning May 2008
and ending May 2013.
3. Income taxes
The provision for income taxes is based on the estimated effective income
tax rate for the year.
4. Comprehensive income (loss)
The Company's consolidated comprehensive income (loss) was $3,204,000 and
$1,894,000 for the three months ended June 30, 2003 and 2002, respectively
and $5,207,000 and ($1,940,000) for the nine months ended June 30, 2003 and
2002, respectively. The differences between the net earnings (loss)
reported in the condensed unaudited consolidated statements of earnings
(loss) and the consolidated comprehensive net income (loss) for the periods
consisted of changes in foreign currency translation adjustments.
5. Goodwill and other intangible assets
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 142, Goodwill and Other Intangible Assets, which was effective October
1, 2002. The Company elected to early adopt SFAS No. 142 prior to the
filing of its first quarter financial statements on Form 10-Q for the
quarter ending December 31, 2001. SFAS No. 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill, and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS No.
142 also requires the Company to complete a transitional goodwill
impairment test within six months from the date of adoption. As a result of
the implementation of this change in accounting principle, the Company
recorded an impairment of goodwill associated with the automated inspection
systems reporting unit, based on a discounted cash-flow analysis, effective
at the beginning of fiscal 2002, of $4.4 million, and related income tax
benefits of $71,000. The Company determined there was no impairment to the
$2.5 million of goodwill associated with the process systems reporting
unit.
6. Product warranties
In November 2002, the FASB issued FASB Interpretation No. 45, which, among
other things, requires additional disclosure related to a company's product
warranties. As described in the Company's "Application of Critical
Accounting Policies" section of its Management's Discussion and Analysis of
Financial Condition and Results of Operations, the Company's products are
covered by warranty plans that extend between 90 days and 2 years,
depending upon the product and contractual terms of sale. The Company
establishes allowances for warranties on an aggregate basis for
specifically identified, as well as anticipated, warranty claims based on
contractual terms, product conditions and actual warranty experience by
product line.
A reconciliation for the charges in the Company's allowances for warranties
for the nine months ended June 30, 2003 and 2002 (in thousands) is as
follows:
9
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
Nine months ended
---------------------------------------------
June 30, 2003 June 30, 2002
------------------ ------------------
Beginning balance $ 869 $ 748
Warranty costs incurred (1,283) (1,898)
Warranty expense accrued 1,163 1,920
Translation adjustments 21 2
------------------ ------------------
Ending balance $ 770 $ 772
================== ==================
7. Accounting pronouncements adopted
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements
No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections, which was effective October 1, 2002. Earlier application of
this Statement was encouraged, but not required. SFAS No. 145, among other
things, rescinds the requirement of SFAS No. 4 to treat gains and losses on
the early extinguishment of debt as extraordinary items. Restatement of
prior periods is required. As a result, amounts recorded in fiscal year
2002 as extraordinary items from the early extinguishment of debt have been
restated to part of net income from continuing operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated
with Exit or Disposal Activities. The standard requires companies to
recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to an exit or disposal
plan. Costs covered by the standard include lease termination costs and
certain employee severance costs that are associated with a restructuring.
This statement is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. The Company believes that
this statement did not have a material effect on its financial statements.
8. Future accounting changes
In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which is effective October 1, 2003. SFAS No. 143
requires, among other things, the accounting and reporting of legal
obligations associated with the retirement of long-lived assets that result
from the acquisition, construction, development, or normal operation of a
long-lived asset. The Company is currently assessing but has not yet
determined the effect of SFAS No. 143 on its financial position, results of
operations, and cash flows.
In November 2002, the Emerging Issues Task Force (EITF) ratified a
consensus on Issue No. 00-21, Revenue Arrangements with Multiple
Deliverables, which is effective for the Company beginning October 1, 2003.
Issue No. 00-21 addresses accounting and reporting of a company's delivery
or performance of multiple products, services, and/or rights customers
might have to use a company's held assets to fulfill its needs, with
delivery or performance that may occur at different points in time or over
different periods of time. Management is currently evaluating the effects
of this issue on the Company's consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation - Transition and Disclosure, which is effective for fiscal
years ending after December 31, 2002. SFAS No. 148 provides alternative
methods of transition for a voluntary change to the fair value method of
accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS No. 123 to require
prominent disclosures about the method of accounting for stock-based
employee compensation and the effect of the method used on reported
results. The Company has adopted the disclosure requirements (see Note 2).
The Company is currently assessing but has not yet determined the effect of
the remaining provisions of SFAS No. 148 on its financial position, results
of operations, and cash flows.
10
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
NOTES TO CONDENSED UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
In May of 2003, the FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Liabilities and Equity. The
statement establishes standards for issuers' classification as liabilities
in the balance sheet of certain financial instruments that have
characteristics of both liabilities and equity, including financial
instruments which are mandatorily redeemable on a fixed date. This
statement will be effective upon issuance for all contracts created or
modified after the date the statement is issued and will otherwise be
effective beginning the fourth quarter of fiscal 2003. As such, the Company
believes its mandatorily redeemable preferred stock and warrants will be
classified as liabilities.
In November of 2002, the FASB issued Financial Interpretation No. 45,
Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others, on the accounting
and disclosure guidance for guarantors. The standard requires guarantors to
recognize at inception the fair value of all its obligations it has
undertaken to issue a guarantee and requires additional disclosures related
to such. This statement, as it relates to the recognition and measurement
of the liability, if any, would be effective in fiscal 2004 and the Company
does not believe this will have a material effect on its financial
statements. The disclosure requirements, which include a tabular
reconciliation of warranty accrual activity, are effective for fiscal 2003
(see Note 6).
9. Use of estimates
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and reported amounts of
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Certain statements set forth below may constitute "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995. The
forward-looking statements involve known and unknown risks, uncertainties and
other factors that may cause the actual results, performance or achievements to
differ from those expressed or implied by the forward-looking statements. With
respect to the Company, the following factors, among others, could cause actual
results or outcomes to differ materially from current expectations:
- -- the effect of adverse economic conditions in markets served by the Company
and the financial capacity of customers to purchase capital equipment;
- -- the possible adverse effect on sales and prices of competition and advances
in technology;
- -- the ability of new products to compete successfully in either existing or
new markets; o the risks associated with adverse fluctuations in the
foreign currency exchange rates;
- -- the risks involved in expanding international operations and sales;
- -- the availability and future costs of materials and other operating
expenses;
- -- the potential for patent-related litigation expenses and other costs
resulting from claims asserted against the Company or its customers by
third parties; and
- -- other factors discussed in Exhibit 99.1 to the Company's Annual Report on
Form 10-K filed with the SEC in December 2002 which exhibit is hereby
incorporated by reference.
Given these uncertainties, readers are cautioned not to place undue reliance on
the forward-looking statements. The Company disclaims 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.
Application of Critical Accounting Policies
- -------------------------------------------
The Company has identified its critical accounting policies, the application
of which may materially affect the 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 and Statement of Financial Accounting Standards ("SFAS)
No. 142
- -- Allowances for warranties
- -- Accounting for income taxes
Management has discussed the development and selection of these critical
accounting estimates and their related disclosures in the MD&A section of the
Company's periodic reports with the Audit Committee of the Company's Board of
Directors.
Revenue Recognition. The Company recognizes revenue when persuasive evidence
of an arrangement exists, delivery has occurred or services have been provided,
the sale price is fixed or determinable, and collectibility is reasonably
assured. Additionally, the Company sells its goods on terms that 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 factors are
met, including transfer of title and risk of loss, which occurs either upon
shipment by the Company or upon receipt by customers at the location specified
in the terms of sale. Revenue earned from services is recognized ratably over
the contractual period or as the services are performed. If all conditions of
revenue recognition are not met, the Company defers revenue recognition. In the
event of revenue deferral, the sales value is not recorded as revenue to the
Company, accounts receivable are reduced by any amounts owed by the customer,
and the cost of the goods or services deferred is carried in inventory. The
Company believes that revenue recognition is a "critical accounting estimate"
because the Company's terms of sale may vary significantly, and management
exercises judgment in determining whether to defer revenue recognition. Such
judgments may materially affect net sales for any period. Management exercises
judgment within the parameters of GAAP in determining when contractual
obligations are met, title and risk of loss are transferred, sales price is
fixed or determinable and collectibility is reasonably assured. During fiscal
2002 and 2003, some customers were more aggressive in requiring additional
contractual commitments from the Company before final acceptance of equipment
and associated transfer of title could occur, which has resulted in additional
deferrals of revenue recognition. Increased customer contractual obligations may
affect revenue recognition on an increased, yet indeterminate, amount of
shipments in future periods. At June 30, 2003, the Company had deferred revenues
of $1,652,000 as compared to $1,463,000 at September 30, 2002.
12
Allowances for doubtful accounts. The Company establishes 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 collectibility of receivables include customer satisfaction
and general economic or political factors in certain countries that affect the
ability of customers to meet current obligations. The Company actively manages
its credit risk by utilizing an independent credit rating and reporting service,
by requiring certain percentages of down payment and progress payments on
significant customer projects and by requiring secured forms of payment for
customers with uncertain credit profiles or locations 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. The Company believes 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 the Company's control. As
of June 30, 2003, the balance sheet included allowances for doubtful accounts of
$411,000. Actual charges to the allowance for doubtful accounts for the
nine-month period ended June 30, 2003 were $25,000. If the Company experiences
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
profits.
Valuation of inventories. Inventories are stated at the lower of cost or
market. The Company's inventory includes purchased raw materials, manufactured
components, purchased components, work in process, finished goods and
demonstration equipment. Provisions 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 the Company's
purchasing practices, electronic component obsolescence, accuracy of sales and
production forecasts, introduction of new products, product lifecycles and the
associated product support. The Company actively manages its 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 such inventory minimization strategies as vendor-managed inventories.
The Company believes 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, production and to after-sale support. At June 30, 2003, cumulative
inventory adjustments to lower of cost or market totaled $2.6 million compared
to $2.3 million at September 30, 2002. 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, a decrease to
gross margins and may adversely affect the borrowing base available under the
Company's credit facilities.
13
Long-lived assets and SFAS No. 142. The Company regularly reviews all of its
long-lived assets, including property, plant and equipment and intangible
assets, for impairment whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. If the total of future undiscounted
cash flows is less than the carrying amount of assets, an impairment loss, if
any, based on the excess of the carrying amount over the fair value of the
assets, is recorded. As of June 30, 2003, the Company held $17.4 million of
property, plant and equipment and intangible assets, net of depreciation and
amortization. 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 fair values. The Company believes 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 the Company's balance sheet and the
potential material adverse effect on the 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, a charge to income from continuing
operations and a reduction to net profit in the affected period, and may affect
the Company's ability to meet the tangible net worth covenant of it credit
facilities.
Allowances for warranties. The Company's products are covered by warranty
plans that extend between 90 days and 2 years, depending upon the product and
contractual terms of sale. The Company establishes 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. Company products include both manufactured and purchased components, and
therefore warranty plans include third-party sourced parts that may not be
covered by the third-party manufacturer's warranty. Ultimately, the warranty
experience of the Company is directly attributable to the quality of its
products. The Company actively manages its quality program by using a structured
product introduction plan, process monitoring techniques utilizing statistical
process controls, vendor quality metrics, a quality training curriculum for
every employee and feedback loops to communicate warranty claims to designers
and engineers for remediation in future production. Warranty expense has varied
widely in the past due to such factors as significant new product introductions
containing latent defects and design errors on individual large projects. The
Company believes 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 the
Company does not control. As of June 30, 2003, the balance sheet included
allowances for warranties of $770,000, while $1,283,000 of warranty charges were
incurred during the nine months ended June 30, 2003. If the Company's actual
warranty costs are higher than estimates, warranty plan coverages are adversely
varied, or estimates are adversely adjusted in future periods, allowances for
warranty would decrease, warranty expense would increase and gross margins would
decrease. See Note 6.
Accounting for income taxes. The Company's 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 such as foreign tax credit carryovers 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. There was no
valuation allowance at June 30, 2003, due to anticipated utilization of all tax
deferred tax assets. During the period, income tax expense was reduced by
approximately $200,000 due primarily to changes in tax laws which
re-characterized previously non-deductible items. The Company believes 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 the Company's 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 established 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
income.
14
Results of Operations
- ---------------------
Sales for the three-month period ended June 30, 2003 increased 25.8% to $25.0
million compared with $19.9 million in the corresponding quarter last year. Net
earnings for the quarter were $3.0 million, or $0.60 per diluted share, compared
with net earnings of $1.4 million, or $0.25 per diluted share, in the
corresponding period a year ago.
Sales for the nine months ended June 30, 2003 were $61.3 million compared with
$52.7 million for the comparable period in fiscal 2002. The Company reported net
earnings for the period of $4.4 million, or $0.88 per diluted share, compared
with a net loss of $2.4 million, or $0.62 per diluted share, for the nine-month
period in fiscal 2002. The nine-month period ended June 30, 2002 included a $4.3
million charge for the impairment of goodwill resulting from the Company's
implementation of SFAS No. 142. Excluding this charge, net earnings from
continuing operations for the nine-month period ended June 30, 2002 were $1.9
million, or $0.27 per diluted share.
Three Months. Net sales increased $5.1 million, or 25.8%, in the 2003 third
quarter to $25.0 million from $19.9 million in the 2002 second quarter.
Shipments were up in all product lines, with process systems up $3.1 million,
parts and service up $1.2 million and automated inspection systems up $0.8
million.
Orders decreased $5.5 million, or 25.8%, in the 2003 third quarter to $15.7
million, compared to $21.2 million in the 2002 third quarter. Orders received in
the period one year ago included a single large order by a customer in the
french fry industry while orders in the current year do not include any large
projects. Excluding this large project, orders received in the third quarter of
fiscal 2003 are comparable to those of a year ago and reflect the seasonal
nature of the Company's business.
The Company's backlog decreased $0.9 million, or 4.7%, at the end of the 2003
third quarter to $18.0 million from $18.9 million at the end of the 2002 third
quarter. Backlog from the prior year included the large customer order mentioned
above while backlog at the end of the 2003 third quarter does not include any
large projects. The product mix in the current backlog is consistent with the
product mix in the fourth quarter of last year.
Gross profit increased $2.7 million, or 32.6%, in the third quarter to $11.0
million from $8.3 million in the 2002 third quarter. Gross profit as a percent
of sales increased to 43.9% in the third quarter of 2003 from 41.6% in the third
quarter of 2002. Margins were favorably impacted by product mix, efficiencies in
all manufacturing operations due to heavy shop loading, and by improved results
in the Company's European operations.
15
Operating expenses increased by $0.4 million, or 6.4%, in the third quarter of
2003 to $6.7 million from $6.3 million in the 2002 third quarter. Third quarter
2003 operating expenses reflect several non-recurring items and the Company
expects fourth quarter expenses will return to levels experienced in previous
quarters. Operating expenses as a percent of sales declined to 26.6% in the
third quarter of 2003 from 31.5% in the third quarter of 2002.
Included in the Company's Consolidated Statements of Earnings for the period
ending June 30, 2002 was a gain on sale of assets for $0.9 million resulting
from the sale of the Medford, Oregon facility.
Other expense declined by $721,000 in the 2003 third quarter to $20,000 from
$741,000 in the 2002 third quarter. The prior year period contained a $0.5
million loss from the early extinguishment of debt related to the early payment
penalty on the retirement of the mortgage on the Medford building. The current
period also reflects reduced interest expense related to reductions of
interest-bearing debt.
Nine Months. Net sales increased by $8.7 million, or 16.4%, in the fiscal 2003
nine-month period to $61.3 million from $52.7 million in the 2002 nine-month
period. Automated inspection systems and process systems contributed to the
increase by $3.9 million and $3.6 million respectively. The parts business
contributed $1.8 million, partially offset by a drop in service contracts.
Orders increased by $5.1 million, or 8.7%, in the 2003 nine-month period to
$63.8 million from $58.7 million in the prior nine-month period. Year-to-date
increases can be attributed to the Company's Optyx(R) and tobacco sorter product
lines as well as strength in its European subsidiary.
Gross profit increased by $4.2 million, or 19.6%, in the 2003 nine-month period
to $25.4 million from $21.2 million in the prior nine-month period. Gross profit
as a percent of sales increased to 41.4% in third quarter of 2003 from 40.3% in
the third quarter of 2002. Factory efficiencies and improved performance in the
Company's European operation contributed to the increase.
Operating expenses increased by $0.9 million, or 5.1%, in the 2003 nine-month
period to $18.8 million from $17.9 million in the 2002 corresponding period.
Operating expenses as a percentage of sales were 30.6% for the 2003 nine-month
period compared to 33.9% in the prior year and were in line with the Company's
expectations.
Other expense decreased by $1.2 million in the 2003 nine-month period to $0.2
million from $1.4 million in the 2002 nine-month period. Improvements are due to
reduced interest expense resulting from decreased interest-bearing debt plus a
favorable foreign currency exchange rate for the period. Included in other
expense for the 2002 period was a $0.5 million loss from the early
extinguishment of debt related to the early payment penalty on the retirement of
the mortgage on the Medford building.
Net earnings from continuing operations increased by $2.5 million, or 131.5%, in
the 2003 nine-month period to $4.4 million from $1.9 million in the 2002
nine-month period. The increase in sales, margins and continued emphasis on cost
controls contributed to this improvement.
Liquidity and Capital Resources
For the nine months ended June 30, 2003, net cash provided by operating
activities totaled $9.2 million compared with cash provided by operating
activities of $7.7 million in the corresponding period of the prior fiscal year.
During the most recent nine-month period, net earnings of $4.4 million, net of
non-cash charges of $4.3 million, contributed cash of $8.7 million from
operating activities. Non-cash charges consisted primarily of depreciation,
amortization, and deferred income taxes (due to application of net operating
loss carry forwards). Cash from operations was also provided by an increase in
customers' deposits of $0.9 million, increases in accounts payable of $1.3
million, and increases in accrued payroll and other accrued liabilities of $1.5
million. These contributions to cash were partially offset by increases in
inventories of $0.9 million and increases in accounts receivable of $3.4
million.
16
Net cash resources used in investing activities was $0.7 million in the nine
months ended June 30, 2003 compared to cash provided of $7.5 million in the
comparable period a year ago. The current period spending funded the acquisition
of capital goods in the amount of $0.7 million, an increase of $0.2 million over
the corresponding period last year. The corresponding period last year also
included cash proceeds of $3.6 million from the sale of a discontinued operation
and $4.3 million from the sale of property. At June 30, 2003, the Company had no
significant commitments for capital expenditures.
Net cash used in financing activities during the nine months ended June 30, 2003
totaled $9.0 million, reflecting repayments of short term borrowings of $6.7
million, repayments of long term debt of $1.4 million, long term borrowing of
$0.5 million, and redemption of preferred stock and warrants of $1.5 million.
This use of cash compares to net cash flows used in financing activities of
$14.0 million in the nine-month period of the prior year, consisting of
repayments of short-term debt of $2.0 million, repayment of long-term debt of
$18.0 million and $6.5 million of additions to long-term debt. The Company
continues to maintain strong cash flows from operating activities and has
therefore been able to make significant reductions to bank debt and redeemable
preferred stock and warrants. The Company anticipates making further reductions
to bank debt, convertible preferred stock, and warrants in the remainder of
2003.
During the nine-month period ended June 30, 2003, working capital increased by
$7.0 million to $14.6 million. At the end of the period, the balance of cash and
cash equivalents totaled $1.6 million, a $0.1 million decrease compared to the
balance at the beginning of the period, resulting from the Company's operating,
investing and financing activities during the period. Trade accounts receivable
increased by $3.8 million principally as a result of a high volume of shipments
during the most recent quarter. Inventories increased by $1.6 million as a
result of increases in raw materials and work-in-process inventories to support
the future production requirements represented by the increased backlog. Current
liabilities decreased by $2.4 million to $16.4 million. Accounts payable,
customer deposits, and accrued payroll expenses were up for the period, but
short-term borrowings were zero and the current portion of long term debt was
down compared to the beginning of the nine-month period.
The Company's domestic credit facility provides a credit accommodation totaling
$14.4 million, consisting of a term loan of $3.4 million, a revolving credit
facility of up to the lesser of $10.0 million or the available borrowing base,
which is based on varying percentages of eligible accounts receivable and
inventories, and a $1.0 million standby line of credit. The term loan and
operating line bear interest at the Wall Street Journal prime rate plus 1.0% and
prime plus 0.5% per annum respectively, which totaled 4.75% at June 30, 2003,
while the standby line of credit, should it be utilized, bears interest at the
Wall Street Journal prime rate plus 2%. The credit facility is secured by all of
the United States personal property, including patents and other intangibles, of
the Company and its subsidiaries, and contains covenants which require the
maintenance of a defined debt service ratio, a defined net worth balance and
ratio, minimum working capital and current ratio, and minimum profitability. At
June 30, 2003, the Company was in compliance with all loan covenants and had an
available borrowing base of approximately $7.8 million under the revolving
credit facility. At June 30, 2003, there were no borrowings under this facility
and $3.4 million under the term loan with no borrowings under the standby line
of credit.
17
The revolving credit facility matured on July 31, 2003 and was renewed by an
Amendment to Loan Documents extending the maturity date to July 31, 2004.
Various adjustments to the covenants were included as well as a reduction of
interest rates on any outstanding balance from the Wall Street Journal prime
rate plus 0.5% per annum to prime rate plus 0.0%. The standby line of credit is
no longer needed and was not renewed. The Company's term loan remains in place
with a maturity date of July 31, 2007.
Additionally, the Company's credit accommodation with a commercial bank in The
Netherlands provides a credit facility for its European subsidiary. This credit
accommodation totals $3.8 million and includes a term loan of $840,000, an
operating line of the lesser of $1.8 million or the available borrowing base,
which is be based on varying percentages of eligible accounts receivable and
inventories, and a bank guarantee facility of $1.2 million. If the bank
guarantees total more than $1.2 million, the operating line will be reduced by
the excess amount. The term loan facility requires quarterly payments of
principal and matures in August 2012. The term loan is secured by real property
of the Company's European subsidiary, while the operating line and bank
guarantee facility are secured by all of the subsidiary's personal property. The
credit facility bears interest at the bank's prime rate plus 1.75%, which at
June 30, 2003 totaled 4.50%. At June 30, 2003, the Company had borrowings under
this facility of $840,000 in term loans. Additionally, the Company had secured
bank guarantees of $1,573,000 under the agreement.
Outstanding Series B convertible preferred stock totaled 161,930 shares as of
June 30, 2003, and outstanding warrants totaled 38,388. Preferred stock and
warrants are redeemable upon demand and will require the payment of
approximately $2.0 million when presented. Presentments for preferred stock and
warrant redemptions have slowed recently, and therefore the Company expects to
fund future redemptions from operating cash flows.
The Company anticipates that the future cash flows from operations along with
currently available operating credit lines will be sufficient to fund presently
foreseeable cash needs and provide for future growth.
The Company's continuing contractual obligations and commercial commitments
existing on June 30, 2003 are as follows:
Payments due by period (in Thousands)
Less than 1 After 5
Contractual Obligations Total year 1-3 years 4-5 years years
- ------------------------------------------------------------------------------------------------
Long-term debt * $ 4,240 $ 941 $ 1,940 $ 1,157 $ 202
Capital lease obligations 374 171 201 2 -
Operating leases 12,460 1,379 2,834 2,530 5,717
Warrant redemption obligations 384 384 - - -
Series B redemption obligations 1,619 1,619 - - -
-----------------------------------------------------------
Total contractual cash obligations $ 19,077 $ 4,494 $ 4,975 $ 3,689 $ 5,919
===========================================================
* Includes the revolving credit line, term loan and mortgage payments on the
Company's owned facility in Europe.
18
At June 30, 2003, the Company had standby letters of credit totaling $2.1
million, which includes secured letters of credit under the Company's credit
facility in Europe and letters of credit securing certain self-insurance
contracts and lease commitments.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Market Risk
The Company has assessed its exposure to market risks for its financial
instruments and has determined that its exposures to such risks are generally
limited to those affected by the strength of the U.S. dollar against the Euro
and to a lesser extent the Australian dollar.
The terms of sales to European customers are typically denominated in either
Euros, U.S. dollars, or to a far lesser extent, the respective legacy currencies
of its European customers. The terms of sales to customers in Australia/New
Zealand are typically denominated in their local currency. The Company expects
that its standard terms of sale to international customers, other than those in
Europe and Australia/New Zealand, will continue to be denominated in U.S.
dollars. For sales transactions between international customers, including
European customers, and the Company's domestic operations, which are denominated
in currencies other than U.S. dollars, the Company assesses its currency
exchange risk and may enter into a currency hedging transaction to minimize such
risk. At June 30, 2003, the Company was not a party to any currency hedging
transactions. As of June 30, 2003, management estimates that a 10% change in
foreign exchange rates would affect net income before taxes by approximately
$129,000 on an annual basis as a result of converted cash and accounts
receivable denominated in foreign currencies.
During the nine-month period ended June 30, 2003, the Euro gained a net of 15%
in value against the U.S. dollar. The effect of the weaker dollar on the
operations and financial results of the Company were:
- -- Translation adjustments of $631,000, net of income tax, were recognized as
a component of comprehensive income as a result of converting the Euro
denominated balance sheet of Key Technology B.V. into U.S. dollars.
- -- Foreign exchange gains of $261,000 were recognized in the other income and
expense section of the consolidated income statement as a result of
conversion of Euro and other foreign currency denominated receivables and
cash carried on the balance sheet of the U.S. operations, as well as the
result of the conversion of other non-functional currency receivables,
payables and cash carried on the balance sheet of the European operations.
A relatively weaker U.S. dollar on the world markets makes the Company's
U.S.-manufactured goods relatively less expensive to international customers
when denominated in U.S. dollars or potentially more profitable to the Company
when denominated in a foreign currency. A relatively weaker U.S. dollar on the
world markets, especially as measured against the Euro, may favorably affect the
Company's outlook for international sales.
The Company anticipates that the reduction of U.S. interest rates during the
fiscal first quarter of the year will result in a corresponding reduction of
customers' cost of capital, which had previously contributed to the delay of
certain projects. However, there can be no assurance that customers in the
Company's markets will maintain or increase their investment in Company products
as a result of changes in the cost of capital and other market or economic
factors.
19
Under the Company's current credit facilities, the Company may borrow at the
lender's prime rate plus between 100 - 200 basis points. At June 30, 2003, the
Company had $3.4 million of borrowings that had variable interest rates. During
the quarter then ended, the interest rate on its various credit facilities
ranged from 4.50% to 5.25%. At June 30, 2003, the interest rate ranged from
4.50% to 4.75%. As of June 30, 2003, management estimated that a 100 basis point
change in the interest rate would affect net income before taxes by
approximately $34,000 on an annual basis.
ITEM 4. CONTROLS AND PROCEDURES.
The Company's President and Chief Executive Officer and the Chief Financial
Officer have reviewed the disclosure controls and procedures relating to the
Company at June 30, 2003 and concluded that such controls and procedures were
effective to provide reasonable assurance that all material information about
the financial and operational activities of the Company was made known to them.
There were no changes in the Company's internal control over financial reporting
during the quarter ended June 30, 2003 that materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002
32.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K
1. Registrant's Form 8-K dated April 24, 2003 and filed with
the Securities and Exchange Commission on April 24, 2003
related to a press release regarding Key's financial results
for its second fiscal quarter ended March 31, 2003.
2. Registrant's Form 8-K dated June 9, 2003 and filed with the
Securities and Exchange Commission on June 9, 2003 related
to a press release announcing that Kirk W. Morton has been
elected to succeed Thomas C. Madsen as Chief Executive
Officer of the Company.
20
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
SIGNATURES
- --------------------------------------------------------------------------------
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
KEY TECHNOLOGY, INC.
(Registrant)
Date: August 13, 2003 By /s/ Kirk W. Morton
----------------------------------------------
Kirk W. Morton,
President and Chief Executive Officer
Date: August 13, 2003 By /s/ Phyllis C. Best
-----------------------------------------------
Phyllis C. Best,
Chief Financial Officer
(Principal Financial and Accounting Officer)
21
KEY TECHNOLOGY, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE NINE MONTHS ENDED JUNE 30, 2003
- --------------------------------------------------------------------------------
EXHIBIT INDEX
Exhibit
- -------
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002
32.1 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
32.2 Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant
to Section 906 of the Sarbanes-Oxley Act of 2002
22