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 of the Company 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:
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adverse economic conditions, particularly in the food processing industry, may adversely affect the Company's revenues; |
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competition and advances in technology may adversely affect sales and prices; |
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the Company's new products may not compete successfully in either existing or new markets; |
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the limited availability and possible cost fluctuations of materials used in the Company's products could adversely affect the Company's gross profits; |
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the Company's inability to protect its intellectual property may adversely affect the Company's competitive advantage; |
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intellectual property-related litigation expenses and other costs resulting from infringement claims asserted against the Company or its customers by third parties may adversely affect the Company’s results of operations and its customer relations; and |
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other factors discussed in Exhibit 99.1 hereto which is incorporated herein 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.
General
Key Technology, Inc. (the “Company”) was founded in 1948 as a local producer of vegetable processing equipment. The Company has evolved into a worldwide supplier of process automation solutions to the food processing industry and other industries such as tobacco, plastics and pharmaceuticals. The present Company was incorporated in 1982 as a result of a management buyout of the predecessor organization.
The Company and its operating subsidiaries design, manufacture, sell and service process 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 which include specialized conveying and preparation systems. The Company provides parts and service for each of its product lines to customers throughout the world. Industries served include food processing, non-food and industrial applications.
Sales for the year ended September 30, 2004 were $80.6 million compared with $82.6 million for fiscal 2003. The Company reported net earnings for fiscal 2004 of $3.7 million, or $0.71 per diluted share, compared with net earnings of $5.8 million, or $1.15 per diluted share, for fiscal 2003. Export and international sales for the fiscal years ended September 30, 2004, 2003 and 2002 accounted for 44%, 50% and 42% of net sales in each such year, respectively.
Industry Background
Food Processing Industry
The Company's primary market is the food processing industry. Food processors must process large quantities of raw product through different stages, including sorting to remove defective pieces and inspection for product quality and safety. The frequency and severity of defects in the raw product is highly variable depending upon local factors affecting crops. Historically, defect removal and quality control in the food processing industry have been labor intensive and
dependent upon and limited by the variability of the work force. The industry has sought to replace manual methods with automated systems that achieve higher yield, improve product quality and safety, and reduce costs.
The Company's strategy is to solve processing industry problems of high labor costs, inadequate yields and inconsistent quality and safety by providing automated inspection systems and process systems. The Company's process automation systems use advanced optical inspection technology to improve product yield (more of the good product recovered) and quality (higher percentage of defective product being removed) over the manual sorting and defect removal methods historically used by food processors. In a typical application, process automation systems can replace 5 to 75 processing line employees, resulting in labor cost savings and improved yield sufficient to pay for the system in less than one year, as well as providing significant improvements in product quality.
The largest markets for the Company's products have been processors of potatoes, vegetables and snack foods. The Company has also experienced recent success in the dry product markets, which include cereals and pet food. The Company believes many additional applications for its systems exist in both food and non-food markets.
The principal potato market served by the Company's systems is french fries. French fries comprise approximately 90% of the over eight billion pounds of frozen potato products processed annually in the United States. The expansion of American-style fast food chains in other countries is resulting in development of the frozen french fry market overseas. Current investment in new french fry processing facilities has declined relative to historical levels, largely in response to changing consumer preferences. The Company’s diversification strategies during this same period have resulted in less dependence on this industry although it continues to be a strategically important market.
The Company's products are used in the fruit and vegetable processing market where field-harvested products are cleaned, graded, automatically sorted, blanched and processed prior to freezing, canning or packaging for sale to institutional and retail markets. Principal fruit and vegetable markets for the Company are green beans, corn, carrots, peas, onions, apples, pears, cranberries and peaches.
The global food processing industry has been in a consolidation period and market conditions suggest further consolidation in the future. The Company believes the resulting food processing companies are financially stronger, yet are faced with the need to improve profitability while satisfying external pressures to hold or reduce prices for their own products and provide safer products to the consuming public. Since the Company’s equipment results in higher product yields, improved product quality and safety, as well as reduced processing costs, the Company believes these surviving companies will have increased interest in the Company’s products to satisfy these needs, allowing for expanded sales into the food processing industry in future years. Due to the seasonal nature of the food processing industry
, the Company does experience some seasonality of orders and shipments. Orders and shipments to this industry in the Company’s first fiscal quarter of the year tend to be lower than during the Company’s other fiscal quarters. During fiscal 2004, the Company experienced project deferrals in the food processing industry with investment declines in the North American processed vegetable sector. In addition, an anticipated increase in spending in the worldwide snack food industry, particularly with replacement programs for older Key optical systems, did not materialize.
Non-food Industries - Tobacco, Pharmaceuticals & Plastics
Processors in non-food industries also implement systems solutions to reduce costs, increase yields, and produce higher quality products that are safe for consumers.
The largest non-food processing market for the Company is the tobacco processing market. With the acquisition of AMVC and its subsidiary SRC Vision in 2000, which had an installed base of over 100 automated inspection systems in the tobacco industry, the Company significantly increased its potential opportunities in this market and may be able to introduce additional products to tobacco customers. The Company’s products provide tobacco companies sorting capability to remove impurities and foreign matter from a stream of stripped tobacco. Although the Company also experienced project deferrals in the Asian toba
cco sector during fiscal 2004, the Company expects that the tobacco market may provide opportunities for expanded sales of process systems to complement new and existing installations of automated inspection systems.
At present, the pharmaceutical, plastics and other non-food industries represent a relatively small share of the Company’s sales and installed base. However, to further its growth strategy, the Company is actively pursuing expansion into new markets, such as chemical, plastics, and recycled paper. The Company believes market potential exists in the growing recycling industry where input process streams include a wide variety of mixed recyclable base materials. The Company believes the most promising applications are the recycling of plastics and paper, which form a large portion of the recycling market. The Company also believes that many additional applications for its products exist in both food and non-food markets, particularly in the area of automated process control.
Products
The following table sets forth sales by product category for the periods indicated:
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|
Fiscal Year Ended September 30, |
|
| |
|
2004 |
|
2003 |
|
2002 |
|
| |
|
(in thousands) |
|
|
Automated inspection systems |
|
$ |
28,675 |
|
|
36 |
% |
$ |
30,230 |
|
|
37 |
% |
$ |
24,965 |
|
|
35 |
% |
|
Process systems |
|
|
27,713 |
|
|
34 |
% |
|
31,759 |
|
|
38 |
% |
|
25,767 |
|
|
37 |
% |
|
Parts and service/contracts |
|
|
24,222 |
|
|
30 |
% |
|
20,633 |
|
|
25 |
% |
|
19,502 |
|
|
28 |
% |
|
Net sales |
|
$ |
80,610 |
|
|
100 |
% |
$ |
82,622 |
|
|
100 |
% |
$ |
70,234 |
|
|
100 |
% |
Service and maintenance contracts are less than 10% of total net sales and therefore are summarized with parts.
The following table sets forth the percent of the total gross margin contributed by each product category for the periods indicated:
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|
Fiscal Year Ended September 30, |
|
| |
|
2004 |
|
2003 |
|
2002 |
|
|
Automated inspection systems |
|
|
42 |
% |
|
42 |
% |
|
39 |
% |
|
Process systems |
|
|
22 |
% |
|
28 |
% |
|
28 |
% |
|
Parts and service/contracts |
|
|
36 |
% |
|
30 |
% |
|
33 |
% |
|
Total gross margin |
|
|
100 |
% |
|
100 |
% |
|
100 |
% |
Automated Inspection Systems
Automated inspection systems are used in various applications to detect and eliminate defects, most often during processing of raw and semi-finished products. The Company’s product families within this group include the following: ADR® automatic defect removal systems used in the French fry industry; Tobacco Sorter 3Ô tobacco sorting systems used in tobacco threshing and primary processing; and the Tegra® and Optyx® sorter families which are used in a wide variety of applications in many industries and markets. In fiscal 2004, the Company introduced G-6, a new vision engine, which will be used in its optical sorting systems, i
ncluding the Tegra, Optyx, and tobacco sorter product lines.
Nearly all systems in this group use proprietary linear array, charged coupled device ("CCD") monochromatic, color or multi-spectral cameras. Each of the cameras scan the product-streams, which move at 5 to 20 feet per second, at the rate of 1,500 to 4,000 times per second and can identify defects as small as 1/16 of an inch (1.5 mm) in diameter. Systems with monochromatic cameras generally are sold at lower price levels and are most effective for product that has a marked disparity in shade between the defective and the good product. Systems with color cameras are required when a variety of defect and product colors occur simultaneously or when the difference in shading between the defective and the good product is more subtle. In 1998, the Company developed multi-spectral systems which utilize either infrared or
ultraviolet technologies, individually or in combination with visible light, to identify defects that may not be detectable by using solely visible light spectra.
Tegra System. Tegra has been the leading seller of the Company’s automated inspection system product families for many years. Tegra incorporates object-specific sorting technology that recognizes not only color and size, but also
shape. This capability provides a solution to previously difficult sorting problems, such as differentiation between green beans and green bean stems. Tegra cameras are capable of high fidelity color-image processing to scan product at a rate of over 4,000 times per second, offering a sensitivity to color subtleties beyond human vision. Tegra also incorporates KeyWareÒ software that substantially reduces operational complexity. KeyWare consists of application packages, each specifically designed for a single product category that, together with the system’s computer hardware capability and networking software, support all standard factory con
trol and automation interfaces. These features allow Tegra to establish data connectivity and communication with a processing plant's computer network system. Certain present and potential applications for Tegra systems include potato products, green beans, dried beans, corn, carrots, peas, spinach and other leafy vegetables, pears, nuts, grains, coffee, recycled commodities such as paper and plastic, and tobacco.
Tobacco Sorter 3. The tobacco industry has special requirements in the handling and sorting of its tobacco products, which vary in size and moisture content and other properties depending upon the type of product being produced and the point of handling and inspection. Key’s Tobacco Sorter 3 (TS3), introduced worldwide in 2001, utilizes the machine vision engine of the PrismÒ System in a specially constructed frame, enclosure, and material handling arrangement to meet the specific product inspection requirements of this industry. TS3 has now b
een installed in North America, Latin America, Europe and Asia. Customers have benefited from TS3’s improved color resolution, significantly enhanced data communications capability, and reduced maintenance requirements.
Optyx System. During fiscal 2001 and 2002, the Company developed and introduced its new automated inspection systems making up the Optyx line of sorters. The Optyx 3000 series sorter has the power and sorting capabilities of a larger sorter in an economical and compact machine. The lower cost Optyx 3000 series is ideal for smaller processors and lower volume processing lines which were previously unable to justify the expense of a larger sorter. The larger Optyx 6000 series sorter replaces the former Prism 2. Optyx series sorters employ a novel broad-band illumination system and are designed to require minimal maintenance. The Optyx line of sorters has gained strong acceptance in segments of the fruit, vegetable, pr
ocessed potato and snack food markets. Additionally, Optyx has been placed in applications inspecting plastics, tobacco, and paper.
ADR System. The Company's ADR systems are used to transport, inspect and remove defects from french fry potatoes. The Company believes its ADR system is the principal optical inspection and defect removal system used in the french fry processing industry. The Company's full-capacity ADR systems can process up to 27,000 pounds of product per hour.
Pharmaceutical Inspection System. Using patented spatial color analysis technology, this product line inspects solid-dose pharmaceuticals, including tablets, capsules and soft gel caps for broken or missing pieces, foreign products, discoloration or coating defects, as well as the integrity of capsules. The pharmaceutical inspection system also verifies and detects color, size, location and shape defects at processing rates of over one million pieces per hour. Sales of this product line are a minor contributor to automated inspection system revenues.
ScanTrac. Through a joint venture with Peco Controls Corporation created in fiscal 2004, InspX LLC, the Company added an established product and new technical expertise in x-ray technology to its product line. ScanTrac is a compact, high performance x-ray system used to inspect packaged products for foreign material contamination or packaging imperfections.
Process Systems
Conveying and other custom designed processing systems are utilized throughout the food industry, as well as other industries, to move large quantities of product within a processing plant. The Company's process systems include the Iso-Flo, HorizonÔ, MarathonÔ, and ImpulseÔ vibratory conveyor systems. The Company’s product line is made up of mechanical sizing, sorting, separating and grading equipment. In addition, the process systems group includes other custom designed conveying and raw food sizing, grading and preparation equipment.
Iso-Flo Vibratory Conveying Systems. The Company's principal specialized conveying system is its Iso-Flo vibratory conveyor system. The Iso-Flo conveyor is a type of pan conveyor. Pan conveyors are common throughout industries that process product streams of discrete pieces, especially the food processing industry. Pan conveyors move
product pieces by vibrating the pan at high frequency along a diagonal axis, upward and forward. This action propels the product ahead in small increments and distributes it evenly for close control of movement and presentation.
Iso-Flo systems are used in a variety of processing applications, including potato products, vegetables and fruits (green beans, peas, carrots, corn, peaches, pears, cranberries and apples), snack foods, cereals, pet foods, poultry, and seafood. Non food processing applications include soap, tobacco, wood chips, plastics, and certain industrial applications.
The Horizon is a horizontal motion vibratory conveyor that uses a gentle conveying action to move fragile foods, such as snacks, cereals and seasoned/coated products, through the processing stages. The design of the Horizon eliminates vertical bounce of the processor’s product. The revised product action results in reduced costs to certain processors who have a specific need for very gentle product conveying. Cost savings result from reduced product damage, reduced seasoning/coating loss and elimination of condiment build-up on the conveying surface.
The Impulse is a line of electromagnetic conveyors which combine the advantage of quick start/stop with precise metering control. Additionally, the Impulse conveyor drive systems are oil-free, which limits the potential for contamination and improves the safety of edible food products. This conveyor system was developed for packaging applications in snack food, dry ingredient, chemical and pharmaceutical processing.
The Marathon is the Company’s longest conveyor and moves product up to 100 feet or more on a single conveyor bed. This conveyor is targeted for use in high volume applications such as corn, green beans and other bulk conveying markets to maximize the processor’s production efficiency.
The mechanical sizing, sorting, separating, and grading products sold under the Farmco brand name are used in many food processing systems. These proprietary rotary sizing and grading technologies optimize yield, increase packaging efficiency, and improve product quality primarily by removing either over or undersized and small irregular-shaped pieces of product from the line or separating product into predetermined size categories. In combination with other Company-provided equipment, these products can increase overall line efficiency and systems capability.
Food Pumping Systems and Belt Conveyors. The Company's hydro food pumping systems are used to transport food items over distances and elevations in processing plants. A typical pumping system consists of a stainless steel contoured tank and food pump to propel the product through lengths of piping to a water removal/product spreading subsystem. The systems can be configured so that food processing functions, such as blanching, cooling and cutting, can also occur during pumping. The Company also designs and manufactures belt conveyors using a variety of belt materials and frame configurations.
Preparation Systems. The Company designs and manufactures raw food preparation systems to prepare vegetables prior to freezing, canning or other processing. Products in this group include blanchers, air cleaners, air coolers, froth flotation cleaners, vegetable metering and blending systems, and bulk handling equipment. These products represent the Company's most mature product line. Sales of these products over the years have formed a customer base for sales of other Company products and are also establishing a customer base in markets in developing countries.
Preparation system revenues may also include a variety of third-party supplied equipment and installation services which are sold as components of larger processing lines, for which the Company has assumed turn-key sales responsibility. In addition, the process systems group includes other custom designed conveying and raw food sizing, grading, and preparation equipment.
Parts and Service/Contracts
The Company provides spare parts and post-sale field and telephone-based repair services to support its customers’ routine maintenance requirements and seasonal equipment startup and winterization processes. The Company considers its parts and maintenance service sales to be important potential sources of future revenue growth. The Company has realigned its service organization so that field service personnel are now geographically located closer to its customers throughout the world. This strategy has contributed to revenue growth and improved gross margins in parts and service.
The Company also typically provides system installation support services which are included in the sales price of certain of its products, principally automated inspection systems.
The Company believes that there is an opportunity for the sale of upgrade product offerings to its customers so that newer technology with advanced features, greater reliability, and performance enhancements can benefit owners of Key systems. The Company has developed specific upgrade products at the request of certain of its largest customers who own large numbers of the Company’s systems - particularly for its automated inspection systems. Additionally, the Company believes that its introduction of the G6 vision engine creates upgrade opportunities for many customers in its installed base of sorting systems.
Engineering, Research and Development
At September 30, 2004, the Company's research and development department had 46 employees who conduct new product research and development and sustaining engineering for released products. The Company’s technical staff includes electronic, optical, mechanical and software engineers, mathematicians and technical support personnel.
The Company’s project engineering department had 38 employees engaged in project engineering for custom systems. The project engineering teams are responsible for engineering and designing the details of each custom order. A document control team maintains and controls product documentation and the product modeling database for the development engineering and project engineering teams as well as the manufacturing department.
In fiscal 2004, the Company's research and development expenses, together with engineering expenses not applied to the manufacturing costs of products, were approximately $5.8 million, compared to $4.9 million and $4.5 million in 2003 and 2002, respectively.
Manufacturing
The Company maintains three domestic manufacturing facilities, two located in Walla Walla, Washington and one in Redmond, Oregon, and a European manufacturing facility located in The Netherlands. The Company's current manufacturing facilities and its product design and manufacturing processes integrate Computer Aided Engineering (CAE), Finite Element Analysis (FEA), Computer Aided Design (CAD), Computer Aided Manufacturing (CAM) and Computer Integrated Manufacturing (CIM) technologies. Manufacturing activities include process engineering; fabrication, welding, finishing, and assembly of custom designed stainless steel systems; camera and electronics assembly; subsystem assembly; and system test and integration. The Company manufactures specific products in the following locations:
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Location |
Size in Square Feet |
Products/Services Produced |
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