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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549-1004
 
 
FORM 10-K
 
x
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
            For the fiscal year ended September 30, 2002
 
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
 
 
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)
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
None
 
Securities registered pursuant to Section 12(g) of the Act:
 
Common Stock, no par value
Series B Convertible Preferred Stock, par value $.01 per share
Warrants to purchase Common Stock, dated July 12, 2000
 
 
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨  
 
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  ¨  No  x
 
The aggregate market value of the Registrant’s common stock held by non-affiliates on March 29, 2002 and December 4, 2002 (based on the last sale price of such shares) was approximately $13,991,722 and $21,523,081, respectively.
 
The number of shares of the Registrant’s common stock outstanding on December 4, 2002 was 4,767,206 shares of common stock.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
Parts of Registrant’s Proxy Statement dated on or about January 13, 2003 prepared in connection with the Annual Meeting of Shareholders to be held on February 5, 2003 are incorporated by reference into Part III of this Report.
 

Table of Contents
 
KEY TECHNOLOGY, INC.
2002 FORM 10-K
TABLE OF CONTENTS
 
PART I
        
PAGE
      Item 1.
      
1
      Item 2.
      
12
      Item 3.
      
12
      Item 4.
      
12
PART II
          
      Item 5.
      
13
      Item 6.
      
16
      Item 7.
      
17
      Item 7A.
      
30
      Item 8.
      
32
      Item 9.
      
59
PART III
          
      Item 10.
      
59
      Item 11.
      
59
      Item 12.
      
60
      Item 13.
      
60
      Item 14.
      
60
PART IV
          
      Item 15.
      
61
       SIGNATURES
   
64
       EXHIBIT INDEX
  
67
 

Table of Contents
 
PART I
 
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:
 
•
 
adverse economic conditions in the food processing industry may also adversely affect the Company’s business;
•
 
reductions in capital expenditures in industries served by the Company, and the financial capacity of customers in these industries to purchase capital equipment, may limit sales;
•
 
achievement of product performance specifications may increase warranty expenses;
•
 
competition and advances in technology may adversely affect sales and prices;
•
 
the Company’s new products may not compete successfully in either existing or new markets;
•
 
the Company may not be able to maintain or expand international operations and sales, which may adversely affect the Company’s sales;
•
 
adverse fluctuations in foreign currency exchange rates may adversely affect results of operations;
•
 
the Company may not be able to comply with bank covenants or obtain additional financing in the future, which may adversely affect the Company’s financial condition;
•
 
the Company’s future success is dependent upon the Company’s ability to develop, improve and market its products and services;
•
 
the limited availability and possible cost fluctuations of materials used in the Company’s products could adversely affect the Company’s business;
•
 
the Company’s substantial redemption obligations may adversely affect the Company’s operations and future growth;
•
 
the Company may not achieve its anticipated revenue growth objectives which may adversely affect the Company’s profitability and ability to retain key employees;
•
 
the Company’s inability to protect its intellectual property may adversely affect the Company’s competitive advantage;
•
 
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
•
 
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.
 
ITEM 1. BUSINESS.
 
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.

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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 and non-food and industrial applications such as tobacco, plastics, and pharmaceuticals.
 
Sales for the year ended September 30, 2002 were $70.2 million compared with $73.0 million for fiscal 2001. The Company reported net earnings from continuing operations for fiscal 2002 of $2.8 million, or $0.46 per diluted share, compared with a net loss from continuing operations of $2.3 million, or $0.69 per diluted share, for fiscal 2001. In addition to extraordinary losses of $0.5 million on early extinguishment of debt, the Company also recorded a non-cash loss of $4.3 million on the impairment of goodwill resulting from the implementation of Statement of Financial Accounting Standards (SFAS) No. 142, which was reported as a change in accounting principle and was adopted as of the beginning of the Company’s 2002 fiscal year. After giving effect to the losses due to the change in accounting principle and the extraordinary item, slightly offset by earnings from the discontinued operation, the net loss for the year ended September 30, 2002 was $2.0 million, or $0.53 per diluted share, compared to a net loss of $4.9 million, or $1.24 per diluted share, after giving effect to losses from a discontinued operation of $0.5 million and loss on the sale of the discontinued operation of $2.1 million in fiscal 2001.
 
The Company made two acquisitions during fiscal 2000. On June 1, 2000, the Company acquired Farmco, Inc. and its sister company Ro-Tech, Inc. (collectively “Farmco”). Farmco, based in Redmond, Oregon, designs, manufactures and sells equipment that mechanically sorts, grades, selects, or removes product based upon its size or shape. Subsequent to acquisition, the operations of Farmco were merged into the parent company operations. On July 12, 2000, the Company acquired Advanced Machine Vision Corporation (“AMVC”), a company based in Medford, Oregon. AMVC and its subsidiaries designed, manufactured and marketed machine vision systems that combine lighting, camera, processor and software technologies to improve quality, enhance yield, reduce production costs and increase throughput in a variety of markets. Applications include systems for the food, tobacco, plastics recycling and pulp wood industries. Subsequent to acquisition, the operations of AMVC and its subsidiaries, exclusive of its subsidiary Ventek, Inc. (“Ventek”), were merged into the parent company operations. On October 31, 2001, the Company sold Ventek, a wholly-owned subsidiary that supplied machine vision systems predominantly to the wood panel industry.
 
The Company’s domestic operations are headquartered in Walla Walla, Washington with manufacturing facilities in Walla Walla, Washington and Redmond, Oregon. The Company moved the AMVC manufacturing activities from Medford to Walla Walla in fiscal 2001, fully integrating the acquired operations into its existing business. The Company continues to maintain a presence in Medford performing research and development, service and sales activities. The Company supplies products from both product groups—automated inspection systems and process systems—to customers in its primary markets through common sales and distribution channels. In addition, the Company supplies parts and service through its worldwide service organization.

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Industry Background
 
The Company considers the size and variety of worldwide processing industries to be a significant opportunity for growth. The Company provides solutions not only to solve existing quality and safety issues in its existing markets, but also seeks to provide safe processing technologies to new international markets. Accordingly, the Company devoted significant resources in fiscal 2002 to sales and marketing activities and new product research and development that will increase the Company’s ability to address these potential global markets.
 
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 global food processing industry has been in a consolidation period for approximately three years. Market conditions suggest further consolidation in the future. The Company believes the resulting food processing companies are financially stronger, and 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. In 2001 and 2002, the consolidation in the food processing industry, as well as weaker general economic conditions, have resulted in the Company’s customers delaying investment in its products. Certain sectors, such as vegetable processing, are beginning to increase capital equipment spending, some of which has occurred subsequent to fiscal 2002. Barring any major regional economic depression or political turmoil, the Company believes that the recent increases in capital equipment spending will continue, although a cautious approach by customers is still evident.
 
Non-food Industries – Tobacco, Pharmaceuticals & Plastics
 
Processors in non-food industries are also implementing systems solutions to reduce costs, increase yields, and produce higher quality products that are safe for consumers.
 
The largest non-food processing market is the tobacco industry. With the acquisition of AMVC and its subsidiary SRC Vision, which has 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. 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 and plastics, recycled paper, and wood chips. The Company believes that many additional applications for its products exist in both food and non-food markets, particularly in the area of automated process control.

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Products
 
The Company has developed a modular family of product lines that can be configured in a variety of ways and integrated to provide complete solutions for specific applications. Advances in any one module can therefore benefit a number of the Company’s products. Despite the incorporation of sophisticated technology, the Company’s products can be operated by plant personnel with minimal specialized training and are built to withstand the harsh environments found in processing plants.
 
The following table sets forth sales by product category for the periods indicated:
 
    
Fiscal Year Ended September 30,
    
2002
   
2001
   
2000
    
(in thousands)
Automated inspection systems
   
$
24,965
   
$
26,884
   
$
24,002
Process systems
   
 
25,767
   
 
27,050
   
 
26,414
Parts and service/contracts
   
 
19,502
   
 
19,020
   
 
16,996
    
  
  
Net sales
   
$
70,234
   
$
72,954
   
$
67,412
    
  
  
 
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:
 
    
Fiscal Year Ended September 30,
  
    
2002
     
2001
     
2000
  
Automated inspection systems
   
39
%
   
39
%
   
40
%
Process systems
   
28
%
   
32
%
   
28
%
Parts and service/contracts
   
33
%
   
29
%
   
32
%
    
  
  
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 products. The Company’s systems within this group include the ADR® and Tegra® systems, representing the fourth generation of automated inspection systems designed by Key Technology; PrismTM and Tobacco Sorter IITM and Tobacco Sorter 3TM designed by SRC Vision; and the new Optyx® and Prism IITM automated inspection systems, designed by design teams of the merged companies. All systems are now manufactured at the Walla Walla manufacturing facility.
 
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.

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Tegra System. In fiscal 1996, the Company introduced its fourth generation of automated inspection system sorters. Named Tegra, this generation of automated inspection systems incorporates a number of technological and mechanical advances that result in significant improvements to processing efficiency and product throughput with higher recovery and defect-removal rates. 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.
 
Tegra incorporates object-specific IntelliSortTM technology. IntelliSort sorting technology 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 KeyWare® 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 control and automation interfaces. These features allow Tegra to establish data connectivity and communication with a processing plant’s computer network system.
 
Prism System. In 1999, SRC Vision introduced the new Prism sorting system. Designed for stable performance in challenging environments, Prism has gained strong acceptance in segments of the fruit, vegetable and snack food markets. It uses a novel broad-band illumination system, and is designed to require minimal maintenance. In addition to present and potential applications in potato products, vegetables, fruits, plastics, and snack foods, Prism adds specific applications with products such as dehydrated potato flakes, plastic flake and peaches.
 
Prism incorporates a new image processing module, the “Advanced Vision Processor” (“AVPTM“). Introduced concurrently with Prism, AVP uses a high speed serial processor to convert color camera signals into product separation actions. It incorporates the latest in high frequency bus architecture, and incorporates cameras that have eight times the color resolution of previous generations. Designed for flexibility, AVP is comprised of modules that provide an on-going upgrade path, minimizing sustaining development costs, and maximizing the effective life of the design. AVP uses a powerful combination of a high speed “super-pipelined” sorting engine with a Windows NT-based user interface. An internal communication network enables detailed self-diagnosis to be performed on many system components.
 
In November 2002, the Company introduced the new Prism II. This product incorporates the same capabilities and strengths as its predecessor in a more economical design, enabling the Company to improve on the less-than-satisfactory gross margins available on the earlier version of the machine.
 
Tobacco Sorter II and 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. SRC Vision’s Tobacco Sorter 3 (TS3), introduced worldwide in 2001, utilizes the machine vision engine of the Prism System in a specially constructed frame, enclosure, and material handling arrangement to meet the specific product inspection requirements of this industry. In addition to the large installed base of its predecessor, Tobacco

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Sorter II, the new TS3 has now been installed successfully 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.  In fiscal 2001, the company developed and introduced its new automated inspection system named Optyx. The Optyx system was developed by the combined research and development organizations of Key Technology and SRC Vision. The new sorter incorporates the best technologies of both companies to create a sorter that maintains the power and sorting capabilities of a large sorter in an economical and compact machine. Optyx employs the advanced camera, lighting, image processing, and ejection technologies used in the Tegra and Prism products. The lower cost Optyx system is ideal for smaller processors and lower volume processing lines which were previously unable to justify the expense of a larger sorter. Present and potential applications include the Company’s traditional potato, fruit, vegetable and tobacco markets. The Company is pleased with the market acceptance of this product, with more than 18 units shipped in fiscal 2002.
 
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.  In fiscal 1996, the Company purchased certain inventory, trademarks and patents related to a pharmaceutical inspection product line, the I-300 Pharmaceutical Inspection System, from the Imaging Division of Oncor, Inc. 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.
 
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®, Horizon™, Marathon™, and Impulse™ vibratory conveyor systems. The Farmco acquisition added another significant product group that is made up of mechanical sizing, sorting, separating and grading equipment. In addition, the product line includes food pumping systems, belt conveyors, spiral elevators and other custom designed conveying technologies.
 
Iso-Flo Vibratory Conveying Systems.  The Company’s principal specialized conveying system is its Iso-Flo vibratory conveyor system, which was introduced in 1978. 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, seafood and certain nonfood products.

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Most Iso-Flo conveyors are custom designed and engineered by the Company to customer specifications. As a result of the Company’s research and development activities in fiscal 1999 and 2000, it expanded its family of vibratory conveyors with the introduction of three new products in the first quarter of fiscal 2000. These products were the Horizon™, the Impulse™ and the Marathon™ conveying systems. During fiscal 2002, activity in research and development focused on product enhancement options, including vibration sensors, conveying methods and materials, and added automation and control technologies for all process systems.
 
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 the processor due to 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 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 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 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 fiscal 2002 and 2001, the Company did not sell significant third-party products for which it assumed turn-key sales responsibility. In fiscal 2000, these third-party supplied products accounted for approximately $1.8 million of the $26.4 million total net sales of process systems. However, during fiscal 2002, the Company accepted an order from a customer in the tobacco industry for which it assumed turn-key sales responsibility that includes approximately $600,000 of third-party supplied products for shipment in fiscal 2003, and anticipates continuing its strategy of pursuing such opportunities.

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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. In response to increasing customer demand for maintenance and parts services, the Company introduced a new multi-tier service product offering named UpTime™ in fiscal 1999. During fiscal 2000 the Company tested the ability to supply remote diagnostics in the UpTime™ offering and began selling this service as UpTime Connection® in Fiscal 2001. The Company considers its parts and maintenance service sales to be important potential sources of future revenue growth. In fiscal 2001, to help increase parts and maintenance service revenues and provide a higher level of customer service, the Company realigned its service organization so that field service personnel are now geographically located closer to its customers throughout the world. This strategy contributed to revenue growth and improved gross margins in parts and service in fiscal 2002. 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.
 
Customers and Markets
 
The Company’s primary market is the food processing industry. 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. The current investment in new french fry processing facilities is occurring outside the United States but has slowed in the Company’s fiscal 2001 and 2002, reflecting a reduced global growth rate. 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 segment.
 
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 market segments for the Company are green beans, corn, carrots, peas, onions, apples, pears, cranberries and peaches.
 
In non-food markets, the Company’s principal market is the tobacco industry. The Company’s products provide tobacco companies sorting capability to remove impurities and foreign matter from a stream of stripped tobacco. The Company believes market growth for tobacco systems shows great promise based upon the high degree of acceptance demonstrated by its customers and the significant size of the worldwide tobacco processing market. Additionally, the Company expects that the tobacco market may provide opportunities for expanded sales of process systems to compliment new and existing installations of automated inspection systems.

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Export and international sales for the fiscal years ended September 30, 2002, 2001 and 2000 accounted for 42%, 49% and 41% of net sales in each such year, respectively. Most export sales of products manufactured in the United States for shipment into international markets other than Europe and Australia/New Zealand have been denominated in U.S. dollars. Sales into Europe of systems, spare parts and service, as well as products manufactured in Europe, are generally denominated in European currencies, most commonly Euros. Sales into Australia/New Zealand are typically denominated in their local currency. In its export and international sales, the Company is 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 the sales prices in local currencies of the Company’s products in international markets; tariffs and other barriers and restrictions; and the burdens of complying with a variety of international laws. Additional information regarding export and international sales is set forth in Note 15 to the Company’s Consolidated Financial Statements for the year ended September 30, 2002.
 
During fiscal 2002, 2001 and 2000, sales to McCain Foods represented approximately 16%, 17% and 14% of total net sales, respectively. While the Company believes that its relationship with McCain is satisfactory, the loss of this customer could have a material adverse effect on the Company’s results of operations.
 
The Company markets its products directly and through independent sales representatives. In North America, the Company operates sales offices in Walla Walla, Washington; Medford, Oregon; and Redmond, Oregon. The Company’s subsidiary, Key Technology B.V., provides sales and service to European customers. The Company’s subsidiary, Key Technology Australia Pty. Ltd., provides sales and service to customers primarily in Australia and New Zealand.
 
Engineering, Research and Development
 
At September 30, 2002, the Company’s research and development department had 50 employees who conduct new product research and development and sustaining engineering for released products. The Company’s engineering department had 45 employees engaged in project engineering for custom systems. The Company’s technical staff includes electronic, mechanical and software engineers, mathematicians and technical support personnel.
 
The Company’s 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 2002, the Company’s research and development expenses, together with engineering expenses not applied to the manufacturing costs of products, were approximately $4.5 million, compared to $5.4 million and $5.3 million in 2001 and 2000, respectively.
 
Manufacturing
 
The Company maintains three domestic manufacturing facilities, two located in Walla Walla 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), Computer Aided Design (CAD), Computer Aided Manufacturing (CAM) and Computer Integrated Manufacturing (CIM) technologies. Manufacturing activities include process engineering; cutting, welding, fabrication 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
Walla Walla, Washington
     
150,000
   
Automated Inspection
Process Systems
Parts and Service
Walla Walla, Washington
     
100,000
   
Process Systems
Redmond, Oregon
     
19,000
   
Process Systems
           
Parts and Service
Beusichem, The Netherlands
     
45,000
   
Process Systems
Parts and Service
Beusichem, The Netherlands
     
18,000
   
Parts warehouse
Future manufacturing expansion
 
The Company manufactures certain of its products to Underwriters Laboratories, United States Department of Agriculture and Occupational Safety and Health Administration standards. The Company’s domestic manufacturing processes in its Walla Walla operations originally became qualified in January 1995 for certification to the ISO-9001 quality management and assurance standards. Those specific operations were audited in fiscal 2001 and found to be compliant. During fiscal 2002, the Company embarked upon recertification under the new ISO-9001:2000 standards, with onsite audits at each facility in the United States, including the Redmond and Medford facilities, taking place early in fiscal 2003. Each of those facilities became certified to the ISO-9001:2000 quality standard in November 2002. Certain of the Company’s products also comply with the Canadian Standards Association (CSA), European CE (Conformité Européene) and Electronic Testing Laboratory (ETL) safety standards.
 
Certain components and subassemblies included in the Company’s products are obtained from single-source or sole-source suppliers. The Company attempts to ensure that adequate supplies are available to maintain manufacturing schedules. Although the Company seeks to reduce its dependence on sole and limited source suppliers, the partial or complete loss of certain sources of supply could have an adverse effect on the Company’s results of operations and relations with customers.
 
Backlog
 
The Company’s backlog as of September 30, 2002 and September 30, 2001 was approximately $15.1 million and $12.5 million, respectively. Gross orders exceeded shipments of Company products by $2.6 million in fiscal 2002. The Company schedules production based on firm customer commitments and forecasted requirements. The Company includes in backlog only those customer orders for which it has accepted purchase orders. The Company believes backlog is a meaningful indicator of future financial results only in the short-term, as it typically ships products ordered within eight to thirteen weeks from the date of receipt. Large multiple-unit system orders or orders for systems in high demand may result in longer delivery times and make backlog an imprecise indicator of short-term results. Orders for fiscal 2002 included a $5.0 million order from a large french fry customer for installation outside the United States. Shipment of this order is expected to occur during the Company’s first and second quarters of fiscal 2003.

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Competition
 
The markets for automated inspection systems and process systems are highly competitive. Important competitive factors include price, performance, reliability, and customer support and service. The Company believes that it currently competes effectively with respect to these factors, although there can be no assurance that existing or future competitors will not introduce comparable or superior products at lower prices. Certain of the Company’s competitors may have substantially greater financial, technical, marketing and other resources. The Company’s principal competitors are believed to be FMC Technologies, Inc., Heat & Control, Sortex Ltd., the Pulsarr B.V. and Elbicon N.V. subsidiaries of Barco N.V., Kiremko B.V., and BEST N.V. During fiscal 2002, the Company encountered additional small competitors entering its markets, including introductions of three potentially competing tobacco sorters into the Chinese market manufactured by Chinese companies. It is too early to determine whether any of these recent market entrants will be successful in addressing the strenuous processing needs of this or other industries. As the Company enters new markets, it expects to encounter new niche competitors.
 
Patents and Trademarks
 
The Company currently holds fifty-three United States patents issued from 1988 through 2002 and twenty-one issued by other countries, the first of which expires in calendar 2002. As of December 4, 2002, fifteen other national patent applications have been filed and are pending in the United States and other countries and four international applications have been filed that are awaiting the national phase. The Company has twenty-six registered trademarks and no pending applications for trademarks.
 
The Company also attempts to protect its trade secrets and other proprietary information through proprietary information agreements and security measures with employees, consultants and others. The laws of certain countries in which the Company’s products are or may be manufactured or sold may not protect the Company’s products and intellectual property rights to the same extent as the laws of the United States. The Company is currently evaluating the protections available to its intellectual property in China, which has been a significant source of orders for its tobacco sorters and has seen the recent introduction of three potentially competing sorters.
 
Employees
 
At September 30, 2002, the Company had 489 full-time employees, including 212 in manufacturing, 95 in engineering, research and development, 124 in marketing, sales and service, and 58 in general administration and finance. A total of 112 employees are located outside the United States. The Company utilizes temporary contract employees, which improves the Company’s ability to adjust manpower in response to changing demand for Company products. Of the total employees at September 30, 2002, 20 were contract employees. None of the Company’s employees in the United States are represented by a labor union. The manufacturing employees located at the Company’s facility in Beusichem, The Netherlands are represented by the Small Metal Union. The Company has never experienced a work stoppage, slowdown or strike. While the Company considers its employee relations to be excellent, it is also recognizes that increased stresses have been placed on employees as a result of the employment cut-backs and other business pressures as management has brought the Company back to profitability during fiscal 2002 after the economic challenges of fiscal 2001. During fiscal 2002, fulltime employees were reduced by approximately 10% from a total of 543 at the beginning of the year.

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ITEM 2.   PROPERTIES.
 
The Company owns or leases the following properties:
 
Location
     
Purpose
     
Square
Feet
     
Owned or Leased
     
Lease
Expires
     
Renewal Period
Walla Walla, Washington
     
Corporate office, manufacturing, research and development, sales and marketing, administration
     
150,000
     
Leased with option to purchase within the lease term
     
2015
     
none
Walla Walla, Washington
     
Manufacturing, research and development, sales and marketing
     
100,000
     
Leased with option to purchase beginning January 1, 2002
     
2005
     
2010
Medford, Oregon
     
Research and development, sales and marketing (1)
     
16,000
     
Leased
     
2007
     
none
Medford, Oregon
     
Vacant Lot
     
50,000
     
Owned (2)
              
Redmond, Oregon
     
Manufacturing, research and development, sales, administration
     
19,000
     
Leased
     
2003
     
2008
Beusichem, The Netherlands
     
Manufacturing, sales and marketing, administration
     
45,000
     
Leased
     
2008
     
2013
Beusichem, The Netherlands
     
Parts warehouse, future manufacturing expansion
     
18,000
     
Owned
     
n/a
     
n/a
 
 
(1)
 
In fiscal 2001, the manufacturing activities previously performed in Medford were moved to the Company’s 150,000 square foot facility in Walla Walla. The Company sold its partially-vacant Medford facility in April 2002 and leased back a small portion of the building.
 
(2)
 
The Company originally acquired 150,000 square feet of vacant land in conjunction with the acquisition of AMVC. Subsequently, the Company has sold 100,000 square feet to various third parties. Based upon these transactions and the number and quality of continuing inquiries, the Company expects to sell the remaining property at or above its book value.
 
ITEM 3.   LEGAL PROCEEDINGS.
 
From time-to-time, the Company is named as a defendant in legal proceedings arising out of the normal course of its business. As of December 4, 2002, the Company was not a party to any material legal proceedings.
 
ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
None.

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PART II
 
ITEM 5.   MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
 
Common Stock
 
Shares of the Company’s common stock are quoted on the Nasdaq National Market System under the symbol “KTEC”. The following table shows the high and low bid prices per share of the Company’s common stock by quarter for the two most recent fiscal years ended September 30:
 
    
High
   
Low
Fiscal 2002
              
1st Quarter
   
$
3.360
   
$
2.150
2nd Quarter
   
 
3.800
   
 
2.350
3rd Quarter
   
 
5.000
   
 
2.996
4th Quarter
   
 
6.139
   
 
4.600
Fiscal 2001
              
1st Quarter
   
$
8.938
   
$
4.125
2nd Quarter