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EX-32.2 - EXHIBIT 32.2: Q4 FY17 - KEY TECHNOLOGY INCexhibit322093017q4.htm
EX-32.1 - EXHIBIT 32.1: Q4 FY17 - KEY TECHNOLOGY INCexhibit321093017q4.htm
EX-31.2 - EXHIBIT 31.2: Q4 FY17 - KEY TECHNOLOGY INCexhibit312093017q4.htm
EX-31.1 - EXHIBIT 31.1: Q4 FY17 - KEY TECHNOLOGY INCexhibit311093017q4.htm
EX-23.1 - EXHIBIT 23.1: Q4 FY17 - KEY TECHNOLOGY INCexhibit23093017q4.htm
EX-21 - EXHIBIT 21: Q4 FY17 - KEY TECHNOLOGY INCexhibit21093017q4.htm
EX-10.7 - EXHIBIT 10.7: Q4 FY17 - KEY TECHNOLOGY INCexhibit107093017q4.htm
EX-10.6 - EXHIBIT 10.6: Q4 FY17 - KEY TECHNOLOGY INCexhibit106093017q4.htm


UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.   20549
____________________________________________
FORM 10-K
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2017
OR
o
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
(State or jurisdiction of incorporation or organization)
93-0822509
(I.R.S. Employer Identification No.)
150 Avery Street
Walla Walla, Washington
(Address of Principal Executive Offices)
99362
(Zip Code)
 Registrant’s telephone number, including area code:  (509) 529-2161
__________________________________________
  Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
Common Stock, no par value
Name of each exchange on which registered
 The NASDAQ Global Market
 Securities registered pursuant to Section 12(g) of the Act: None
 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes  ¨ No  ý 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes  ¨ No  ý 
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  ý No  ¨ 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes  ý 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.  ý 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “accelerated filer,” “large accelerated filer," “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.  (Check one):
 
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o (Do not check if a smaller reporting company.)
Smaller reporting company ý 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨ No  ý
The aggregate market value of the Registrant's common stock held by non-affiliates on March 31, 2017 (based on the last sale price of such shares) was approximately $61,474,169.
There were 6,479,166 shares of the Registrant's common stock outstanding on December 1, 2017.
 DOCUMENTS INCORPORATED BY REFERENCE
Parts of Registrant's Proxy Statement, dated on or about January 2, 2018, prepared in connection with the Annual Meeting of Shareholders to be held on February 7, 2018, are incorporated by reference into Part III of this Report.




KEY TECHNOLOGY, INC.
2017 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

 
 
PAGE
 
 
 
 
 
 
 
 








INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS

From time to time, Key Technology, Inc. (“we," "us" or "our"), through its management, may make forward-looking public statements with respect to the Company regarding, among other things, expected future revenues or earnings, projections, plans, future performance, product development and commercialization, and other estimates relating to our future operations.  Forward-looking statements may be included in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), in press releases, in our president's letter to shareholders, or in oral statements made with the approval of an authorized executive officer of the Company.  The words or phrases “will likely result,” “are expected to,” “intends,” “is anticipated,” “estimates,” “believes,” “projects” or similar expressions are intended to identify “forward-looking statements” within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are subject to a number of risks and uncertainties, the occurrence of any of which could cause the price of our common stock to fluctuate significantly, making it difficult for shareholders to resell common stock at a time or price they find attractive.  We caution investors not to place undue reliance on our forward-looking statements, which speak only as of the date on which they are made.  Our actual results may differ materially from those described in the forward-looking statements as a result of various factors, including those listed below:

global economic conditions may adversely affect our customers and our operating results;
political, economic, and other risks associated with international sales and operations could adversely affect our business and operating results;
variable economic conditions in the food processing industry, either globally or regionally, may adversely affect our sales;
significant investments in unsuccessful research and development efforts could materially adversely affect our business;
our existing and new products may not compete successfully in either current or new markets, which could result in the loss of market share and a decrease in our sales and profits;
the loss of any of our significant customers could reduce our sales and profitability;
competition may result in lower sales and prices for our products and services;
consolidation by our competitors could increase competition in the food processing equipment industry, and consolidation by our food processing industry customers could increase their purchasing power, both of which could reduce our sales and profitability;
customer sourcing initiatives and purchasing power may adversely affect our new equipment and aftermarket sales, and could result in reduced gross margins;
our sales and profits may vary widely from quarter to quarter and year to year due to the timing, size and composition of major orders;
our operating results are seasonal and may further fluctuate due to severe weather conditions affecting the agricultural industry in various parts of the world;
the failure of our independent sales representatives to perform as expected would harm our net sales;
our international operations subject us to a number of risks that could adversely affect our sales, operating results and growth;
we have made, or may make, acquisitions or enter into distribution agreements or similar business relationships that could disrupt our operations and harm our operating results;
fluctuations in foreign currency exchange rates could result in unanticipated losses that could adversely affect our results of operations and financial position;
advances in technology by competitors may adversely affect our sales and profitability;
our expansion into new markets, increasingly complex projects and applications, and integrated product offerings could increase our cost of operations and reduce gross margins and profitability;
the failure of our suppliers to deliver quality products in a timely manner or our inability to obtain components for our products could adversely affect our operating results;
our dependence on certain suppliers may leave us temporarily without adequate access to raw materials, intellectual property or products;
the limited availability and possible cost fluctuations of materials used in our products could adversely affect our gross margins;
our products may suffer from defects leading to warranty claims;
information security breaches or business system disruptions may adversely affect our business;
our potential inability to attract and retain experienced management and other key personnel, or the loss of key management personnel, may adversely affect our business and prospects for growth;
our potential inability to protect our intellectual property, especially as we expand geographically, may adversely affect our competitive advantage;

1



intellectual property-related litigation expenses and other costs resulting from infringement claims asserted against us by third parties may adversely affect our results of operations and our customer relations;
our financing agreements contain restrictive and financial covenants that may adversely affect us; and
changes in tax laws could adversely affect our business, financial condition and results of operations.

Given these uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements.  We disclaim any obligation 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.

PART I


ITEM 1.
BUSINESS.

General

Key Technology was founded in 1948 as a local producer of vegetable processing equipment.  We have evolved into a worldwide supplier of process automation solutions to the food processing industry and other industries such as pharmaceuticals and tobacco. We were incorporated in 1982 as a result of a management buyout of our predecessor organization.

We and our operating subsidiaries design, manufacture, sell and service automation equipment that processes product streams of discrete pieces to improve product safety and quality.  These systems integrate electro-optical automated inspection and digital sorting systems with other processing systems that include specialized conveying and preparation equipment. We provide parts and service for each of our product lines to customers around the world.

Net sales for the year ended September 30, 2017 were $139.9 million compared with $120.0 million for fiscal 2016 and $102.9 million for fiscal 2015.  We reported net earnings for fiscal 2017 of $4.0 million, or $0.63 per diluted share, compared with a net loss of $0.7 million, or $0.11 per diluted share, for fiscal 2016 and a net loss of $5.0 million, or $0.80 per diluted share, for fiscal 2015.  Export and international sales for the fiscal years ended September 30, 2017, 2016 and 2015 accounted for 60%, 53% and 50% of net sales in each year, respectively.  Total assets at September 30, 2017 were $107.8 million compared to $96.0 million at September 30, 2016.

Industry Background

Food Processing Industry

Our primary market is the food processing industry where we apply our processing knowledge and application expertise to help customers improve quality, increase yield and reduce cost. Our integrated sorting, conveying and other processing solutions are sold to small, medium and large-sized food processing companies for a range of specialized applications. Food processors generally experience thin profit margins and, therefore, are focused on increasing profitability and efficiency in their processing plants by improving the performance of their equipment and production lines. In addition, food processors recognize the value of new technology and continue to demand innovative equipment that improves food safety, quality, yields, operational efficiencies and productivity in their plants to achieve a competitive advantage.

Our strategy is to offer equipment that reduces reliance on manual inspection and addresses common food processing industry problems associated with high labor costs, workforce shortages, inadequate yields, inconsistent product quality and food safety.  In highly developed markets, including those in North America and Western Europe, the substitution of automated processes for manual labor is well underway.  Food processors in these regions typically appreciate the value of replacing manual labor with automated systems and look for solutions that will help maximize yields, product quality and food safety. In developing countries, interest in automation is rising as food processors in these regions increasingly strive to compete in a global economy by improving product quality and food safety.

Within the food processing industry, the greatest opportunities for automated inspection systems have been in potatoes, vegetables and fruits where the frequency and severity of foreign material and defects is highly variable, depending on the countless factors that affect harvested crops.  In addition, dried fruit and tree nuts are high value products and processors of these products increasingly demand inspection and automation to increase profitability. We believe that many additional applications for our automated inspection systems exist in other food processing markets as well.


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The principal potato market served by our systems is potato strips (commonly referred to as french fries in the United States).  Potato strips have historically accounted for a very large portion of the frozen potato products produced in the U.S.  Although we have successfully been diversifying into other food and non-food markets in recent years to reduce dependence on this market, potato strips remain an important market along with other potato products such as wedges, curly fries, formed products, whole potatoes and potato chips.

Other important markets within the food processing industry are fruits and vegetables, including both fresh-cut produce and processed products that may ultimately be canned or frozen for institutional and retail customers. Because foreign material and product defects plague these field-harvested products, digital sorting enhances the quality and safety of the product while improving yields and reducing labor costs.  Our principal fruit and vegetable markets are fresh, frozen, canned and dehydrated green beans, corn, carrots, peas, onions, berries, cranberries, pears and peaches, as well as ready-to-eat fresh-cut salads.

We also offer a comprehensive suite of products that address the dried fruit and nut market which includes digital sorters and mechanical grading systems.  Nut processors strive to produce various products (shelled or unshelled) that are free of foreign material, extraneous vegetative matter and out-of-specification nuts to maximize the value of their product. 

We believe that selected areas of the food processing industry will continue to present opportunities for growth in new and existing insertion points in our core markets and other potential adjacencies.  Additionally, food processing companies are facing pressure to improve product quality and safety while maintaining or reducing prices for their own products. As a result, equipment and processing methods that can meet those objectives and offer lower production costs or increased yields have become strategically important to food manufacturers throughout the world.  We believe we are well positioned to help satisfy the needs of the food processing industry.

Cyclical and seasonal fluctuations in the potato, fruit and vegetable processing industries cause us to experience volatility in order and shipment volumes. Cyclicality is experienced over multiple years and is generally dependent upon economic cycles and fluctuations of capital spending levels in the food processing industry.  Orders and shipments are seasonal for this industry and tend to be lower during our first two fiscal quarters of the year than during the second half of the fiscal year.  Other, less seasonal markets that are served by the company include snack, bakery, dairy and poultry products, as well as non-food markets.

Non-food Industries – Pharmaceuticals, Nutraceuticals and Tobacco

Processors, manufacturers and packagers in several non-food industries are interested in automated inspection systems that reduce costs, increase yields and improve product quality and safety.  Our primary non-food markets include pharmaceuticals, nutraceuticals and the tobacco industry.

In fiscal 2017, the pharmaceutical and nutraceutical industry, which is served by our pharmaceutical product line, SYMETIX®, also represented less than 5% of our net sales.  SYMETIX’s optical inspection systems for softgels and tablets remove defects and foreign capsules and tablets from the product stream.  These systems are of interest to brand owners, product manufacturers and contract packers looking to ensure product quality while reducing labor costs. We also own a 15% non-controlling interest in Proditec SAS. Proditec, headquartered in Pessac, France, is a manufacturer of automated, solid dose pharmaceutical inspection systems based on machine vision technology.  

The tobacco industry typically accounts for less than 5% of our net sales.  With systems that remove non-tobacco-related material from primary processing lines and threshing lines, we help tobacco processors maximize product quality.  We have an original equipment manufacturer distribution agreement with Hauni Maschinenbau AG, a leading supplier of equipment to the tobacco industry.  The agreement gives Hauni exclusive rights to market our equipment to tobacco processors worldwide, which are generally incorporated into Hauni's processing systems, and makes us the sole supplier of optical sorting equipment to Hauni for the tobacco market.


 

3



Products

The following table sets forth sales by product category for the periods indicated (in thousands):

 

Fiscal Year Ended September 30,
 

2017

2016

2015
Automated inspection systems

$
51,981


37
%

$
38,620


32
%

$
37,529


36
%
Process systems                                      

57,088


41
%

52,339


44
%

37,768


37
%
Parts and service                                      

30,845


22
%

29,081


24
%

27,628


27
%
Net sales

$
139,914


100
%

$
120,040


100
%

$
102,925


100
%

Service and maintenance contracts are less than 10% of total net sales and are therefore summarized with parts and service.

The following table sets forth the percent of total gross margin contributed by each product category for the periods indicated:

 
 
Fiscal Year Ended September 30,
 
 
2017
 
2016
 
2015
Automated inspection systems                                                                                   
 
34
%
 
32
%
 
34
%
Process systems                                                                                   
 
37
%
 
34
%
 
26
%
Parts and service                                                                                   
 
29
%
 
34
%
 
40
%
Total gross margin
 
100
%
 
100
%
 
100
%

Automated Inspection Systems

Automated inspection systems are used in various applications to detect and remove defects and foreign material from the product stream and help processors improve quality and increase the value of their end product. Key offers a wide range of digital sorters that accommodate throughputs of less than 1,000 kg to more than 20 metric tons of product per hour. We tailor each sorter around the product characteristics and production objectives of each processor with the optimal mechanical configuration, sensor types, sensor positions, lighting, ejection system, product handling and intelligent software.  Our sophisticated sensors, coupled with proprietary algorithms, recognize color, size, shape, structural properties and chemical composition to detect the widest range of visible and invisible product defects and foreign material.

Depending on the needs of each application, our sorters can be designed with a combination of cameras and lasers to detect and remove a wide variety of defects and foreign material, which is an important contributor to food safety. Cameras are often best at distinguishing color, size, shape, texture and density, while lasers and multi-spectral sensors are better at detecting foreign material. Hyperspectral imaging recognizes the unique chemical characteristics of objects, which allows it to detect invisible defects and foreign material, such as high concentrations of sugar in potatoes, and easily differentiate nut meat from nut shells.

In September 2015, the Company introduced the VERYX® family of digital sorters with the launch of our first VERYX chute-fed sorter, followed by the launch of our first VERYX belt-fed sorter in August 2016. In 2017, Key expanded the family with the addition of two new VERYX models - the B140 and the C70. Available in a range of inspection widths, VERYX is designed to satisfy food processors with small to very large production capacity requirements. This family of belt-fed and chute-fed sorters offers high-performance capabilities for fresh, frozen and dried vegetables and fruits, processed potato products, nuts and other products. Innovative mechanical architecture and intelligent decision-making help maintain optimal performance while minimizing operator interaction. VERYX advancements include sustained all-sided surface inspection and multi-sensor Pixel Fusion™ that, together with the highest resolution cameras and laser sensors available on a digital sorter and an intelligent ejection system, enable VERYX to achieve new levels of foreign material and product defect removal. Advanced auto-learn, self-adjusting capabilities and recipe-driven operation offer enhanced ease-of-use. VERYX was deliberately designed as a modular, configurable, and flexible platform to serve as the intelligent core of an entire suite of digital sorting solutions, able to support a broad range of applications and processing needs.

VERYX complements our belt-fed sorters, Optyx®, Tegra® and Manta®, used primarily in the fresh and frozen fruit, vegetable and potato products market segments, and our chute-fed sorters, Taurys™, Spyder®, Python and Cayman®, which are well-suited for sorting nuts, dried fruits and frozen fruits and vegetables. Our other automated inspection systems include Veo™, an optical

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sorter designed specifically for seed corn; VitiSort® for red wine grapes; DateSort™ for dates; Tobacco Sorter™ systems used in tobacco threshing and primary processing; and ADR® automatic defect removal systems used in the potato strip industry.

The power of the Company's digital sorters is expanding with the continued adoption of Information Analytics, a set of data acquisition and connectivity capabilities that enable the collection, analysis and sharing of data across the food processor’s enterprise. Equipped with Information Analytics, the sorter continuously collects and stores a variety of information about the sort process and the product flowing through the sorter to drive more intelligent sorting or generate customized statistical reports. It helps food processors better manage raw materials and optimize processes upstream and downstream of the sorter in addition to improving the sorter’s accept/reject decisions.

Software-driven intelligence, such as our Sort-to-Grade™ technology for potato strip processing, continues to extend the value of sorting. Sort-to-Grade allows sorters to grade defects and length by count, accepting or rejecting each strip to control the quality of the output to a defined grade, as defined by the processor.

We also offer automated inspection equipment for solid dose pharmaceuticals and nutraceuticals through our SYMETIX pharmaceutical product line. Available in a range of sizes, VeriSym® sorting systems inspect the color, size and shape of tablets and softgels and automatically remove defects and foreign tablets or softgels from the product stream at rates of up to 1,000,000 tablets or capsules per hour.  These inspection systems help product manufacturers and contract packers ensure the quality of their finished product and are designed to replace batch processing systems historically used in this industry.
  
We have a large installed base of automated inspection systems which we support with upgrades to extend the life of the equipment and enable customers to continue operating at peak performance as technology advances.  Upgrades often provide customers with a less capital intensive alternative to acquiring new automated inspection systems.  

Process Systems

Conveying and processing equipment are utilized worldwide throughout many industries to move and process product within a production plant.  The process systems group includes standard and custom designed equipment that conveys, dewaters, transfers, distributes, aligns, feeds, meters, separates, grades, cleans, washes and polishes products. Our Smart Shaker® vibratory solutions, which include Iso-Flo®, Impulse® and Horizon™ systems, combine a wide variety of processing functions and vibratory conveying with gentle material handling.  Rotary sizing and grading systems, and SYMETIX equipment for pharmaceuticals and nutraceuticals, complete our conveying and processing equipment product line.

Our mechanical sizing, sorting, separating and grading equipment is also used in many food processing and fresh vegetable packing operations.  These rotary sizing and grading technologies can remove oversized, undersized and small irregular-shaped pieces of product from the line or separate product into predetermined size categories.  Additionally, this equipment can remove field debris, broken pieces, seeds, juice, fines, and other targeted material.

Preparation Systems.  We design and manufacture systems to prepare a wide range of food products prior to cooking, freezing, canning, or other types of processing.  Equipment in this group includes air cleaners, air coolers, vegetable metering and blending systems and bulk handling equipment.  This equipment represents our most mature product line.  Sales of these solutions over the years have formed a customer base for sales of our other solutions and are also establishing a new customer base in developing markets.  Preparation system revenues include sales of a variety of third-party supplied equipment and installation services, which are sold as components of larger, integrated processing lines, for which we have assumed turn-key sales responsibility.  

Line Solutions

Integrated Solutions. Our Integrated Solutions Group (ISG) provides integrated whole-line solutions.  From pre-engineering and project definition to plant start-up, ISG offers complete turn-key solutions that can include the integration of third-party products along with Key’s sorting, conveying and processing systems to meet the specific needs of each application.  We leverage our industry expertise and strong engineering and project management capabilities to deliver complete integration services, all from a single source.

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Parts and Service

We have a large installed base of inspection and processing systems, which generates potential business for our parts, service and training programs.  Our PROliance™ suite of support services, parts, protection plans and training solutions provides spare parts and post-sale field and telephone-based repair services to support our customers’ routine maintenance requirements and seasonal equipment startup and winterization processes.  Our field service personnel are close to customers around the world, enabling quick response time and regional technical support.  We typically provide incidental system installation support services in the sale price of select systems, principally automated inspection systems.

RemoteMD™. RemoteMD is a real-time condition monitoring and diagnostics analysis tool for G6 optical sorters - Manta, Optyx and Tegra - as well as G6 ADR systems and our new VERYX sorters. RemoteMD permits us to monitor the condition of the customer’s system, assess the status, and alert the customer if problems are detected. RemoteMD provides detailed information to our service technicians, which increases the first-time fix-rate, reduces in-plant service calls, speeds resolution time and enhances customer productivity. We offer three distinct levels of RemoteMD services as part of our comprehensive protection plans - SelectPRO, PlusPRO and PremierPRO.  Each of the three protection plans is sold via annual subscription.

Online Training. This program provides customers with an interactive multimedia curriculum covering selected optical inspection systems and vibratory conveyors.  The flexible, web-based program offers a wide variety of self-paced training modules designed for operators, maintenance personnel, sanitation crews, supervisors and others working with this equipment.  Our online training program includes modules that cover VERYX, Optyx, Manta and Tegra sorters, ADR systems, Iso-Flo vibratory conveyors and a variety of industry-related compliance topics.

Research and Development

At September 30, 2017, our research and development department had 47 employees who conduct new product research and development and sustaining engineering for released products.  Our technical staff includes electronic, optical, mechanical and software engineers, mathematicians and technical support personnel.

In fiscal 2017, our research and development expenses were approximately $11.5 million, compared to $10.6 million in fiscal 2016 and $9.6 million in fiscal 2015.

Manufacturing

We maintain manufacturing facilities in Walla Walla, Washington; Redmond, Oregon; Beusichem, The Netherlands; and Hasselt, Belgium. Our current manufacturing facilities and our 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 following table provides a summary of our manufacturing locations and manufacturing floor space:

Location
Manufacturing Facility
Products/Services Produced
Walla Walla, Washington
132,000 square feet
Automated Inspection Systems
Process Systems
Parts and Service
Redmond, Oregon
17,000 square feet
Process Systems
Parts and Service
Beusichem, The Netherlands
37,000 square feet
Process Systems
Automated Inspection Systems
Parts and Service
Hasselt, Belgium
13,000 square feet
Automated Inspection Systems
Parts and Service

We manufacture certain products to Underwriters Laboratories and United States Department of Agriculture standards.  Certain of our products also comply with the Canadian Standards Association (CSA), European CE (Conformité Européene) and Electronic Testing Laboratory (ETL) safety standards.  Certain products for the pharmaceutical/nutraceutical industry are FDA 21 CFR 11-compliant and designed using GAMP4 guidelines.  Our domestic facilities were recertified to the ISO 9001:2008 standard in 2015.

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Certain components and subassemblies included in our products are obtained from limited-source or sole-source suppliers.  We attempt to ensure that adequate supplies are available to maintain manufacturing schedules.  We may also use contract or third-party manufacturers to fulfill customer needs for ancillary products or equipment that we do not manufacture. We do not have long-term contracts with any of our suppliers. We also rely on third-party domestic and foreign suppliers for certain raw materials. Several of these suppliers are the single source of the raw material. We may be adversely affected in the event that these suppliers cease operations or if pricing terms become less favorable.
  
Sales and Marketing

We market our equipment worldwide both directly and through independent sales representatives.  Sales by independent sales representatives generally account for between 20% and 30% of our annual consolidated net sales.  In the United States, we operate a sales office in Walla Walla, Washington.  Our international sales offices are: Key Technology B.V. and Visys N.V., which provide sales and service to European, Middle Eastern, Indian, and African customers ("EMEIA"); Key Technology Australia Pty Ltd., which provides sales and service to customers primarily in Australia and New Zealand; and Productos Key Mexicana S. de R.L. de C.V., which provides sales and service to customers in Latin America. We have Innovation & Solution Centers in the United States in Walla Walla, Washington and Sacramento, California. Internationally, we have Innovation & Solution Centers in Hasselt, Belgium; Beusichem, the Netherlands; and Dandenong, Australia. We supply equipment from both of our product groups - automated inspection systems and process systems - to customers in our primary markets through common sales and distribution channels.  In addition, we supply parts and service through our worldwide service organization.

Sales of most exports of products manufactured in the United States for shipment into international markets, other than Europe, have been denominated in U.S. dollars.  Sales of products in Europe are typically denominated in Euros.  As we expand our international operations, transactions denominated in the local currencies of other countries may increase.  In connection with our export and international sales, we are subject to the risks of conducting business internationally, including unexpected changes in regulatory requirements; fluctuations in the value of the U.S. dollar, which could increase or decrease the sales prices of our products in local currencies in international markets; tariffs and other barriers and restrictions; and the requirements of complying with a variety of international laws.  Additional information regarding domestic and international sales is set forth in Note 16 to the Company’s Consolidated Financial Statements for the fiscal year ended September 30, 2017.

During fiscal 2017, sales to Lamb Weston Holdings, Inc. and McCain Foods Limited each represented approximately 14% of total net sales. During fiscal 2016, sales to Lamb Weston Holdings, Inc. represented 19% of total net sales. During fiscal 2015, sales to McCain Foods Limited represented 11% of total net sales.  While we believe that our relationship with these customers is satisfactory, the loss of either of these customers could have a material adverse effect on our revenues and results of operations.  Each of these customers represents a group of plants under common control.  Generally, purchasing decisions for these customers are made at the individual plant level, which may diversify the concentration of risk.

Backlog

Our backlog as of September 30, 2017 and September 30, 2016 was approximately $43.9 million and $40.4 million, respectively.  We schedule production based on firm customer commitments and forecasted requirements.  We include in backlog only those customer orders for which we have accepted purchase orders, or the equivalent.

Competition

The markets for automated inspection systems and process systems are highly competitive.  We experience significant price competition across almost all our product lines.  Other important competitive factors include performance, reliability, and customer support and service.  We believe that we currently compete 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 our competitors may have substantially greater financial, technical, marketing and other resources.  Other companies which sell products in certain of our markets include Heat & Control, Inc. and its subsidiaries; Tomra Systems ASA and its subsidiaries, BEST N.V. and Odenberg Inc.; Sortex Ltd. (which is owned by the Buhler Group); Kiremko B.V.; Meyer Precision, Inc.; KMG Systems Ltd.; VDL Industrial Products B.V.; TNA Australia Pty. Ltd.; Raytech Vision SpA; and Concept Engineers B.V.  We have also encountered additional smaller competitors entering our markets.  As we enter new markets, we expect to encounter additional new competitors.


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Intellectual Property

We currently hold 46 United States patents on various features of our products issued from 2001 through fiscal 2017, and 57 other national patents issued by other countries.  The first of these patents will expire in fiscal 2018.  Although we consider our patents to be important to our business, we believe these expirations will not have a significant effect. Of the numbers above, 22 patents were issued in fiscal 2017.  As of December 1, 2017, 18 U.S. patent applications and 45 other foreign national patent applications were pending.  We had 69 registered trademarks and 6 pending application for trademarks as of the same date.

We also attempt to protect our 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 our products are or may be manufactured or sold may not protect our products and intellectual property rights to the same extent as the laws of the United States.

Employees

At September 30, 2017, we had 645 full-time employees, including 400 in manufacturing and project engineering, 47 in research and development, 151 in marketing, sales and service, and 47 in general administration and finance.  A total of 186 employees are located outside the United States.  We also use temporary contract employees, which improves our ability to adjust manpower in response to changing demand for our products.  Of the total number of employees at September 30, 2017, eight were contract employees.  None of our employees in the United States are represented by a labor union.  The employees located at our facility in Beusichem, The Netherlands are represented by the Small Metal Union.  We have never experienced a work stoppage, slowdown or strike.

Available Information

Our annual and quarterly reports and other filings with the United States Securities and Exchange Commission (SEC) are made available free of charge through the Investor Relations section of our website at www.key.net as soon as reasonably practicable after we file such material with the SEC.  The information on or that can be accessed through our website is not a part of this Annual Report on Form 10-K.


8



ITEM 1A.
RISK FACTORS.

In addition to the other information in this Annual Report on Form 10-K, the following risk factors should be considered carefully in evaluating our business because such factors may have a significant effect on our operating results and financial condition.  As a result of the risk factors set forth below and the information presented elsewhere in this Annual Report on Form 10-K, actual results could differ materially from those included in any forward-looking statements.

Global economic conditions may adversely affect our customers and our operating results.

Our sales may be adversely affected by uncertainties and general economic conditions that may cause customers to defer or cancel new orders and sales commitments previously made. If global economic conditions were to deteriorate, our revenue and ability to generate operating profits would be materially adversely affected and subject our business to the following risks, among others:

impair the financial condition of some of our customers and suppliers, thereby increasing customer bad debts or non- performance by suppliers;
adversely affect our ability to fund new product development necessary to meet future customer requirements;
negatively affect global demand for our customers' products, particularly in the food industry, which could result in a reduction of sales, underutilization of our production facilities, and a reduction in operating income and cash flows;
adversely affect our expansion plans, including possible acquisitions;
negatively affect our customers' ability to obtain financing, which could result in a reduction in sales, operating income and cash flows;
negatively affect our return on cash and cash equivalents;
make it more difficult or costly for us to obtain financing for our operations or investments;
negatively affect the results of our risk management activities if we are required to record losses related to financial instruments or experience counterparty failure;
result in charges for excess or obsolete inventory or require other asset write-downs; and
the volatility of the trading price of our common stock may increase.

Political, economic, and other risks associated with international sales and operations could adversely affect our business and operating results.

Recent political and economic developments, including the Brexit vote in the U.K., the presidential election in the U.S., central bank monetary policies, low growth in various international markets, rising global debt, renegotiation of trade agreements, and the threat of deflation, may affect global economic conditions and, in turn, our sales. In 2017, approximately 60% of our revenue was derived from customers located outside of the United States. We anticipate that international sales will continue to account for a significant portion of our revenue. We intend to continue to expand our sales and operations outside of the United States. As a result, our business is subject to the risks inherent in international sales and operations, including, among other things:

various regulatory and statutory requirements;
difficulties in injecting and repatriating cash;
export and import restrictions;
transportation delays;
new tariffs and customs duties;
employment regulations and local labor conditions;
difficulties in staffing and managing foreign sales operations;
instability in economic or political conditions;
difficulties protecting intellectual property;
business systems connectivity issues; and
potentially adverse tax consequences.

Any of these factors could have a material adverse effect on our operating results.


9



Variable economic conditions in the food processing industry, either globally or regionally, may adversely affect our sales.

The markets we serve, particularly in the food processing industry, are generally experiencing variable economic conditions. Additionally, varying consumer demand due to economic conditions, or dietary trends, product supply, and excess plant capacity, most notably in the potato market, could result in reduced or deferred capital equipment purchases for our product lines. A significant portion of our food processing customer base operates on relatively low margins and consequently can be quickly affected by adverse economic conditions, resulting in a decline in purchases from us. Loss of business, particularly in the potato industry, would have a negative effect on our net sales and net earnings.

Significant investments in unsuccessful research and development efforts could materially adversely affect our business.

Product development in our industry is a complex, time-consuming and costly process involving significant investment in research and development with no assurance of return on investment. If we fail to predict and meet future customer needs and preferences, fail to incorporate industry-leading technologies in our products, or fail to allocate our research and development funding to products with higher customer acceptance and growth prospects, we may find we have invested in the development of products that do not lead to significant revenue for a number of years, if at all. Failure to successfully develop new products may also cause existing or potential customers to choose competitors' products. Even if we successfully develop new products and product enhancements, we may incur substantial costs in doing so, and our profitability may be reduced. Moreover, new products may not generate the gross margins that we anticipate.

Our existing and new products may not compete successfully in either current or new markets, which could result in the loss of market share and a decrease in our sales and profits.

Our future success and growth is dependent upon our ability to develop, manufacture, market, and sell products and services in certain food processing markets as well as to introduce new products into other existing and potential markets. There is no assurance that we will be able to introduce new products, or platforms such as VERYX, in accordance with our anticipated release dates or that new products will achieve market acceptance. The ultimate commercial success of a product depends upon various factors, many of which are not under our control. Customers have become increasingly concerned about their return on investment, energy conservation, sanitation and food safety, and our market solutions need to be cognizant of these considerations. There can be no assurance that we can successfully and profitably penetrate these potential markets or expand into new international markets with our current or future products. In addition, new product introductions and enhancements of existing products may reduce demand for our existing products or delay purchases by customers awaiting arrival of our new products. As new or enhanced products are introduced, we must successfully manage the transition from existing products. Difficulties that arise in managing the transition from our older products to our new or enhanced products could result in additional costs and deferred or lost revenue. There are also inherent risks in developing new technologies, entering new markets, and expanding in our existing markets including:

length of time and cost for development of these technologies and markets;
our ability to bring new solutions to the market in a timely manner and maintain a competitive advantage;
our ability to transition our production processes to meet increased demand for new products;
development of the technological capability to address the requirements and performance specifications of new and existing markets;
our ability to obtain new technology from third parties when we cannot cost-effectively develop these technologies ourselves;
our ability to manufacture our products in various geographies may affect our success in certain new markets;
our ability to design products for ease of manufacturability and service;
increased dependence on sole source providers of integral components for new products;
our ability to design and manufacture products for configurability, modularity and cost-effectiveness;
our ability to manufacture and sell our new products at sustainable gross margins;
our ability to train and develop personnel on new production, sales and service methods;
product reliability issues related to both new technology and adaptation of existing products to operate in new or rugged operating environments at customer sites;
reliability, quality or operability problems with high capacity products or products with new technology;
design or manufacturing flaws that may lead to increased product liability or warranty claims, excess or obsolete inventory and resulting charges; and
failure to meet performance specifications, which could damage our profitability and the reputation of our products.



10



The loss of any of our significant customers could reduce our sales and profitability.

We have significant, strategic customers and we anticipate that our operating results may continue to depend on these customers for the foreseeable future. The loss of any one of those customers, or a significant decrease in the volume of products they purchase from us, could adversely affect our sales and materially adversely affect our profitability. Any difficulty in collecting outstanding amounts due from one of those customers may also harm our operating results. In addition, sales to any particular large customer may fluctuate from quarter to quarter, causing fluctuations in our quarterly operating results.

Competition may result in lower sales and prices for our products and services.

We face aggressive pricing by our competitors, particularly in periods of excess manufacturing capacity. Consolidation among our primary competitors may provide these competitors with greater resources than we have and allow these competitors to compete more effectively on price. We may not be able to compete successfully in the future and our investments in research and development, sales and marketing may be insufficient to enable us to maintain our competitive advantage. Competitive pressure has in the past and may in the future lead to price erosion that could have a material adverse effect on our gross margins and operating results.

Consolidation by our competitors could increase competition in the food processing equipment industry, and consolidation by our food processing industry customers could increase their purchasing power, both of which could reduce our sales and profitability.

The food processing equipment industry has experienced recent consolidation. Consolidation by our competitors may enhance their production capacity, technological abilities, broaden their product lines and resources, and lower their cost structure and prices, causing us to be at a competitive disadvantage. Consolidation by our customers could adversely affect capital spending levels which could reduce the volume of products they purchase from us. In addition, certain large customers may exert purchasing power over their vendors and insist on discount pricing or require a higher level of post-sale support, which may lower our gross margin percentage. Our ability to respond to any of these changing market conditions could result in significant price erosion, reduced revenue, lower margins, and loss of market share, any of which could adversely affect our net earnings.

Customer sourcing initiatives and purchasing power may adversely affect our new equipment and aftermarket sales, and could result in reduced gross margins.

Many large companies, including our customers and prospective customers, have undertaken supply chain integration focused primarily on cost savings. In addition, because of their purchasing power, our larger customers can influence suppliers to compete on price terms. If we are not able to offset resulting price reductions by improving operating efficiencies and reducing expenses, such price reductions may have an adverse effect on our profit margins and net earnings.

Our sales and profits may vary widely from quarter to quarter and year to year due to the timing, size and composition of major orders.

The length of our sales cycle and the timing of our significant orders depend on a number of factors over which we may have little or no control, including the size and complexity of a potential order, the level of competition that we encounter in our sales activities, and our current and potential customers' internal budgeting and approval process. In addition, the industries we serve, particularly the potato market, have buying patterns that vary greatly between fiscal years. As a result, we may expend significant effort and resources over a long period of time in an attempt to obtain an order, but ultimately not obtain the order, or the order ultimately received may be smaller than anticipated. In addition, if the timing of these orders is delayed from one quarter to the next or from one year to the next, we may also experience fluctuations in our quarterly and annual sales and operating results. Our orders from different customers vary from quarter to quarter, and a customer with a large order in one quarter may generate significantly lower orders in subsequent quarters. In addition to timing, the composition and product mix of orders received may result in lower margins than anticipated and may therefore adversely affect our gross margins in subsequent quarters. Due to the resulting fluctuations, we believe that quarter-to-quarter comparisons of our revenue and operating results may not be meaningful, and that these comparisons may not be an accurate indicator of our future performance. These fluctuations in orders will also result in fluctuations in our annual operating results. Additionally, operating margins may be adversely affected by a reduction in sales or changes in product mix, and we may not be able to reduce our costs in a timely manner to adjust for the difference between actual and forecasted sales.


11



Our operating results are seasonal and may further fluctuate due to severe weather conditions affecting the agricultural industry in various parts of the world.

A large portion of our customer base processes agricultural products and its demand for our products and solutions fluctuates seasonally. These fluctuations can be independent of the effects of changes in general economic conditions. Consequently, we generally experience lower sales and net income in our first two fiscal quarters. As a result of these seasonal and quarterly fluctuations, comparisons of our sales and operating results between different quarters within a single fiscal year may not necessarily provide meaningful comparisons.

In addition, in the event of severe weather conditions, climate change, geological events or other natural disasters that negatively affect the production of growers, such as prolonged droughts, serious floods or earthquakes, and crop diseases, the food processing industry may not invest in a particular year or years in new equipment in the affected locations. As a result, our sales, results of operations and cash flows could be materially adversely affected.

The failure of our independent sales representatives to perform as expected would harm our net sales.

Sales by independent sales representatives generally account for between 20% and 30% of our consolidated net sales. If our independent sales representatives fail to market, promote and sell our products, our business will be adversely affected. Our independent sales representatives could reduce or discontinue sales of our products, sell competitors' product lines, or may not devote adequate resources to selling our products in the volumes and within the time frames that we expect, any of which could adversely affect our sales and net earnings. In addition, our reliance on independent sales representatives may reduce our visibility into demand and pricing issues.

Our international operations subject us to a number of risks that could adversely affect our sales, operating results and growth.

We conduct business outside the United States, which subjects us to the risks inherent in international operations. In fiscal 2017, our international sales represented approximately 60% of our consolidated net sales, compared to approximately 53% of our consolidated net sales in fiscal 2016. Risks inherent in international operations include the following:

unexpected changes in regulatory and certification requirements;
restrictive governmental actions (such as restrictions on the transfer or repatriation of funds and trade protection measures, including export duties and quotas, customs duties and tariffs, or trade barriers erected by either the United States or other countries where we do business);
sanctions imposed by the United States which may affect our ability to do business in foreign countries but may not necessarily affect our competitors;
currency restrictions and exchange rate fluctuations;
scrutiny of foreign tax authorities which could result in significant fines, penalties and additional taxes;
changes in import or export licensing requirements;
longer payment cycles;
transportation delays due to port shutdowns, capacity overloads, varying customs requirements and other factors beyond our control;
competitive pricing that we may experience internationally;
challenges in implementing cost effective operating and manufacturing strategies in varied geographic regions;
difficulties in implementing effective internal financial and operating controls;
challenges in meeting customer requirements in different operating environments;
challenges in meeting customer needs in different regions due to regional differences in products and processes;
inability to globalize solutions for our global customers;
economic downturns, civil disturbances or political instability;
geopolitical turmoil, including terrorism or war;
difficulties and costs of staffing and managing geographically disparate operations;
more stringent employment regulations and local labor conditions;
laws and business practices favoring local companies;
limitations on our ability under local law to protect our intellectual property;
changes in domestic and foreign tax rates and laws; and
difficulties in obtaining sales representatives and servicing products in foreign countries, which may adversely affect sales in those countries.

The occurrence of any of the above risks could adversely affect our sales, operating results, reputation and growth prospects.

12



We have made, or may make, acquisitions or enter into distribution agreements or similar business relationships that could disrupt our operations and harm our operating results.

We have made, or may in the future make, acquisitions of businesses, or enter into distribution agreements or similar business relationships that offer products, services, or technologies that we believe would complement our business. These changes in our business present significant challenges and risks and there can be no assurances that we will manage these changes successfully. These changes in our business involve numerous risks, including:

significant potential expenditures of cash, stock, and management resources;
difficulty achieving the potential financial and strategic benefits of the acquisition or business relationship;
difficulties in integrating acquired operations or products, including the potential loss of key employees from the acquired business;
difficulties of integrating different technologies into products and markets;
diversion of management's attention from our core business, including loss of management's focus on marketplace development;
assumption of product liabilities, including warranty costs, for third-party products;
increased costs due to required minimum purchase levels and commitments for payments to third parties;
difficulties and costs associated with evaluating and integrating the information systems and internal control systems of the acquired business;
reduction in our future operating results from amortization of intangible assets and possible future impairment of assets related to goodwill and other intangible assets;
adverse effects on existing business relationships with suppliers and customers, including the potential loss of suppliers and customers of the acquired business;
assumption of liabilities, known and unknown, related to the acquired business in general, and litigation and other legal process involving the acquired business in particular, including intellectual property litigation risk;
entering geographic areas or distribution channels in which we have limited or no prior experience; and
those risks related to general economic and political conditions.

There can be no assurance that attractive acquisition opportunities will be available to us, that we will be able to obtain financing for or otherwise consummate any acquisition, or that any acquisition that we do consummate will be successful.

Fluctuations in foreign currency exchange rates could result in unanticipated losses that could adversely affect our results of operations and financial position.

We are exposed to foreign currency exchange rate fluctuations because a portion of our sales, expenses, assets and liabilities are denominated in foreign currencies. Changes in the value of foreign currencies affect our results of operations and financial position. With respect to international sales denominated in U.S. dollars, a decrease in the value of foreign currencies relative to the U.S. dollar would make our products less price competitive. We attempt to manage certain effects of foreign currency fluctuations by entering into short-term forward exchange contracts in situations where it is both possible and practical. These contracts are designed to minimize specific foreign currency gains or losses, as the gains or losses on the derivative are intended to offset the losses or gains on the underlying exposure. However, these contracts do not cover our full exposure and, additionally, there is no guarantee that these forward contracts will protect against the foreign exchange fluctuations in the underlying exposure. Accordingly, we could experience foreign currency gains or losses that could have a material effect on our operating results.

Advances in technology by competitors may adversely affect our sales and profitability.

The rapidly changing needs of the markets for our products demand constant innovation. Competitors may be able to adapt or develop technologies to create or enhance product offerings that directly compete with our products. Advances in technology may also remove some barriers to market entry, enabling additional competitors to enter our markets. These innovations could cause our products to become less competitive or obsolete, leading to a decrease in our sales and profits, or potentially causing us to take an impairment charge, either of which would have a material adverse effect on our business and financial condition. There can be no assurance that we will be able to continue to develop new products to compete effectively in the future.



13



Our expansion into new markets, increasingly complex projects and applications, and integrated product offerings could increase our cost of operations and reduce gross margins and profitability.

Our growth strategy includes expansion into new product and geographic markets, complex projects and applications, and integrated product offerings to provide turnkey solutions to customers. As a result, we may encounter new types of competition and be required to develop new sales channels. Successful development of new markets and market adjacencies requires us to understand the unique requirements and differentiated customer needs of these markets, and to develop our infrastructure to respond to these demands. Development of such markets and turnkey solutions is likely to require sustained investment, increase our cost of sales, reduce our gross margins to the extent products purchased from others are integrated into our product offerings, reduce margins due to competition or market conditions, and result in overall reduced profitability. We are also likely to encounter technical challenges and increased costs related to the integration of products from multiple vendors, acquisition and integration of intellectual property from multiple vendors, adaptation and installation of products in larger and more complex plants, ensuring product performance in more difficult operating environments, and meeting unfamiliar customer requirements and performance specifications. Such expansion into new markets and increased project complexity could increase demands on our operations and resources, which may affect our ability to timely supply our customers with the services and solutions they have requested. Despite rigorous testing and quality processes, newly developed or enhanced products or solutions may encounter challenges during or after their initial introduction or installation. We may also encounter increased warranty costs, performance issues and liability risks from products we sell but do not manufacture.

The failure of our suppliers to deliver quality products in a timely manner or our inability to obtain components for our products could adversely affect our operating results.

In certain instances, we depend on original equipment manufacturers and other suppliers of components, including intellectual property, included in our products for the timely delivery of our integrated turnkey products. As we develop new products and solutions, we may become more dependent on original equipment manufacturers in the future. Such suppliers may experience problems beyond our control, which may disrupt our ability to deliver our products to our customers and damage our relationships with current and future customers. These risks may include varying lead times, supplier capacity, delayed shipments, and quality control problems. In addition, supplier pricing may change and be higher than anticipated. As a result of these and other factors, our sales and profit margins may be adversely affected.

Our dependence on certain suppliers may leave us temporarily without adequate access to raw materials, intellectual property or products.

We rely on third-party domestic and foreign suppliers for certain raw materials. Several of these suppliers are the single source of the raw material or supply products that are the intellectual property of the supplier. As we develop new and more technologically advanced products, our reliance on single source providers or their intellectual property may increase. We do not have long-term contracts with any supplier. In addition, as we develop new products and technological solutions, we may become more dependent on sole source providers. We may be adversely affected in the event that these suppliers cease operations, cease doing business with us or if pricing terms become less favorable. The loss of a key vendor may force us to purchase our necessary raw materials and components in the open market, which may not be possible or may be at higher prices, until we could secure another source. There is no assurance that the terms of any subsequent supply arrangements we may enter into would be as favorable as the supply arrangements we currently have in place. If we are unable to replace a key supplier, we may face delays in delivering finished products, which could have an adverse effect on our sales, financial performance and reputation.
 
The limited availability and possible cost fluctuations of materials used in our products could adversely affect our gross margins.

Certain basic materials, such as stainless steel, are used extensively in our product fabrication processes. Such basic materials have, in the past, been subject to worldwide shortages or price fluctuations related to the supply of, or demand for, raw materials, such as nickel, which are used in their production by our suppliers. A significant increase in the price or decrease in the availability of one or more of these components, subassemblies or basic materials could adversely affect our results of operations.

Our products may suffer from defects leading to warranty claims.

We include complex system designs and components in our products that may contain defects, particularly when we incorporate new technology into our products or release new versions. If any of our products are defective, we might be required to redesign those products or pay substantial warranty claims. Such an event could result in significant expenses, including expenses arising from re-engineering and warranty claims, disrupt sales and affect our reputation and that of our products, which could have a material adverse effect on our business, financial condition and results of operations.

14




Information security breaches or business system disruptions may adversely affect our business.

We rely on our information technology infrastructure and management information systems to effectively run our business. We may be subject to information security breaches caused by illegal hacking, computer viruses, or acts of vandalism or terrorism. Our security measures may not detect or prevent such breaches, or we may not have devoted sufficient resources to addressing information security risks. Any compromise to our information security could result in a misappropriation of our cash or other assets; an interruption in our operations; the unauthorized publication of our confidential business or proprietary information; the unauthorized release of customer, vendor, or employee data; the violation of privacy or other laws; and the exposure to litigation, any of which could harm our business and operating results. Any disruption occurring with our management information systems may cause significant business disruption, including our ability to provide quotes, process orders, ship products, invoice customers, process payments, and otherwise run our business. Our failure to comply with United States or foreign laws on data protection or privacy could also adversely affect our business. Any disruption occurring with these systems may have a material adverse effect on our operating results.

Our potential inability to attract and retain experienced management and other key personnel, or the loss of key management personnel, may adversely affect our business and prospects for growth.

Our success depends in part on the skills and experience of our executives and key employees. The loss of services of such employees could adversely affect our business until suitable replacements can be found. In addition, our corporate headquarters is located in Walla Walla, Washington and we have facilities in Beusichem, The Netherlands and Hasselt, Belgium, which are small, relatively remote geographic locations. As such, there may be a limited number of individuals locally with the requisite skill and experience, and we have from time-to-time experienced difficulty recruiting individuals from larger metropolitan areas. The seasonal and cyclical nature of our business may also adversely affect our ability to attract suitable replacements. Additionally, our operations require that we have a number of sales and service personnel working remotely from wide geographic regions, which may create logistical and recruitment challenges.

Consequently, we may not be able to attract and retain a sufficient number of qualified individuals on acceptable terms to maintain our business or achieve operational targets. Our success also depends, to a significant degree, upon the continued individual and collective contributions of our management team. A limited number of individuals have primary responsibility for managing our business, including our relationships with key customers. These individuals are integral to our success based on their expertise and knowledge of our business and products. The loss of the services of members of the management team and other key employees for any reason could have a material adverse effect on our business.

Our potential inability to protect our intellectual property, especially as we expand geographically, may adversely affect our competitive advantage.

Our competitive position may be affected by our ability to protect our proprietary technology. We have obtained certain patents and have filed a number of patent applications. We also anticipate filing patent applications for protection of our future products and technology. There can be no assurance that any such patents will provide meaningful protection for our product innovations, or that the issuance of a patent will give us any material advantage over our competition in connection with any of our products. We may experience additional intellectual property risks in international markets where we may lack patent protection or experience challenges to our intellectual property. The patent laws of other countries differ from those of the U.S. as to the patentability of our products and processes. Moreover, the degree of protection afforded by foreign patents may be different from that of U.S. patents.

Intellectual property-related litigation expenses and other costs resulting from infringement claims asserted against us by third parties may adversely affect our results of operations and our customer relations.

The technologies used by us may infringe the patents or proprietary technology of others. There is also a trend toward aggressive, strategic enforcement of intellectual property rights. As a result, there is a risk that we would be subject to infringement claims which, regardless of validity, could:

be expensive, time consuming and divert management attention away from normal business operations;
require us to pay monetary damages or enter into non-standard royalty and licensing agreements;
require us to modify our product sales and development plans; or
require us to satisfy indemnification obligations to our customers.


15



Regardless of whether these claims have any merit, they can be burdensome to defend or settle and can harm our business and reputation.

Our financing agreements contain restrictive and financial covenants that may adversely affect us.

Certain of our financing agreements require us to comply with various restrictive covenants and contain financial covenants that require us to comply with specified financial ratios and tests if certain conditions are met. Our failure to meet these covenants could result in default under these agreements. In the event of default and our inability to obtain a waiver of the default, all amounts outstanding under the loan agreements could be declared immediately due and payable and we would lose the ability to provide customers standby letters of credit and lose our ability to utilize short-term credit facilities. As a result, the failure to comply with these covenants could adversely affect our results of operations and financial condition.

Changes in tax laws could adversely affect our business, financial condition and results of operations.

The United States and other countries where we do business are pursuing legislation to significantly reform their corporate tax systems.   While we are unable to predict which, if any, of these proposed tax reforms will be enacted into law, and what effects any enacted legislation will have on our liability for corporate tax in the United States or other countries, these potential changes could have a material adverse effect on our business, financial condition and results of operations.  One of the key provisions of these proposals being discussed is the reduction in corporate income tax rates.  If enacted, a reduction in the federal corporate tax rate in the United States and other countries could result in a significant reduction in our existing $4.5 million of  net deferred tax assets recorded as of September 30, 2017, and consequently a charge to our net earnings, in the period in which any rate change is enacted.  It is uncertain whether or when any such US or foreign tax reform proposals will be enacted and the cumulative effect of any such tax reforms on our business and financial results is also uncertain.


ITEM 1B.
UNRESOLVED STAFF COMMENTS

None.

16




ITEM 2.
PROPERTIES

We own or lease 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
173,000
Owned
n/a
n/a
Walla Walla, Washington
Customer Visitor Center, equipment demonstration facility
31,500
Leased
2020
One five-year renewal period
Redmond, Oregon
Manufacturing, research and development, administration
19,000
Leased
2022
Two five-year renewal periods
Beusichem, The Netherlands
Manufacturing, sales and marketing, administration
45,000
Leased
2020
Five years
Beusichem, The Netherlands
Warehouse
11,000
Leased
2020
Five years
Hasselt, Belgium
Manufacturing, research and development
19,500
Leased
2019
Every Three years
Hasselt, Belgium
Customer Visitor Center, equipment demonstration facility; sales and marketing, administration
25,000
Leased
2025
Annual thereafter

We also lease office space for sales and service, and other activities, in Walla Walla, Washington; Sacramento, California; Dandenong, Australia; and Querétaro, Mexico.

We consider all of our properties suitable for the purposes for which they are used.

ITEM 3.
LEGAL PROCEEDINGS.

From time-to-time, we may be named as a defendant in legal proceedings arising out of the normal course of our business. Currently, we are not a party to any material legal proceedings.

ITEM 4.
MINE SAFETY DISCLOSURE.

Not Applicable.


17



PART II

 
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

Market Information

Shares of our common stock are quoted on The NASDAQ Global Market under the symbol “KTEC”.  The following table shows the high and low sales prices per share of our common stock, as reported on NASDAQ, by quarter for the two most recent fiscal years ending September 30, 2017:

Stock price by quarter
 
High
 
Low
Fiscal year ended September 30, 2017
 
 
 
 
First Quarter
 
$
13.74

 
$
9.68

Second Quarter
 
$
13.95

 
$
11.70

Third Quarter
 
$
14.00

 
$
12.10

Fourth Quarter
 
$
19.67

 
$
11.08

 
 
 
 
 
Fiscal year ended September 30, 2016
 
 
 
 
First Quarter
 
$
12.20

 
$
8.08

Second Quarter
 
$
10.44

 
$
6.25

Third Quarter
 
$
9.97

 
$
6.88

Fourth Quarter
 
$
12.98

 
$
8.92


We had approximately 1,546 beneficial owners of our common stock, of which 294 are of record, as of December 1, 2017.

We have not historically paid dividends on our common stock.  The board of directors presently intends to continue its policy of retaining earnings for reinvestment in our operations.

Issuer Purchases of Equity Securities

Effective May 30, 2012, our board of directors approved a discretionary program to repurchase up to 500,000 shares of our outstanding common stock. The timing of any repurchases and the exact number of shares of common stock to be purchased will be determined by the board of directors and will depend on market conditions and other factors. The program does not incorporate a fixed expiration date. At September 30, 2017, there were 429,202 shares remaining that could be repurchased under the program. There were no repurchases of common stock during the three months ended September 30, 2017.


18




STOCK PERFORMANCE GRAPH

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
AMONG KEY TECHNOLOGY, INC., THE RUSSELL MICROCAP INDEX, AND PEER GROUP

ktec2017.jpg

 
2012
2013
2014
2015
2016
2017
 
 
 
 
 
 
 
Key Technology, Inc.
$100.00
$142.56
$136.78
$121.49
$113.64
$195.14
Russell Microcap Index
100.00
132.12
135.80
138.04
156.63
191.61
New Peer Group
100.00
137.35
147.61
142.98
211.79
267.86
Old Peer Group
100.00
154.72
166.36
159.85
220.80
351.33

NEW PEER GROUP: John Bean Technologies Corporation, Cognex Corporation, Group Aktengesellschaft, Isra Vision AG, Tomra Systems, Marel hf.
OLD PEER GROUP: Cognex Corporation, Perceptron, Inc., Flir Systems, Inc., John Bean Technologies Corporation, Tomra Systems, Inc., Isra Vision AG.
During 2017, the Company modified its peer group to delete Perceptron, Inc. and Flir Systems, Inc. and add Group Aktiengesellschaft and Marel hf.  The Company believes that the companies that comprise its new peer group more closely align with the Company's business and industry and provide a better comparison of returns.  For comparison purposes, we have also included the Company's previous peer group in the fiscal 2017 performance graph.


19



ITEM 6.
SELECTED FINANCIAL DATA.

The selected consolidated financial information set forth below for each of the five years in the period ended September 30, 2017 has been derived from our audited consolidated financial statements.  The information below should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and our Consolidated Financial Statements and the Notes thereto as provided in Item 7 and Item 8, respectively, of this Annual Report on Form 10-K.

 
 
Fiscal Year Ended September 30,
 
 
2017
 
2016
 
2015
 
2014
 
2013
 
 
(in thousands, except per share data)
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
 
Net sales                                                 
 
$
139,914

 
$
120,040

 
$
102,925

 
$
118,258

 
$
136,783

Cost of sales                                                 
 
92,729

 
83,994

 
74,111

 
83,961

 
90,739

Gross profit                                                 
 
47,185

 
36,046

 
28,814

 
34,297

 
46,044

Operating expenses                                                 
 
40,129

 
36,195

 
36,185

 
42,309

 
40,213

Gain (loss) on disposition of assets
 
(3
)
 
(1
)
 
13

 
7

 
42

Income (loss) from operations                                                 
 
7,053

 
(150
)
 
(7,358
)
 
(8,005
)
 
5,873

Other income (expense)                                                 
 
(884
)
 
(1,004
)
 
(621
)
 
(242
)
 
(460
)
Earnings (loss) before income taxes
 
6,169

 
(1,154
)
 
(7,979
)
 
(8,247
)
 
5,413

Income tax (benefit) expense                                                 
 
2,137

 
(457
)
 
(2,960
)
 
(2,834
)
 
1,402

Net earnings (loss)
 
$
4,032

 
$
(697
)
 
$
(5,019
)
 
$
(5,413
)
 
$
4,011

Earnings (loss) per share
– basic
 
$
0.63

 
$
(0.11
)
 
$
(0.80
)
 
$
(0.86
)
 
$
0.69

 
– diluted
 
$
0.63

 
$
(0.11
)
 
$
(0.80
)
 
$
(0.86
)
 
$
0.69

Cash dividends per share
 
$

 
$

 
$

 
$

 
$

Shares used in per share calculation
– basic
 
6,447

 
6,332

 
6,295

 
6,295

 
5,836

 
– diluted
 
6,447

 
6,332

 
6,295

 
6,295

 
5,855

Balance Sheet Data:
 
 

 
 

 
 

 
 

 
 

Cash and cash equivalents and short-term investments
 
$
9,337

 
$
10,491

 
$
7,726

 
$
9,741

 
$
17,601

Working capital                                               
 
39,861

 
36,105

 
34,831

 
38,203

 
42,338

Property, plant and equipment, net
 
12,911

 
13,789

 
14,799

 
16,652

 
17,259

Total assets                                               
 
107,838

 
95,984

 
97,546

 
98,345

 
114,624

Current portion of long-term debt
 
4,566

 
587

 
705

 
804

 
871

Long-term debt, less current portion
 

 
4,565

 
5,149

 
4,733

 
5,612

Shareholders' equity                                               
 
68,652

 
62,994

 
62,737

 
68,168

 
73,125




20



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

Introduction

We and our wholly-owned subsidiaries design, manufacture and sell process automation systems integrating electro-optical inspection, sorting and process systems. We manufacture products in Walla Walla, Washington; Redmond, Oregon; Beusichem, The Netherlands; and Hasselt, Belgium.

Overview

Net sales increased $19.9 million, or 16.6%, to $139.9 million for the year ended September 30, 2017 compared to $120.0 million for fiscal 2016, while orders increased $13.5 million, or 10.5%, in fiscal 2017 compared to fiscal 2016. Net sales were up most significantly in automated inspection systems as well as in the potato market and in Europe.  Gross margins improved to 33.7% in fiscal 2017 from 30.0% in fiscal 2016 reflecting an improved product mix. Operating expenses were $40.1 million, or 28.7% of net sales, compared to $36.2 million, or 30.2% of net sales, for fiscal 2016. We reported net earnings for fiscal 2017 of $4.0 million, or $0.63 per diluted share, compared with a net loss of $0.7 million, or $0.11 per diluted share, for fiscal 2016.  Net earnings increased in fiscal 2017 compared to fiscal 2016 as a result of higher sales and gross profits and lower operating expenses in relation to net sales.   

Orders for fiscal 2017 were $142.3 million as compared to $128.7 million in the prior year. Orders were up most significantly in the potato market. Orders for automated inspection systems increased 19%, process system orders increased 3%, and parts and service orders increased 11% in fiscal 2017 compared to the prior fiscal year. Our new VERYX platform is steadily becoming a more significant portion of our overall Automated Inspection Systems orders and net sales. Backlog at September 30, 2017 increased 9%, or $3.5 million, to $43.9 million compared to the $40.4 million reported at the end of fiscal 2016. A majority of the backlog is scheduled to ship subsequent to the first quarter of fiscal 2018.

An important part of our overall strategy has been to significantly increase our market share in the EMEIA region, which includes Europe, the Middle East, India and Africa. In 2017, EMEIA orders in euros exceeded the prior year record level by 15%. Orders in EMEIA over the last two fiscal years have increased by 41%. The increase in orders occurred most significantly in processed potatoes. Our ability to produce and demonstrate our optical and process systems solutions in both North America and EMEIA is enabling us to leverage effectively our infrastructure to produce higher volumes of orders and to be more responsive to customers on a regional basis.

Application of Critical Accounting Policies
We have identified our critical accounting policies, the application of which may materially affect our financial statements, either because of the significance of the financial statement item to which they relate, or because they require management judgment to make estimates and assumptions in measuring, at a specific point in time, events which will be settled in the future.  The critical accounting policies, judgments and estimates which management believes have the most significant effect on the financial statements are set forth below:

Revenue recognition
Allowances for doubtful accounts
Valuation of inventories
Long-lived assets
Allowances for warranties
Accounting for income taxes

Management has discussed the development, selection and related disclosures of these critical accounting estimates with the Audit Committee of our Board of Directors.

Revenue Recognition.  We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectability is reasonably assured.  Additionally, we sell our goods on terms 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 criteria are met, including transfer of title and risk of loss, which occurs either upon shipment by us or upon receipt by customers at the location specified in the terms of sale.  Sales of system upgrades are recognized as revenue upon completion of the conversion of the customer’s existing system when this conversion occurs at the customer site.  Revenue earned from services (maintenance,

21



installation support, and repairs) is recognized ratably over the contractual period or as the services are performed.  If any contract provides for both equipment and services (multiple deliverables), the sales price is allocated to the various elements based on the relative selling price.  Each element is then evaluated for revenue recognition based on the previously described criteria.  We typically have a very limited number of contracts with multiple deliverables and they are not material to the financial statements.  Our sales arrangements provide for no other significant post-shipment obligations.  

If all conditions of revenue recognition are not met, we defer revenue recognition.  In the event of revenue deferral, the sale value is not recorded as revenue to us, accounts receivable are reduced by any related amounts owed by the customer, and the cost of the goods or services deferred is carried in inventory.  In addition, we periodically evaluate whether an allowance for sales returns is necessary.  Historically, we have experienced few sales returns.  We account for cash consideration (such as sales incentives) that are given to customers or resellers as a reduction of revenue rather than as an operating expense unless an identified benefit is received for which fair value can be reasonably estimated.  We believe that revenue recognition is a “critical accounting estimate” because our terms of sale vary significantly, and management exercises judgment in determining whether to recognize or defer revenue based on those terms.  Such judgments may materially affect net sales for any period.  Management exercises judgment within the parameters of accounting principles generally accepted in the United States of America (GAAP) in determining when contractual obligations are met, title and risk of loss are transferred, the sales price is fixed or determinable and collectability is reasonably assured.  At September 30, 2017, we had invoiced $3.7 million, compared to $1.7 million at September 30, 2016, for which we have not recognized revenue.

Allowances for doubtful accounts.  We have established allowances for doubtful accounts for specifically identified, as well as anticipated, doubtful accounts based on credit profiles of customers, current economic trends, contractual terms and conditions, and customers’ historical payment patterns.  Factors that affect collectability of receivables include general economic or political factors in certain countries that affect the ability of customers to meet current obligations.  We actively manage our credit risk by using an independent credit rating and reporting service, by requiring certain percentages of down payments, and by requiring secured forms of payment for customers with uncertain credit profiles or located in certain countries.  Forms of secured payment could include irrevocable letters of credit, bank guarantees, third-party leasing arrangements or EX-IM Bank guarantees, each using Uniform Commercial Code filings, or the like, with governmental entities where possible.  We believe that the accounting estimate related to allowances for doubtful accounts is a “critical accounting estimate” because it requires management judgment in making assumptions relative to customer or general economic factors that are outside our control.  As of September 30, 2017, the balance sheet included allowances for doubtful accounts of $299,000 as compared to $266,000 at September 30, 2016.  Amounts charged to bad debt expense for fiscal 2017 and 2016 were $32,000 and $18,000, respectively.  Actual charges to the allowance for doubtful accounts for fiscal 2017 and 2016 were $8,000 and $14,000, respectively.  If we were to experience actual bad debt expense in excess of estimates, or if estimates were adversely adjusted in future periods, the carrying value of accounts receivable would decrease and charges for bad debts would increase, resulting in decreased net earnings.

Valuation of inventories.  Inventories are stated at the lower of cost or market. Our inventory includes purchased raw materials, manufactured components, purchased components, service and repair parts, work in process, finished goods and demonstration equipment.  Write downs for excess and obsolete inventories are made after periodic evaluation of historical sales, current economic trends, forecasted sales, estimated product lifecycles and estimated inventory levels.  The factors that contribute to inventory valuation risks are our purchasing practices, electronic component obsolescence, accuracy of sales and production forecasts, introduction of new products, product lifecycles and the associated product support.  We actively manage our exposure to inventory valuation risks by maintaining low safety stocks and minimum purchase lots, using just in time purchasing practices, managing product end-of-life issues brought on by aging components or new product introductions, and by using inventory minimization strategies such as vendor-managed inventories.  We believe that the accounting estimate related to valuation of inventories is a “critical accounting estimate” because it is susceptible to changes from period-to-period due to the requirement for management to make estimates relative to each of the underlying factors ranging from purchasing to sales to production to after-sale support.  At September 30, 2017, cumulative inventory adjustments to lower of cost or market totaled $5.7 million compared to $5.1 million as of September 30, 2016.  Amounts charged to expense to record inventory at lower of cost or market for fiscal 2017 and 2016 were $1.5 million and $2.2 million, respectively.  Actual charges to the cumulative inventory adjustments upon disposition or sale of inventory were $0.9 million and $1.4 million for fiscal 2017 and 2016, respectively.  If actual demand, market conditions or product lifecycles are adversely different from those estimated by management, inventory adjustments to lower market values would result in a reduction to the carrying value of inventory, an increase in inventory write-offs, and a decrease to gross margins.

Long-lived assets.  We regularly review all of our long-lived assets, including property, plant and equipment, and amortizable intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable.  If the total of projected future undiscounted cash flows is less than the carrying amount of these assets, an impairment loss based on the excess of the carrying amount over the fair value of the assets is recorded.  In addition, goodwill is reviewed based on its fair value at least annually.  As of September 30, 2017, we held $29.1 million of long-lived assets, net of depreciation and amortization.  There were no material changes in our long-lived assets that would result in an adjustment of the carrying value

22



for these assets.  Estimates of future cash flows arising from the utilization of these long-lived assets and estimated useful lives associated with the assets are critical to the assessment of recoverability and fair values. We believe that the accounting estimate related to long-lived assets is a “critical accounting estimate” because:  (1) it is susceptible to change from period-to-period due to the requirement for management to make assumptions about future sales and cost of sales generated throughout the lives of several product lines over extended periods of time; and (2) the potential effect that recognizing an impairment could have on the assets reported on our balance sheet and the potential material adverse effect on reported earnings.  Changes in these estimates could result in a determination of asset impairment, which would result in a reduction to the carrying value and a reduction to net earnings in the affected period.

Allowances for warranties.  Our products are covered by standard warranty plans included in the price of the products ranging from 90 days to five years, depending upon the product and contractual terms of sale.  The majority of the warranty periods are for one year or less.  We establish allowances for warranties for specifically identified, as well as anticipated, warranty claims based on contractual terms, product conditions and actual warranty experience by product line.  Our products include both manufactured and purchased components and, therefore, warranty plans include third-party sourced parts which may not be covered by the third-party manufacturer’s warranty.  We actively manage our quality program by using a structured product introduction plan, process monitoring techniques utilizing statistical process controls, vendor quality metrics, and feedback loops to communicate warranty claims to designers and engineers for remediation in future production.  We believe that the accounting estimate related to allowances for warranties is a “critical accounting estimate” because:  (1) it is susceptible to significant fluctuation period-to-period due to the requirement for management to make assumptions about future warranty claims relative to potential unknown issues arising in both existing and new products, which assumptions are derived from historical trends of known or resolved issues; and (2) risks associated with third-party supplied components being manufactured using processes that we do not control.  As of September 30, 2017, the balance sheet included warranty reserves of $1.9 million, while $2.9 million of warranty charges were incurred during the fiscal year then ended, compared to warranty reserves of $1.9 million as of September 30, 2016 and warranty charges of $3.2 million for the fiscal year then ended.  If our actual warranty costs are higher than estimates, future warranty plan coverages are different, or estimates are adversely adjusted in future periods, reserves for warranty expense would need to increase, warranty expense would increase and gross margins would decrease.

Accounting for income taxes.  Our provision for income taxes and the determination of the resulting deferred tax assets and liabilities involves a significant amount of management judgment.  The quarterly provision for income taxes is based partially upon estimates of pre-tax financial accounting income for the full year and is affected by various differences between financial accounting income and taxable income.  Judgment is also applied in determining whether the deferred tax assets will be realized in full or in part.  In management’s judgment, when it is more likely than not that all or some portion of specific deferred tax assets will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable.  At September 30, 2017, we had valuation reserves of approximately $197,000 for deferred tax assets for capital loss carryforwards and changes in the carrying value of our investment in Proditec, and for foreign deferred tax assets, primarily related to net operating loss carry forwards in the foreign jurisdictions that we believe will not be utilized during the carryforward periods. During fiscal 2017, there was no overall change in our valuation reserves. During fiscal 2016, we recorded net additional reserves of $67,000 related to tax carry forwards in foreign jurisdictions that we believe will not be utilized during the carryforward period. During fiscal 2015, our valuation reserves were reduced by $54,000 due to the expiration of capital loss carryforwards. In addition, in fiscal 2017 and 2016, we reversed offsetting amounts of valuation reserves for foreign deferred tax assets and U.S. deferred tax liabilities related to the utilization of net operating loss carry forwards in Europe. As these amounts were offsetting, these charges had no effect on net earnings.   There were no other material valuation allowances at September 30, 2017 due to anticipated utilization of all the deferred tax assets as we believe we will have sufficient taxable income to use these assets.  We maintain reserves for estimated tax exposures in jurisdictions of operation.  These tax jurisdictions include federal, state and various international tax jurisdictions.  Potential income tax exposures include potential challenges of various tax credits and deductions, and issues specific to state and local tax jurisdictions.  Exposures are typically settled primarily through audits within these tax jurisdictions, but can also be affected by changes in applicable tax law or other factors, which could cause our management to believe a revision of past estimates is appropriate.  At September 30, 2017, we had reserves of $86,000 for estimated tax exposures.  During fiscal 2017 and 2016, there were no significant changes in these estimates.  Management believes that an appropriate liability has been established for estimated exposures; however, actual results may differ materially from these estimates.  We believe that the accounting estimate related to income taxes is a “critical accounting estimate” because it relies on significant management judgment in making assumptions relative to temporary and permanent timing differences of tax effects, estimates of future earnings, prospective application of changing tax laws in multiple jurisdictions, and the resulting ability to utilize tax assets at those future dates.  If our operating results were to fall short of expectations, thereby affecting the likelihood of realizing the deferred tax assets, judgment would have to be applied to determine the amount of the valuation allowance required to be included in the financial statements in any given period.  Establishing or increasing a valuation allowance would reduce the carrying value of the deferred tax asset, increase tax expense and reduce net earnings.


23



In fiscal 2016, income tax expense was reduced by approximately $106,000 for additional research and development tax credits related to expenditures incurred in fiscal 2015 due to the permanent renewal of the tax credit retroactive to January 1, 2015. During fiscal 2015, the research and development tax credit was renewed for a one-year period retroactive to January 1, 2014. In fiscal 2015, income tax expense was reduced by approximately $305,000 for additional research and development tax credits related to expenditures incurred during fiscal 2014.  

Recent Accounting Pronouncements Not Yet AdoptedIn May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 supersedes nearly all existing revenue recognition guidance under US GAAP. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The Company is currently analyzing the effect of the standard across all of its revenue streams to evaluate the effect of the new standard on revenue contracts. This analysis includes reviewing current accounting policies and practices to identify potential differences that would result from applying the requirements under the new standard. Most of the Company's contracts for goods and services are not complex and are primarily short-term in nature, and the Company's assessment at this stage is that it does not expect the adoption of the new revenue recognition standard to have a material effect on its financial statements. The Company plans to adopt the standard in the first quarter of fiscal 2019 using the modified retrospective method by recognizing any cumulative effect of initially applying the new standard as an adjustment to the opening balance of retained earnings.

In November 2015, the FASB issued ASU 2015-17, "Balance Sheet Classification of Deferred Taxes," which eliminates the current requirement to present deferred tax liabilities and assets as current and non-current in a classified balance sheet. Instead, entities will be required to classify all deferred tax assets and liabilities as non-current. This ASU will be effective for the Company beginning in its first quarter of fiscal 2018 and may be adopted prospectively or retrospectively. The Company has elected to adopt the new guidance prospectively. As a result, effective October 1, 2017, the Company will reclassify the net of $4.8 million of deferred tax assets in Current Assets and $1.5 million of deferred tax liabilities in Long-term liabilities as long-term deferred tax assets on its Consolidated Balance Sheet.

In March 2016, the FASB issued ASU 2016-09, "Stock Compensation," which is intended to simplify several aspects of the accounting for share-based payment award transactions, including adjustments to the timing of when excess tax benefits should be recorded and classification in the statement of cash flows. The guidance will be effective for fiscal 2018. Effective October 1, 2017, the Company will prospectively adopt the new guidance. As a result, a cumulative effect of $69,000 will be recorded as a change to deferred tax assets and a credit to equity upon adoption. Historically, if this pronouncement was in effect in prior years, the effect on our results of operations would not have been material. As the effects of this change are highly dependent upon the stock price at the time of vesting, and when shares vest, future effects on the effective tax rate, particularly on a quarterly basis, may be significant.

In July 2015, the FASB issued ASU 2015-11, "Simplifying the Measurement of Inventory" ("ASU 2015-11"). The previous standard required entities to measure inventory at the lower of cost or market, with market defined as net realizable value or replacement cost. ASU 2015-11 requires entities to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. ASU 2015-11 is effective for annual reporting periods beginning after December 15, 2016, including interim periods therein. The Company does not anticipate that it will have a material effect on its financial statements.

In February 2016, the FASB issued ASU 2016-02, "Leases" (“ASU 2016-02”), which is intended to improve financial reporting about leasing transactions. ASU 2016-02 will require lessees to recognize the assets and liabilities for the rights and obligations created by their leases on their balance sheet. Lessees will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. ASU 2016-02 is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted. The Company has not yet determined the effect that the adoption of ASU 2016-02 will have on its consolidated financial position and consolidated results of operations.


24



Comparison of Fiscal 2017 to Fiscal 2016
 
 
 
 
 
 
 
 
 
 
Fiscal Year Ended September 30,
 
 
2017
 
2016
 
Change $
 
Change %
 
 
(in thousands)
Statement of Operations Data
 
 
 
 
 
 
 
 
Net sales
 
$
139,914

 
$
120,040

 
$
19,874

 
16.6

Gross profit
 
47,185

 
36,046

 
11,139

 
30.9

Operating Expenses:
 
 

 
 

 
 

 
 

Sales and marketing
 
19,421

 
16,389

 
3,032

 
18.5

Research and development
 
11,497

 
10,615

 
882

 
8.3

General and administrative
 
8,347

 
8,070

 
277

 
3.4

Amortization
 
864

 
1,121

 
(257
)
 
(22.9
)
Total operating expense
 
40,129

 
36,195

 
3,934

 
10.9

Gain (loss) on disposition of assets
 
(3
)
 
(1
)
 
(2
)
 
200.0

Income (loss) from operations
 
7,053

 
(150
)
 
7,203

 
(4,802.0
)
Other income (expense)
 
(884
)
 
(1,004
)
 
120

 
(12.0
)
Income tax expense (benefit)
 
2,137

 
(457
)
 
2,594

 
(567.6
)
Net earnings (loss)
 
$
4,032

 
$
(697
)
 
$
4,729

 
(678.5
)
Balance Sheet Data
 
 

 
 

 
 

 
 

Cash and cash equivalents
 
$
9,337

 
$
10,491

 
$
(1,154
)
 
(11.0
)
Accounts receivable
 
20,177

 
14,024

 
6,153

 
43.9

Inventories
 
38,588

 
30,687

 
7,901

 
25.7

Other Data (unaudited)
 
 

 
 

 
 

 
 

Orders for year ended September 30
 
142,288

 
128,749

 
13,539

 
10.5

Backlog at fiscal year end
 
43,873

 
40,370

 
3,503

 
8.7


Results of Operations

Fiscal 2017 compared to Fiscal 2016

Net sales for the year ended September 30, 2017 were $139.9 million, a 17% increase from the $120.0 million reported for fiscal 2016. International sales for fiscal 2017 were 60% of net sales and 53% in fiscal 2016. The increase in net sales occurred most significantly in Europe.  The increases in net sales were primarily due to strength in the potato market and to a lesser extent in the processed fruit and vegetable market. Sales in our automated inspection systems product line increased $13.4 million, or 35%, to $52.0 million in fiscal 2017, accounting for 37% of total revenues, compared to $38.6 million in fiscal 2016, or 32% of total revenues.  Process systems sales in fiscal 2017 were $57.1 million, a 9% increase from the $52.3 million reported for fiscal 2016.  Sales of process systems accounted for 41% of total revenues in fiscal 2017 compared to 44% in fiscal 2016.  The increase in process systems sales was across most process system equipment product lines. Parts and service sales increased over the prior year by $1.8 million, or 6%, to $30.8 million compared to $29.1 million in fiscal 2016.  Parts and service sales represented 22% of net sales in fiscal 2017 and 24% in fiscal 2016.

Orders increased 11%, or $13.5 million, to $142.3 million in fiscal 2017 from the $128.7 million of new orders received in fiscal 2016.  Backlog at September 30, 2017 increased 9% to $43.9 million compared to the $40.4 million reported at the end of fiscal 2016. The increase in orders was primarily in Europe and North America, with smaller increases in Latin America and the Asia-Pacific region. Orders increased most significantly in the potato market, and to a lesser degree in the processed fruit and vegetable market.  For fiscal 2017, automated inspection systems orders increased by $8.4 million, or 19.1%, representing 37% of order volume in fiscal 2017 compared to 34% in the prior year. This increase occurred primarily for belt-fed products, ADR, and ADR upgrade product lines.  Orders for process systems increased by $1.9 million, or 3%, and represented 41% of order volume in fiscal 2017 compared to 44% in the prior year.  The increase in orders for process systems occurred across most process system product lines. Parts and service orders increased from the prior year by $3.2 million, or 11%, and represented 22% of orders in both fiscal 2017 and fiscal 2016.

Automated inspection systems backlog was up $0.7 million, or 3%, to $21.7 million at the end of fiscal 2017 compared to $21.0 million at the same time a year ago. The increase in backlog for automatic inspection systems was primarily in the ADR

25



and ADR upgrade product lines. Backlog for process systems was up $1.9 million, or 11%, to $19.6 million at the end of fiscal 2017 compared to $18 million at the same time a year ago. The increase in the backlog for process systems was across most process systems product lines. Backlog by product line at September 30, 2017 was 49% automated inspection systems, 45% process systems, and 6% parts and service, compared to 52% automated inspection systems, 44% process systems, and 4% parts and service at September 30, 2016. A majority of the backlog is scheduled to ship subsequent to the first quarter of fiscal 2018.

Gross profit increased to $47.2 million for fiscal 2017 compared to $36.0 million in fiscal 2016, or 33.7% and 30.0% of net sales, respectively.  The principal reasons for the increase in the gross profit margin percentage was due to a more favorable product mix and increased efficiencies due to the higher manufacturing volumes.

Sales and marketing expense in fiscal 2017 increased to $19.4 million compared to $16.4 million in fiscal 2016.  As a percentage of sales, sales and marketing expense increased to 13.9% of sales in fiscal 2017 from 13.7% of sales in fiscal 2016.  The primary reason for the sales and marketing expense increase was due to increased sales commissions related to the increase in net sales, personnel related costs, including incentive compensation, and increased participation in trade shows.

Research and development expense increased $0.9 million to $11.5 million, or 8.2% of sales, in fiscal 2017 from $10.6 million, or 8.8% of sales, in fiscal 2016, due to higher spending on research and development projects and increased personnel costs.

General and administrative expense in fiscal 2017 was $8.3 million or 6.0% of sales for the year, compared to $8.1 million or 6.7% of sales for fiscal 2016.  The primary reason for the increase as a percentage of sales in spending was the result of increased personnel costs, including incentive compensation.

Other income and expense was an expense of $0.9 million for fiscal 2017 compared to $1.0 million of expense for fiscal 2016.  Other income and expense was favorably affected by lower interest expense and bank charges.

The effective tax rate for the Company was 34.6% in fiscal 2017 compared to a tax benefit rate of 39.6% in fiscal 2016. The effective tax rate for fiscal 2016 was affected by the research and development credits recorded in fiscal 2016, including $106,000 of additional research and development tax credits related to fiscal 2015 recorded in fiscal 2016 due to changes in tax law during fiscal 2015 to retroactively and permanently renew the research and development tax credit.

Many countries are pursuing legislation to significantly reform their corporate tax systems.   While we are unable to predict which, if any, of these proposed tax reforms will be enacted into law, and what effects any enacted legislation will have on our liability for corporate tax, some of the proposals being discussed include a reduction in corporate income tax rates.  If enacted, a reduction in the federal corporate tax rate could result in a significant reduction in our existing $4.5 million of  net deferred tax assets recorded as of September 30, 2017, and consequently a charge to our net earnings, in the period in which any rate change is enacted.  It is uncertain whether or when any such US or foreign tax reform proposals will be enacted and the cumulative effect of any such tax reforms on our business and financial results is also uncertain.

Net earnings in fiscal 2017 were $4.0 million, or $0.63 per diluted share, compared to a net loss of $0.7 million, or $0.11 per diluted share, in fiscal 2016.  The principal reasons for the increased net earnings for fiscal 2017 compared to fiscal 2016 were higher net sales and gross profits and lower operating expenses in relation to net sales.

Fiscal 2016 compared to Fiscal 2015

Net sales for the year ended September 30, 2016 were $120.0 million, a 17% increase from the $102.9 million reported for fiscal 2015. International sales for fiscal 2016 were 53% of net sales and 50% in fiscal 2015. The increase in net sales occurred most significantly in Europe, North America and the Asia-Pacific region.  Sales in our automated inspection systems product line increased $1.1 million, or 3%, to $38.6 million in fiscal 2016, accounting for 32% of total revenues, compared to $37.5 million in fiscal 2015, or 36% of total revenues.  Process systems sales in fiscal 2016 were $52.3 million, a 39% increase from the $37.8 million reported for fiscal 2015.  Sales of process systems accounted for 44% of total revenues in fiscal 2016 compared to 37% in fiscal 2015.  The increase in process systems sales was across most process system equipment product lines. Sales of process systems were favorably impacted by several large integrated solutions projects shipped during fiscal 2016. Parts and service sales increased by $1.5 million, or 5%, in fiscal 2016 to $29.1 million compared to $27.6 million in fiscal 2015.  Parts and service sales represented 24% of sales in fiscal 2016 and 27% in fiscal 2015.

Orders increased 12%, or $13.9 million, to $128.7 million in fiscal 2016 from the $114.8 million of new orders received in fiscal 2015.  Backlog at September 30, 2016 increased 31% to $40.4 million compared to the $30.7 million reported at the end of fiscal 2015. The increase in orders was primarily in Europe and North America, partially offset by decreases in Latin America

26



and the Asia-Pacific region. Orders increased most significantly in the potato market, and to a lesser degree in the nuts and dried fruit market. These increases were partially offset by decreases in the tobacco market.  The order mix for fiscal 2016 changed from fiscal 2015.  For fiscal 2016, automated inspection systems orders decreased by $0.2 million, or 0.3%, representing 34% of order volume in fiscal 2016 compared to 38% in the prior year. This decrease occurred primarily for chute-fed and upgrade products, mostly offset by increases in belt-fed products.  Orders for process systems increased by $13.5 million, or 31%, and represented 44% of order volume in fiscal 2016 compared to 38% in the prior year.  The increase in orders for process systems occurred across most process system product lines. Parts and service orders increased from fiscal 2015 by $0.7 million, or 2%, and represented 22% and 24% of orders in fiscal 2016 and fiscal 2015, respectively.

Automated inspection systems backlog was up $5.5 million, or 35%, to $21.0 million at the end of fiscal 2016 compared to $15.5 million at the same time in fiscal 2015. The increase in backlog for automatic inspection systems was across most product lines. Backlog for process systems was up $4.7 million, or 36%, to $17.7 million at the end of fiscal 2016 compared to $13 million in fiscal 2015. The increase in the backlog for process systems was across most process systems product lines. Backlog by product line at September 30, 2016 was 52% automated inspection systems, 44% process systems, and 4% parts and service, compared to 51% automated inspection systems, 42% process systems, and 7% parts and service at September 30, 2015.

Gross profit increased to $36.0 million for fiscal 2016 compared to $28.8 million in fiscal 2015, or 30.0% and 28.0% of net sales, respectively.  The principal reasons for the increase in the gross profit margin percentage were more effective factory utilization and lower warranty and customer support costs.

Sales and marketing expense in fiscal 2016 decreased to $16.4 million compared to $17.0 million spent in fiscal 2015.  As a percentage of sales, sales and marketing expense decreased to 13.7% of sales in fiscal 2016 from 16.6% of sales in fiscal 2015.  The primary reasons for the sales and marketing expense decrease were cost reduction initiatives that began in the prior year and reduced marketing costs related to new product roll outs.

Research and development expense increased $1.1 million to $10.6 million, or 8.8% of sales, in fiscal 2016 from $9.6 million, or 9.3% of sales, in fiscal 2015, due to higher spending on research and development projects and field testing of the new VERYX platform.

General and administrative expense in fiscal 2016 was $8.1 million or 6.7% of sales for the year, compared to $8.1 million or 7.9% of sales for fiscal 2015.  The primary reason for the decrease as a percentage of sales in spending was the result of increased sales.

Other income and expense was an expense of $1.0 million for fiscal 2016 compared to $621,000 of expense for fiscal 2015.  In fiscal 2016, we recognized foreign exchange losses of $275,000, net of the effects of forward contracts settled during the year, compared with exchange losses of $155,000 in fiscal 2015. Other income and expense was also unfavorably affected by higher interest expense and bank charges, partially offset by favorable changes in the fair market value of derivatives.

The effective tax rate for the Company was a tax benefit rate of 39.6% in fiscal 2016 compared to a tax benefit rate of 37.1% in fiscal 2015. The effective tax rate for fiscal 2016 was affected by the research and development credits recorded in fiscal 2016, including $106,000 of additional research and development tax credits related to fiscal 2015 recorded in fiscal 2016 due to changes in tax law during fiscal 2015 to retroactively and permanently renew the research and development tax credit. The effective tax rate in fiscal 2015 was favorably affected by $305,000 due to similar changes in tax law. 

The net loss in fiscal 2016 was $0.7 million, or $0.11 per diluted share, compared to a net loss of $5.0 million, or $0.80 per diluted share, in fiscal 2015.  The principal reasons for the decrease in the net loss for fiscal 2016 compared to fiscal 2015 were higher net sales and gross profits and lower operating expenses in relation to net sales.

Liquidity and Capital Resources

Fiscal 2017

For fiscal 2017, net cash decreased by $1.2 million to $9.3 million on September 30, 2017 from $10.5 million on September 30, 2016.  Cash provided by operating activities during fiscal 2017 was $1.4 million.  Investing activities consumed $2.1 million of cash.  Financing activities used $753,000 of cash.  

Cash provided by operating activities during fiscal 2017 was $1.4 million.  For fiscal 2017, net earnings were $4.0 million.  Non-cash items included in the net earnings for fiscal 2017, such as depreciation, amortization and share-based compensation, were approximately $5.4 million.  In fiscal 2017, changes in non-cash working capital used $8.0 million of cash

27



in operating activities. The major changes in current assets and liabilities using cash in fiscal 2017 were increases in inventory of $7.2 million due to higher backlog and production levels, increases in accounts receivable of $5.9 million due to increased net sales and the timing of shipments and collections, increases in income tax receivables of $1.1 million due to the timing of payments and decreases of $1.6 million in customer deposits due to the timing of orders and collections. These uses of cash were partially offset by increases in accounts payable of $2.9 million due to increased production and timing of payments, increases in accrued payroll liabilities and commissions of $2.6 million due to increased personnel costs and the timing of payrolls, increases of $1.3 million in income taxes payable due to the timing of jurisdictional payments and a $0.9 million increase in other accrued liabilities due to the timing of payments.

For fiscal 2016, $5.8 million of cash was provided by operating activities, composed of net loss of $0.7 million, non-cash items such as depreciation, amortization and share-based compensation included in the net loss of $5.8 million, and changes in non-cash working capital provided $0.7 million. The primary changes in fiscal 2017 as compared to fiscal 2016 were the net earnings and related changes in deferred taxes, increases in cash used for working capital items such as accounts receivable and inventory, and decreases in customer deposits, partially offset by increases in accounts payable, accrued payroll and commissions and other accrued liabilities and the timing of tax refunds and deductions.

Cash used in investing activities totaled $2.1 million during fiscal 2017, which primarily consisted of capital expenditures.  Capital expenditures were primarily for information systems hardware and software and equipment, and manufacturing equipment.

Cash used in financing activities totaled $0.8 million in fiscal 2017. During fiscal 2017, $582,000 of cash was used for recurring payments on long term debt and the term loan facility. Cash of $214,000 was used for exchanges of shares for statutory tax withholding. There were $43,000 of proceeds from the issuance of common stock for employee stock purchases.

The Company's domestic credit facility provides for a maximum borrowing of $20.3 million consisting of a three-year term loan of $5.3 million and revolving loans up to the lesser of $15.0 million or a borrowing base calculated based on the outstanding amount of the Company's eligible accounts receivable and eligible inventory. The credit facility also provides for a credit sub-facility of up to $4.0 million for standby letters of credit. The credit facility matures on July 19, 2018 and the Company expects to renew or refinance the credit facility in fiscal 2018. The revolving credit facility bears interest, at the Company's option, at either the lender's base lending rate or LIBOR using a tiered structure depending on the Company's achievement of specified financial ratios. The Company's base lending rate option will be the lender's base lending rate plus 0.75%, 1.00% or 1.25% per annum. The Company's LIBOR option will be LIBOR plus 2.25%, 2.50% or 2.75%. At September 30, 2017, the interest rate would have been 3.48% based on the lowest of the available alternative rates. The term loan facility bears interest, at the Company's option, at either the lender's base lending rate plus 1.75% or the one-, two-, or three-month LIBOR rate plus 3.25%. The Company also simultaneously entered into an interest rate swap agreement with the lender to fix the term loan interest rate at 6.20%. The lending facility is secured by the Company's receivables, equipment and fixtures, inventory, general intangibles, subsidiary stock, securities, investment property, financial assets, real property, and certain other assets. The credit facility contains covenants related to minimum liquidity levels and certain financial covenants that will be applicable only if the Company does not exceed certain calculated total unrestricted cash and credit availability or an event of default occurs. The credit facility permits capital expenditures to a certain level and contains customary default and acceleration provisions. The credit facility also restricts, above certain levels, acquisitions, incurrence of additional indebtedness, payment of dividends and lease expenditures. At September 30, 2017, the Company had no outstanding borrowings under the revolving line of credit and $1.1 million of outstanding standby letters of credit.

The Company's Belgian subsidiary has a credit facility with a commercial bank in Belgium. This credit accommodation totals €2.7 million ($3.2 million) and includes an operating line of €800,000 ($0.9 million), a bank guarantee facility of €500,000 ($0.6 million), and loan agreement provision of €1.4 million ($1.6 million). The operating line and bank guarantee facility are secured by all of the subsidiary's current assets. The Belgian operating line bears interest at the bank's prime rate, plus 1.25%. At September 30, 2017, the interest rate was 9.75%. At September 30, 2017, the subsidiary had no borrowings under the operating line. At September 30, 2017, the subsidiary had a loan outstanding under the loan agreement provision totaling €27,000 ($32,000). The fixed interest rate on this loan was 3.98%. The loan matured in November 2017. At September 30, 2017, the subsidiary had no bank guarantees outstanding under the bank guarantee facility.

We anticipate that current cash balances, ongoing cash flows from operations and borrowing capacity under currently available operating credit lines will be sufficient to fund our operating needs for the foreseeable future. The Company expects to renew or refinance its domestic credit facility in fiscal 2018.  Cash provided by operating activities was $1.4 million and $5.8 million in fiscal 2017 and 2016 respectively, and cash used in operating activities was $48,000 in fiscal year 2015.  We had no material commitments for capital expenditures at September 30, 2017.


28



Prior Years - Fiscal 2016 and 2015

For fiscal 2016, net cash increased by $2.8 million to $10.5 million on September 30, 2016 compared to $7.7 million on September 30, 2015.  Cash provided by operating activities was $5.8 million. Investing activities used $2.3 million of cash and $0.9 million was used in financing activities.

Cash provided by operating activities during fiscal 2016 was $5.8 million.  For fiscal 2016, the net loss was $0.7 million.  Non-cash items included in the net loss for fiscal 2016, such as depreciation, amortization and share-based compensation, were approximately $5.8 million.  In fiscal 2016, changes in non-cash working capital provided $0.7 million of cash in operating activities. The major changes in current assets and liabilities providing cash in fiscal 2016 were increases in customer deposits of $4.4 million related to increased orders and backlog, decreases of prepaid and other current costs of $0.9 million due to the timing of payments, and decreases in accounts receivable of $0.7 million related to the timing of shipments and collections. These sources of cash were offset by uses of cash for decreases in accounts payable of $3.4 million due to the timing of purchases and related payments, decreases in other accrued liabilities of $1.0 million related to the timing of payments including customer purchase plans, and reductions in accrued payroll liabilities and commissions due to the timing of payrolls.

Cash used in investing activities totaled $2.3 million during fiscal 2016, which primarily consisted of capital expenditures.  Capital expenditures were primarily for information systems hardware and software, and manufacturing equipment.

Cash used in financing activities totaled $0.9 million in fiscal 2016. During fiscal 2016, $0.7 million of cash was used for recurring payments on long term debt and the term loan facility. Cash of $256,000 was used for exchanges of shares for statutory tax withholding. There were $49,000 of proceeds from the issuance of common stock for option exercises and employee stock purchases. Short-term borrowings provided $2.0 million of cash during fiscal 2016, which was all repaid during fiscal 2016.

Cash used in operating activities during fiscal 2015 was $48,000.  For fiscal 2015, the net loss was $5.0 million.  Non-cash items included in the net loss for fiscal 2015, such as depreciation, amortization and share-based compensation, were approximately $4.5 million.  In fiscal 2015, changes in non-cash working capital provided $0.5 million of cash in operating activities. The major changes in current assets and liabilities providing cash during fiscal 2015 were an increase in accounts payable of $4.9 million due to the timing of purchases and related payments, decreases in income tax receivables of $2.8 million due to tax refunds received from net operating loss carry backs and increases of $1.2 million in customer deposits related to the timing of orders and collection. These sources of cash were offset by uses of cash from a $5.7 million increase in inventories related to the increased backlog and increases in accounts receivable of $2.8 million due to the timing of shipments and related collections.

Cash used in investing activities totaled $2.1 million during fiscal 2015, which primarily consisted of capital expenditures.  Capital expenditures were primarily for information systems software and equipment and manufacturing equipment.

Cash used in financing activities totaled $0.3 million in fiscal 2015. The refinancing of our term loan facility on our headquarters provided $5.3 million in cash, of which $4.2 million was used to pay off the existing mortgage. During fiscal 2015, $0.7 million of cash was used for recurring payments on long term debt and the term loan facility. Cash of $339,000 was used for exchanges of shares for statutory tax withholding. There were $151,000 of proceeds from the issuance of common stock for option exercises and employee stock purchases.


29



Contractual Obligations

Our continuing contractual obligations and commercial commitments existing on September 30, 2017 are as follows:

 
 
 
 
Payments due by period (in thousands)
Contractual Obligations(1)
 
Total
 
Less than 1 year
 
1 – 3 years
 
4 – 5 years
 
After 5 years
Long-term debt
 
$
4,566

 
$
4,566

 
$

 
$

 
$

Interest on long-term debt (2)
 
249

 
249

 

 

 

Operating leases
 
4,568

 
1,414

 
2,043

 
717

 
394

Total contractual cash obligations
 
$
9,383

 
$
6,229

 
$
2,043

 
$
717

 
$
394


(1) 
We also have $86,000 of contractual obligations related to uncertain tax positions for which the timing and amount of payment cannot be reasonably estimated due to the nature of the uncertainties and the unpredictability of jurisdictional examinations in relation to the statute of limitations.
(2) 
Includes the effect of the interest-rate swap agreement that fixes the interest rate at 6.20%.

At September 30, 2017, we had standby letters of credit totaling $1.1 million, which includes secured bank guarantees under our domestic and European credit facilities.  If we fail to meet our contractual obligations, these bank guarantees and letters of credit may become liabilities of the Company.  We have no off-balance sheet arrangements or transactions, or arrangements or relationships with “special purpose entities.”

30



ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Foreign Currency Exchange Risk.  We have assessed our exposure to market risks for our financial instruments and have determined that our exposures to such risks are generally limited to those affected by the value of the U.S. dollar compared to the Euro and to a lesser extent the Australian dollar and Mexican peso.

The terms of sales to European customers are typically denominated in Euros.  We expect that our standard terms of sale to international customers, other than those in Europe, will continue to be denominated in U.S. dollars, although as we expand our international operations, transactions denominated in local currencies of these countries may increase.  As of September 30, 2017, management estimates that a 10% change in foreign exchange rates would affect net earnings before taxes by approximately $363,000 on an annual basis as a result of the conversion to U.S. dollars of cash, accounts receivable, loans to foreign subsidiaries, and sales or other contracts denominated in foreign currencies.  These changes would positively affect net earnings if the U.S. dollar weakens on world markets and negatively affect net earnings if the U.S. dollar strengthens on world markets. We assess our currency exchange risk and may enter into forward contracts to minimize such risk.  At September 30, 2017, we held a 30-day forward contract for €2.4 million ($2.8 million).

As of September 30, 2017, the U.S. dollar lost approximately 4% in value against the Euro compared to its value at September 30, 2016.  During the twelve-month period ended September 30, 2017, changes in the value of the U.S. dollar against the Euro ranged between a 7% gain and a 6% loss as compared to the value at September 30, 2016.  The U.S. dollar lost in value against most other relevant currencies as of September 30, 2017 compared to the values at September 30, 2016, showing similar fluctuations during the year as with the Euro.  The effect of these fluctuations on our operations and financial results in fiscal 2017 were:

Translation adjustments of $887,000, net of income tax, were recognized as a component of comprehensive income as a result of converting the Euro denominated balance sheets of our European subsidiaries into U.S. dollars, and to a lesser extent, the Australian dollar balance sheet of our Australian subsidiary and Peso balance sheets of our Mexican subsidiaries.

Foreign exchange losses of $268,000, net of the effects of forward contracts settled during the year, were recognized in the other income and expense section of the consolidated statement of operations as a result of conversion of Euro and other foreign currency denominated receivables, intercompany loans, 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 sheets of the European, Australian, and Mexican operations.

When the U.S. dollar weakens on the world markets, our market and economic outlook for international sales could be positively affected as products sold to international customers become relatively less expensive to those customers.  Conversely, a relatively stronger U.S. dollar makes our U.S.-manufactured goods more expensive to international customers when denominated in U.S. dollars or potentially less profitable to us when denominated in a foreign currency.  On the other hand, materials or components imported into the U.S. may be less expensive.  Our Netherlands-based subsidiary transacts business primarily in Euros and does not have significant exports to the U.S, but does import a significant portion of its products from its U.S.-based parent company. These imports from the U.S. are expected to decrease in the future as we expand our manufacturing capacity in Europe. Our Belgian-based subsidiary also transacts business primarily in Euros and has significant exports to the U.S.-based parent Company which are expected to decrease in the future as manufacturing of these U.S. destined products will be done in the U.S.

Interest Rate Risk.  Under our domestic credit facility, we may borrow at either (a) the lender’s prime rate plus 75, 100 or 125 basis points or (b) at LIBOR plus 225, 250 or 275 basis points depending on our achievement of a specified financial ratio.  Our Belgian subsidiary may borrow on our Belgian credit facility at the lender's prime rate plus 1.25%.  At September 30, 2017, we had no borrowings under these arrangements.  During the year ended September 30, 2017, interest rates applicable to these variable rate credit facilities ranged from 3.19% to 9.75%.  At September 30, 2017, the rate was 3.48% on our domestic credit facility and 9.75% on our Belgian credit facility based on the lowest of the available alternative rates.  The term loan facility on our headquarters bears interest at the Company's option, at the lender's base lending rate plus 175 basis points or the one-,two- or three-month LIBOR rate plus 325 basis points, but we simultaneously entered into an interest rate swap agreement with the lender to fix the interest rate at 6.20%. Long-term fixed borrowings at our Belgian subsidiary bear interest at 3.98%.  As of September 30, 2017, management estimates that a 100 basis point change in these interest rates would not affect net income before taxes because we had no borrowings outstanding under our variable interest rate credit facilities and the interest rate swap effectively converts our variable rate term loan facility into a fixed rate.

31



ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Title
Page

Report of Independent Registered Public Accounting Firm
33

Consolidated Balance Sheets at September 30, 2017 and 2016
34

Consolidated Statements of Operations for the three years ended September 30, 2017
36

Consolidated Statements of Comprehensive Income for the three years ended September 30, 2017
37

Consolidated Statements of Shareholders' Equity for the three years ended September 30, 2017
38

Consolidated Statements of Cash Flows for the three years ended September 30, 2017
39

Notes to Consolidated Financial Statements
41

Supplementary Data
57


32




REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


Board of Directors and Shareholders
Key Technology, Inc.

We have audited the accompanying consolidated balance sheets of Key Technology, Inc. (an Oregon corporation) and subsidiaries (the “Company”) as of September 30, 2017 and 2016, and the related consolidated statements of operations, statements of comprehensive income, changes in shareholders’ equity, and cash flows for each of the three years in the period ended September 30, 2017. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Key Technology, Inc. and subsidiaries as of September 30, 2017 and 2016, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2017 in conformity with accounting principles generally accepted in the United States of America.



/s/ GRANT THORNTON LLP

Seattle, Washington
December 8, 2017




33



KEY TECHNOLOGY, INC. AND SUBSIDIARIES
 
 
 
 
CONSOLIDATED BALANCE SHEETS
 
 
 
 
SEPTEMBER 30, 2017 AND 2016
 
 
 
 
(In thousands)
 
 
 
 
 
 
2017
 
2016
ASSETS
 
 
 
 
CURRENT ASSETS:
 
 
 
 
Cash and cash equivalents
 
$
9,337

 
$
10,491

Trade accounts receivable, net of allowance for doubtful accounts of $299 and $266, respectively
 
20,177

 
14,024

Inventories
 
38,588

 
30,687

Deferred income taxes
 
4,770

 
3,934

Income tax receivable
 
1,127

 
59

Prepaid expenses and other assets
 
3,312

 
3,226

Total current assets
 
77,311

 
62,421

PROPERTY, PLANT AND EQUIPMENT, Net
 
12,911

 
13,789

DEFERRED INCOME TAXES
 
1,299

 
3,001

INTANGIBLES, Net
 
4,457

 
5,149

INVESTMENT IN PRODITEC
 
1,127

 
1,127

GOODWILL
 
10,616

 
10,277

OTHER ASSETS
 
117

 
220

TOTAL
 
$
107,838

 
$
95,984

See notes to consolidated financial statements.
 
 
 



34



KEY TECHNOLOGY, INC. AND SUBSIDIARIES
 
 
 
 
CONSOLIDATED BALANCE SHEETS
 
 
 
 
SEPTEMBER 30, 2017 AND 2016
 
 
 
 
(In thousands, except shares)
 
 
 
 
 
 
2017
 
2016
LIABILITIES AND SHAREHOLDERS' EQUITY
 
 
 
 
CURRENT LIABILITIES:
 
 
 
 
Accounts payable
 
$
10,490

 
$
7,381

Accrued payroll liabilities and commissions
 
7,714

 
4,932

Customers' deposits
 
8,085

 
9,139

Accrued customer support and warranty costs
 
2,276

 
2,197

Income tax payable
 
1,357

 

Current portion of long-term debt
 
4,566

 
587

Customer purchase plans
 
1,039

 
1,124

Other accrued liabilities
 
1,923

 
956

Total current liabilities
 
37,450

 
26,316

LONG-TERM DEBT
 

 
4,565

DEFERRED INCOME TAXES
 
1,514

 
1,761

OTHER LONG TERM LIABILITIES
 
222

 
348

COMMITMENTS AND CONTINGENCIES
 


 


SHAREHOLDERS' EQUITY:
 
 
 
 
Preferred stock-no par value; 5,000,000 shares authorized; none issued and outstanding
 

 

Common stock-no par value; 45,000,000 shares authorized; 6,487,687 and 6,403,870 issued and outstanding at September 30, 2017 and 2016, respectively
 
34,959

 
34,237

Retained earnings
 
34,580

 
30,548

Accumulated other comprehensive income (loss)
 
(887
)
 
(1,791
)
Total shareholders' equity
 
68,652

 
62,994

      Total liabilities and shareholder's equity
 
$
107,838

 
$
95,984

See notes to consolidated financial statements.
 
 
 



35



KEY TECHNOLOGY, INC. AND SUBSIDIARIES
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
 
 
 
 
THREE YEARS ENDED SEPTEMBER 30, 2017
 
 
 
 
 
 
(In thousands, except per share data)
 
 
 
 
 
 
 
 
2017
 
2016
 
2015
NET SALES
 
$
139,914

 
$
120,040

 
$
102,925

COST OF SALES
 
92,729

 
83,994

 
74,111

Gross profit
 
47,185

 
36,046

 
28,814

OPERATING EXPENSES:
 
 
 
 
 
 
Sales and marketing
 
19,421

 
16,389

 
17,037

Research and development
 
11,497

 
10,615

 
9,560

General and administrative
 
8,347

 
8,070

 
8,104

Amortization of intangibles
 
864

 
1,121

 
1,484

Total operating expenses
 
40,129

 
36,195

 
36,185

GAIN (LOSS) ON DISPOSITION OF ASSETS
 
(3
)
 
(1
)
 
13

INCOME (LOSS) FROM OPERATIONS
 
7,053

 
(150
)
 
(7,358
)
OTHER INCOME (EXPENSE):
 
 
 
 
 
 
Royalty income
 
23

 
81

 
66

Interest income
 

 

 
12

Interest expense
 
(324
)
 
(382
)
 
(273
)
Reclassification from Other comprehensive income
 
(25
)
 
(25
)
 
(4
)
Foreign exchange loss
 
(268
)
 
(275
)
 
(155
)
Other, net
 
(290
)
 
(403
)
 
(267
)
Total other income (expense)-net
 
(884
)
 
(1,004
)
 
(621
)
Earnings (loss) before income taxes
 
6,169

 
(1,154
)
 
(7,979
)
Income tax expense (benefit)
 
2,137

 
(457
)
 
(2,960
)
Net earnings (loss)
 
$
4,032

 
$
(697
)
 
$
(5,019
)
EARNINGS (LOSS) PER SHARE - Basic
 
$
0.63

 
$
(0.11
)
 
$
(0.80
)
EARNINGS (LOSS) PER SHARE - Diluted
 
$
0.63

 
$
(0.11
)
 
$
(0.80
)
SHARES USED IN PER SHARE CALCULATION - Basic
 
6,447

 
6,332

 
6,295

SHARES USED IN PER SHARE CALCULATION - Diluted
 
6,447

 
6,332

 
6,295

See notes to consolidated financial statements.
 
 
 
 
 
 

36




KEY TECHNOLOGY, INC. AND SUBSIDIARIES
 
 
 
 
 
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
 
 
 
 
 
THREE YEARS ENDED SEPTEMBER 30, 2017
 
 
 
 
 
 
(Dollars in thousands)
 
 
 
 
 
 

 

 

 


 
2017
 
2016
 
2015
Net earnings (loss)
 
$
4,032

 
$
(697
)
 
$
(5,019
)
Other comprehensive income (loss):
 

 

 

Foreign currency translation adjustment
 
1,344

 
63

 
(2,534
)
Unrealized changes in fair value of derivatives
 

 

 
(7
)
Reclassification adjustment for changes in fair value of derivatives included in net earnings
 
25

 
25

 
4

Income tax (expense) benefit related to items of comprehensive income (loss)
 
(465
)
 
(30
)
 
863

Total comprehensive income (loss)
 
$
4,936

 
$
(639
)
 
$
(6,693
)

 

 

 

See notes to consolidated financial statements.
 
 
 
 
 
 


37



KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
THREE YEARS ENDED SEPTEMBER 30, 2017
(Dollars in thousands)
 
 
Common Stock
 
 
 
 
 
 
 
 
 
 
Shares
 
Amount
 
Warrants
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
Total
Balance at September 30, 2014
 
6,307,543

 
$
31,414

 
$
665

 
$
36,264

 
$
(175
)
 
$
68,168

Net loss
 

 

 

 
(5,019
)
 

 
(5,019
)
Comprehensive income - foreign currency translation adjustment, net of tax benefit of $862
 

 

 

 

 
(1,672
)
 
(1,672
)
Unrealized changes in value of derivatives, net of tax benefit of $2
 

 

 

 

 
(5
)
 
(5
)
Reclassification for changes in fair value of derivatives included in net earnings, net of tax expense of $1
 

 

 

 

 
3

 
3

Tax benefits from share-based payments



(4
)







(4
)
Share based payments
 

 
1,454

 

 

 

 
1,454

Issuance of stock upon exercise of stock options
 
10,000

 
96

 

 

 

 
96

Issuance of stock for Employee Stock Purchase Plan
 
5,003

 
55

 

 

 

 
55

Stock grants - performance-based

65,284

 

 

 

 

 

Stock grants - employment-based

84,108

 

 

 

 

 

Restricted stock surrendered in payment of taxes

(26,753
)
 
(339
)
 

 

 

 
(339
)
Stock forfeitures and retirements
 
(63,381
)
 

 

 

 

 

Balance at September 30, 2015
 
6,381,804

 
32,676

 
665

 
31,245

 
(1,849
)
 
62,737

Net loss
 

 

 

 
(697
)
 

 
(697
)
Comprehensive income - foreign currency translation adjustment, net of tax benefit of $21
 

 

 

 

 
42

 
42

Reclassification for changes in fair value of derivatives included in net earnings, net of tax expense of $9
 

 

 

 

 
16

 
16

Tax benefits from share-based payments
 

 
(50
)
 

 

 

 
(50
)
Warrants forfeited



665


(665
)






Share based payments
 

 
1,153

 

 

 

 
1,153

Issuance of stock for Employee Stock Purchase Plan
 
6,314

 
49

 

 

 

 
49

Stock grants - performance-based
 
63,257

 

 

 

 

 

Stock grants - employment-based
 
117,104

 

 

 

 

 

Restricted stock surrendered in payment of taxes

(25,058
)

(256
)







(256
)
Stock forfeitures and retirements
 
(139,551
)
 

 

 

 

 

Balance at September 30, 2016
 
6,403,870

 
34,237

 

 
30,548

 
(1,791
)
 
62,994

Net earnings
 

 

 

 
4,032

 

 
4,032

Comprehensive income - foreign currency translation adjustment, net of tax expense of $457
 

 

 

 

 
887

 
887

Reclassification for changes in fair value of derivatives included in net earnings, net of tax expense of $8
 

 

 

 

 
17

 
17

Tax benefits from share-based payments
 

 
(80
)
 

 

 

 
(80
)
Share based payments
 

 
973

 

 

 

 
973

Issuance of stock for Employee Stock Purchase Plan
 
3,584

 
43

 

 

 

 
43

Stock grants - performance-based
 
93,108

 

 

 

 

 

Stock grants - employment-based
 
67,493

 

 

 

 

 

Restricted stock surrendered in payment of taxes
 
(18,911
)
 
(214
)
 

 

 

 
(214
)
Stock forfeitures and retirements
 
(61,457
)
 

 

 

 

 

Balance at September 30, 2017
 
6,487,687

 
$
34,959

 
$

 
$
34,580

 
$
(887
)
 
$
68,652

See notes to consolidated financial statements.
 
 
 
 
 
 
 
 
 
 
 
 

38




KEY TECHNOLOGY, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED SEPTEMBER 30, 2017
 
 
 
 
 
 
(In thousands)
 
 
 
 
 
 
 
 
2017
 
2016