News Column

KEY TECHNOLOGY INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

August 8, 2014

From time to time, Key Technology, Inc. ("we", "us" or "our"), through its management, may make forward-looking public statements with respect to the company regarding, among other things, expected future revenues or earnings, projections, plans, future performance, product development and commercialization, and other estimates relating to our future operations. Forward-looking statements may be included in reports filed under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), in press releases or in oral statements made with the approval of an authorized executive officer of Key. The words or phrases "will likely result," "are expected to," "intends," "is anticipated," "estimates," "believes," "projects" or similar expressions are intended to identify "forward-looking statements" within the meaning of Section 21E of the Exchange Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to a number of risks and uncertainties, the occurrence of any of which could cause the price of our common stock to fluctuate significantly, making it difficult for shareholders to resell common stock at a time or price they find attractive. We caution investors not to place undue reliance on our forward-looking statements, which speak only as of the date on which they are made. Our actual results may differ materially from those described in the forward-looking statements as a result of various factors, including those listed below:



changes in general economic conditions and disruption in financial markets

may adversely affect the business of our customers and our business and results of operations; ongoing uncertainty and volatility in the global financial markets may adversely affect our operating results;



discord, conflict, and lack of compromise within and between the executive

and legislative branches of the U.S. government related to federal

government budgeting, taxation policies, government expenditures, and U.S.

borrowing/debt ceiling limits could adversely affect our business and

operating results;

economic conditions in the food processing industry, either globally or

regionally, may adversely affect our revenues;

the loss of any of our significant customers could reduce our revenues and

profitability;

significant investments in unsuccessful research and development efforts

could materially adversely affect our business;

industry consolidation could increase competition in the food processing

equipment industry;

we are subject to price competition that may reduce our profitability;

the significance of major orders could result in significant fluctuation in

quarterly operating results;

the failure of our independent sales representatives to perform as expected

would harm our net sales; we have made, or may make, acquisitions, or enter into distribution agreements or similar business relationships that could disrupt our operations and harm our operating results;



our international operations subject us to a number of risks that could

adversely affect our revenues, operating results and growth; fluctuations in foreign currency exchange rates could result in



unanticipated losses that could adversely affect our liquidity and results

of operations; advances in technology by competitors may adversely affect our sales and profitability;



our existing and new products may not compete successfully in either current

or new markets, which would adversely affect our sales and operating results; our expansion into new markets, increasingly complex projects and applications, and integrated product offerings could increase our cost of operations and reduce gross margins and profitability; our inability to obtain products and components from suppliers would adversely affect our ability to manufacture and market our products;



our information systems, computer equipment and information databases are

critical to our business operations, and any damage or disruptions could

adversely affect our business and results of operations; our potential inability to retain and recruit experienced management and



other key personnel, or the loss of key management personnel, may adversely

affect our business and prospects for growth;

the potential inability to protect our intellectual property, especially as

we expand geographically, may adversely affect our competitive advantage;

intellectual property-related litigation expenses and other costs resulting

from infringement claims asserted against us by third parties may adversely

affect our results of operations and our customer relations; our dependence on certain suppliers may leave us temporarily without adequate access to raw materials or products;



our operating results are seasonal and may further fluctuate due to severe

weather conditions affecting the agricultural industry in various parts of

the world;

the limited availability and possible cost fluctuations of materials used in

our products could adversely affect our gross margins;

compliance with recently passed health care legislation and increases in the

cost of providing health care plans to our employees may adversely affect

our business; 17

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our reported results may be affected adversely by the implementation of new,

or changes in the interpretation of existing, accounting principles or financial reporting requirements, which could require us to incur substantial additional expenses; and



compliance with changing regulation of corporate governance and public

disclosure will result in additional expenses to us and pose challenges for

our management. More information may be found in Item 1A, "Risk Factors," in our Annual Report on Form 10-K for the fiscal year ended September 30, 2013 filed with the SEC on December 13, 2013, which item is hereby incorporated by reference. Given these uncertainties, readers are cautioned not to place undue reliance on the forward-looking statements. We disclaim any obligation subsequently to revise or update forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. Overview General We and our operating subsidiaries design, manufacture, sell and service automation systems that process product streams of discrete pieces to improve safety and quality. These systems integrate electro-optical automated inspection and sorting systems with process systems that include specialized conveying and preparation systems. We provide parts and service for each of our product lines to customers throughout the world. Industries served include food processing, tobacco, plastics, pharmaceuticals and nutraceuticals. We maintain two domestic manufacturing facilities and two European manufacturing facilities located in Belgium and the Netherlands. We market our products directly and through independent sales representatives. In recent years, 40% or more of our sales have been made to customers located outside the United States. In our export and international sales, we are subject to the risks of conducting business internationally, including unexpected changes in regulatory requirements; fluctuations in the value of the U.S. dollar, which could increase or decrease the sales prices in local currencies of our products; tariffs and other barriers and restrictions; and the burdens of complying with a variety of international laws. The worldwide economy and economic uncertainty continue to challenge operating results. We continue to see customers seeking to retain cash and requiring higher returns on investment, price sensitivity, longer or delayed purchasing cycles, and more purchasing decisions at corporate levels rather than local operating locations. In addition, in response to excess capacity, the market continues to see very aggressive pricing efforts to stimulate demand, which has increased price competition for our products, particularly in automated inspection systems where pricing and competition are particularly aggressive. In the last quarter of fiscal 2012 and first quarter of fiscal 2013, we saw increased capital spending, particularly in the potato market, for which we received several large orders. These large orders did not recur in fiscal 2014, which is reflective of the cyclical and seasonal nature of this market.



Current period - third fiscal quarter of 2014

Net sales of $31.3 million in the third quarter of fiscal 2014 were $8.1 million, or 21%, lower than net sales of $39.4 million in the corresponding quarter a year ago. The lower net sales in the third fiscal quarter of 2014 were due primarily to decreased sales of process systems. International sales were 47% of net sales for the third fiscal quarter of 2014, compared to 44% in the corresponding prior-year period. Net sales for the fourth quarter of fiscal 2014 are expected to decrease moderately as compared to the net sales recorded in the third quarter of fiscal 2014. Backlog of $26.6 million at the end of the third fiscal quarter of 2014 represented a $15.1 million, or 36%, decrease from the ending backlog of $41.7 million at the end of the corresponding quarter a year ago. This decrease in backlog as compared to the prior year is due primarily to fewer large orders, primarily in the potato market, than were received in the fourth quarter of fiscal 2012 and the first quarter of fiscal 2013. These large orders, which did not recur in fiscal 2014, are reflective of the cyclical and seasonal industries included in our markets. On June 26, 2014, the Company announced cost reduction initiatives which resulted in a pre-tax charge of approximately $1.2 million in the third quarter of fiscal 2014. These initiatives include a planned reduction of approximately 8% of our global workforce. The majority of these cost reductions will be fully implemented, and the majority of the associated cash expenditures will be incurred, during the fourth quarter of fiscal 2014.



Orders in the third fiscal quarter of 2014 of $26.9 million were down $4.0 million, or 13%, compared to orders of $30.9 million in the third fiscal quarter of 2013. Orders decreased as compared to the same period in the prior year primarily in automated inspection systems.

18 -------------------------------------------------------------------------------- Gross margin percentages in the third fiscal quarter of 2014 decreased from the margins for the third fiscal quarter of 2013 due to less favorable changes in product mix, less effective factory utilization due to lower production volumes, and costs related to the workforce reduction. Gross margins are expected to be higher in the fourth quarter of fiscal 2014 as compared with the third quarter of fiscal 2014 and more in alignment with the year-to-date gross margins adjusted for the cost reduction charges. The net loss for the third fiscal quarter of 2014 was $2.0 million, or $0.32 per diluted share. The net earnings for the corresponding three-month period in fiscal 2013 were $1.4 million, or $0.23 per diluted share. The net loss in the most recent three-month period is primarily due to lower net sales, lower gross margins and higher operating expenses due to increased spending on research and development and the charges related to the workforce reduction.



First nine months of fiscal 2014

In the first nine months of fiscal 2014, net sales and net earnings decreased compared to the corresponding period in the prior fiscal year. Net sales of $85.6 million for the first nine months of fiscal 2014 were $9.2 million, or 10%, lower than net sales of $94.8 million in the corresponding period a year ago. International sales were 46% of net sales for the first nine months of fiscal 2014 which was the same as the corresponding prior year period. Net sales were down 30% in process systems which were partially offset by a 2% increase in automated inspection systems and a 4% increase in parts and service. Orders in the first nine months of fiscal 2014 of $86.5 million decreased $15.2 million, or 15%, compared to orders of $101.7 million in the first nine months of fiscal 2013. Customer orders decreased 30% in process systems, decreased 10% in automated inspection systems, and increased 1% in parts and service. The net loss for the first nine months of fiscal 2014 was $5.3 million, or $0.85 per diluted share. Net earnings for the corresponding nine-month period in fiscal 2013 were $2.7 million, or $0.47 per diluted share. The decrease in net earnings is primarily due to lower net sales, lower gross margins related to less effective factory utilization due to lower production volumes, a less favorable product mix and higher operating expenses. Due to the results of the first nine months of fiscal 2014, we anticipate that we will not be profitable for fiscal year 2014. Outlook Earlier this fiscal year, we disclosed our annualized business model which we expect to achieve within the next two-to-three years that we believe is reasonably attainable through organic growth. Our current expectations are as follows for the revenue, gross margin, operating income margin and EBITDA that may be reasonably achieved during the fiscal 2015-2017 period:



Revenue: $160 million - $170 million

Gross Margin: 36+%

Operating Income Margin: 8+%

EBITDA: $18 million - $19+ million

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



Application of Critical Accounting Policies

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



Allowances for doubtful accounts

Valuation of inventories Long-lived assets Allowances for warranties



Accounting for income taxes

Management has discussed the development, selection and related disclosures of these critical accounting estimates with the audit committee of our board of directors. 19 -------------------------------------------------------------------------------- Revenue Recognition. We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred or services have been provided, the sale price is fixed or determinable, and collectability is reasonably assured. Additionally, we sell our goods on terms which transfer title and risk of loss at a specified location, typically shipping point, port of loading or port of discharge, depending on the final destination of the goods. Accordingly, revenue recognition from product sales occurs when all criteria are met, including transfer of title and risk of loss, which occurs either upon shipment by us or upon receipt by customers at the location specified in the terms of sale. Sales of system upgrades are recognized as revenue upon completion of the conversion of the customer's existing system when this conversion occurs at the customer site. Certain other, less frequent, equipment sales are recognized as revenue upon completion of installation at the customer site. Revenue earned from services (maintenance, installation support, and repairs) is recognized ratably over the contractual period or as the services are performed. If any contract provides for both equipment and services (multiple deliverables), the sales price is allocated to the various elements based on the relative selling price. Each element is then evaluated for revenue recognition based on the previously described criteria. We typically have a very limited number of contracts with multiple deliverables and they are not material to the financial statements. Our sales arrangements provide for no other significant post-shipment obligations. If all conditions of revenue recognition are not met, we defer revenue recognition. In the event of revenue deferral, the sale value is not recorded as revenue to us, accounts receivable are reduced by any related amounts owed by the customer, and the cost of the goods or services deferred is carried in inventory. In addition, we periodically evaluate whether an allowance for sales returns is necessary. Historically, we have experienced few sales returns. We account for cash consideration (such as sales incentives) that are given to customers or resellers as a reduction of revenue rather than as an operating expense unless an identified benefit is received for which fair value can be reasonably estimated. We believe that revenue recognition is a "critical accounting estimate" because our terms of sale vary significantly, and management exercises judgment in determining whether to recognize or defer revenue based on those terms. Such judgments may materially affect net sales for any period. Management exercises judgment within the parameters of accounting principles generally accepted in the United States of America (GAAP) in determining when contractual obligations are met, title and risk of loss are transferred, the sales price is fixed or determinable and collectability is reasonably assured. At June 30, 2014, we had invoiced $4.2 million, compared to $4.0 million at September 30, 2013, for which we have not recognized revenue. Allowances for doubtful accounts. We establish allowances for doubtful accounts for specifically identified, as well as anticipated, doubtful accounts based on credit profiles of customers, current economic trends, contractual terms and conditions, and customers' historical payment patterns. Factors that affect collectability of receivables include general economic or political factors in certain countries that affect the ability of customers to meet current obligations. We actively manage our credit risk by utilizing an independent credit rating and reporting service, by requiring certain percentages of down payments, and by requiring secured forms of payment for customers with uncertain credit profiles or located in certain countries. Forms of secured payment could include irrevocable letters of credit, bank guarantees, third-party leasing arrangements or EX-IM Bank guarantees, each utilizing Uniform Commercial Code filings, or the like, with governmental entities where possible. We believe that the accounting estimate related to allowances for doubtful accounts is a "critical accounting estimate" because it requires management judgment in making assumptions relative to customer or general economic factors that are outside our control. As of June 30, 2014, the balance sheet included allowances for doubtful accounts of $398,000 as compared to $296,000 at September 30, 2013. Amounts charged to bad debt expense for the nine months ended June 30, 2014 and 2013, respectively, were $99,000 and $(9,000). Actual charges to the allowance for doubtful accounts for the nine months ended June 30, 2014 and 2013, respectively, were $(1,000) and $6,000. If we experience actual bad debt expense in excess of estimates, or if estimates are adversely adjusted in future periods, the carrying value of accounts receivable would decrease and charges for bad debts would increase, resulting in decreased net earnings. Valuation of inventories. Inventories are stated at the lower of cost or market. Our inventory includes purchased raw materials, manufactured components, purchased components, service and repair parts, work in process, finished goods and demonstration equipment. Write downs for excess and obsolete inventories are made after periodic evaluation of historical sales, current economic trends, forecasted sales, estimated product lifecycles and estimated inventory levels. The factors that contribute to inventory valuation risks are our purchasing practices, electronic component obsolescence, accuracy of sales and production forecasts, introduction of new products, product lifecycles and the associated product support. We actively manage our exposure to inventory valuation risks by maintaining low safety stocks and minimum purchase lots, utilizing just in time purchasing practices, managing product end-of-life issues brought on by aging components or new product introductions, and by utilizing inventory minimization strategies such as vendor-managed inventories. We believe that the accounting estimate related to valuation of inventories is a "critical accounting estimate" because it is susceptible to changes from period to period due to the requirement for management to make estimates relative to each of the underlying factors ranging from purchasing to sales to production to after-sale support. At June 30, 2014, cumulative inventory adjustments to the lower of cost or market totaled $4.3 million compared to $3.4 million as of June 30, 2013. Amounts charged to expense to record inventory at lower of cost or market for the nine months ending June 30, 2014 and 2013 were $1.4 million and $1.2 million, respectively. Actual charges to the cumulative inventory adjustments upon disposition or sale of inventory were $662,000 and $480,000 for the nine months ending June 30, 2014 and 2013, respectively. If 20 -------------------------------------------------------------------------------- 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 June 30, 2014, we held $38.4 million of long-lived assets, net of depreciation and amortization. There were no material changes in our long-lived assets that would result in an adjustment of the carrying value for these assets. Estimates of future cash flows arising from the utilization of these long-lived assets and estimated useful lives associated with the assets are critical to the assessment of recoverability and fair values. We believe that the accounting estimate related to long-lived assets is a "critical accounting estimate" because: (1) it is susceptible to change from period to period due to the requirement for management to make assumptions about future sales and cost of sales generated throughout the lives of several product lines over extended periods of time; and (2) the potential effect that recognizing an impairment could have on the assets reported on our balance sheet and the potential material adverse effect on reported earnings or loss. Changes in these estimates could result in a determination of asset impairment, which would result in a reduction to the carrying value and a reduction to net earnings in the affected period. Allowances for warranties. Our products are covered by standard warranty plans included in the price of the products ranging from 90 days to five years, depending upon the product and contractual terms of sale. The majority of the warranty periods are for one year or less. We establish allowances for warranties for specifically identified, as well as anticipated, warranty claims based on contractual terms, product conditions and actual warranty experience by product line. Our products include both manufactured and purchased components and, therefore, warranty plans include third-party sourced parts which may not be covered by the third-party manufacturer's warranty. We actively manage our quality program by using a structured product introduction plan, process monitoring techniques utilizing statistical process controls, vendor quality metrics, and feedback loops to communicate warranty claims to designers and engineers for remediation in future production. We believe that the accounting estimate related to allowances for warranties is a "critical accounting estimate" because: (1) it is susceptible to significant fluctuation period-to-period due to the requirement for management to make assumptions about future warranty claims relative to potential unknown issues arising in both existing and new products, which assumptions are derived from historical trends of known or resolved issues; and (2) risks associated with third-party supplied components being manufactured using processes that we do not control. As of June 30, 2014, the balance sheet included warranty reserves of $2.0 million. Warranty charges of $2.5 million were incurred during the nine-month period then ended. Warranty reserves were $2.8 million as of June 30, 2013 and warranty charges of $3.1 million were incurred during the nine-month period then ended. If our actual warranty costs are higher than estimates, future warranty plan coverages are different, or estimates are adversely adjusted in future periods, reserves for warranty expense would need to increase, warranty expense would increase and gross margins would decrease. Accounting for income taxes. Our provision for income taxes and the determination of the resulting deferred tax assets and liabilities involves a significant amount of management judgment. The quarterly provision for income taxes is based partially upon estimates of pre-tax financial accounting income for the full year and is affected by various differences between financial accounting income and taxable income. Judgment is also applied in determining whether the deferred tax assets will be realized in full or in part. In management's judgment, when it is more likely than not that all or some portion of specific deferred tax assets will not be realized, a valuation allowance must be established for the amount of the deferred tax assets that are determined not to be realizable. At June 30, 2014, we had valuation reserves of approximately $185,000 for deferred tax assets for capital loss carryforwards and changes in the carrying value of our investment in Proditec, and offsetting amounts for foreign deferred tax assets and U.S. deferred tax liabilities, primarily related to net operating loss carryforwards in the foreign jurisdictions that we believe will not be utilized during the carryforward periods. During the nine months ended June 30, 2014, there were no material changes in our valuation reserves. There were no other material valuation allowances at June 30, 2014 due to anticipated utilization of all the deferred tax assets as we believe we will have sufficient taxable income to utilize these assets. We maintain reserves for uncertain tax positions in jurisdictions of operation. These tax jurisdictions include federal, state and various international tax jurisdictions. Potential income tax exposures include potential challenges of various tax credits and deductions, and issues specific to state and local tax jurisdictions. Exposures are typically settled primarily through audits within these tax jurisdictions, but can also be affected by changes in applicable tax law or other factors, which could cause our management to believe a revision of past estimates is appropriate. Thus far, during fiscal 2014, there have been no significant changes in these estimates. Management believes that an appropriate liability has been established for estimated exposures; however, actual results may differ materially from these estimates. We believe that the accounting estimate related to income taxes is a "critical accounting estimate" because it relies on significant management judgment in making assumptions relative to temporary and permanent timing differences of tax effects, estimates of future 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 21 --------------------------------------------------------------------------------



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.

In fiscal 2013, the American Taxpayer Relief Act was enacted which renewed the research and development tax credit for a two-year period retroactive to January 1, 2012. In the second quarter of fiscal 2013, income tax expense was reduced by approximately $192,000 for additional research and development tax credits related to expenditures incurred during fiscal 2012 due to changes in tax law that were enacted during the quarter to retroactively renew these tax credits. In addition, the income tax expense for the three-month period ended March 31, 2013 was reduced by estimated research and development tax credits for the six-month period then ended to reflect the retroactive renewals. The research and development credit expired on December 31, 2013 and, as of the date of this report, has not been renewed. Recent Accounting Pronouncements Not Yet Adopted. In 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. We are evaluating our existing revenue recognition policies to determine whether any contracts in the scope of the guidance will be affected by the new requirements. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods therein.



Results of Operations

For the three months ended June 30, 2014 and 2013

Net sales decreased $8.1 million, or 21%, to $31.3 million in the third quarter of fiscal 2014 from $39.4 million recorded in the corresponding quarter a year ago. International sales for the three-month period ending June 30, 2014 were 47% of net sales compared to 44% in the corresponding prior year period. The decrease in net sales occurred in most geographic regions with the exception of Latin America. Net sales decreased most significantly in the potato market, and also decreased in the tobacco market, partially offset by increases in the processed fruit and vegetable market. The decrease in net sales occurred primarily in process systems which decreased $7.0 million, or 43%, to $9.1 million in the third quarter of fiscal 2014. Decreases in process system sales related primarily to vibratory products in North America and Europe, third party equipment, and rotary sizers and graders. Automated inspection systems net sales were down $1.1 million, or 7%, to $15.1 million. The decrease in automated inspection system sales was primarily in certain belt-fed products and upgrades, partially offset by increases in chute-fed products. Parts and service sales were $7.1 million, approximately the same as the corresponding period a year ago. Automated inspection systems sales, including upgrade systems, represented 48% of net sales in the third quarter of fiscal 2014 compared to 41% of net sales in the third quarter of fiscal 2013. Process systems sales represented 29% of net sales in the third quarter of fiscal 2014 compared to 41% during the third quarter of fiscal 2013, while parts and service sales accounted for 23% of net sales in the third quarter of fiscal 2014, compared to 18% during the third quarter of fiscal 2013. We expect net sales in the fourth quarter of fiscal 2014 to decrease moderately as compared to the net sales reported in the third quarter of fiscal 2014. Total backlog was $26.6 million at the end of the third quarter of fiscal 2014 and was $15.1 million, or 36%, lower than the $41.7 million backlog at the end of the third quarter of the prior fiscal year. Automated inspection systems backlog decreased by $8.9 million, or 38%, to $14.5 million at the end of the third quarter of fiscal 2014 compared to $23.4 million at the same time a year ago. The decrease was across almost all product lines. Backlog for process systems was down $6.1 million, or 39%, to $9.8 million at June 30, 2014 compared to $15.9 million at June 30, 2013. The decrease in the backlog for process systems was primarily driven by a decrease in orders for vibratory products in Europe and North America, third party equipment, and rotary sizers and graders. Backlog by product line at June 30, 2014 was 54% automated inspection systems, 37% process systems, and 9% parts and service, as compared to 56% automated inspection systems, 38% process systems, and 6% parts and service at June 30, 2013. Orders of $26.9 million in the third quarter of fiscal 2014 were $4.0 million, or 13%, lower than the third quarter new orders of $30.9 million a year ago. Automated inspection systems orders decreased $3.9 million, or 27%, during the third quarter of fiscal 2014 to $10.3 million compared to $14.2 million in the third quarter of fiscal 2013. Orders for process systems during the third quarter of fiscal 2014 decreased $0.2 million, or 2%, to $8.9 million from $9.1 million in the comparable quarter of fiscal 2013. Orders for parts and service increased $0.1 million, or 1%, during the third quarter of fiscal 2014 to $7.7 million compared to $7.6 million in the third quarter of fiscal 2013. The decrease in orders for automated inspection systems occurred primarily in belt-fed products and upgrades, partially offset by increases in chute-fed products. The decrease in orders for process systems occurred primarily in rotary sizers and graders and other non-food products, partially offset by increases in vibratory products and 22 -------------------------------------------------------------------------------- other process equipment in North America and Europe. Orders were down primarily in the North America region and decreased primarily in the potato market as customers have delayed or redirected capital expenditures. This decrease was partially offset by increases in the nuts and dried fruits market.



In the third quarter of fiscal 2014, the Company announced cost reduction initiatives which resulted in pre-tax charges of $1.2 million during the quarter. Approximately $750,000 of these charges were expensed to cost of goods sold, with the remainder expensed to operating expenses.

Gross profit for the third quarter of fiscal 2014 was $8.2 million compared to $13.3 million in the corresponding period last year. Gross margin in the third quarter of fiscal 2014, as a percentage of net sales, decreased to 26.0% compared to the 33.7% reported in the corresponding quarter of fiscal 2013. This gross margin percentage for the third quarter of fiscal 2014 decreased significantly due to less favorable changes in the product mix, less effective factory utilization due to lower production volumes, and charges related to the cost reduction initiatives. We anticipate gross margin percentages will be higher in the fourth quarter of fiscal 2014 compared to the third quarter of fiscal 2014 and more in alignment with the year-to-date gross margins adjusted for the cost reduction charges. Operating expenses of $11.1 million for the third quarter of fiscal 2014 were 35.5% of net sales compared to $11.0 million for the third quarter of fiscal 2013 and 27.9% of net sales. The amount of operating expenses increased due to higher spending on research and development efforts related to the field testing of new developments, and charges related to the cost reduction initiatives. We anticipate operating expenses will decrease significantly in the fourth quarter of fiscal 2014 as compared to the third quarter of fiscal 2014.



Other expense for the third quarter of fiscal 2014 was $93,000 compared to $208,000 for the corresponding period in fiscal 2013 primarily due to foreign exchange gains in the third quarter of fiscal 2014 as compared to foreign exchange losses in the prior year's third fiscal quarter.

The net loss for the quarter ending June 30, 2014 was $2.0 million, or $0.32 per diluted share. Net earnings for the corresponding period last year were $1.4 million, or $0.23 per diluted share. The higher net loss in the third quarter of fiscal 2014 was primarily the result of lower net sales, lower gross margins and higher operating expenses. Due to the results for the first nine months of fiscal 2014, we anticipate that we will not be profitable for fiscal year 2014.



For the nine months ending June 30, 2014 and 2013

Net sales in the first nine months of fiscal 2014 decreased by $9.2 million, or 10%, to $85.6 million compared to $94.8 million for the same period in fiscal 2013. The decrease in net sales occurred in the North American, European, and Asia-Pacific regions, partially offset by an increase in net sales in the Latin American region. Net sales decreased most significantly in the potato market, partially offset by increases in the processed fruit and vegetable, nuts and dried fruit, and most other markets. International sales for the more recent nine-month period were 46% of net sales, the same as the first nine months of fiscal 2013. Decreases in total net sales for the first nine months of fiscal 2014 compared to the same period in the prior year occurred in process systems sales, which were down $10.7 million, or 30%, partially offset by increases in automated inspection systems which were up $0.7 million, or 2%, and parts and service sales which were up $0.8 million, or 4%. The decrease in process systems sales related primarily to decreases in the sales of vibratory systems in Europe and North America, third party equipment, and rotary sizers and graders. Automated inspection system sales increased in the chute-fed product lines, partially offset by decreases in the belt-fed and upgrade product lines. Automated inspection systems net sales represented 48% of net sales in the first nine months of fiscal 2014, as compared to 42% of net sales in the first nine months of fiscal 2013. Process systems represented 29% of net sales in the first nine months of fiscal 2014 compared to 38% of net sales in the first nine months of fiscal 2013. Parts and service sales were 23% of net sales in the first nine months of fiscal 2014 and 20% for the first nine months of fiscal 2013. New orders for the first nine months of fiscal 2014 decreased $15.2 million, or 15%, to $86.5 million compared to new orders of $101.7 million in the first nine months of fiscal 2013. Orders for automated inspection systems decreased $4.7 million, or 10%, to $40.8 million compared to $45.5 million in the first nine months of fiscal 2013. Automated inspection system orders decreased for belt-fed and upgrade product lines, offset by an increase in orders for chute-fed product lines. Orders for process systems decreased $10.7 million, or 30%, to $25.5 million compared to $36.2 million in the first nine months of fiscal 2013 across most all major product lines. Orders for process systems decreased for vibratory products in North America and Europe, other process system equipment, rotary sizers and graders, and third party equipment. Orders for parts and service were $20.2 million, up $0.2 million, or 1%, from $20.0 million in the prior year. The decrease in orders as compared to the prior year occurred primarily in the potato market, and also decreased in the pharmaceutical market, partially offset by increases in the nuts and dried fruit and other foods and non food markets. The decrease in orders was most significant in the North American and Asia-Pacific regions. 23 -------------------------------------------------------------------------------- Gross profit for the first nine months of fiscal 2014 was $24.6 million compared to $32.6 million in the corresponding period last year. Gross margin for the first nine months of fiscal 2014, as a percentage of sales, was 28.7% as compared to 34.4% reported for the same period of fiscal 2013. This decreased gross margin percentage for the first nine months of fiscal 2014 reflected less favorable changes in the product mix, less efficient factory utilization due to lower production volumes, acquisition-related fair value adjustments, and charges related to the cost reduction initiative. Operating expenses of $32.4 million for the first nine months of fiscal 2014 were 37.8% of sales compared with $28.7 million, or 30.3%, of sales for the first nine months of fiscal 2013. Operating expenses for the first nine months of fiscal 2014 were higher than the operating expenses for the first nine months of fiscal 2013 due primarily to increased spending on research and development efforts, higher amortization of intangible assets, the inclusion of Visys N.V. operating expenses for the entire nine months, charges related to the cost reduction initiative, and the settlement of the Visys N.V. litigation. The comparable prior period of fiscal 2013 included $785,000 of Visys N.V. acquisition-related expenses. Other expense for the first nine months of fiscal 2014 was $251,000 compared to other expense of $262,000 for the corresponding period in fiscal 2013, primarily due to lower foreign exchange losses and bank charges, partially offset by lower royalty income, as compared to the first nine months of fiscal 2013. The net loss for the first nine months of fiscal 2014 was $5.3 million, or $0.85 per diluted share. Net earnings for the same period in fiscal 2013 were $2.7 million, or $0.47 per diluted share. The net loss for the first nine months of fiscal 2014 increased compared to 2013 primarily due to lower net sales, lower gross margins and higher operating expenses.



Liquidity and Capital Resources

In the first nine months of fiscal 2014, net cash decreased by $4.8 million to $12.8 million on June 30, 2014 from $17.6 million on September 30, 2013. Cash used in operating activities was $2.0 million during the nine months ended June 30, 2014. Investing activities consumed $2.1 million of cash. Financing activities used $0.8 million of cash. Cash used in operating activities during the nine months ended June 30, 2014 was $2.0 million. For the first nine months of fiscal 2014, the net loss was $5.3 million. Non-cash items included in the net loss in the first nine months of fiscal 2014, such as depreciation, amortization and share-based compensation, were approximately $4.7 million. In the first nine months of fiscal 2014, changes in non-cash working capital used $1.4 million of cash in operating activities. The major changes in current assets and liabilities using cash during the first nine months of fiscal 2014 were increases in inventory of $2.3 million due to the timing of shipments, a decrease of $2.2 million in accrued payroll liabilities due to payments of fiscal 2013 incentive compensation and the timing of payroll, partially offset by accruals for one-time termination benefits, decreases in accounts payable of $0.6 million due to the timing of payments, decreases in accrued customer support and warranty costs of $0.7 million due to lower warranty costs and lower net sales, and changes of $2.7 million in income tax receivables and payables due to the timing of payments. These uses were partially offset by decreases in accounts receivable of $6.5 million due to the timing of collections and sales activity, and $0.7 million increase in customer deposits related to the timing of orders and collections. For the first nine months of fiscal 2013, $10.5 million of cash was provided by operating activities, composed of net earnings of $2.7 million; non-cash items such as depreciation, amortization and share-based compensation included in net earnings were $2.0 million; and changes in non-cash working capital of $5.8 million. The primary changes in the first nine months of fiscal 2014 as compared to the first nine months of fiscal 2013 were the increased net loss and increases in cash used for working capital for items such as inventory, payroll and accrued incentives, the timing of tax payments and deductions, and lower customer deposits, partially offset by decreased accounts receivable and increases in non-cash items included in the net loss. Net cash used in investing activities was $2.1 million for the first nine months of fiscal 2014 compared to net cash of $13.6 million used in investing activities for the first nine months of fiscal 2013 . Cash used for investing activities in fiscal 2014 related entirely to capital expenditures. Cash used for investing activities in fiscal 2013 included $11.6 million used for the acquisition of Visys N.V. Net cash used in financing activities during the first nine months of fiscal 2014 was $814,000, compared with net cash used in financing activities of $787,000 during the corresponding period in fiscal 2013. Net cash used in financing activities during the first nine months of fiscal 2014 primarily resulted from $671,000 of repayments of long-term debt, and $227,000 of payroll taxes paid in connection with stock surrenders related to compensatory stock awards, partially offset by $53,000 of proceeds from the issuance of common stock. Cash used in financing activities during the first nine months of fiscal 2013 resulted mainly from payments on long-term debt of $464,000, payroll taxes of $216,000 paid in connection with stock surrenders related to compensatory stock awards, $30,000 of stock repurchases, and $188,000 of issuance costs for stock and warrants related to the Visys N.V. acquisition, partially offset by $81,000 of proceeds from the issuance of common stock. 24 -------------------------------------------------------------------------------- Our domestic credit facility provides for a variable-rate revolving line of credit up to $15,000,000 and a credit sub-facility of up to $6,000,000 for standby letters of credit, of which up to 3.0 million ($4.1 million) is available to our Netherlands subsidiary. The credit facility matures on September 30, 2014. The credit facility bears interest, at our option, at either the bank's prime rate or the British Bankers Association LIBOR Rate ("BBA LIBOR") using a tiered structure depending upon our achievement of a specified financial ratio. Our prime rate option will be either the bank's prime rate or prime less 0.25% per annum. Our BBA LIBOR option will be either BBA LIBOR plus 1.75% or 1.50% per annum. At June 30, 2014, the interest rate would have been 1.66% based on the lowest of the available alternative rates. The credit facility is secured by all U.S. accounts receivable, inventory, equipment, and fixtures. The loan agreement also provided for a 15-year term loan in the amount of $6.4 million of which $4.5 million was outstanding as of June 30, 2014. The term loan provides for a mortgage on our Avery Street headquarters' land and building located in Walla Walla, Washington. The term loan bears interest at the BBA LIBOR rate plus 1.40% and matures on January 2, 2024. We simultaneously entered into an interest rate swap agreement with the lender to fix the interest rate at 4.27%. The credit facility contains covenants which require operating within a funded debt to EBITDA ratio, a fixed charge coverage ratio and minimum working capital levels. The loan agreement permits capital expenditures up to a certain level, and contains customary default and acceleration provisions. The credit facility also restricts acquisitions, incurrence of additional indebtedness and lease expenditures above certain levels without the prior consent of the lender. On February 12, 2013, the relevant loan agreement covenant was amended to permit the acquisition of Visys N.V. At June 30, 2014, we were in compliance with our loan covenants. At June 30, 2014, we had no borrowings outstanding under the revolving line of credit and $0.9 million in outstanding standby letters of credit. Our Belgian subsidiary's credit accommodation with a commercial bank in Belgium provides a credit facility for Visys N.V. This credit accommodation totals 2.7 million ($3.7 million) and includes an operating line of 800,000 ($1.1 million), a bank guarantee facility of 500,000 ($683,000), and loan agreement provisions of 1.4 million ($1.9 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 June 30, 2014, the interest rate was 9.75%. At June 30, 2014, the subsidiary had no borrowings under the operating line. At June 30, 2014, the subsidiary had various loans outstanding under the loan agreement provision totaling 0.8 million ($1.2 million). The fixed interest rates on these loans ranged from 2.91% to 3.98%. The loans mature between November 2016 and November 2017. The credit accommodation contains a covenant which requires the maintenance of a minimum tangible net worth and debt to EBITDA ratio levels at the subsidiary measured at the end of its statutory fiscal year. At the last measurement date, the subsidiary was not in compliance with the bank covenants. The Company has received a waiver from the bank until September 30, 2014, the next measurement date. The Company does not expect such non-compliance to have any material effect on its operations. At June 30, 2014, the subsidiary had no bank guarantees outstanding under the bank guarantee facility. Additionally, the subsidiary had a subordinated loan with another European lender of 91,000 ($124,000). The loan has a fixed interest rate of 4.99% and matures in March 2016.



Our continuing contractual obligations and commercial commitments existing on June 30, 2014 are as follows:

Payments



due by period (in thousands)

Less than 1 Contractual Obligations (1) Total year 1 - 3 years 4 - 5 years After 5 years Long-term debt $ 5,828$ 831$ 1,584$ 1,002 $ 2,411 Interest on long-term debt (2) 1,101 238 363 248 252 Operating leases 5,224 1,170 1,761 1,272 1,021 Purchase obligations (3) 1,067 1,067 - - -



Total contractual cash obligations $ 13,220$ 3,306$ 3,708$ 2,522 $ 3,684

(1) We also have $118,000 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 4.27%. (3) Purchase obligations are commitments to purchase certain materials and supplies which will be used in the ordinary course of business. 25

-------------------------------------------------------------------------------- We anticipate that current cash balances and ongoing cash flows from operations will be sufficient to fund our operating needs for the foreseeable future. We also have significant credit lines available if needed. At June 30, 2014, we had standby letters of credit totaling $0.9 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 our liabilities. We have no off-balance sheet arrangements or transactions, or arrangements or relationships with "special purpose entities." 26



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Source: Edgar Glimpses


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