Key Technology, Inc. F4Q08 (Qtr End 09/30/08) Earnings Call Transcript

Key Technology, Inc. (KTEC)

F4Q08 Earnings Call

November 13, 2008 5:00 pm ET

Executives

Cathy Burlingame – Investor Relations

David M. Camp, Ph.D. – President and Chief Executive Officer

John J. Ehren – Senior Vice President and Chief Financial Officer

Analysts

Manny Reiser - Wachovia Securities

James Ricchiuti – Needham & Company

David [Woodia] – Keeley Asset Management

Greg Garner - Singular Research

Ernie Ursaner – CJS Securities

Matthew [Burke] – CJS Securities

Beth Lilly – Gabelli & Co.

Rob Sinskey – 21st Century Equity Research

Presentation

Operator

Welcome to the Key Technology fiscal year 2008 fourth quarter and year-end results conference call. (Operator Instructions) It is now my pleasure to introduce Cathy Burlingame.

Cathy Burlingame

Thank you for joining us for the Key Technology fiscal 2008 fourth quarter and year-end results conference call. Hosting the call today will be David Camp, President and Chief Executive Officer, and Jack Ehren, Senior Vice President and Chief Financial Officer. Today’s call is being recorded and will be available for replay on the Investor Relations homepage of our website at www.key.net.

Before we begin I’d like to remind you that comments made in today’s call may include forward-looking statements within the meaning of the federal securities laws. These statements about anticipated future results are based on current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those we discuss today. These risks and uncertainties are explained in detail in today’s release and in the company’s Form 10-K filed with the Securities and Exchange Commission in December 2007.

And now I’d like to turn the call over to David Camp, President and Chief Executive Officer, for discussion of the company’s results.

David M. Camp, Ph.D.

Good afternoon. These past few months have truly been remarkable. On June 5 our stock traded at $39.47 and then we reported record-breaking results for our third quarter. Yesterday, on November 12, our stock price had lost 68% of its value and traded at $12.75, yet in the last quarter of fiscal 2008 we had fourth quarter record shipments, orders, gross margin dollars, and a record backlog entering the new fiscal year.

On Monday, November 3, the Wall Street Journal reported the manufacturing output was at a 26-year low yet our fiscal fourth quarter was a record all time high with shipments of $40.2 million. However, we wanted to deliver more to our bottom line in the fourth quarter. With that said, our profitability has been affected in the fourth quarter by both the very rapid changes in the Euro and peso relative to the dollar, and the European market that has become softer, certainly no surprise to any of our investors.

Our operating expenses incurred in the fourth quarter of fiscal 2008 as compared to the fourth quarter of fiscal 2007 also increased for three primary reasons: increased sales expenses related to sales by external sales reps generating a higher percentage of our sales; expenses related to our ERP project; and R&D expenses related to the development to of new products that we are delivering to our market place.

We fully recognize that we cannot, and will not, spend at this rate in 2009 and have already taken actions that will have effects in the first quarter of 2009.

In 2008 we took unprecedented actions to develop four new products that have already been introduced, plus two products introduced this week at Process Expo in Chicago that will generate positive results in 2009 and beyond.

We developed the all-new Manta sorter for fruits and vegetables and recognized revenue for two of these in 2008. We expect to recognize revenue for more of these sorters in the current quarter.

It is important to note that these initial sorters were placed in production environment at major industry names the each of you would recognize. We also have strong evidence that these sorters are performing significantly better than our competition in head-to-head competition.

This week we exhibited the new 2-meter-wide sorter for the first time and our customers were very excited and interested in this new high-capacity sorter. Development is underway for additional Mantra platforms for other industry applications in this fiscal year.

Additionally, at Process Expo we introduced our industry’s first interactive Internet training program which was received very warmly by all customers. This product will be available in multiple languages such as Spanish, German, Dutch, Chinese, and French. Many of our customers have significant labor turnover problems and do not have adequate training programs to bring employees rapidly up to speed on processing equipment.

This offering is designed to meet this need and we will market this as annual, renewable license. We expect to see a major change through this service in how our customer base approaches training in their industry.

We also introduced a number of technology advancements and new capabilities for our sorting family, including FM Alert, an enhanced quality monitoring capability that allows processors to improve their tracking and control of foreign material, or FM, by capturing FM occurrences in an event log with time and date stamps. This is another industry first.

In addition, the Manta at the show was configured with a new multiple wave-length laser which combines multiple wave-length lasers with color cameras on one sorter to maximize production versatility and achieve superior product quality and food safety.

Next I would like to transition this discussion to what we see ahead. Key has no debt and we now have over $36.0 million in cash at the end of the fiscal year. Subsequent to the end of the fiscal year we exercised our purchase option and purchased our Avery Street facility and grounds. The purchase price was approximately $6.5 million. We have a commitment for long-term financing for the property and expect to have the financing finalized by the end of the first quarter of fiscal 2009.

Additionally, as we have just discussed, we are entering this uncertain period with several new products that reduce cost and improve the product yields of our customers. We are confident that the R&D efforts of the last year have developed the right products at the right time for the right needs of our customers.

We are going to continue carefully spending resources to develop new solutions and products for our customers in the coming year.

However, these are uncertain times and at this moment we are seeing both negatives and positives. We believe that the world’s current liquidity and financial issues may negatively affect our results in Q1 though we remain confident in the fundamentals of our business opportunity for the current year.

We have a number of significant customer projects underway and have seen no indication that these projects will not be implemented. In fact, a number of major accounts are accelerating capital spending plans to take advantage of efficiency and yield improvements during this financial turndown.

We are continuing in our ERP project and, as predicted, it has been difficult. However, the finished product is going to be worth the effort. We are convinced that with the completion and successful startup of our ERP project we will have the analytical and financial tools in place to allow Key to grow to several multiples of our current revenue.

In closing, these have been trying times and Key is well positioned to come out of this uncertainty stronger and more competitive than we have ever been.

With that I will turn it over to Jack Ehren.

John J. Ehren

We are pleased to report our fourth quarter financial results. Key’s net sales for the quarter were $40.2 million, a new all time quarterly record and a 27% increase over the $31.7 million of net sales reported for the same period last year.

Annual net sales for fiscal year 2008 were $134.1 million, also an all-time record and a 25% increase over the $107.5 million of net sales reported for fiscal year 2007.

Key’s orders for the quarter were 31.8 million compared to 26.0 million in the fourth quarter of the prior year, a fourth quarter record.

Annual fiscal year 2008 orders of 136.9 million is also a new company record and represents a 19% increase over the 115.3 million of orders reported for fiscal year 2007.

Key ended the fourth quarter with a backlog of $33.8 million, a record year-ending backlog. This represents a $2.9 million, or a 9% increase, over the $30.9 million backlog at the same time last year. The backlog mix at the end of the fourth quarter was 62% automated inspection systems, including upgrades, 35% process systems, and 3% parts and service, compared to 48% automated inspection systems, 50% process systems, and 2% parts and service at the same time last year.

Net earnings for the fourth quarter were $2.2 million, or $0.40 per diluted share. Total earnings for the same quarter last year were $2.3 million, or $0.42 per diluted share.

Net earnings for fiscal year 2008 were $7.5 million, or $1.35 per diluted share. Net earnings for fiscal year 2007 were $7.4 million, or $1.37 per diluted share, which included a $750,000 gain, or $0.14 per share, from the sale of the company’s InspX joint venture.

Earnings from operations in fiscal year 2008 were $10.3 million, which represents a $1.7 million increase over the $8.6 million earnings from operations in fiscal year 2007.

As I previously mentioned, net sales for the fourth quarter increased 27% to $40.2 million compared to the $31.7 million of net sales reported in the fourth quarter of last year.

Sales of automated inspection systems of $18.6 million increased $4.1 million, or 28%, over the corresponding quarter last year. Sales of process systems of $15.6 million were up $4.1 million, or 36%. Parts and service sales were $6.0 million, compared to $5.8 million in the prior year, an increase of 4%.

For fiscal year 2008 net sales of automated inspection systems were $56.0 million, which represents a $9.1 million, or 19%, increase over the prior year. Annual net sales of process systems were $56.6 million, which represents a $15.7 million, or 38%, increase over the prior year. Year-to-date parts and service net sales were $21.5 million compared to the $19.7 million in the prior year, an increase of 9%.

A significant portion of the backlog at the end of the fourth quarter is scheduled to ship after the first quarter of fiscal 2009. Revenues for the first quarter of fiscal 2009 are expected to be consistent with, or slightly lower, than the revenues recorded in the first quarter of fiscal 2008.

Gross profit for the fourth quarter of 2008 was $15.4 million compared to $11.9 million for the fourth quarter of fiscal 2007. As a percent of sales, gross profit margins for the first quarter of 38.3% increased from the 37.5% margins reported for the same quarter a year ago.

Gross profit for fiscal year 2008 was $53.2 million compared to $41.4 million for fiscal year 2007. As a percent of sales, annual gross profit margins of 39.7% increased 1.2% from the 38.5% reported for the same period in the prior year. The 1.2% increase in margins in fiscal 2008 compared to fiscal 2007 resulted primarily from increased volumes and efficiencies in manufacturing operations.

The gross profit margin percentage for the first quarter of fiscal 2009 is expected to be consistent to slightly higher than the gross profit margin percentage reported for the fourth quarter of fiscal 2008.

Operating expenses of $11.8 million for the fourth quarter of fiscal 2008 were 29.2% of net sales, compared with the operating expenses of $9.0 million, or 28.5% of net sales, for the same quarter last year.

Operating expenses of $43.0 million for fiscal year 2008 were 32% of net sales compared to operating expenses of $32.8 million, or 30.5% of net sales, in fiscal 2007.

Fourth quarter and annual operating expenses increases over the corresponding periods in fiscal 2007 were a result of increased sales expenses related to the higher sales activity, additional general and administrative expenditures, including costs associated with the company’s new ERP system, and increased research and development spending.

Operating expenses in the first quarter of fiscal 2009 are anticipated to be lower than the fourth quarter expenses of fiscal 2008 due to management’s focus on overall control of expenditures, reduced R&D spending, and reduced sales expenses associated with anticipated lower sales volumes.

Our cash and overall balance sheet position has continued to strengthen. Our September 30, 2008, cash balance of $36.3 million was up $8.4 million from $27.9 million reported at September 30, 2007. Cash provided by operating activities was $13.1 million in fiscal year 2008.

Capital expenditures in 2008 were $5.5 million of which $2.3 million was for the ERP project.

It is also worth noting that the company has also made significant progress over the last six months in our balance sheet management, particularly with regards to our receivable and inventory balances.

With that, I would like to say thank you and turn the call back over to David.

David M. Camp, Ph.D.

At this time I would like to open the floor up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Manny Reiser - Wachovia Securities.

Manny Reiser - Wachovia Securities

David, you started off by talking about what our stock price was. I guess it was in June when we were in the high 30s and where we are now in the $12.00 range. So let me start off my questioning as a follow-up. You announced the buyback of up to .5 million shares. Since our stock seems to be such a bargain here, why don’t we do with such auction at a certain price and really go into the market, since our stock is down 60% from it was four to five months ago?

David M. Camp, Ph.D.

I certainly respect your question. These kinds of things are on the table and obviously we clearly wanted to send a message to all investors by reloading the buyback to the original .5 million shares. I don’t think I have to comment too much about what the intent of doing that reload was but I would say that all issues at this point in time, we certainly consider the Key stock a bargain at these levels and obviously we have intent to seek value for the company and we will be proceeding as you might expect.

Manny Reiser - Wachovia Securities

Was that tender actually ever considered? Because it would seem to me that if we are truly serious that would be one way of really setting a floor on the stock and sending a signal that we think our stock is significantly under-valued as opposed to buying a certain amount each day and dragging it out and maybe not acquiring much of anything.

David M. Camp, Ph.D.

There has been some discussion about it but there hasn’t been a final decision on the Dutch tender.

Manny Reiser - Wachovia Securities

And what about when you talked in the past about other acquisitions or dividends and/or dividends?

David M. Camp, Ph.D.

At this point in time we have had quite a bit of discussion regarding dividends and frankly I think that the Board would say that this is not the time to use our cash for dividends.

We clearly had an opportunity to look at a number of opportunities in terms of technology or company acquisitions and frankly, we like what we see in terms of potential low PDE ratios. There are a number of opportunities that we think may provide us with significant accretion for the company. So I obviously can’t get into specific details but we think that this is probably the time that we should be using our collateral for different types of acquisitions.

Manny Reiser - Wachovia Securities

The press release did not mention anything about Asia or Symetecs. Can you add any color as to what might be going on with Symetecs and Asia?

David M. Camp, Ph.D.

It wasn’t an oversight. It just basically we had so much that we thought we were trying to cover in the press release. Symetecs continues to do very well. I don’t have with me the final numbers for Symetecs at the end of the year. I know it was a significant increase in terms of revenue for 2008 and I know that we are entering 2009 with some strong opportunities. So we are very encouraged by what Symetecs is doing.

There is one event that I can mention to you. We are in a development now for our next Symetec product and I may be wrong on this but I believe that we are going to try and get that out in the March/April time frame of 2009. It is a somewhat revolutionary product for the market place.

In terms of Asia, we have had some real good activity recently, particularly in the tobacco area and we are very encouraged by some of the signs that we are seeing in Asia. So it has not done as much as we would have liked to have done but we are very encouraged by some of the things we’re seeing in terms of new tobacco opportunities, particularly in China.

Manny Reiser - Wachovia Securities

Several months ago we had talked about if Asia doesn’t turn around we would have some tough decisions to make regarding China. Do I detect that it is starting to turn and that you are quite a bit more optimistic than you were three months ago about Asia?

David M. Camp, Ph.D.

I think the jury is still out. We are encouraged by what we’re seeing with tobacco, but frankly, we have to make sure that we understand what the opportunities are there. And I would say at this point it’s still a—we may have seen some signs of life but we still may have some hard decisions.

Manny Reiser - Wachovia Securities

Let’s talk a little about the expense side of the ledger. Expenses were pretty high. Part of it new, the ERP system, R&D, and we indicated that we will be cutting expenses moving into the new year. Jack spoke about R&D will be cut a little bit as well as on the sales side, expenses will be down a little. When does the ERP expenditure start to decline, or what are we looking at next year on that?

David M. Camp, Ph.D.

Very fair questions. We are expecting that the expenditures on ERP are going to significantly be reduced in the third quarter of 2009. We are expecting that the expenditures on ERP are going to continue pretty much as they have been in Q1 and Q2 but they will significantly be reduced after that.

In terms of some of the things we have already done, as anyone would have expected, we took a number of actions to do a lot of things to cut and control our discretionary expenses. We just wanted to make sure that as we were trying to get a handle on what 2009 looked like and what Q1 looked like, we have taken some actions to basically make sure that we were very careful.

So we are seeing some results already. We are encouraged by the expense reductions that we have already seen in the month of October so I believe that the actions that we have taken are taking effect. We were just being prudent, very simply.

John J. Ehren

Just to follow up on a couple of things that David said. First of all, with regards to your question regarding Symetecs, it is approximately 3% of our business at this time, it’s an area of focus and investment that we think has significant potential.

Manny Reiser - Wachovia Securities

So it did about $5.0 million in the fiscal year ending September?

John J. Ehren

Approximately. Which is more than double from where it was the previous year.

With regards to the ERP system, the expenses in the current year that went through the P&L for ERP was approximately $1.2 million, or about $300,000 per quarter, and I would expect that to continue for most of the fiscal year 2009.

Manny Reiser - Wachovia Securities

David, I think you used the term, ERP system, the integration, or something to that effect, was difficult. The word I want to focus in on is difficult. Could you elaborate as to what you meant with that being difficult?

David M. Camp, Ph.D.

Whenever you are changing the way your culture is built so that you can actually do things differently, it really is a difficult process to implement. To really make the ERP effective and to tie the different elements of the business, the systems, the way we do shipping and receiving and billing and human resources and all of the elements together, it forces any business to do things differently than the way we have done them. So you have to change your way of thinking. And when you are changing processes and you are changing culture, it is difficult to do. And frankly, I think anybody who has gone through this, these ERP implementations are difficult and that’s basically what we’re doing. But we are making a lot of progress and we are very comfortable that it is going to be a success.

Manny Reiser - Wachovia Securities

When do you see the ERP system actually being finished and generating for us the kind of results you hope to achieve?

John J. Ehren

We have not announced a “go live” date at this point. There is actually a couple of phases associated with the project. The first phase is really to get our primary locations to go live, which includes the Walla Walla facility, our Redmond site in Oregon, as well as our Netherland facility.

The second phase will include getting our other remote sites up as well as some other types of modules. But the primary Phase I, we haven’t announced the date yet but it will be in fiscal year 2009.

Manny Reiser - Wachovia Securities

My last comment deals with a housekeeping situation. For this particular press release you released the numbers after the close of the market, whereas before, for a long while you were releasing the numbers early in the morning and we had a little bit of time to really gather our thoughts together. You also pushed the conference call back to 5:00. I would just like to chime in, I prefer it the other way where the numbers came out early in the morning and we had the day to really analyze it. It made our job a little bit easier, from my perspective.

David M. Camp, Ph.D.

Thanks for the comments. We will certainly take that into consideration.

Operator

Your next question comes from James Ricchiuti – Needham & Company.

James Ricchiuti – Needham & Company

Could you talk about the environment in a little more detail? We are about six weeks into Q1, how would you characterize bookings thus far versus a year ago?

David M. Camp, Ph.D.

Let me do it this way. John Vusacarus and I just left yesterday the Process Expo, which is our largest trade show that we go to in a year. And we really didn’t know what to expect going to Process Expo. It was actually stunning for us. It was much better than we could have possibly expected.

The people that came to the show came to the show, to a very large extent, with the purpose of placing orders. We came out of the show with multiples of millions of dollars of orders and frankly, we weren’t expecting that.

So to partially answer your question, there is no question that when the shock of what was going on was hitting in late September and early October, there were a number of people that went to the sidelines. I would say some of the orders slowed up for a while. We think we are seeing a rebound at this point in time. Very encouraged by what we have seen in terms of the show, but right now I would say we are probably a little behind the order rate that we had a year ago. I don’t have the exact numbers in front of me, I would be surprised if we weren’t behind the numbers we had for the Q1 from a year ago.

James Ricchiuti – Needham & Company

I’m wondering if your customers are in a situation where there might be some budget flush related to the end of the calendar year and then as we look out into potentially the uncertainty next year, could there be more caution? Any evidence of that? And it may not be the case, just given the seasonality of your business.

David M. Camp, Ph.D.

I guess I have to answer that two ways. You’re asking a good question. We are becoming more optimistic about the results from this quarter because of what we have seen. In terms of what we’re looking ahead, we do look at an opportunity list and the last time I looked at it was about 11 days ago, which looks at all the opportunities that we are looking at going out 12 to 18 months.

And the last time I looked at this, the opportunity list was continuing to increase, which indicated to us that we were still getting requests for quotes, requests for engineering. Our sales people were looking at opportunities that were continuing to look positive.

And I think what you are basically asking me is, okay, if Q1 comes in that’s great, but how do Q2 and Q3 look. It’s really a little difficult to say exactly. I think that if we were sort of guessing a little bit, there certainly is softness out there, but frankly, I don’t want to put too much of a negative spin on it because I would have probably said at the very beginning of October when there was so much uncertainty that things were beginning to look a little dark. But frankly, I’m much more encouraged with the orders that we have seen recently.

So I guess the point I am trying to make here is I don’t want to spin this too negatively in terms of Q2.

James Ricchiuti – Needham & Company

Now new products are going to figure into the mix next year and it sounds like you have got Symetecs, next version of that in March/April, so that sounds like good news for the first half of calendar of 2009. Other new products, are they going to be more toward the back half of the year?

David M. Camp, Ph.D.

No, I hope not. As you know, what you are always doing with new products is you plan for things. At least, based on what I know at this time, we just came out with three new products. We came out with a potato Manta, we came out with the FM Alert, and we came out with online interactive training. I believe that we have a new product coming out in the January time frame and I believe that there is another new product that will be coming out, roughly guessing, in early third quarter. But I don’t know that for sure.

The things that we’ve done, I’m sure you might feel comfortable commenting that Key historically hasn’t come out with this range and number of new products on annual basis the way we have been doing recently. And I think that really is going to help us see through this soft period.

Operator

Your next question comes from David [Woodia] – Keeley Asset Management.

David [Woodia] – Keeley Asset Management

You mentioned you expected fiscal first quarter sales to be down, record backlog. Could you give us a little more detail on what’s behind that? Is there something going on affecting the year-over-year comparison?

David M. Camp, Ph.D.

Not really. What ends up happening some times, and it is not always transparent to the investors, is we end up--and you may recall at the end of Q2 we had a very large backlog and we tried to let the investors know that we knew that not all of that backlog was going to ship in Q3.

We know right now that the backlog that we have had coming into Q1, based on the dates that the customers are requesting it to be delivered—because they have to sometimes do work themselves at their factories, some of this is going to ship in Q1, some of it is going to ship in Q2.

Most of that backlog will have shipped in either Q1 or Q2. It’s not an unusual thing to occur.

David [Woodia] – Keeley Asset Management

Could you give more detail on what the items are in the other income and expense?

John J. Ehren

In the fourth quarter our pre-tax earnings were negatively impacted by approximately $500,000 associated with foreign exchange rate changes. For the year the negative FX impact was approximately $150,000. In comparison to the prior year, in 2007, there was a gain of about $570,000 and the fourth quarter had a gain of about $149,000.

Now FX is a complex area and we do take out forward contracts with the Euro to try to minimize the impact of the FX where we can. But that’s the majority of what happened in the other income and expense.

Operator

Your next question comes from Greg Garner - Singular Research.

Greg Garner - Singular Research

I just want to address this credit issue just to get a sense for what you may be seeing from your customers. Are they perhaps pushing out orders, pushing them back, or are you seeing that some customers are having difficulty getting financing and having to cancel orders? Any color on that?

David M. Camp, Ph.D.

You have given me an either/or question. We are not seeing customers pushing out orders. What we are seeing—and I want to make sure that this is very clear—it is not across the board but we are seeing some customers who are looking at different types of financing schemes. Sometimes they are asking us to do it, sometimes they are looking at other third parties to do the financing.

But there is no question that because of the financial uncertainties and the credit uncertainties, that some—a small amount of our customers—are looking at options that we didn’t see not too long ago.

Greg Garner - Singular Research

So might you get involved with financing some of your customer purchases? Are you thinking about that?

David M. Camp, Ph.D.

My general take on it is we don’t feel like we are in the financing business, however they may be circumstances that we may do some things for customers that we understand very well.

John J. Ehren

We certainly will not do anything that will negatively impact revenue recognition or put the company at risk with regards to extending terms, but there might be some arrangements that make good business sense for us that we may consider.

But we certainly won’t become a financial institution for our customers.

Greg Garner - Singular Research

Are you seeing orders coming from a certain geography that are stronger or not weakening as much as other areas? Any insight on that?

David M. Camp, Ph.D.

Actually, I think from a geographical standpoint, certainly Latin America has been a very positive area for us, from an order standpoint. Actually, North America has actually been very positive from an order and a shipment standpoint as well.

From an order standpoint in Europe it has been a little bit flatter.

Greg Garner - Singular Research

And Symetecs, this new product that should be out March/April time frame, is this an innovative new product or is it an upgrade of an existing one? Anything you can tell us about that or any success stories in the Symetecs product line or new customer list?

David M. Camp, Ph.D.

What we are doing right now with Symetecs is this product that is coming out is the first of three products that we are going to be introducing in the next approximately year in Symetecs.

We knew when we first came out with our first products in Symetecs that we were essentially taking food sorters and adapting them for a pharmaceutical environment and we did not do the entire adaptation. There were some things that we knew that we were going to have to do later and we wanted to wait until we saw that Symetecs was going to be a success.

We see that Symetecs is being successful and what we have done is we have made several changes in Symetecs that basically will allow us to get past a few obstacles. Let me just give you a couple of examples.

Right now we have been using water to cool the chamber. The Symetecs sorter is going to be using air, which is really what a lot of customers want us to use so they don’t have to pull water into their clean rooms.

The second thing that is going to end up happening is this machine is going to be able to fit through a 30” wide by 6’ tall door, which actually allows us to get into some processing lines that we couldn’t get into because our equipment was too large.

And there are several other changes that have been made in this system that will be coming out in March/April. The other thing that ends up happening is these changes allow us to make some pretty significant changes on this platform later on in the year. So we believe that this will be a pretty substantial change for Symetecs and its customers and it will position to be able to make some pretty substantial changes later in 2009 and probably into 2010.

Greg Garner - Singular Research

Do you find historically something relatively new to the company, that when there are a number of new products introduced, does it create a lot of interest in looking at new products or does it also translate to orders in the short term?

David M. Camp, Ph.D.

I think it creates considerable interest. There is no question that the introduction we made with Manta in early 2008 has generated a significant amount of interest and has really given us some opportunities that we could not address if we had not come up with Manta.

There’s little question to me that the other thing that has really gone on here is we have really began to change the culture of Key to getting products out to the market place in a very short amount of time. And by introducing three to five new products on an annual basis, I believe it does two things.

Number one is it shows the market place that we are meeting their needs and hence will generate more revenues. But the other thing it’s going to do is I believe it is going to help us grow our gross margin percent line because when you are introducing products such as this, it does help in terms of being able to provide those new features and attributes that customers weren’t able to get beforehand. And hopefully we will be able to turn that into gross margin dollars.

Operator

Your next question comes from Ernie Ursaner – CJS Securities.

Ernie Ursaner – CJS Securities

I’m going to turn it over to Matt before I do I would like to offer a comment as was related to Manny. I thought his suggestion to you of releasing results in the morning and then having your stock trade in the open market all day without your input is a very poor idea and I would strongly vote you don’t even consider it. And I will turn it over to Matt to ask questions.

Matthew [Burke] – CJS Securities

On the new sorters that were placed, were they against competitors or are they replacing your older sorters?

David M. Camp, Ph.D.

They were all placed directly against competitors.

Matthew [Burke] – CJS Securities

How many of these might a sizeable customer purchase say in fiscal 2009?

David M. Camp, Ph.D.

Nice question. Without getting into specifics on this, we could easily see one or more customers looking at—guessing a little bit—some could potentially be looking at double digits.

Matthew [Burke] – CJS Securities

What are the competitive advantages of these new sorters?

David M. Camp, Ph.D.

I can tell you that based on what we have seen so far is the actual sort in terms of what the customers are getting in terms of the product they are desiring versus the product that they want to remove has been superior to the competition in a number of circumstances. To the point that some of the competitions’ sorters have actually been removed from service on a head-to-head competition.

Matthew [Burke] – CJS Securities

In R&D is it going to be more food-related or medical-related going forward?

David M. Camp, Ph.D.

That is a good question. I guess you would have to look at that in terms of the actual dollars spent.

John J. Ehren

We are certainly going to continue to invest significantly in the Symetecs area because we believe in the potential, but from an overall dollar standpoint there will be more dollars spent in the food processing area.

Operator

Your next question comes from Beth Lilly – Gabelli & Co.

Beth Lilly – Gabelli & Co.

Jack talked about first quarter gross margins and that they are going to look more like fourth quarter gross margins. Did I hear that correctly?

John J. Ehren

We said the first quarter margins would be consistent to slightly better than what the margins were in the fourth quarter. In the fourth quarter they certainly were lower than what they had been previously during the year, for several factors, including increased warranty expenses for specific customer and product-related issues that arose during the fourth quarter, that we effectively addressed. We did have a lower utilization of our European factory in the previous quarter. The weakening Euro had an impact on margins, as we talked about previously. And then we had higher than normal scrap of inventory.

So those are factors that brought the margins to the 38% in Q4, with the lower sales volumes than Q4 in Q1. We think that the margins will be consistent with Q4 to slightly improved.

Beth Lilly – Gabelli & Co.

As you look out then, as you roll out these new products and you get a higher service component, do you expect gross margins to expand over the year?

John J. Ehren

We are certainly focused on improving the gross margin percentage.

David M. Camp, Ph.D.

There is another component to that, which is that we have clearly put people responsible for cost reductions in our manufacturing areas so it’s not just a new product introduction and the fact that we’re introducing new service components.

But we really believe that there are some opportunities to take cost out of our operations.

Beth Lilly – Gabelli & Co.

So we will start to see that show up in 2009?

David M. Camp, Ph.D.

I am going to be disappointed if it doesn’t happen.

Beth Lilly – Gabelli & Co.

As the ERP spending comes down we will continue to see continued operating profit growth, and do you expect operating margins to expand then?

John J. Ehren

We do expect an improvement in our operating margins in fiscal year 2009 over fiscal year 2008.

Beth Lilly – Gabelli & Co.

Taking out the extraordinary items, because they were down.

John J. Ehren

Correct.

Beth Lilly – Gabelli & Co.

Let’s say you back out the extraordinary items and we will see operating margins expand beyond call at 8%?

John J. Ehren

We don’t disclose specific numbers associated with that or provide any of those numbers, yet, at this time.

Beth Lilly – Gabelli & Co.

But still, you will see margins expand if we back out [break in audio].

David M. Camp, Ph.D.

That certainly is the system with the work that we’re putting into it.

John J. Ehren

And to elaborate a little more with regards to your question on the margins, there are several factors that impact that. Certainly the release of new products. We expect to have value added differentiation and expect to be able to get valid margins with regards to those products when we bring them to the market.

We are certainly looking at efficiencies and cost reductions within our own facilities and utilizing third partners where it makes good business sense.

So there are several areas that we are focused on on the margin side.

Operator

Your next question comes from Rob Sinskey – 21st Century Equity Research.

Rob Sinskey – 21st Century Equity Research

I just had a question about the cranberry industry and what you are seeing there. I understand it’s doing well and they are increasing acreage. I think in Wisconsin the state government is allowing them to expand their property, etc. Are you seeing any flow-through from that?

David M. Camp, Ph.D.

Yes. We are very much involved with the cranberry industry and we believe that everything that we see right now indicates to us that this is going to turn into more opportunities for us.

We have been working with major cranberry manufacturers for a significant amount of time and I can tell you that everything indicates to us that 2009 will be a banner year for the cranberry processors.

There is no question that people are looking at cranberries and craisins and other products from cranberries as a major growth opportunity and we expect to participate in that.

Rob Sinskey – 21st Century Equity Research

In terms of product mix, with the hesitation in the credit markets thus far and so forth, are you seeing customers look more closely at the Manta product, which I guess is your sort of low-cost alternative?

John J. Ehren

With regards to the Manta it is not the low-cost alternative. It is actually a 2-meter machine, which is the much larger machine and provides significant increase in the volume of product that is able to flow through the machine. For example, it will allow you to process over 60,000 pounds of potatoes an hour. So it’s really the larger customers with the large facilities that find the efficiencies and utilization and speed of the Manta to be more effective for them.

David M. Camp, Ph.D.

What we are seeing is that the customers are being attracted to the Manta because of what they see as a very high ROI. They are seeing that they are getting a great level of efficiency for this machine in their production and because of the design of it, you are able to put it into a space where the previous equipment, if there was some there, had much lower capacity.

So we are seeing that customers are making what I think is right decision, that it is providing them the capacity and the returns that basically justify the expenditure.

Rob Sinskey – 21st Century Equity Research

In terms of raw material pricing as a percentage of gross margin, is that fairly negligible? I guess I would have expected since stainless steel prices I think have moderated, so I would have expected maybe a little bump from that. Is that just not a large percentage of our cost of good?

John J. Ehren

First of all there are several different types of stainless steel, depending upon the alloys that you use. The two alloys that are in the stainless steel that we use are mainly nickel and chromium. What has happened now with nickel, nickel has actually been dropping since March 2008 so in Q4 we have seen lower pricing with regards to our stainless steel and we continue to see that into the first quarter.

It represents approximately 20% of our material costs.

Rob Sinskey – 21st Century Equity Research

So there is potential to see gross margin bump up from that?

John J. Ehren

We certainly are seeing a benefit from lower steel costs currently.

Rob Sinskey – 21st Century Equity Research

Were there any shares repurchased this last quarter.

David M. Camp, Ph.D.

We haven’t repurchased any in quite some time.

Rob Sinskey – 21st Century Equity Research

In terms of purchasing the property for the headquarters, is there going to be any material impact on SG&A in terms of decreased rent expense or anything like that?

David M. Camp, Ph.D.

The reason we did this purchase and the remortgage of this property was that we saw a direct benefit to the shareholders in terms of a reduction of quarterly expense and that’s why we did it.

Rob Sinskey – 21st Century Equity Research

And that should be a meaningful reduction?

David M. Camp, Ph.D.

I guess it all comes down to what you define as meaningful but obviously we felt like that the right to do was—we had it under a long-term lease in which at the end of that lease we were still going to end up owning money to the port if we had acquired it. We basically have converted what we were doing to a mortgage and at the end of that mortgage we would own the property. So there is a substantial value to us by doing what we have done.

John J. Ehren

One important thing to note is a significant of our building square footage is manufacturing so the largest benefit of the reduced rent will be in the manufacturing area but it will be spread across all areas of the company. The rent expense that we will save—now there will be added interest expense once we put in place the long-term financing—but the rent expense that will be save will be between $200,000 and $250,000 a quarter.

Rob Sinskey – 21st Century Equity Research

On R&D spending, it looks like it kind of goes in waves in the past and that you may have a significant and then the following year you still have an increase but it’s less substantial. Are you sort of adhering to that kind of cycle going forward?

David M. Camp, Ph.D.

What you have just described has not been part of our strategic thinking. We really believe that there are significant more opportunities than we can actually address as a business right now. What we typically have done is we sit down as a team, look at the opportunities that are presented to us and essentially try to make a value judgment as to how much we can afford, and of course, the kinds of return that we expect from the opportunities that are before us.

I believe that the numbers that we are at right now, which I believe is pretty close to 8% of sales, are numbers that we should be able to sustain for some time. But frankly, there are going to be other factors that may end up affecting that. I don’t like to see yo-yo situations with R&D percent of sales going up and down. I think it’s kind of disruptive to our technical forces.

John J. Ehren

In 2007 R&D was about 5% of sales and in 2008 it’s about 6.5%. As David mentioned, we want to keep it pretty much in that range but we’re very selective in making sure that we are investing in those products and projects that are going to get us the return we need.

Rob Sinskey – 21st Century Equity Research

International sales, do you have numbers in terms of percentage of sales?

John J. Ehren

North America, which includes U.S. and Canada, runs about 59% of sales and about 41% is rest of the world.

Rob Sinskey – 21st Century Equity Research

How does that compare to prior fiscal year? About the same?

John J. Ehren

Pretty consistent.

Operator

There are no further questions at this time.

David M. Camp, Ph.D.

I would like to thank all of you for participating. Considering all the uncertainty that is out there, and John Vusaceras and I have had a chance to talk to a number of investors recently and certainly understand the uncertainties that all of you are facing.

I think that we are cautiously optimistic at this time. The business seems to be doing what we were hoping it was going to do. The new products that we are introducing are getting the traction we were hoping for. And I guess there is part of me that says don’t be too optimistic because I look at a number of other people that are truthfully struggling, but the team here has worked very hard and I am really encouraged by what we are seeing. Things can change, but right now I believe that we are still on the right track and I don’t see any reason that we should be changing our strategic direction or the effort that we are putting into it.

Operator

This concludes today’s conference call.

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