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Key Technology, Inc. (NASDAQ:KTEC)

Q3 2014 Earnings Conference Call

July 24, 2014 05:00 PM ET

Executives

Cathy Burlingame - IR

Jack Ehren - President and CEO

Jeff Siegal - VP and CFO

Analysts

Jim Ricchiuti - Needham & Company

Jason Ursaner - CJS Securities

Beth Lilly - Gamco Investors

Operator

Good evening ladies and gentleman, and welcome to the Key Technology fiscal 2014 third quarter conference. At this time all participants are in a listen only mode, later we’ll conduct a question and answer session and instructions will be given at that time. (Operator Instructions) As a reminder this conference call is being recorded, and now I would like to introduce your host for today’s conference, Cathy Burlingame you may begin.

Cathy Burlingame

Thank you, Ashley. Good afternoon and thank you joining us for the Key Technology fiscal 2014 third quarter conference call. Hosting the call today will be Jack Ehren, President and Chief Executive Officer, and Jeff Siegal, 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 Safe Harbor provision of the private securities litigation reform act of 1995. These statements are based on management’s current expectations or beliefs and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. These and other cautionary statements are listed in today’s release. For more detailed discussion, please refer to the company’s annual report on Form 10-K filed with the Securities and Exchange Commission in December 2013.And now I’d like to turn the call over to Jack Ehren, President and Chief Executive Officer, for a discussion of the company’s results.

Jack Ehren

Thank you, Cathy. Good afternoon. We fully acknowledge that our 2014 fiscal year financial year results have been below all of our expectations and that these results cannot continue over the long term. Fiscal year 2014 has continued to be adversely impacted by a year-over-year decline in bookings and revenues most significantly in the potato market. In fiscal year 2013, we successfully and effectively executed on a significant number of global potato market opportunities which we believe are helping position us well for future business in this segment. Although in fiscal 2014, we continued to be challenged to overcome the large order gap in our global potato market we are actively working with several major potato processors regarding future projects which are expected to be realized beyond 2014. We are committed to continuing to bring new innovation and differentiated value that will positively impact our customers operations and help ensure the optimization of their yields and profitability.

Until we more fully execute on integrating our new differentiated solutions and developments into new and existing insertion points in our core market and in high potential adjacencies we remain highly vulnerable and subject to the cyclical trends in our markets. Despite our current overall order challenges associated with the potato market in fiscal year ’14, we are achieving important progress and positive results in several areas of our business. Year-to-date we have achieved a moderate increase in orders from our European region compared to the prior year even after a significant decline in orders in the potato market. These results are encouraging and we continue to focus on growing our business in this region with existing and new strategic customers. Our year-to-date orders in the nuts and dried food market have increased significantly over the prior year. We remain positive and encouraged by the penetration we are achieving with the shoot wet solutions we obtained through the Visys acquisition in fiscal year ’13.

We are especially pleased with our overall acceptance of the Taurys our new shoot wet solution introduced to the market in late September. We have already successfully sold Taurys systems into walnut, raisin, cranberry and blueberry applications. Also the Key Iso-Flo Vibratory Shaker is the ideal in fleet shaker to partner with our Taurys, Cayman and other shoot fed solutions, thereby enabling Key to provide complete solutions to our customers. We have successfully completed our field trial of the CIT technology on our ADR, for the detection of invisible defects such as sugar ends in potato strips based upon the chemical composition of the product with the planned first production installation of this solution at a customer’s site in the first quarter of fiscal 2015.

We recently announced the expansion of our Veo family of seed corn sorters with our new Veo Max, which contains a unique high capacity configuration that enables the output of multiple huskers to be consolidated and fed into a single digital sorter having the potential to inspect up to 4500 ears of corn per minute. We successfully drove the Veo Max from development implementation in just a few short months to quickly respond to market needs. We expect to place this system into full operation next season. The addition of the Veo Max now provides Key with a fully complementary line of seed corn ear sorting systems for any capacity or configuration. In addition as previously communicated this summer we have initiated our field testing of many new developments and capabilities for insertion points into our core markets and other high potential adjacencies. We are very encouraged by the current progress of our extensive field testing which includes test and validations for multiple global market applications. We are excited about our new solutions and very optimistic that they will bring real, added and differentiated value to our customers’ operation. Field testing is expected to continue in North America and Europe throughout calendar 2014. We are being very thorough and disciplined with our testing to ensure that our new solutions are robust, cost efficient and will effectively achieve the requirements of our customers on a global basis. We expect to commercialize many of these new developments and capabilities during our 2015 fiscal year. These initiatives are evidence that Key is focused on specific, critical, market drivers that formulate our unique strategic position. The following are Key’s main strategic themes that are driving the basis for our overall long term corporate strategy and direction. Trusted partner to be complete customer satisfaction partner to ensure the optimization of our customers’ operation.

Innovation architecture to provide unique and differentiated industry meeting value add solutions leveraging M&A and technology partnerships. Smart and intelligent systems partner for yield improvement, to help ensure the optimization of customer processing lines, yields and profitability, leveraging our advanced proprietary sort engine, software and algorithms and fourth leading provider of global food processing solutions to offer full processing improvement solution, a holistic mix of hardware, software and intelligent information leveraging our deep process knowledge and application expertise with an ever increasing global footprint post to core markets and strategic customers. In addition to ensuring that we continue to aggressively execute on our long term strategy and vision that we believe will drive sustainable success and results for our shareholders and our customers. We are also fully committed to improving the company’s profitability in the short term. In alignment with this commitment in the third quarter we announced an 8% workforce reduction to improve our financial model in the short term.

In taking this action, however we have carefully retained the required infrastructure and foundation necessary to fully execute on our overall goals and objectives for the future. The workforce reduction included the impact of organizational changes and recently vacated positions, early retirements and other involuntary reduction. In the third quarter we took a pretax charge of 1.2 million associated with the workforce reduction and we expect the payback of these charges to occur during the first quarter of fiscal year ’15. Approximately 50% of the cost savings will occur in operating expenses, primarily R&D, and sales and marketing and 50% in the manufacturing operations. We are focused on continuing to build a strong successful and sustainable foundation and strategy for our future, we believe our organizational changes along with new innovative and differentiated technologies and solutions will enable us to generate sustainable growth in new and existing insertion points in our core and adjacent markets globally. Despite our financial performance in fiscal 2014 our team is not deterred, we remain focused and we will not compromise on our commitment to continue building the trust and confidence of our customers on a global basis. I’m very proud of the discipline, dedication and drive of our employees during this challenging yet very exciting time as we continue executing on our convictions and our vision and long term strategy to return shareholder value. I will now turn the call over to Jeff for his summary of the financial results.

Jeff Siegal

Thank you, Jack. First I will discuss the third quarter results for fiscal 2014. Third quarter net sales were $31.3 million compared with $39.4 million reported in the same quarter a year ago. Sales of automated inspection systems in the third quarter totaled $15.1 million compared with $16.2 million in the same period a year ago, a 7% decrease. Third quarter net sales of process systems were $9.1 million compared with $16.1 million in 2013, a 43% decrease. The decrease in process systems is primarily due to decreases in the potato market across all geographies with the most significant impact in North America. Parts and service net sales were $7.1 million in the third quarter of both 2014 and 2013.

As we previously announced on June 26 during the third quarter, the company recorded approximately$ 1.25 million of pretax charges related to cost reduction activities that included a final reduction of approximately 8% of our global workforce, the majority of these cost reductions will be fully implemented during the fourth quarter. Gross profit for the third quarter was $8.2 million compared with $13.3 million for the third quarter of fiscal 2013, as a percent of sales margins of 26.9% decreased from the 33.7% reported for the same quarter a year ago. Gross margins for the quarter ended June 30th, 2014 were down compared to the corresponding prior year period due primarily to less payable charges, changes in the product mix and less efficient plant utilization due to lower sales and production volumes. The 2014 third quarter gross profit was also negatively impacted by approximately $750,000 of workforce reduction cost. Operating expenses of $11.1 million for the third quarter were 35.5% of net sales compared with $11 million or 27.9% of net sales for the same quarter last year. Operating expenses for the three month period ended June 30th, 2014 were impacted compared to the same period in the prior year primarily by higher R&D expenses associated with the field testing of new developments. The 2014 third quarter operating expenses also included approximately $500,000 of workforce reduction costs.

The net loss for the third quarter was $2 million or $0.33 per fully diluted share compared with net income of $1.4 million or $0.23 per share in the same period last year. I will now discuss our third quarter 2014 orders and backlog. During the third quarter ended June 30th, we recorded new orders of $26.9 million; last year’s third quarter new orders totaled $30.9 million. Our backlog at the end of the third quarter was $26.6 million, this compares with $41.7 million at the end of the third quarter last year, the backlog in the prior year consisted of a few significant orders primarily related to potatoes which were restated in the fourth quarter of fiscal 2012 and the first quarter of fiscal 2013. These orders which did not recur in 2014 are reflective of the seasonal and cyclical industries included in our markets. The backlog mix at the end of the third quarter was 55% automated inspection systems, 37% process systems and 8% parts and service.

For the nine months ended June 30th, 2014 net sales were $85.6 million as compared to $94.8 million for the same period in the prior year. The net loss for the first nine months of fiscal 2014 was $0.85 per diluted share as compared to net earnings $0.47 per diluted share in the first nine months of 2013. Our balance sheet remains very strong with working capital of approximately $38 million, asset the end of the quarter was $12.8 million compared with $17.6 million at September 30th, 2013.

Looking forward, net sales for the fourth quarter of fiscal 2014 are expected to decrease moderately as compared to the net sales reported in the third quarter of fiscal 2014. Gross margins are expected to be higher in the fourth quarter of fiscal 2014 as compared to the third quarter of fiscal 2014 and more in alignment with the year to date gross margin adjusted for the gross, for the cost reduction charges. Operating expenses for the fourth quarter of fiscal 2014 are anticipated to decrease significantly as compared to third quarter of fiscal 2014. I will now turn the call back over to Jack.

Jack Ehren

Thank you, Jeff. And we will now open up the call for questions.

Question-and-Answer Session

Operator

Thank you, (Operator Instructions) our first question comes from Jim Ricchiuti of Needham & Company, your line is open.

Jim Ricchiuti - Needham & Company

Thanks. I wonder if you can comment on breakeven. I know that mix certainly is going to play into this, but can you give us a sense with the restructuring charges where your quarterly breakeven is from a revenue standpoint?

Jack Ehren

We’re not really at the point where we’re going to talk about what the breakeven point is but for the fourth quarter it will be challenging but yet we believe achievable and a focus for us in the fourth quarter.

Jim Ricchiuti - Needham & Company

Okay, that is helpful, Jack. Can you also -- you alluded to activity and future projects in the potato market looking out beyond fiscal 2014. Can you give us a sense, Jack, as to what the timeline might be? Is this something where you potentially could see orders in the early part of fiscal 2015 or is it still somewhat uncertain?

Jack Ehren

It is still somewhat uncertain and several of these orders would relate to ’15 but some could beyond and into ’16 as well.

Operator

Thank you, our next question comes from Jason Ursaner of CJS Securities, your line is open.

Jason Ursaner - CJS Securities

Good afternoon. Just first want to make sure I heard on the pretax charges, so it was $700,000 were in COGS and $500,000 in operating expenses?

Jack Ehren

$750,000 in costs per sales and 500,000 in operating expenses.

Jason Ursaner - CJS Securities

Okay, so there’s going to implementation next quarter, but no additional charges next quarter?

Jack Ehren

That is correct.

Jason Ursaner - CJS Securities

Okay. What is the total payback you are expecting to start realizing in fiscal Q1?

Jack Ehren

We’ve not disclosed what the total payback is, but we did say that we expected us to realize the payback during the first quarter of 2015.

Jason Ursaner - CJS Securities

Realize a full annualized run rate?

Jack Ehren

We expect to realize the cost of $1.25 million during the first quarter of fiscal ’15.

Jason Ursaner - CJS Securities

Okay. And for the potato market, from a revenue perspective, now that you are sort of looking at the full year with orders in hand for the fourth quarter, how large a gap overall did that end up being for the year? If I look at full-year sales down roughly $20 million or -- I am sorry -- roughly -- at roughly $20 million if I'm looking at Q4 down a little bit, how much of that was the potato market?

Jack Ehren

Potatoes is the most significant impact in the majority of the difference that we’re dealing with and it’s on a global basis.

Jason Ursaner - CJS Securities

And is it just mainly that you didn't see the large-scale projects or even the smaller onesie, twosie replacement type stuff just wasn't -- also wasn't as….

Jack Ehren

It’s more a factor of there being less large deals in fiscal ’14 than what we experienced in the prior year.

Jason Ursaner - CJS Securities

Okay. And the field testing, how much of R&D was related to the field testing?

Jack Ehren

Well, a significant portion of our expenses in R&D, are related these new developments and new capabilities that we have taken to field testing and so we would expect a reduction in R&D expenses beginning in the fourth quarter.

Jason Ursaner - CJS Securities

Okay, but it is spending on bringing the machines to a customer facility to test it with them?

Jack Ehren

What we have said previously was that it was extremely important that we really understand the needs and requirements of our customers on a global basis and that we would be doing extensive field testing in North America as well as Europe so that we really provide frugal, global solutions to our customers and so yes, there is extensive cost associated with bringing capabilities and developments to field testing in both Europe and the United States.

Jason Ursaner - CJS Securities

Okay. And when you bring it into a customer facility, why wouldn't customers be seeing the same differentiated value that you are? If the payback and the ROI on a machine is there, why would that not be translating to orders in the short term? What is the difference in what they are seeing?

Jack Ehren

We are partnering and working with our customers to enable us to bring our new developments and our new capabilities to test them in the field so they are commercialized solutions at this point in time. We are working at partnering with our customers to ensure that ultimately when we come with new solutions that they fully address and create the value that we expect to provide to our customers, but we’re working with them hand in hand to make sure we’re generating that type of value. So these are not commercialized solutions.

Jason Ursaner - CJS Securities

Okay. And on the cash position, just how much of that is uncommitted at this point? Is there any of that that is deposits and essentially customer cash and what other sources of liquidity do you have at this point?

Jack Ehren

The customer deposits at the end of the quarter were little less than $7 million, and the other balance sheet accounts and working capital accounts there for the most part fairly stable with where we have been throughout the year; the decrease in cash is primarily related to the losses incurred here today.

Operator

Thank you, our next question comes from Beth Lilly of Gamco Investors, your line is open.

Beth Lilly - Gamco Investors

Good afternoon. So here is what I want to understand, you talked about the extensive field testing that is going on with the customers and such and so your R&D line is a little bit higher not only on a three-month basis, but on the nine-month basis. So as we look out to next year, is that number going to come down?

Jack Ehren

Yes, and as I said earlier we expected a decline in R&D expenses in the fourth quarter as well.

Beth Lilly - Gamco Investors

Okay, so what kind of number are we talking about Jack.

Jack Ehren

More in alignment as a percentage of revenue as to what we have been incurring previously more on that 6-8% type of range.

Beth Lilly - Gamco Investors

All right. Okay, and then I wanted to go back to I think it was Jim Ricchiuti's first question in regards to the breakeven level. I think in the past you talked about maybe $35 million being the breakeven level. And so now you have taken out another $1.2 million in costs. So can you give us a sense of -- in the past, you have been willing to commit to a breakeven number on the revenue, so can you give us a sense of what it is going to be now with the cost that has come out?

Jack Ehren

Well first of all I don’t ever recall saying that 35, so I just want to make that statement and I think in the past we’ve given ballpark figures before the acquisition that were somewhere in the mid, after we had the reductions in ’13 that we’re in the mid 20s breakeven and I think last quarter we said obviously our breakeven had gone up higher than that. What I did say from a breakeven standpoint was that it’ll be a challenge in the fourth quarter but it is an achievable goal and something that we’re focused on.

Beth Lilly - Gamco Investors

Okay. And then as we look out -- so from your comments over the last couple quarters, last two quarters, it sounds like the real issue of course has been the potato market. So as you look out, do you think there is the potential for recovery in the potato market and recovery in orders for you next year?

Jack Ehren

As I stated earlier there definitely are projects that we’re working on that will have an impact in ’15, and I do believe that there will be projects that will stretch out into 2016 as well.

Beth Lilly - Gamco Investors

Okay so you think you’re going to get orders next year in the potato side.

Jack Ehren

We definitely will get orders on the potato side next year.

Operator

Thank you, (Operator Instructions) I’m not showing any questions in queue, I’d like to turn the call back over to management for any further remarks.

Jack Ehren

I would just like to thank all of our investors for their commitment to working with us and again you have our commitment to do what we can to drive up the shareholder value and we are excited about changes that we’ve made within our organization and the direction that we’re going and again we’re committed to generating that shareholder value that you’re looking for, and we look forward to talking with you again next quarter, thank you.

Operator

Ladies and gentlemen thank you for participating in today’s conference, this concludes today’s program, you may all disconnect. Everyone have a great day.

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