Key Technology Inc. F1Q08 (Qtr End 12/31/2007) Earnings Call Transcript

Key Technology Inc. (KTEC)

F1Q08 Earnings Call

February 7, 2008 4:30 pm ET

Executives

Cathy Burlingame – Investor Relations

David Camp Ph.D. – CEO

Jim Brausen – Corporate Controller

Jack Ehren - CFO

Analysts

Rick Doteal – Columbia Management

Manny Reiser – Wachovia Securities

Presentation

Operator

Greetings ladies and gentlemen and welcome to the Key Technology First Quarter Fiscal Year 2008 Earnings Conference Call.

(Operator Instructions)

It is now my pleasure to introduce your host Ms. Cathy Burlingame of Key Technology. Thank you, Ms. Burlingame, you may begin.

Cathy Burlingame

Good afternoon and thank you for joining us for the Key Technology Fiscal 2008 First Quarter Conference Call.

Hosting the call today will be David Camp, President and Chief Executive Officer and Jim Brausen, Corporate Controller. 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 would like to remind you that comments made on today’s call may include forward-looking statements within the meaning of the Federal Security Laws. These statements about anticipated future results are based on current expectations and are subject to a number of risk and uncertainties that could cause actual result to differ materially from those we discuss today.

These risks and uncertainties are explained in detail in today’s release. The company’s Form 10-K filed with the Securities Exchange Commission in December 2006.

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

David Camp

Good afternoon, this has been another very good quarter for Key Technology. Our shipments of 28.9 million are our first quarter record, beating the previous 2007 first quarter by 28%. Our first quarter net earnings were $1.1 million, the 2008 earnings from operation worth $364, 000.00 more than our 2007 earnings from operation. However, the total first quarter net earning from 2007 were higher due to the $750,000.00 gain from the sale of company’s 50% interest in an InspX joint venture.

As we have previously projected, our cost in the first quarter increased to support critical growth initiatives. Record orders during the quarter contributed to higher sales expense and our Global ERP project has begun in its own schedule and at our previously announced cost projection. Four of our five development programs had been funded and staffed and we are on schedule for new product releases later in this fiscal year. Additionally, Rich Hebel has taken a newly created position as Chief Technology Officer. He has two specific assignments: 1.) Analyzing new and emerging technologies and companies and assessing their value to Key, with an emphasis on potential for diversification in new business formation, and 2.) Analyzing and proposing research projects to ensure that we have the potential to add value to the company and shareholders.

Highlighting the few of our operations in the first quarter, revenue and Key BB grew by 67% compared to the first quarter of 2007, recovering from the impact of the poor potato harvest of the year ago that we talked about so much. Of course, the Key BB net income increased considerably as well. In China, even though the revenues in Q1 were down slightly, the future opportunities have increased by over a 100% in the last 12 months. We have not unfortunately had the opportunity to assess what effects the enormous winter storm that has been getting so much television play may have on our business in China.

Our revenues in Latin America in the first quarter were also down slightly from a year ago. This is primarily timing, and we expect to realize increased revenues in the second quarter in Latin America.

In terms of Symetics we are on plan for both revenue and income for fiscal 2008. I want to read from the press release of one our Symetics costumers, Robinson Pharmaceutical. Robinson Pharmaceutical Inc., RPI, announced that it has upgraded its soft gel inspection capability to a fully automated process using a Symetics optical inspection system. The press release continues.

The new systems can process up to $1 million doses per hour. The machine can check for irregularities in ischemic color, size, shape with symmetry and surface quality, as well as detect foreign objects or flaws such as twinning and reject unacceptable and individual doses with the jet up air as the product moves through the equipment.

Changing subjects, and looking forward as we assess prospects for the balanceof 2008, we anticipate that our planned revenue growth would justify increase operating expenses that we plan to incur current fiscal year to invest in Key’s future. This planned increased operating expenses or specifically focused on the ERP project and product introduction that would deliver long-term value to our shareholders in 2008 and beyond.

We continue to expect that our sales expenses will increase as a result of the order increases that have surpassed our expectations this far this year. I will now turn the call over to Jim Brausen for a more detailed discussion of the financial results.

Jim Brausen

We are pleased to report our first quarter result. Key’s orders for the quarter were $35 million a new all time record for order volume and a 50% increase over the $23.4 million of orders recorded for the same period last year.

Net sales of $28.9 million were at record level for any previously recorded first quarter. Sales for the first quarter were up $6.3 million or 28% from the $22.6 million reported in the same quarter a year ago. We ended the quarter with the largest backlog ever, $36.8 million. This represents a $13.3 million or 55% increase from this time last year. The backlog mix at the end of the quarter was 49% automated inspection systems, including upgrades, 50% process systems and 1% parts and service, compared to 64% automated inspection systems, 33% process systems and 3% parts and service at this time last year. This record backlog positions the company well for sale in the second and third quarter fiscal 2008. Net earnings for the first quarter were $1.1 million or $0.20 per diluted share. Total net earnings for the same period last year were $1.6 million, or $0.29 per diluted share, which included a $750,000.00 gain, or $0.14 per share, from the sale of the Company’s InspX joint venture.

As mentioned, net sales for the first quarter increased 28% to nearly $29 million compared to the first quarter of last year. Sales of automated inspection systems of $11.7 million, increased $3.1 million or 37% over the corresponding quarter last year, sales of process systems of $29.9 million were up $3.2 million or 33%, parts and service sales remain consistent with the prior year quarter at $40.4 million.

Gross profit for the first quarter was $11.5 million compared to $8.7 million for the first quarter of fiscal 2007, as a percent of sales, margins of 39.6% increased from 38.6% reported for the same quarter a year ago. That 1% improvement from the prior results resulted primarily from increase manufacturing efficiency, reduction in all the expenses and increased sale of higher margin upgrade systems. Operating expenses of $10.2 million for the first quarter or 35.2% of sales compared with $7.8 million or 34.6% of sales for the same quarter last year. Spending increase $2.4 million as a result of higher sales activities, increased research and development spending, additional and general administrative expenditures and higher stock based and incentive compensation expenses. Going forward, operating expenses are anticipated to remain higher than the prior year to support the higher sales level and the company’s investment in research and development as well as the new company wide ERP system. Our cash position continues to be strong with our quarter in cash balance of $27.8 million up nearly $10 million from December a year ago. Cash at December 31, 2007 remained basically unchanged from $27.9 million reported at September 30, 2007.

Cash generated from earnings during the quarter were offset by increases in working capital. Primarily, an increase in inventories preparing for second quarter shipments and reduction in current liabilities related to timing. And with that I would like to turn the call back over to David.

David Camp

Before we open this call to questions, I would like to take this opportunity to introduce Jack Ehren who will be joining us shortly as our new Chief Financial Officer. Jack will be coming to us from Planar Systems and was gracious enough to join us this week to participate in our Board Meeting and this earnings release. I know it has taken us a year to find a replacement CFO. However, we believe that finding Jack Ehren and getting him to join our team has made the effort all worthwhile. We have looked at hundreds of candidates in this process. Jack impressed us all and we know he is going to have a big impact on Key. Welcome Jack.

Jack Ehren

I just want to say that I am extremely excited to join the Key Technology team; Key is a very impressive company with significant potential and great people. I also look forward to meeting with all of you in person in the near future.

David Camp

I would also like to thank Jim Brausen for its contributions in past year. He has had two jobs and he has managed for the most part to keep his sense of humor.

Jim, the Board of Directors and I thank you for what you have contributed to the business; we will not forget your dedication, your commitment, and your intensity and your sense of humanity. So, with that I will open the phone call to questions.

Operator

(Operator Instructions)

Our first question is coming from Rick Doteal (ph) with Columbia Management.

Rick Doteal - Columbia Management

Terrific job guys. Just a couple of questions, I want to address one of my favorite subjects, gross margin, looks like you are getting a little bit of improvement in that. Can you talk about, characterize the mix of business? I guess you addressed that already in the quarter but also the mix of business in the backlog.

David Camp

Well, I am going to just get the numbers in front of him. I can tell that we are on the surface. We are actually very pleased with the margin, because the next was not particularly advantageous in Q1 in terms of the process systems in Optical. But, I will let Jim give you the numbers so he can help you out with that a little bit.

Jim Brausen

We did talk about that just briefly, the current backlog mix is 49% automated in the inspection systems and 50% process systems. That compares to 64% of automated inspection and 33% this time last year so, it is more of a balance between automated inspection and process systems this quarter than it was last year. Primarily due to some big projects at some of our major costumers, there are three major costumers that have got some major projects with very intense process system components to those.

David Camp

Which hopefully makes you feel good Rick considering that that change that the margin actually went up.

Rick Doteal - Columbia Management

Absolutely and I know last year given the growth and I guess the growth has continued, certainly it looks like with the backlog you guys have discussed here. You had to do a lot of hiring particularly on the production folks; do you feel like that hiring is starting to come up the learning curves so that we can see some benefits in the margin line?

David Camp

I do not have the exact numbers in front of me so what I am going to be saying to you is I would probably have to go back and get the exact numbers if you wanted it but, last summer, one of the things we look at is the labor efficiency. We were running about 6% to 7% negative to plan last summer when we were doing a lot of hiring. The most recent numbers I looked at was we still were about minus 2% and I think that the people have become better trained, they are learning their jobs better, we still have ways to go that those numbers should even increase further. So, obviously some of those numbers we had last summer, we were very aware that we were going to a pretty heavy training process, we think there are some opportunity there for that to continue to improve, Rick.

Rick Doteal - Columbia Management

And then I will ask one more and pass it on. The Symetics, were there any incremental orders in this quarter in the Symetics category.

David Camp

I am going to have to turn that one over to Jim as well. I know that we have shipments coming out, some shipments in Q2 and some shipments in Q3, but I am going to have to ask Jim what he has got in his page here for Symetics orders in Q1.

Jim Brausen

The Symetics order in Q1 was lighter than we had hoped. They have several in the pipeline that almost got PO’s in. Shipments, we have orders that are in the pipeline that will be coming out in the second quarter and we have some of those that will flop over into the third quarter, but a lot of activity, a lot of testing slightly below where we had hoped in our internal plan, but the expectations are there, we would meet our expectations for the year.

Operator

Our next question is coming from Manny Reiser with Wachovia Securities, please state your question.

Manny Reiser – Wachovia Securities

I will echo Rick’s comments about congratulations on a very, very positive first quarter and I hope it is not too much to say I can extrapolate orders and backlogs for the first quarter and imagine it to be the same as we go through succeeding quarters. Just a few things here, David or Jim, can you give me a breakdown, just a monthly progression type of breakdown, October, November, December as to orders, both in Symetics as well as in the regular business. I am just kind of curious how that shakes up, what October looks like in orders in November and December to kind of get a progressive flow of things?

Jim Brausen

We do not provide that kind of information.

David Camp

You would normally expect that you would have some slowing down at the end of the year, but frankly, there was a little slowing down, but I mean, December is typically a shorter month, besides the fact that it was outstanding throughout the entire quarter, it was pretty constant. I mean, it was not any big variation.

Manny Reiser – Wachovia Securities

So we really did not see a December slow down as normally would be expected.

David Camp

No, in fact, I can tell you that the numbers that we saw in the first quarter and what we already experienced and we have been very curious and I think this is where you are taking the question about whether or not this mortgage meltdown might be affecting the business and we have been trying to monitor those ourselves. We have been looking at anything that would give us a clue that people were becoming credit weary or that there were other things going on and, knock on wood, but frankly, we are not seeing it so far. We are not seeing that there is a slow down yet. We have got a pretty good look forward in some of the tools we use. I certainly do not want to say that our telescope looking forward is perfect. We are not seeing the same type of slowing down that some other businesses might be seeing.

Manny Reiser – Wachovia Securities

Since we have completed January where I would imagine you have the numbers of January, has January basically continued the pattern of the first quarter?

David Camp

Very, very similar.

Manny Reiser – Wachovia Securities

Add a little bit more color to the Mexico or Latin America or in Chinese situation, David.

David Camp

The Latin American situation, we have got a number of significant projects that are, I am trying not to get into Q2 at this point in time that we knew had flopped over Q1 into Q2. We do not see, if anything, we see that potentially accelerating in Q2, the actual shipments that we had in Q1 in Latin America were down, but it is not disturbing us. We think we have got a pretty good handle on it.

One of the things we are trying to learn a little bit about China is the issue of getting money freed up from projects and so we have actually continued to grow the number of people, I think we have 14 over there now, but the issue of how do you get the money converted from the R&D and the dollar is something that we are still struggling with a little bit. I think we are going to past this issue as we are developing a better level of expertise, but our business was a little down in Q1 than what we expected, so we have got some work to there.

Manny Reiser – Wachovia Securities

And on the Symetics side, you quoted from the press release, is the company Robinson or Robertson? Could you just let me know the spelling on that.

David Camp

Robinson Pharmaceutical and you can go to their website. It is Robinson Pharma Inc.

Manny Reiser – Wachovia Securities

Okay, and are they a subsidiary of one of the majors or?

David Camp

No, they are not. They are actually in California.

Manny Reiser – Wachovia Securities

And were they a new customer for us or, tell me a little bit more about them is what I am asking you.

David Camp

This was their first installation. And we did not have to encourage them to put this on the website. They did this on their own.

Manny Reiser – Wachovia Securities

And are they a generic company or what their basic business?

David Camp

If I recall, and I could be correct, Ricci might run in here and correct me, I am almost certain they are a nutraceutical company, but I could be wrong.

Manny Reiser – Wachovia Securities

And Jim indicated Symetics in the first quarter was a drop light, what might you attribute that too and also you have the confidence that we are going to overcome it, so I assume you are seeing in the pipeline some nice potential orders there, but what might you attribute the first quarter bit lightness too?

Jim Brausen

Trying to get through the fabrication acceptance test and there is also a material handling component to these systems that we are trying to also manufacture and get developed and those are in the pipeline being developed as we speak and it should be available in the March is what we are thinking right now.

David Camp

Let me throw a little more color on what you may not be aware of Manny. We actually did something in this past quarter which I may not have discussed with you. We moved our pharma business out of this building into another building in Walla Walla and actually that slowed us down a little bit because I mean it is just a natural disruption, we are out of space, so we are in the process of building and leasing a facility from the Port of Walla Walla, sort of like what we do here. We do not know if the building here, we are having a discussion with the current Board of Walla Walla about leasing a new building that we would be designed to our specifications, so we lost a little time with Symetics in the first quarter. I am very confident we are going to get it back, but when you disrupt people and move to another building, we actually had to find a building and lease it, and it has costs us a little bit.

Manny Reiser – Wachovia Securities

What were actual orders for Symetics in the first quarter, David?

Jim Brausen

With that part, Manny, because that gets buried in this one report I am looking at, below $503,000.00.

Manny Reiser – Wachovia Securities

And for the year as a whole we are expecting?

David Camp

I do not feel comfortable giving you that number, Manny.

Manny Reiser – Wachovia Securities

Okay, tell me, last year, what we did for Symetics as a whole?

Jim Brausen

With that part, for the first quarter, it was just slightly over 600.

Manny Reiser – Wachovia Securities

But for the year, as a whole, what did Symetics do for 2007?

Jim Brausen

We will have to ask someone bring that into us. We will get to you.

David Camp

But they were still in the $4 million range, but I cannot remember exactly.

Jim Brausen

But I believe orders were $4.5 million and I believer shipments were $2.2 million.

Manny Reiser – Wachovia Securities

Moving to a somewhat different subject, our cash position stayed essentially flat despite the increase expenditures. With the record backlog, now that we are looking after the second quarter, is it fair to assume that our cash position would increase at the end of the second quarter?

Jim Brausen

I would be disappointed if I said it would be otherwise.

Manny Reiser – Wachovia Securities

And looking at the third quarter, which is also normally a very strong quarter, again, is it fair to assume that the cash would increase at the end of the third quarter as well?

David Camp

I think your model works pretty well, Manny.

Manny Reiser – Wachovia Securities

You know, David what I am going to be asking you?

David Camp

I know where you are going.

Manny Reiser – Wachovia Securities

Have we had any further discussion on movement on the question of quarterly dividends, stock dividend or anything of that ilk?

David Camp

It is a Board discussion at every Board meeting and the meetings that we are at right now, there were a number of moving parts including basically the fact that the cash position did not change in this first quarter, but there was no decision made to issue a special or a quarterly dividend at the meeting yesterday.

Manny Reiser – Wachovia Securities

Okay, from your vantage point, David, knowing that the first quarter is traditionally our weakest of the year and that we spent more money on the ERP system and sales et cetera, will you pleased with the way our cash position ended? Because you discussed with the Board that it was essentially flat? The flatness, did you think we would the end quarter somewhat lower or how did that quarter end from a cash point from where you sit?

David Camp

In any of these things, Manny, there are so many moving parts. I can tell you that anytime that we have, we are a cash machine and having a flat cash quarter considering all the pieces in here that the stuff we are doing with ERPs, the money we are spending for our new projects, the fact that we have actually paid out cash incentives to the executives this past quarter, I do not like and I am never comfortable having a flat cash quarter. We have looked very hard at what our expectations are for the rest of the year. We believe that we are very comfortable with our cash projections that we have in our planning and so we are comfortable where things are going as a business.

But I could tell you that this is sort of on the side, considering all of the credit issues that are out there right now, it has been nice not to be in a situation that some people possibly are in having to worry about where they are going to find cash.

Manny Reiser – Wachovia Securities

And in terms of looking at the record backlog moving Symetics to a new facility, do we feel comfortable still looking at the rest of the year without any acquisitions because we have always discussed the past acquisitions and how they worked out. We will have an increased cash position moving forward, are we at a point where we see where we need to start looking again at acquisitions or we are very comfortable building up that cash using it where we are at without acquisitions.

David Camp

I think you asked two questions. I think that the plans that we have for the fiscal year 2008 can be accomplished without us having to make any type of an acquisition. I think that was a part of it. But I think there was a second question there. One of the things that I take very seriously and I think you know this because we might not have had a chance to look straight to each other, Manny, if there are significant accretive opportunities, whether that as a business or a technology that gives value and significant appreciation to the shareholders, I will consider those, but frankly, I am not one of those people and I think you know it because you and I talk, Manny, cash does not burn a whole in my pocket that I have this great need to go and spend it. My goal is to find those things that really contribute value, so I do not feel that just because we have cash at this point in time, I have to go and spend it.

With that said, if there is something that is out there that is significant, I hope that when and if that might occur, we bring something to the shareholders and the stakes, measured, clearly understood, who understand why we are making this decision, but frankly, there is nothing like that right now.

Manny Reiser – Wachovia Securities

And my final question and then I will get off. With the credit issues facing many companies, you indicated that we have not seen that affecting our business, our customers as well as prospective customers seem to be reasonably good financial shape, David?

David Camp

That is a tough question. Most of our customers are private. It is hard for me to get that feeling for a lot of our customers, however, I can tell you that when you go and look at the quoting activity that we have, the kind of activities that we go through, our sales people are very busy. They are looking at all kinds of things, and frankly, all over the world, do we look at financing possibly opportunities? Absolutely, but I do not sense that there is a restriction on new orders because of financing capabilities right now, but I want to make sure I emphasize Manny, that could happen. There are so many people so concerned about this whole credit thing that if we see it, we will certainly tell you we are seeing it.

Manny Reiser – Wachovia Securities

But as of now, it has not been a factor?

David Camp

Not yet.

Manny Reiser – Wachovia Securities

Again, congratulations, David on a very fine start for the year and I look forward to future calls.

David Camp

Two other things, Manny, the actual shipments for Symetics in fiscal year 2007 were $2.1 million, the orders were 4.5 million. And the other thing is, I expect that Jack and I may have a chance to be back in the East in March and so if we do, we will try and touch base with you then.

Manny Reiser – Wachovia Securities

That would be wonderful. I would look forward to it again. Thank you again, David and Jim, thank you.

Jim Brausen

One thing on cash, it is a major timing issue. The inventories are built for the big backlog we have in the second quarter to be prepared for that, but accounts payable is one of the things with the timing issue is, as some things go up in September, because the payables had been very high at the end of last year. At the end of the year, it is $5.7 million, trade payables did. Payables at the end of this year were $4.1 million, last year at this time, payables were $3 million, so we had a lot of payables at the end of September, so it is really more of a timing issue on the working capitals than anything else, and just like David mentioned, we paid out a lot of all the annual incentive plans to save the first quarter.

Manny Reiser – Wachovia Securities

Right, first quarter, we normally see that, so we look forward to the second quarter and see an increased cash on the balance sheet. So thank you.

David Camp

That way too, we will have the same discussion about dividends, Manny.

Operator

(Operator Instructions)

Gentlemen, it appears we have no further questions. I would like to turn the floor back over to management for any closing comments.

David Camp

I would like to first thank you all for joining us today and I would also like to thank Jack for joining us. We are really glad you are here, Jack. We look forward to you participating in the future on these phone calls and I could tell you that I think can see relief on Jim at this both in time and Jim, once again, thanks a lot. You have really held on two jobs fantastically. We are looking forward to this next quarter. We think we have got some good things going on. Obviously, with the backlog that we have, we are very encouraged because as many of you know, those had been long term investors, to have a backlog like this coming out of Q1 is more than rare. So we look forward to talking to you next quarter and I am sure that I will be hearing from many of you between now and then. Thanks a lot.

Operator

Ladies and gentlemen, this does conclude today’s program. You may disconnect your lines at this time. Thank you for your participation.

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