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MANAGEMENT'S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS.
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From time
to time, Key Technology, Inc. (“Key” or the “Company”), through its management,
may make forward-looking public statements with respect to the Company
regarding, among other things, expected future revenues or earnings,
projections, plans, future performance, product development and
commercialization, and other estimates relating to the Company’s future
operations. Forward-looking statements may be included in reports
filed under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”), in press releases or in oral statements made with the approval of an
authorized executive officer of Key. The words or phrases “will
likely result,” “are expected to,” “intends,” “is anticipated,” “estimates,”
“believes,” “projects” or similar expressions are intended to identify
“forward-looking statements” within the meaning of Section 21E of the Exchange
Act and Section 27A of the Securities Act of 1933, as amended, as enacted by the
Private Securities Litigation Reform Act of 1995.
Forward-looking
statements are subject to a number of risks and uncertainties. The
Company cautions investors not to place undue reliance on its forward-looking
statements, which speak only as of the date on which they are
made. Key’s actual results may differ materially from those described
in the forward-looking statements as a result of various factors, including
those listed below:
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adverse
economic conditions, particularly in the food processing industry, either
globally or regionally, may adversely affect the Company's
revenues;
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competition
and advances in technology may adversely affect sales and
prices;
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failure
of the Company’s new products to compete successfully in either existing
or new markets;
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the
limited availability and possible cost fluctuations of materials used in
the Company’s products could adversely affect the Company’s gross
profits;
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the
inability of the Company to protect its intellectual property, especially
as the Company expands geographically, may adversely affect the Company’s
competitive advantage; and
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intellectual
property-related litigation expenses and other costs resulting from
infringement claims asserted against the Company by third parties may
adversely affect the Company’s results of operations and its customer
relations.
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More
information may be found in Item 1A, “Risk Factors,” in the Company’s Annual
Report on Form 10-K filed with the SEC on December 14, 2007, which item is
hereby incorporated by reference.
Given
these uncertainties, readers are cautioned not to place undue reliance on the
forward-looking statements. The Company disclaims any obligation
subsequently to revise or update forward-looking statements to reflect events or
circumstances after the date of such statements or to reflect the occurrence of
anticipated or unanticipated events.
Overview
General
The
Company and its operating subsidiaries design, manufacture, sell and service
process automation systems that process product streams of discrete pieces to
improve safety and quality. These systems integrate electro-optical
automated inspection and sorting systems with process systems that include
specialized conveying and preparation systems. The Company provides
parts and service for each of its product lines to customers throughout the
world. Industries served include food processing, as well as tobacco,
plastics, and pharmaceuticals. The Company maintains two domestic
manufacturing facilities and a European manufacturing facility located in the
Netherlands. The Company markets its products directly and through
independent sales representatives.
In the
past several years, 40% or more of the Company’s sales have been made to
customers located outside the United States. In its export and
international sales, the Company is subject to the risks of conducting business
internationally, including unexpected changes in regulatory requirements;
fluctuations in the value of the U.S. dollar which could increase or decrease
the sales prices in local currencies of the Company’s products; tariffs and
other barriers and restrictions; and the burdens of complying with a variety of
international laws.
Current
period – second quarter of fiscal 2008
The
results for the second quarter of fiscal 2008 showed continued growth in order
volume, net sales and backlog compared to the same period in the prior fiscal
year. Customer orders in the second quarter of fiscal 2008
of
$39.4
million were up 22% over orders of $32.3 million in the second quarter of fiscal
2007. The orders received during the second quarter of fiscal 2008
were an all-time record, up 12% from the previous record of $35.0 million set in
the first quarter of fiscal 2008. This increase in orders is
attributable to several factors: the increasing global concern regarding food
safety and security; the continuing decline of available labor in the food
processing industry; the growth of our business in the North America, Latin
America and Europe; and, finally, the continued confidence of our customers in
the Company’s ability to provide processing solutions.
Net sales
of $29.1 million in the second fiscal quarter of 2008 were $6.9 million, or 31%,
higher compared to net sales of $22.2 million in the corresponding quarter a
year ago. Backlog of $47.2 million at the end of the second fiscal
quarter of 2008 was also at a record level, exceeding the prior record of $36.8
million set in the first fiscal quarter of 2008, and represented a $13.3
million, or 39%, increase over ending backlog of $33.9 million in the
corresponding quarter a year ago. Net earnings for the second quarter
of fiscal 2008 were $1.2 million or $0.22 per diluted share. Net
earnings for the same period last year were $608,000, or $0.11 per diluted
share. During the second quarter of fiscal 2008, the Company
continued to focus on growing market share and revenues in its established
markets and geographies, strengthening its presence in the pharmaceutical and
nutraceutical market, increasing upgrade system sales, and continuing to
establish its global market presence.
Additionally,
the Company began work to implement a new global enterprise resource planning
(“ERP”) system. Implementation will be spread over a three-year
period, with an estimated cost of $5.5 million, including both internal and
external resources. A significant portion of these implementation
costs will be capitalized. Operating expenses of $430,000 and capital
expenditures of approximately $251,000 related to the ERP implementation were
incurred during the second quarter of fiscal 2008.
First
six months of fiscal 2008
The
results for the first half of fiscal 2008 also showed continued growth in order
volume and net sales compared to the same period in the prior fiscal
year. Customer orders for the first half of fiscal 2008 were $74.4
million which represented an $18.7 million, or 34%, increase over customer
orders of $55.7 million in the same period in fiscal 2007. This
increase in orders related to the growth of our business primarily in North
America, Europe and Latin America.
Net sales
of $58.1 million for the first six months of fiscal 2008 were $13.3 million, or
30%, higher compared to net sales of $44.8 million in the corresponding period a
year ago. Net earnings for the first half of fiscal 2008 were $2.3
million, or $0.42 per diluted share. Net earnings for the
corresponding period last year were $2.2 million, or $0.41per diluted
share. Net earnings in the first half of fiscal 2007 included a
$750,000 gain, or $0.14 per share, from the sale of the Company’s InspX joint
venture.
For the
first half of fiscal 2008, the Company incurred operating expenses of $554,000
and capital expenditures of approximately $625,000 associated with the
implementation of the ERP system. Cumulative ERP-related capital
expenditures and operating expenses, including amounts incurred in fiscal 2007,
are $1.3 million and $554,000, respectively.
Application of Critical
Accounting Policies
The
Company has identified its critical accounting policies, the application of
which may materially affect the financial statements, either because of the
significance of the financial statement item to which they relate, or because
they require management judgment to make estimates and assumptions in measuring,
at a specific point in time, events which will be settled in the
future. The critical accounting policies, judgments and estimates
which management believes have the most significant effect on the financial
statements are set forth below:
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Allowances
for doubtful accounts
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Valuation
of inventories
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Allowances
for warranties
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Accounting
for income taxes
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Management
has discussed the development, selection and related disclosures of these
critical accounting estimates with the audit committee of the Company’s board of
directors.
Revenue
Recognition.
The Company recognizes revenue when persuasive
evidence of an arrangement exists, delivery has occurred or services have been
provided, the sale price is fixed or determinable, and collectability is
reasonably assured. Additionally, the Company sells its goods on
terms which transfer title and risk of loss at a specified location, typically
shipping point, port of loading or port of discharge, depending on the final
destination of the goods. Accordingly, revenue recognition from
product sales occurs when all criteria are met, including transfer of title and
risk of loss, which occurs either upon shipment by the Company or upon receipt
by customers at the location specified in the terms of sale. Revenue
earned from services (maintenance, installation support, and repairs) is
recognized ratably over the contractual period or as the services are
performed. If any contract provides for both equipment and services
(multiple deliverables), the sales price is allocated to the various elements
based on objective evidence of fair value. Each element is then
evaluated for revenue recognition based on the previously described
criteria. The Company’s sales arrangements provide for no other
significant post shipment obligations. If all conditions of revenue
recognition are not met, the Company defers revenue recognition. In
the event of revenue deferral, the sale value is not recorded as revenue to the
Company, accounts receivable are reduced by any amounts owed by the customer,
and the cost of the goods or services deferred is carried in
inventory. In addition, the Company periodically evaluates whether an
allowance for sales returns is necessary. Historically, the Company
has experienced few sales returns. If the Company believes there are
potential sales returns, the Company will provide any necessary provision
against sales. In accordance with the Financial Accounting Standard
Board’s Emerging Issues Task Force Issue No. 01-9,
“Accounting for Consideration Given
by a Vendor to a Customer or a Reseller of the Vendor’s Product,”
the
Company accounts for cash consideration (such as sales incentives) that are
given to customers or resellers as a reduction of revenue rather than as an
operating expense unless an identified benefit is received for which fair value
can be reasonably estimated. The Company believes that revenue
recognition is a “critical accounting estimate” because the Company’s terms of
sale vary significantly, and management exercises judgment in determining
whether to recognize or defer revenue based on those terms. Such
judgments may materially affect net sales for any period. Management
exercises judgment within the parameters of accounting principles generally
accepted in the United States of America (GAAP) in determining when contractual
obligations are met, title and risk of loss are transferred, the sales price is
fixed or determinable and collectability is reasonably assured. At
March 31, 2008, the Company had invoiced $4.1 million compared to $2.3 million
at September 30, 2007 for which the Company has not recognized
revenue.
Allowances for doubtful
accounts.
The Company establishes allowances for doubtful
accounts for specifically identified, as well as anticipated, doubtful accounts
based on credit profiles of customers, current economic trends, contractual
terms and conditions, and customers’ historical payment
patterns. Factors that affect collectability of receivables include
general economic or political factors in certain countries that affect the
ability of customers to meet current obligations. The Company
actively manages its credit risk by utilizing an independent credit rating and
reporting service, by requiring certain percentages of down payments, by
requiring secured forms of payment for customers with uncertain credit profiles
or located in certain countries, and by obtaining credit insurance on specific
transactions. Forms of secured payment could include irrevocable
letters of credit, bank guarantees, third-party leasing arrangements or EX-IM
Bank guarantees, each utilizing Uniform Commercial Code filings, or the like,
with governmental entities where possible. The Company believes that
the accounting estimate related to allowances for doubtful accounts is a
“critical accounting estimate” because it requires management judgment in making
assumptions relative to customer or general economic factors that are outside
the Company’s control. As of March 31, 2008, the balance sheet
included allowances for doubtful accounts of $441,000. Amounts
charged to bad debt expense for the six-month period ended March 31, 2008 and
2007 were ($2,000) and ($3,000), respectively. Actual charges to the
allowance for doubtful accounts for the six-month period ended March 31, 2008
and 2007 were ($4,000) and $37,000, respectively. If the
Company experiences actual bad debt expense in excess of estimates, or if
estimates are adversely adjusted in future periods, the carrying value of
accounts receivable would decrease and charges for bad debts would increase,
resulting in decreased net earnings.
Valuation of
inventories.
Inventories are stated at the lower of cost or
market. The Company’s inventory includes purchased raw materials, manufactured
components, purchased components, work in process, finished goods and
demonstration equipment. Write downs of excess and obsolete
inventories are made after periodic evaluation of historical sales, current
economic trends, forecasted sales, estimated product lifecycles and estimated
inventory levels. The factors that contribute to inventory valuation
risks are the Company’s purchasing practices, electronic component obsolescence,
accuracy of sales and production forecasts, introduction of new products,
product lifecycles and the associated product support. The Company
actively manages its exposure to inventory
valuation
risks by maintaining low safety stocks and minimum purchase lots, utilizing just
in time purchasing practices, managing product end-of-life issues brought on by
aging components or new product introductions, and by utilizing inventory
minimization strategies such as vendor-managed inventories. The
Company believes that the accounting estimate related to valuation of
inventories is a “critical accounting estimate” because it is susceptible to
changes from period to period due to the requirement for management to make
estimates relative to each of the underlying factors ranging from purchasing to
sales to production to after-sale support. At March 31, 2008,
cumulative inventory adjustments to lower of cost or market totaled $1.8 million
compared to $1.8 million as of September 30, 2007. Amounts charged to
expense to record inventory at lower of cost or market for the six-month period
ended March 31, 2008 and 2007 were $185,000 and $179,000,
respectively. Actual charges to the cumulative inventory adjustments
upon disposition or sale of inventory were $292,000 and $825,000 for the
six-month period ended March 31, 2008 and 2007, respectively. If
actual demand, market conditions or product lifecycles are adversely different
from those estimated by management, inventory adjustments to lower market values
would result in a reduction to the carrying value of inventory, an increase in
inventory write-offs, and a decrease to gross margins.
Long-lived
assets.
The Company regularly reviews all of its long-lived
assets, including property, plant and equipment, and amortizable intangible
assets, for impairment whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. If the total of projected
future undiscounted cash flows is less than the carrying amount of these assets,
an impairment loss based on the excess of the carrying amount over the fair
value of the assets is recorded. In addition, goodwill is reviewed
based on its fair value at least annually. As of March 31, 2008, the
Company held $11.0 million of property, plant and equipment, goodwill and other
intangible assets, net of depreciation and amortization. There were
no changes in the Company’s long-lived assets that would result in an adjustment
of the carrying value for these assets. Estimates of future cash
flows arising from the utilization of these long-lived assets and estimated
useful lives associated with the assets are critical to the assessment of
recoverability and fair values. The Company believes that the
accounting estimate related to long-lived assets is a “critical accounting
estimate” because: (1) it is susceptible to change from period to
period due to the requirement for management to make assumptions about future
sales and cost of sales generated throughout the lives of several product lines
over extended periods of time; and (2) the potential effect that recognizing an
impairment could have on the assets reported on the Company’s balance sheet and
the potential material adverse effect on reported earnings or
loss. Changes in these estimates could result in a determination of
asset impairment, which would result in a reduction to the carrying value and a
reduction to net earnings in the affected period.
Allowances for
warranties.
The Company’s products are covered by standard
warranty plans included in the price of products ranging between 90 days and
five years, depending upon the product and contractual terms of
sale. The Company establishes allowances for warranties for
specifically identified, as well as anticipated, warranty claims based on
contractual terms, product conditions and actual warranty experience by product
line. Company products include both manufactured and purchased
components and, therefore, warranty plans include third-party sourced parts
which may not be covered by the third-party manufacturer’s
warranty. Ultimately, the warranty experience of the Company is
directly attributable to the quality of its products. The Company
actively manages its quality program by using a structured product introduction
plan, process monitoring techniques utilizing statistical process controls,
vendor quality metrics, a quality training curriculum for every employee and
feedback loops to communicate warranty claims to designers and engineers for
remediation in future production. The Company believes that the
accounting estimate related to allowances for warranties is a “critical
accounting estimate” because: (1) it is susceptible to significant
fluctuation period to period due to the requirement for management to make
assumptions about future warranty claims relative to potential unknown issues
arising in both existing and new products, which assumptions are derived from
historical trends of known or resolved issues; and (2) risks associated with
third-party supplied components being manufactured using processes that the
Company does not control. As of March 31, 2008, the balance sheet
included warranty reserves of $1.3 million, while $1.2 million of warranty
charges were incurred during the six-month period ended March 31, 2008, compared
to warranty reserves of $941,000 as of March 31, 2007 and warranty charges of
$973,000 for the six-month period then ended. If the Company’s actual
warranty costs are higher than estimates, future warranty plan coverages are
different, or estimates are adversely adjusted in future periods, reserves for
warranty expense would need to increase, warranty expense would increase and
gross margins would decrease.
Accounting for income
taxes.
The Company’s provision for income taxes and the
determination of the resulting deferred tax assets and liabilities involves a
significant amount of management judgment. The quarterly provision
for income taxes is based partially upon estimates of pre-tax financial
accounting income for the full year and is affected by various differences
between financial accounting income and taxable income. Judgment is
also applied
in
determining whether the deferred tax assets will be realized in full or in
part. In management’s judgment, when it is more likely than not that
all or some portion of specific deferred tax assets, such as foreign tax credit
carryovers, will not be realized, a valuation allowance must be established for
the amount of the deferred tax assets that are determined not to be
realizable. At March 31, 2008, the Company had valuation reserves of
approximately $510,000 consisting of $450,000 for deferred tax assets related to
the sale of the investment in the InspX joint venture and the valuation reserve
for notes receivable and contingent payments; and a net $60,000 for combined
U.S., Australian and Chinese deferred tax assets and liabilities, primarily
related to net operating loss carryforwards in those foreign
jurisdictions. There were no other valuation allowances at March 31,
2008 due to anticipated utilization of all the deferred tax assets as the
Company believes it will have sufficient taxable income to utilize these
assets. The Company maintains reserves for estimated tax exposures in
jurisdictions of operation. These tax jurisdictions include federal,
state and various international tax jurisdictions. Potential income
tax exposures include potential challenges of various tax credits,
export-related tax benefits, and issues specific to state and local tax
jurisdictions. Exposures are typically settled primarily through
audits within these tax jurisdictions, but can also be affected by changes in
applicable tax law or other factors, which could cause management of the Company
to believe a revision of past estimates is appropriate. During fiscal
2007 and thus far in fiscal 2008, there have been no significant changes in
these estimates other than the adoption of FASB Interpretation 48, Accounting
for Uncertainty in Income Taxes, as discussed further
below. Management believes that an appropriate liability has been
established for estimated exposures; however, actual results may differ
materially from these estimates. The Company believes that the
accounting estimate related to income taxes is a “critical accounting estimate”
because it relies on significant management judgment in making assumptions
relative to temporary and permanent timing differences of tax effects, estimates
of future earnings, prospective application of changing tax laws in multiple
jurisdictions, and the resulting ability to utilize tax assets at those future
dates. If the Company’s operating results were to fall short of
expectations, thereby affecting the likelihood of realizing the deferred tax
assets, judgment would have to be applied to determine the amount of the
valuation allowance required to be included in the financial statements
established in any given period. Establishing or increasing a
valuation allowance would reduce the carrying value of the deferred tax asset,
increase tax expense and reduce net earnings.
Adoption of FASB
Interpretation 48, Accounting for Uncertainty in Income
Taxes
The
Company adopted the provisions of FASB Interpretation 48, Accounting for
Uncertainty in Income Taxes, on October 1, 2007. Previously, the Company had
accounted for tax contingencies in accordance with Statement of Financial
Accounting Standards 5, Accounting for Contingencies. As required by
Interpretation 48, which clarifies Statement 109, Accounting for Income Taxes,
the Company recognizes the financial statement benefit of a tax position only
after determining that the relevant tax authority would more likely than not
sustain the position following an audit. For tax positions meeting the
more-likely-than-not threshold, the amount recognized in the financial
statements is the largest benefit that has a greater than 50 percent likelihood
of being realized upon ultimate settlement with the relevant tax authority. At
the adoption date, the Company applied Interpretation 48 to all tax positions
for which the statute of limitations remained open. As a result of the
implementation of Interpretation 48, the Company recognized a decrease of
approximately $250,000 in the liability for unrecognized tax benefits, which was
accounted for as an increase to the October 1, 2007 balance of retained
earnings.
The
amount of unrecognized tax benefits as of October 1, 2007 was approximately
$91,000 which, if ultimately recognized, will reduce the Company’s annual
effective tax rate. There have been no material changes in unrecognized tax
benefits since October 1, 2007.
The
Company is subject to income taxes in the U.S. federal jurisdiction and various
state and foreign jurisdictions. Tax regulations within each jurisdiction are
subject to the interpretation of the related tax laws and regulations and
require significant judgment to apply. With few exceptions, the Company is no
longer subject to U.S. federal, state and local, or non-U.S. income tax
examinations by tax authorities for the years before 2002.
The
Company is not currently under examination by any U.S. federal, state, or
foreign jurisdictions and there are no expected material changes in the
unrecognized tax benefit liability within the next twelve months.
The
Company recognizes interest accrued related to unrecognized tax benefits in
interest expense and penalties in other income and expense for all periods
presented. The Company had accrued approximately $37,000 for the payment of
interest and penalties at October 1, 2007. Subsequent changes to accrued
interest and penalties have not been significant.
Results of
Operations
For
the three months ended March 31, 2008 and 2007
Orders
increased by $7.1 million, or 22%, to $39.4 million in the second quarter of
fiscal 2008 compared to new orders of $32.3 million in the same period a year
ago. Orders for automated inspection systems remained strong during
the second quarter of fiscal 2008, increasing $2.2 million, or 15%, to $16.6
million from $14.4 million in the comparable quarter in fiscal
2007. The increase was driven by orders in Europe, Latin America and
China. Process system orders increased $3.9 million, or nearly 29%,
during the second quarter of fiscal 2008 to $17.4 million compared to $13.5
million in the second quarter of fiscal 2007. The increase in process
systems orders over the second quarter of fiscal 2007 was due to significantly
increased orders for vibratory products in both North America and Latin
America. Orders for parts and service were $5.4 million, up 23% from
$4.4 million for the same period in the prior year.
Total
backlog increased to a record $47.2 million at the end of the second quarter of
fiscal 2008. Backlog was $13.4 million higher than at the
corresponding point in the prior fiscal year, and $10.4 million higher than the
previous record of $36.8 million set at the end of the first quarter of fiscal
2008. Backlog for automated inspection systems was up $3.7 million,
or 18%, to $23.6 million at March 31, 2008 compared to $19.9 million at March
31, 2007. The increased automated inspection systems backlog included
increases in pharmaceutical systems, the new Manta product, and system
upgrades. Process systems backlog increased by $9.7 million, or 73%,
to $22.9 million at the end of the second quarter of fiscal 2008 compared to
$13.2 million at the same time a year ago. The backlog increase for
process systems was primarily related to vibratory products. Backlog
by product line at March 31, 2008 was 50.0% automated inspection systems, 48.5%
process systems, and 1.5% parts and service, compared to 58.9% automated
inspection systems, 39.1% process systems, and 2.0% parts and service on March
31, 2007. The swing in backlog to more process systems was driven by
orders related to large projects for various customers.
Net sales
increased $6.9 million, or 31%, to $29.1 million in the second quarter of fiscal
2008 over the $22.2 million in net sales recorded in the same quarter a year
ago. This was a new record sales level for a second quarter, up from
the previous record of $22.2 million in the second quarter of fiscal
2007. International sales for the three-month period were 46% of net
sales compared to 41% in the corresponding prior year
period. Increases in net sales occurred in automated inspection
systems sales, up $1.1 million, or 12%; process systems sales, up $5.0 million,
or 62%; and parts and service sales, up $823,000, or 18%, over the prior year
quarter. The significant increase in process system sales was the
result of increased shipments in vibratory products. Automated
inspection systems net sales, including upgrade systems, represented 37% of net
sales in the second quarter of fiscal 2008 compared to 43% of net sales in the
second quarter of fiscal 2007. Process systems represented 45% of net
sales in the second quarter of fiscal 2008 compared to 37% during the second
quarter of fiscal 2007, while parts and service net sales accounted for 18% of
the more recent quarter's net sales, down from 20% in the same quarter a year
ago.
Gross
profit for the second quarter of fiscal 2008 was $11.3 million compared to $8.3
million in the corresponding period last year. Gross profit in the
second quarter of fiscal 2008, as a percentage of sales, increased to 38.8%
compared to the 37.6% reported the same quarter of fiscal 2007. The
margin improvement from the same quarter a year ago was primarily a result of
increased efficiency of manufacturing operations and favorable material price
variances, somewhat offset by the mix of increased sales of lower margin process
systems.
Operating
expenses of $10.0 million for the second quarter of fiscal 2008 were 34.5% of
sales compared with $7.7 million, or 34.5%, of sales for the second quarter of
fiscal 2007. Spending increased $2.4 million as a result of higher
research and development spending, increased sales activity, additional general
and administrative expenses, and higher stock-based compensation
expenses. As previously announced, the Company plans to increase
spending throughout fiscal 2008 on research and development to continue to
expand capabilities and to provide new and innovative solutions. The
Company continues to invest in sales and marketing efforts, which contributed to
an order backlog increase during the second quarter of fiscal
2008. The Company also experienced increased sales commissions in the
second quarter of fiscal 2008 due to a higher mix of sales through our outside
sales representatives. General and administrative expenses during the
second quarter of fiscal 2008 were up compared to the prior year quarter, a
result of meeting new regulatory requirements including compliance with Section
404 of the Sarbanes-Oxley Act of 2002, increased recruiting expenses and work to
implement a new global enterprise resource planning system.
Other
income for the second quarter of fiscal 2008 was $506,000 compared to $229,000
for the same period in fiscal 2007, primarily due to interest income, foreign
exchange gains and gains from reductions of other liabilities.
Net
earnings for the quarter ending March 31, 2008 were $1.2 million, or $0.22 per
diluted share. Net earnings for the same period last year were
$608,000, or $0.11 per diluted share. In the second quarter of fiscal
2008, higher revenues and better gross margins were also partially offset by
higher operating expenses. Operating expenses are anticipated to
remain higher in the third quarter of fiscal 2008 than in the prior year to
support the higher sales levels and the Company’s investments in research and
development, as well as the new ERP system.
For
the six months ended March 31, 2008 and 2007
New
orders for the first six months of fiscal 2008 increased $18.7 million, or 34%,
to $74.4 million compared to orders of $55.7 million for the first half of
fiscal 2007. Orders for process systems increased $11.7 million, or
nearly 55%, to over $33.1 million compared to $21.4 million in fiscal
2007. The increase in process systems orders in the first half of
fiscal 2008 over the first half of fiscal 2007 was due to increased orders for
vibratory products in North America, Europe and Latin America. Orders
for automated inspection systems increased approximately $6.2 million, or nearly
25%, to $31.5 million compared to $25.3 million in fiscal 2007. This
increase was driven primarily by system upgrades and increased orders in Europe
and Latin America. New orders for system upgrades were $9.6 million,
up $1.7 million, or 22%, from $7.9 million in the prior year. Orders
for parts and service were $9.7 million, up $746,000, or 8%, from $9.0 million
in the prior year.
Net sales
in the first half of fiscal 2008 increased by $13.3 million, or 30%, to $58.1
million compared to $44.8 million for the same period in fiscal
2007. International sales for the more recent six-month period were
52% of net sales compared to 43% for the first half of fiscal
2007. Increases in total net sales for the first six months of fiscal
2008 compared to the same period in the prior year occurred in process systems
sales, up $8.2 million, or 46%; automated inspection systems sales, up $4.2
million, or 23%; and parts and service sales, up $865,000, or
10%. The increase in process system sales was primarily the result of
increased shipments of vibratory products. The increase in automated
inspection systems sales resulted significantly from upgrade sales, which
increased $2.7 million to $8.3 million in the first six months of fiscal 2008
compared to the same period in the prior year. Automated inspection
systems net sales, including upgrade systems, represented 38% of net sales in
the first half of fiscal 2008 compared to 40% of net sales in the first half of
fiscal 2007. Process systems represented 45% of net sales in the
first half of fiscal 2008 compared to 40% of net sales in the first six months
of fiscal 2007. Parts and service accounted for 17% of net sales in
the first half of fiscal 2008, down from 20% for the same period in fiscal
2007.
Gross
profit for the first six months of fiscal 2008 was $22.8 million compared to
$17.1 million in the corresponding period last year. Gross profit as
a percentage of sales in the first half of fiscal 2008 increased to 39.2%,
compared to the 38.1% reported for the same period of fiscal
2007. The margin improvement for the first six months of fiscal 2008
compared to the same period in fiscal 2007 was primarily a result of increased
efficiency of manufacturing operations and favorable material price variances,
partially offset by the mix of increased sales of lower margin process
systems.
Operating
expenses of $20.3 million for the first six months of fiscal 2008 were 34.9% of
sales compared with $15.5 million, or 34.6%, of sales for the first half of
fiscal 2007. Spending increased by $4.8 million as a result of higher
research and development spending, increased sales activity, additional general
and administrative expenditures, and higher stock-based and incentive
compensation expenses. The Company plans to increase spending
throughout fiscal 2008 on research and development to continue to expand
capabilities and to provide new and innovative solutions. The Company
continues to invest in sales and marketing efforts. These efforts
have contributed to an order backlog increase of $16.3 million in the first six
months of fiscal 2008. The Company also experienced increased sales
commissions due to a higher mix of sales through our outside sales
representatives. General and administrative expenses during the first
six months of fiscal 2008 increased compared to the prior year as a result of
meeting new regulatory requirements, increased recruiting expenses and work to
implement the global ERP system.
Other
income for the first half of fiscal 2008 was $813,000 compared to $1.3 million
for the same period in fiscal 2007. Other income consisted primarily
of interest income, foreign exchange gains and gains from reductions in other
liabilities. The first half of fiscal 2007 included a $750,000 gain
from the sale of the Company’s 50% interest in the InspX joint
venture.
Net
earnings for the first six months of fiscal 2008 were $2.3 million, or $0.42 per
diluted share. The net earnings for the same period in fiscal 2007
were $2.2 million, or $0.41 per diluted share, which included a $750,000 gain,
or $0.14 per share, from the sale of the Company’s 50% interest in its InspX
joint venture. In the first half of fiscal 2008, higher revenues and
better gross margins were also significantly offset by the higher operating
expenses. Operating expenses are anticipated to remain higher in the
second half of fiscal 2008 than in the prior year to support the higher sales
levels and the Company’s investments in research and development, as well as the
new ERP system.
Liquidity and Capital
Resources
For the
six months ended March 31, 2008, net cash decreased by $2.5 million to $25.4
million on March 31, 2008 from $27.9 million on September 30,
2007. The Company used $1.8 million of cash for operating activities
during the six-month period ended March 31, 2008. Investing
activities consumed $1.4 million of cash, a result of $1.4 million in capital
expenditures, while financing activities generated $472,000 of
cash. The effect of exchange rate changes on cash was a positive
$179,000 during the first six months of fiscal 2008.
Cash used
in operating activities during the six-month period ended March 31, 2008 was
$1.8 million compared to $4.5 million of cash provided by operating activities
for the comparable period in fiscal 2007. The primary contributor was
the change in non-cash working capital. In the first six months of
fiscal 2007, changes in non-cash working capital provided $798,000 of cash from
operating activities. During the first six months of fiscal 2008,
changes in non-cash working capital used $5.2 million of cash from operating
activities. The major changes in current assets and current
liabilities during the first six months of fiscal 2008 were increased trade
receivables of $4.2 million, increased inventories of $4.3 million related to
higher production levels, new product introductions and increased deferred
revenues. These were offset by an increase in accounts payable of
$1.3 million and customer deposits of $2.3 million. In addition,
there were reductions in accrued payroll liabilities and commissions of $741,000
due to annual payouts for profit sharing and incentive compensation
plans.
The net
cash used in investing activities of $1.4 million for the first six months of
fiscal 2008 represents a $1.9 million change from the $523,000 of net cash
generated from investing activities in the corresponding period a year
ago. The major change in investing activities resulted from the
$750,000 in proceeds from the sale of the Company’s interest in the InspX joint
venture during the first quarter of fiscal 2007. In addition, the
Company’s investments in property, plant and equipment increased by $1.2 million
in the first half of fiscal 2008 from the corresponding period a year ago, the
largest component of which relates to investments in a new ERP
system. Subsequent to the end of the second quarter of fiscal 2008,
the Company entered into a commitment to acquire capital equipment of
approximately $700,000.
Net cash
provided by financing activities during the first half of fiscal 2008 was
$472,000, compared with net cash used of $716,000 during the corresponding
period in fiscal 2007. The net cash provided by financing activities
during the first six months of fiscal 2008 resulted from excess tax benefits
from share-based payments and proceeds from issuance of common stock for
employee stock option exercises, offset by the exchange of shares for statutory
withholding. Financing activities during the first six months of the
prior fiscal year included $1.3 million used in the stock repurchase program
partially offset by $588,000 generated from the issuance of common stock
relating to employee stock option exercises. No stock was purchased
under the Company’s stock repurchase program in the first half of fiscal
2008.
The
Company’s domestic credit facility provides for a revolving credit line of up to
$10 million and credit sub-facilities of $3.0 million each for sight commercial
letters of credit and standby letters of credit. The credit facility
matures on June 30, 2009. The credit facility bears interest, at the
Company’s option, of either the bank prime rate minus 1.75% or LIBOR plus 1.0%
per annum. At March 31, 2008, the interest rate would have been
3.5%. The credit facility is secured by all U.S. accounts receivable,
inventory and fixed assets. The credit facility contains covenants
which require the maintenance of a defined net worth ratio, a liquidity ratio
and an EBITDA coverage ratio. The credit facility also restricts
mergers and acquisitions, incurrence of additional indebtedness, and
transactions, including purchases and retirements, in the Company’s own common
stock, without the prior consent of the Lender. At March 31, 2008,
the Company had no borrowings outstanding under the credit facility and $380,000
in standby letters of credit. At March 31, 2008, the Company was in
compliance with its loan covenants, and had received the consent of the lender
for its stock repurchase program.
The
Company’s credit accommodation with a commercial bank in the Netherlands
provides a credit facility for its European subsidiary. This credit
accommodation totals $4.0 million and includes an operating line of the
lesser
of
$2.4 million or the available borrowing base, which is based on varying
percentages of eligible accounts receivable and inventories, and a bank
guarantee facility of $1.6 million. The operating line and bank
guarantee facility are secured by all of the subsidiary’s personal
property. The credit facility bears interest at the bank’s prime
rate, with a minimum of 3.00%, plus 1.75%. At March 31, 2008, the
interest rate was 7.15%. At March 31, 2008, the Company had no
borrowings under this facility and had received bank guarantees of $1.4 million
under the bank guarantee facility. The credit facility allows
overages on the bank guarantee facility. Any overages reduce the
available borrowings from the operating line.
The
Company’s continuing contractual obligations and commercial commitments existing
on March 31, 2008 are as follows:
|
|
|
|
|
|
Payments
due by period (in thousands)
|
|
|
Contractual
Obligations
(1)
|
|
Total
|
|
|
Less
than 1 year
|
|
|
1 –
3 years
|
|
|
4 –
5 years
|
|
|
After
5 years
|
|
|
Operating
leases
|
|
$
|
13,826
|
|
|
$
|
1,499
|
|
|
$
|
2,771
|
|
|
$
|
2,678
|
|
|
$
|
6,878
|
|
|
Total
contractual cash obligations
|
|
$
|
13,826
|
|
|
$
|
1,499
|
|
|
$
|
2,771
|
|
|
$
|
2,678
|
|
|
$
|
6,878
|
|
(1)
The
Company also has $95,000 of contractual obligations related to uncertain tax
positions for which the timing and amount of payment can not be reasonably
estimated due to the nature of the uncertainties and the unpredictability of
jurisdictional examinations in relation to the statute of
limitations.
The
Company anticipates that current cash balances and ongoing cash flows from
operations will be sufficient to fund the Company’s operating needs in the near
term. At March 31, 2008, the Company had standby letters of credit
totaling $1.8 million, which includes secured bank guarantees under the
Company’s credit facility in Europe and letters of credit securing certain
self-insurance contracts and lease commitments. If the Company fails
to meet its contractual obligations, these bank guarantees and letters of credit
may become liabilities of the Company. The Company has no off-balance
sheet arrangements or transactions, or arrangements or relationships with
“special purpose entities.”
Future Accounting
Changes
In
September 2006, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) No. 157, “Fair Value Measurements,” which establishes guidelines
for measuring fair value and expands disclosures regarding fair value
measurements. SFAS No. 157 does not require any new fair
value measurements but rather it eliminates inconsistencies in the guidance
found in various prior accounting
pronouncements. SFAS No. 157 is effective for fiscal years
beginning after November 15, 2007. The Company is evaluating the
potential effects of this standard, although the Company does not expect the
adoption of SFAS No. 157 to have a material effect on its financial
position, results of operation, or cash flows.
In
February 2007, the FASB issued Statement 159, “The Fair Value Option for
Financial Assets and Financial Liabilities”. This Statement permits
entities to elect to measure certain financial instruments and other items at
fair value. The fair value option may be applied on an instrument by
instrument basis, is irrevocable and is applied only to entire
instruments. SFAS 159 requires additional financial statement
presentation and disclosure requirements for those entities that elect to adopt
the standard and is effective for fiscal years beginning after November 15,
2007. The Company does not expect the adoption of SFAS 159 to have a
material effect on its financial position, results of operations or cash
flows.