Frank Voisin is the author of the popular value focused website Frankly Speaking, found at http://www.FrankVoisin.com
Near the beginning of the year, I wrote about Key Technology, Inc (NASDAQ: KTEC), a manufacturer of process automation systems primarily aimed at the food industry. I noted that the the company was
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trading at a market cap just shy of $71 million, yet the company has $26 million in net cash, is profitable and generated $10.8 million in free cash last year (for an ex-cash yield of 24%!).
Since that write-up was published, the company’s share price has fallen another 27%, to lows not seen since the 2009 market trough. The company now (as of late May) trades for just $55 million. Unfortunately, net cash has also declined, and by an even larger percentage (33%) to just $17.5 million. Given the dramatic decline in cash, we turn to the company’s consolidated statement of cash flows, to ensure that there is a good reason (ideally expected to reverse in the near future) for the decline. We see the following as the three biggest uses of cash:
- Trade Accounts Receivable: $2.351m
- Customers’ deposits: $1.183m
- Purchases of PP&E: $1.18m
Another reason I am not worried about the accounts receivable and customer deposit growth is due to the nature of the company’s business, which is such that it receives a relatively small number of large orders which drives its revenue quarter to quarter. This contributes to greater volatility as the delay of orders (or collection of payment) from one quarter to the next can have a big effect on the company’s financial performance.
Turning to the company’s discussion of the quarter, we find these explanations:
David Camp, President and Chief Executive Officer, stated, “Net sales and the results of operations were unfavorably affected by the postponement of two shipments due to customer-requested delays. These orders, totaling over $2.5 million, will ship in the third fiscal quarter of 2012. The Company anticipates that net sales in the third quarter of fiscal 2012 will be significantly higher than in the second quarter of fiscal 2012.”
we are experiencing substantial quote activity for potential large-scale projects in these markets.
This seems to confirm my belief that the fluctuation in the company’s cash balance is driven primarily by timing differences in projects. However, never one to take management comments at face value, I like to look for confirming evidence. In this case, to get more comfortable with the fluctuations over the last few quarters, it is worth looking at the Book-to-Bill ratio, which is useful in any industry where orders are taken well in advance of revenue recognition. Here we compare the company’s disclosures regarding new orders to its reported revenues.
Here’s the company’s book-to-bill data for the last ten quarters:
We see the Book-to-Bill ratio has dropped below 1.0 for the first time in several quarters, and is the second consecutive quarter of decline. This is something we should keep track of going forward and hopefully we see a reversal in coming quarters, but I wouldn’t get too upset about this until a few more quarters continuing in this direction. Other reasons I am not too worried is that the company’s Book-to-Bill is pretty average, and its current backlog is above its average for the last 2.5 years.
So overall, it appears to me that KTEC has is experiencing its usual operating volatility and that its decline in cash is likely to reverse in coming quarters. I don’t think the decline in share price is justified and given the company’s long history of strong free cash flows (especially relative to invested capital), I see little reason the company should be this cheap.
A few other things to note. First, Rutabaga Capital Management, a value fund specializing in microcaps, owns a significant stake in the company (11.2%) and has increased its position over the last year (from 570,561 to 612,111 shares).
Second, on May 18th, the company announced that its President and CEO would be stepping down and the CFO would be taking his place. I like having a finance guy run the show, and this creates a rare opportunity whereby we might see a shift in strategy for the company’s traditionally high cash balance. Ideally we will see the company deploy some of its cash to repurchasing shares while they stay at depressed levels.
What do you think of KTEC?