Natural Selection

Mice, glass, bones. Nails, snails, snake heads. Stems,
sticks, slugs and bugs. Razor blades. They are among the debris gathered from
agricultural fields during the process of harvesting vegetables and fruits that
have ended up in production lines at large food processors that package
everything from frozen french fries to fresh lettuce.

Fortunately, high-technology sorting and inspection
equipment helped to identify and remove those unwanted items. The equipment is
built by Key Technology Corp., a company based in Walla Walla, in the heart of
eastern Washingtons wine country.

The business, with $100 million in annual sales, has operations
in Shanghai, Mexico, South America, the Netherlands and Australia; it serves
2,700 customers in 73 countries. But David Camp, CEO, says Key Technologys
just getting started. Camp is plowing capital into research and development as
well as new information technology to lay the foundation to build a
multinational powerhouse.

I am putting the things in place that are necessary to grow
to be a $1 billion company in the next 10 to 15 years, says Camp, who has a
Ph.D. in chemical engineering from the Massachusetts Institute of Technology.

It wont be easy. The firms primary competitor, BEST
(Belgium Electronic Sorting Technology), receives millions of dollars a year in
subsidies from the Belgian government, although it only makes sorting equipment
rather than the more comprehensive imaging, inspection and conveyor technology
Key makes. And the marketplace has been more than a little volatile. Key
Technology lost money last year when its sales plunged by nearly a third as
many companies deferred purchases of Keys inspection systems, and prices of
the equipment, some of which can cost as much as $500,000 apiece, dropped.

They [Key] dont have much U.S.-based competition, but they
have some competition in Europe, says Jim Ricchiuti, a New York-based analyst
with Needham & Co., an investment banking and asset management firm.
Ricchiuti points out that some European countries have been creative about
providing grants to local businesses to keep employment at high levels. We
have a hold rating on the stock, says Ricchiuti. The big issue is to see
whether demand is coming back.

Fortunately, with up to 20 percent of its revenues coming
from spare parts and servicing equipment, the company has remained cash flow
positive, putting it in the enviable position of having little debt and $18
million in reserve cash. With that healthy balance sheet, Camp was able to
continue plowing 8 percent of Keys annual revenues into R&D.

Key Technology Corp.s Manta 2000 Laser/Camera Sorter can sort up to 44,000 pounds of produce, such as corn, per hour. Image courtesy Key Technology.

That turned out to be a good move. Last year, in the midst
of a recession, the company introduced 16 new products, more than triple the
number it had released the year before. To further speed product development
and to incorporate feedback from customers to improve its products more
quickly, the business recently made the decision to invest in a new enterprise
resource planning system from Microsoft.

Key Technology is also in a strong position to hold off its
competitors, Camp says, because, unlike firms that focus on a particular
segment of the market, Key Technology designs and sells entire production
systems. That enables it, for example, to develop sorting procedures that
distribute the food on conveyor belts so that its equipment can best inspect
the food.

Key Technologys systems use cameras and lasers that scan
the food dropping from one conveyor belt to another. Computers employ
sophisticated algorithms to identify defects in the products such as stems on
raisins, brown spots on french fries or foreign objects. In a microsecond, the
machine creates an image of the unwanted object and instructs a selection from
a row of 256 tiny air jets to blast the unwanted items from the production line
into either a refuse bin for disposal, or a recycling bin where the product can
be put back into the production line for further processing. If a dangerous
substance like glass comes through the line, it shows up bright red on the
operators screen so that person can choose to stop the line for a more
thorough evaluation.

This stuff used to be sorted by hand, says Camp, who came
to Key Technology at the end of 2006 from British Oxygen Co., a global provider
of industrial gases. Our system can handle a million pounds of french fries a
day. The equipment can deal with that volume and yet meet precise standards
down to the size of brown spots permitted on a McDonalds french fry. And the
nice thing about computers is that they dont get tired.

Walk through Keys expansive manufacturing facility on the
southern edge of Walla Walla and you can see lasers cutting the thick sheets of
stainless steel using dressmaker-like patterns to get the best yield from each
sheet. The company is the largest consumer of stainless steel west of Kansas
City. Because urban growth limits have led to a rise in the cost of housing in
Walla Walla, many of the companys workers commute 15 miles from across the
Oregon state line.

One of the biggest challenges Camp faces is a maturing
American market for machines that inspect processed vegetables and fruits,
Keys traditional business. Camp is seeking to develop new markets for his
equipment in industries like pharmaceuticals where variations in the size of a
pill can mean a significant difference in dosage. Key Technology methods can
identify and eject pills that dont meet strict criteria.

Camp also sees strong demand for equipment that processes
produce as worldwide demand for freshly packaged lettuce, broccoli and other
vegetables climbs 20 percent to an estimated $175 million by 2012. Key
Technology has consequently developed a machine capable of identifying and
removing wilted or spoiled lettuce. And to make sure they catch the occasional
caterpillar or bug that used to slip through, researchers added the ability to
remove any object that doesnt contain chlorophyll. Thats important because
such critters are often the source for E. coli or salmonella outbreaks, which
can be ruinous for companies that sell fresh produce.

Keys new technology is helping it expand its share of the
most important growth market of allexports. Already, half of the companys
sales go overseas, up from just 40 percent four years ago. Recently, it won a
$20 million order from an undisclosed North American vegetable processor and a
$5 million-plus order from Sweden.

Often, Key Technology substantially helps its customers
boost profits. A major export product from Abu Dhabi, for example, is Majule
dates, once reserved for royalty. The dates are expensive because they are hand
selected for their golden color. Key Technology sold an Abu Dhabi company a
$1.6 million system that can separate out the best dates based on a complex
algorithm. In Chile, Keys systems sort blueberries, raspberries and prunes for
fussier export markets in Europe, the United States and Japan.

Firms in Brazil and China are ordering systems to inspect
and package french fries and fresh produce for a surging middle class. But,
more important, businesses in these markets see Key Technology equipment as a
quick way to raise the quality of their products so they can penetrate markets
in Korea and Japan. Key Technology has seen sales to China jump 60 percent
during the past year.

The Key system raises process speed and allows selling
price to be increased by 25 to 30 percent because of the improved quality,
says Camp.

The company continues to experiment, working on algorithms,
for example, that would allow lasers to determine the hardness of an apple or
the sugar content in a grape. The ability to harvest only grapes that have
reached a certain sugar content level could help wineries develop better wines.
Thats what Keys neighbors in neighboring Walla Walla wine country are hoping
for.