<PAGE>

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                           WASHINGTON, D.C. 20549-1004

                   __________________________________________

                                    FORM 10-K

            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934
                  for the fiscal year ended September 30, 2001

                                       or

          [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

                         SECURITIES EXCHANGE ACT OF 1934
                        For the transition period from ___ to ___.

                           Commission File No. 0-21820

                   __________________________________________

                              KEY TECHNOLOGY, INC.
             (Exact name of Registrant as specified in its charter)

                  OREGON                          93-0822509
          (State of Incorporation)    (I.R.S. Employer Identification No.)

           150 Avery Street, Walla Walla, Washington           99362
            (Address of principal executive offices)         (Zip Code)

                                 (509) 529-2161
              (Registrant's telephone number, including area code)

                   __________________________________________

           Securities registered pursuant to Section 12(b) of the Act:
                                      None
           Securities registered pursuant to Section 12(g) of the Act:
                           Common Stock, no par value
         Series B Convertible Preferred Stock, par value $.01 per share
             Warrants to purchase Common Stock, dated July 12, 2000

     Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [_]

     The aggregate market value of the Registrant's common stock held by
non-affiliates on December 18, 2001 (based on the last sale price of such
shares) was approximately $12,828,634.

     The number of shares of the Registrant's common stock outstanding on
December 18, 2001 was 4,751,346 shares of common stock.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Parts of Registrant's Proxy Statement dated on or about January 30, 2002
prepared in connection with the Annual Meeting of Shareholders to be held on
February 20, 2002 are incorporated by reference into Part III of this Report.

<PAGE>

                              KEY TECHNOLOGY, INC.
                                 2001 FORM 10-K
                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
PART I                                                                         PAGE
                                                                               ----
<S>                                                                            <C>
     Item 1.   BUSINESS ......................................................    1

     Item 2.   PROPERTIES ....................................................   12

     Item 3.   LEGAL PROCEEDINGS .............................................   13

     Item 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ...........   13


PART II

     Item 5.   MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
               STOCKHOLDER MATTERS ...........................................   13

     Item 6.   SELECTED FINANCIAL DATA .......................................   16

     Item 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
               CONDITION AND RESULTS OF OPERATIONS ...........................   17

     Item 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
                MARKET RISK ..................................................   24

     Item 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ...................   26

     Item 9.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
               ACCOUNTING AND FINANCIAL DISCLOSURE ...........................   51


PART III

     Item 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ............   51

     Item 11.  EXECUTIVE COMPENSATION ........................................   52

     Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
               AND MANAGEMENT ................................................   52

     Item 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ................   52


PART IV

     Item 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON
               FORM 8-K ......................................................   53

     SIGNATURES ..............................................................   56

     EXHIBIT INDEX ...........................................................   57
</TABLE>



<PAGE>

                                     PART I

    Certain statements set forth below may constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The forward-looking statements involve known and unknown risks,
uncertainties and other factors that may cause the actual results, performance
or achievements to differ from those expressed or implied by the forward-looking
statements. With respect to the Company, the following factors, among others,
could cause actual results or outcomes to differ materially from current
expectations:

 .    the Company's inability to meet its potential equity redemption obligations
     in July 2002 when it may be required to redeem for cash all or a portion of
     its outstanding preferred stock or at any time when it may be required to
     redeem certain warrants;

 .    the effect of the Company's substantial debt on its operations and future
     growth; o the Company's inability to obtain additional financing in the
     future;

 .    the effect on the Company's business of adverse economic conditions in the
     food processing industry and other industries served by the Company;

 .    the performance and needs of industries served by the Company and the
     financial capacity of customers in these industries to purchase capital
     equipment;

 .    the ability to achieve revenue growth;

 .    the ability of new products to compete successfully in either existing or
     new markets;

 .    competitive factors;

 .    the risks involved in expanding international operations and sales;

 .    achievement of product performance specifications and any related effect on
     product upgrade or warranty expenses;

 .    the potential for adverse fluctuations in foreign currency exchange rates;

 .    the effect of product or market development activities;

 .    availability and future costs of materials and other operating expenses;

 .    uncertainties relating to patents and proprietary information;

 .    the potential for patent-related litigation expenses and other costs
     resulting from claims asserted against the Company or its customers by
     third parties; and

 .    other factors discussed in Exhibit 99.1 hereto which is incorporated herein
     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.

ITEM 1.    BUSINESS.

General

     Key Technology, Inc. (the "Company") was founded in 1948 as a local
producer of vegetable processing equipment and has evolved into a worldwide
supplier of process automation solutions to the food processing industry and
other industries such as tobacco, plastics and pharmaceuticals. The present
Company was incorporated in 1982 as a result of a management buyout of the
predecessor organization.

                                       1

<PAGE>

     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 which 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 and non-food and industrial
applications such as tobacco, plastics, and pharmaceuticals.

     During fiscal 2001, the Company's net sales were $73.0 million compared to
sales of $67.4 million in fiscal 2000. The Company incurred a net loss of $4.9
million, or $1.24 per share, for the year ended September 30, 2001, which
included merger-related amortization and non-recurring integration costs of $3.4
million, or $2.1 million after tax, and the loss on the sale of Ventek of $2.1
million. Excluding these merger-related and non-recurring integration costs, as
well as the loss on the sale of Ventek, the net loss would have been $643,000,
or $0.33 per diluted share. The loss for fiscal 2001 compares with a reported
net loss of $333,000, or $0.12 per diluted share, for fiscal 2000, which
included merger-related and one-time acquisition costs of $3.0 million or $1.9
million after tax. Excluding merger-related and one-time acquisition charges,
net earnings would have been $1.6 million or $0.29 per diluted share for the
year ended September 30, 2000.

     The Company acquired two separate organizations during fiscal 2000. On June
1, 2000 the Company acquired Farmco, Inc. and its sister company Ro-Tech, Inc.
(collectively "Farmco"). Both companies are based in Redmond, Oregon. Farmco
manufactures and sells equipment that mechanically sorts, grades, selects, or
removes product based upon its size or shape. Ro-Tech, Inc. performed research
and development activities for Farmco products and owned the intellectual
property associated with Farmco products. On July 12, 2000 the Company acquired
Advanced Machine Vision Corporation (AMVC), a company based in Medford, Oregon.
AMVC and its subsidiaries design, manufacture and market machine vision systems
that combine lighting, camera, processor and software technologies to improve
quality, enhance yield, reduce production costs and increase throughput in a
variety of markets. Applications include systems for the food, tobacco, plastics
recycling, pulp wood, and wood panel industries.

     Prior to September 30, 2001, the Company committed to a plan to sell
Ventek, Inc. ("Ventek"), a wholly-owned subsidiary that supplies machine vision
systems to the forest products industry. Ventek was acquired by Key as part of
its acquisition of AMVC in July 2000.

     The Company's domestic operations are headquartered in Walla Walla,
Washington with manufacturing facilities in Walla Walla, Washington and Redmond,
Oregon. The Company moved the manufacturing activities acquired from AMVC from
Medford to Walla Walla in fiscal 2001, but continues to maintain a presence in
Medford performing research and development, service and sales activities. The
Company supplies all product groups - automated inspection systems and process
systems - to customers in its primary markets through common sales and
distribution channels. In addition, the Company supplies parts and service
through its worldwide service organization.


Industry Background

     The Company considers the size and variety of worldwide processing
industries to be a significant opportunity for growth, not only to solve
existing quality and safety issues, but also to assist in providing safe
processing technologies to expanding global markets. Accordingly, the Company

                                       2

<PAGE>

devoted increased resources in fiscal 2001 to selling and marketing activities
and new product research and development that will increase the Company's
ability to address these potential global markets.

Food Processing Industry

    Food processors must process large quantities of raw product through
different stages, including sorting to remove defective pieces and inspection
for product quality and safety. The frequency and severity of defects in the raw
product is highly variable depending upon local factors affecting crops.
Historically, defect removal and quality control in the food processing industry
have been labor intensive and dependent upon and limited by the variability of
the work force. The industry has sought to replace manual methods with automated
systems that achieve higher yield, better product quality and safety and reduced
cost.

    The Company's strategy is to solve processing industry problems of high
labor costs, inadequate yields and inconsistent quality and safety by providing
automated inspection systems and process systems. The Company's process
automation systems use advanced optical inspection technology to improve product
yield (more of the good product recovered) and quality (higher percentage of
defective product being removed) over the manual sorting and defect removal
methods historically used by food processors. In a typical application, process
automation systems can replace 25 to 75 processing line employees, resulting in
labor cost savings and improved yield sufficient to pay for the system in less
than one year, as well as providing significant improvements in product quality.

    The global food processing industry is currently in a consolidation period
and is facing low single-digit growth rates. Market conditions may point to
further consolidations in the future. The consolidations in the food processing
industry have resulted in Key's customers delaying investment in it's products.
Key believes the food processing companies that emerge from this consolidation
period will be financially stronger, however these surviving companies will be
looking for ways to improve product quality and safety, as well as ways to make
themselves more competitive. Since Key's equipment results in higher product
yields, improved product quality and safety, as well as reduced processing
costs, Key believes these surviving companies will have more interest in its
products allowing for expanded sales into this industry in future years.

Non-food Industries - Tobacco, Pharmaceuticals & Plastics

    Processors in non-food industries are also implementing systems solutions to
reduce costs, increase yields, and produce higher quality products that are safe
for consumers.

    The largest non-food processing market is the tobacco industry. With the
acquisition of AMVC and its subsidiary SRC Vision, which has an installed base
of over 100 units in the tobacco industry, the Company significantly increased
its potential opportunities in this market and may be able to introduce other
products along with automated inspection systems to tobacco customers. At
present, the pharmaceutical, plastics and other non-food industries represent a
relatively small share of the Company's sales and installed base. However, to
further its growth strategy, the Company is actively pursuing expansion into new
markets, some of which have the potential for higher profit margins. The
Company believes that many additional applications for its products exist in
both food and non-food markets, particularly in the area of automated process
control.

                                       3

<PAGE>

Products

    The Company has developed a modular family of product lines that can be
configured in a variety of ways and integrated to provide complete solutions for
specific applications. Advances in any one module can therefore benefit a number
of the Company's products. Despite the incorporation of sophisticated
technology, the Company's products can be operated by plant personnel with
minimal specialized training and are built to withstand the harsh environments
found in processing plants.

    The following table sets forth sales by product category for the periods
indicated:

<TABLE>

                                                                Fiscal Year Ended September 30,
                                                    --------------------------------------------------------
                                                       2001                  2000                  1999
                                                    ------------          ------------          ------------
                                                                        (in thousands)
<S>                                                    <C>                   <C>                   <C>
Automated inspection systems .....................     $26,884               $24,002               $22,342
Process systems ..................................      27,050                26,414                33,950
Parts and service/contracts ......................      19,020                16,996                13,239
                                                    ------------          ------------          ------------
       Net sales .................................     $72,954               $67,412               $69,531
                                                    ============          ============          ============
</TABLE>

Service and maintenance contracts are less than 10% of total net sales and
therefore are summarized with parts.

     The following table sets forth the percent of the total gross margin
contributed by each product category for the periods indicated:

<TABLE>

                                                                Fiscal Year Ended September 30,
                                                    --------------------------------------------------------
                                                       2001                  2000                  1999
                                                    ------------          ------------          ------------
<S>                                                 <C>                   <C>                   <C>
Automated inspection systems .....................      39%                   40%                   39%
Process systems ..................................      32%                   28%                   41%
Parts and service/contracts ......................      29%                   32%                   20%
                                                    ------------
                                                    ------------          ------------          ------------
       Total gross margin ........................     100%                  100%                  100%
                                                    ============          ============          ============
</TABLE>

Automated Inspection Systems

    Automated inspection systems are used in various applications to detect and
eliminate defects, most often during processing of raw products. The Company's
systems within this group include the ADR(R) and Tegra(R) systems, representing
the fourth generation of automated inspection systems designed by Key
Technology; Prism(R) and Tobacco Sorter II(TM) and Tobacco Sorter 3(TM) designed
by SRC Vision; and the new Optyx(TM) automated inspection system, designed by
the merged companies. All systems are now manufactured at the Walla Walla
manufacturing facility.

    Nearly all systems in this group use proprietary linear array charged
coupled device ("CCD") mono-chromatic, color or multi-spectral cameras. Each of
the cameras scan the product-streams, which move at 5 to 20 feet per second, at
the rate of 1,500 to 4,000 times per second and can identify defects as small as
1/16 of an inch (1.5 mm) in diameter. Systems with monochromatic cameras
generally are sold at lower price levels and are most effective for product that
has a marked disparity in shade between the defective and the good product.
Systems with color cameras are required when a variety of defect and product
colors occur simultaneously or when the difference in shading between the
defective and the good product is more subtle. In 1998, the Company developed
multi-spectral

                                        4

<PAGE>

systems which utilize either infrared or ultraviolet technologies, individually
or in combination with visible light, to identify defects that may not be
detectable by using solely visible light spectra.

    Tegra System. In fiscal 1996, the Company introduced its fourth generation
of automated inspection system sorters. Named Tegra, this generation of
automated inspection systems incorporates a number of technological and
mechanical advances that result in significant improvements to processing
efficiency and product throughput with higher recovery and defect-removal rates.
Certain present and potential applications for Tegra systems include potato
products, green beans, dried beans, corn, carrots, peas, spinach and other leafy
vegetables, pears, nuts, grains, coffee and tobacco.

    Tegra incorporates object-specific IntelliSort(TM) technology. IntelliSort
sorting technology recognizes not only color and size, but also shape. This
capability provides a solution to previously difficult sorting problems, such as
differentiation between green beans and green bean stems. Tegra cameras are
capable of high fidelity color-image processing to scan product at a rate of
over 4,000 times per second, offering a sensitivity to color subtleties beyond
human vision. Tegra also incorporates KeyWare(R) software that substantially
reduces operational complexity. KeyWare consists of application packages, each
specifically designed for a single product category that, together with the
system's computer hardware capability and networking software, support all
standard factory control and automation interfaces. These features allow Tegra
to establish data connectivity and communication with a processing plant's
computer network system.

     Prism System. In 1999, SRC Vision introduced the new Prism sorting system.
Designed for stable performance in challenging environments, Prism has gained
strong acceptance in segments of the fruit, vegetable and snack food markets. It
incorporates optional sensing of short-wave infrared light, uses a novel
broad-band illumination system, and is designed to require minimal maintenance.
In addition to present and potential applications in potato products,
vegetables, fruits, plastics, and snack foods, Prism adds specific applications
with products such as dehydrated potato flakes, plastic flake and peaches.

     Prism incorporates a new image processing module, the "Advanced Vision
Processor" ("AVP(TM)"). Introduced concurrently with Prism, AVP uses a high
speed serial processor to convert color camera signals into product separation
actions. It incorporates the latest in high frequency bus architecture, and
incorporates cameras that have eight times the color resolution of previous
generations. Designed for flexibility, AVP is comprised of modules that provide
an on-going upgrade path, minimizing sustaining development costs, and
maximizing the effective life of the design. AVP uses a powerful combination of
a high speed "super-pipelined" sorting engine with a Windows NT-based user
interface. An internal communication network enables detailed self-diagnosis to
be performed on many system components.

     Tobacco Sorter II and Tobacco Sorter 3. The tobacco industry has special
requirements in the handling and sorting of its tobacco products, which vary in
size and moisture content and other properties depending upon the type of
product being produced and the point of handling and inspection. SRC Vision's
Tobacco Sorter 3 (TS3), introduced worldwide in 2001, utilizes the machine
vision engine of the Prism System in a specially constructed frame, enclosure,
and material handling arrangement to meet the specific product inspection
requirements of this industry. In addition to the large installed base of its
predecessor, Tobacco Sorter II, the new TS3 has now been installed successfully
in North America, Latin America, Europe and Asia. Customers have benefited from

                                       5

<PAGE>

TS3's improved color resolution, significantly enhanced data communications
capability, and reduced maintenance requirements.

      Optyx System. In fiscal 2001, the company developed and introduced its new
automated inspection system named Optyx. The Optyx system was developed by the
combined research and development organizations of Key Technology and SRC
Vision. The new sorter incorporates the best technologies of both companies to
create a sorter that maintains the power and sorting capabilities of a large
sorter in an economical and compact machine. Optyx employs the advanced camera,
lighting, image processing, and ejection technologies used in the Tegra and
Prism products. The lower cost Optyx system is ideal for smaller processors and
lower volume processing lines which were previously unable to justify the
expense of a larger sorter. Present and potential applications include the
Company's traditional fruit, vegetable and tobacco markets. The Optyx system has
successfully proven its technical capabilities at several beta site locations
and the Company has received orders for several Optyx systems.

     ADR System. The Company's ADR systems are used to transport, inspect and
remove defects from french fry potatoes. The Company believes its ADR system is
the principal optical inspection and defect removal system used in the french
fry processing industry. The Company's full-capacity ADR systems can process up
to 27,000 pounds of product per hour.

    Pharmaceutical Inspection System. In fiscal 1996, the Company purchased
certain inventory, trademarks and patents related to a pharmaceutical inspection
product line, the I-300 Pharmaceutical Inspection System, from the Imaging
Division of Oncor, Inc. Using patented spatial color analysis technology, this
product line inspects solid-dose pharmaceuticals, including tablets, capsules
and softgels for broken or missing pieces, foreign products, discoloration or
coating defects, as well as the integrity of capsules. The pharmaceutical
inspection system also verifies and detects color, size, location and shape
defects at processing rates over one million pieces per hour. Sales of this
product line are a minor contributor to automated inspection system revenues.

Process Systems

    Conveying and other custom designed processing systems are utilized
throughout the food industry, as well as other industries, to move large
quantities of product within a processing plant. The Company's process systems
include the Iso-Flo(R), Horizon(TM), Marathon(TM), and Impulse(TM) vibratory
conveyor systems. The Farmco acquisition added another significant product
group, that is made up of mechanical sizing, sorting, separating and grading
equipment. In addition, the product line includes food pumping systems, belt
conveyors, spiral elevators and other custom designed conveying technologies.

     Iso-Flo Vibratory Conveying Systems. The Company's principal specialized
conveying system is its Iso-Flo vibratory conveyor system, which was introduced
in 1978. The Iso-Flo conveyor is a type of pan conveyor. Pan conveyors are
common throughout industries that process product streams of discrete pieces,
especially the food processing industry. Pan conveyors move product pieces by
vibrating the pan at high frequency along a diagonal axis, upward and forward.
This action propels the product ahead in small increments and distributes it
evenly for close control of movement and presentation.

                                       6

<PAGE>

     Iso-Flo systems are used in a variety of processing applications, including
potato products, vegetables and fruits (green beans, peas, carrots, corn,
peaches, pears, cranberries and apples), snack foods, cereals, pet foods,
poultry, seafood and certain nonfood products.

     Most Iso-Flo conveyors are custom designed and engineered by the Company to
customer specifications. The Company considers its vibratory conveyor technology
to be a proprietary core competency. As a result of the Company's research and
development activities in fiscal 1999 and 2000, it expanded its family of
vibratory conveyors with the introduction of three new products in the first
quarter of fiscal 2000. These products were the Horizon(TM), the Impulse(TM) and
the Marathon(TM) conveying systems. Initial placements of beta and trial units
were made in fiscal 2000 which resulted in initial sales of all the new products
during fiscal 2001. Product reliability and performance met expectations in all
placements with order and quote volume increasing. During fiscal 2001, activity
in research and development focused on product enhancement options, including
new automated diverters for product movement, vibration sensors, and added
automation and control technologies for all process systems.

     The Horizon is a horizontal motion vibratory conveyor that uses a gentle
conveying action to move fragile foods, such as snacks, cereals and
seasoned/coated products, through the processing stages. The design of the
Horizon eliminates vertical bounce of the processor's product. This feature
results in reduced costs to the processor due to minimized product damage,
reduced seasoning/coating loss and elimination of condiment build-up on the
conveying surface.

    The Impulse is a line of electromagnetic conveyors which combine the
advantage of quick start/stop with precise metering control. Additionally, the
Impulse conveyor drive systems are oil-free which limits the potential for
contamination and improves the safety of edible food products. This conveyor
system was developed for packaging applications in snack food, dry ingredient,
chemical and pharmaceutical processing.

    The Marathon is the Company's longest conveyor and moves product up to 100
feet or more on a single conveyor bed. This conveyor is targeted for use in high
volume applications such as corn, green beans and other bulk conveying markets
to maximize the processor's production efficiency.

    The mechanical sizing, sorting, separating, and grading products are used in
many food processing systems. These proprietary rotary sizing and grading
technologies optimize yield, increase packaging efficiency, and improve product
quality primarily by removing small irregular-shaped pieces of product from the
line or separating product into predetermined size categories. In combination
with other Company provided equipment, these products can increase overall line
efficiency and systems capability.

    Food Pumping Systems and Belt Conveyors. The Company's hydro food pumping
systems are used to transport food items over distances and elevations in
processing plants. A typical pumping system consists of a stainless steel
contoured tank and food pump to propel the product through lengths of piping to
a water removal/product spreading subsystem. The systems can be configured so
that food processing functions, such as blanching, cooling and cutting, can also
occur during pumping. The Company also designs and manufactures belt conveyors
using a variety of belt materials and frame configurations.

                                       7

<PAGE>

    Preparation systems. The Company designs and manufactures raw food
preparation systems to prepare vegetables prior to freezing, canning or other
processing. Products in this group include blanchers, air cleaners, air coolers,
froth flotation cleaners, vegetable metering systems, and bulk handling
equipment. These products represent the Company's most mature product line.
Sales of these products over the years have formed a customer base for sales of
other Company products and are also establishing a customer base in markets in
developing countries.

    Preparation system revenues may also include a variety of third-party
supplied equipment and installation services which are sold as components of
larger processing lines, for which the Company has assumed turn-key sales
responsibility. In fiscal 2001, the Company did not sell any third-party
products for which it assumed turn-key sales responsibility. In fiscal 2000,
these third-party supplied products accounted for approximately $1.8 million of
the $26.4 million total net sales of process systems.

Parts and Service/Contracts

    The Company provides spare parts and post-sale field and telephone-based
repair services to support its customers' routine maintenance requirements and
seasonal equipment startup and winterization processes. In response to
increasing customer demand for maintenance and parts services, the Company
introduced a new multi-tier service product offering named UpTime(TM) in fiscal
1999. During fiscal 2000 the Company tested the ability to supply remote
diagnostics in the UpTime(TM) offering and began selling this service as UpTime
Connection in Fiscal 2001. The Company considers its parts and maintenance
service sales to be important potential sources of future revenue growth. In
fiscal 2001, to help increase parts and maintenance service revenues and provide
a higher level of customer service, the Company realigned its service
organization so that field service personnel are now geographically located
closer to its customers throughout the world. The Company also typically
provides system installation support services which are included in the sales
price of certain of its products, principally automated inspection systems.

Customers and Markets

    The Company's primary market is the food processing industry. The largest
markets for the Company's products have been processors of potatoes, vegetables
and snack foods. The Company has also experienced recent success in the dry
product markets which include cereals and pet food. The Company believes many
additional applications for its systems exist in both food and non-food markets.

    The principal potato market served by the Company's systems is french fries.
French fries comprise approximately 90% of the over eight billion pounds of
frozen potato products processed annually in the United States. The expansion of
American-style fast food chains in other countries is resulting in parallel
development of the frozen french fry market overseas. The major investment in
new french fry processing facilities is occurring outside the United States.

    The Company's products are used in the fruit and vegetable processing market
where field-harvested products are cleaned, graded, automatically sorted,
blanched and processed prior to freezing, canning or packaging for sale to
institutional and retail markets. Principal fruit and vegetable market segments
for the Company are green beans, corn, carrots, peas, onions, apples, pears,
cranberries and peaches.

                                       8

<PAGE>

    In non-food markets, the Company's principal market is the tobacco industry.
The Company's products provide tobacco companies sorting capability to remove
impurities and foreign matter from a stream of stripped tobacco. The Company
believes market growth for tobacco systems shows great promise based upon the
high degree of acceptance demonstrated by its customers and the significant size
of the worldwide tobacco processing market. Additionally, the Company expects
that the tobacco market may provide opportunities for expanded sales of process
systems to compliment new and existing installations of automated inspection
systems.

    Export and international sales for the fiscal years ended September 30,
2001, 2000 and 1999 accounted for 49%, 41% and 46% of net sales in each such
year, respectively. Nearly all export sales of products manufactured in the
United States for shipment into international markets other than Europe have
been denominated in U.S. dollars. Sales into Europe of systems, spare parts and
service, as well as products manufactured in Europe, are generally denominated
in European currencies. 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 the sales prices in local currencies of the
Company's products in international markets; tariffs and other barriers and
restrictions; and the burdens of complying with a variety of international laws.
Additional information regarding export and international sales is set forth in
Note 13 to the Company's Consolidated Financial Statements for the year ended
September 30, 2001.

    During fiscal 2001, 2000 and 1999 sales to McCain Foods represented
approximately 17%, 14% and 11% of total net sales, respectively. While the
Company believes that its relationship with McCains is satisfactory, the loss of
this customer could have a material adverse effect on the Company's results of
operations.

    The Company markets its products directly and through independent sales
representatives. In North America, the Company operates sales offices in Walla
Walla, Washington; Medford, Oregon; and Redmond, Oregon. The Company's
subsidiary, Key Technology B.V., provides sales and service to European
customers.

Engineering, Research and Development

    At September 30, 2001, the Company's engineering departments had 115
technical and support employees who conduct new product research and
development, sustaining engineering for released products and project
engineering for custom systems. The department includes electronic, mechanical
and software engineers, mathematicians and technical support personnel.

    The Company's project engineering teams are responsible for engineering and
designing the details of each custom order. A document control team maintains
and controls product documentation and the product modeling database for the
development engineering and project engineering teams as well as the
manufacturing department.

    In fiscal 2001, the Company's engineering, research and development expenses
were approximately $5.4 million, compared to $5.3 million and $4.3 million in
2000 and 1999, respectively.

                                       9

<PAGE>

Manufacturing

    The Company maintains three domestic manufacturing facilities, two located
in Walla Walla and one in Redmond, Oregon, and a European manufacturing facility
located in The Netherlands. The Company's current manufacturing facilities and
its product design and manufacturing processes integrate Computer Aided
Engineering (CAE), Computer Aided Design (CAD), Computer Aided Manufacturing
(CAM) and Computer Integrated Manufacturing (CIM) technologies. Manufacturing
activities include process engineering; cutting, welding, fabrication and
assembly of custom designed stainless steel systems; camera and electronics
assembly; subsystem assembly; and system test and integration. The Company
manufactures products in the following locations:

<TABLE>
      ---------------------------------------------------------------------------------------------------
<S>                                        <C>                           <C>
      Location                             Size in Square Feet           Products/Services Produced
      ---------------------------------------------------------------------------------------------------
      Walla Walla, Washington              150,000                       Automated Inspection
                                                                         Process Systems
                                                                         Parts and Service
      ---------------------------------------------------------------------------------------------------
      Walla Walla, Washington              100,000                       Process Systems
      ---------------------------------------------------------------------------------------------------
      Redmond, Oregon                      19,000                        Process Systems
                                                                         Parts and Service
      ---------------------------------------------------------------------------------------------------
      Beusichem, The Netherlands           45,000                        Process Systems
                                                                         Parts and Service
      ---------------------------------------------------------------------------------------------------
      Beusichem, The Netherlands           18,000                        Parts warehouse
                                                                         Future manufacturing expansion
      ---------------------------------------------------------------------------------------------------
</TABLE>

     The Company manufactures certain of its products to Underwriters
Laboratories, United States Department of Agriculture and Occupational Safety
and Health Administration standards. The Company's domestic manufacturing
processes in its Walla Walla operations originally became qualified in January
1995 for certification to the ISO-9001 quality management and assurance
standards. Those specific operations were audited in fiscal 2001 and found to be
compliant. The processes of qualifying and certifying the Company's Redmond,
Oregon operations and the engineering and service operations in Medford, Oregon
is currently under review. It is the Company's expectation that each of those
entities will become certified to the ISO-9001 quality standard. Certain of the
Company's products also comply with the Canadian Standards Association (CSA),
European CE (Conformite Europeene) and Electronic Testing Laboratory (ETL)
safety standards.

    Certain components and subassemblies included in the Company's products are
obtained from single-source or sole-source suppliers. The Company attempts to
ensure that adequate supplies are available to maintain manufacturing schedules.
Although the Company seeks to reduce its dependence on sole and limited source
suppliers, the partial or complete loss of certain sources of supply could have
an adverse effect on the Company's results of operations and relations with
customers.

                                       10

<PAGE>

Backlog

    The Company's backlog as of September 30, 2001 and September 30, 2000 was
approximately $12.5 million and $14.1 million, respectively. Gross shipments
exceeded orders by $1.6 million in fiscal 2001. The Company schedules production
based on firm customer commitments and forecasted requirements. The Company
includes in backlog only those customer orders for which it has accepted
purchase orders. However, the Company believes that backlog is not necessarily a
meaningful indicator of future financial results as it typically ships products
ordered within eight to thirteen weeks from the date of receipt of the order.
Large multiple-unit system orders or orders for systems in high demand may,
however, result in longer delivery times.

Competition

    The markets for automated inspection systems and process systems are highly
competitive. Important competitive factors include price, performance,
reliability, and customer support and service. The Company believes that it
currently competes effectively with respect to these factors, although there can
be no assurance that existing or future competitors will not introduce
comparable or superior products at lower prices. Certain of the Company's
competitors may have substantially greater financial, technical, marketing and
other resources. The Company's principal competitors are believed to be FMC
Technologies, Inc., Heat & Control, Sortex Ltd., the Pulsarr B.V. and Elbicon
N.V. subsidiaries of Barco N.V., Kiremko B.V., and BEST N.V. As the Company
enters new markets, it expects to encounter new niche competitors.

Patents and Trademarks

    The Company currently holds fifty-seven active United States patents issued
from 1984 through 2001 and twenty-three active patents issued by other
countries, the first of which expires in calendar 2002. As of December 18, 2001,
twenty-two other patent applications had been filed and are pending in the
United States and other countries. The Company has twenty-three registered
trademarks and applications pending for three trademarks.

     The Company also attempts to protect its trade secrets and other
proprietary information through proprietary information agreements and security
measures with employees, consultants and others. The laws of certain countries
in which the Company's products are or may be manufactured or sold may not
protect the Company's products and intellectual property rights to the same
extent as the laws of the United States.

Employees

    At September 30, 2001, the Company had 543 full-time employees, including
230 in manufacturing, 115 in engineering, research and development, 136 in
marketing, sales and service and 62 in general administration and finance. A
total of 112 employees are located outside the United States. None of the
Company's employees in the United States are represented by a labor union. The
manufacturing employees located at the Company's facility in Beusichem, The
Netherlands are represented by the Small Metal Union. The Company has never
experienced a work stoppage, slowdown or strike. The Company considers its
employee relations to be excellent.

                                       11

<PAGE>

 ITEM 2.    PROPERTIES.

    The Company owns or leases the following properties:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------
                                                                                        Lease      Renewal
Location                 Purpose                     Square Feet  Owned or Leased       Expires    Period
----------------------------------------------------------------------------------------------------------------
<S>                      <C>                         <C>          <C>                   <C>        <C>

Walla Walla, Washington  Corporate office,           150,000      Leased with option    2010
                         manufacturing, research                  to purchase within
                         and development, sales and               the lease term
                         marketing, administration
----------------------------------------------------------------------------------------------------------------
Walla Walla, Washington  Manufacturing, research     100,000      Leased with option    2005       2010
                         and development, sales and               to purchase
                         marketing                                beginning January 1,
                                                                  2002

----------------------------------------------------------------------------------------------------------------
Medford, Oregon          Research and development,   82,000       Owned  (2)
                         sales and marketing (1)
----------------------------------------------------------------------------------------------------------------
Medford, Oregon          Vacant Lot                  50,000       Owned  (3)
----------------------------------------------------------------------------------------------------------------
Redmond, Oregon          Manufacturing, research     19,000       Leased                2003       2008
                         and development,
                         administration

----------------------------------------------------------------------------------------------------------------
Beusichem, The           Manufacturing, sales and    45,000       Leased                2008       2013
Netherlands              marketing, administration
----------------------------------------------------------------------------------------------------------------
Beusichem, The           Parts warehouse, future     18,000       Owned
Netherlands              manufacturing expansion
----------------------------------------------------------------------------------------------------------------
</TABLE>

     (1)  In fiscal 2001 the manufacturing activities previously performed in
          Medford were moved to the Company's 150,000 square foot facility in
          Walla Walla. The Company has offered for sale its partially-vacant
          Medford facility.

     (2)  Subject to a deed of trust securing an approximately $2.9 million loan
          made by Bank of America National Trust and Savings Association. The
          loan bears interest at 8.3% and is due May 1, 2008.

     (3)  The Company originally acquired 150,000 square feet of vacant land in
          conjunction with the acquisition of AMVC. Subsequently, the Company
          has sold 100,000 square feet to various third parties. Based upon
          these transactions and the number and quality of continuing inquiries,
          the Company expects to sell the remaining property at or above its
          book value.

                                       12

<PAGE>

ITEM 3.    LEGAL PROCEEDINGS.

    From time-to-time, the Company is named as a defendant in legal proceedings
arising out of the normal course of its business. As of December 5, 2001, the
Company was not a party to any material legal proceedings.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

    None.

                                     PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

Common Stock

    Shares of the Company's common stock are quoted on the Nasdaq National
Market System under the symbol "KTEC". The following table shows the high and
low bid prices per share of the Company's common stock by quarter for the two
most recent fiscal years ended September 30:

                                        High             Low
                                        ------           ------
         Fiscal 2001
         -----------
             1st Quarter                $8.938           $4.125
             2nd Quarter                 8.250            5.188
             3rd Quarter                 7.250            4.050
             4th Quarter                 5.040            2.040

         Fiscal 2000
         -----------
             1st Quarter               $10.000           $6.578
             2nd Quarter                11.188            8.125
             3rd Quarter                 9.875            7.000
             4th Quarter                10.063            8.250

     The sources of these quotations for the Company's common stock were
Nasdaq's Summary of Activity(TM) reports and the Nasdaq OnlineSM Internet site.

    The Company had approximately 1,850 beneficial owners of its common stock,
of which 191 are of record, as of December 18, 2001.

     The Company has not historically paid dividends on its common or preferred
stock. The Board of Directors does not anticipate payment of any dividends in
the foreseeable future and intends to continue its present policy of retaining
earnings for reinvestment in the operations of the Company. The current credit
facility with the Company's principal domestic bank restricts the payment of
dividends on its common stock, other than dividends payable in its stock, or the
retirement of any of the Company's outstanding shares or the alteration or
amendment of the Company's capital structure

                                       13

<PAGE>

without the prior written consent of the bank. The Company anticipates the
proposed credit facility with the Company's principal bank will also contain
similar restrictions.

Series B Convertible Preferred Stock

     Shares of the Company's Series B convertible preferred stock were issued in
the merger with AMVC on July 12, 2000. These shares are quoted on the Nasdaq
SmallCap Market under the symbol "KTECP". The following table shows the high and
low bid prices per share of the Company's Series B convertible preferred stock
by quarter for the two most recent fiscal years ended September 30:

                                                  High              Low
                                                  ----              ---
                        Fiscal 2001
                        -----------
                            1st Quarter          $7.266           $6.438
                            2nd Quarter           7.625            6.875
                            3rd Quarter           7.500            6.270
                            4th Quarter           7.100            4.700

                        Fiscal 2000
                        -----------
                            1st Quarter             N/A              N/A
                            2nd Quarter             N/A              N/A
                            3rd Quarter             N/A              N/A
                            4th Quarter          $7.375           $6.125

     The sources of these quotations for the Company's Series B convertible
preferred stock were Nasdaq's Summary of Activity(TM) reports and the Nasdaq
OnlineSM Internet site.

     The Company had approximately 1,387 beneficial owners of its Series B
convertible preferred stock, of which 77 are of record, as of December 18, 2001.

     Each whole share of Key Technology Series B convertible preferred stock is:

         . convertible at the election of the holder at any time for 2/3 of a
           share of Key Technology common stock; or
         . redeemable at the election of the holder after July 12, 2002 for
           $10.00 in cash; or
         . to be redeemed by the Company on July 12, 2005, or may be redeemed
           earlier by the Company if the average closing price of Key Technology
           common stock exceeds $15.00 per share for 30 consecutive trading
           days, for $10.00 in cash plus declared and unpaid dividends, if any.

     Upon closing the AMVC acquisition on July 12, 2000, FMC Technologies, Inc.
 (FMC) option to purchase shares of AMVC common stock was converted into an
 option to purchase 210,000 shares of Key Technology Series B convertible
 preferred stock and warrants to purchase 52,500 shares of Key Technology common
 stock for $2,520,000. This option expires October 14, 2003.

     The Series B convertible preferred stock is not entitled to dividends. If a
dividend is declared payable on the outstanding common stock, the holders of
Series B convertible preferred stock are entitled to the dividend that would be
payable on the common stock into which the Series B could convert.

                                       14

<PAGE>

Warrants

     Warrants were issued in the merger with AMVC on July 12, 2000. These
warrants are quoted on the Nasdaq SmallCap Market under the symbol "KTECW". The
following table shows the high and low bid prices of the Company's warrants by
quarter for the two most recent fiscal years ended September 30:

                                                    High              Low
                                                    ----              ---
                        Fiscal 2001
                        -----------
                            1st Quarter           $ 9.875           $9.750
                            2nd Quarter            10.000            9.875
                            3rd Quarter             9.890            9.813
                            4th Quarter             9.860            9.800

                        Fiscal 2000
                        -----------
                            1st Quarter               N/A              N/A
                            2nd Quarter               N/A              N/A
                            3rd Quarter               N/A              N/A
                            4th Quarter           $ 9.875           $9.875

     The warrants do not accrue any dividends or interest until exercised and
then only to the extent it is exercised.

                                       15

<PAGE>

ITEM 6. SELECTED FINANCIAL DATA.

    The selected consolidated financial information set forth below for each of
the five years in the period ended September 30, 2001 has been derived from the
audited consolidated financial statements of the Company. The information below
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations and the Company's Consolidated
Financial Statements and Notes thereto as provided in Item 7 and Item 8 of this
Annual Report on Form 10-K, respectively.

<TABLE>
<CAPTION>
                                                                      Fiscal Year Ended September 30,
                                                          ------------------------------------------------------
                                                              2001        2000        1999       1998       1997
                                                          --------    --------    --------   --------   --------
                                                                    (in thousands, except per share data)
<S>                                                       <C>         <C>         <C>        <C>        <C>
Statement of Earnings (Loss) Data:

Net sales .............................................   $ 72,954    $ 67,412    $ 69,531   $ 54,132   $ 58,843
Cost of sales .........................................     47,186      42,412      43,838     34,884     41,025
                                                          --------    --------    --------   --------   --------
Gross profit ..........................................     25,768      25,000      25,693     19,248     17,818
Operating expenses ....................................     28,190      25,302      21,022     18,085     17,648
                                                          --------    --------    --------   --------   --------
Income (loss) from operations .........................     (2,422)       (302)      4,671      1,163        170
Other income (expense) ................................     (1,264)        180         490        226        449
                                                          --------    --------    --------   --------   --------
Earnings (loss) from continuing operations
    before income taxes ...............................     (3,686)       (122)      5,161      1,389        619
Income tax (benefit) expense ..........................     (1,343)       (168)      1,632        464        197
                                                          --------    --------    --------   --------   --------

Net earnings (loss) from continuing operations ........   $ (2,343)   $     46    $  3,529   $    925   $    422

Total loss on discontinued operation (net of tax) .....     (2,581)       (379)         --         --         --
                                                          --------    --------    --------   --------   --------
Net earnings (loss) ...................................     (4,924)       (333)      3,529        925        422
Accretion of manditorily redeemable preferred stock....       (939)       (235)         --         --         --
                                                          --------    --------    --------   --------   --------
Net earnings (loss) available to common shareholders ..   $ (5,863)   $   (568)   $  3,529   $    925   $    422
                                                          ========    ========    ========   ========   ========
Net earnings (loss) from continuing
    operations per share - basic and diluted ..........   $  (0.69)   $  (0.04)   $   0.75   $   0.20   $   0.09
                                                          ========    ========    ========   ========   ========
Net loss from discontinued operation per
    share - basic and diluted .........................   $  (0.55)   $  (0.08)   $     --   $     --   $     --
                                                          ========    ========    ========   ========   ========
Earnings (loss) per share - basic and diluted .........   $ (1.24)    $  (0.12)   $   0.75   $   0.20   $   0.09
                                                          ========    ========    ========   ========   ========
Cash dividends per share ..............................   $     --    $     --    $     --   $     --   $     --
                                                          ========    ========    ========   ========   ========
Shares used in per share calculation - basic ..........      4,740       4,723       4,707      4,692      4,674
                                                          ========    ========    ========   ========   ========
Shares used in per share calculation - diluted ........      4,740       4,723       4,711      4,721      4,760
                                                          ========    ========    ========   ========   ========
</TABLE>


                                       16

<PAGE>

<TABLE>
<CAPTION>
                                                                                 September 30,
                                                                 -----------------------------------------------
                                                                   2001      2000      1999      1998      1997
                                                                 -------   -------   -------   -------   -------
                                                                                  (in thousands)
<S>                                                              <C>       <C>       <C>       <C>       <C>
Balance Sheet Data:

Cash and cash equivalents and short-term Investments .........   $   738   $ 6,535   $ 6,403   $ 6,333   $ 2,896
Working capital ..............................................    10,722    25,202    22,973    18,949    17,308
Property, plant and equipment, net ...........................    11,436    13,784     8,582     9,584     9,380
Total assets .................................................    74,841    85,417    44,420    39,357    39,441
Current portion of long-term debt ............................    11,739     3,447       304       579       852
Long-term debt, less current portion .........................     6,581    19,483       722     1,103     1,293
Mandatorily redeemable preferred stock and warrants ..........    13,531    17,105         0         0         0
Shareholders' equity .........................................    25,711    31,465    32,657    29,315    28,031
</TABLE>



ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

Introduction

     The Company and its wholly-owned subsidiaries design, manufacture and sell
process automation systems, integrating electro-optical inspection and sorting
and process systems.

     The Company consists of Key Technology, Inc. which directly owns three
subsidiaries: Key Technology FSC, Inc., a foreign sales corporation (FSC); Key
Holdings USA LLC; and Key Technology AMVC LLC. Key Holdings USA LLC owns
Suplusco Holdings B.V., its European subsidiary, which owns Key Technology B.V.
Key Technology AMVC LLC owns Applied Laser System, Inc. (inactive) and ARC
Netherlands B.V. (inactive). The Company manufactures products in Walla Walla,
Washington; Redmond, Oregon; and Beusichem, The Netherlands. Through the
maintenance of its wholly-owned foreign sales corporation subsidiary, Key
Technology FSC, Inc., a portion of the Company's domestically originated foreign
trade income is exempt from tax at the corporate level.

     The Company acquired Farmco and AMVC on June 1, 2000 and July 12, 2000,
respectively. The operations of the acquired entities are included in the
consolidated financial statements from their respective acquisition dates and
account for a large portion of the fluctuation in amounts between fiscal years
2001, 2000 and 1999.

Results of Operations

     For the fiscal years ended September 30, 2001, 2000 and 1999, the Company's
net sales were $73.0 million, $67.4 million, and $69.5 million, respectively.
Sales of automated inspection systems, process systems, and parts and
service/contracts increased by 12%, 2% and 12%, respectively, in fiscal 2001
compared to fiscal 2000. The Company has experienced the benefits of the
acquisitions of Farmco and AMVC made in the third and fourth quarters of fiscal
2000, as the incremental net sales from acquisitions accounted for the revenue
growth in all product categories in fiscal 2001. Acquired

                                       17

<PAGE>

product lines contributed 22% of the systems sold in fiscal 2001. The
acquisition of AMVC also helped accelerate the Company's strategy of
diversification, as net sales of non-food systems, principally to the tobacco
industry, represented 14% of system sales in fiscal 2001. A 46% increase in
sales of process systems into the European market were largely offset by
decreases in that product group in other parts of the world. Parts and
service/contract net sales increased by 12% in fiscal 2001 over fiscal 2000 as a
result of the acquisitions of Farmco and AMVC made in fiscal 2000.

     The incremental net sales from acquired product lines were partially offset
by decreased net sales from the Company's traditional business, the food
processing industry in the United States. Sales to the food processing industry
continued to weaken in fiscal year 2001 and were unfavorably affected by market
factors including:

     . Further consolidation among food processors, which resulted in delayed
       investments in capital equipment by the Company's customers.
     . Softness in the vegetable industry caused by processed inventories
       carried over from the previous season and lower prices for customers'
       products.
     . Higher energy costs in certain sectors of the Company's markets which
       contributed to reduced spending by customers for both new equipment and
       maintenance expenditures for parts and service.
     . The strength of the U.S. dollar in world markets, which has made
       U.S.-manufactured goods relatively more expensive to international
       customers.

     The Company did not experience any "turn-key" sales in fiscal 2001 as
compared to fiscal 2000 where turn-key sales were approximately $1.8 million.

     Net sales in fiscal 2000 decreased by 3% compared to fiscal 1999. Automated
inspection systems and parts and service/contracts increased by 7% and 28%,
respectively, but these increases were more than offset by decreases in process
systems in fiscal 2000 compared to fiscal 1999. Sales for the year ended
September 30, 2000 were unfavorably affected by market factors including:

     . Consolidation among food processors, which resulted in delayed
       investments in capital equipment by Key's customers.
     . Softness in the vegetable industry caused by processed inventories
       carried over from the previous season and lower prices for customers'
       products.
     . Customers' higher costs of capital due to increased interest rates in the
       United States, which delayed certain projects.
     . The strength of the U.S. dollar in world markets, which has made
       U.S.-manufactured goods relatively more expensive to international
       customers.

     Sales by subsidiaries acquired during the third and fourth quarters of
fiscal 2000 contributed approximately $5.1 million to the Company's consolidated
net sales in fiscal 2000.

     Export and international sales accounted for 49%, 41% and 46% of total net
sales in fiscal 2001, 2000 and 1999, respectively. An increase in sales to
international customers of 29% was partially offset by a 6% decrease in sales to
domestic customers in fiscal 2001. European customers represented the largest
market for such international sales in each of the three fiscal years.

                                       18

<PAGE>

     Gross profit was 35%, 37% and 37% of sales in fiscal 2001, 2000 and 1999,
respectively. The gross margin, as a percentage of net sales in fiscal 2001 as
compared to fiscal 2000, suffered from decreased margins in automated inspection
systems and in parts and service/contracts, partially offset by increased
margins in process systems. Automated inspection systems gross margins, as a
percent of net sales, decreased by four percentage points in fiscal 2001 from
fiscal 2000, principally as the result of a 62% increase in warranty costs, the
underutilization of manufacturing facilities and the accounting treatment of
acquired inventories. Parts and service/contracts gross margins, as a percent of
net sales, decreased by eight percentage points in fiscal 2001 from fiscal 2000,
principally as the result of underutilization of field service personnel due to
customer cutbacks in maintenance spending, and the costs associated with
cross-training of service personnel on all product lines. The gross margins for
process systems improved principally as a result of better cost control, and
because the Company did not experience any lower margin turn-key sales in fiscal
2001 as compared to $1.8 million of turn-key sales in fiscal 2000.

     The gross margin, as a percentage of net sales in fiscal 2000 compared to
fiscal 1999, benefited from improved margins in automated inspection systems and
in parts and service, offset by decreased gross margins in process systems.
Automated inspection system gross margins, as a percent of sales, improved two
percentage points in fiscal 2000 over fiscal 1999, principally the result of a
16% decrease in warranty costs, which continued the favorable trend of a 41%
decrease in warranty costs in the previous year. The gross margins for parts and
service/contracts improved principally as a result of an increased volume of
higher margin upgrades. Decreased process systems gross margins were principally
due to an increase in manufacturing overhead resulting from decreased production
volumes between the two comparable periods. Process system revenues in both
fiscal 2000 and 1999 included a variety of third-party supplied equipment and
installation services which were sold at very low margins as components of
larger processing lines. During fiscal 2000, third-party supplied products
accounted for approximately $1.8 million of $26.4 million in total net sales of
process systems compared to $3.1 million of the $34.0 million in total net sales
in fiscal 1999.

     Operating expenses increased to $28.2 million in fiscal 2001 from $25.3
million in fiscal 2000 and $21.0 million in fiscal 1999, and represented 39%,
38% and 30% of net sales in each such year, respectively. Operating expenses in
fiscal 2001 include a full year of operating expenses and amortization of
intangibles of acquired companies, while fiscal 2000 included such expenses for
only approximately one quarter. Substantial expense reductions from the higher
expense levels earlier in the year have resulted in a lower run rate and,
therefore the Company expects that total operating expenses in fiscal 2002
should approximate 29 to 31 percent of fiscal 2002 revenues.

     Selling and marketing expenses were $13.2 million in fiscal 2001, $12.8
million in fiscal 2000 and $11.1 million in fiscal 1999, and represented 18%,
19% and 16% of net sales in each such year, respectively. In fiscal 2001,
selling and marketing expenses increased 4% over fiscal 2000, principally due to
the expenses contributed by the acquisitions. Selling and marketing expenses in
fiscal 2000 increased 15% compared to fiscal 1999, also principally due to the
expenses contributed by acquisitions. The Company also increased investment in
new product promotions related to four new products introduced in fiscal 2000
and expanded sales coverage to new European and Latin American markets.

     Research and development expenses increased in fiscal 2001 to $5.4 million
from $5.3 million in fiscal 2000 and $4.3 million in fiscal 1999, and
represented 7%, 8% and 6% of net sales in each such year, respectively. Research
and development expenses in fiscal 2001 increased by approximately 2%

                                       19

<PAGE>

compared to fiscal 2000, and research and development expenses in fiscal 2000
increased by approximately 23% compared to 1999. The increases in both periods
are principally due to expenses contributed by acquisitions. Activities in
fiscal 2002 will focus on continuing to extend the capabilities and applications
of the technologies contained in Optyx, Tegra and Prism, and development of new
inspection technologies.

     General and administrative expenses increased to $7.5 million in fiscal
2001 from $5.7 million in fiscal 2000 and $5.4 million in fiscal 1999, and
represented 10%, 9% and 8% of net sales in each such year, respectively. General
and administrative expenses increased in fiscal 2001 by approximately 31%
compared to fiscal 2000 as a result of a full year of combined operations in
fiscal 2001 as compared to only a partial year in fiscal 2000. General and
administrative expense in fiscal 2000 increased approximately 7% compared to
fiscal 1999 also as a result of the acquisitions of Farmco and AMVC made in the
third and fourth quarters of fiscal 2000.

     The increase in amortization of intangibles is the result of a full year of
amortization of acquired intangibles as compared to only a partial year in
fiscal 2000. The Company obtained independent appraisals of the fair market
value of the AMVC intangible assets acquired. Acquired intangible assets,
including goodwill, patents, existing technologies and established customer
base, are amortized over the shorter of their remaining lives or periods of 10
to 15 years. A one-time charge of $800,000 associated with the write-off of
acquired in-process research and development was recorded immediately subsequent
to the acquisition of AMVC in the Company's fourth quarter of fiscal 2000.

     Other income and expense includes interest income and expense, royalty
income and other income from miscellaneous sources. Net interest expense in
fiscal 2001 was $1.5 million compared to net interest expense of $48,000 in
fiscal 2000 and net interest income of $210,000 in fiscal 1999. The increase in
net interest expense in fiscal 2001 compared to fiscal 2000 resulted from
increased interest expense on long-term debt arising from the acquisitions in
the third and fourth quarter of fiscal 2000 and lower interest earnings as a
result of lower invested cash and cash equivalents, and short-term investment
balances. During fiscal 2001, the Company received royalty payments of $131,000
compared to total royalty income of $110,000 in fiscal 2000 and $77,000 in
fiscal 1999. As part of a settlement agreement entered into during 1997, the
Company received royalty payments through fiscal 2001 related to the sale of
certain equipment to a selected market. The Company recognized royalty income
from this agreement of $122,000 in fiscal 2001, $71,000 in fiscal 2000 and
$26,000 in fiscal 1999. During fiscal 2001, the Company recognized foreign
currency transaction gains totaling $242,000 on cash and accounts receivable
held primarily in Euros and Dutch guilders. This compares to foreign currency
transaction losses of $407,000 in fiscal 2000 and foreign currency transaction
gains of $58,000 in fiscal 1999.

     The Company's effective income tax rate was a tax benefit of 36.5% and
137.2% in fiscal 2001 and fiscal 2000, respectively, and tax expense of 31.6%
for fiscal 1999. The effective tax benefit or tax expense rate varies from the
statutory rate of 34% due to permanent differences in tax obligations arising
from activities of the FSC, research and development tax credits, and other
permanent differences. The larger variance from statutory rates in fiscal 2000
compared to fiscal 2001 and 1999 is principally due to the small taxable net
loss reported for fiscal 2000 compared to larger taxable earnings or loss for
the other fiscal years.

     Prior to September 30, 2001, the Company committed to a plan to sell
Ventek, Inc., a wholly-owned subsidiary that supplies machine vision systems to
the forest products industry. Ventek was

                                       20

<PAGE>

acquired as part of the acquisition of AMVC. The Company's strategic objective
when it purchased AMVC was to acquire SRC Vision (SRC), which the Company
believes yielded the expected synergies. The Company did not experience the same
synergies with Ventek, which served different markets. Ventek was also adversely
affected by the slowdown in the forest products industry over the past year,
resulting in a decreased financial contribution to the consolidated group. The
sale of Ventek continues the efforts the Company has taken throughout the year
to reduce costs and improve its financial results. As a result of the sale of
Ventek, the Company recorded a loss on the sale of discontinue operations of
approximately $2.1 million in fiscal 2001. See Note 2 to the Company's
Consolidated Financial Statements for a more complete description of the sale of
Ventek.

    Net loss after tax was $4.9 million in fiscal 2001 compared to a net loss of
$333,000 in fiscal 2000 and net earnings of $3.5 million in fiscal 1999. Basic
and diluted net loss per share in fiscal 2001 was $1.24 compared to net loss per
share of $0.12 in fiscal 2000 and earnings per share of $0.75 in fiscal year
1999. The net loss of $4.9 million for the year ended September 30, 2001
included merger-related and one-time acquisition costs of $3.4 million, or $2.1
million after tax, and the loss on the sale of Ventek of $2.1 million. Excluding
these merger-related and non-recurring integration costs, as well as the loss on
the sale of Ventek, the net loss would have been $643,000, or $0.33 per diluted
share for the year ended September 30, 2001. The increase in the net loss in
fiscal 2001 compared to fiscal 2000 resulted principally from decreased gross
margins due to an increase in warranty costs, integration and overhead costs
associated with the combination of the service and manufacturing organizations
resulting from the AMVC acquisition and the required accounting treatment of
acquisition-related inventories. The decrease in net earnings in fiscal 2000
compared to fiscal 1999 was principally due to decreased sales volume in the
Company's core business and the one-time acquisition costs and amortization
related to acquisitions.

Liquidity and Capital Resources

     During fiscal 2001, net cash provided by operating activities totaled $2.8
million compared to $4.2 million and $1.9 million in fiscal 2000 and 1999,
respectively. During fiscal 2001, cash provided by operating activities was
affected by an increase in accounts receivable totaling $4.2 million that
resulted from slower payment patterns of certain European customers and the
grant of extended payment terms to certain customers. The Company believes that
these receivables are fully collectible or sufficiently reserved for. During
fiscal 2000 cash was generated by a decrease in accounts receivable totaling
$4.2 million that resulted principally from a decrease in sales volume and
improved accounts receivable management. Accounts receivable balances during
fiscal 1999 increased, and cash decreased, by $3.8 million. Operating activities
during 2001 provided $5.1 million in cash from a decrease in inventory compared
to $1.3 million provided by a decrease in inventories in fiscal 2000 and $2.1
million used by an increase in inventories in 1999. Increases in trade accounts
payable, income taxes payable and a decrease in prepaid expenses, partially
offset by decreases in accrued payroll liabilities, accrued customer support and
warranty costs, other accrued liabilities and customer deposits provided cash of
$1.3 million during fiscal 2001. By comparison, decreases in trade accounts
payable, accrued payroll liabilities, income taxes payable, other accrued
liabilities, and increases in prepaid expenses, utilized cash totaling $6.3
million during fiscal 2000. The Company was provided cash totaling $2.0 million
in fiscal 1999 by increases in trade accounts payable, accrued payroll
liabilities and income taxes payable, partially offset by a decrease in accrued
customer support and warranty costs and an increase in prepaid expenses.

                                       21

<PAGE>

     Net cash resources from investing activities totaling $621,000, $2.2
million and $1.3 million were used to fund the acquisition of capital equipment
during 2001, 2000 and 1999, respectively. At September 30, 2001, the Company had
no material commitments for capital expenditures. The Company generated $478,000
from the sale of excess properties in fiscal 2001. In fiscal 2000 the Company
used $16.2 million of cash to acquire AMVC and Farmco during the third and
fourth quarters. There were no purchases or sales of short-tem investments in
fiscal 2001. Net proceeds of $1.0 million arising from the sale and purchase of
short-term investments in fiscal 2000 compared to net investments of $984,000
used to purchase short-term investments in fiscal 1999.

    The Company's cash flows from financing activities were affected in fiscal
2001 by cash generated from short-term borrowings of $2.0 million. There were no
short-term borrowings in fiscal 2000 and 1999. The Company repaid long-term debt
during fiscal 2001, 2000 and 1999 totaling $5.6 million, $2.8 million and
$539,000, respectively. Separately, cash flows from the issuance of long-term
debt totaled $18.2 million for fiscal 2000 with no such issuances in fiscal 2001
and 1999. Proceeds from the issuance of common stock under the Company's
employee stock option and stock purchase plans during fiscal 2001, 2000 and 1999
totaled $71,000, $146,000 and $77,000, respectively. During fiscal 2001 and
2000, the Company redeemed for cash warrants totaling $2.1 million and $703,000,
respectively. During fiscal 2001, the Company redeemed for cash its series C
preferred stock totaling $2.4 million. There were no redemptions of warrants in
fiscal 1999 and no redemptions of series C preferred stock in fiscal 2000 and
1999.

    The Company had a domestic credit accommodation with a commercial bank which
provided for revolving credit loans and an operating line up to $4,500,000. The
operating line expired November 30, 2001 and was repaid. Borrowings under the
operating line were $2,000,000 and zero at September 30, 2001 and 2000,
respectively. In January 2002, the Company completed the refinancing of its
domestic credit accommodation. The refinanced domestic credit accommodation
provides for a term loan of $6,500,000 and a revolving credit facility of up to
the lesser of $10,000,000 or the available borrowing base, which is based on
varying percentages of eligible accounts receivable and inventories. The
refinanced domestic credit accommodation bears interest at the bank's prime rate
plus 2% per annum, is secured by all of the personal property of the Company and
its subsidiaries and contains covenants which require the maintenance of a debt
service ratio, as defined, and limits capital expenditures. The $6,500,000 term
loan requires quarterly principal installments of $500,000 beginning March 31,
2002 plus 50% of excess cash flow (as defined in the borrowing agreement),
subject to certain minimum payments through October 2003. The $10,000,000 credit
facility expires in November 2002. At that time the Company will need to renew
or refinance this facility. At present, the Company's best estimate anticipates
generating sufficient cash flow from operations to meet all known principal and
interest payments on existing debt through 2002.

    With the acquisition of AMVC, the Company assumed a mortgage note with a
domestic commercial bank on its Medford facility which had a balance of $2.9
million at September 30, 2001. The Company and the bank have determined that the
Company is in compliance with all provisions of this loan. The Company is
currently trying to sell this facility.

    The Company's operating, investing and financing activities during fiscal
2001 resulted in a decrease of cash and cash equivalents totaling $5.4 million,
compared to an increase totaling $950,000 in 2000 and a decrease totaling
$914,000 in 1999. The balance of cash and cash equivalents totaled $738,000,
$6.4 million and $5.4 million at the end of fiscal 2001, 2000 and 1999,
respectively.
                                       22

<PAGE>

    On November 30, 2001 the Company completed the sale of Ventek, Inc. to
Veneer Technology, Inc. The Company received a cash payment of approximately
$3.6 million, a deferred payment obligation of approximately $900,000 and the
tender for cancellation of Veneer Technology's holdings of Key Technology Series
B convertible preferred stock having a stated redemption value of $2.0 million.
The cash proceeds from the sale were used to pay down Company debt and increase
cash reserves.

    In connection with the acquisition of AMVC, the Company issued Series B
Convertible Preferred stock, Series C Convertible Preferred stock and warrants,
each of which carries conversion or redemption privileges. A complete
description of these instruments is contained in the Company's Registration
Statement on Form S-4, Post-Effective Amendment No. 1, filed March 23, 2001.
Series C Convertible Preferred stock was redeemed during fiscal 2001 for a total
of $2.4 million. A brief description of the securities outstanding at November
30, 2001 is as follows:

 .    Outstanding Series B Convertible Preferred stock at November 30, 2001,
     after the tender for cancellation of Veneer Technology's holdings of Series
     B Convertible Preferred stock, totaled 1,137,404 shares. Each share is
     convertible at any time at the election of the holder for 2/3 share of the
     Company's Common stock, or redeemable at the election of the holder
     beginning July 12, 2002 for $10 per share.
 .    Outstanding warrants at November 30, 2001 totaled 80,550. Each five-year
     warrant entitles the holder to purchase one share of the Company's Common
     stock for $15 or is redeemable at $10 per warrant at any time at the
     election of the holder.

    If all holders were to redeem their preferred stock and warrants at the
earliest possible time, the cash requirements would be $805,000 presently and an
additional $11.4 million in July 2002. The Company's ability to make cash
payments with respect to such equity redemption obligations and to satisfy or
refinance its other debt obligations will in part depend upon its future
operating performance. The Company believes, based on current circumstances,
that its cash flow from operations, together with anticipated available
borrowings under its new revolving credit facility, will not be sufficient to
permit it to pay in full its potential equity redemption obligations in July
2002. As a result, the Company will be required to pursue alternatives that may
include reducing or delaying capital expenditures, selling assets, restructuring
or refinancing present debt, restructuring the terms of the preferred stock, or
seeking additional subordinated debt or equity capital. While the Company
anticipates operating results sufficient to support the availability of these or
other alternatives, there can be no assurance that any of these alternatives can
be effected on satisfactory terms, if at all. There is no assurance that the
Company will be able to obtain additional or alternative financing or that such
financing, if available, will be on terms favorable to the Company.

The Euro Conversion

     On January 1, 1999, certain member countries of the European Union,
including the Netherlands, established fixed conversion rates between their
existing sovereign (legacy) currencies and the Euro, leading to the adoption of
the Euro by these countries as their common legal currency. The information
systems of the Company's European subsidiary, Key Technology B.V., currently
accommodates multiple currency transactions and has integrated Euro denominated
transactions with no difficulty. Key Technology began implementing a conversion
of its business systems to the Euro concurrent with the start of the Company's
fiscal 2000 year. The Company completed the conversion in October 2001, well
before January 1, 2002 when the legacy currencies may no longer be legal tender.

                                       23

<PAGE>

Future Accounting Changes

     In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations. The statement discontinues the use of the pooling of interest
method of accounting for business combinations. The statement is effective for
all business combinations after June 30, 2001. Management has completed an
evaluation of the effects of this statement and believes that it will not have a
material effect on the Company's consolidated financial statements.

     In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which is effective October 1, 2002 and may be early adopted by the
Company prior to its filing of its first quarter financial statements on Form
10-Q for the quarter ending December 31, 2001. SFAS No. 142 requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill, and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS No. 142
also requires the Company to complete a transitional goodwill impairment test
within six months from the date of adoption. The Company is currently assessing
but has not yet determined the effect of SFAS No. 142 on its financial position
and results of operations. Goodwill amortization was $749,000, $299,000, and
$155,000 during the years ended September 30, 2001, 2000, and 1999,
respectively.

     In August 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations, which is effective October 1, 2003. SFAS No. 143
requires, among other things, the accounting and reporting of legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development, or normal operation of a long-lived
asset. The Company is currently assessing but has not yet determined the effect
of SFAS No. 143 on its financial position, results of operations, and cash
flows.

     In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which is effective October 1, 2002
but may be early adopted. SFAS No. 144 addresses accounting and reporting of all
long-lived assets, except goodwill, that are either held and used or disposed of
through sale or other means. The Company has early adopted the provisions of
SFAS No. 144 related to discontinued operations (see Note 2).

ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

     The Company has assessed its exposure to market risks for its financial
instruments and has determined that its exposures to such risks are generally
limited to those affected by the strength of the U.S. Dollar against the Euro
and the Dutch guilder.

     The terms of sales to European customers by Key Technology B.V., the
Company's European subsidiary, are typically denominated in either Euros, U.S.
Dollars, Dutch guilders or to a far lesser extent, the respective legacy
currencies of its European customers. The Company expects that its standard
terms of sales to international customers, other than those in Europe, will
continue to be denominated in U.S. dollars. For sales transactions between
international customers, including
                                       24

<PAGE>

European customers, and the Company's domestic operations which are denominated
in currencies other than U.S. dollars, the Company assesses its currency
exchange risk and may enter into a currency hedging transaction to minimize such
risk. At September 30, 2001, the Company was not a party to any currency hedging
transaction. As of September 30, 2001, management estimates that a 10% change in
foreign exchange rates would affect net income before taxes by approximately
$110,000 on an annual basis as a result of converted cash and accounts
receivable denominated in foreign currencies.

     During the Company's fiscal 2001, the Euro and the Dutch guilder lost 3% of
their respective values against the U.S. dollar. The majority of this currency
exchange movement occurred in the last two months of the Company's fiscal year.
The effect of the stronger dollar on the operations and financial results of the
Company were:

 .     Translation adjustments of $31,000, net of income tax, were recognized as
      a component of comprehensive income in the Company's Statement of
      Shareholders' Equity as a result of converting the guilder denominated
      balance sheet of Key Technology B.V. into U.S. dollars.
 .     Foreign exchange gains of $242,000 were recognized in the other income and
      expense section of the consolidated income statement as a result of
      conversion of guilder and Euro denominated receivables and cash carried on
      the balance sheet of the U.S. operations as well as the result of the
      conversion of other non-functional currency receivables and cash carried
      on the balance sheet of the European operations.

     A relatively strong U.S. dollar on the world markets makes the Company's
U.S.-manufactured goods relatively more expensive to international customers
when denominated in U.S. dollars or potentially less profitable to the Company
when denominated in a foreign currency. Although the Company experienced strong
orders from and shipments to international markets during fiscal 2001, the
continuing strength of the U.S. dollar on the world markets may unfavorably
affect the Company's market and economic outlook for these international sales.

     The Company anticipates that the reduction of U.S. interest rates both
during and subsequent to the close of the year ended September 30, 2001 will
result in a corresponding reduction of customers' cost of capital, which had
previously delayed certain projects. However, there can be no assurance that
customers in the Company's markets will maintain or increase their investment in
Company products as a result of changes in the cost of capital and other market
or economic factors.

     Subsequent to the end of the period, in January 2002, the Company entered
into a new credit accommodation with a domestic bank. Under this new facility
the Company may borrow at the lender's prime rate plus 200 basis points. At
September 30, 2001, the Company had $16.2 million of borrowings which had
variable interest rates. During the year then ended, interest on the credit
facility varied from 3.30% to 9.75%. Currently the rate is 6.75%. As of
September 30, 2001 management estimates that a 100 basis point change in the
interest rate would affect net income before taxes by approximately $162,000 on
an annual basis.
                                       25

<PAGE>

ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

       Title                                                              Page
       -----                                                              ----
       Independent Auditors' Report ....................................   27

       Consolidated Balance Sheets at September 30, 2001 and 2000 ......   28

       Consolidated Statements of Earnings (Loss) for the three years
            ended September 30, 2001 ...................................   30

       Consolidated Statements of Shareholders' Equity for the three years
            ended September 30, 2001 ...................................   32

       Consolidated Statements of Cash Flows for the three years ended
            September 30, 2001 .........................................   33

       Notes to Consolidated Financial Statements ......................   35

       Supplementary Data ..............................................   51


                                       26

<PAGE>

INDEPENDENT AUDITORS' REPORT

Key Technology, Inc.
Walla Walla, Washington

We have audited the accompanying consolidated balance sheets of Key Technology,
Inc. and subsidiaries as of September 30, 2001 and 2000, and the related
consolidated statements of earnings (loss), shareholders' equity, and cash flows
for each of the three years in the period ended September 30, 2001. The
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Key Technology, Inc. and
Subsidiaries as of September 30, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
September 30, 2001 in conformity with accounting principles generally accepted
in the United States of America.

DELOITTE & TOUCHE LLP



Portland, Oregon
January 10, 2002


                                       27

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2001 AND 2000
(In Thousands)
--------------------------------------------------------------------------------


ASSETS                                               2001      2000

CURRENT ASSETS:
  Cash and cash equivalents                       $   738   $ 6,427
  Short-term investments
                                                        -       108
  Trade accounts receivable, net                   13,072     9,426
  Inventories                                      14,461    22,011
  Deferred income taxes                             1,884     1,699
  Prepaid expenses and other assets                   824     2,372
  Assets held for sale                              8,460         -
                                                  -------   -------
           Total current assets                    39,439    42,043
PROPERTY, PLANT, AND EQUIPMENT, Net                11,436    13,784
DEFERRED INCOME TAXES                               5,376     1,237
OTHER ASSETS                                          108       445
GOODWILL AND OTHER INTANGIBLES, Net                18,482    27,908
                                                  -------   -------
TOTAL                                             $74,841   $85,417
                                                  =======   =======

See notes to consolidated financial statements.              (Continued)

                                       28

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2001 AND 2000
(In Thousands, Except Shares)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY                                             2001        2000
<S>                                                                          <C>         <C>
CURRENT LIABILITIES:
  Short-term borrowings                                                      $  2,000    $      -
  Accounts payable                                                              5,395       3,843
  Accrued payroll liabilities and commissions                                   2,533       3,972
  Accrued customer support and warranty costs                                   1,015         947
  Income tax payable                                                              338         185
  Other accrued liabilities                                                     1,061       1,790
  Customers' deposits                                                           2,200       2,657
  Current portion of long-term debt                                            11,739       3,447
  Liabilities held for sale                                                     2,436           -
                                                                             --------    --------

         Total current liabilities                                             28,717      16,841

LONG-TERM DEBT                                                                  6,581      19,483

DEFERRED INCOME TAXES                                                             301         523

COMMITMENTS AND CONTINGENCIES                                                       -           -

MANDATORILY REDEEMABLE PREFERRED STOCK                                         12,705      14,156

WARRANTS                                                                          826       2,949

SHAREHOLDERS' EQUITY:
  Preferred stock - no par value; 5,000,000 shares authorized;
    none issued and outstanding                                                     -           -
  Common stock - no par value; 15,000,000 shares authorized; 4,751,346 and
    4,733,560 issued and outstanding 2001 and 2000, respectively                9,407       9,329
  Retained earnings                                                            17,507      23,370
  Accumulated comprehensive loss                                               (1,203)     (1,234)
                                                                             --------    --------
           Total shareholders' equity                                          25,711      31,465
                                                                             --------    --------

TOTAL                                                                        $ 74,841    $ 85,417
                                                                             ========    ========
</TABLE>

See notes to consolidated financial statements.                      (Concluded)

                                       29

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
THREE YEARS ENDED SEPTEMBER 30, 2001
(In Thousands, Except Per Share Data)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                     2001        2000        1999
<S>                                                              <C>         <C>         <C>
NET SALES                                                        $ 72,954    $ 67,412    $ 69,531
COST OF SALES                                                      47,186      42,412      43,838
                                                                 --------    --------    --------
           Gross profit                                            25,768      25,000      25,693
                                                                 --------    --------    --------
OPERATING EXPENSES:
  Selling                                                          13,248      12,777      11,125
  Research and development                                          5,371       5,278       4,282
  General and administrative                                        7,487       5,734       5,378
  Amortization of intangibles                                       2,084         713         237
  In-process research and development                                   -         800           -
                                                                 --------    --------    --------
           Total operating expenses                                28,190      25,302      21,022
                                                                 --------    --------    --------
INCOME (LOSS) FROM OPERATIONS                                      (2,422)       (302)      4,671
                                                                 --------    --------    --------
OTHER INCOME (EXPENSE):
  Royalty income                                                      131         110          77
  Interest income                                                     126         379         318
  Interest expense                                                 (1,673)       (427)       (108)
  Other, net                                                          152         118         203
                                                                 --------    --------    --------
           Total other income (expense) - net                      (1,264)        180         490
                                                                 --------    --------    --------
Earnings (loss) from continuing operations before income taxes     (3,686)       (122)      5,161
Income tax (benefit) expense                                       (1,343)       (168)      1,632
                                                                 --------    --------    --------
Net earnings (loss) from continuing operation                      (2,343)         46       3,529
                                                                 --------    --------    --------

Loss from discontinued operation (net of income tax)                 (436)       (379)          -
Loss on sale of discontinued operation (net of income tax)         (2,145)          -           -
                                                                 --------    --------    --------
Total loss from discontinued operation                             (2,581)       (379)          -
                                                                 --------    --------    --------
NET EARNINGS (LOSS)                                                (4,924)       (333)      3,529
Accretion of mandatorily redeemable preferred stock                  (939)       (235)          -
                                                                 --------    --------    --------
Net earnings (loss) available to common shareholders             $ (5,863)   $   (568)   $  3,529
                                                                 ========    ========    ========
</TABLE>

See notes to consolidated financial statements.                      (Continued)

                                       30

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (LOSS)
THREE YEARS ENDED SEPTEMBER 30, 2001
(In Thousands, Except Per Share Data)

--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                        2001    2000       1999
<S>                                                    <C>     <C>         <C>
Net earnings (loss) from continuing operations per
  share - basic and diluted                            (0.69)  (0.04)      0.75
                                                       =====   =====   ========

Net loss from discontinued operations per
  share - basic and diluted                            (0.55)  (0.08)         -
                                                       =====   =====   ========

EARNINGS (LOSS) PER SHARE - Basic and diluted          (1.24)  (0.12)      0.75
                                                       =====   =====   ========

SHARES USED IN PER SHARE CALCULATION - Basic           4,740   4,723      4,707
                                                       =====   =====   ========

SHARES USED IN PER SHARE CALCULATION - Diluted         4,740   4,723      4,711
                                                       =====   =====   ========
</TABLE>

See notes to consolidated financial statements.                      (Concluded)

                                       31

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
THREE YEARS ENDED SEPTEMBER 30, 2001
(Dollars In Thousands)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                 Common Stock                        Accumulated
                                            -----------------------    Retained     Comprehensive
                                               Shares      Amount      Earnings     Income (Loss)      Total
                                           ------------ ----------   ----------   ---------------   ---------
<S>                                         <C>          <C>          <C>             <C>            <C>
Balance at October 1, 1998                  $  4,701,502 $    9,106   $   20,409      $   (200)      $  29,315

Components of comprehensive income (loss):
  Net earnings                                                             3,529                         3,529
  Comprehensive loss - foreign currency
    translation adjustment, net of tax                                                    (264)           (264)
                                                                                                     ---------

           Total comprehensive income                                                                    3,265
                                                                                                     ---------

Issuance of common stock upon exercise of
  stock options                                      100          1            -             -               1

Issuance of stock for Employee Stock
  Purchase Plan                                   12,393         76            -             -              76
                                            ------------ ----------   ----------      --------       ---------

Balance at September 30, 1999                  4,713,995      9,183       23,938          (464)         32,657

Components of comprehensive income (loss):
  Net loss                                                                  (333)                         (333)
  Comprehensive loss - foreign currency
    translation adjustment, net of tax                                                    (770)           (770)
                                                                                                     ---------


           Total comprehensive loss                                                                     (1,103)
                                                                                                     ---------

  Accretion of mandatorily redeemable
    preferred stock                                                         (235)                         (235)

Issuance of common stock upon
    exercise of stock options                     11,500         85            -             -              85

Issuance of stock for Employee Stock
  Purchase Plan                                    8,065         61            -             -              61
                                            ------------ ----------   ----------      --------       ---------

Balance at September 30, 2000                  4,733,560      9,329       23,370        (1,234)         31,465

Components of comprehensive income (loss):
  Net loss                                                                (4,924)                       (4,924)
  Comprehensive income - foreign currency
    translation adjustment, net of tax                                                      31              31
                                                                                                     ---------

           Total comprehensive loss                                                                     (4,893)

  Accretion of mandatorily redeemable
    preferred stock                                                         (939)            -            (939)

Issuance of common stock upon exercise
  of preferred stock and warrants                    602          7            -             -               7

Issuance of stock for Employee Stock
  Purchase Plan                                   17,184         71            -             -              71
                                            ------------ ----------   ----------      --------       ---------

Balance at September 30, 2001               $  4,751,346 $    9,407   $   17,507      $ (1,203)      $  25,711
                                            ============ ==========   ==========      ========       =========
</TABLE>

See notes to consolidated financial statements.

                                       32

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED SEPTEMBER 30, 2001
(In Thousands)
--------------------------------------------------------------------------------

<TABLE>
<CAPTION>
                                                                 2001        2000        1999
<S>                                                           <C>         <C>         <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
 Net earnings (loss)                                          $ (4,924)   $   (333)   $  3,529
 Adjustments to reconcile net earnings (loss) to net cash
     provided by operating activities:
      Loss from sale of discontinued operations, net of tax      2,145           -           -
      Loss from discontinued operations, net of tax                436         379           -
      Foreign currency exchange (gain) loss                       (242)        407         (58)
      Depreciation and amortization                              4,530       3,086       2,371
      In-process research and development                            -         800           -
      Deferred income taxes                                     (1,343)        787         (30)
      Deferred rent                                                 26          31          42
      Bad debt expense (recoveries)                                 63        (103)       (117)
 Changes in assets and liabilities:
    Trade accounts and notes receivable                         (4,204)      4,171      (3,768)
    Inventories                                                  5,052       1,334      (2,125)
    Prepaid expenses and other current assets                      830      (1,181)       (452)
    Accounts payable                                             2,212        (659)        354
    Accrued payroll liabilities and commissions                 (1,259)       (665)      1,665
    Accrued customer support and warranty costs                   (104)        (24)       (246)
    Income taxes payable                                           171        (314)        256
    Other accrued liabilities                                     (735)     (3,442)        280
    Customers' deposits                                           (183)         66         189
    Other                                                          323        (106)          -
                                                              --------    --------    --------

           Cash provided by operating activities                 2,794       4,234       1,890
                                                              --------    --------    --------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Proceeds from sale of short-term investments                       -       3,500           -
  Purchases of short-term investments                                -      (2,519)       (984)
  Proceeds from sale of property                                   478           -           -
  Purchases of property, plant, and equipment                     (621)     (2,165)     (1,338)
  Cash paid for acquired companies, net of cash acquired             -     (16,208)          -
                                                              --------    --------    --------

           Cash used in investing activities                      (143)    (17,392)     (2,322)
                                                              --------    --------    --------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from short-term borrowings                            2,000           -           -
  Payments on long-term debt                                    (5,591)     (2,750)       (539)
  Proceeds from issuance of long-term debt                           -      18,150           -
  Redemption of warrants                                        (2,122)       (703)          -
  Redemption of preferred stock                                 (2,382)          -           -
  Proceeds from issuance of common stock                            71         146          77
                                                              --------    --------    --------

           Cash provided by (used in) financing activities      (8,024)     14,843        (462)
                                                              --------    --------    --------
</TABLE>

See notes to consolidated financial statements                       (Continued)

                                       33




<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE YEARS ENDED SEPTEMBER 30, 2001
(In Thousands)
--------------------------------------------------------------------------------


<TABLE>
<CAPTION>
                                                                   2001        2000        1999
<S>                                                              <C>         <C>         <C>
EFFECT OF EXCHANGE RATE CHANGES ON CASH                          $    (42)   $   (735)   $    (20)
                                                                 --------    --------    --------

NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS FROM CONTINUING OPERATIONS                           (5,415)        950        (914)

NET INCREASE (DECREASE) IN CASH AND CASH
  EQUIVALENTS FROM DISCONTINUED OPERATIONS                           (274)         58          --

CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR                        6,427       5,419       6,333
                                                                 --------    --------    --------

CASH AND CASH EQUIVALENTS, END OF YEAR                           $    738    $  6,427    $  5,419
                                                                 ========    ========    ========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW
  INFORMATION:

    Cash paid during the year for interest                       $  1,818    $    344    $    148
    Cash paid (received) during the year for income taxes            (731)        880       1,408

SUPPLEMENTAL DISCLOSURE OF NONCASH
  INVESTING AND FINANCING ACTIVITIES:
    Equipment obtained through capital leases                    $    126    $     96    $     --
    Accounts payable paid through lease financing                     856          --          --
    Noncash portion of acquisitions (assumption of liabilities
      and issuance of mandatorily redeemable preferred stock
      and warrants)                                                    --      33,249          --
</TABLE>


See notes to consolidated financial statements.                      (Concluded)

                                       34

<PAGE>

KEY TECHNOLOGY, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE YEARS ENDED SEPTEMBER 30, 2001

--------------------------------------------------------------------------------


1.   THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Key Technology, Inc. and its wholly-owned subsidiaries (the "Company")
     design, manufacture, and sell process automation systems, integrating
     electro-optical inspection and sorting, specialized conveying and product
     preparation equipment. The consolidated financial statements include the
     accounts of Key Technology, Inc. and its wholly-owned subsidiaries, Key
     Technology Holdings U.S.A., LLC, Key Technology AMVC LLC, and Key
     Technology FSC, Inc., a foreign sales corporation (FSC). Suplusco Holding
     B.V., a wholly-owned European subsidiary of Key Technology Holdings U.S.A.,
     LLC includes the accounts of Key Technology, B.V. AMVC LLC includes the
     accounts of ARC Netherlands B.V. (inactive) and Applied Laser Systems, Inc.
     (inactive). All significant intercompany accounts and transactions have
     been eliminated.

     Revenue Recognition - Sales revenue net of allowances is recognized at the
     time equipment is shipped to customers or when title passes, or in the case
     of trial units, upon the customers' acceptance of the product. Revenue from
     maintenance and support contracts is recognized ratably over the period the
     service is provided. Revenue from other service contracts is recognized at
     the time the service is provided. Upon receipt of an order, the Company
     generally receives a deposit which is recorded as customers' deposits. The
     Company makes periodic evaluations of the creditworthiness of its customers
     and generally does not require collateral. An allowance for credit losses
     is provided based upon historical experience and anticipated losses.

     Cash and Cash Equivalents and Short-Term Investments - The Company
     considers all highly liquid investments with original maturities of 90 days
     or less at date of acquisition to be cash equivalents. The Company invests
     from time-to-time in short-term investments which consist primarily of
     bankers acceptances and commercial paper with original maturities of
     greater than 90 days and less than one year. These short-term investments
     are typically held to maturity and the carrying value approximates fair
     value.

     Inventories are stated at the lower of cost (first-in, first-out method) or
     market.

     Property, Plant, and Equipment are recorded at cost and depreciated over
     estimated useful lives on the straight-line method. The range in lives for
     assets is as follows:

                                                                   Years

        Buildings and improvements                                7 to 40
        Manufacturing equipment                                   5 to 10
        Office equipment, furniture, and fixtures                  3 to 7

                                       35

<PAGE>

      Goodwill and Other Intangibles - Goodwill is amortized over the estimated
      useful lives of the related goodwill or 15 years, whichever is shorter.
      Patent costs are amortized over the estimated useful lives of the related
      patents or 17 years, whichever is shorter. Management periodically
      evaluates the recoverability of goodwill and other intangibles based upon
      current and anticipated net income and undiscounted future cash flows.
      Amortization of goodwill and other intangibles was $2,084,000, $713,000,
      and $237,000 for the years ended September 30, 2001, 2000, and 1999,
      respectively.

      Accrued Customer Support and Warranty Costs - The Company provides
      customer support services consisting of installation and training to its
      customers. The Company also provides a warranty on its products ranging
      from ninety days to two years following the date of shipment. Management
      establishes a reserve for customer support and warranty costs based upon
      the types of products shipped, customer support and product warranty
      experience and estimates such costs for related new products where
      experience is not available. The provision of customer support and
      warranty costs is charged to cost of sales at the time such costs are
      known or estimable.

      Income Taxes - Deferred income taxes are provided for the effects of
      temporary differences arising from differences in the reporting of
      revenues and expenses for financial statement and income tax purposes
      under the asset and liability method using currently enacted tax rates.

      Foreign Currency Translation - Assets and liabilities denominated in a
      foreign currency are translated to U.S. dollars at the exchange rate on
      the balance sheet date. Translation adjustments are shown separately in
      shareholders' equity. Revenues, costs, and expenses are translated using
      an average rate. Realized and unrealized foreign currency transaction
      gains and losses are included in the consolidated statement of earnings.

      Impairment of Long-Lived Assets - The Company evaluates its long-lived
      assets for financial impairments and will continue to evaluate them if
      events or changes in circumstance indicate the carrying amount of such
      assets may not be fully recoverable.

      Estimates - The preparation of financial statements in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make estimates and assumptions that affect the
      reported amounts of assets and liabilities and disclosure of contingent
      assets and liabilities at the date of the financial statements and
      reported amounts of revenues and expenses during the reporting period.
      Actual results could differ from those estimates.

      Financial Instruments - The carrying value of the Company's cash and cash
      equivalents, short-term investments, accounts and notes receivable, trade
      payables, and other accrued liabilities approximates their estimated fair
      values due to the short maturities of those instruments.

      Earnings Per Share - Basic earnings (loss) per share ("EPS") has been
      computed by dividing net earnings (loss) available to common shareholders
      by the weighted average number of shares outstanding during each period.
      Diluted EPS has been computed by dividing net earnings (loss) available to
      common shareholders by the weighted average common stock and common stock
      equivalent shares outstanding during each period using the treasury stock
      method for employee stock option plans and warrants, and the if-converted
      method for mandatorily redeemable preferred stock, if the common
      equivalent shares were not anti-dilutive. In fiscal years 2001 and 2000,
      all common stock equivalents were anti-dilutive. Net earnings (loss) for
      the calculation of both basic and diluted EPS is the same for each period
      presented. The calculation of the weighted average outstanding shares is
      as follows (in thousands):

                                       36

<PAGE>

                                                    2001    2000    1999

Weighted average shares outstanding - basic        4,740   4,723   4,707
Common stock options and warrant                      --      --       4
                                                   -----   -----   -----

Weighted average shares outstanding - diluted      4,740   4,723   4,711
                                                   =====   =====   =====

Options to purchase 699,433 and 724,833 shares of common stock were outstanding
as of September 30, 2001 and 2000, respectively, but were not included in the
computation of diluted EPS for the year then ended because the options were
anti-dilutive. These options expire on dates beginning May 2003 through February
2011. For the year ended September 30, 1999, options for 509,183 shares of
common stock were not included in the computation of diluted EPS because the
options' exercise prices were greater than the average market price of the
common stock. As of September 30, 2001, common equivalent shares of 892,756 and
82,200 from assumed conversion of mandatorily redeemable preferred stock and
warrants, respectively, were not included in the computation of diluted EPS due
to anti-dilution. As of September 30, 2000, common equivalent shares of
1,091,543 and 294,551 from assumed conversion of mandatorily redeemable
preferred stock and warrants, respectively, were not included in the computation
of diluted EPS due to anti-dilution.

Future Accounting Changes - In July 2001, the Financial Accounting Standards
Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No.
141, Business Combinations. The statement discontinues the use of the pooling of
interest method of accounting for business combinations. The statement is
effective for all business combinations after June 30, 2001. Management has
completed an evaluation of the effects of this statement and believes that it
will not have a material effect on the Company's consolidated financial
statements.

In July 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible
Assets, which is effective October 1, 2002 and may be early adopted by the
Company prior to its filing of its first quarter financial statements on Form
10-Q for the quarter ending December 31, 2001. SFAS No. 142 requires, among
other things, the discontinuance of goodwill amortization. In addition, the
standard includes provisions for the reclassification of certain existing
recognized intangibles, reclassification of certain intangibles out of
previously reported goodwill, and the identification of reporting units for
purposes of assessing potential future impairments of goodwill. SFAS No. 142
also requires the Company to complete a transitional goodwill impairment test
within six months from the date of adoption. The Company is currently assessing
but has not yet determined the effect of SFAS No. 142 on its financial position
and results of operations. Goodwill amortization was $749,000, $299,000, and
$155,000 during the years ended September 30, 2001, 2000, and 1999,
respectively.

In August 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, which is effective October 1, 2003. SFAS No. 143 requires, among
other things, the accounting and reporting of legal obligations associated with
the retirement of long-lived assets that result from the acquisition,
construction, development, or normal operation of a long-lived asset. The
Company is currently assessing but has not yet determined the effect of SFAS No.
143 on its financial position, results of operations, and cash flows.

In October 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which is effective October 1, 2002 but may be
early adopted. SFAS No. 144 addresses accounting and reporting of all long-lived
assets, except goodwill, that are either held and used or disposed of through
sale or other means. The Company has early adopted the provisions of SFAS No.
144 related to discontinued operations (see Note 2).

                                       37

<PAGE>

     Other Assets includes approximately $280,000 of a note receivable due from
     a director of the Company at September 30, 2000. The note was repaid by the
     director during the year ended September 30, 2001.

     Reclassifications - Certain reclassifications have been made to prior year
     amounts to conform to the current year presentation.

     Shipping and Handling - In the fourth quarter of fiscal 2001, the Company
     adopted Emerging Issues Task Force Issue No. 00-10, Accounting for Shipping
     and Handling Fees and Costs ("EITF 00-10"). As a result, the Company now
     accounts for revenue generated by shipping products to customers as net
     sales. Previously, these amounts were included in other income (expense)
     along with the related costs incurred to ship the products. Net sales, cost
     of sales, and other income (expense) for prior periods have been restated
     to reflect EITF 00-10. This change has no effect on reported net earnings
     (loss) or earnings (loss) per share.

2.   DISCONTINUED OPERATION

     Prior to September 30, 2001, management, with Board of Directors approval,
     committed to a plan to sell Ventek, Inc. ("Ventek"), a wholly-owned
     subsidiary that supplies machine vision systems to the forest products
     industry. Ventek was acquired by Key as part of its acquisition of Advanced
     Machine Vision Corporation ("AMVC") in July 2000. In October 2001, the
     Company signed a definitive agreement to sell Ventek to Veneer Technology,
     Inc., a company owned by four current managers of Ventek. The terms of the
     sale include a cash payment of approximately $3.6 million, a note for $0.9
     million and the cashless tender of Veneer Technology's holdings of Key
     Technology Series B convertible preferred stock having a stated redemption
     value of $2.0 million. As a result of the sale of Ventek, the Company
     recorded a one-time charge of approximately $2.1 million, with no tax
     effect, in its fiscal 2001 results.

     Accordingly, the financial statements for fiscal years 2000 and 2001
     reflect Ventek as a discontinued operation.

     In fiscal year 2001, Ventek revenues were $4,992,000 with a pre-tax loss of
     $678,000. For fiscal year 2000, of which Ventek was part of the
     consolidated group since July 12, 2000, Ventek revenues were $1,270,000
     with a pre-tax loss of $586,000.

     The following assets and liabilities were reclassified as held for sale on
     September 30, 2001 (in thousands):

        Assets held for sale:
          Cash                                       $  623
          Accounts receivable                           752
          Inventory                                   2,013
          Intangibles                                 4,902
          Property, plant, and equipment and other      170
                                                     ------

                   Total assets held for sale        $8,460
                                                     ======

        Liabilities held for sale:
          Accounts payable                           $   67
          Accrued payroll                               178
          Customer deposits                             266
          Deferred taxes                              1,925
                                                     ------

                   Total liabilities held for sale   $2,436
                                                     ======

                                       38

<PAGE>

3.   ACQUISITIONS

     Effective June 1, 2000, the Company acquired all the outstanding stock of
     Farmco, Inc. and its sister company, Ro-Tech, Inc. (collectively,
     "Farmco"). The purchase price was $5,040,000. The Company financed the cash
     purchase price from cash on hand, short-term investments and existing lines
     of credits. The acquisition was accounted for as a purchase and Farmco's
     results of operations for the period subsequent to the acquisition have
     been included in the Company's Consolidated Statements of Earnings for the
     year ended September 30, 2000. On September 29, 2000 these legal entities
     were statutorily dissolved and merged with the Company. The purchase price
     has been allocated to the assets and liabilities of Farmco based on their
     estimated fair values. Based on these estimates, the Company recorded
     approximately $1,950,000 of goodwill in its consolidated balance sheet at
     September 30, 2000, which is being amortized on a straight-line basis over
     15 years. Assets and liabilities acquired were as follows (in thousands):

        Fair value of assets acquired:
          Tangible assets                                        $ 1,420
          Patents/developed technologies and goodwill              5,091
        Cash paid for common stock, less cash acquired of $453    (4,587)
                                                                 -------

                   Liabilities assumed                           $ 1,924
                                                                 =======

     The amortization period for patents/developed technologies is ten years.
     The product lines associated with the existing technology are expected to
     continue to generate revenues for an extended period of time.

     Effective July 12, 2000, the Company acquired all the outstanding stock of
     AMVC. The Company financed the purchase of outstanding common and preferred
     stock by issuing $11,539,000 of Series B convertible preferred stock,
     $2,382,000 of Series C convertible preferred stock, $3,652,000 of warrants,
     and by paying cash of $11,621,000. The acquisition was accounted for as a
     purchase and AMVC's operations for the period subsequent to the acquisition
     have been included in the Company's consolidated statements of earnings for
     the year ended September 30, 2000. The purchase price was initially
     allocated to the assets and liabilities of AMVC based on their estimated
     fair values. In its final allocation of purchase price, the Company
     recorded approximately $6,200,000 of goodwill in its Consolidated Balance
     Sheet, which is being amortized on a straight-line basis over 15 years.
     Assets and liabilities acquired were as follows (in thousands):

        Fair value of assets acquired:
          Tangible assets                                           $16,428
          Patents/developed technologies, in-process research and
            development costs and goodwill                           23,998
          Deferred tax assets acquired                                2,610
                                                                    -------

                   Fair value of assets acquired                     43,036
        Less:
          Cash paid for stock, less cash acquired of $2,877          11,621
          Mandatorily redeemable preferred stock issued (both
            Series B and Series C)                                   13,921
          Warrants issued                                             3,652
                                                                    -------

                   Liabilities assumed                              $13,842
                                                                    =======

                                       39

<PAGE>

     The Company obtained independent appraisals of the fair market value of the
     intangible assets acquired. The Company identified eight significant
     categories of projects under development at the date of the acquisition.
     None of the projects in these categories had been proven technologically
     feasible or had generated revenue as of the date of the evaluation. These
     projects are expected to generate revenue in the near future. A one-time
     charge of $800,000 associated with the write-off of acquired in-process
     research and development was recorded upon closing of the transaction.

     The Company identified 11 product categories as developed technologies. The
     amortization period for existing products is 10 years. The product lines
     associated with the developed technologies are expected to continue to
     generate revenues for an extended period of time.

     Pro forma combined statements of operations data (excluding the
     discontinued operation - see Note 2), is presented as if the mergers had
     occurred on October 1 of each year are as follows (dollars in thousands,
     except per share data):

<TABLE>
<CAPTION>
                                                                  September 30,
                                                              ---------------------
                                                                2000*       1999

       <S>                                                    <C>         <C>
       Net sales                                              $ 82,933    $ 92,486
       Net earnings (loss)                                      (3,957)        529
       Accretion of mandatorily redeemable preferred stock        (940)       (940)
       Net earnings (loss) available to common shareholders     (4,897)       (411)
       Pro forma net earnings (loss) per share                   (1.04)      (0.09)
       Pro forma weighted average shares outstanding             4,723       4,707
</TABLE>

     *Pro forma results for the 2000 period presented include an $800,000 charge
     for in-process research and development resulting from the acquisition of
     AMVC.

4.   TRADE ACCOUNTS RECEIVABLE

     Trade accounts receivable consist of the following (in thousands):

                                                             September 30,
                                                        -----------------------
                                                             2001        2000

       Trade accounts receivable                         $ 13,494    $  9,847
       Allowance for doubtful accounts                       (422)       (421)
                                                         --------    --------

                  Total trade accounts receivable, net   $ 13,072    $  9,426
                                                         ========    ========


                                       40

<PAGE>

5.   INVENTORIES

     Inventories consist of the following (in thousands):

                                                             September 30,
                                                         -----------------------
                                                             2001        2000

       Purchased components and raw materials              $  6,099    $  7,964
       Sub-assemblies                                         2,758       2,941
       Work-in-process                                        3,299       4,343
       Finished goods                                         2,305       6,763
                                                           --------    --------

          Total inventories                                $ 14,461    $ 22,011
                                                           ========    ========



6    PROPERTY, PLANT, AND EQUIPMENT

     Property, plant, and equipment consist of the following (in thousands):

                                                             September 30,
                                                         -----------------------
                                                             2001        2000

       Land                                                $  1,407    $  1,768
       Buildings and improvements                             7,236       7,364
       Manufacturing equipment                               11,910      11,213
       Office equipment, furniture, and fixtures             11,971      11,657
       Equipment purchases in process                            --         433
                                                           --------    --------

                                                             32,524      32,435
       Accumulated depreciation                             (21,088)    (18,651)
                                                           --------    --------

          Total property, plant, and equipment - net       $ 11,436    $ 13,784
                                                           ========    ========



7.   FINANCING AGREEMENTS

     At September 30, 2001, the Company had a domestic credit accommodation with
     a commercial bank which provided for revolving credit loans and an
     operating line up to $4,500,000. The operating line expired November 30,
     2001 and was repaid. Borrowings under the operating line were $2,000,000
     and zero at September 30, 2001 and 2000, respectively.

     In January 2002, the Company completed the refinancing of its domestic
     credit accommodation. The accompanying balance sheet as of September 30,
     2001 reflects the effect of this refinancing and the new scheduled debt
     maturities. The refinanced domestic credit accommodation is secured by all
     of the personal property of the Company and contains covenants which
     require the maintenance of a debt service coverage ratio and limit capital
     expenditures.

     Long-term debt consists of the following (in thousands):

                                       41

<PAGE>

                                                               September 30,
                                                           --------------------
                                                             2001        2000

Revolving credit facility dated January 2002, variable
  interest payable monthly at the bank's prime rate
  plus 2% per annum (6.75% at January 7, 2002), due
  November 30, 2002. Total borrowings available based
  on the lesser of $10,000,000 or the available
  borrowing base, which is based on varying percentages
  of eligible accounts receivable and inventories.
  Secured by business personal property.                   $  7,733    $      -

Term loan dated January 2002, variable interest payable
  monthly at the bank's prime rate plus 2% per annum
  (6.75% at January 7, 2002), due in quarterly
  principal payments of $500,000 plus 50% of excess
  cash flow, as defined, subject to minimum payments
  through October 15, 2003. Secured by business
  personal property.                                          6,500           -

Revolving credit agreement, variable interest rate
  (5.6% at September 30, 2001), due in quarterly
  installments, secured by business personal property.
  Refinanced by credit agreement dated January 2002.              -      10,000

Revolving credit agreement, variable interest rate
  (5.6% at September 30, 2001), due in quarterly
  installments, secured by business personal property.
  Refinanced by credit agreement dated January 2002.              -       8,150

Mortgage note payable, interest of 8.3%, due in monthly
  principal and interest installments through May 2008,
  secured by certain land and buildings.                      2,859       2,905

Notes payable, interest rate of 11.25%, due in
  quarterly interest installments through April 2001.
  The principal amount is payable in April 2001.                  -         900

Note payable, interest rate of 6%, due in quarterly
  principal and interest installments through October
  2006, secured by certain land and buildings.                  347         400

Note payable to Veneer Technology, Inc. (which is owned
  by a former director and certain former employees of
  the Company), interest of 6.75%, due in July 2001.              -         250

Note payable, interest rate of 5.625%, due in quarterly
  principal and interest installments through October
  2001, secured by receivables.                                  21         100

Capital leases, interest rates between 6% and 11%, due
  in principal and interest installments through
  September 2005, secured by certain office and
  manufacturing equipment.                                      860         225
                                                           --------    --------
                                                             18,320      22,930
Current portion                                             (11,739)     (3,447)
                                                           --------    --------

     Total long-term debt                                  $  6,581    $ 19,483
                                                           ========    ========

                                      42



<PAGE>

     Principal payments on long-term debt are as follows (in thousands):

          September 30,

             2002                                                      $  11,739
             2003                                                          2,954
             2004                                                            668
             2005                                                            242
             2006                                                            135
          Thereafter                                                       2,582
                                                                       ---------

                    Total                                              $  18,320
                                                                       =========




     Based on the borrowing rates currently available to the Company for loans
     with similar terms and average maturities, the fair value of long-term debt
     at September 30, 2001 approximates carrying value.

8.   LEASES

     The Company has agreements with the Port of Walla Walla to lease two
     operating facilities which expire in 2010. The Company currently has the
     option to purchase the land and plant under both of the agreements. The
     purchase price of one facility is determined by reducing the original plant
     construction costs of approximately $8,800,000 by one thirty-fifth for each
     lease year prior to the exercise of the option and adding $600,000 for the
     land, subject to further reductions if exercised after the fifteenth year
     of the lease. The other facility may be purchased, commencing January 1,
     2002, at the appraised fair market value. The Company also has a leased
     operating facility in Oregon. This lease expires in 2003 and is owned by a
     current employee of the Company. The Company has leased an operating
     facility in The Netherlands. This lease expires in 2008.

     Rent expense is recognized on a straight-line basis over the term of the
     lease. Rental expense for the Company's operating leases referred to above
     was $1,202,000 for the year ended September 30, 2001, $1,152,000 for the
     year ended September 30, 2000, and $1,133,000 for the year ended September
     30, 1999. Rental expense on the leased operating facility in Oregon which
     is owned by an employee of the Company was $120,000, $40,000, and zero for
     the years ended September 30, 2001, 2000, and 1999, respectively.

     The following is a schedule of future minimum rental payments required
     under the operating leases and future rental expense (in thousands):

          Year Ending                                       Rental      Rental
          September 30,                                    Payments     Expense
                                                          ----------   ---------

             2002                                         $  1,179      $  1,194
             2003                                            1,162         1,154
             2004                                            1,108         1,074
             2005                                            1,135         1,074
             2006                                            1,170         1,083
          Thereafter                                         4,342         4,010
                                                          --------      --------

                    Total                                 $ 10,096      $  9,589
                                                          ========      ========


<PAGE>

9.    MANDATORILY REDEEMABLE PREFERRED STOCK AND WARRANTS

      The Company issued 1,340,366 shares of Series B convertible preferred
      stock ("Series B") at a price of $8.60 per share in conjunction with the
      acquisition of AMVC (see Note 3). Series B is convertible at the option of
      the holder at any time, unless previously redeemed, or by the company upon
      a merger, consolidation, share exchange or sale of substantially all of
      its assets. The Series B, par value of $0.01 per share, may be converted
      into 2/3 of a share of common stock. The holders of Series B may require
      the Company to repurchase any or all of their shares at any time after
      July 12, 2002 at the redemption price of $10.00. If not converted to
      common stock or redeemed at the option of the Series B holder after July
      12, 2002, the Company must redeem the Series B for $10.00 per share on
      July 12, 2005. The Series B is being accreted from its issue price to its
      scheduled redemption price using the effective interest method.

      The holders of Series B are entitled to vote on all matters based on the
      number of whole shares of common stock into which the holder's stock could
      be converted. The holders of Series B are not entitled to any dividends.
      In the event of any liquidation, dissolution, or winding up of the
      company's business, the holders of Series B would be entitled to a payment
      of $10.00 per share before any amount is distributed to holders of common
      stock. If assets were insufficient to permit this payment to the holders
      of Series B, the entire assets available for distribution to holders of
      capital stock would be distributed ratably among the holders of Series B.

      The Company also issued 119,106 shares of Series C convertible preferred
      stock ("Series C") at a price of $20.00 per share in conjunction with the
      acquisition of AMVC (see Note 3). In fiscal year 2001, the Series C
      shareholder redeemed the entire outstanding amount of its shares and
      warrants.

      Also, the Company issued 365,222 warrants at a fair market value of $10.00
      per warrant in conjunction with the issuance of the convertible preferred
      stock. Each warrant entitles its holder to purchase at any time for a
      period of five years from July 12, 2001 one share of common stock at
      $15.00 per share, subject to certain adjustments. The warrants permit the
      holder to engage in a net exercise of the warrants if the fair market
      value of one share of common stock is greater than $15.00 per share on the
      date of exercise. Prior to the expiration date of the warrant, the holder
      may require the Company to redeem the warrant for cash at a price equal to
      $10.00 for each whole share of common stock that may be purchased under
      the warrant. The warrant holders do not have the right to vote or
      participate in any other matters as shareholders.

      If all holders were to redeem their preferred stock and warrants at the
      earliest possible time, the cash requirements would be $805,000 presently
      and an additional $11.4 million in July 2002. The Company's ability to
      make cash payments with respect to such equity redemption obligations and
      to satisfy or refinance its other debt obligations will in part depend
      upon its future operating performance. The Company believes, based on
      current circumstances, that its cash flow from operations, together with
      anticipated available borrowings under its new revolving credit facility,
      will not be sufficient to permit it to pay in full its potential equity
      redemption obligations in July 2002. As a result, the Company will be
      required to pursue alternatives that may include reducing or delaying
      capital expenditures, selling assets, restructuring or refinancing present
      debt, restructuring the terms of the preferred stock, or seeking
      additional subordinated debt or equity capital. The Company anticipates
      operating results sufficient to support the availability of these or other
      alternatives.

                                       44

<PAGE>

10.   INCOME TAXES

      The provision (benefit) for income taxes consists of the following (in
thousands):

                                                 Year Ended September 30,
                                           ------------------------------------
                                             2001           2000           1999
Current:
  Federal                                  $      -       $  (906)      $ 1,520
  State
                                                  -           (49)          142
                                           --------       -------       -------
                                                  -          (955)        1,662
                                           --------       -------       ------
Deferred:
  Federal                                    (1,247)          736           (32)
  State                                         (96)           51             2
                                           --------       -------       -------
                                             (1,343)          787           (30)
                                           --------       -------       -------
Total income tax expense (benefit)         $ (1,343)      $  (168)      $ 1,632
                                           ========       =======       =======


      The tax effects of temporary differences that give rise to significant
      portions of deferred tax assets and deferred tax liabilities are as
      follows (in thousands):

                                                      September 30,
                                                  -------------------------
                                                      2001          2000

Deferred tax asset:
  Reserves and accruals                            $  2,091     $  1,807
  NOL carryforward                                    8,150        6,301
  Translation adjustment to equity                      620          636

Deferred tax liability:
  Accumulated depreciation                             (127)        (148)
  Intangible assets                                  (3,775)      (6,183)
                                                   --------     --------

           Net deferred tax asset                  $  6,959     $  2,413
                                                   ========     ========

Deferred tax:
  Current asset                                    $  1,884     $  1,699
  Long-term asset                                     5,376        1,237
  Long-term liability                                  (301)        (523)
                                                   --------     --------

           Net deferred tax asset                  $  6,959     $  2,413
                                                   ========     ========

                                       45

<PAGE>

      Income tax expense (benefit) is computed at rates different than statutory
      rates. The reconciliation between effective and statutory rates is as
      follows:

<TABLE>
<CAPTION>
                                                                              Year Ended September 30,
                                                                           -----------------------------
                                                                            2001        2000      1999
<S>                                                                         <C>         <C>       <C>
          Statutory rates                                                   (34.0)%     (34.0)%    34.0%
          Increase (reduction) in income taxes resulting from:
            FSC commissions                                                  (3.5)      (87.7)     (5.0)
            FSC tax                                                             -        30.3       1.7
            R&D credit                                                       (1.6)      (47.5)        -
            State income taxes, net of federal benefit                       (1.7)       (1.6)      1.8
            Other permanent differences                                       4.3         3.3      (0.9)
                                                                           ------     -------     -----

                     Income tax combined effective rate                     (36.5)%    (137.2)%    31.6%
                                                                           ======     =======     =====
</TABLE>

      At September 30, 2001, there were $23.4 million of net operating loss
      carryforwards which expire between 2004 and 2021, $76,000 of research and
      development credit carryforwards which expire between 2020 and 2021,
      $340,000 of foreign tax credit carryforwards which expire between 2005 and
      2006, and $74,000 of AMT credit carryforwards which do not expire.

11.   SHAREHOLDERS' EQUITY

      Employee Stock Purchase Plan - Most employees are eligible to participate
      in the Company's Employee Stock Purchase Plan (the "Plan"). Shares are not
      available to employees who already own 5% or more of the Company's stock.
      Employees can withhold, by payroll deductions, up to 5% of their regular
      compensation to purchase shares at a purchase price of 85% of the fair
      market value of the common stock on the purchase date. There were 500,000
      shares reserved for purchase under the Plan. During the years ended
      September 30, 2001, 2000, and 1999, the Company issued shares totaling
      17,184, 8,065, and 12,393, respectively, under the Plan.

      Employees' Stock Option Plan - Under the 1996 Employees' Stock Option Plan
      (the "1996 Plan"), eligible employees may receive either incentive stock
      options or nonstatutory stock options and such options may be exercised
      only after an employee has remained in continuous employment for one year
      after the date of grant. Thereafter, the options become exercisable as
      stipulated by the individual option agreements, generally 25% per year on
      the anniversary date of the grant. The option price is determined to be
      fair market value at date of grant. The following table summarizes
      activity under this Plan:

                                       46

<PAGE>

<TABLE>
<CAPTION>
                                                             Outstanding Options
                                                         -----------------------------
                                                                          Weighted
                                                                           Average
                                                         Number of          Price
                                                          Shares          Per Share
<S>                                                      <C>              <C>
Balance at October 1, 1998 ....................          602,783          $   15.19
  Options granted .............................           45,000          $    8.23
  Options exercised ...........................             (100)         $    7.00
  Options forfeited ...........................          (91,700)         $   16.09
                                                         -------

Balance at September 30, 1999 .................          555,983          $   14.48
  Options granted .............................          298,250          $    8.84
  Options exercised                                      (11,500)         $    7.00
  Options forfeited ...........................         (117,900)         $   14.96
                                                         -------

Balance at September 30, 2000 .................          724,833          $   12.20
  Options granted .............................           40,000          $    7.89
  Options exercised ...........................             --                  --
  Options forfeited ...........................          (65,400)         $   13.21
                                                         -------

Balance at September 30, 2001 .................          699,433          $   11.86
                                                         =======
</TABLE>

      At September 30, 2001, the total number of shares reserved for option
      exercises was 1,187,483, of which 488,050 were available for grant. At
      that date, options for 410,066 shares were exercisable at prices from
      $7.00 to $23.25 per share. At September 30, 2000, the total number of
      shares reserved for option exercises was 1,187,483, of which 462,650 were
      available for grant. At that date, options for 326,418 shares were
      exercisable at prices from $7.00 to $23.25 per share. At September 30,
      1999, the total number of shares reserved for option exercises was
      698,983, of which 143,000 were available for grant. At that date, options
      for 320,780 shares were exercisable at prices from $7.00 to $23.25 per
      share.

      During 1995, FASB issued SFAS No. 123, Accounting for Stock-Based
      Compensation, which defines a fair value based method of accounting for
      employee stock options and similar equity instruments and encourages all
      entities to adopt that method of accounting for all of their employee
      stock compensation plans. However, it also allows an entity to continue to
      measure compensation cost for those plans using the method of accounting
      prescribed by Accounting Principles Board Opinion No. 25 ("APB 25").
      Entities electing to remain with the accounting in APB 25 must make pro
      forma disclosures of net income and, if presented, earnings per share, as
      if the fair value based method of accounting defined in SFAS No. 123 has
      been adopted.

      The Company has elected to account for its stock-based compensation plans
      under APB 25. The Company has computed, for pro forma disclosure purposes,
      the value of all stock and stock options granted under the Employee Stock
      Purchase Plan and the 1996 Employees' Stock Option Plan during 2001, 2000,
      and 1999 using the Black-Scholes option pricing model as prescribed by
      SFAS No. 123 using the following weighted average assumptions for the
      years ended September 30, 2001, 2000, and 1999:

                                       47

<PAGE>

                                             2001            2000          1999

Risk-free interest rate                      3.7 %          6.2 %          5.0 %
Expected dividend yield                       0 %            0 %            0 %
Expected lives                             5.5 years      5.5 years      6 years
Expected volatility                          71 %            66 %           66 %



      Using the Black-Scholes methodology, the total value of stock options
      granted during 2001, 2000, and 1999 was $192,000, $1,598,000, and
      $225,000, respectively, which would be amortized on a pro forma basis over
      the vesting period of the options (typically five years). The weighted
      average fair value of options granted under the 1996 Employees' Stock
      Option Plan during 2001, 2000, and 1999 was $5.03 per share, $5.60 per
      share, and $5.28 per share, respectively.

      The total compensatory value of stock purchased under the Employee Stock
      Purchase Plan during 2001, 2000, and 1999 was $12,000, $11,000, and
      $13,000, respectively. The weighted average fair value of the stock
      purchased during 2001, 2000, and 1999 was $0.73 per share, $1.34 per
      share, and $1.08 per share, respectively.

      If the Company had accounted for its 1996 Plan and Employee Stock Purchase
      Plan in accordance with SFAS No. 123, the Company's net earnings and
      earnings per share would approximate the pro forma disclosures below (in
      thousands, except per share amounts):

<TABLE>
<CAPTION>
                                     Year Ended               Year Ended               Year Ended
                                 September 30, 2001       September 30, 2000       September 30, 1999
                              ------------------------ ------------------------ ------------------------
                               As Reported Pro Forma    As Reported Pro Forma    As Reported Pro Forma
<S>                             <C>         <C>         <C>       <C>          <C>        <C>
Net earnings (loss)             (4,924)     (5,542)     (333)     (1,083)      3,529      2,633
Earnings (loss) per share -
  basic and diluted              (1.24)      (1.37)    (0.12)      (0.28)       0.75       0.56
</TABLE>

      The effects of applying SFAS No. 123 in this pro forma disclosure are not
      indicative of future amounts. SFAS No. 123 does not apply to awards prior
      to October 1, 1995, and additional awards are anticipated in future years.

      The following table summarizes information about stock options outstanding
at September 30, 2001:

<TABLE>
<CAPTION>
                      Options Outstanding                              Options Exercisable
----------------------------------------------------------------- -------------------------------
                                      Weighted
                                       Average      Weighted         Weighted
      Range of                        Remaining      Average         Number of       Average
      Exercise          Number       Contractual     Exercise          Shares        Exercise
       Prices         Outstanding   Life (years)      Price         Exercisable       Price
<S>                   <C>           <C>            <C>              <C>             <C>
$7.00 -  10.00            408,483        4.5       $    8.59         144,794        $    8.47
$10.01 - 15.00            117,700        6.2           11.69          92,022            11.67
$15.01 - 20.00             94,450        5.4           17.24          94,450            17.24
$20.01 - 23.25             78,800        4.6           22.58          78,800            22.58
--------------            -------        ---       ---------         -------        ---------
$7.00 -  23.25            699,433        4.9       $   11.86         410,066        $   13.92
==============            =======        ===       =========         =======        =========
</TABLE>

12.   EMPLOYEE BENEFIT PLANS

      The Company has a 401(k) profit sharing plan which covers substantially
      all employees. The Company is required to match 50% of employee
      contributions up to 2% of each participating employee's

                                       48

<PAGE>

      compensation. The Company contributed $331,000, $257,000, and $200,000 in
      matching funds to the plan for the years ended September 30, 2001, 2000,
      and 1999, respectively.

      The 401(k) plan also permits the Company to make discretionary profit
      sharing contributions to all employees. Discretionary profit sharing
      contributions are determined annually by the Board of Directors. Profit
      sharing plan expense was zero, zero, and $506,000 for the years ended
      September 30, 2001, 2000, and 1999, respectively.

13.   SEGMENT INFORMATION

      The Company's business units serve customers in its primary market - the
      food processing and agricultural products industry - through common sales
      and distribution channels. Therefore, the Company reports on one segment.
      The following is information about products and services (in thousands).

<TABLE>
<CAPTION>
                                                   Year Ended September 30,
                                                 -----------------------------
                                                   2001      2000      1999
<S>                                              <C>       <C>       <C>
Net sales by product category:
  Automated inspection systems                   $26,884   $24,002   $22,342
  Process systems                                 27,050    26,414    33,950
  Parts and service/contracts                     19,020    16,996    13,239
                                                 -------   -------   -------
           Total net sales by product category   $72,954   $67,412   $69,531
                                                 =======   =======   =======
</TABLE>

      Net sales for service/contracts were less than 10% of total net sales for
      the years ended September 30, 2001, 2000, and 1999, respectively.

      The following is information about geographic areas:

<TABLE>
<CAPTION>

                                                    Year Ended September 30,
                                                 ----------------------------
                                                    2001      2000     1999
<S>                                              <C>       <C>       <C>
Net sales:
  Domestic                                       $37,496   $40,030   $37,844
  International                                   35,458    27,382    31,687
                                                 -------   -------   -------

           Total net sales                       $72,954   $67,412   $69,531
                                                 =======   =======   =======

Long-lived assets:
  Domestic                                       $26,995   $38,306   $ 6,192
  International                                    3,031     3,332     4,007
                                                 -------   -------   -------
           Total long-lived assets               $30,026   $41,638   $10,199
                                                 =======   =======   =======
</TABLE>

      During fiscal 2001, 2000, and 1999, net sales to one major customer
      amounted to approximately 17%, 14% and 11% of total net sales,
      respectively.

      During 2001, net sales to various customers in France accounted for
      approximately 10% of total net sales. No single geographic location
      accounted for more than 10% of net sales during 2000. During 1999, net
      sales to various customers in Canada accounted for approximately 11% of
      total net sales. Location of the customer is the basis for the
      categorization of net sales.

                                       49

<PAGE>

14.   ROYALTY INCOME

      As part of a settlement agreement entered into during 1997, the Company
      may receive royalty payments through 2001 related to the sale of certain
      equipment to a selected market. The payment may be reduced by a percentage
      of the purchases of equipment from the Company by the other party. The
      Company recognized royalty income from this agreement of $122,000,
      $71,000, and $26,000 during the years ended September 30, 2001, 2000, and
      1999, respectively.

                                   * * * * * *

                                       50

<PAGE>

SUPPLEMENTARY DATA

QUARTERLY FINANCIAL INFORMATION (Unaudited)

The following is a summary of operating results by quarter for the years ended
September 30, 2001 and 2000 (in thousands, except per share data):
<TABLE>
<CAPTION>
2001 Quarter Ended                      December 31,     March 31,    June 30,  September 30,   Total
<S>                                        <C>           <C>          <C>         <C>          <C>
Net sales                                  18,767        18,359       20,518      15,310       72,954
Gross profit                                7,156         5,739        8,156       4,717       25,768
Net earnings (loss) from
continuing operations                        (391)       (1,401)         585      (1,136)      (2,343)
Net earnings (loss) from
discontinued operation                        101          (419)         157      (2,420)      (2,581)
Net earnings (loss)                          (290)       (1,820)         742      (3,556)      (4,924)
Net earnings (loss) from
continuing
  operations per share - basic              (0.13)        (0.35)        0.08       (0.29)       (0.69)
Net earnings (loss) from
continuing
  operations per share - diluted            (0.13)        (0.35)        0.07       (0.29)       (0.69)
Net earnings (loss) from
discontinued
  operations per share - basic and
diluted                                      0.02         (0.08)        0.03       (0.51)       (0.55)
Net earnings (loss) per share -
basic                                       (0.11)        (0.43)        0.11       (0.80)       (1.24)
Net earnings (loss) per share -
diluted                                     (0.11)        (0.43)        0.10       (0.80)       (1.24)

<CAPTION>
2001 Quarter Ended                      December 31,     March 31,    June 30,  September 30,   Total
<S>                                        <C>           <C>          <C>         <C>          <C>
Net sales                                  15,421        17,387       17,035      17,569       67,412
Gross profit                                5,453         6,453        6,929       6,165       25,000
Net earnings (loss) from
continuing
  operations                                   90           834        1,196      (2,074)          46
Net earnings (loss) from
discontinued
  operation                                     -             -            -        (379)        (379)
Net earnings (loss)                            90           834        1,196      (2,453)        (333)
Net earnings (loss) from
continuing
  operations per share - basic and
  diluted                                    0.02          0.18         0.25       (0.49)       (0.04)
Net earnings (loss) from
discontinued
  operations per share - basic and
  diluted                                       -             -            -       (0.08)       (0.08)
Net earnings (loss) per share -
basic
  and diluted                                0.02          0.18         0.25       (0.57)       (0.12)
</TABLE>


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.

    None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

    There is hereby incorporated by reference the information under the captions
"Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" in the Company's definitive Proxy Statement to be filed pursuant to
Regulation 14A, which Proxy Statement is anticipated to be filed with the
Securities and Exchange Commission within 120 days after the end of Registrant's
fiscal year ended September 30, 2001.

                                       51

<PAGE>

ITEM 11. EXECUTIVE COMPENSATION.

    There is hereby incorporated by reference the information under the caption
"Executive Compensation" in the Company's definitive Proxy Statement to be filed
pursuant to Regulation 14A, which Proxy Statement is anticipated to be filed
with the Securities and Exchange Commission within 120 days after the end of
Registrant's fiscal year ended September 30, 2001.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

    There is hereby incorporated by reference the information under the caption
"Principal Shareholders" in the Company's definitive Proxy Statement to be filed
pursuant to Regulation 14A, which Proxy Statement is anticipated to be filed
with the Securities and Exchange Commission within 120 days after the end of
Registrant's fiscal year ended September 30, 2001.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

        There is hereby incorporated by reference the information under the
caption "Certain Relationships and Related Transactions" in the Company's
definitive Proxy Statement to be filed pursuant to Regulation 14A, which Proxy
Statement is anticipated to be filed with the Securities and Exchange Commission
within 120 days after the end of Registrant's fiscal year ended September 30,
2001.

                                       52

<PAGE>

                                     PART IV

ITEM 14.     EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND
             REPORTS ON FORM 8-K.

                                                                           PAGE
                                                                           ----

(a) The following documents are filed as part of this report:


     1.   Financial Statements:

          Reference is made to Part II, Item 8, for a listing of required
          financial statements filed with this report .....................   26

     2.   Financial Statement Schedules:

          Financial statement schedules are omitted because they are not
          applicable or the required information is included in the accompanying
          consolidated financial statements or notes thereto.

     3.   Exhibits:

          (3)  Articles of Incorporation and Bylaws

               (3.1)  Restated Articles of Incorporation (filed as Exhibit 3.1
                      to the Registration Statement on Form S-1 (Registration
                      No. 33-63194) filed with the Securities and Exchange
                      Commission on May 24, 1993 and incorporated herein by
                      reference)

               (3.2)  Restated Bylaws, as amended (filed as Exhibit 3.2 to the
                      Quarterly Report on Form 10-Q for the quarterly period
                      ended December 31, 1993 and incorporated herein by
                      reference)

          (10) Material contracts

               (10.1) Construction and Lease Agreement dated October 17, 1989
                      between the Port of Walla Walla and Registrant (filed as
                      Exhibit 10.1 to the Registration Statement on Form S-1
                      (Registration No. 33-63194) filed with the Securities and
                      Exchange Commission on May 24, 1993 and incorporated
                      herein by reference)

               (10.2) Indenture of Trust dated as of February 1, 1993 between
                      Port of Walla Walla Public Corporation and Key Bank of
                      Washington, as Trustee (filed as Exhibit 10.2 to the
                      Registration Statement on Form S-1 (Registration No.
                      33-63194) filed with the Securities and Exchange
                      Commission on May 24, 1993 and incorporated herein by
                      reference)

               (10.3) Loan Agreement dated February 1, 1993 between Port of
                      Walla Walla Public Corporation and Registrant (filed as
                      Exhibit 10.3 to the Registration Statement on Form S-1
                      (Registration No. 33-63194) filed with the Securities and
                      Exchange Commission on May 24, 1993 and incorporated
                      herein by reference)

               (10.4) Pledge and Security Agreement dated as of February 1, 1993
                      between Registrant and U.S. Bank of Washington, N.A.
                      (filed as Exhibit 10.4 to the Registration Statement on
                      Form S-1 (Registration No. 33-63194) filed with the
                      Securities and Exchange Commission on May 24, 1993 and
                      incorporated herein by reference)

                                       53

<PAGE>

                      (10.5)*   Registrant's 1989 Employees' Stock Option Plan,
                                as amended (filed as Exhibit 10.5 to the
                                Registration Statement on Form S-1 (Registration
                                No. 33-63194) filed with the Securities and
                                Exchange Commission on May 24, 1993 and
                                incorporated herein by reference)
                      (10.6)*   Registrant's 401(k) Profit Sharing Plan dated
                                May 11, 1992 (filed as Exhibit 10.6 to Amendment
                                No. 1 to Form S-1 (Registration No. 33-63194)
                                filed with the Securities and Exchange
                                Commission on May 24, 1993 and incorporated
                                herein by reference)
                      (10.7)*   Registrant's Restated Phantom Stock Plan, as
                                amended (filed as Exhibit 10.7 to the
                                Registration Statement on Form S-1
                                (Registration No. 33-63194) filed with the
                                Securities and Exchange Commission on May 24,
                                1993 and incorporated herein by reference)
                      (10.8)    License Agreement effective July 1, 1992
                                between Registrant and Simco/Ramic
                                Corporation (filed as Exhibit 10.8 to the
                                Registration Statement on Form S-1
                                (Registration No. 33-63194) filed with the
                                Securities and Exchange Commission on May 24,
                                1993 and incorporated herein by reference)
                      (10.9)*   Registrant's Restated 1989 Employees' Stock
                                Option Plan, as amended (filed as Exhibit 10.1
                                to the Form 10-Q filed with the Securities and
                                Exchange Commission on May 12, 1995 and
                                incorporated herein by reference)
                      (10.10)*  Registrant's 1996 Employees' Stock Option Plan
                                (filed as Exhibit 10.1 to the Form 10-Q filed
                                with the Securities and Exchange Commission on
                                May 2, 1996 and incorporated herein by
                                reference)
                      (10.11)*  Registrant's 1996 Employees Stock Purchase Plan
                                (filed as Exhibit 10.2 to the Form 10-Q filed
                                with the Securities and Exchange Commission on
                                May 2, 1996 and incorporated herein by
                                reference)
                      (10.12)   Lease Agreement dated April 18, 1996 between the
                                Port of Walla Walla and Registrant (filed as
                                Exhibit 10.1 to the Form 10-Q filed with the
                                Securities and Exchange Commission on August 7,
                                1996 and incorporated herein by reference)
                      (10.13)   Business Loan Agreement dated as of January 25,
                                1999 between Registrant and U.S. Bank National
                                Association (filed as Exhibit 10.1 to the Form
                                10-Q filed with the Securities and Exchange
                                Commission on May 14, 1999 and incorporated
                                herein by reference)
                      (10.14)   Agreement and Plan of Merger by and among the
                                Registrant, KTC Acquisition Corp. and Advanced
                                Machine Vision Corporation dated February 15,
                                2000 as amended by Amendment No. 1 dated
                                February 25, 2000 and as amended by Amendment
                                No. 2 dated April 24, 2000 (filed as Exhibit 2.1
                                to the Form 8-K filed with the Securities and
                                Exchange Commission on July 27, 2000 and
                                incorporated herein by reference)
                      (10.15)   Stock Purchase Agreement by and among the
                                Registrant, Farmco, Inc., Ro-Tech, Inc., John E.
                                Mobley and Nancy L. Mobley dated May 16, 2000
                                (filed as Exhibit 2.1 to the Form 8-K filed with
                                the Securities and Exchange Commission on May
                                31, 2000 and incorporated herein by reference)
                      (10.16)   Promissory Note dated April 24, 1998 between SRC
                                Vision, Inc. and Bank of America National Trust
                                & Savings Association (filed as Exhibit 10.17 to
                                Form 10-K filed with the Securities and Exchange
                                Commission on December 19, 2000 and incorporated
                                herein by reference)

                                       54

<PAGE>

              (21)    List of Subsidiaries

              (23)    Consent of Deloitte & Touche LLP

              (99)    Forward-Looking Statement Risk and Uncertainty Factors

              ________________
              * Management contract or compensatory plan or arrangement.

(b) Reports on Form 8-K

        1.  No reports on Form 8-K were filed by the Registrant during the last
            quarter of the fiscal year ended September 30, 2001.

                                       55

<PAGE>

                                   SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                KEY TECHNOLOGY, INC.

                                By: /s/ Thomas C. Madsen
                                   ---------------------------------------------
                                    Thomas C. Madsen
                                    Chairman and Chief Executive Officer

                                By: /s/ Ted R. Sharp
                                   ---------------------------------------------
                                    Ted R. Sharp
                                    Chief Financial Officer
                                    (Principal Financial and Accounting Officer)

January 15, 2002


Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons on behalf of the Registrant and in the
capacities and on the dates indicated.

/s/  Thomas C. Madsen                                          January 15, 2002
-------------------------------------------------------
Thomas C. Madsen, Chairman and Chief
Executive Officer

/s/  Harold R. Frank                                           January 15, 2002
-------------------------------------------------------
Harold R. Frank, Director

/s/  John E. Pelo                                              January 15, 2002
-------------------------------------------------------
John E. Pelo, Director

/s/  Michael L. Shannon                                        January 15, 2002
-------------------------------------------------------
Michael L. Shannon, Director

/s/  Peter H. van Oppen                                        January 15, 2002
-------------------------------------------------------
Peter H. van Oppen, Director

/s/  Gordon Wicher                                             January 15, 2002
-------------------------------------------------------
Gordon Wicher, Director

/s/  Ted R. Sharp                                              January 15, 2002
-------------------------------------------------------
Ted R. Sharp, Chief Financial Officer
  (Principal Financial and Accounting Officer)

                                       56

<PAGE>

                              KEY TECHNOLOGY, INC.
                                    FORM 10-K
                                  EXHIBIT INDEX

    EXHIBIT
    NUMBER                                                                 PAGE
    ------                                                                 ----

     21.1   List of Subsidiaries .........................................   58

     23.1   Consent of Deloitte & Touche LLP .............................   59

     99.1   Forward-Looking Statement Risk and Uncertainty Factors .......   60

                                       57