Key Tronic Corporation (NASDAQ:KTCC) Q1 2024 Earnings Call Transcript

Key Tronic Corporation (NASDAQ:KTCC) Q1 2024 Earnings Call Transcript October 31, 2023

Operator: Good day, and welcome to the Key Tronic First Quarter Fiscal 2024 Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Brett Larsen. Please go ahead.

Brett Larsen: Thank you. Good afternoon, everyone. I am Brett Larsen, Chief Financial Officer of Key Tronic. I would like to thank everyone for joining us today for today's conference call. Joining me here in our Spokane Valley headquarters is Craig Gates, our President and Chief Executive Officer. As always, I would like to remind you that during the course of this call, we might make projections or other forward-looking statements regarding future events or the company's future financial performance. Please remember that such statements are only predictions. Actual events or results may differ materially. For more information, you may review the risk factors outlined in the documents the company has filed with the SEC, specifically our latest 10-K, quarterly 10-Qs and 8-Ks. Please note that on this call, we will discuss historical financial and other statistical information regarding our business and operations.

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Some of this information is included in today's press release, and a recorded version of this call will be available on our website. Today, we released the results for the three months ended September 30, 2023. For the first quarter of fiscal 2024, we reported revenue of approximately $147.8 million, up 8% from $137.3 million in the same period of fiscal 2023. The increase in revenue reflects the continued ramp in production for new programs, particularly those produced in our U.S. facilities. Revenue is down sequentially from the fourth quarter of fiscal 2023 due to the customers' redesign of a large outdoor power equipment program, but we estimate that program to come back online later in fiscal 2025. The company's gross margin for the first quarter of 2024 was 7.4%, and operating margin was 2.2% compared to a gross margin of 7.6% and an operating margin of 2.4% in the same period of fiscal 2023.

The margins in the first quarter of fiscal 2024 included severance costs of about $0.6 million as we reduced our workforce by over 100 employees in Mexico and in the U.S. The workforce reduction reflects some softening demand for a number of different programs for the next few quarters in Mexico and is expected to reduce operating expenses by more than $5 million on an annualized basis. Excluding these severance costs in the first quarter of fiscal 2024, gross margins and operating margins would have been approximately 7.8% and 2.6%, respectively. Our recent production efficiencies, strategic labor cost reductions and the gradual stabilization in the supply chain and labor markets has been largely offset by the strengthening of the Mexican peso relative to the U.S. dollar in recent months.

However, in the second quarter of fiscal 2024, we are beginning to see the peso weakened to the U.S. dollar, which may translate into improving conditions moving forward. For the first quarter of fiscal 2024, net income was $0.3 million or $0.03 per share compared to $1.2 million or $0.11 per share for the same period of fiscal 2023. The year-over-year decline in earnings was primarily due to a $1.1 million increase in interest expense on higher interest rates and an unanticipated severance cost of $0.6 million or approximately $0.04 to $0.05 per diluted share. Net income continued to be adversely impacted by the strength of the Mexican peso. Turning to the balance sheet. We ended up the first quarter of fiscal 2024 with reducing inventory by approximately $43 million or roughly 25% from the same time a year ago, primarily reflecting increased shipments and a concerted effort to drive inventory reductions.

Total inventory turns increased to 4x in the first quarter of fiscal 2024, up from 3.1 turns a year ago. We are pleased to see our inventory levels start to become in line with our current revenue. At the same time, the state of the worldwide supply chain still requires that we look out much further in the future than in historical periods. We are still recovering from the COVID supply chain chaos as our customers have revamped their forecasting methodologies, and we have significantly modified and improved our material resource planning algorithms. As a result, we should be better equipped for future disruptions in the supply chain even as we continue to drive inventory down. During the first quarter, we also reduced accounts payable, leasing obligations and overall debt by a combined amount of $22.7 million during the quarter.

At the same time, accounts receivable remained relatively flat on increased revenues year-over-year with DSOs at 81 days, down from 91 days a year ago, which we believe reflects some improvement of certain customers with respect to disruptions from supply chain issues. Total capital expenditures were about $0.4 million for the first quarter of fiscal 2024, and we expect total CapEx for the full fiscal year to be around $8 million. While we're carefully keeping an eye out on capital expenditures, we plan to continue to invest selectively in our production equipment, SMT equipment and plastic molding capabilities, utilize leasing facilities as well as make efficiency improvements to prepare for growth and add capacity. For the second quarter of fiscal 2024, we're seeing a continued increase in demand for programs based in our U.S. facilities and some softening of customer demand for our Mexico-based programs.

As previously announced, the large program with a leading power equipment company, is now expected to resume materially in fiscal 2025 rather than 2024 with a customer redesigned product. For the second quarter of fiscal 2024, we expect to report revenue in the range of $135 million to $145 million and earnings in the range of $0.05 to $0.10 per diluted share. In the second half of fiscal 2024, we expect increased demand for our Mexico-based programs and continued growth in the U.S. and Vietnam. We also have a strong pipeline of potential new business. Over the longer term, we believe that we are increasingly well positioned to win new EMS programs and continue to profitably expand our business. That's it for me. Craig?

Craig Gates: Thanks, Brett. During the first quarter of fiscal 2024, we continue to ramp many new programs produced in our U.S. facilities and remain profitable despite a temporary softening of customer demand for our Mexico-based programs. We're also pleased to see our inventories be more in line with current revenue levels and other improvements made on the balance sheet. Over the past four years, we have seen a 9.4% CAGR of revenue, largely driven by an increase in new programs predominantly in North America. During the same four years, we have seen our total number of new customer programs grow by approximately 100% from the number in fiscal 2020, while revenues increased by 31% over the same period. This has led to less concentration in any single customer and has enabled us to be less financially dependent on any single program.

During fiscal 2023, we had only one customer that represented over 10% of revenues, and they represented only 12%. Meanwhile, our U.S. sites have added over $60 million in new program wins in the past 12 months as a direct result of continued onshoring. Moving into fiscal 2024, we continue to see the favorable trend of contract manufacturing returning to North America. As a result, we continued to expand our customer base and won new programs involving security equipment, sporting goods, environmental solutions and industrial control systems. Global logistics problems and China-U.S. geopolitical tensions continue to drive OEMs to examine their traditional outsourcing strategies. We believe these customers increasingly realize that they have become overly dependent on their China-based contract manufacturers for not only product but also for design and logistics services.

Over time, the decision to onshore or nearshore production is becoming more widely accepted as a smart long-term strategy. As a result, we see opportunities for continued growth. Moreover, a growing number of potential customers are actively evaluating the migration of the China-based manufacturing to our facility in Vietnam. In the coming years, we expect our Vietnam facility to play a major role in our growth. While China growth has slowed and many companies have decided to take risk mitigation steps with their China manufacturers, the fact remains that many components must be sourced from China. Our procurement group in Shanghai, which serves the entire corporation, remains important for managing the China component supply chain on an ongoing basis.

The combination of our global footprint and our expansive design capabilities is proving to be extremely effective in capturing new business. Many of our large and medium-sized manufacturing program wins are predicated on Key Tronic's deep and broad design services. And once we have completed a design and ramped it into production, we believe our knowledge of a program-specific design challenges makes that business extremely sticky. We also invested in vertical integration and manufacturing process knowledge, including a wide range of plastic molding, injection below gas assist multi-shot as well as PCB assembly, metal forming, painting, and coating, complex high-volume automated assembly and the design, construction and operation of complicated test equipment.

This expertise may set us apart from our competitors of a similar size. As a result, a customer looking to leave their contract manufacturer will find a one-stop shop in Key Tronic, which is expected to make the transition to our facilities much less risky than cobbling together a group of providers each limited to a portion of the value chain. In fact, most of the new customers we have onboarded take advantage of this one-stop shop capability that we provide. We believe global logistics problems, China-U.S. political tensions and heightened concerns about supply chains will continue to drive a favorable trend of contract manufacturing returning to North America as well as to our Vietnam facilities. We continue to see improvement across the metrics associated with business development, including a significant increase in the number of active quotes with prospective customers.

This unprecedented increase in demand for our unique mix of skills, location and people has enabled us to negotiate more favorable pricing terms and business parameters than in the past as well as to be much more selective in the new customers we bring on. While this shift in leverage will not manifest in the short term, its effect on our long-term performance should be profound. We move into fiscal 2024 with a strong pipeline of potential new business, and we're seeing some improvement in our gross margins. Production delays and softness in demand in Q2 and higher interest rates and a strong peso will continue to dampen our growth and profitability in the near term. Nevertheless, we're very encouraged by our progress and potential for growth in fiscal 2024 and beyond.

This concludes the formal portion of our presentation. Brett and I will now be pleased to answer your questions.

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