Q3 2023 Key Tronic Corp Earnings Call
Participants
Brett R. Larsen; Executive VP of Administration, CFO & Treasurer; Key Tronic Corporation
Craig D. Gates; President, CEO & Director; Key Tronic Corporation
Sheldon Grodsky; President, Financial & Operations Principal, Treasurer, Secretary, CEO, CFO and CCO; Grodsky Associates, Inc.
William J. Dezellem; President, CIO & Chief Compliance Officer; Tieton Capital Management, LLC
Presentation
Operator
Please stand by. Good day, and welcome to the Third Quarter Fiscal 2023 Key Tronic Corporation Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Brett Larsen. Please go ahead.
Brett R. 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 our investor 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, on this call, we will discuss historical, financial and other statistical information regarding our business and operations. 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 our results for the quarter ended April 1, 2023. For the third quarter of fiscal 2023, we reported record quarterly total revenue of $164.6 million, up 19% from $138.4 million in the same period of fiscal 2022. As expected, the significant increase in revenue for the third quarter of fiscal 2023 included approximately $20 million in production for the large program with a leading power equipment company as well as increased demand from a number of other customers. For the first 9 months of fiscal 2023, our total revenue was $425.5 million, up 5% or up 5% from $405.6 million in the same period of fiscal 2022. For the third quarter of fiscal 2023, our gross margin was 8.7% and operating margin was 3.1% and up from a gross margin of 8.3% and an operating margin of 2.0% in the same period of fiscal 2022.
Our gross margin in the third quarter of fiscal 2023 benefited from increased revenue levels and some stabilization in the labor market, but it was adversely impacted by a strengthening of the Mexican peso relative to the U.S. dollar. For the third quarter of fiscal 2023, our net income was $2 million or $0.18 per share, up 100% from $1 million or $0.09 per share for the same period of fiscal year 2022. Our results for the third quarter of fiscal 2023 include a gain on insurance proceeds of roughly $400,000 or approximately $0.03 per share related to equipment damage in the storm at our Arkansas facility earlier in the year. For the first 9 months of fiscal 2023 net income was $4.1 million or $0.38 per share, up 73% from $2.4 million or $0.22 per share for the same period of fiscal 2022.
Turning to the balance sheet. We ended the third quarter with total working capital of $199 million and a current ratio of 2.2:1. Our receivables increased by $14.1 million from a year ago, reflecting the growth in our revenue levels. At the same time, our DSOs were at 79 days, down from 92 days a year ago, which we believe reflects improvement among certain customers with respect to disruptions from COVID-19 and supply chain issues. At the end of the third quarter of fiscal 2023, our inventory decreased by approximately $17.4 million or roughly 10% from the prior period, primarily reflecting increased shipments during the quarter. While the state of the worldwide supply chain still requires that we look out much further in the future than in historical periods, we attempt to carefully balance customer demand in the likelihood of successfully bringing in parts in time for planned production. In coming quarters, we expect to see our inventory levels continue to decrease and inventory turns to continue to improve.
Total capital expenditures were about $1.1 million for the third quarter of fiscal 2023, and we expect total CapEx for the year to be around $9 million. We've also utilized the insurance proceeds from the storm damage to modernize our operations, which should increase efficiencies in our Arkansas facility. While we're keeping a careful eye 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. Despite disruptions from the global supply chain that have continued to limit production and adversely impact operating efficiency -- operating efficiencies, we are expecting significant growth in fiscal 2023. For the fourth quarter of fiscal 2023, we expect to report revenue in the range of $150 million to $160 million and earnings in the range of $0.10 to $0.20 per diluted share.
While profitability has improved with increasing revenue, higher interest rates on our line of credit and the strong Mexican peso will continue to limit a portion of that expected improvement. In summary, we continue to grow our pipeline of new sales prospects and continue to increase our customer demand to unprecedented levels for Key Tronic. We believe that we are increasingly well positioned to win new EMS programs and to continue to profitably expand our business over the longer term. That's it for me, Craig.
Craig D. Gates
Okay. Thanks, Brett. We're pleased with the significant growth in our revenue and earnings in the third quarter of fiscal 2023, driven by our successful ramp of new programs, including major contributions from the large power equipment program. Production for that program is now fully on track. During the third quarter of fiscal 2023, we continue to see the favorable trend of contract manufacturing returning to North America. Currently awarded new business has created backlog that will support over 20% growth in the U.S. sites over the next fiscal year. We have continued to expand our customer base and won new programs involving security equipment, video, tin ball machines, mining, safety and productivity products as well as communication devices. Global logistics problems, war in Europe 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 the 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.
As we've discussed in prior calls, we built Key Tronic to offer the ideal solution for customers as they move to respond to deal with political pressures. Our facilities in Mexico represent a campus of 1.8 million. square feet in Juarez, most of which is continuously located in 9 facilities acquired over time. Our 3 U.S.-based manufacturing sites have also benefited greatly from the macro forces driving business back to North America. Moreover, a growing number of potential customers are actively evaluating a migration of their China-based manufacturing to our facilities in Vietnam. Our Shanghai plant has added capability to management staff and systems that allow it to serve Chinese customers directly. Shanghai has replaced the business that we moved to Vietnam and our procurement group in Shanghai, which serves the entire corporation is important for managing the supply issues that cripple many of our competitors without boots on the ground in China. 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 wrapped 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 molding, blow 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 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.
We believe global logistics problems, China U.S. political tensions and heightened concerns about supply chains will continue to drive the favorable trend of contract manufacturing returning to North America as well as our expanding Vietnam facilities. The fact that we are continuing to see significant backlog levels in the fourth quarter indicates our growing momentum. Along with the records we are setting for revenue, we see a noteworthy improvement in all metrics associated with business development. For example, over the past year, the number of active quotes with prospective customers has increased significantly. This unprecedented increase in demand for our unique mix of skills, location and people as powerful applications beyond the obvious revenue growth potential. In particular, we have been able to negotiate more favorable pricing turns 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 moved into the fourth quarter with significant backlog levels and a strong pipeline of potential new business, and we're seeing improvement in the global supply issues and lower labor turnover, which severely limited our production in prior periods. We're very encouraged by our progress and potential for growth. This concludes the formal portion of our presentation. Brett and I will now be pleased to answer your questions.
Question and Answer Session
Operator
(Operator Instructions) We will pause for just a moment to allow everyone the opportunity to signal for questions. We will take our first question from Bill Dezellem with Tieton Capital.
William J. Dezellem
Relative to the 4 wins that you had this quarter, what is the size of each of them? Were they existing customers with new programs or new customers? And were any of these for Vietnam?
Craig D. Gates
No more for Vietnam. The largest was a new program actually with a new division, a different division of a current customer. That was worth $15 million. Next one was new customer worth about $5 million. Next one new customer worth about $3.5 million. Next one, new customer worth about $3 million and then quite a few other smaller ones, total up around $1.7 million for the total wins in this last quarter.
William J. Dezellem
And so these wins are primarily if they're in that the $5 million range, I'm presuming these are coming to U.S. locations.
Craig D. Gates
Yes. The top one the $15 million one is going to (inaudible). The other 4 or 3 plus miscellaneous are going to the U.S.
William J. Dezellem
Right. And you did say the first one was $15 million, correct?
Craig D. Gates
Correct.
William J. Dezellem
Yes. Okay. And so these that are going to the U.S. locations, are those coming from China? Or are those just business that's being picked up around the country from the internal manufacturing or other U.S. manufacturers?
Craig D. Gates
I've seen the biggest one of those U.S. came from China. The other 3 are people that were doing it in the States.
William J. Dezellem
That's helpful. And then anything else you'd like to add on any of these?
Craig D. Gates
No.
William J. Dezellem
Shifting then to the power equipment company. Talk to us about the future with that relationship. Is this like a one-and-done sort of deal? Does this go on? How are you thinking about this?
Craig D. Gates
Well, the first piece of business will be in a bit of a slowdown from the end of this current quarter through the first quarter of next fiscal year and then that will ramp back up to larger than it was this year. And then once we complete that season is worth, we have already been awarded 2 other pieces of off-cycle business that will fill in next year's summer production with other products. So it's definitely not a one-and-done. The relationship has been a success and is going to expand over the coming periods.
William J. Dezellem
Congratulations. So I presume then that your guidance -- revenue guidance being down a bit sequentially. That's really the seasonality that you're referencing with this customer?
Craig D. Gates
Yes.
William J. Dezellem
And if I just heard you correctly, that next year, we won't have this seasonality because of the 2 additional programs you've won.
Craig D. Gates
Yes.
William J. Dezellem
Excellent. All right. That's helpful. And then would you further dive into one of your opening comments, and it was also in the press release that you have potential customers that are evaluating the Vietnam facility and moving product from China there.
Craig D. Gates
So that just follows the trend we've been talking about is people are trying to find solutions to be focusing so much of their production in China. And there are places people are looking at India, Vietnam, Eastern Europe, Mexico, United States. So it just depends on a customers given situation on where they're going to land which location meets their requirements.
William J. Dezellem
And does Vietnam, other than its geographic location and proximity to China have any meaningful benefit for either larger programs and so it's really competing with Mexico or smaller programs so it's really competing with the U.S.? Or is it entirely a geographic play? Can you fill in a little bit more around that?
Craig D. Gates
Vietnam is nominally less expensive than China, which puts it novelly less expensive than Mexico by quite a bit. You still have the logistics problems and getting product back to the States or Europe, if that's where your product is going. Workforce was finding to be excellent, goverment, oversight and influence we're finding to be very good. All in all, we announce there's been a very positive experience for us and the customers that are there now with us.
William J. Dezellem
And how big are these customers that are evaluating Vietnam?
Craig D. Gates
They have large programs in the $20 million to $50 million to $80 million range.
William J. Dezellem
And do you find yourself -- so the spirit of this question is your likelihood of winning lots of business. So do you find yourself as you are competing for this business and in the evaluation process, making lots of progress working down to the finalist list or are you finding some regular hurdles that you need to address? How is that developing?
Craig D. Gates
The only regular hurdle that we had issues with was COVID, and that shut us down for a while in terms of getting prospective customers in to view the plant. As you look at the way OEMs outsource their products, it seems like a lot of outsourcing is done as a response to CEO edict. And for years, CEO Edit was go to China, I don't care what you say, China is best. Now the CEO Edit appears to be get out of China. I'm not sure where you should go, come tell me where you're going to go. So we have people that are really looking at business -- putting business with us, and they're not sure which location they want to put it in. So we've started setting up our quotes, so it's very easy for us to flip the rates and quote a product out of Mexico out of the Midwest and out of Vietnam and then have a discussion with our customer or prospective customer on the pluses and minuses of each of those locations and how they map on to whatever that customer situation is. So I don't see a -- there is no common theme of what we have to overcome in selling Vietnam. It's more a case of that location gathering steam and acceptance among people who are making the Edit without doing a whole lot of in-depth analysis of the pluses and minuses of the various options.
William J. Dezellem
That's helpful, Craig. And I know I've taken up a lot of time, but I would like to ask one more. Relative to other competitors in Vietnam. And I did hear what you just said that you quote with the price for the U.S., a price for Mexico and a price for Vietnam and then talk about the pros and cons. But if someone is making a decision that they want to be in Vietnam, are you finding that you all have any special advantage or disadvantage relative to others that are in Vietnam that would be competing on the same quotes?
Craig D. Gates
Well, one advantage we have is that we chose the right city. So Danang is working out very well compared to our other 2 options. And the other advantage we have is that we run our program management out of the States, most of the customers that are looking to exit China or go to Asia for the first time are comforted by the fact that their program managers will be speaking to them in English on the American time zone. So those 2 advantages, coupled with the fact that you can get our design services, our production process development, our quality system, you can get all of that in a new location in Vietnam is a pretty big advantage to somebody who's just starting the first offshore facility or somebody who is headquartered somewhere other than the U.S.
William J. Dezellem
Great. Thank you on a fantastic quarter. It's nice to see all the success of the last or the efforts of the last few years starting to turn into success.
Operator
We will take our next question from Sheldon Grodsky with Grodsky Associates.
Sheldon Grodsky
Good afternoon, everybody. The first thing I'm just going to mention is that your stock is actually down in the aftermarket. Do you know of any expectations that people had that were unusually high that would explain that? I mean it looks like the numbers are pretty good, other than the low end of your estimate for the next quarter for earnings.
Craig D. Gates
No. I don't know what's going on.
Sheldon Grodsky
Okay, anyhow. So I believe you said and I hope the naysayers will hear the question. I believe that you said that you're expecting revenue growth over the next year to be roughly 20%.
Craig D. Gates
20% in our domestic locations.
Sheldon Grodsky
Your domestic locations?
Craig D. Gates
Correct.
Sheldon Grodsky
Okay. Did you say anything about overall?
Craig D. Gates
We never give that type of information out because we are too much affected by things we can't control.
Sheldon Grodsky
Okay. So it's 20% in the U.S., okay. In any case, I keep waiting every quarter for a breakout quarter. And do you think this was a breakout quarter for you?
Craig D. Gates
Well, in my book, $164 million was pretty broken.
Sheldon Grodsky
Okay. I noticed that your interest expenses are growing very rapidly as one would expect in the current environment where we're moving off the 0% interest rates. I assume that until you get to reduce some of your working capital, that will probably continue to be a big number for you. Is that correct?
Craig D. Gates
Yes. And our big goal, which we are seeing some nice success with is driving inventory out. We like everybody else in our sector had our inventory balloon during COVID. And so we're working hard and effectively to drive that out. So inventory down, accounts receivable up, accounts payable down and all said that it's headed in the right direction. But for sure, our government is doing -- our government is doing neither us or anybody in business, any favors.
Sheldon Grodsky
Say it again, please?
Craig D. Gates
I said for sure, our government is doing neither us or any of our competitors, any favors with their current monetary policy.
Operator
We will go back to Bill Dezellem with Tieton Capital.
William J. Dezellem
One of the things that we really haven't addressed but with the economy, is the elephant in the room is the question of recession. What are you seeing from your customers really since you have such a broad base that would indicate that there seems to be resilience, slowdown, mixed messages, share with as much as you can, please?
Craig D. Gates
Well, I saw recently the good old Elon Musk said that he had the most knowledge of anybody in the world about the economy, and when I look at our 200 customers, I disagree. I think it's us. I think your question is very valid. Last quarter, I think I told you that we were seeing hardly any signs of a change in the wind. And unfortunately, right now, we are beginning to see some signs of the wind changing into a bad direction. We've probably got -- probably got maybe 5% of our revenue base is giving us push out and reduction signals. At the same time, we've got probably more than that, giving us pull in and speed up singles. So it's still in the mix both but there's more downturn than what I saw 3 months ago.
William J. Dezellem
Are there any more upturns or are the upturn similar?
Craig D. Gates
I'd say the upturns are about the same.
William J. Dezellem
And given the supply chain challenges, do you have a sense that some of your customers built inventory is really safety stock and that some of the adjustments that you're seeing now is that same group of customers reversing safety stock? Or are you sensing that something different than that?
Craig D. Gates
I don't think people were able to build safety stock. And I think this mess that's on us now came along too quick for people to get safety stock built before they started seeing a downturn. So people were already talking about a downturn before we actually cleared the majority of the supply constraints. And a lot of where I see the pressure growing is in the distribution market, people that buy parts and then turn around and sell them again. They are really being put under a lot of pressure from the manufacturers who basically coerced large volume, long-term forecast out of people during COVID and are holding people to those forecasts and orders. So it looks to me like the bulge in the snake is at the distribution and not the end of distribution or middle of the chain. We've done some really, really exciting systematic improvements. I talked about last time how MRP works or used to work and how we've flipped ours on its head. And that continues to yield all kinds of fairly cool results.
It was also an interesting quarter because after -- in many cases, close to a year of arguing with customers who had committed to buying aged inventory as long as we are able to go get it for them. We've had -- as of today, we don't have any large outstanding aged inventory payment that we're arguing on for the customer. And that's down from spending probably 50% of my time arguing with high levels within the customer base about the money we were owed for aged inventory. So we were able to get our slowdown before the balls came through and hit us.
William J. Dezellem
Is the implication of your last comment, Craig, that you have reduced inventory further from the end of March?
Craig D. Gates
Yes.
William J. Dezellem
And by roughly how much?
Craig D. Gates
Good amount.
William J. Dezellem
That's better than a bad amount. Thank you. Let me see if I can get a more precise answer to a balance sheet question. But actually, in all seriousness, is there anything else relative to what you're seeing with the customer base before I jump to the balance sheet?
Craig D. Gates
No, I think it's -- in general, it's gloomier and doomier than it was 3 months ago.
William J. Dezellem
Well, I guess I was wondering, should we be interpreting your comments as gloomy and doomy or just directionally, it's not as positive as it was. I mean I look at the results, and it doesn't feel gloomy and doomy. So I just wanted to make sure that we're interpreting comments and results and future all appropriately.
Craig D. Gates
Well, yes, I'm glad you asked that question because I'm not saying gloom and doom for Key Tronic. I'm saying gloom and doom for the overall economy. So far, our new business wins are far outstripping anything I see as recessionary pressures on our revenue. So unless something dramatically falls off a cliff, we're exceedingly optimistic about the next year even with the gloom and the doom that I'm hearing from the overall market.
William J. Dezellem
So even if there is an overall economic slowdown and/or a recession, your view from what you see with your customer base and your new customers is that you will be able to continue to grow revenues on an absolute basis through that pressure?
Craig D. Gates
As we do it today and what I know today answer is yes. If it turns worse, I don't know how bad it's going to get.
William J. Dezellem
Yes. I totally understand. That's quite helpful. And maybe I'll circle back to questions about Vietnam since winning 1 or 2 of a $20 million or $50 million or $80 million piece of business makes a big difference. Would you anticipate that any of those pieces of business would ramp any -- at a pace any different than the normal pace of a piece of business coming into Mexico of meaningful size?
Craig D. Gates
Well, I think first comment to make is that we used to say it took between 9 months to 1.5 years to ramp a new piece of business. And we're seeing now that the time from initial contact through to actually beginning to build product has dramatically decreased as people have become more convinced that the right path and the easy path is into locales that we are strong in. So that has sped up nicely compared to what it used to be because there's not 5, 6 months of debate within the customer on why are we not going to China because everybody goes to China. So that delay is now gone. And a lot of people who call us used to be, yes, we're going to run a market basket analysis, and we're going to have 20 people quote on this. And if you have questions, don't bother me because nobody else has questions. That used to be probably half of the quotes we got. Now I'd say the majority of what we get is my boss says, I got to get out of China. I got to make a decision. You guys are the only guys I can find they can do X so when can I have a plant tour? So it's completely changed the tenor and the speed of the relationship as it goes from first meeting to first production.
William J. Dezellem
So not to be overly focused on Vietnam, but literally the -- go ahead.
Craig D. Gates
I said too late, but I was joking.
William J. Dezellem
Fair enough, and it will even be worse with this question. But with the movement of business from China, away from China, some of that likely ends up in Vietnam, and you have capacity there, so you can ramp quickly. And just coming back to this concept that with an economic slowdown that you could grow through it, Vietnam would be an important component of that equation than if we're hearing you right and putting all the pieces of this together, right?
Craig D. Gates
I'm not sure I understand why you think Vietnam stands out as an important element. It's one element for sure.
William J. Dezellem
Yes. I think it's because you had mentioned in response to a question that I narrowly focused on Vietnam, that you had $20 million, $50 million, $80 million pieces of business. And I know that you have capacity there. So that's where my mindset is coming from, but I'd love you to stretch my mind, if you would and go beyond that if you think you also see that type of business potentially flowing into Mexico at the same time.
Craig D. Gates
Yes. So that's why clarity is always a good thing to strive for. We see that size business and more opportunities in Mexico and in the Midwest, and we have capacity in Mexico and in the Midwest.
William J. Dezellem
All right. So to continue down the Clarity path, I'll pick a midpoint of $50 million between the $20 million, $50 million and $80 million. So there are $50 million pieces of business that may land in Vietnam, may land in Mexico, may land in the Midwest?
Craig D. Gates
Yes. Well, the $50 million won't land in the Midwest because that's too big. But certainly, there's one right now that will be $20 million.
William J. Dezellem
Congratulations. I mean that one piece of business there will get you a long way towards your 20% growth in the U.S. operations?
Craig D. Gates
Yes.
William J. Dezellem
Okay. Anything else on that before I do jump to the balance sheet now?
Craig D. Gates
No. Brett's been sitting here, waiting to talk so go for it.
William J. Dezellem
Excellent. Brett, 2 questions relative to the balance sheet. The other current liabilities dropped pretty meaningfully versus the December quarter. So 18.3% dropped to 12.8%, and it was pretty high or much higher a year ago also. And then the long-term obligations also dropped sequentially -- I'm sorry, that one went up sequentially. Can you talk about those changes between those balance sheet accounts, please?
Brett R. Larsen
Sure. That's predominantly our leasing facilities. So through the new leasing standard, it's required that you put on the balance sheet specific amounts for the fair value of those leases. The transformation from current to long term is just that we've entered into some new leases and paid some of the old leases off that were due within that 12-month period.
William J. Dezellem
Understood. So the long term and other long-term obligations and other current liabilities, those 2 are interacting with each other. And bottom line, I'm just asking about lease assets and lease liabilities as it turns out.
Brett R. Larsen
Correct. That is correct.
William J. Dezellem
Okay. Well, my apologies for that. I didn't appreciate that was tucked in under the other category. So thank you both. And again, congratulations on a great quarter and what the next few quarters might bring for you.
Operator
(Operator Instructions) There are no further questions at this time. Mr. Gates, I will turn the conference back to you for any additional or closing remarks.
Craig D. Gates
Okay. Well, thank you, everybody. Thanks for participating in today's conference call. And Brett and I look forward to talking with you again next quarter.
Operator
This concludes today's call. Thank you for your participation, and you may now disconnect.
